Foundations of Economics, 3e (Bade/Parkin) - Testbank 3
Chapter 12 Production and Cost
1) Jake opens a pig farm in Idaho. To start his farm, he uses his entire $50,000 of savings from his savings
account. The bank was paying him $2,500 interest on his saving. Explain why the $2,500 is one of Jake's costs.
Answer: When Jake provides the $50,000 to finance his farm's operations, he forgoes the $2,500 in interest. Thus
the opportunity cost of the $50,000 is the interest income forgone and so the $2,500 is an implicit cost
of running the farm.
Topic: Implicit cost
Skill: Level 2: Using definitions
Objective: Checkpoint 12.1
Author: PH
2) What is a normal profit? Is it part of the firm's opportunity costs, total revenue, or neither?
Answer: The normal profit is the return to entrepreneurship. It is part of the firm's opportunity costs.
Topic: Normal profit
Skill: Level 2: Using definitions
Objective: Checkpoint 12.1
Author: SB
3) What is the difference between a normal profit and an economic profit?
Answer: A normal profit is the return to entrepreneurship and is part of the opportunity cost of operating a
business. An economic profit is the difference between the firm's total revenue and its total
opportunity cost. Because the normal profit is part of the firm's opportunity cost, an economic profit is
a profit above and beyond a normal profit. If the firm earns an economic profit, the entrepreneur
running the firm receives the normal profit plus the economic profit.
Topic: Economic profit
Skill: Level 2: Using definitions
Objective: Checkpoint 12.1
Author: MR
4) Professor Rush decided to quit teaching economics and opens a shoe store out at the mall. He gave up an
annual income of $50,000 to open the store. A year after opening the shoe store, the total revenue for the year
was $200,000. Rush's expenses were $30,000 for labor, rent was $18,000, and utilities were $1,200. He also had
to purchase new shoes from manufacturers, at a cost of $60,000, which was financed by cashing in his
savings of $60,000 that had been in a bank earning 8 percent per year. The normal profit from operating a
shoe store in the mall is $20,000. Determine Professor Rush's explicit costs, implicit costs, and economic
profit.
Answer: The explicit costs are the cost of labor, the rent, the utilities, and the cost of the shoes. Thus the explicit
cost equals $30,000 + $18,000 + $1,200 + $60,000 = $109,200. The implicit costs are the forgone income
from the job he quit, the forgone interest, and the normal profit. The forgone interest is (8 percent) ×
($60,000) = $4,800, so the total implicit costs equals $50,000 + $4,800 + $20,000 = $74,800. The economic
profit equals the total revenue minus the total opportunity cost and the total opportunity cost equals
the sum of the explicit and implicit costs. Therefore the total opportunity cost is $109,200 + $74,800 =
$184,000. Thus the economic profit = $200,000 - $184,000 = $16,000.
Topic: Costs and economic profit
Skill: Level 3: Using models
Objective: Checkpoint 12.1
Author: TS
5) Jessica is a young doctor who has just started her own practice. Her previous position paid her $80,000 a
year. For office space, she uses a building which she owns and which she has rented in the past for $40,000 a
year. Her total revenue from her new practice is $250,000. She pays $50,000 to other firms for materials and
supplies, and she pays $40,000 in wages to her office nurse. Assume that Jessica's building and equipment do
not depreciate and that her normal profit is $20,000.
a. Which of Jessica's costs are explicit costs and what is their total?
b. Which of Jessica's costs are implicit costs and what is their total?
c. What is the opportunity cost of all factors of production employed by Jessica?
d. What is Jessica's economic profit?
Answer: a. Jessica's explicit costs are the wages and the amount she paid to other firms for material and
supplies. Hence her explicit costs equal $40,000 + $50,000 = $90,000.
b. Jessica's implicit costs are her forgone wages, the forgone rent on her building, and her normal
profit. Hence her implicit costs equal $80,000 + $40,000 + $20,000 = $140,000.
c. The opportunity cost equals the sum of explicit costs plus implicit costs, so Jessica's opportunity
cost equals $90,000 + $140,000 = $230,000.
d. Economic profit equals total revenue minus total opportunity cost, or $250,000 - $230,000 =
$20,000.
Topic: Costs and economic profit
Skill: Level 3: Using models
Objective: Checkpoint 12.1
Author: SB
6) What resources can a firm change in the short run? In the long run?
Answer: In the short run, the firm can change its variable inputs. These would be inputs such as labor. The firm
cannot change its fixed inputs, such as its capital stock. The inputs the firm cannot change are called its
plant. In the long run, the firm can change all of its inputs. Indeed, the long run is defined as the
period of time long enough so that the firm can change all of its inputs.
Topic: Short run and long run
Skill: Level 2: Using definitions
Objective: Checkpoint 12.2
Author: WM
7) What do economists mean when they say that a firm's plant is fixed?
Answer: The phrase that a "firm's plant is fixed" refers to the fact that, in the short run, there are some resources
that are fixed, that is, the quantity employed cannot be changed. These resources, which include
factors such as the firm's capital, are collectively referred to as the firm's plant.
Topic: Short run, plant
Skill: Level 1: Definition
Objective: Checkpoint 12.2
Author: SB
8) What is the difference between decreasing marginal returns and negative marginal returns?
Answer: Decreasing marginal returns occur when the marginal product of an additional worker is less than the
marginal product of the previous worker. In this case, if the marginal product of the new worker is
positive, the additional worker adds to total product, but adds less than did the previous worker.
Negative marginal returns occurs when an additional worker actually decreases total product.
Topic: Marginal returns
Skill: Level 2: Using definitions
Objective: Checkpoint 12.2
Author: CD
9) What does the average product of labor equal?
Answer: The average product of labor equals the total product (the total output) divided by the quantity of
labor.
Topic: Average product
Skill: Level 1: Definition
Objective: Checkpoint 12.2
Author: PH
10) "If the marginal product of labor curve slopes downward, then the average product of labor curve
necessarily must slope downward." Explain whether the previous statement is correct or incorrect?
Answer: The statement is incorrect. The relationship between the marginal product and average product of
labor is that when the marginal product of labor exceeds the average product of labor, the average
product of labor curve slopes upward and when the marginal product of labor is less than the average
product of labor, the average product of labor curve slopes downward. So, even if the marginal
product of labor curve slopes downward, as long as it is above the average product of labor curve, the
average product of labor curve slopes upward.
Topic: Marginal product and average product
Skill: Level 2: Using definitions
Objective: Checkpoint 12.2
Author: JC
11) The above table has the total product schedule for Jesse's Lawn Service.
a. In the figure, label the axes and then graph the total product curve.
b. Find the average product for the different amounts of employment.
Answer:
a. The figure graphs the total product curve.
b. The average product when 1 worker is employed is 3 lawns mowed per day; when 2 workers are
employed, it is 4 lawns per day; when 3 workers are employed, it is 5 lawns per day; when 4 workers
are employed, it is 5 lawns per day; and when 5 workers are employed, it is 4.2 lawns per day.
Topic: Total product
Skill: Level 3: Using models
Objective: Checkpoint 12.2
Author: SB
12) Ajax Manufacturing has a fixed scale of plant with the levels of total product given in the table for different
levels of labor. Complete the table by calculating the average product and marginal product.
Answer:
The completed table is above.
Topic: Short-run production
Skill: Level 3: Using models
Objective: Checkpoint 12.2
Author: TS
13) The above table shows the total product schedule for Hair Today, a hair styling salon.
a. What is the first worker's marginal product? The second worker? The third worker? The fourth worker?
The fifth worker?
b. Over what range of workers is there increasing marginal returns? Over what range is there decreasing
marginal returns?
Answer: a. The first worker's marginal product is 10 hair stylings. The second worker's marginal product is 15
hair stylings. The third worker's marginal product is 20 hair stylings. The fourth worker's marginal
product is 15 hair stylings. The fifth worker's marginal product is 10 hair stylings.
b. There are increasing marginal returns for the first 3 workers. After the third worker, there are
decreasing marginal returns.
Topic: Marginal product
Skill: Level 3: Using models
Objective: Checkpoint 12.2
Author: WM
14) Jake is a corn farmer in Nebraska. He rents his land on a long-term lease for $250,000 a year. He pays his
farm hands $128,000 a year. Is his rent a fixed cost or a variable cost? Are the wages he pays his workers a
fixed cost or a variable cost? Briefly explain your answers.
Answer: Jake's rent is a fixed cost. He is renting his land on a long-term lease and so the land is a fixed input.
The wages Jake pays are a variable cost. Labor is a variable input so the wages are a variable cost.
Topic: Fixed cost, variable cost
Skill: Level 2: Using definitions
Objective: Checkpoint 12.3
Author: JC
15) "In the short run, even when output is zero, the firm still has some variable costs it must pay." Is the
statement correct or incorrect? Briefly explain your answer.
Answer: The statement is incorrect. When output is zero, there are no variable costs because there are no
variable inputs being employed. However, in the short run there might be fixed resources, in which
case the firm would still have some fixed costs it must pay.
Topic: Fixed cost, variable cost
Skill: Level 2: Using definitions
Objective: Checkpoint 12.3
Author: TS
16) When plotted against the total output, what does the total fixed cost curve look like?
Answer: The total fixed cost curve is a horizontal straight line, indicating that at any level of output the total
fixed cost does not change as output changes.
Topic: Fixed cost curve
Skill: Level 1: Definition
Objective: Checkpoint 12.3
Author: JC
17) Downsizing is the practice of laying off workers in an attempt to decrease average total cost. Can laying off
workers decrease average total cost? Is it possible for the firm to downsize and have its average total cost
increase? Explain your answer.
Answer: Yes, downsizing by laying off workers can decrease the firm's average total cost. And it is possible for
a firm to downsize and increase its average total cost. Suppose that the firm initially is producing more
output than the level that minimizes average total cost. In this case, downsizing by laying off workers
decreases the amount of output the firm produces and the firm can move along its average total cost
curve to a lower average total cost. However, the firm can lay off too many workers. If it lays off too
many workers, it decreases its output so much that it moves along its average total cost curve enough
that its average total costs wind up higher than they were initially.
Topic: Average total cost curve
Skill: Level 4: Applying models
Objective: Checkpoint 12.3
Author: JC
18) How do we calculate average fixed cost and why does average fixed cost fall as output increases?
Answer: Average fixed cost is calculated by dividing total fixed cost by the quantity of output. Because total
fixed cost stays the same for all levels of output, as the quantity produced increases, the average fixed
cost decreases.
Topic: Average fixed cost
Skill: Level 2: Using definitions
Objective: Checkpoint 12.3
Author: SA
19) The average total cost curve is U-shaped. At the quantity of output where average total cost is at its
minimum, is the marginal cost curve above the average total cost curve, below the average total cost curve,
or intersecting the average total cost curve?
Answer: When the average total cost is at its minimum, the average total cost equals the marginal cost.
Therefore at the quantity of output where the average total cost is at its minimum, the marginal cost
curve intersects the average total cost curve.
Topic: Marginal cost and average total cost curve
Skill: Level 1: Definition
Objective: Checkpoint 12.3
Author: SA
20) Which average cost curves are U-shaped?
Answer: Both the average total cost and the average variable cost curves are U-shaped. The only average cost
curve that is not U-shaped is the average fixed cost curve.
Topic: Why the average total cost curve is U-shaped
Skill: Level 1: Definition
Objective: Checkpoint 12.3
Author: SA
21) What is the relationship between the marginal product of labor and the marginal cost?
Answer: Initially, as each additional unit of labor is employed, the marginal product of labor increases. The cost
of each worker is the same--the wage rate. Because each worker's cost is the same, but each additional
worker produces more output than the previous worker, the cost of producing an additional unit of
output decreases. The cost of producing an additional unit of output is the marginal cost. Therefore
when the marginal product of labor is increasing, the marginal cost is decreasing. At some point, the
marginal product of labor will reach a peak, at which level of output marginal cost is minimized. After
that amount of output, the marginal product of an additional worker starts to decrease. When the
marginal product decreases, the marginal cost increases; each worker costs the same to hire, but an
additional worker produces less output than the previous worker. Therefore when the marginal
product of labor is decreasing, the marginal cost is increasing.
Topic: MP and MC
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: JC
22) Explain how new technologies, which increase productivity, affect the average variable cost, average total
cost, and marginal cost curves.
Answer: A technological change that increases productivity shifts the total product, average product, and the
marginal product curves upward. Because the new technologies enable existing inputs to produce
more output, this effect means that the average variable cost, average total cost, and marginal cost
curves shift downward, reflecting the decrease in average and marginal costs. However, the new
technologies often need to use more capital and less labor. In this case, the firm's fixed cost increases
and its variable cost decreases. The increase in fixed cost leads to an increase in total cost while the
decrease in variable cost leads to a decrease in total cost. Although the net effect is ambiguous,
generally the total cost increases at low levels of output and decreases at higher levels of output. In
this case, the average total cost curve shifts upward at lower levels of output and shifts downward at
higher levels of output.
Topic: Shifts in the cost curves, technology
Skill: Level 2: Using definitions
Objective: Checkpoint 12.3
Author: PH
23) When the Rent-A-Limo Company negotiates its new labor contract it finds that the wages it must pay drivers
have increased. How does this wage hike affect the Rent-A-Limo Company's average fixed cost, average
variable cost, average total cost, and marginal cost?
Answer: The drivers' wages are a variable cost because the number of drivers needed varies with how many
limousines are rented. The increase in wages will have no effect on the average fixed cost but the
average variable cost will increase. The increase in average variable cost leads to an increase in the
average total cost and an increase in the marginal cost.
Topic: Shifts in the cost curves, prices of factors of production
Skill: Level 2: Using definitions
Objective: Checkpoint 12.3
Author: PH
24) The table above has the total product schedule for an imaginary good called a widget. Each unit of labor
costs $25 and the total cost of capital is $100.
a. Use this information to complete the table. In the table, TFC is the total fixed cost, TVC is the total
variable cost, TC is the total cost, AFC is the average fixed cost, AVC is the average variable cost, ATC is the
average total cost, and MC is the marginal cost.
b. Suppose that labor becomes twice as expensive (so that one unit of labor now costs $50) but nothing else
changes. Complete the above table with the new cost schedules. If you plotted the cost curves, how would
the increased wage rate affect the cost curves?
Answer:
a.
The completed table is above. All the costs in dollars.
b. The completed table is above. All the costs are in dollars. There would be no change in the total
fixed and average fixed cost curves because the fixed cost did not change. The total cost, total variable
cost, average total cost, average variable cost, and marginal cost curves would all shift upward.
Topic: Short-run costs
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: SB
25) This month, the local widget factory produced 100 widgets. The total variable cost of production was $500
and the average total cost of production was $8.
a. What is the total cost?
b. What is the total fixed cost?
c. What is the average fixed cost?
d. What is the average variable cost?
Answer: a. Total cost can be calculated as average total cost times output, which is $8 × 100 = $800.
b. Total fixed cost equals total cost minus total variable cost. The total cost from part (a) is $800. The
total variable cost is $500. Therefore the total fixed cost is $800 - $500 = $300.
c. Average fixed cost equals total fixed cost divided by output, which is $300÷100 = $3.
d. Average variable cost equals total variable cost divided by output. The total variable cost from
part (b) is $500, so the average variable cost is $500÷100 = $5.
Topic: Short-run costs
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: SB
26) Acme produces rocket shoes for use by slow coyotes. Acme's total cost schedule is given in the table above.
Acme's total fixed cost is $12. Complete the table. (In the table, TFC is the total fixed cost, TVC is the total
variable cost, AFC is the average fixed cost, AVC is the average variable cost, and ATC is the average total
cost.)
Answer:
The completed table is above.
Topic: Short-run costs
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: TS
27) Rufus runs a skunk-skinning service in West Virginia. He employs skinners at a wage rate of $240 a week for
each one. He leases the shack where his workers work for $200 per week. The rent is fixed for the next two
years. Last week his 10 employees managed to skin a total of 300 skunks.
a. What is the average product of labor for Rufus's company?
b. What is Rufus' total variable cost per week?
c. What is the average variable cost for Rufus's company?
d. If Rufus adds his brother Jethro to his staff, at a wage rate of $240 a week, and his company can now skin
310 skunks per week, what is Rufus's new average variable cost?
Answer: a. The average product of labor is 30 skunks skinned per worker.
b. The total variable cost per week is $2,400.
c. The average variable cost is $8 per skunk skin.
d. The new total variable cost is $2,640. Hence the new average variable cost is $8.52 per skunk skin.
Topic: Short-run costs
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: JC
28) The above table gives the total cost schedule for oil changes at the local Jiffy Lube.
a. What is Jiffy Lube's total fixed cost?
b. What is the total variable cost of 2 oil changes?
c. What is the average variable cost of 4 oil changes?
d. What is the average fixed cost of 2 oil changes?
e. What is the marginal cost of the 3rd oil change?
Answer: a. The total fixed cost is $10. At zero output, the total variable cost is $0, so the entire cost, $10, must
be the fixed cost.
b. The total variable cost of 2 oil changes is $25. The total cost, TC, is $35 and from part (a) the total
fixed cost, TFC, is $10. The total variable cost, TVC, is equal to TC - TFC or $35 - $10 = $25.
c. The average variable cost for 4 oil changes is $17.50. Start similarly to part (b) by calculating that
the total variable cost, TVC, for 4 oil changes is $70. Then, the average variable cost, AVC, equals the
total variable cost divided by output, or TVC ÷ Q. In this case, the AVC is equal to $70 ÷ 4 = $17.50.
d. The average fixed cost of 2 oil changes is $5. The average fixed cost, AFC, equals the total fixed
cost divided by output, or TFC ÷ Q. From part (a), the total fixed cost is $10, so the average fixed cost
equals $10 ÷2 = $5.
e. The marginal cost is $15. Marginal cost is defined as the change in the total cost that results from a
one-unit increase in output. The total cost of 2 oil changes is $35 and the total cost of 3 oil changes is
$50. Therefore the change in the total cost is $15, which is the marginal cost.
Topic: Short-run costs
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: SA
29) Suppose the local newspaper hires students to fold and bag newspapers for delivery and pays them $20 per
shift. Five students can fold and bag 300 newspapers per shift. The fourth student added 50 newspapers to
total output. The cost of the capital the firm uses is fixed at $50 per shift.
a. Is the newspaper operating in the long run or short run? Why?
b. What is the average product of 5 students?
c. Calculate the total fixed, total variable, and total costs of folding and bagging 300 newspapers.
d. Calculate the average fixed, average variable, and average total costs of folding and bagging 300
newspapers.
e. What is the marginal cost of one of the 50 newspapers folded and bagged by the fourth student?
Answer: a. The firm is operating in the short run because its capital cost is fixed.
b. Average product equals 300 ÷ 5 = 60 newspapers per shift.
c. Total fixed cost = $50, total variable cost = 5 × $20 = $100, and so total cost = $50 + $100 = $150.
d. Average fixed cost = $50 ÷ 300 = $0.17, average variable cost = $100 ÷ 300 = $0.33, and average
total cost = $150 ÷ 300 = $0.50 (alternatively, average total cost = average fixed cost + average variable
cost = $0.17 + $0.33 = $0.50).
e. Marginal cost = change in total cost divided by change in output, or $20 ÷ 50 = $0.40.
Topic: Production and cost
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: SB
30) Draw an average total cost curve, an average variable cost, and a marginal cost curve all on the same graph.
Make sure to correctly label the axes. What relationship must exist between the marginal cost curve and the
average total cost and average variable cost curves?
Answer:
Typical cost curves are above. The average variable cost curve, AVC, and average total cost curve,
ATC, are U-shaped. The marginal cost curve, MC, intersects the AVC curve and ATC curve at their
minimum points.
Topic: Short-run cost curves
Skill: Level 3: Using models
Objective: Checkpoint 12.3
Author: CD
31) In the long run all costs are variable costs. Why?
Answer: The long run is defined as the time frame over which all resources can be varied. The costs of the
variable inputs are the variable costs. Taken together, these definitions imply that in the long run all
inputs are variable inputs so all costs are variable costs.
Topic: Long-run costs
Skill: Level 1: Definition
Objective: Checkpoint 12.4
Author: SA
32) Which curve shows the lowest average total cost at which it is possible to produce each output when the firm
has time to change both its labor force and plant size?
Answer: The long-run average cost curve shows the lowest average total cost at which it is possible to produce
each output when the firm has had time to change all its inputs.
Topic: Long-run average cost curve
Skill: Level 1: Definition
Objective: Checkpoint 12.4
Author: PH
33) What is the long-run average cost curve? What are the three ranges of output and in what order do they
occur? Briefly define each of the three ranges.
Answer: The long-run average cost curve shows the lowest average cost at which it is possible to produce each
output when the firm has time to change both its labor force and its plant size. The long-run average
cost curve is U-shaped and shows three possible production ranges. In order, these ranges are:
economies of scale, constant returns to scale, and diseconomies of scale. Economies of scale are when a
firm increases its plant size and labor employed by the same percentage and its output increases by a
larger percentage so that its average total cost decreases. Constant returns to scale are when a firm
increases its plant size and labor employed by the same percentage and its output increases by the
same percentage so that its average total cost does not change. And, diseconomies of scale are when a
firm increases its plant size and labor employed by the same percentage and its output increases by a
smaller percentage so that its average total cost increases.
Topic: Long-run average cost curve
Skill: Level 1: Definition
Objective: Checkpoint 12.4
Author: CD
34) Are the short-run average total cost curve and the long-run average cost both U-shaped for the same
reasons? If so, carefully explain these reasons. If not, explain why each curve is U-shaped.
Answer: The curves are U-shaped for quite different reasons. In the short run, the firm's plant, that is, its
capital, is fixed. Therefore the only way to increase output is by increasing the quantity of the variable
resource, labor. Initially as labor increases, there are gains from specialization and division of labor,
which leads the marginal product to rise and the average total cost to fall as more workers are
employed. Eventually, however, the firm runs up against its capital constraint and workers must share
tools and building space. As this happens, decreasing marginal returns begin and average total cost
eventually begins to rise.
In the long run, both labor and capital are variable. As a firm expands its use of both resources,
gains from specialization of both labor and capital cause average total costs to fall. Eventually,
however, the business becomes so large it is difficult to coordinate and control. When this happens,
long-run average total cost begins to rise.
Thus the short-run average total cost is U-shaped because more workers must make do with the
same amount of plant. The long-run average cost curve is U-shaped because the very scale of the
firm's operations make it difficult to control efficiently and effectively.
Topic: Long-run and short-run average cost curves
Skill: Level 4: Applying models
Objective: Checkpoint 12.4
Author: SB
35) What are economies of scale? What is the main source of economies of scale?
Answer: Economies of scale are when a firm increases its plant size and labor employed by the same percentage
and its output increases by a larger percentage so that its average total cost decreases. Economies of
scale result because of specialization. When a firm increases its capital stock, the capital can be more
specialized and hence produce more output than less specialized, more generalized capital. Similarly,
when a firm increases its labor force, it can hire more specialists, each of whom is better at doing his or
her assigned task than a less specialized individual. As a result of specialization, the firm's average
product increases so that its average total cost decreases.
Topic: Economies of scale
Skill: Level 1: Definition
Objective: Checkpoint 12.4
Author: MR
36) Explain the difference between increasing marginal returns and economies of scale.
Answer: Increasing marginal returns apply to the case where a firm has increased only the amount of labor it
uses while keeping capital fixed. If increasing marginal returns occur, an additional worker is more
productive than the previous worker hired. In this case, the marginal product of the new worker
exceeds the marginal product of the previous worker. Economies of scale apply when a firm increases
both the amount of labor it uses and the amount of capital it uses. If there are economies of scale, when
a firm increases labor and capital by the same percentage, its output increases by a larger percentage.
Topic: Economies of scale, increasing marginal returns
Skill: Level 2: Using definitions
Objective: Checkpoint 12.4
Author: CD
37) What are diseconomies of scale and why might they occur?
Answer: Diseconomies of scale mean that as the firm increases all its inputs by the same percentage, its output
increases by a smaller percentage. As a result, the firm's long-run average cost rises. Diseconomies of
scale can arise from the sheer size of a firm. As a firm grows larger, it becomes increasingly more
difficult to manage. Communicating information up and down the management hierarchy as well as
communicating between managers and workers on the same level becomes more costly. In this case
the firm experiences diseconomies of scale, that is, its long-run average cost increases as it expands the
scale of its operation by producing yet more output.
Topic: Diseconomies of scale
Skill: Level 1: Definition
Objective: Checkpoint 12.4
Author: SA
38) A firm increases both its plant and its labor force by the same percentage and its average total costs remain
unchanged. Is the firm experiencing increasing returns to scale, constant returns to scale, or decreasing
returns to scale?
Answer: The firm is experiencing constant returns to scale.
Topic: Constant returns to scale
Skill: Level 2: Using definitions
Objective: Checkpoint 12.4
Author: WM
39) Most banks use ATMs (Automated Teller Machines) to handle banking transactions. These banks assert that
ATMs handle the transactions at a lower average total cost than human tellers. Some small credit unions
employ tellers rather than use ATMs. Why? What has to happen before these credit unions begin using
ATMs?
Answer: The credit unions that use tellers are small. At their smaller scale of operations, the average cost of a
transaction is lower with a teller than a machine. Before ATMs become economically feasible for these
credit unions, the credit union has to expand its output and move to a different scale of operation. If
they do so, they will move along their long-run average cost curve and experience the benefits of
specialization in their capital resource and thereby produce transactions at a lower average total cost.
Topic: Eye on the U.S. economy, the ATM and the cost of getting cash
Skill: Level 2: Using definitions
Objective: Checkpoint 12.4
Author: SB
40) Jones Production started business with a small scale plant. Fortunately for Smith, the owner of Jones
Production, the business grew rapidly. It doubled its plant scale and its labor force every year for the next six
years. The table above gives the total costs and the associated total products for each year.
a. Complete the table by finding the average cost for each scale.
b. Over what range of total product (output) did Jones Production experience economies of scale, constant
returns to scale, and diseconomies of scale?
Answer:
a. The completed table is above.
b. There are economies of scale from 100 to 500 units of total product, constant returns to scale from
500 to 1,000 units of total product, and diseconomies of scale from 1,000 to 2,500 units of total product.
Topic: Long-run average cost
Skill: Level 3: Using models
Objective: Checkpoint 12.4
Author: TS
41) Ayanna grows herbs. Last year she grew 2,000 pounds of herbs in a year while using 250 square feet of land
and 1 worker. This year she doubled her land to 500 square feet, doubled her workers to 2, and grew 4,500
pounds of herbs. She sells her rare, organic herbs for $50 a pound. She pays her a worker $25,000 a year and
rents her land for $100 per square foot for a year. These are her only costs.
a. What was Ayanna's total cost last year and this year?
b. What was Ayanna's average total cost last year and this year?
c. Did Ayanna experience economies or diseconomies of scale?
Answer: a. Ayanna's total cost last year was $50,000 and her total cost this year is $100,000.
b. Ayanna's average total cost last year was $25 a pound and her average total cost this year is $22.22
a pound.
c. Ayanna's average total cost decreased so she experienced economies of scale.
Topic: Economies of scale
Skill: Level 3: Using models
Objective: Checkpoint 12.4
Author: WM
42) The above figure represents the average total cost curves of a wheat farmer.
a. Which average total cost curve has the lowest average total cost of producing 30,000 bushels of wheat?
b. Over what range of output is the farmer experiencing economies of scale?
c. Over what range of output is the farmer experiencing diseconomies of scale?
d. Which average total cost curve has the lowest possible average cost of production?
e. Which average total cost curve represents the largest plant?
Answer: a. ATC3 has the lowest average total cost to produce 30,000 bushels of wheat.
b. The farmer is experiencing economies of scale between 0 to 30,000 bushels of wheat.
c. The farmer is experiencing diseconomies of scale for more than 30,000 bushels of wheat.
d. ATC3 has the lowest possible average total cost, which occurs at 30,000 bushels of wheat.
e. ATC4 represents the largest plant.
Topic: Long-run average cost curve
Skill: Level 3: Using models
Objective: Checkpoint 12.4
Author: SB