Your aunt is thinking about opening a hardware store. She estimates that it would cost $500,000
per year to rent the location and buy the stock. In addition, she would have to quit her $50,000
job as an accountant.
a. Define opportunity cost.
b. What is your aunt’s opportunity cost of running a hardware store for a year? If your aunt
thought she could sell $510,000 worth of merchandise in a year, should she open the
store? Explain.
2. Suppose that your college charges you separately for tuition and for room and board.
a. What is the cost of attending college that is not an opportunity cost?
b. What is an explicit opportunity cost of attending college?
c. What is an implicit opportunity cost of attending college?
3. A commercial fisherman notices the following relationship between hours spent fishing and the
quantity of fish caught:
Hours
Quantity of fish (in pounds)
0
0
1
10
2
18
3
24
4
28
5
30
a. What is the marginal product of each hour spent fishing?
b. Use these data to graph the fisherman’s production function. Explain the shape.
c. The fisherman has a fixed cost of $10 (his pole). The opportunity cost of his time is $5
per hour. Graph the fisherman’s total-cost curve. Explain its shape.
4. Your cousin Vinnie owns a painting company with fixed costs of $200 and the following schedule
for variable costs:
1.
Quantity of Houses
Painted per month
1
2
3
4
5
6
7
Variable costs
$10
$20
$40
$80
$160
$320
$640
Calculate the average fixed cost, average variable cost, and average total cost for each quantity.
What is the efficient scale of the painting company?
5. Consider the following table of long-run total cost for three different firms:
Quantity
Firm A
Firm B
Firm C
1
60
11
21
2
70
24
34
3
80
39
49
4
90
56
66
5
100
75
85
6
110
96
106
Does each of these firms experience economies or diseconomies of scale?
7
120
119
129
1. The answers are as follows:
a. The opportunity cost of something is what must be given up to acquire it.
b. The opportunity cost of running the hardware store is $550,000, consisting of $500,000
to rent the store and buy the stock and a $50,000 opportunity cost, because your aunt
would quit her job as an accountant to run the store. Because the total opportunity cost
of $550,000 exceeds revenue of $510,000, your aunt should not open the store, as her
profit would be negative.
2. The answers are as follows:
a. Because you would have to pay for room and board whether you went to college or not,
that portion of your college payment is not an opportunity cost.
b. The explicit opportunity cost of attending college is the cost of tuition and books.
c. An implicit opportunity cost of attending college is the cost of your time. You could work
at a job for pay rather than attend college. The wages you give up represent an
opportunity cost of attending college.
3.
a. The following table shows the marginal product of each hour spent fishing:
Variable
Marginal
Hours
Fish
Fixed Cost
Total cost
cost
Product
0
0
10
0
10
--1
10
10
5
15
10
2
18
10
10
20
8
3
24
10
15
25
6
4
28
10
20
30
4
5
30
10
25
35
2
b. Figure 1 graphs the fisherman’s production function. The production function becomes
flatter as the number of hours spent fishing increases, illustrating diminishing marginal
product.
Figure 1.
c. The table shows the fixed cost, variable cost, and total cost of fishing. Figure 2 shows the
fisherman’s total-cost curve. It has an upward slope because catching additional fish
takes additional time. The curve is convex because there are diminishing returns to
fishing time because each additional hour spent fishing yields fewer additional fish.
Figure 2.
4. The following table illustrates average fixed cost (AFC), average variable cost (AVC), and average
total cost (ATC) for each quantity. The efficient scale is four houses per month, because that
minimizes average total cost.
Quantity
0
1
2
3
4
5
6
7
VC
0
10
20
40
80
160
320
640
FC
200
200
200
200
200
200
200
200
TC
200
210
220
240
280
360
520
840
AFC
--200
100
66.7
50
40
33.3
28.6
AVC
--10
10
13.3
20
32
53.3
91.4
ATC
--210
110
80
70
72
86.7
120
5. The following table shows quantity (Q), total cost (TC), and average total cost (ATC) for the
three firms:
Firm A
Firm B
Firm C
Quantity
TC
ATC
TC
ATC
TC
ATC
1
60
60
11
11
21
21
2
70
35
24
12
34
17
3
80
26.7
39
13
49
16.3
4
90
22.5
56
14
66
16.5
5
100
20
75
15
85
17
6
110
18.3
96
16
106
17.7
7
120
17.1
119
17
129
18.4
Firm A has economies of scale because average total cost declines as output increases. Firm B
has diseconomies of scale because average total cost rises as output rises. Firm C has economies
of scale for output from one to three and diseconomies of scale for levels of output beyond three
units.