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© 2013 Pearson
Production and Cost
14
CHECKPOINTS
© 2013 Pearson
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Checkpoint 14.1
Clicker
version
Checkpoint 14.3
Checkpoint 14.4
Problem 1
Problem 1
Problem 2
Problem 2
Problem 2
In the news
Problem 3
Problem 3
Checkpoint 14.2
In the news
In the news
Problem 1
Problem 1
Problem 2
Problem 3
In the news
© 2013 Pearson
Clicker
version
CHECKPOINT 14.1
Practice Problem 1
Lee is a computer programmer
who earned $35,000 in 2007. But
in 2007, he opened a body board
manufacturing business.
At the end of the first year of
operation, he submitted the
information in the table to his
accountant.
Calculate Lee’s explicit costs,
implicit costs, and economic
profit.
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
He spent $50,000 on materials, etc.
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He used $10,000 from his savings
account, which earns 5% a year interest.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
© 2013 Pearson
CHECKPOINT 14.1
Solution
Lee’s explicit costs are
costs paid with money:
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
• $50,000 on materials etc;
He spent $50,000 on materials, etc.
• $10,000 on leased
He leased machines for $10,000 a year.
machines;
He paid $15,000 in wages.
• $15,000 in wages;
He used $10,000 from his savings
account, which earns 5% a year interest.
• $4,000 in bank interest
He borrowed $40,000 at 10% a year.
These items total $79,000.
© 2013 Pearson
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
CHECKPOINT 14.1
Lee’s implicit costs are:
• $35,000 in forgone wages;
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
• $2,500 in forgone rent less
He spent $50,000 on materials, etc.
the increase in the value
of his cottage;
• $500 in forgone interest
on his savings account;
• $25,000 in normal profit.
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He used $10,000 from his savings
account, which earns 5% a year interest.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
These items total $63,000
© 2013 Pearson
Normal profit is $25,000 a year.
CHECKPOINT 14.1
Lee’s economic profit
equals total revenue
$160,000 minus total cost.
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
Total cost is the sum of
explicit costs plus implicit
costs.
He spent $50,000 on materials, etc.
Total cost = $79,000 +
$63,000, or $142,000.
He used $10,000 from his savings
account, which earns 5% a year interest.
So Lee’s economic profit is
$160,000 – $142,000, or
$18,000.
© 2013 Pearson
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
CHECKPOINT 14.1
Study Plan Problem
Lee is a computer programmer who
earned $50,000 in 2007. But in 2008,
he opened a custom woodworking
business. At the end of his first year,
he submitted the information in the
table to his accountant.
His explicit costs are ____ and his
implicit costs are ____.
A.
B.
C.
D.
E.
$50,000; $89,200
$86,200; $22,900
$89,200; $50,000
$22,900; $86,200
$22,900; $89,200
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
He spent $50,000 on materials, etc.
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He used $10,000 from his savings
account, which earns 5% a year interest.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
© 2013 Pearson
CHECKPOINT 14.1
Lee is a computer programmer who
earned $50,000 in 2007. But in
2008, he opened a custom
woodworking business. At the
end of his first year, he submitted
the information in the table to his
accountant.
Lee’s economic profit is ____.
A.
B.
C.
D.
E.
–$9,000
$13,800
$35,000
$77,000
$9,000
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
He spent $50,000 on materials, etc.
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He used $10,000 from his savings
account, which earns 5% a year interest.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
© 2013 Pearson
CHECKPOINT 14.1
Practice Problem 2
Lee is a computer programmer
who earned $35,000 in 2007. But
in 2007, he opened a body board
manufacturing business.
At the end of the first year of
operation, he submitted the
information in the table to his
accountant.
Lee’s accountant recorded the
depreciation on Lee’s cottage
during 2007 as $7,000.
What did the accountant say
Lee’s profit or loss was?
© 2013 Pearson
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
He spent $50,000 on materials, etc.
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He used $10,000 from his savings
account, which earns 5% a year interest.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
CHECKPOINT 14.1
Solution
The accountant measures
Lee’s profit as total revenue
minus explicit costs minus
depreciation.
Profit = $160,000 – $79,000
– $7,000
Profit = $74,000
He stopped renting out his cottage for
$3,500 a year and used it as his factory.
The market value of the cottage
increased from $70,000 to $71,000.
He spent $50,000 on materials, etc.
He leased machines for $10,000 a year.
He paid $15,000 in wages.
He used $10,000 from his savings
account, which earns 5% a year interest.
He borrowed $40,000 at 10% a year.
He sold $160,000 worth of body boards.
Normal profit is $25,000 a year.
© 2013 Pearson
CHECKPOINT 14.1
In the news
What does it cost to make 100 pairs of running shoes?
The Asian manufacturer of running shoes pays its workers
$275 to make 100 pairs per hour. These workers use
company-owned equipment that costs the company in
forgone interest and economic depreciation $300 an hour.
Materials cost $900.
Source: washpost.com
Which costs are explicit costs and which costs are implicit
costs? If the total revenue from the sale of 100 pairs of shoes
is $1,650, what is the manufacturer’s economic profit?
© 2013 Pearson
CHECKPOINT 14.1
Solution
Explicit costs are wages of $275 and materials of $900.
Implicit costs are the forgone interest and economic
depreciation of $300.
Economic profit equals total revenue minus total cost.
Total cost is $1,475.
So economic profit equals $1,650 minus $1,475, which is
$175.
© 2013 Pearson
CHECKPOINT 14.2
Practice Problem 1
Tom leases a farmer’s field
and grows pineapples. Tom
hires students to pick and
pack the pineapples. The
table sets out Tom’s total
production schedule.
Calculate the marginal
product of the third student
and the average product of
three students.
© 2013 Pearson
CHECKPOINT 14.2
Solution
The marginal product of the
third student is the change in
total product that results from
hiring the third student.
When Tom hires 2 students,
total product is 220 pineapples
a day.
When Tom hires 3 students,
total product is 300 pineapples
a day.
© 2013 Pearson
CHECKPOINT 14.2
Marginal product of the third
student is the total product of
3 students minus the total
product of the 2 students.
That is, the marginal product
of the third student is 300
pineapples – 220 pineapples
a day, which equals 80
pineapples a day.
© 2013 Pearson
CHECKPOINT 14.2
Average product equals total
product divided by the number
of students.
Average product of three
students is the total product of
three students divided by 3.
That is, the average product of
three students is 300
pineapples ÷ 3, which equals
100 pineapples a day.
© 2013 Pearson
CHECKPOINT 14.2
Practice Problem 2
Tom leases a farmer’s field
and grows pineapples. Tom
hires students to pick and
pack the pineapples. The
table sets out Tom’s total
production schedule.
Over what range of numbers
of students does marginal
product increase?
© 2013 Pearson
CHECKPOINT 14.2
Solution
Marginal product of the first
student is 100 pineapples a day.
Marginal product of the second
student is 120 pineapples a day.
Marginal product of the third
student is 80 pineapples a day.
So marginal product increases
when Tom hires the first and
second students.
© 2013 Pearson
CHECKPOINT 14.2
Study Plan Problem
Tom leases a farmer’s field and grows
pineapples. Tom hires students to pick and
pack the pineapples. The table sets out
Tom’s total production schedule.
Marginal product increases when Tom
hires ________.
A.
B.
C.
D.
E.
the first and second students
the first, second, and third students
each additional student
only the first student
the first, second, third and fourth
students
© 2013 Pearson
CHECKPOINT 14.2
Practice Problem 3
Tom leases a farmer’s field
and grows pineapples. Tom
hires students to pick and
pack the pineapples. The
table sets out Tom’s total
production schedule.
When marginal product
increases, is average
product greater than, less
than, or equal to marginal
product?
© 2013 Pearson
CHECKPOINT 14.2
Solution
When Tom hires 1 student,
marginal product is 100
pineapples per student and
average product is 100
pineapples per student.
© 2013 Pearson
CHECKPOINT 14.2
When Tom hires 2 students,
marginal product is 120
pineapples per student and
average product is 110
pineapples per student.
That is, when Tom hires the
second student, marginal
product increases and average
product is less than marginal
product.
© 2013 Pearson
CHECKPOINT 14.2
In the news
Budget cuts bring layoffs to museums
The Detroit Institute of Arts cut its staff by 56 full-time and 7
part-time employees and canceled some of this year’s
planned exhibitions.
Source: The New York Times, February 25, 2009
As the number of museum workers decreased and some
planned exhibitions were canceled, how do you think the
marginal product and average product of a museum worker
changed in the short run?
© 2013 Pearson
CHECKPOINT 14.2
Solution
With a decrease in the number of exhibitions, output of the
museum (number of visitors to the museum) might fall, but
the percentage decrease in output is probably less than
the percentage cut in labor services.
Marginal product per worker will increase and the increase
in marginal product will lead to an increase in the workers’
average product.
© 2013 Pearson
CHECKPOINT 14.3
Practice Problem 1
Tom leases a farmer’s field for
$120 a day and grows
pineapples. He pays students
$100 a day to pick and pack the
pineapples and he leases
capital at $80 a day. The table
shows Tom’s daily output.
What is Tom’s total cost and
average total cost if he
produces 300 pineapples a
day?
© 2013 Pearson
CHECKPOINT 14.3
Solution
Total cost = Total fixed cost +
Total variable cost.
Total fixed cost is cost of
leasing the field ($120 a day)
and cost of leasing the capital
($80 a day).
Total fixed cost is $200 a day.
© 2013 Pearson
CHECKPOINT 14.3
Total variable cost is the wages
paid.
To produce 300 pineapples a
day, Tom must hire 3 students
at $100 a day, so total variable
cost is $300 a day.
Total cost = $200 + $300
Total cost = $500 a day.
© 2013 Pearson
CHECKPOINT 14.3
Average total cost is the total
cost divided by total product.
When Tom produces 300
pineapples a day, his total cost
is $500 a day.
So average total cost equals
$500 ÷ 300 pineapples, which
is $1.67 a pineapple.
© 2013 Pearson
CHECKPOINT 14.3
Practice Problem 2
Tom leases a farmer’s field
for $120 a day and grows
pineapples. He pays
students $100 a day to pick
and pack the pineapples and
he leases capital at $80 a
day. The table shows Tom’s
daily output.
What is the marginal cost of
the 400th pineapple?
© 2013 Pearson
CHECKPOINT 14.3
Solution
Marginal cost is the increase
in total cost that results from
picking and packing one
additional pineapple a day.
The TC column in the table
shows the total cost of
producing each output level.
© 2013 Pearson
CHECKPOINT 14.3
The total cost of producing 400
pineapples a day is $700.
The total cost of producing 360
pineapples a day is $600.
The increase in the number of
pineapples is 40, and the
increase in total cost is $100.
Marginal cost is the increase in
total cost divided by 40 and is
$2.50 per pineapple.
© 2013 Pearson
CHECKPOINT 14.3
The MC column in the table
shows the marginal cost of
producing a pineapple.
The marginal cost of the 380th
pineapple a day is $2.50 and
the marginal cost of the 410th
pineapple a day is $5.00, so the
marginal cost of the 400th
pineapple is about $4.00.
© 2013 Pearson
CHECKPOINT 14.3
Practice Problem 3
Tom leases a farmer’s field
for $120 a day and grows
pineapples. He pays
students $100 a day to pick
and pack the pineapples and
he leases capital at $80 a
day. The table shows Tom’s
daily output.
At what output is Tom’s
average total cost a
minimum?
© 2013 Pearson
CHECKPOINT 14.3
Solution
At the minimum of average
total cost, average total cost
equals marginal cost.
Minimum average total cost
is $1.67 a pineapple at 330
pineapples a day—midpoint
between 300 and 360
pineapples.
© 2013 Pearson
CHECKPOINT 14.3
In the news
Metropolitan Museum completes round of layoffs
The museum has cut 74 jobs and 95 other workers retired.
The museum also laid off 127 other employees in its retail
shops. The cut in its labor costs is $10 million, but the
museum expects no change in the number of visitors.
Source: The New York Times, June 22, 2009
Explain how the job cuts will change the museum’s shortrun average cost curves and marginal cost curve.
© 2013 Pearson
CHECKPOINT 14.3
Solution
A cut in labor but no change in output increases marginal
product of labor and decreases marginal cost of producing
the output.
The MC, AVC, and ATC curves shift downward.
The shop closures decrease total fixed cost and shift the
AFC and ATC curves downward.
© 2013 Pearson
CHECKPOINT 14.4
Practice Problem 1
Tom can lease one field for
$120 a day and capital for $80 a
day or two fields for $240 a day
and twice as much capital at
$160 a day.
He hires students at $100 a
day.
What is his average cost when
he farms two fields and grows
220 pineapples a day?
© 2013 Pearson
The table shows his output
with one field and two fields.
CHECKPOINT 14.4
Solution
Total cost is fixed cost of
leasing two fields at $400 a
day plus $100 a day for each
student hired.
Tom can produce 220
pineapples with 2 fields and 1
student, so total cost is $500
a day.
© 2013 Pearson
The table shows his output
with one field and two fields.
CHECKPOINT 14.4
Average total cost is the total
cost divided by output.
Average total cost of
producing 220 pineapples a
day is $500 divided by 220
and equals $2.27 a
pineapple.
© 2013 Pearson
The table shows his output
with one field and two fields.
CHECKPOINT 14.4
Practice Problem 2
Tom can lease one field for $120
a day and capital for $80 a day or
two fields for $240 a day and
twice as much capital at $160 a
day. He hires students at $100 a
day.
Make a graph of Tom’s average
total cost curve and show the
long-run average cost curve.
Over what output range will Tom
use 1 field and use 2 fields?
© 2013 Pearson
The table shows his output
with one field and two fields.
CHECKPOINT 14.4
Solution
The table sets out Tom’s
average total costs and the
figure graphs the two ATC
curves.
© 2013 Pearson
CHECKPOINT 14.4
Tom’s long-run average cost
curve is the lower segments of
the two ATC curves,
highlighted in the figure.
© 2013 Pearson
CHECKPOINT 14.4
Practice Problem 3
Tom can lease one field for $120
a day and capital for $80 a day or
two fields for $240 a day and
twice as much capital at $160 a
day.
He hires students at $100 a day.
Does Tom experience constant
returns to scale, economies of
scale, or diseconomies of scale?
© 2013 Pearson
The table shows his output
with one field and two fields.
CHECKPOINT 14.4
Solution
Tom experiences economies
of scale if he doubles both
labor and capital, he
produces more than double
the output.
The red arrows show that
Tom experiences economies
of scale up to an output of
740 pineapples a day.
The black arrow shows
diseconomies of scale.
© 2013 Pearson
The table shows his output
with one field and two fields.
CHECKPOINT 14.4
In the news
GM restructuring plan released
GM’s restructuring plan will close 11 plants and reduce
output at 3 others.
Source: boston.com, May 31, 2009
Explain the effects of the restructuring plan on GM’s total
fixed cost, total variable cost, short-run ATC curve, and
LRAC curve.
© 2013 Pearson
CHECKPOINT 14.4
Solution
Closing 11 plants will lower GM’s total fixed cost.
Closing 11 plants and decreasing output at 3 plants will
lower GM’s total variable cost.
With a smaller scale, GM will move to the ATC curve
associated with that smaller scale and move left along its
LRAC curve.
© 2013 Pearson