Chapter 4 – Costs of Production – Teacher Provided Questions.
4.1
Production, Costs, and Profit
1.
What is a business?
An enterprise that brings financial resources and economic resources together to produce a
good or service for economic gain.
2.
What is production?
The process of transforming a set of resources into a good or service that has economic value.
3.
What are inputs?
The resources used for production.
4.
What are outputs?
The quantity of a good or service that results from production.
5.
Explain labour-intensive process.
Is one that employs more labour and less capital than do other processes to produce a certain
quantity of output.
6.
Explain capital-intensive process.
Uses more capital and less labour to produce the same quantity of output.
7.
Define productive efficiency.
Making a given quantity of output at the lowest cost.
8.
Define explicit costs. How else may it be referred by?
Payments made by a business to businesses or people outside it. Accounting costs.
9.
Define implicit costs, provide an example.
The owner’s opportunity costs of being involved with a business.
Normal profit – the minimum return the owners must receive to keep their funds and
entrepreneurial skills tied up in the business.
10.
Define economic costs and provide the formula to calculate it.
Business’s total explicit and implicit costs.
Economic costs = explicit costs + implicit costs.
11.
Define accounting profit.
The access of a business’s total revenue over its explicit costs.
12.
Define economic profit and provide the formula to calculate it.
The access of a business’s total revenue over its economic costs.
13.
How does economic profit determine whether a business should continue to operate?
When economic profit is positive, the business should continue to operate. If economic profit
is negative over an extended period of time, the business’s owners should consider closing.
4.2
Production in the Short Run
1.
Define fixed inputs.
Inputs whose quantities can not be adjusted in the short run.
2.
Define variable inputs.
Inputs whose quantities can be adjusted in the short run.
3.
Define total product.
The overall total output produced with a given workforce.
4.
What is average product? How is it calculated?
The quantity of output produced per worker.
Average produce = total product/number of workers
5.
What is marginal product? How is it calculated?
The amount of output produced with an additional worker.
Marginal product = change in total product/change in number of workers.
6.
Explain the law of diminishing marginal returns in the short run.
At some point, as more of a variable input are added to a fixed input the marginal product will
start to decrease.
7.
Explain the short run in regards to a business’s inputs.
Where at least one input is fixed.
8.
Explain the Three Stages of Production.
Stage 1 – marginal product increases as more workers are added. Each added unit of input
increases output by more than the previous one added. Businesses will never limit production in this
range. A positive slope that gets steeper.
Stage 2 – marginal product begins to fall but is still positive. Businesses will end up selecting
production somewhere in this stage.
Stage 3 – marginal product begins to falls below zero and total product decreases. Businesses
will never chose to produce at this stage.
4.3
Costs in the Short Run
Explain fixed costs.
Economic costs for inputs that remain the fixed
at all quantities of output. Does not change when a
business changes its quantity of output. – ex.
Machinery or land.
1.
2. Explain variable costs.
Economic costs for inputs that vary at each
quantity of output.
3. What are the most important variable costs?
The most important variable costs are wages and
the payment for materials used in production.
4. Provide the formula to calculate Total cost.
Total cost = fixed cost + variable cost
5. Define marginal cost.
The extra cost in producing an additional unit of
production.
6. What is the most important cost concept in
economics?
Marginal cost.
7. Provide the formula to calculate marginal cost.
Marginal cost = change in total cost/change in
total production.
8. Define the three types of per-unit costs –
average fixed cost, average variable cost and
average
cost.
Average fixed cost - the fixed cost per unit of
production.
Average variable cost - the variable cost per unit of
production.
Average cost – the sum of average fixed cost and
average variable cost at each quantity of output.
9. Provide the formulas to calculate each of the
three types of per-unit costs.
Average fixed cost = fixed cost/total production
Average variable cost = variable cost/total
production
Average cost = average fixed cost + average variable
cost
4.4
Production and Costs in the Long Run
1.
Define the Long run in regards to quantities used in an industry.
Is the period in which quantities of all resources used in an industry can be adjusted.
2.
Why does the law of diminishing marginal returns not apply in the long run?
Because all inputs can be varied in the long run.
3.
Define Increasing returns to scale ( economy of scales)
A situation in which a percentage increase in all inputs leads to a greater percentage
increase in output.
4.
What are the three basic causes of returns to scale?
Division of labour – performing fewer tasks allows workers to become more efficient at
their jobs. Specialization of labour.
Specialized capital – specialized machinery performing fewer tasks more efficiently.
Specialized management – managers are assigned areas in which they have the most
expertise.
5.
Define constant returns to scale.
A situation in which a percentage increase in all inputs causes an equal percentage
increase in outputs.
6.
Define decreasing returns to scale.
A situation in which a percentage increase in all inputs causes a smaller percentage
increase in outputs.
7.
What are the two major reasons for decreasing returns to scale.
Management difficulties – as more management is added the business can become too
cumbersome that managers will face problems with coordinating operations to ensure
efficient production.
Limited natural resources – in primary industries, a business may be able to acquire only
a limited supply of easily available natural resources, even in the long run. In this case,
an output level is reached above which further increases in all inputs lead to a smaller
rise in output.
8.
Why do Manufacturing industries exhibit an extended range of increasing returns to
scale?
It is due to the degree in which specialization is possible in both labour and capital. Ex.
Assembly line in the auto industry.
9.
Why do craft industries have constant returns to scale?
Because output levels of crafts tends to depend on repeating exactly the method of
production, an increase in inputs leads to exactly the same increase in outputs.
10.
Why do primary industries tend to have decreasing returns to scale?
The limit of resource supplies are particularly acute. Ex. Fishing.
11.
Outline the size of companies that most likely would be found in the three different
returns to scale. -
Increasing returns to scale– very large manufacturing businesses, ex. General Motors,
Constant returns to scale – Craft industries.
Decreasing returns to scale - Primary industries.
CHAPTER 4
Page 98
a. With Process A, total daily costs of employing labour and capital are $400 [= ($80 x 2 workers) + ($40 x
6 machines)].
With Process B, these costs are $360 [= ($80 x 3 workers) + ($40 x 3 machines)]. Because Process B
minimizes daily costs and maximizes productive efficiency, it will be chosen by the owner.
b. $400 [= ($80 x 3) + ($40 x 3) + $30 + $10]
c. $200 [= (.06 x 10 000) - $400].
d. Implicit costs are $180 [= ($150 + $30)]. Economic costs are $580 [= ($400 + $180)]
e. $20 [= ($600 - $580)].
f. No, the owner should not consider closing, since the shop is making a positive economic profit.
Page 98
1. As an NBA team manager wishing to increase the average height of players on your team you should
draft new players whose own height (the relevant marginal value) exceeds the team’s current average
height.
2a. Marginal product is
50 [= (50 – 0)] pots for the first worker,
150 [= (200 – 50)] pots for the second worker,
70 [= (270 – 200)] pots for the third worker,
30 [= (300 – 270)] pots for the fourth worker,
-60 [= (240 – 300)] pots for the fifth worker.
b. Marginal product rises when the first and second workers are hired. Marginal product falls and is
positive when the third and fourth workers are hired. Marginal product is negative when the fifth
worker is hired.
c. This is because it becomes increasingly difficult for each of these new workers to raise output given
the potter's fixed inputs.
d. Average product is
50 [= (50/1)] pots with one worker,
100 [= (200/2)] pots with two workers,
90 [= (270/3)] pots with three workers,
75 [= (300/4)] pots when four workers are employed,
48 [= (240/5)] pots when five workers are employed.
e. Marginal and average product are the same when the first worker is hired. As marginal product is
rising (when the second worker is hired), marginal product is greater than average product. As marginal
product falls (when the last three workers are hired), marginal product is less than average product.
f.
Total Product Curve
350
Pots Produced per Week
300
250
TP
200
150
100
50
0
0
1
2
3
4
5
6
Number of Workers Employed per Week
Marginal and Average Product Curves
200
Pots Produced per Week
150
100
50
AP
0
0
-50
1
2
3
4
5
6
MP
-100
Number of Workers Employed per Week
g. Marginal product reaches its peak where diminishing marginal returns set in. Total product rises less
rapidly and finally becomes negatively sloped once diminishing marginal returns set in. Average product
reaches its maximum where it equals marginal product. Then, because of diminishing marginal returns,
with marginal product falling and below average product, average product declines.
Page 103
a. Variable costs are $0 at a zero output,
$100 at an output of 50 pots,
$200 at 200 pots,
$300 at 270 pots,
$400 at 300 pots.
Total cost is $100 [= ($100 + $0)] at 0 pots,
$200 [= ($100 + $100)] at 50 pots,
$300 [= ($100 + $200)] at 200 pots,
$400 [= ($100 + $300)] at 270 pots,
$500 [= ($100 + $400)] at 300 pots.
b. Marginal cost is $2.00 [= ($100 - $0)/(50 – 0)] when moving
from 0 to 50 pots;
$0.67 [= ($200 - $100)/( 200 – 50)] from 50 to 200 pots;
$1.43 [= ($300 - $200)/(270 – 200)] from 200 to 270 pots;
$3.33 [= ($400 - $300)/(300 – 270)] from 270 to 300 pots.
c. Average fixed cost is $2.00 [= ($100/50) at 50 pots,
$0.50 [= ($100/200)] at 200 pots,
$0.37 [= ($100/270)] at 270 pots,
$0.33 [= ($100/300)] at 300 pots.
Average variable cost is $2.00 [= ($100/50)] at 50 pots,
$1.00 [= ($200/200)] at 200 pots,
$1.11 [= ($300/270)] at 270 pots,
$1.33 [= ($400/300)] at 300 pots.
Average cost is $4.00 [= ($200/50)] at 50 pots,
$1.50 [= ($300/200)] at 200 pots, $1.48 [= ($400/270)] at 270
pots,
$1.67 [= ($500/300)] at 300 pots.
d.
Average Fixed Cost Curve
2.50
2.00
$ per Pot
1.50
1.00
0.50
AFC
0.00
0
100
200
Pots Produced per Week
300
400
Marginal, Average Variable and Average Cost Curves
4.50
4.00
3.50
MC
$ per Pot
3.00
2.50
2.00
AC
1.50
AVC
1.00
0.50
0.00
0
100
200
300
400
Pots Produced per Week
e. Yes. The marginal cost and average variable cost curves are J-shaped, and the average cost curve is
bowl-shaped, with the minimum points of both average variable cost and average cost occurring at the
curves' intersection with the marginal cost curve.
Page 109
a. The percentage increase in the labour input is 50% [= ((9 – 6)/6)) x 100%] and the percentage increase
in the capital input is also 50% [= ((3 – 2)/2)) x 100%], while the percentage increase in output is 100% [=
(240 – 120)/120]. Because the relative increase in output exceeds the relative increase in each of the
inputs, the business is experiencing increasing returns to scale. Long run average cost falls from $5.33 [=
((6 x $100) + (2 x $20))/120] to $4 [= ((9 x $100) + (3 x $20))/240].
b. The percentage increase in output is 50% [= (180 – 120)/120]. Because the relative increase in output
equals the relative increase in each of the inputs, the business is experiencing constant returns to scale.
Long run average cost at 120 units is $5.33 [= ((6 x $100) + (2 x $20))/120] and at 180 units is also $5.33
[= ((9 x $100) + (3 x $20))/180].
c. The percentage increase in output is 33% [= (160 – 120)/120]. Because the relative increase in output
is less than the relative increase in each of the inputs, the business is experiencing decreasing returns to
scale. Long run average cost rises from $5.33 [= ((6 x $100) + (2 x $20))/120] to $6 [= ((9 x $100) + (3 x
$20))/160].
CHAPTER 4:Costs of Production
1a. The daily cost of Process A is $130 [= ($20 x 4 workers) + ($25 x
2 machines)] and the daily cost of Process B is $135 [= ($20 x 3
workers) + ($25 x 3 machines)]. Because wages are lower than in the
text example, Process A is cheaper than Process B, and therefore
maximizes productive efficiency.
b. The daily cost of Process A is $700 [= ($100 x 4 workers) + ($150 x
2 machines)] and the daily cost of Process B is $750 [= ($100 x 3
workers) + ($150 x 3 machines)]. Because the daily cost of a sewing
machine is higher than in the text example, Process A is now cheaper
than Process B, and therefore maximizes productive efficiency.
2a. Rodriguez's total explicit costs, which include rent, taxes and
inventory costs, are $390 000 [= $25 000 + $15 000 + $350 000]. His
total implicit costs, which include normal profit and implicit wages,
are 106 000 [= (.20 x $80 000) + $90 000].
b. The store's accounting profit, which is found by subtracting
explicit costs from total revenue, is $90 000 (= $480 000 - $390 000).
c. The store's economic profit, which is found by subtracting both
explicit costs and implicit costs from total revenue, is -$16 000 (=
$480 000 - $390 000 - $106 000).
d. Economic profit is a better indicator of the performance of
Rodriguez's business, since it takes into account all relevant
opportunity costs. However, because implicit costs are based on
subjective estimates by the owner, accountants prefer to use
accounting profit rather than economic profit as a measure of business
performance.
e. Because the variety store is making an economic loss, Rodriguez
should consider closing down this business.
3a. a fixed cost, because depreciation is limited to the firm’s fixed
inputs such as machinery and buildings
b. a variable cost, since employee benefits vary with the number of
workers employed by the business
c. a variable cost, because lumber is a material input that varies
with the business’s output
d. a fixed cost, since property insurance is related to the
restaurant’s fixed inputs such as furniture and equipment
e. a variable cost, since gasoline is a material input that varies
with the business’s output
f. a fixed cost, because the firm’s research outlays do not vary with
its software output
g. a fixed cost, because the wireless spectrum, once purchased, does
not vary with the provider’s output of services
4a. Column 3 (marginal product): 100, 180, 230, 50, -20; Column 4
(average product): 100, 140, 170, 140, 108.
b.
FIGURE 4A–1
The behaviour of both total product and average product can be related
to the marginal product curve. Total product reaches a maximum at the
same employment level (4 workers) at which marginal product equals
zero. At employment levels below 4 workers, a positive marginal
product means that total product is rising. At employment levels above
4 workers, marginal product is negative and therefore total product is
falling. Average product reaches a maximum at 3 workers, which is the
same employment level at which average product equals marginal
product. At employment levels below 3 workers, marginal product
exceeds average product, which causes average product to rise as
employment expands. Once marginal product falls below average product,
at employment levels above 3 workers, average product drops with
expanding employment.
c. Marginal product rises when the first, second, and third workers
are hired, since the marginal product of the second worker (180)
exceeds that of the first worker (100), and the marginal product of
the third worker (230) exceeds that of the second worker. Marginal
product falls and is positive when the fourth worker is hired, since
marginal product is declining (from 230 to 50). Marginal product is
negative (-20) when the fifth worker is hired.
5a. Column 3 (marginal product): 120, 160, 130, 110, 60; Column 6
(total cost): 60, 240, 420, 600, 780, 960; Column 7 (marginal cost):
1.50, 1.13, 1.38, 1.64, 3.00; Column 8 (average fixed cost): .50, .21,
.15, .12, .10; Column 9 (average variable cost): 1.50, 1.29, 1.32,
1.38, 1.55; Column 10 (average cost): 2.00, 1.50, 1.46, 1.50, 1.66.
b. Marginal product begins to fall when the third worker is hired,
since marginal product decreases from 160 to 130 cars per day. This is
related to the point at which marginal cost begins to rise from its
minimum of $1.13 to $1.38. Once each new worker adds less to total
product, the extra cost of this new output begins to rise.
c.
FIGURE 4A–2
d. Average variable cost and marginal cost have the same value at an
output of 280 cars (point a in the graph), while average cost and
marginal cost have the same value at an output of 410 cars (point b in
the graph).
6a. Column 3 (marginal product): 20, 35, 25, 20, 5; Column 6 (total
cost): 1200, 1400, 1600, 1800, 2000, 2200; Column 7 (marginal cost):
10.00, 5.71, 8.00, 10.00, 40.00; Column 8 (average fixed cost): 60.00,
21.82, 15.00, 12.00, 11.43; Column 9 (average variable cost): 10.00,
7.27, 7.50, 8.00, 9.52; Column 10 (average cost): 70.00, 29.09, 22.50,
20.00, 20.96.
b. Diminishing returns set it when the third worker is hired, since
marginal product decreases from 35 to 25 kites per day. This is
related to the point at which marginal cost begins to rise from its
minimum of $5.71 to $8.00.
c. FIGURE 4A–3
FIGURE 4A–4
d. Average variable cost and marginal cost have the same value at an
output of 55 cars (point a in the graph), while average cost and
marginal cost have the same value at an output of 100 cars (point b in
the graph).
7a. An extended range with a zero slope, reflecting constant returns
to scale, since an expansion of output requires an exact repetition of
production methods, so that inputs and output vary by the same
percentage.
b. An extended range with a negative slope, reflecting economies of
scale, since an expansion of output allows for added specialization of
labour and capital, so that output rises more quickly than inputs.
c. An extended range with a positive slope, reflecting diseconomies of
scale, since limited resource supplies mean that an increase in inputs
does not lead to as large a percentage increase in output.
d. An extended range with a negative slope, reflecting economies of
scale, since an expansion of output allows the same distribution and
marketing software to be used in selling more e-book titles.
8a. Column 3 (fixed costs): 500, 500, 500, 500, 500; Column 4
(variable costs): 0, 120, 240, 360, 480; Column 5 (total cost): 500,
620, 740, 860, 980; Column 6 (marginal cost): 1.20, 0.67, 0.52, 2.40.
b.
FIGURE 4A-5
c. As output increases, total cost and variable cost both rise in ways
identical to one another. In the first output range - to the left of
points a and b - total cost and variable cost both increase at a
decreasing rate. This reflects falling marginal cost, which means
progressively smaller rates of change in both total cost and variable
cost. After point c, marginal cost begins to rise, so that the rates
of change in both total cost and variable cost become progressively
bigger.
d. The output range in which total cost and variable cost become
progressively flatter (up to an output of 395, which is halfway
between 280 and 510) corresponds to the employment range where
marginal product is rising (when the first, second, and third workers
are hired). This is because a greater extra product for each new
worker employed means a smaller rate of change for both total cost and
variable cost. In contrast, the output range in which total cost and
variable cost become progressively steeper (above an output of 395) is
the result of the law of diminishing marginal returns, which sets in
when the fourth worker is hired. Once a smaller marginal product is
added by each new worker, the rates of change of total cost and
variable cost rise.
9. The first point has a horizontal coordinate of 40, which is the
midpoint of the two associated output levels, 0 and 80 T-shirts (40 =
(80 + 0)/2). The second point has a coordinate of 140 (= (200 +
80)/2), the third a coordinate of 225 (= (250 + 200)/2), the fourth a
coordinate of 260 (= (270 + 250)/2), and the fifth a coordinate of 275
(= (280 + 270)/2).
10. Governments can help reduce the price of knowledge (for
example, by funding research and development, or by
subsidizing knowledge-producing industries). This helps
reduce one of the main fixed costs of knowledge-based
industries, thereby raising profits and spurring expansion
in these industries.