RELATED CONCEPTS:|ACCOUNTING PROFIT |AVERAGE VARIABLE, FIXED, AND TOTAL COSTS |CONSTANT RETURN TO SCALE |DISECONOMIES OF SCALE |ECONOMIC PROFIT |ECONOMIES OF SCALE |EXPLICIT COSTS |IMPLICIT COSTS |LAW OF DIMINISHING MARGINAL RETURNS |LONG AND SHORT RUN |LONG-RUN AVEAGE COST|MARGINAL COST |MARGINAL PHYSICAL PRODUCT |TOTAL COST |TOTAL FIXED COSTS |TOTAL VARIABLE COSTS |.
If one added worker increases output by ten units, how much labor is embodied in each unit of output? If the added worker costs $120,000, what is the marginal cost of one extra unit of output?
- One-tenth of a worker is embodied in each unit of output. So each unit costs one-tenth of $12,000, or $1,200.
Answer true or false:
a. ATC falls only when MC falls.
b. At the minimum AVC, AVC = MC
c. ATC falls when MC
d. TC increases by MC.
a. False.
b. True.
c. True.
d. True.
Mary Jones can work in a factory and earn $16,000 a year, or alternatively, be a farmer. Assume that except for monetary reward, she doesn’t care which she does. To farm, Mary has to invest her savings of $20,000. The annual cost of seed, fertilizer, etc., is $5,000. She could earn 10% annually on her best alternative investment.
a. What is the total cost of farming (including implicit costs)?
b. What is the minimum Mary must make in farming to just make it worthwhile?
c. If her farm revenues ar $30,000, what is her economic profit? Her accounting profit? Should she stay in farming?
d. Answer (c) above for revenues of $20,000
a. $23,000: Explicit costs are $5,000. Implicit costs include her forgone earnings of 416,000 plus the forgone interest of $2,000 she could have earned had she invested the $20,000 of savings at 10%.
b. $23,000
c. Economic profit = - $7,000. Accounting profit = $25,000. She should farm.
d. Economic profit = - $3,000 (i.e., a $3,000 loss). Accounting profit = $15,000. She should not farm.
Old Fud owns a jewelry store. He didn’t raise his prices on the diamonds he bought last year even though diamond prices have since doubled. He says: “I’m still making a profit at my old price.” Is Old Fud right?
- Old Fud is wrong. He is ignoring the higher opportunity costs of diamonds.
Between two towns, one can (a) fly at a cost of $100 taking one hour, or (b) take a bus at $50, which takes five hours. Why are business men and women more likely to choose (a) while relatively more students will choose (b)?
- Businessmen and women usually have a higher opportunity cost of time than students and so are more likely to find flying cheaper. For example, if the opportunity cost of time is $20 an hour, the plane’s cost is $120 while the bus’s cost is $150.
Consider the cost curves of a trucking firm.
a. Suppose there is an increase in the price of gasoline. How will each of these cost curves shift up (if they shift at all): MC, ATC, AVC, AFC?
b. Suppose the cost of incorporating and setting up a trucking business goes up. How will each of the above cost curves shift?
a. MC, AVC, and ATC will shift up. AFC will be unchanged.
b. AFC and ATC will shift up. MC and AVC will be unchanged.
Suppose a firm’s production process can be characterized as having economies of scale. If so, when output doubles, what happens to total cost? To ATC?
- Total costs will less than double, such that ATC falls.
Copyright 2008 by Sujanto Rusli
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