Download Lab11 Production and Cost

Lab11 Production and Cost
1. Short-run V.S. long-run
In the short run, at least one of a firm’s inputs is fixed. In particular, the firm’s technology and
the size of its physical plant are both fixed. Therefore, there are both fixed cost and variable cost
in the short run.
In the long run, firm can vary all its inputs, adopt new technology and increase or decrease the
size of its physical plant. Hence, all the costs are variable costs. No fixed cost in the long run.
2. Average product (AP) V.S. Marginal product (MP)
2.1. Average product is the average output for each variable input (like labor).
2.2. Marginal product is the additional output if a firm increases one more unit of variable input
(like labor).
Example:
# of workers
0
1
2
3
4
5
6
# of pizza ovens
2
2
2
2
2
2
2
Pizza output
0
200
450
550
600
625
640
MPL
APL
200
250
100
50
25
15
200
225
183.3
150
125
106.7
2.3.Law of diminishing returns- Adding more of a variable input such as labor to the same
amount of a fixed input, such as capital, will eventually (MP can increase at the beginning
when the quantity of variable input are low) cause the marginal product of the variable input
to decline.
Question: does this law apply in the long run?
Answer: it doesn’t apply in the long run because in the long run none of the inputs are fixed;
all can vary.
3. Explicit cost V.S. Implicit cost
{
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4. Fixed cost (FC): costs that remain constant as output changes. Ex: land rent cost
Variable cost (VC): costs that change as output changes. Ex: labor cost, raw material cost
Marginal cost (MC): total cost increase when firm increase one more unit of output
MC= dTC / dq
Note: 1. As output increases, average fixed cost gets smaller and smaller
2. As output increases, AVC and ATC curves get closer and closer.
3. MC, AVC, ATC curves are all U-shaped
4. MC curve intersects AVC and ATC curve at their minimum points
i.e. When MC< AVC, AVC is decreasing; when MC>AVC, AVC is increasing
When MC< ATC, ATC is decreasing; when MC> ATC, ATC is increasing
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Exercises:
1. Corrugated packaging is sold in a competitive market, and the current market price is $1.65 per
corrugated box. Use this information to answer the following two questions.
1) At the current (short-run) profit maximizing level of production, your firm produces 1,000,000
corrugated boxes per month. Paper and electricity are the only variable inputs used in the
production process. The paper cost per unit of output is $0.50; while the electricity cost per unit
of output is $0.05. The fixed costs of your firm are $1,000,000 per month. It follows that:
A. Average fixed cost must be less than average variable cost-i.e. AFC<AVC
B. Marginal cost must be less than $1.65-i.e. MC<1.65
C. Average total cost is $1.55-i.e. ATC=1.55
D. Average variable cost is $1.55- i.e. AVC=1.55
Answer: C
Since paper and electricity are variable input, AVC=0.5+0.05=$0.55.
AFC=FC/q=$1,000,000/1,000,000=$1
ATC=AVC+AFC=$1.55
Choice B is wrong because in a perfectly competitive market, MC=p=$1.65 for a profitmaximizing firm. We will learn this in next chapter.
2) At the current (short-run) profit maximizing level of production, your firm produces 500,000
corrugated boxes per month. Paper and electricity are the only variable inputs used in the
production process. The paper cost per unit of output is $0.50; while the electricity cost per unit
of output is $0.05. The fixed costs of your firm are $1,000,000 per month. It follows that:
A. Your firm is making an economic profit
B. Your firm is making an economic loss
C. You cannot calculate profit or loss, but the marginal cost is $0.55 per unit
D. You cannot calculate profit or loss, but average fixed cost must be less than $0.55-i.e.
AFC<0.55
Answer: B
AVC=0.5+0.05=$0.55, AFC=FC/q=1,000,000/500,000=$2. ATC=AVC+AFC=$2.55
Since P=1.65<ATC=2.55, the firm is losing money
2. Suppose the average total cost of producing a gallon of milk at your dairy is $3.00. Further
suppose that the free market equilibrium price of milk is $3.50, and you produce 1,000 gallons a
day. Ceteris paribus, it follows that:
A. Your firm’s daily total revenue is: 1,000*(3.50-3.00)=$500
B. Your firm is making a loss of $0.50 per gallon of milk
C. Your firm is making a profit of $3.00 per gallon of milk
D. Your firm is making a profit of $0.50 per gallon of milk
Answer: D
We know that ATC=$3, P=$3.5, q=1,000. Since ATC<p, the firm is making profit which
equal to (P-ATC)=$0.5 per gallon. Choice A is wrong because TR=P*q=3.5*1000=$3500.
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The expression in choice A actually calculates the total profit, which equal to total revenue
minus total cost.
3. Using the graph to answer the two following questions:
1) At 100 units of output per month, what is the firm’s average total cost
A. $34
B. $24*100=$2400
C. $34*100=$3400
D. $58
Answer: D
Just look at the curve of ATC. When q=100, ATC=$58
2) At 100 units of output per month, what is the firm’s total fixed cost?
A. $34
B. $24*100=$2400
C. $34*100=$3400
D. $58
Answer: B
At 100 units of output, ATC= $58, AVC=$34. We can get AFC=ATC-AVC=$24. And
FC=AFC*q=$24*100=$2400
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