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CHAPTER 9
Businesses and the Costs of Production
A. Short-Answer, Essays, and Problems
1. Why are costs important in economics?
2. Why don’t economists use the same cost data as accountants use?
3. What is the real cost of putting an unemployed laborer to work raking leaves or digging holes and refilling
4. How do firms incorporate opportunity costs to calculate economic costs? Discuss and give example using
5. Why is it important to distinguish between explicit and implicit costs?
6. Discuss whether the cost below is an implicit or explicit cost for Jack’s Pizza Shop.
7. Your firm has total sales revenue of $1,000,000 and total explicit costs of $600,000 and total implicit cost
of $300,000. What will be the accounting profit for the firm? What will be the economic profit for the
8. See the two scenarios below, should the individual think about the economic profit or accounting profit of
the firm.
9. Why must normal profits be counted as a cost, according to economists?
10. Evaluate this statement: “If the economic profit is zero, a business will shut down.”
11. Jane quit her job at IBM where she earned $50,000 a year. She cashed in $50,000 in corporate bonds that
earned 10% interest annually to buy a mini-bus. Jane has decided to buy the mini-bus and set up a
commuter service between Lincoln and Omaha. There are 1000 people who will pay $400 a year each for
the commuter service; $280 from each person goes for gas, maintenance, insurance, and depreciation. She
estimates that her entrepreneurial skills would have typically yielded a normal profit of $5,000 in another
business.
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12. Debbie was earning $100,000 a year working as a scientist for a drug company. She decided to start her
own business that conducted drug trials. She estimates this entrepreneurial talent or forgone
13. Tomas quit his job at the Tri-City bank where he earned $50,000 a year to start his own businesses, a bank
marketing company. He estimates his entrepreneurial talent or forgone entrepreneurial income to be
14. John is determining whether he should close his construction firm. His accountant has advised him to
remain open because he is making an accounting profit. As his economist friend, give him advice on
15. Why is the distinction between fixed and variable cost important?
16. Indicate whether the inputs below are variable (V) or fixed (F) in the short run.
Input
Output
_____
Meat
in
hamburgers.
_____
Fire insurance
in
dry cleaning.
_____
Tires
in
automobiles.
_____
Property tax
in
textile production.
_____
Gasoline
in
trucking services.
_____
Depreciation
in
aircraft production.
17. What is the difference between the short run and the long run?
18. Discuss what is meant by the “long–run” in economics. When does the long-run occur?
19. Explain the difference between total product, marginal product and average product.
20. What is the relationship between total product, marginal product, and average product shown by the law of
diminishing returns?
21. Interpret this statement: “If diminishing returns did not occur, the world could be fed out of a flower pot.”
22. Comment on the problem with this statement: “Of course, there are diminishing marginal returns from
adding more workers to a fixed quantity of plant and equipment because additional workers are not as good
23. What is the law of diminishing returns? Give a descriptive example.
24. (Consider This) How can total course learning and studying be related to the law of diminishing returns?
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25. The table below shows the total production of a firm as the quantity of labor employed increases. The
quantities of all other resources employed are constant. Compute the marginal and average products and
enter them in the table.
Inputs of
labor
Total
product
Marginal
product of
labor
Average
product of
labor
0
0
—
—
1
40
_____
_____
2
100
_____
_____
3
165
_____
_____
4
200
_____
_____
5
225
_____
_____
6
240
_____
_____
7
245
_____
_____
8
240
_____
_____
26. Explain: “Whenever a number which is less than the previous average of a total is added to that total, the
average will necessarily fall. Conversely, whenever a number which is greater than the previous average of
a total is added to that total, the average will necessarily rise.” How does this help explain the relationship
between the various short-run cost curves? Between the various productivity curves?
27. Complete the following table by finding the average and marginal product. At what input-output level will
average variable cost begin to rise? Explain.
Inputs of
labor
Total
product
Average
product
Marginal
product
0
0
_____
1
8
_____
_____
2
18
_____
_____
3
25
_____
_____
4
30
_____
_____
5
33
_____
_____
6
34
_____
_____
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28. You are given the following short-run information for an individual firm. Labor (L) is the only variable
input. The price of labor is $200/week. Fixed costs are $100 /week. Complete the rest of the table.
Describe the relationship between the MP and MC. At which output level does the law of diminishing
returns set in?
Total
product
Q
MP
TVC
TFC
TC
MC
0
_____
$_____
$_____
$_____
20
_____
_____
_____
_____
$_____
55
_____
_____
_____
_____
_____
100
_____
_____
_____
_____
_____
150
_____
_____
_____
_____
_____
200
_____
_____
_____
_____
_____
230
_____
_____
_____
_____
_____
250
_____
_____
_____
_____
_____
263
_____
_____
_____
_____
_____
270
_____
_____
_____
_____
_____
275
_____
_____
_____
_____
_____
278
_____
_____
_____
_____
_____
280
_____
_____
_____
_____
_____
29. What is the relationship between marginal cost and marginal product?
30. Why does the short-run marginal-cost curve eventually increase for the typical firm?
31. Assume that a firm has a plant of fixed size and that it can vary its output only by varying the amount of
labor it employs. The table below shows the relationships among the amount of labor employed, the output
of the firm, the marginal product of labor, and the average product of labor.
(a) Assume each unit of labor costs the firm $20. Compute the total cost of labor for each quantity of
Total
output
Marginal
product of
labor
Average
product of
labor
Total
variable
cost
Marginal
cost
Average
variable
cost
0
—
—
—
—
10
10
10.00
$_____
$_____
$_____
22
12
11.00
_____
_____
_____
36
14
12.00
_____
_____
_____
48
12
12.00
_____
_____
_____
58
10
11.60
_____
_____
_____
66
8
11.00
_____
_____
_____
72
6
10.28
_____
_____
_____
76
4
9.50
_____
_____
_____
78
2
8.66
_____
_____
_____
78
0
7.80
_____
_____
_____
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32. Assume a firm has fixed costs of $80 and variable costs as indicated in the table below. Complete the cost
table.
Total
product
Total
variable
cost
Total
cost
AFC
AVC
ATC
MC
0
$ 0
$ 80
—
—
—
—
1
110
190
$_____
$_____
$_____
$_____
2
150
230
_____
_____
_____
_____
3
180
260
_____
_____
_____
_____
4
220
300
_____
_____
_____
_____
5
270
350
_____
_____
_____
_____
6
340
420
_____
_____
_____
_____
7
440
520
_____
_____
_____
_____
8
580
660
_____
_____
_____
_____
33. Complete the following short-run cost table using the information provided.
Total
product
TFC
AFC
TVC
AVC
TC
MC
0
$_____
—
$_____
—
$_____
$_____
1
_____
$_____
_____
$12
_____
_____
2
_____
12
_____
10
_____
_____
3
_____
_____
_____
12
_____
_____
4
_____
_____
_____
14
_____
_____
34. In the table below you will find a schedule of a firm’s fixed cost and variable cost. Complete the table by
computing total cost, average fixed cost, average variable cost, average total cost, and marginal cost.
Total
product
Total
fixed
cost
Total
variable
cost
Total
cost
Average
fixed
cost
Average
variable
cost
Average
total
cost
Marginal
cost
0
$100
$ 0
$_____
—
—
—
—
1
100
100
_____
$_____
$_____
$_____
$_____
2
100
180
_____
_____
_____
_____
_____
3
100
240
_____
_____
_____
_____
_____
4
100
320
_____
_____
_____
_____
_____
5
100
440
_____
_____
_____
_____
_____
6
100
600
_____
_____
_____
_____
_____
7
100
800
_____
_____
_____
_____
_____
8
100
1040
_____
_____
_____
_____
_____
9
100
1340
_____
_____
_____
_____
_____
10
100
1800
_____
_____
_____
_____
_____
35. Complete the following short-run cost table using the information provided.
Q
TC
TFC
TVC
AVC
ATC
MC
0
$ 4
$_____
$_____
$_____
$_____
$_____
1
7
_____
_____
_____
_____
_____
2
9
_____
_____
_____
_____
_____
3
10
_____
_____
_____
_____
_____
4
11
_____
_____
_____
_____
_____
5
13
_____
_____
_____
_____
_____
6
17
_____
_____
_____
_____
_____
7
22
_____
_____
_____
_____
_____
36. (Consider This) Suppose your friend is currently a nursing major. She decides she wants to switch her
major to economics, but she would lose many of the college credits she has already earned. Explain to her
why the past college credits should not be figured into her marginal benefit and marginal cost calculation.
37 . Answer the questions below on the basis of the diagram.
(a) How can you tell if these cost curves are for the short run or the long run?
(b) What does the graph indicate about:
(1) AVC at 6000 units of output?
(2) ATC at 6000 units of output?
(3) AFC at 6000 units of output?
(4) TVC at 6000 units of output?
(5) TFC at all levels of output?
(6) TC at 10,000 units of output?
(7) When diminishing returns set in?
39. What effect would each of the following have on the short-run average and marginal costs of an auto
dealership: (a) auto mechanics receive a 10% wage increase; (b) property taxes decrease; (c) auto dealers
institute a one-time only promotional campaign?
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41. The following are three short-run average total cost schedules for the only three possible plant sizes, 1, 2,
and 3. Find the long-run average cost schedule and show the result in the second table.
Size 1
Size 2
Size 3
Q
ATC
Q
ATC
Q
ATC
10
$1.00
20
$ .95
40
$1.00
20
.90
30
.80
50
.87
30
.85
40
.76
60
.84
40
.88
50
.79
70
.80
50
.93
60
.83
80
.95
60
1.05
70
.90
90
1.05
Long Run
Q
AC
10
$_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
90
_____
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42. In the table below are data from a book company that prints and binds special-order books. The data show
various quantities that can be produced by the firm in an hour and the unit costs of each quantity.
(1)
Quantity of
books
(2)
Unit cost A
of books
(3)
Unit cost B
of books
100
$70
$_____
200
60
_____
300
50
_____
400
40
_____
500
35
_____
600
30
_____
700
35
_____
800
45
_____
900
60
_____
1000
80
_____
(a) In the graph below, label the axes and plot the long-run average cost curve for this firm using the data
in columns 1 and 2 of the table above.
(b) The firm then decides to subcontract the binding work to another company that specializes in the
binding of books. As a consequence, the unit costs of the firm are decreased by $20 at each output
level. Fill in column 3 of the table, and then graph the new long-run average cost curve B for the firm
on the graph.
(c) What will be the minimum cost with unit cost A? With unit cost B?
(d) If the firm produces 400 books, what will be the cost with curve A? With curve B?
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43. Below are the short-run average-total-cost schedules for three plants of different size that a firm might
build to produce its product. Assume that these are the only possible sizes of plants that the firm might
build. What is the long-run average-cost schedule for the firm? Show it in the second table below.
Plant size X
Plant size Y
Plant size Z
Output
ATC
Output
ATC
Output
ATC
5
$10
5
$13
5
$72
10
9
10
12
10
65
15
8
15
11
15
52
20
7
20
10
20
41
25
6
25
8
25
33
30
9
30
7
30
20
35
12
35
9
35
15
40
18
40
12
40
14
45
20
45
17
45
12
50
23
50
19
50
14
55
29
55
25
55
20
60
31
60
33
60
30
Output
Average cost
5
$_____
10
_____
15
_____
20
_____
25
_____
30
_____
35
_____
40
_____
45
_____
50
_____
55
_____
60
_____
For what output levels should the firm build plant X, plant Y, and plant Z?
44. How can diseconomies of scale occur at larger capacities?
45. What factors explain economies of scale?
46. What is minimum efficient scale? What insights would it give about the size of firms in an industry?
47. The values for the long-run ATC curves of three different firms are listed in the table below.
Quantity
ATC 1
ATC 2
ATC 3
5
10
7
12
10
8
6
9
15
7
5
7
20
6
6
6
25
6
7
5
30
6
9
4
35
7
13
6
40
8
17
9
(a) Which firm faces the lowest minimum ATC?
(b) Which firm has the greatest minimum efficient scale?
(c) Which firm has the smallest economies of scale?
48. Consider the diagram below. Curves 1–8 are the short-run curves which occur with different plant sizes.
Answer the next two questions.
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49. What effect does the increase of the price of corn have on the cost curves of a firm producing items like
50. What effect does the increase of the price of gasoline have on the cost curves of package delivery firms
such as Federal Express or United Parcel Service? How might the effects differ for a software firm such as
51. What are some of the sources of cost savings for recent business start-ups in the U.S. economy such as
Intel, Starbucks, Microsoft, Dell, Google and Cisco Systems?
52. How would a Verson stamping machine help a firm achieve economies of scale?
54. Why are there two plants run by one firm that produce large commercial aircraft and thousands of plants
55. (Last Word) The iPhone costs billions of dollars to develop. Discuss why this product is available to the
56. (Last Word) Discuss how the 3-D printer is set to make manufactured goods more affordable for the average
person in the United States.
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B. Answers to Short-Answer, Essays, and Problems
1. Why are costs important in economics?
2. Why don’t economists use the same cost data as accountants use?
Implicit costs are as important as the explicit costs which are generally the so-called “accounting costs.”
For example, economists (but not accountants) would count the income forgone in the use of the owner’s
time as an economic cost, the interest forgone by using one’s own funds, and so on for the use of other
3. What is the real cost of putting an unemployed laborer to work raking leaves or digging holes and refilling
them during a severe recession? Explain.
4. How do firms incorporate opportunity costs to calculate economic costs? Discuss and give example using
an explicit economic cost and an implicit economic cost.
All resources used by the firm have an opportunity cost which is the value of the next best alternative use
5. Why is it important to distinguish between explicit and implicit costs?
Implicit costs are as important as the explicit costs which are generally the so-called “accounting costs.”
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6. Discuss whether the cost below is an implicit or explicit cost for Jack’s Pizza Shop.
a) Jack was offered a job at a competing pizza restaurant for $50,000 a year.
b) Jack pays his niece an hourly wage of $9 an hour to waitress.
c) Jack owns the building for his restaurant. A nearby building rents for $1,000 a month.
d) Jack’s insurance bill is $2,500.
e) Jack purchases ingredients for his pizzas from a local farmers market each week totaling
$200.
7. Your firm has total sales revenue of $1,000,000 and total explicit costs of $600,000 and total implicit cost
of $300,000. What will be the accounting profit for the firm? What will be the economic profit for the
firm? Explain the difference using the data.
Accounting profit is the difference between total revenue and explicit cost, so in this case it is $400,000
8. See the two scenarios below, should the individual think about the economic profit or accounting profit of
the firm.
9. Why must normal profits be counted as a cost, according to economists?
10. Evaluate this statement: “If the economic profit is zero, a business will shut down.”
11. Jane quit her job at IBM where she earned $50,000 a year. She cashed in $50,000 in corporate bonds that
earned 10% interest annually to buy a mini-bus. Jane has decided to buy the mini-bus and set up a
commuter service between Lincoln and Omaha. There are 1000 people who will pay $400 a year each for
the commuter service; $280 from each person goes for gas, maintenance, insurance, and depreciation. She
estimates that her entrepreneurial skills would have typically yielded a normal profit of $5,000 in another
business.
(a) Complete the following questions: (1) What are Jane’s total revenues? (2) What are Jane’s explicit
12. Debbie was earning $100,000 a year working as a scientist for a drug company. She decided to start her
own business that conducted drug trials. She estimates this entrepreneurial talent or forgone
entrepreneurial income to be $10,000 a year. She used $500,000 in savings that earned 5 percent interest
annually to finance the new business. In the first year, the firm earned revenue of $1,500,000. The costs
for rent, supplies, and employees’ salaries were $1,100,000. What was the accounting profit for the new
business? What was the economic profit (or loss)? Explain your calculations for both questions.
13. Tomas quit his job at the Tri-City bank where he earned $50,000 a year to start his own businesses, a bank
marketing company. He estimates his entrepreneurial talent or forgone entrepreneurial income to be
$5,000 a year. He used $100,000 in savings that earned 5 percent interest annually to finance the new
business. In the first year, the firm earned revenue of $250,000. The costs for rent, supplies, and an
employee’s salary were $200,000. What was the accounting profit for the new business? What was the
economic profit (or loss)? Explain your calculations for both questions.
14. John is determining whether he should close his construction firm. His accountant has advised him to
remain open because he is making an accounting profit. As his economist friend, give him advice on
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15. Why is the distinction between fixed and variable cost important?
16. Indicate whether the inputs below are variable (V) or fixed (F) in the short run.
Input
Output
_____
Meat
in
hamburgers.
_____
Fire insurance
in
dry cleaning.
_____
Tires
in
automobiles.
_____
Property tax
in
textile production.
_____
Gasoline
in
trucking services.
_____
Depreciation
in
aircraft production.
Input
Output
V
Meat
in
hamburgers.
F
Fire insurance
in
dry cleaning.
V
Tires
in
automobiles.
F
Property tax
in
textile production.
V
Gasoline
in
trucking services.
F
Depreciation
in
aircraft production.
17. What is the difference between the short run and the long run?
18. Discuss what is meant by the “long–run” in economics. When does the long-run occur?
19. Explain the difference between total product, marginal product and average product.
Total product is the total product, or total output, of a particular good produced. Marginal product is the
change in total product resulting from each additional input of labor. Average product is the total product
divided by the total number of workers. It is also called labor productivity.
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20. What is the relationship between total product, marginal product, and average product shown by the law of
diminishing returns?
21. Interpret this statement: “If diminishing returns did not occur, the world could be fed out of a flower pot.”
If diminishing returns did not occur, the world could be fed out of a flower pot by simply increasing inputs
and labor. The more fertilizer used, the more output would increase. There would be no limit to this
22. Comment on the problem with this statement: “Of course, there are diminishing marginal returns from
adding more workers to a fixed quantity of plant and equipment because additional workers are not as good
as initial workers.”
The law of diminishing returns assumes all units of variable inputs, which would be workers in this case,
23. What is the law of diminishing returns? Give a descriptive example.
The law states that as additional units of a variable resource such as labor are added to a fixed resource
24. (Consider This) How can total course learning and studying be related to the law of diminishing returns?
Total course learning can be considered an output in the educational production process. The inputs include