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Chapter 7: The Costs of Production
Solutions Manual
Learning Objectives for Chapter 7
After reading this chapter, you should know
LO 07-01. What the production function represents.
LO 07-02. Why the law of diminishing returns applies to production processes.
LO 07-03. How the various measures of cost relate to each other.
LO 07-04. How economic and accounting costs differ.
LO 07-05. What (dis)economies of scale are.
Questions for Discussion
1. What are the production costs of your economics class? What are the fixed costs? The
variable costs? What’s the marginal cost of enrolling more students? (LO 07-03)
Answer: The marginal cost of enrolling one more student would include the added cost of
registration (processing the paperwork to officially enroll the student) and the added cost to
described.
2. Suppose all your friends offered to help wash your car. Would marginal physical product
decline as more friends helped? Why or why not? (LO 07-02)
3 How many batteries will Tesla want to produce in its new gigafactory? (See News, p.
154.) (LO 07-01)
4. Owner/operators of small gas stations rarely pay themselves an hourly wage. How does
this practice affect the economic cost of dispensing gasoline? (LO 07-04)
Answer: It reduces the accounting cost of dispensing gasoline, but not the economic cost.
5. Corporate funeral giants have replaced small family-run funeral homes in many areas, in
large part because of the lower costs they achieve. What kind of economies of scale exist in
the funeral business? Why doesn’t someone build one colossal funeral home and drive costs
down further? (LO 07-05)
1
© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
6. Are colleges subject to economies of scale or diseconomies? (LO 07-05)
7. Why don’t more U.S. firms move to Mexico to take advantage of low wages there?
Would an identical plant in Mexico be as productive as its U.S. counterpart? (LO 07-01)
8. How would your productivity in completing coursework be measured? Has your
productivity changed since you began college? What caused the productivity changes? How
could you increase productivity further? (LO 07-01)
9. What is the economic cost of doing this homework? (LO 07-04)
10. What causes unit labor costs to rise in some nations and fall in others (World View, p. 157)?
(LO 07-03)
Problems
1. (a) Complete the following cost schedule:
2
© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Output Total
Cost Marginal
Cost Average
Fixed Cost
Average
Variable
Cost
Average Total
Cost
0 $600
1 800
2 1,050
3 1,400
4 1,800
5 2,300
(b) Use the cost data to plot the ATC and MC curves on the accompanying graph.
(c) At what output rate is ATC minimized? (Use higher rate.)
(LO 07-03)
Answers:
(a) See table on next page.
Output Total
Cost Marginal
Cost Average
Fixed Cost
Average
Variable
Cost
Average Total
Cost
0 $600 - - - -
1 800 200 600 200 800
(b)
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
1 2 3 4 5
0
200
400
600
800
1000
1200
ATC
MC
QUANT ITY (units per period)
COST (dollars per unit)
(c) 4 units.
Feedback:
(a) Average fixed cost is total fixed cost/total output. In this case the total fixed cost is $600
(b) In order to plot the average total cost and marginal cost curves, you simply plot the
(c) Average total cost is minimized when average total costs are at their minimal or smallest
(a) First diminish?
(b) Become zero?
(c) Turn negative?
(LO 07-02)
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Answers:
Feedback:
(a) Marginal physical product is diminishing between points C & D.
3. Suppose a company incurs the following costs: labor, $500; equipment, $300; and materials,
$200. The company owns the building, so it doesn’t have to pay the usual $800 in rent.
(a) What is the total accounting cost?
(b) What is the total economic cost?
(c) If the company sold the building and then leased it back, what would be the change in
(i) Accounting costs?
(ii) Economic costs? (LO 07-04)
Answers:
(a) $1,000.
Feedback:
(a) The accounting cost is associated with explicit dollar costs only. This means to calculate
(b) The total economic cost is the accounting costs of $1,000 plus the implicit or opportunity
(c) (i) Accounting costs would increase to $1,800. If the company has additional monthly
(ii) Economic costs do not change; if the company sold its building and then leased it back,
4. Refer to the production table for jeans (Table 7.1). Suppose a firm has two sewing machines
and can vary only the amount of labor input.
(a) Graph the production function for jeans given the two sewing machines.
(b) Compute and graph the marginal physical product curve.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
(c) At what amount of labor input does the law of diminishing returns first become apparent
in your graph of marginal physical product?
(d) Is total output still increasing when MPP begins to diminish?
(e) When total output stops increasing, what is the value of MPP?
(LO 07-02)
Answers:
(a)
9876543210
90
80
70
60
50
40
30
20
10
0
Labor Input (workers per day)
Labor Output (pairs per day)
Production Function for Jeans
(b) Given two sewing machines,
Input Total Physical Product (Output) Marginal Physical Product
0 0 —
1 20 20
2 46 26
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
876543210
25
20
15
10
5
0
Labor Input (workers per day)
Marginal Physical Product
Marginal Physical Product Curve for J eans
(c) 3 units.
(d) Yes.
(e) –2.
Feedback:
(a) A production function is the technological relationship expressing the maximum quantity
(b) Marginal physical product is the change in total output associated with one additional unit
(c) The law of diminishing returns says that the marginal physical product of any factor of
(d) Marginal physical product diminishes at three units of labor, yet at three units of labor
(e) Total output stops increasing with the eighth worker. Total output decreases from 82 units
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
5. The following table indicates the average total cost of producing varying quantities of output
from three different plants:
(a) Plot the ATC curves for all three firms on the graph.
(b) Which plant(s) should be used to produce 40 units?
(c) What plant(s) should be used to produce 100 units?
(d) Are there economies of scale in these plant size choices?
(LO 07-03)
Answers:
(a)
OUT PUT (units per perio d)
AVERAGE COS T (per unit)
0
1 0 0
20 0
30 0
4 0 0
5 0 0
6 0 0
70 0
8 0 0
9 0 0
1000
11 0 0
0 1 0 20 30 4 0 5 0 6 0 70 8 0 9 0 1 0 0
S ma ll
firm
La rge
firm
Medium
firm
Feedback:
(a) In order to plot the average total cost curves for the three firms, simply pair average total
(b) At 40 units of output, the small firm has an average cost of $500, the medium firm has an
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
(c) At 100 units of output, the small firm has an average cost of $1,100, the medium firm has
(d) Economies of scale exist up to 50 units of output because the medium firm shows lower
6. According to the World View on page 157, (a) which nation had the biggest loss of
competitive position in years 2007–2011? (b) Which had the biggest gain? (LO 07-05)
Feedback:
(a) According to the World View, Finland had the biggest loss of competitive advantage in
(b) Taiwan had the biggest gain in terms of competitive advantage. Its unit labor costs
7. Suppose (A) the hourly wage rate is $24 in the United States and $3 in China, and (B)
productivity is 20 units per hour in the United States and 4 units per hour in China. What are
unit labor costs in
(a) The United States?
(b) China?
(LO 07-01)
Answers:
Feedback:
(a) Unit labor costs are simply wage rates divided by marginal physical product (or
(b) Unit labor costs are simply wage rates divided by marginal physical product (or
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
