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Chapter 09 - Businesses and the Costs of Production
9-1
Chapter 09 - Businesses and the Costs of Production
McConnell Brue Flynn 21e
DISCUSSION QUESTIONS
1. Distinguish between explicit and implicit costs, giving examples of each. What are some
explicit and implicit costs of attending college? LO1
2. Distinguish between accounting profit, economic profit, and normal profit. Does accounting
profit or economic profit determine how entrepreneurs allocate resources between different
business ventures? Explain. LO1
Chapter 09 - Businesses and the Costs of Production
3. Complete the table directly below by calculating marginal product and average product.
Plot the total, marginal, and average products and explain in detail the relationship between each
pair of curves. Explain why marginal product first rises, then declines, and ultimately becomes
negative. What bearing does the law of diminishing returns have on short-run costs? Be specific.
“When marginal product is rising, marginal cost is falling. And when marginal product is
diminishing, marginal cost is rising.” Illustrate and explain graphically. LO2
Chapter 09 - Businesses and the Costs of Production
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Plots, or graphs, for this problem will need to be done by students and instructors.
MP is the slope—the rate of change—of the TP curve. When TP is rising at an
4. Why can the distinction between fixed costs and variable costs be made in the short run?
Classify the following as fixed or variable costs: advertising expenditures, fuel, interest on
company-issued bonds, shipping charges, payments for raw materials, real estate taxes, executive
salaries, insurance premiums, wage payments, depreciation and obsolescence charges, sales taxes,
and rental payments on leased office machinery. “There are no fixed costs in the long run; all
costs are variable.” Explain. LO3
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5. List several fixed and variable costs associated with owning and operating an automobile.
Suppose you are considering whether to drive your car or fly 1,000 miles to Florida for spring
break. Which costs—fixed, variable, or both—would you take into account in making your
decision? Would any implicit costs be relevant? Explain. LO3
6. Use the concepts of economies and diseconomies of scale to explain the shape of a firm’s
long-run ATC curve. What is the concept of minimum efficient scale? What bearing can the
shape of the long-run ATC curve have on the structure of an industry? LO4
Chapter 09 - Businesses and the Costs of Production
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7. LAST WORD Does additive manufacturing rely on economies of scale to deliver low costs?
What are two ways in which additive manufacturing lowers costs? Besides what's written in the
book, might there be another reason to expect 3-D blueprints to be inexpensive? (Hint: Think in
terms of supply and demand.)
REVIEW QUESTIONS
1. Linda sells 100 bottles of homemade ketchup for $10 each. The cost of the ingredients and the
bottles and the labels was $700. In addition, it took her 20 hours to make the ketchup and to do so
she took time off from a job that paid her $20 per hour. Linda’s accounting profit is
_____________ while her economic profit is ______________. LO1
a. $700; $400
b. $300; $100
c. $300; negative $100
d. $1,000; negative $1,100
2. Which of the following are short-run and which are long-run adjustments? LO1
a. Wendy’s builds a new restaurant.
b. Harley-Davidson Corporation hires 200 more production workers.
c. A farmer increases the amount of fertilizer used on his corn crop.
d. An Alcoa aluminum plant adds a third shift of workers.
Chapter 09 - Businesses and the Costs of Production
9-6
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Answer:
a. Long-Run. This is a capital investment, which takes time to become productive.
b. Short-Run. The new laborers can work immediately.
c. Short-Run. Although this takes time via the growing process, this is still a short-run
adjustment. It influences the growth of current crops immediately.
d. Short-Run. The new laborers can work immediately.
3. A firm has fixed costs of $60 and variable costs as indicated in the table at the bottom of this
page. Complete the table and check your calculations by referring to problem 4 at the end of
Chapter 10. LO3
a.Graph total fixed cost, total variable cost, and total cost. Explain how the law of diminishing
returns influences the shapes of the variable-cost and total-cost curves.
b.Graph AFC, AVC, ATC, and MC. Explain the derivation and shape of each of these four curves
and their relationships to one another. Specifically, explain in nontechnical terms why the MC
curve intersects both the AVC and the ATC curves at their minimum points.
c.Explain how the location of each curve graphed in question 3b would be altered if (1) total fixed
cost had been $100 rather than $60 and (2) total variable cost had been $10 less at each level of
output.
Chapter 09 - Businesses and the Costs of Production
9-7
Chapter 09 - Businesses and the Costs of Production
9-8
c. (1) If TFC has been $100 instead of $60, the AFC and ATC curves would be
(2) If TVC has been $10 less at each output, MC would be $10 lower for the first
unit of output but remain the same for the remaining output. The AVC and ATC
4. Indicate how each of the following would shift the (1) marginal-cost curve, (2) average-
variable-cost curve, (3) average-fixed-cost curve, and (4) average-total-cost curve of a
manufacturing firm. In each case specify the direction of the shift. LO3
a.A reduction in business property taxes.
b.An increase in the nominal wages of production workers.
c.A decrease in the price of electricity.
d.An increase in insurance rates on plant and equipment.
e.An increase in transportation costs.
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5. True or false. The U shape of the long-run ATC curve is the result of diminishing returns.
LO4
6. Suppose a firm has only three possible plant-size options, represented by the ATC curves
shown in the accompanying figure. What plant size will the firm choose in producing (a) 50, (b)
130, (c) 160, and (d) 250 units of output? Draw the firm’s long-run average-cost curve on the
diagram and describe this curve. LO4
Chapter 09 - Businesses and the Costs of Production
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Answer:
PROBLEMS
1. Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of
$5,000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds
invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000 per year if
alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor.
He estimates his entrepreneurial talents are worth $3,000 per year. Total annual revenue from
pottery sales is $72,000. Calculate the accounting profit and the economic profit for Gomez’s
pottery firm. LO1
2. Imagine you have some workers and some hand-held computers that you can use to take
inventory at a warehouse. There are diminishing returns to taking inventory. If one worker uses
one computer, he can inventory 100 items per hour. Two workers can together inventory 150
items per hour. Three workers can together inventory 160 items per hour. And four or more
workers can together inventory fewer than 160 items per hour. Computers cost $100 each and you
must pay each worker $25 per hour. If you assign one worker per computer, what is the cost of
inventorying a single item? What if you assign two workers per computer? Three? How many
workers per computer should you assign if you wish to minimize the cost of inventorying a single
item? LO2
Chapter 09 - Businesses and the Costs of Production
9-11
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Answer: 1.25; 1.00; 1.09; 2
If you assign one worker per computer, the cost of inventorying a single item is $1.25.
You incur the cost of the computer, $100, and the cost of employing one worker, $25,
which is divided by the number of units inventoried, 100 (= ($100 + $25) / 100)).
If you assign two workers per computer, the cost of inventorying a single item is $1.00.
You incur the cost of the computer, $100, and the cost of employing two workers, $50
($25 each), which is divided by the number of units inventoried by the two workers, 150
(= ($100 + $50) / 150)).
If you assign three workers per computer, the cost of inventorying a single item is $1.09.
You incur the cost of the computer, $100, and the cost of employing three workers, $75
($25 each), which is divided by the number of units inventoried by the three workers, 160
(= ($100 + $75) / 160)).
To minimize the cost of inventorying a single item, you should assign two workers to
each computer. This is the lowest cost per unit inventoried given the information above.
3. You are a newspaper publisher. You are in the middle of a one-year rental contract for your
factory that requires you to pay $500,000 per month, and you have contractual labor obligations
of $1 million per month that you can’t get out of. You also have a marginal printing cost of $0.25
per paper as well as a marginal delivery cost of $0.10 per paper. If sales fall by 20 percent from 1
million papers per month to 800,000 papers per month, what happens to the AFC per paper, the
MC per paper, and the minimum amount that you must charge to break even on these costs? LO3
Answers:
Here Marginal Cost (MC) is constant, which implies that Average Variable Cost (AVC)
Chapter 09 - Businesses and the Costs of Production
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Now assuming sales fall by 20% to 800,000 papers sold, the new average fixed cost
(AFC) is $1.88. This equals the total fixed cost $1.5 million divided by the new number
4. There are economies of scale in ranching, especially with regard to fencing land. Suppose that
barbed-wire fencing costs $10,000 per mile to set up. How much would it cost to fence a single
property whose area is one square mile if that property also happens to be perfectly square, with
sides that are each one-mile long? How much would it cost to fence exactly four such properties,
which together would contain four square miles of area? Now, consider how much it would cost
to fence in four square miles of ranch land if, instead, it comes as a single large square that is two-
miles long on each side. Which is more costly—fencing in the four, one-square-mile properties or
the single four-square-mile property? LO4
to set up. How much would it cost to fence a single property whose area is one square
mile if that property also happens to be perfectly square, with sides that are each one-mile
Chapter 09 - Businesses and the Costs of Production
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Now, consider how much it would cost to fence in four square miles of ranch land if,
instead, it comes as a single large square that is two-miles long on each side. Here, we
This implies that it is cheaper to fence a property of four square miles than four properties
of one square mile. The cost savings comes from the fact that we do not need to fence off
the inner sides of the square miles (dashed lines).
