Chapter 7/Production, Inputs, and Costs: Building Blocks for Supply Analysis
CHAPTER 7
PRODUCTION, INPUTS, AND COSTS: BUILDING
BLOCKS FOR SUPPLY ANALYSIS
TEST YOURSELF
1. A firm’s total fixed cost is $360,000. Construct a table of its total and average fixed
costs for output levels varying from zero to six units. Draw the corresponding TFC
and AFC curves.
TFC AFC
(thousands (thousands
Output of dollars) of dollars)
0 360 —
1 360 360
2 360 180
FIGURE 1
2. With the following data, calculate the firm’s AVC and MVC and draw the graphs for
TVC, AVC, and MVC. Why is MVC the same as MC?
Quantity Total
Variable
Costs
1 $ 40,000
2 80,000
3 120,000
4 176,000
5 240,000
Chapter 7/Production, Inputs, and Costs: Building Blocks for Supply Analysis
6 360,000
TVC AVC MVC
(thousands (thousands (thousands
Output of dollars) of dollars) of dollars)
1 40 40 40
2 80 40 40
FIGURE 2
3. From the data in Test Yourself Questions 1 and 2, calculate TC and AC for each of the
output levels from one to six units and draw the two graphs.
TC AC
(thousands (thousands
Output of dollars) of dollars)
0 360 —
1 400 400
2 440 220
Chapter 7/Production, Inputs, and Costs: Building Blocks for Supply Analysis
FIGURE 3
4. If a firm’s commitments in 2011 include machinery that will need replacement in
five years, a factory building rented for 12 years, and a three-year union contract
specifying how many workers it must employ, when, from its point of view in 2011,
does the firm’s long run begin?
5. If the marginal revenue product of a gallon of oil used as input by a firm is $2.20
and the price of oil is $2.07 per gallon, what can the firm do to increase its profits?
It can raise its profits by increasing its use of oil. Adding 1 gallon of oil will raise its
6. A firm hires two workers and rents 15 acres of land for a season. It produces
150,000 bushels of crop. If it had doubled its land and labor, production would have
been 325,000 bushels. Does it have constant, decreasing, or increasing returns to
scale?
7. Suppose that wages are $20,000 per season per person and land rent per acre is
$3,000. Calculate the average cost of 150,000 bushels and the average cost of 325,000
bushels, using the figures in Test Yourself Question 6. (Note that average costs
increase when output increases.) What connection do these figures have with the
firm’s returns to scale?
Chapter 7/Production, Inputs, and Costs: Building Blocks for Supply Analysis
150,000 Bushels 325,000 Bushels
Wages $40,000 $80,000
Rent $45,000 $90,000
8. Suppose that wages are $20,000 per season per person and land rent per acre is
$3,000. Calculate the average cost of 150,000 bushels and the average cost of 325,000
bushels, using the figures in Test Yourself Question 6. (Note that average costs
increase when output increases.) What connection do these figures have with the
firm’s returns to scale?
When Naomi bought a great deal of feed, the MPP of feed was low because of
diminishing returns. The ratio of feed to chicks was high: More feed could not produce
9. Labor costs $12 per hour. Nine workers produce 180 bushels of product per hour,
whereas 10 workers produce 196 bushels. Land rents for $1,200 per acre per year.
With 10 acres worked by nine workers, the marginal physical product of an acre of
land is 1,400 bushels per year. Does the farmer minimize costs by hiring nine
workers and renting 10 acres of land? If not, which input should he use in larger
relative quantity?
For labor, the MPP is 16, the price is $12, and the ratio of the two is a bit more than 1.3;
10. Remember Al, the builder of inexpensive garages? Suppose that his total costs
increase by $5,000 per year at every input level. Modify Table 2 to show how this
change affects his total and average costs.
Number of
Carpenters
(Input)
Old
Total Cost
Old
Average Cost
New
Total Cost
New
Average Cost
0 0 0 5,000 0
1 50,000 12,500 55,000 13,750
Chapter 7/Production, Inputs, and Costs: Building Blocks for Supply Analysis
DISCUSSION QUESTIONS
1. A firm experiences a sudden increase in the demand for its product. In the short
run, it must operate longer hours and pay higher overtime wage rates to satisfy this
new demand. In the long run, the firm can install more machines instead of
operating fewer machines for longer hours. Which do you think will be lower, the
short-run or the long-run average cost of the increased output? How is your answer
affected by the fact that the long-run average cost includes the new machines the
firm buys, whereas the short-run average cost includes no machine purchases?
The long-run average cost will be lower than the short-run average cost, even though the
former includes the cost of new machines. In the long run, the firm will have lower labor
ANSWERS TO APPENDIX QUESTIONS
TEST YOURSELF
1. Compound Consolidated Corporation (CCC) produces containers using two inputs:
labor and glue. If labor costs $10 per hour and glue costs $5 per gallon, draw CCC’s
budget line for a total expenditure of $100,000. In this same diagram, sketch a
production indifference curve indicating that CCC can produce no more than 1,000
containers with this expenditure.
FIGURE 4
2. With respect to Test Yourself Question 1, suppose that wages rise to $20 per hour
and glue prices rise to $6 per gallon. How are CCC’s optimal input proportions
likely to change? (Use a diagram to explain your answer.)
3. What happens to the location of the expansion path of the firm in Test Yourself
Question 2?
When the price ratio of glue to labor falls, the ratio of glue to labor used rises. Therefore,