sno– cone machine, which also costs $15/hour but
makes 15 sno– cones an hour. In this case, it
would make sense to hire the college student first.
However, if additional workers face diminishing
marginal product, then at some point, when the
marginal product of the next college student falls
below 15 sno- cones an hour, it makes more sense
to rent a machine instead. Likewise, once the
4. When marginal product is positive and increas-
ing, the total product of the firm is increasing at
an increasing rate. When marginal product is
positive but decreasing, the total product of the
firm is increasing (but at a decreasing rate). When
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Questions for Review
1. ■ Economic profit (or loss) “ Total revenue Total
cost “ Total revenue Explicit costs Implicit costs.
■ Accounting profit (or loss) “ Total revenue
Explicit costs.
In a nutshell, a com pany’s profit is what it earns
by selling its products (revenue) minus what it
2. Accounting profit may sometimes be misleading
in indicating how successful a com pany is. Eco–
nomic profit is not. Suppose you quit your job to
start your own business, and, in its first year, the
business pulls in an accounting profit of $75,000.
accounting profit looks pretty good; however, your
economic profit tells the true story: you would
have been better off staying at your former job.
This makes economic profit a better mea sure of
the true profit.
3. Comparing the marginal product of labor with
the marginal product of capital will determine
the ideal mix of labor and capital. The fact that
Solutions to Chapterfi8 Text Prob lems
192 / CHAPTER 8 Business Costs and Production
As hotels open even more locations, they may
need to create dif fer ent levels of man ag ers to
oversee operations in their dif fer ent locations.
Diseconomies of scale: law firms. Law
firms would face diseconomies of scale: in order
for a law firm to expand into dif fer ent types of
law ( family law versus litigation), the lawyers in
Study Prob lems
1. Some tips for playing the lemonade game:
■ Keep your eye on the weather. On clear, hot
days, the demand for lemonade is higher,
■ Cups never go bad, so you should stock up
when prices are low. Ice will melt at the end of
the day, so buy only enough for that day’s
production.
2. The easiest way to determine where diminishing
marginal product occurs is to create a third col-
Input of Labor
Total Output of
Laptop Computers MP
520020
6205 5
ninth workers, marginal product is negative. This
means that hiring that seventh worker actually
lowers the total product. The same is true for the
eighth and ninth workers.
5. Marginal cost directly determines average vari-
able cost, and average total cost depends on aver–
Hints and Common Errors: As long as
marginal cost is below average variable cost—
regardless of whether it is increasing or
decreasing— average variable cost is decreasing.
As soon as marginal cost rises above average
6. The short- run cost curve reects that some costs
are fixed, and businesses face diminishing mar–
ginal product. In the long run, all costs are vari-
able, and diminishing marginal product is no
longer relevant. The short- run cost curves are all
U- shaped, while the long– run cost curve can have
7. Economies of scale: telephone companies. Tele–
phone companies should face economies of
scale— they lay out hundreds or thousands of
pany (and one gas com pany) in a city or region.
Constant returns to scale: hotels. Hotel
chains should face constant returns to scale. As
they open more hotel locations, they are able to
Solutions to Chapterfi8 Text Prob lems / 193
d. False. Economic profit is always less than
accounting profit. Recall that accounting
profit is defined as a firm’s total revenue
minus its explicit costs, while economic profit
is defined as total revenue minus explicit and
ing an additional unit of output (e.g., the cost
of producing five units minus the cost of pro–
ducing four units).
6. These products exhibit economies of scale. Long-
run cost is a reection of scale and the cost of
providing additional output. For digital media, a
large- scale operation that covers many markets
is very cheap and requires only a web site, which
is accessible to anyone with a computer. Provid-
ing an additional unit of a product costs noth-
The variable cost might include things like fuel
and the cost of the ight attendants. However,
when the airline calculates its profits, it has to
include the fixed costs incurred that year, such as
the cost of buying the plane that ies that route.
This is a huge fixed cost that the revenue from
topay only an additional $10. This $10 (not
theaverage cost of $25) is what you should
consider when deciding whether to get the
two- daypass.
10.
Output
Total
Fixed
Cost
Total
Variable
Cost
Total
Cost
Average
Fixed
Cost AVC ATC MC
0500 0 500 — — —
The point of diminishing marginal product is
where marginal product starts to decrease, which
happens at the third labor input. At the third
input of labor, marginal product falls from 60 to
50.
product occurs much earlier, at the third worker.
3.
Output
(pizzas/day)
Total Cost
of Output AFC VC AVC ATC MC
0$25 $0
10 75 2.50 50 5.00 7.50 5
20 115 1.25 90 4.50 5.75 4.00
30 150 0.83 125 4.17 5.00 3.50
40 175 0.63 150 3.75 4.38 2.50
In order to calculate the average fixed cost, divide
the fixed cost (25) by the output. In order to
calculate average variable cost, it is easier first to
calculate the variable cost by subtracting the
5. a. True. The average fixed cost can never rise as
output increases. This is because average fixed
cost is calculated by dividing fixed cost by out–
put. The fixed cost (numerator) never changes,
as it is fixed. However, as output increases, the
denominator of average fixed cost increases,
making the entire number smaller. Intuitively,
you’re spreading the fixed cost out over the
output; this means that as output gets larger,
would include the cost of hourly workers in
addition to the costs mentioned above. Let’s say,
during a busy season, Cold Stone hires one or
two more workers at $10 an hour. They help the
cashier work faster, and each makes 10 addi-
tional ice creams an hour. Then the marginal
Declining marginal cost means economies of
scale, and the sixth unit involves no additional
production cost whatsoever.
This kind of thing might happen with a
digital product, such as a piece of software, where
First, fill out the total fixed cost column (which
should stay fixed at 500) and the average fixed
cost column (which is just total fixed cost divided
by output). Total fixed cost Total variable
cost “ Total cost. This helps fill out most of the
cells in the total variable cost and total cost
producing that additional unit.
11. The marginal cost of production in this case is
the cost of an additional cup of ice cream or fro–
zen yogurt. At frozen yogurt places, it is the cost
of a cup, avored ice cream, and mix– ins you
choose. The self- serve machines, other tools/