Production cost Questions

Part A: Conceptual questions

1. Suppose you own a television factory and at your current level of output, you have average total cost of $800 per television, average variable costs of $700 per television, and a marginal cost of $400. If the price your buyers are willing to pay is $500, should you decrease or increase production? Explain your reasoning, and make sure to cite at least one of the required readings in your answer.

Since the marginal cost (MC) is lower than the average variable cost (AVC), it shows that both the AVC and average total cost (ATC) are decreasing. AVC will decrease to meet the MC at the shut down point. If the shut down point is higher than the price the buyers are willing to pay; increasing production will increase both the MC and AVC resulting to a loss. Thus in the short run, production should increase as far as the shut down point is below the price. In the long run, as ATC decreases, it meets the MC at the breakeven point where total revenue equals total cost. Provided the price is higher than the breakeven point, then production should increase (Fuss, McFadden, 2014). If the price is lower than the breakeven point, production should decrease until price is equals to the breakeven point.

2. You are the owner of a restaurant, and currently you have only one waiter. While this keeps costs down, many of your customers go home because they are tired of waiting in line or waiting for their order. You hire four more waiters and waitresses, and you are now able to serve a dramatically higher number of customers.  Seeing the huge productivity gains from hiring more staff, you then hire 20 more waiters and waitresses.  However, you are not able to serve any more customers than you were able to when your staff size was only four.  In fact, your restaurant has become overly crowded because there is not enough room in your restaurant for all of your staff.  You are confused as to why hiring four more staff members increased your productivity, but hiring 20 more did not.  What concept from the background readings best describes what happened in this case?  Explain your reasoning.

As more workers are added, there is increase in productivity. However, at some point, the productivity will reach a maximum and adding more workers will result to diminishing returns. Adding 4 workers increases both the average product of labor (AP) and marginal product of labor (MP). Adding more workers beyond the point where AP=MP will result to diminishing returns (McEachern, 2013). Thus hiring 4 workers results to increasing return since MP>AP but adding 20 workers results in diminishing returns since both the AP and MP  are decreasing.

Part B: Quantitative problems

The following table gives the total weekly output of bicycles at Al’s Bicycle Town.

Table 1

Labor      Total Product (TP)   Average Product of labor (AP)   Marginal Product of labor (MP)

0               0                                  na                                                     na

1             100                              100                                                   100

2             300                             150                                                    200

3             450                             150                                                    150

4             560                            140                                                    110

5             630                             126                                                     70

6             660                             110                                                     30

  • Complete this table.

TC=

An example at two units of labor, the total product is 300, and the average total product is 300 divided by 2 resulting to 150.

The marginal product is the increase in total product when labor increase by a unit.

  • Draw the graphs of the marginal product (MP) and the average product (AP).
  • Where do the AP and MP curve cross?

The AP and MP curves cross at the point where labor is equals to 3. At this point, an increase in labor decreases the average product of labor.

  • The cost of 1 worker is $2000 per month. Total fixed cost is $4000 per month.
  • Complete Table 2 using your answers from Table 1 and by computing total variable cost (TVC) and total cost (TC).

Table 2

Labor      Total Product (TP)   Total variable cost (TVC)   Total cost (TC)

0               0                                  na                                                  4000

1             100                              2000                                               6000

2             300                             4000                                                 8000

3             450                             6000                                                 10000

4             560                             8000                                                 12000

5             630                             10000                                               14000

6             660                            12000                                                16000

TVC= (2,000x Labor units)

With 3 units of labor, the total variable cost is (3×2000) = 6000

TC= (TVC+TFC)

With 3 units of labor, total cost is (6000+4000) = 10,000

  • Draw the graphs of the TC and TVC curves. What is the relationship between these two curves?

As the total variable cost increases, the total cost increases with the same amount. Thus, the curves produce parallel lines that can never meet showing a linear relationship between TVC and TC (Shepherd, 2015).

  • Complete Table 3 by using your answers from the previous Tables and calculating the AVC, ATC, and MC.

Table 3

Total Product (TP) Average variable cost (AVC) Average total cost (ATC) Marginal cost (MC)

0                                na                                na                                           na

100                              20                               60                                             20

300                             13.33                           26.67                                        10

450                             13.33                           22.22                                       13.33

560                             14.29                           21.43                                       18.18

630                             15.87                           22.22                                       28.57

660                             18.18                           24.24                                       66.67

AVC=

ATC=

MC=

  • Draw the graphs of the ATC, AVC, and MC curves. What is the relationship between the ATC and AVC curves? Between the MC and AVC curves?

The AVC and the ATC curves are moving at the same direction. First, both are decreasing and then start to increase at the same point.  The MC and AVC curves meet at the point where AVC is at its lowest. This is the shut down point meaning that the total revenues are just enough to cover the total variable costs (Mankiw, 2012).

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