HIDALGO, ALYANNAH M.

2LM4

EXERCISES FOR TOPIC 6

1. Complete the following table by calculating marginal product and average product from the data given.
Plot total, marginal, and average product 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.” Il-
lustrate and explain graphically.

Inputs of Labor Total Product Marginal Product Average Product

0 0 0 -
1 15 15 15
2 34 19 17
3 51 17 17
4 65 14 16.25
5 74 9 14.80
6 80 6 13.33
7 83 3 11.86
8 82 –1 10.25

90
80
70
60
50
40
30
20
10
0
-10 0 1 2 3 4 5 6 7 8

TP MP AP

When Total Product is increasing, Marginal Product is also positive and rising. When Total Product is
rising at a diminishing rate, Marginal Product is positive but falling. When Total Product is falling, Marginal
Product is negative and falling. Average Product rises when Marginal Product is above it and Average Product
falls when Marginal Product is below it. In the above graph, observe that the marginal product curve rises first.
This is because with the addition of new labor, the productivity with respect to the usage of resources like
equipment and machinery increases. This results in improving the marginal product. With continuous addition of
worker or labor, the law of diminishing returns holds resulting in a decline in the marginal product. Also, more
number of workers than that of the machinery results in congestion resulting in a fall in the marginal product. At
the extreme level, the marginal product with an additional labor also becomes negative resulting in a fall in the
total output.

Because labor is the only variable input and its price (wage rate) is constant, Marginal Cost is found by
dividing the wage rate by Marginal Product. When Marginal product is rising, Marginal Cost is falling; when
Marginal Product reaches its maximum, Marginal Cost is at its minimum; when Marginal Product is falling,
Marginal Cost is rising. The marginal cost curve is a mirror reflection of the marginal product curve.

2. A firm has fixed costs of P60 and variable costs as indicated in the table below. Complete the table.

Total Total Fixed Total Variable Total Average Average Variable Average Total Marginal
Product Cost Cost Cost Fixed Cost Cost Cost Cost
0 P 60 P0 P 60 P- P- P- P-
1 60 45 105 60 45 105 45
2 60 85 145 30 42.50 72.50 40
3 60 120 180 20 40 60 35
4 60 150 210 15 37.50 52.50 30
5 60 185 245 12 37 49 35
6 60 225 285 10 37.50 47.50 40
7 60 270 330 8.57 38.57 47.14 45
8 60 325 385 7.50 40.63 48.13 55
9 60 390 450 6.67 43.33 50 65
10 60 465 525 6 46.50 52.50 75
 a. Graph total fixed cost, total variable cost, and total cost. Explain how the law of diminishing returns
influences the shapes of the total variable-cost and total-cost curves.

COSTS
Cost
600

500

400

300

200

100

0
0 1 2 3 4 5 6 7 8 9 10

TFC TVC TC Total Product

The above figure shows graphically the total fixed cost, total variable cost, and total cost data. The Total
Variable Cost is measured vertically from the horizontal axis at each level of output. Total Fixed Cost is added
vertically to the total variable cost curve to obtain the points on the total cost curve Total Cost. In the graph, you
can see that the slope of the Total Variable Cost and the Total Cost curves upward at a decreasing rate over the 0
to 4 range of the total product or the output. This slope shows an increasing marginal returns. On the contrary, as
the rate of the diminishing marginal returns occur the trend of the curves then increase at an increasing rate.

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 in-
tersects both the AVC and ATC curves at their minimum points.

COSTS
120

100

80

60

40

20

0
0 1 2 3 4 5 6 7 8 9 10
Total Product
AFC AVC ATC MC
 The curve of Average Fixed Cost is continuously decreasing because a fixed amount of capital cost is
spread over more units of output. On the other hand, we can see that the curve of the Average Variable Cost,
Average Total Cost, and the Marginal Cost are U-shape. These three curves reflects the influence of first
increasing then diminishing returns. The total curve of the Average Variable Cost and the Average Fixed Cost
vertically is the Average Total Cost. Inversely, when the curve of the Marginal Cost is above the Average Total
Cost, then the curve of the Average Total Cost increases or rises. When the curve of the Marginal Cost is below
the Average Total Cost, then the curve of the Average Total cost decreases or falls. This tells us that the that
Marginal Cost curve must intersect the Average Total Cost and Average Variable Cost curve at its minimum
point. Likewise, for the minimum point of the Average Variable Cost.

3. What is a sunk cost? Provide an example of a sunk cost other than one from this book. Why are such
costs irrelevant in making decisions about future actions?
Sunk costs are costs that has already occurred and cannot be retrieved or recovered once they have been
incurred in the past. All sunk costs are considered as fixed cost. Sunk costs are irrelevant in making decisions
about future actions since this is a cost which have already wasted and cannot be recovered. They cannot be
undone. The cost will only remain the same regardless of the outcome of a decision made. For example, a
company spends one million pesos to conduct a research regarding the feasibility of their proposed new product.
The study concludes that the product does not suit the tastes of the people, therefore unsuccessful. The one million
peso budget is a sunk cost. The company should not continue with the product launch and the initial marketing
study investment should not be considered when making decisions. Another example is that, when one person
purchased a newly launched cellphone, then decided to just sell it because there is an emergency and he needs the
money, he cannot sell it for the original purchase price. The difference between the original price and the reselling
price is the sunk cost.