Homework 5

Gracena Sesilia Marde Fitria (NPM: 2106629862)

Chapter 7. 
Questions and Review
Page 279  No 3,4,5, 9,10,14

No.3 

A. True. Since there was no financial transaction, there was no clear cost to
account for. However, there is a financial penalty because the business owner
may be hired elsewhere. The opportunity cost of the owner's time is reflected in
the positive economic cost. The worth of the owner's time in the next best
option, or the amount that the owner would make if he accepted the best job, is
the economic cost.
B. True. Accounting profit simply takes into account the direct, monetary costs.
It's possible that when opportunity costs are taken into account, economic profit
will turn negative because some opportunity costs might not have been
completely realized as explicit monetary charges. This shows that the
company's resources are not being used to their full potential.
C. False. From the firm’s point of view, the wage paid to the worker is an explicit
cost whether she was previously unemployed or not. The firm’s opportunity
cost is equal to the wage, because if it did not hire this worker, it would have
had to hire someone else at the same wage. The opportunity cost from the
worker’s point of view is the value of her time, which is unlikely to be zero. By
taking this job, she cannot work at another job or take care of a child or elderly
person at home. If her best alternative is working at another job, she gives up
the wage she would have earned. If her best alternative is unpaid, such as
taking care of a loved one, she will now have to pay someone else to do that
job, and the amount she has to pay is her opportunity cost.

No.4

The marginal product of labor must be increasing. The marginal cost of production
measures the extra cost of producing one more unit of output. If this cost is
diminishing, then it must be taking fewer units of labor to produce the extra unit of
output. If fewer units of labor are required to produce a unit of output, then the
marginal product (extra output produced by an extra unit of labor) must be increasing.
Note also, that MC = w/MPL , so that if MC is diminishing then MPL must be
increasing for any given w.
No.5 
The question states that the MRTS of capital for labor is greater than r/w. Note that
this is different from the MRTS of labor for capital, which is what is used in Chapters
6 and 7. The MRTS of labor for capital equals MPK/MPL. So it follows that
MPK/MPL > r/w or, written another way, MPK/r > MPL/w. These two ratios should
be equal to minimize cost. Since the manufacturer gets more marginal output per
dollar from capital than from labor, she should use more capital and less labor to
minimize the cost of production.

No.9 
Average total cost is equal to average fixed cost plus average variable cost: ATC =
AVC + AFC. When graphed, the difference between the U-shaped average total cost
and U-shaped average variable cost curves is the average fixed cost, and AFC is
downward sloping at all output levels. When AVC is falling, ATC will also fall
because both AVC and AFC are declining as output increases. When AVC reaches its
minimum (the bottom of its U), ATC will continue to fall because AFC is falling.
Even as AVC gradually begins to rise, ATC will still fall because of AFC’s decline.
Eventually, however, as AVC rises more rapidly, the increases in AVC will outstrip
the declines in AFC, and ATC will reach its minimum and then begin to rise.

No.10
When the firm experiences economies of scale, its long-run average cost curve is
downward sloping. When costs increase proportionately with output, the firm’s long-
run average cost curve is horizontal. So this firm’s long-run average cost curve has a
rounded L-shape; first it falls and then it becomes horizontal as output increases.

No.14
Economies of scale depend on the relationship between cost and output—i.e., how
does cost change when output is doubled? Returns to scale depend on what happens to
output when all inputs are doubled. The difference is that economies of scale reflect
input proportions that change optimally as output is increased, while returns to scale
are based on fixed input proportions (such as two units of labor for every unit of
capital) as output increases.
Exercise 
Page 280-281 No 2,3,4, 8,11

No. 2

A.

B.
Average total cost is U-shaped and reaches a minimum at an output of about 7.
Average variable cost is also U-shaped and reaches a minimum at an output between 3
and 4. Notice that average variable cost is always below average total cost. The
difference between the two costs is the average fixed cost. Marginal cost is first
diminishing, up to a quantity of 3, and then increases as q increases above 3. Marginal
cost should intersect average variable cost and average total cost at their respective
minimum points, though this is not accurately reflected in the table or the graph. If
specific functions had been given in the problem instead of just a series of numbers,
then it would be possible to find the exact point of intersection between marginal and
average total cost and marginal and average variable cost. The curves are likely to
intersect at a quantity that is not a whole number, and hence are not listed in the table
or represented exactly in the cost diagram.
No.3

No.4
This tax is a fixed cost because it does not vary with the quantity of output produced.
If T is the amount of the tax and F is the firm’s original fixed cost, the new total fixed
cost increases to TFC = T + F. The tax does not affect marginal or variable cost
because it does not vary with output. The tax increases both average fixed cost and
average total cost by T/q.
Let t equal the per unit tax. When a tax is imposed on each unit produced, total variabl
e cost increases by tq and fixed cost does not
change. Average variable cost increases by t, and because
fixed costs are constant, average total cost also increases by
t. Further, because total cost increases by
t for each additional unit produced, marginal cost increases by t.
No. 8

A.

B.

C.
We no longer assume that K is fixed at 5. We need to find the combination of K and L
that minimizes cost at any level of output q. The cost-minimization rule is given by
To find the marginal product of capital, observe that increasing K by 1 unit increases q
by 5L, so MPK = 5L. Similarly, observe that increasing L by 1 unit increases q by 5K,
so MPL = 5K. Mathematically,

The new plant should accommodate a capital to labor ratio of 1 to 2, and this is the
same regardless of the number of units produced.

No.9

A.
To graph the isoquant, set q = 100 in the production function and solve it for K.
Solving for K: 1/2 1/2 10 q K L = Substitute 100 for q and square both sides. The
isoquant is K = 100/L. Choose various combinations of L and K and plot them. The
isoquant is convex. The optimal quantities of labor and capital are given by the point
where the isocost line is tangent to the isoquant. The isocost line has a slope of −1/4,
given labor is on the horizontal axis. The total cost is TC = ($20)(20) + ($80)(5) =
$800, so the isocost line has the equation 20L + 80K = 800, or K = 10 − 0.25L, with
intercepts K = 10 and L = 40. The optimal point is labeled A on the graph.
B.
The new level of labor is 39.2. To find this, use the production function 1 1 q =10L
K2 2 and substitute 140 for output and 5 for capital; then solve for L. The new cost is
TC = ($20)(39.2) + ($80)(5) = $1184. The new isoquant for an output of 140 is above
and to the right of the original isoquant. Since capital is fixed in the short run, the firm
will move out horizontally to the new isoquant and new level of labor. This is point B
on the graph below. This is not the long-run cost- minimizing point, but it is the best
the firm can do in the short run with K fixed at 5. You can tell that this is not the long-
run optimum because the isocost is not tangent to the isoquant at point B. Also there
are points on the new (q = 140) isoquant that are below the new isocost (for part b)
line. These points all involve hiring more capital and less labor.

C.
This is point C on the graph above. When the firm is at point B it is not minimizing
cost. The firm will find it optimal to hire more capital and less labor and move to the
new lower isocost (for part c) line that is tangent to the q = 140 isoquant. Note that all
three isocost lines are parallel and have the same slope.

D.