Microeconomics For Today 9th Edition Tucker Solutions Manual

Microeconomics For Today 9th Edition Tucker

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Chapter 7
Production Costs
CHAPTER SUMMARY

This chapter begins with a distinction between economic and accounting profit. Economic profit
takes into account implicit costs while accounting profit does not. We are most interested in economic
profit because that indicates whether a business is doing relatively well or not. The bulk of this chapter
introduces the student to the costs of production in the short and long run. The short run is any period of
time in which at least one resource (input) is fixed. In the long run all resources are variable.
There are seven short-run cost figures: TFC, TVC, TC, ATC, AVC, ATC, and MC. We end up with
a graph consisting of AVC, ATC, and MC. From these three cost curves we can determine all seven
short-run cost figures.
The long-run average cost curve is an envelope curve from numerous short-run average cost curves.
This curve is U-shaped. The downward sloping portion illustrates economies of scale; the upward-sloping
portion illustrates diseconomies of scale. There may be a horizontal portion reflecting constant returns to
scale.

NEW CONCEPTS INTRODUCED

explicit costs production function average variable cost (AVC)

implicit costs marginal product average total cost (ATC)
economic profit law of diminishing returns long-run average cost (LRAC)
normal profit total fixed cost (TFC) economies of scale
fixed input total variable cost (TVC) constant returns to scale
variable input total cost (TC) diseconomies of scale
short run marginal cost (MC) marginal-average rule
long run average fixed cost (AFC)

LEARNING OBJECTIVES
After completing this chapter, you should be able to:

1. Categorize a cost as implicit or explicit.

2. Distinguish between economic profit and accounting profit.
3. Define normal profit.
4. Distinguish between a fixed input and a variable input.
5. Explain the difference between the short-run and the long-run.
6. Understand the relation between marginal product and the law of
diminishing returns.
7. Define short-run cost curves.
8. Define the long-run cost curve.
9. Define economies, constant, returns, and diseconomies of scale.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 2 Economics for Today

CHAPTER OUTLINE

7-1 Costs and Profit

a. Explicit and Implicit Costs
b. Economic and Accounting Profit

Exhibit 1 "Computech's Accounting Profit versus Economic Profit"

Checkpoint: "Should the Professor Go or Stay"

7-2 Short-Run Production Costs

a. Short Run versus Long Run
b. The Production Function

Exhibit 2 "A Production Function and the Law of Diminishing Returns"

c. Marginal Product
d. The Law of Diminishing Returns

7-3 Short-Run Cost Formulas

a. Total Cost Curves
1. Total Fixed Cost
2. Total Variable Cost
3. Total Cost

Exhibit 3 "Short-Run Cost Schedule for Computech"

b. Average Cost Curves

1. Average Fixed Cost
2. Average Variable Cost
3. Average Total Cost

c. Marginal Cost

Exhibit 4 "Short-Run Cost Curves"

Exhibit 5 "Short-Run Cost Formulas"

7-4 Marginal Cost Relationships

a. The Marginal-Average Rule

Checkpoint: "Did Michael Jordon Beat the Marginal-Average Rule"

b. Marginal Cost's Mirror Image

Exhibit 6 "The Inverse Relationship between Marginal Product and Marginal Cost"

7-5 Long-Run Production Costs

a. Long-Run Average Cost Curves

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 7: Production Costs 3

Exhibit 7 "The Relationship between Three Factory Sizes and the Long-Run Average Cost
Curve"

b. Different Scales of Production

Exhibit 8 "The Long-Run Average Cost Curve when the Number of Factory Sizes is
Unlimited"

I. Economies of Scale
II. Constant Returns to Scale

Exhibit 9 "A Long-Run Average Cost Curve with Constant Returns to Scale"

III. Diseconomies of Scale

You're The Economist: Analyze the Issue

"Why is That Web Site You’re Using Free?” Applicable Concepts: economies and diseconomies
of scale

Summary of Conclusion Statements

a. Since business decision-making is based on economic profit, rather than accounting profit, the
word profit in this text always means economic profit.
b. The marginal cost declines as the marginal product of a variable input rises if the wage rate is
constant. Beginning at the point of diminishing returns, the marginal cost rises as the marginal
product of a variable input declines.
c. A firm operates in the short run when there is insufficient time to alter some fixed input. The
firm plans in the long run when all inputs are variable.
d. The plant size selected by a firm in the long run depends on the expected level of production.

HINTS FOR EFFECTIVE TEACHING

1. Be prepared to spend some time on this chapter. It pays off later.

2. Mention that in economics we are concerned with economic profit because if it is positive we would
expect more entrepreneurs to move into that line of business; a negative economic profit would cause
some businesspeople to leave that line of business. Accounting profit is a relative number. It says
nothing about whether we would expect entrepreneurs to move in or out of that line of business.
Moreover, we don’t know whether any dollar amount of accounting profit is “good” or “bad” until
we compare it to the opportunity costs of entrepreneurs. But, with an economic profit, any time it is
positive then we know that is positive news for entrepreneurs. Whenever economic profit is negative
(even though the accounting profit is positive, we know that is negative news for entrepreneurs
because we know they are not earning as much as they could in their next best alternative line of
employment or business.
3. Point out that costs vary with the output level in the short run in the same basic fashion as output
varies with the output level. Total cost and total variable cost are inverse functions of the production
function---mirror images of each other. When diminishing marginal productivity is experienced then
both total variable and total cost increase at an increasing rate---they begin to "skyrocket"---and
marginal costs are rising. Indeed, marginal productivity and marginal cost curves are inverses of
each other (mirror images of each other).

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 4 Economics for Today

4. Think of "average" cost as a "per unit" cost---whether it be fixed, variable or total. A synonym for
"average" is "per unit."
5. Many production and operations control managers as well as economists are most often interested in
average fixed, average variable, and average total cost as opposed to total fixed, total variable and
total cost.
6. A synonym for marginal is "extra."
7. To get the diminishing returns concept across, use an easy example all students can associate with.
For example, consider a hot dog stand at a carnival. The stand (capital) is fixed---it's only so big with
so much equipment. Let workers be the only variable input. As more and more workers are cramped
into that stand, diminishing returns will eventually set in and marginal productivity will continue to
decline thereafter.
8. When you end up with the graph containing AVC, ATC, and MC, choose an output at random. Give
it a number. From that output level read off the three short-run cost curves thereby determining
AVC, ATC, and MC. Give each of these a number. Then ask students to numerically determine the
other remaining cost figures.
9. Have students note that when reading a long-run average cost curve that as output increases ever
larger scales of operation (or plant sizes) are being used. Then they can see what happens to "per
unit" costs as larger scales of operation are used.
10. Emphasize the reasons why economies and diseconomies of scale are experienced. Economies of
scale typically result from greater efficiencies that stem from specialization of labor and
management. Diseconomies of scale generally result from management losing control over
operations. Give examples. Indicate that the extent to which economies, constant, and diseconomies
of scale are experienced goes a long way in explaining the size and the number of real-world firms
operating within industries. You may want to introduce a natural monopoly that results from vast
economies of scale, like those associated with public utility companies.
11. When introducing the marginal-average rule use the example of adding a baseball player to a team.
The additional player is the "marginal" concept and the team's batting average is the "average"
concept. If the additional player has a batting average above the team's average then the team's
average will rise, and vice versa. This will hopefully help illustrate the marginal-average rule:
whenever a marginal concept is greater than the average it will pull the average up (and vice versa).

CRITICAL THINKING/GROUP DISCUSSION QUESTIONS

1. Why does the marginal cost curve intersect the average variable and average total cost curves at their
respective minimum points?
Whenever the marginal lies below the average it pulls the average down. Whenever the
marginal lies above the average it pulls the average up. Think of baseball. Whenever an extra
player is added to the team whom has a batting average above the team's average then it pulls
the team's average up; and vice versa.

2. If a firm wished to minimize its cost of production then what output level should it produce?
Produce that output in which average total cost is at a minimum---the output where the ATC
curve is lowest.

3. How can the extent to which economies or diseconomies of scale are experienced help us to predict
the size and number of real-world firms in an industry?
If economies of scale are quite extensive (the curve slopes downward over the relevant range of
output) then we would expect to find a small number of very large scale firms (possibly only
one firm in the case of a natural monopoly) operating in this market; and vice versa.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 7: Production Costs 5

4. Some companies advertise: "We deal in high volume and pass our savings on to you in the form of
lower prices." How could this be?
They are experiencing economies of scale which result in lower per unit costs which can be
passed on to consumers in the form of lower prices without sacrificing their per unit profits.

5. Many people search out and purchase "bargains" at garage and yard sales. What are some implicit
costs associated with this type of shopping?
Time and gas money spent. Plus, there is no guarantee how long these used items may last.
These types of purchases may not be "bargains" after all.

6. Is the "best" quantity of workers to hire where the marginal productivity of the last worker employed
is the greatest (which implies an output level in which the marginal cost of producing additional
units is the cheapest)?
No. The objective is to maximize profits, not to maximize marginal productivity (or to minimize
the extra cost of producing the last unit of output).

7. Why do marginal costs of production rise?

Because of the law of diminishing returns (diminishing marginal productivity)

8. If a firm has $20,000 in total fixed costs, is producing 100 units, has average total cost equal to $240,
then what is its average variable cost of production?
$40. Note: ATC - AFC = AVC. AFC = TFC/Q = $200. So, $240 - $200 = $40.

CLASSROOM GAMES

Approximately 170 non-computerized economic games (experiments) for use in the classroom are
available for free at http://www.marietta.edu/~delemeeg/games/. The following games are recommended
to help teach some of the concepts in this chapter:

Game #3—Objective: To help students understand TPP, APP, MPP, TFC, TVC, TC, MC, AFC, AVC,
AC (and the associated short-run production and cost curves).
Game #27, 28 and 97—Objective: All of these games illustrate a production process subject to
diminishing returns to the variable input.
Game #129—Objective: To illustrate the productivity and cost concepts involved in a short run
production process.

ANSWER TO: "You're the Economist: Analyze the Issue"

WHY IS THAT WEB SITE YOU’RE USING FREE

Suppose a hugely successful Web company has used freeconomics, expanded its scale of operations, and
spread its long-run costs over larger and larger audiences. After years of profits, the company’s profits fell
continuously. Using production costs theory, explain why this situation might be occurring.

The explanation is that as the company expands it can experience diseconomies of scale. The chain
of command lengthens and communications become complex. Key employees leave and too many
executives are paid big salaries to shuffle papers rather than creating new ideas to beat the
competition.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 6 Economics for Today

ANSWERS TO EVEN-NUMBERED "Study Questions and Problems"

2. Fixed inputs include rent, interest on borrowed funds, property taxes, depreciation, and insurance.
Variable inputs include hourly labor, raw material, and shipping charges and sales taxes.

4. The law of diminishing returns applies to the decline in marginal product, which declines before
total output begins to decline. For total output to decline, the marginal product must be negative.

6. (a) Short-Run Cost Schedule

_______________________________________________________________________
Total Total Total Total Marginal Average Average Average
product fixed variable cost cost fixed variable total
cost cost cost cost cost
(Q) (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC)
_______________________________________________________________________
0 $50 $0 $ 50 $ - $ - $ - $ -
1 50 20 70 20 50 20 70
2 50 35 85 15 25 18 43
3 50 45 95 10 17 15 32
4 50 50 100 5 13 13 26
5 50 60 110 10 10 12 22
6 50 80 130 20 8 13 21
7 50 115 165 35 7 16 23
8 50 165 215 50 6 21 27
9 50 225 275 60 6 25 31
________________________________________________________________________

(b) Figure 7A-2

8. AFC = $5 per hammer, AVC = $15 per hammer, ATC = $20 per hammer, and TC = $20,000 per
day.

10. None. Product demand is unrelated to the firm's average total cost curve in the short run.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Microeconomics For Today 9th Edition Tucker Solutions Manual

Chapter 7: Production Costs 7

CHAPTER 7 SUMMARY QUIZ

1. Which of the following statements is true?

a. Economic profit equals accounting profit minus implicit costs.
b. The short run is any period of time in which there is at least one fixed input.
c. A fixed input is any resource for which the quantity cannot change during the period under
consideration.
d. In the long run there are no fixed costs.
e. All of the above.

2. Which of the following statements is true?

a. The law of diminishing returns states that beyond some point the marginal product of a variable
resource continues to rise.
b. The marginal product is the change in total output by adding one additional unit of a fixed input.
c. Fixed costs are costs which vary with the output level.
d. When marginal productivity of a variable input is falling then marginal costs of production must
be rising.
e. When marginal cost is below average cost, average cost rises; when marginal cost is above
average cost, average cost falls.

3. Which of the following statements is false?

a. TC = TFC + TVC.
b. AVC = ATC - AFC.
c. AFC = TFC/Q.
d. MC equals the change in ATC divided by the change in Q.
e. ATC = TC/Q.

4. If a firm enlarges its factory size and realizes higher average (per unit) costs of production then:
a. it has experienced economies of scale.
b. it has experienced diseconomies of scale.
c. it has experienced constant returns to scale.
d. the long-run average cost curve slopes downward.
e. the long-run average cost curve shifts upward.

ANSWERS TO CHAPTER 7 SUMMARY QUIZ

1. e
2. d
3. d
4. b

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.

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