1.

5 Theory of the Firm

Identifying and defining a firm’s short-run costs of production

Instructions: The graph below shows the short-run costs of production for an ice cream shop.
Identify the labels for each of the cost curves and briefly explain what each curve represents.

Ice Cream Shop’s SR

Costs $5 1.____
$4
2.____
3.____
$3

$2

$1
4.____

2,000 4,000 6,000 8,000 10,00

Quantity of Output (number of servings per

1. Identify and define each of the curves labeled on the graph:

1. _________:
Define:

2. _________:
Define:

3. _________:
Define:

4. _________:
 Define:

2. Briefly explain why curve 1 intersects curves 2 and 3 at their lowest points.

3. Explain why curve 4 gets closer and closer to the Q axis without ever touching it.

4. At approximately what level of output does the ice cream shop begin experiencing
diminishing marginal returns? Explain your answer.

5. At approximately what level of output does the ice cream shop achieve the lowest
average total cost (per serving).

6. Explain how each of the following changes in the ice cream shop’s costs of production
would affect the location of each of the short-run curves:
a. Employees’ wages decrease:
b. Prices of cream and sugar increase:

c. Rent for the shop’s retail space falls:

d. The government levies a new tax on each serving of ice cream:

e. The shop owner refinances his loans at a lower interest rate: