Question

7. Please answer questions 7a through 7c below. You produce widgets. Currently you produce 4 widgets at a total cost of $40.

7a. What is your average cost of producing widgets? Please show calculation and work.

7b. Suppose that you could produce 6 widgets and the total cost of producing 6 widgets is $30. If you produce 6 widgets, what will your average total cost be? Compared to your answer in 3a, has your average total cost increased or decreased and does your firm experience economies of scale or diseconomies of scale and why? Please show your work and calculations and then explain.

7c. Suppose that you could produce 10 widgets and the total cost of producing 10 widgets is $120. If you produce 10 widgets, what will your average total cost be? Compared to your answer in 7b, has your average total cost increased or decreased and does your firm experience economies of scale or diseconomies of scale and why? Do you think your firm will experience some problems if your firm does experience diseconomies of scale? If so, why? If not, why not? What can you, as a manager of the widget company, do to correct this problem? Explain. Please show your work and calculations and then explain.

Answer 1

7a.) Given :- number of widgets produced= 4 and Total cost = $40.

Average cost is calculated as -

Average Cost = Total Cost / Quantity

Average cost = $40 / 4

=$10

Average cost of producing 4 widgets is $10.

7b.) Given:- number of widgets produced =  6 and Total cost =  $30.

Average Total Cost (Average cost) =Total cost / Quantity

Average cost= $30 / 6

= $5

Average cost( average total cost) of producing 6 widgets is $5.

When 4 widgets are produced, average total cost is $10 and when 6 widgets are produced average total cost is $5. When production of widget increased from 4 to 6, average total cost decreased from $10 to $5. Hence, on increasing the production of widgets, the average total cost has decreased.

The firm experiences economies of scale. When the firms increase their scale of production they get some advantages known as economies of scale. On increasing the level of output, the firm's per unit cost decreases.

Here, on increasing the production of widgets from 4 to 6 units, the average total cost reduces from $10 to $5 i.e., per unit cost has decreased from $10 to $5. Hence, there is a decrease in per unit cost. So, the firm is experiencing economies of scale.

The firm may experience economies of scale because with increase in production, efficiency of labour increases with specialisation, raw materials and other inputs can be purchased in bulk at low prices. All this leads to decrease in per unit cost.

7c.) Given:- number of widgets produced= 10 and Total Cost= $120

Average Total Cost (Average cost) =Total cost / Quantity

Average total cost = $120 / 10

= $12

Average cost of producing 10 widgets is $12.

When 6 widgets are produced, average total cost is $5 and when 10 widgets are produced average total cost is $12. When production of widget increased from 6 to 10, average total cost increased from $5 to $12. Hence, on increasing the production of widgets, the average total cost has increased.

The firm experiences diseconomies of scale. When the firms increase their scale of production beyond a certain level of output, certain disadvantages accrue to the firm known as diseconomies of scale. On increasing the level of output, the firm's per unit cost increases.

Here, on increasing the production of widgets from 6 to 10, the average total cost increases from $5 to $12 i.e., per unit cost has increased from $5 to $12. Hence, there is an increase in per unit cost.So, the firm is experiencing diseconomies of scale.

The firm may  experience  diseconomies of scale because there may emerge managerial inefficiencies. With increase in production beyond a certain level of output may lead to overcrowding of labour and thus lead to labour inefficiency. All this causes increase in the cost of production.

A firm experiencing diseconomies of scale is a problem because when per unit cost increases, per unit profit decreases. Every firm tries to maximize its profits. Hence to maximize profits, a firm should produce only that level of output at which per unit cost is minimum.

Here,in the question the manager can decrease the level of output the firm is producing in order to increase firm's profits. The firm should produce onlt that much amount of widgets at which per unit cost( average cost) is minimum.If by producing 6 widgets, average cost= $30 / 6 = $5 is the minimum average cost, then the firm should produce only 6 widgets.