Question

Q1: A firm uses physical capital, which is fixed at 4 units, and labour (L) to make its product. The price of physical capital is $250 per unit and the price of labour is $100 per unit.

a) Complete the following table by filling in the columns for marginal product of labour (MP_L), average product of labour (AP_L), total fixed cost (TFC), total variable cost (TVC), total cost (TC), average fixed cost (AFC), average variable cost (AVC), average total cost (ATC) and marginal cost (MC). Show values to 2 decimal places if they are not whole numbers. Hint: Do not confuse L, the amount of labour used with Q, the amount of output produced.

L (units)	Q or TP (units)	MPL (output/unit of L)	APL (output/unit of L)	TFC ($)	TVC ($)	TC ($)	AFC ($/unit of Q)	AVC ($/unit of Q)	ATC ($/unit of Q)	MC ($/unit of Q)
0	0	–	–				–	–	–	–
1	20
2	50						$20
3	90
4	140								$10
5	180				$500
6	210
7	230			$1,000						$5
8	240							$3.33
9	245

b) Why does MC increase at some point when the firm’s output increases? Hint: MC is related to MP_L.

c) How does AVC change (increase, decrease or no change) when the firm uses more labour and AP_L increases?

d) Why does AFC decrease when the firm’s output increases?

e) Why does AVC increase at some point when the firm’s output increases? Hint: How will your ECON 1220 mark will affect your GPA?

f) Which costs would change if the price of physical capital increased from $250 per unit to $300 per unit AND how would these costs change (increase or decrease)?

g) Which costs would change if the price of labour increased from $100 per unit $150 per unit AND how would these costs change (increase or decrease)?

Answer 1

Question 1)

labor	output	marginal product of labor	average product of labor	total fixed cost	total variable cost	total cost	average fixed cost	average variable cost	marginal cost
0	0			1000	0	1000	0	0
1	20	20	20	1000	100	1100	50	5	5.00
2	50	30	25	1000	200	1200	20	4	3.33
3	90	40	30	1000	300	1300	11.11	3.33	2.50
4	140	50	35	1000	400	1400	7.14	2.86	2.00
5	180	40	36	1000	500	1500	5.56	2.78	2.50
6	210	30	35	1000	600	1600	4.76	2.86	3.33
7	230	20	32.86	1000	700	1700	4.35	3.04	5.00
8	240	10	30	1000	800	1800	4.17	3.33	10.00
9	245	5	27.22	1000	900	1900	4.08	3.67	20.00

Question 2)

The U-shape of the marginal cost curve is closely related to the hump-shape of the marginal product curve. The increasing portion of the marginal product curve corresponds with the decreasing portion of the marginal cost curve. The decreasing portion of the marginal product curve corresponds with the increasing portion of the marginal cost curve. The peak of the marginal product curve corresponds with the minimum of the marginal cost curve.

marginal product of labor is maximum when output level is 140 units and marginal cost is at its minimum at $ 2

Question 3)

The average variable cost curve is U-shaped. Average variable cost is relatively high at small quantities of output, then as production increases, it declines, reaches a minimum value, then rises. This shape of the average variable cost curve is indirectly attributable to increasing, then decreasing marginal returns. Therefore, AVC is inversely related to AP, i.e., when AP increases, AVC decreases. When AP is maximum at 36, AVC attains its minimum point ($ 2.78) and when AP decreases, AVC increases. As on a production function, AP measures the efficiency of variable input, for cost curves AVC provides the same measure.

Question 4)

Average fixed cost is the total fixed cost per unit of output incurred when a firm engages in short-run production.

The average fixed cost curve is negatively sloped. Average fixed cost is relatively high at small quantities of output, then declines as production increases. The more production increases, then the more average fixed cost declines. The reason behind this perpetual decline is that a given fixed cost is spread over an increasingly larger quantity of output.

Question 5)

The average variable cost curve is U-shaped. Average variable cost is relatively high at small quantities of output, then as production increases, it declines, reaches a minimum value, then rises. This shape of the average variable cost curve is indirectly attributable to increasing, then decreasing marginal returns. Therefore, AVC is inversely related to AP, i.e., when AP increases, AVC decreases. When AP is maximum at 36, AVC attains its minimum point ($ 2.78) and when AP decreases, AVC increases and is less than marginal cost MC

Question 6)

price of physical capital per unit increases from $ 250 to $ 300. since physical capital is fixed at 4 units

total fixed cost is $ 1200 instead of $1000. Increase in price of physcial capital increases the total fixed cost (TFC), total cost (TC), average cost (AC) at every level of output

output	total fixed cost	total variable cost	total cost	average fixed cost	average variable cost	marginal cost
0	1200	0	1200	0	0
20	1200	100	1300	60	5	5.00
50	1200	200	1400	24	4	3.33
90	1200	300	1500	13.33	3.33	2.50
140	1200	400	1600	8.57	2.86	2.00
180	1200	500	1700	6.67	2.78	2.50
210	1200	600	1800	5.71	2.86	3.33
230	1200	700	1900	5.22	3.04	5.00
240	1200	800	2000	5.00	3.33	10.00
245	1200	900	2100	4.90	3.67	20.00

Question 7)

increase in price of labor from $ 100 unit to $ 150 per unit increases the total variable cost (TVC) , total cost (TC), average variable cost (AVC) marginal cost (MC) at every output level

labor	output	total fixed cost	total variable cost	total cost	average fixed cost	average variable cost	marginal cost
0	0	1000	0	1000	0	0
1	20	1000	150	1150	50	8	7.50
2	50	1000	300	1300	20	6	5.00
3	90	1000	450	1450	11.11	5.00	3.75
4	140	1000	600	1600	7.14	4.29	3.00
5	180	1000	750	1750	5.56	4.17	3.75
6	210	1000	900	1900	4.76	4.29	5.00
7	230	1000	1050	2050	4.35	4.57	7.50
8	240	1000	1200	2200	4.17	5.00	15.00
9	245	1000	1350	2350	4.08	5.51	30.00