Question

A firm faces the following costs: total cost of capital = $2,000; price paid for labor = $12 per labor unit; and price paid for raw materials = $4 per raw-material unit.

Instructions: In parts a and b, round your answers to 2 decimal places. In part c, enter your answer as a whole number.

a. Suppose the firm can produce 6,000 units of output this year by combining its fixed capital with 100 units of labor and 450 units of raw materials. What are the total cost and average total cost of producing the 6,000 units of output?

   

b. Now assume the firm improves its production process so that it can produce 7,000 units of output this year by combining its fixed capital with 100 units of labor and 450 units of raw materials. What are the total cost and average total cost of producing the 7,000 units of output?

   

c. If units of output can always be sold for $1 each, then by how much does the firm’s profit increase after it improves its production process?

    

d. Suppose that implementing the improved production process would require a one-time-only cost of $1,100. If the firm only considers this year’s profit, would the firm implement the improved production process?

      (Click to select)  Yes  No

   What if the firm considers its profit not just this year but in future years as well?

      (Click to select)  No  Yes

Answer 1

sub question:

a) total cost= fixed cost+ variable cost

fixed cost or cost of capital= 2000$

variable cost= cost of labour+ cost of raw material = 12×100 + 450× 4 = 3000$

therefore total cost= 2000+ 3000= 5000$

average variable cost= total cost÷ quantity of production by the firm = 5000÷6000= 0.83$

b) quantity produced(Q) = 7000

tc= fc+vc= 2000+ (12×100+4×450)

tc = 5000$

ac= tc÷Q = 5000÷ 7000= 0.71$

c) profit of the firm = total revenue- total cost

earlier profit= 6000- 5000= 1000$,

after development in the production

profit = total revenue- total cost= 7000 - 5000 (as there is no change in the quantity of raw material used and quantity of the units of labour used) = 2000$

therefore change in the profit= 2000- 1000= 1000$

d) i) if the cost of the development is 1100$ and the firm has to consider only this year's profit then he would not have installed new production mechanism as it is lowers the profit so much that it goes even below the profit he originally earned therefore he would not go for the installation of production techniques.

ii) if he has to look for the upcoming years' profit as well then he would go for the development as it will double the profit for the subsequent years.