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

a) MP = TP from L labor hired - TP frfom (L - 1) labor hired

AP = TP / Q

TFC is fixed at all level of output

TVC = Labor hired * Wage paid to them

TC = TFC + TVC

AFC = TFC / Q

AVC = TVC / Q

L	Q or TP	MP	AP	TFC	TVC	TC	AFC	AVC	MC
0	0	-	-	1,000	0	1,000	-	-	-
1	20	20	20	1,000	100	1,100	50.00	5.00	100
2	50	30	25	1,000	200	1,200	20.00	4.00	100
3	90	40	30	1,000	300	1,300	11.11	3.33	100
4	140	50	35	1,000	400	1,400	7.14	2.86	100
5	180	40	36	1,000	500	1,500	5.56	2.78	100
6	210	30	35	1,000	600	1,600	4.76	2.86	100
7	230	20	32.86	1,000	700	1,700	4.35	3.04	100
8	240	10	30	1,000	800	1,800	4.17	3.33	100
9	245	5	27.22	1,000	900	1,900	4.08	3.67	100

b) MC rises with the level of output because machines gets obsoleted after certain units of production, technological advancement is needed. MC starts rising once it reaches its minimum and MP starts falling when MC starts rising.
c) AVC first falls and then rises as level of output rises.

d) TFC is constant at all level of output which makes AFC falling when quantity produced rises.

e) AVC starts rising after certain point of output because it shows diminishing returns to scale or marginal product is falling.

f) If physical capital increased from $250 to $300 and firm use 4 units of physical capital, there will be rise in fixed cost from 1,000 (250 * 4) to 1,200 (300 * 4).

g) If price of labor increased from $100 to $150, variable cost would increase which will raise total cost. It will result in rise in average total cost and average variable cost. Rise in total cost will raise marginal cost.