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

Sol 1.

a.)

L (units)	Q or TP (Units)	MPL	APL	TFC ($)
0	0	-	-	-
1	20	20	20	1000
2	50	30	25	1000
3	90	40	30	1000
4	140	50	35	1000
5	180	40	36	1000
6	210	30	35	1000
7	230	20	32.85	1000
8	240	10	30	1000
9	245	5	27.2	1000

MP_L = change In output/change in labour

AP_L = TP/units of labour.

TFC = Remains same at all output.

(4 x $250 = $1000)

b.) MC increases even when output increases after 5 units of labour because of decreasing returns to the factor. Decreasing returns is a situation where MP start decreasing and TP increases but at diminishing rate.

So , when less and less quantity of output is added , cost for each successive units tends to increases.

c.) AVC decreases when , AP_L increases because of increasing return to the factor. Increasing return to the factor is a point where TP increases at increasing rate and MP also increases .

So, when Average product tends to increases, cost of producing each quantity of output tends to diminish.

d. ) AFC tends to diminish, when output increases because of the following points:

• Fixed cost remains the same at all level of output.
• And , AFC = TFC/Quantity

So, when output(Q) increases, AFC tends to decreases.