Question

You run a production company. You have the following cost structure choices for your production process.

Choice	Fixed Cost	Avg. Variable Cost
A	8,000	1.00
B	12,000	0.70
C	24,000	0.25

For each of the following levels of production, indicate which cost structure you would use.

If firm were to produce 12,000 units it would employ choice

1. A
2. B
3. C

If firm were to produce 24,000 units it would employ choice

1. A
2. B
3. C

If firm were to produce 30,000 units it would employ choice

1. A
2. B
3. C

Now assume you’ve been historically producing 12,000 units. Due to an increase in demand, you find that you are producing 24,000 units.   Assume that this is a permanent demand increase. How would the average total cost change in the short run? In the long run?

Hint: fill in the chart below. Fill in the SR ATC for each and then the LR ATC for each.

	@ 12,000	@ 24,000
Short Run - ATC
Long Run - ATC

Answer 1

If firm is required to produce 12000 (Q) units,

Average Total Cost in case of choice A=(Fixed Cost/Q)+AVC=(8000/12000)+1=$1.67

Average Total Cost in case of choice B=(Fixed Cost/Q)+AVC=(12000/12000)+0.70=$1.70

Average Total Cost in case of choice C=(Fixed Cost/Q)+AVC=(24000/12000)+0.25=$2.25

ATC is minimum in case of choice A. It should be selected.

Correct option is

a. A

If firm is required to produce 24000 (Q) units,

Average Total Cost in case of choice A=(Fixed Cost/Q)+AVC=(8000/24000)+1=$1.33

Average Total Cost in case of choice B=(Fixed Cost/Q)+AVC=(12000/24000)+0.70=$1.20

Average Total Cost in case of choice C=(Fixed Cost/Q)+AVC=(24000/24000)+0.25=$1.25

ATC is minimum in case of choice B. It should be selected.

Correct option is

b. B

If firm is required to produce 30000 (Q) units,

Average Total Cost in case of choice A=(Fixed Cost/Q)+AVC=(8000/30000)+1=$1.27

Average Total Cost in case of choice B=(Fixed Cost/Q)+AVC=(12000/30000)+0.70=$1.10

Average Total Cost in case of choice C=(Fixed Cost/Q)+AVC=(24000/30000)+0.25=$1.05

ATC is minimum in case of choice C. It should be selected.

Correct option is

c. C

If firm is producing 12000 units historically, it must be using technology A as it is cost minimizing. Choice will be A in short run as well as long run

If demand is increased to 24000, switch over to another technology is not feasible in short run. In short run technology A will be used even if cost minimizing option is available. In long run, firm will switch over to technology B to minimize the ATC.

	@12000	@24000
Short run- ATC	1.67	1.33
Long run - ATC	1.67	1.20