Question

Suppose you are given the following partially complete table for the coming month. You have a meeting with the chief financial officer in fifteen minutes and he is expecting this information in its entirety. Note: all labor units are paid equally and labor is the firm’s only variable input.     

            a)

Labor	Q	Fixed Cost	Variable Cost	Total Cost
0	0		$0
1	5,500
2	8,500
3	9,000
4	9,200		$1,000
5	9,000			$1,250

        

b) Suppose the marginal resource (or factor) cost for the month increases from its current level in part a) to $300 per worker. Given the numbers in part a), if the market price for this output is $0.50 per unit, where would the company stop hiring workers? Make sure you detail your work.

c) What would be the average variable cost when hiring two workers (assume the original numbers from part a)? If the market price is $0.50 per unit, should this firm remain in business or shut down in the short-run? How do you know?

Answer 1

a. It is given that total variable cost at 4 units of labor is $1000. Each labor is paid equally. So, the labor is paid (1000/4) = 250.

Labor is the only factors. So, fixed cost is 0.

b. The firm should hire 2 workers if marginal factor cost increases to $300.

Because employing 2nd worker creates an additional output of 3000. The value of this output is 3000*$.05 = $1500. The wage paid to labor is $300 which is lower than the revenue generated by the labor. So, firm should hire 2nd worker.

Hiring 3rd worker increases the output by 500. The worth of this additional output is 500*$0.5 = $250. The wage paid to labor is $300. The wage paid to labor exceeds the revenue generated by the labor. So, firm should stop hiring after 2nd labor.

c. Total variable cost at 2 workers is $500.

Output at 2 workers is 8500.

So, average variable cost = $500/8500 = $0.058~ $0.06

Average variable cost = $0.06

Price of the output is $0.50.

Average variable cost is less than the price of output.

Therefore, the firm should remain in business in the short run because their operating costs are covered in the short run (A firm should continue to operate in short run if its operating costs are covered).