BUSS1040

Tutorial 3 Week 3
Exercises to be covered in tutorial

1. Tony owns a fancy Italian restaurant, Tony’s Trattoria. He uses only the finest ingredients and
hires the best chefs in the country. Suppose Tony’s total cost function is given by the following
relationship: TC =100 + 10Q + Q 2 , where Q is the number of 3 course meals prepared in an hour.

a. What are Tony’s fixed and variable costs? ,

b. Calculate Tony’s average cost curves: ATC, AFC, and AVC.

ATC = 100/Q + 10 + Q
AVC = 10 + Q
AFC = 100/Q

c. In class, we defined marginal costs as the change in total costs divided by the change in the
quantity of output, or alternatively, as the slope of the total cost curve. That is, we can define
dTC
marginal costs as MC = , the derivative of the total cost function with respect to quantity.
dQ
Calculate Tony’s marginal cost curve. Use the calculus revision provided at the end of this tutorial if
needed.

MC = 10 + 2Q

d. If Tony were minimising his average costs per meal, how many meals would he be producing each
hour?

ATC is minimized when MC = ATC

10 + 2Q = 10 + Q + 100/Q
Q = 10

e. Illustrate the relationship between Tony’s average cost curves and his marginal cost curve.

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 120
MC
ATC
100 AVC
AFC

80
Costs

60

40

20

0
10

12

14

16

18

20

22

24

26

28

30
0

Quantity
MC cuts through min AVC and min ATC: If MC> AVC (or ATC), then AC rises and vice versa. ATC
converges to AVC as q rises (as AFC becomes smaller and smaller).

2. A firm in a competitive industry has fixed costs of FC = 10, marginal costs of MC = 5 + 6Q, and
average variable costs of AVC = 5 + 3Q.

a. What are the firm’s variable costs (VC)?

2
VC = AVC*q = 5Q + 3Q

b. What is the firm’s total cost function?

2
TC = FC + VC 
=+10
Q 3Q+ 5

c. If the price is $35, how much does the firm supply? Why?

A firm sells units as long as P ≥ MC:

P = MC 


35 = 5 + 6Q

Q=5

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d. When the price is $35 is the average total cost increasing or decreasing? Use the relationship
between MC and ATC to answer this question.

ATC = 10/Q + 5 +3Q

ATC is increasing because ATC<MC and ATC crosses MC at the minimum of the ATC.
35=MC > ATC = 10/5 + 5 +3*5= 22

e. At a price of $35, how much profit does the firm make?

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Profit: π = TR – TC = P*Q – (10 + 5Q + 3Q ) = 35*5 – 110 = 65. (Note: check whether Q=5 yields
highest profits by calculating profit at any other output choice Q’≠5).

3. Suppose a clock manufacturer is operating in the short run. The manufacturer knows that his
production function is as in the table below (L represents the number of workers):

L Q
0 0
1 10
2 17
3 22
4 25
5 26
6 25

a. Calculate the marginal and average product of labour for this production function.

L Q AP = Q/L MP
0 0 - -
1 10 10 10
2 17 8.5 7
3 22 7.33 5
4 25 6.25 3
5 26 5.2 1
6 25 4.17 -1

b. Does this production exhibit diminishing returns to labour? Explain.

This production process exhibits diminishing returns to labor. The marginal product of labour, the extra
output produced by each additional worker, diminishes as workers are added, and is actually negative
for the sixth worker.

c. Explain intuitively what might cause the marginal product of labour to become negative.
Labour’s negative marginal product for L > 5 may arise from congestion in the clock manufacturer’s
factory. Since more workers are using the same, fixed in the short-run amount of capital, it is possible

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that they could get in each other’s way, decreasing efficiency and the amount of output.

4. If a firm’s marginal cost is MC = 2 +2q and market price is $10, what is the profit maximising level
of output (assuming the firm produces a positive quantity)?
a. 2
*b. 4: A firm supplies up to P = MC: 10 = 2 + 2q, thus profit-maximising output is q=4.
c. 6
d. 8
e. 10

5. A supply curve:
a. Is derived holding everything constant, except for a firm’s technology.
*b. Is derived holding everything constant, except for the output price of the good itself.
c. Is derived holding everything constant.
d. All of the above.
e. None of the above.

6. A firm that is producing a positive quantity of output has a profit-maximising rule that
*a. it will keep producing until MR is less than MC for the next unit of production.
b. it will keep producing provided MR > 0.
c. it will produce so as to minimise MC.
d. it will stop producing when MR exceeds MC.
e. none of the above.

7. Give an example of an event that would shift a firm’s supply curve to the left.
Firm supply curve = MC curve of a firm. Hence any event that shifts the MC curve to the left (MC higher
at each q produced). For example, rising price of an input factor used in the production process: e.g.
increase in hourly wages, increase in petrol price, or also an increase in sales tax (more about taxes,
subsidies in a few weeks time).

Additional exercises

8. The marginal product of labour is known to be greater than the average product of labour at a
given level of employment. Is the average product increasing or decreasing? Explain.

If the marginal product of labour, MPL, is greater than the average product of labour, APL, then each
additional unit of labour is more productive than the average of the previous units. Therefore, by
adding the last unit, the overall average increases. If MPL is greater than APL, then APL is increasing. If
the MPL is lower than the APL, then the last unit reduces the average. The APL is at a maximum when
the productivity of the last unit is equal to the average of the previous units ( i.e., when MPL = APL).

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9. A firm has a short-run cost function of TC(q) = 100 + 2q + 3q2. What is the firm’s fixed costs?
a. 3q2.
b. 2q
c. It depends on the level of q
d. 80
*e. 100

10. A firm has a short-run cost function of TC(q) = 100 + 2q + 3q2. What is the firm’s MC?
*a. MC = 2 +6q
b. MC = 2
c. MC = 3q
d. MC = 6q
e. none of the above.

11. A firm’s short-run MC curve

*a. is eventually upwards sloping due to diminishing marginal product.
b. is downward sloping due to increasing returns to scale.
c. is eventually upward sloping due to decreasing returns to scale.
d. is flat due to constant returns to scale.
e. none of the above.

12. For practice – draw the typical short-run, TC, ATC, AFC, AVC and marginal costs on a diagram
(that is, u-shaped ATC and AVC). Explain the shapes of these curves.

13. Using a diagram of a firm’s short-run MC, practice determining the quantity a firm will supply in
the short run (assuming it will sell a positive quantity q) as the price changes. Why is the price-taking
assumption so important to undertake this exercise?

To maximize profits, a firm supplies at MR = MC. In a competitive market, firms (and consumers) are
price-takers, and thus MR = P. This results in P = MC as a profit-maximising condition.
Note: If a firm is not a price-taker, it affects the market price by its choice of output (q). In that case,
firm MR is a function of its own output, q – as we will see when discussing market power later this
semester.