C h a p t e r

11 OUTPUT AND
COSTS

Answers to the Review Quizzes

Page 252
1. Distinguish between the short run and the long run.
The short run is a period of time during which the quantity of at least one factor of production is fixed and
cannot be changed. The long run is a period of time ling enough so that the quantities of all factors of
production can be varied.
2. Why is a sunk cost irrelevant to a firm’s current decisions?
Sunk cost is irrelevant because it cannot be changed by any decision. It is already incurred and so must be
paid. The only costs that concern the firm are costs that the firm can change with its current decisions.

Page 256
1. Explain how the marginal product of labour and the average product of labour change as the
quantity of labour employed increases (a) initially and (b) eventually.
Initially, as the quantity of labour is increases, the firm experiences increasing marginal returns, which
means that the marginal product increases as more labour is employed. Increasing marginal returns occur
because hiring additional workers allows the workers to specialize and become more productive.
Eventually, the firm will experience diminishing marginal returns which means that the marginal product
decreases as more labour is employed. Decreasing marginal returns occur because eventually the gains from
specialization diminish and because more and more workers are working with the same fixed amount of
capital. The average product of labour follows the marginal product of labour. Initially, when the marginal
product of labour is increasing, the average product also increases. As long as the marginal product of
labour exceeds the average product of labour, the average product continues to increase. Eventually when
the marginal product is falling it falls enough so that it is less than the average product, at which point the
average product of labour decreases.
2. What is the law of diminishing returns? Why does marginal product eventually diminish?
The law of diminishing returns states that as a firm uses more of a variable factor of production with a given
quantity of fixed factors of production, the marginal product of the variable factor eventually diminishes.
Diminishing marginal returns arises from the fact that ever more workers are using the same capital and
working in the same space.
3. Explain the relationship between marginal product and average product.
As the quantity of labour initially increases the firm experiences increasing marginal returns and the
marginal product of labour increases. The marginal product of labour is greater than the average product
over this range of labour, so the average product of labour increases when the quantity of labour increases.
Eventually, diminishing marginal returns causes the marginal product of labour to fall. When the marginal
product of labour falls below the average product, the average product decreases as the quantity of labour
increases.

Copyright © 2010 Pearson Education Canada

172 CHAPTER 11

Page 261
1. What relationships do a firm’s short-run cost curves show?
The marginal cost (MC), average total cost (ATC) and average variable cost (AVC) curves are all related in
the short run:
• When the MC curve lies above (lies below) the AVC, AVC curve rises (falls) with output. This implies
that as output increases, the MC curve cuts through the AVC curve at its lowest point.
• When the MC curve lies above (lies below) the ATC, ATC curve rises (falls) with output. This implies
that as output increases, the MC curve cuts through the ATC curve at its lowest point.
• As output increases, the ATC curve becomes vertically closer to the AVC curve.
2. How does marginal cost change as output increases (a) initially and (b) eventually?
At small outputs, marginal cost decreases as output increases because of greater specialization and the
division of labour, but as output increases further, marginal cost eventually increases because of the law of
diminishing returns.
3. What does the law of diminishing returns imply for the shape of the marginal cost curve?
The law of diminishing returns states: As a firm uses more of a variable factor of production, with a given
quantity of the fixed factor of production, the marginal product of the variable factor eventually
diminishes. The law of diminishing returns means that each additional worker produces a successively
smaller addition to output. So to get an additional unit of output, ever more workers are required. The cost
of an additional unit of output—marginal cost—is increasing, so the marginal cost curve slopes upward.
4. What is the shape of the AFC curve and why does it have this shape?
Average fixed cost (AFC) equals total fixed cost divided by total product. As the quantity produced
increases, the fixed costs are spread over a larger and larger quantity of output so average fixed cost
decreases. So the AFC curve slopes downward as the quantity produced increases.
5. What are the shapes of the AVC curve and the ATC curve and why do they have these shapes?
The average variable cost (AVC), and average total cost (ATC) curves are both U-shaped.
• The marginal cost (MC) curve shows how total cost changes when output increases by one unit. If the
MC curve lies below the AVC curve, AVC is falling. Diminishing marginal returns means that
eventually the MC curve slopes upward. At some point the MC curve lies above the AVC curve, and the
AVC curve is upward sloping.
• ATC is the sum of average fixed cost (AFC) and AVC. Initially the ATC curve falls as the quantity
produced increases because the AFC is initially quite large, but drops rapidly as total fixed costs are
spread over greater levels of output. However, eventually diminishing returns cause marginal product to
fall below average product, and average product decreases. As a result AVC increases as the quantity
produced increases. If AVC rises more quickly than AFC falls, then the ATC curve is upward sloping.

Page 265
1. What does a firm’s production function show and how is it related to a total product curve?
A firm’s production function is the relationship between the maximum output attainable and the quantities
of both capital and labour. The total product curve shows the maximum output that a given quantity of
labour can produce for a given quantity of capital.
2. Does the law of diminishing returns apply to capital as well as labour? Explain why or why
not.
The law of diminishing returns applies to capital as well as labour. The marginal product of capital is the
change in the total product resulting from a one-unit increase in capital, holding the quantity of labour
constant. A given level of labour will benefit from having access to more capital. Then labour becomes
more productive and can increase output. Eventually, labour’s access to ever more units of capital becomes

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 173

less and less useful, as there are fewer labour units to be combined with any given unit of capital. As a
result each additional unit of capital contributes less and less additional units of output, resulting in
diminishing returns to capital.
3. What does a firm’s long-run average cost curve show? How is it related to the firm’s short-run
average cost curves?
The long-run average cost curve (LRAC) shows the relationship between the lowest attainable ATC and
output when both plant size and labour are varied. The LRAC curve reflects the minimum possible ATC
the firm can attain for any given level of output. For any level of output the firm might choose to produce,
the LRAC reflects the lowest possible ATC taken from an ATC curve that corresponds to a particular plant
size. Once the firm has chosen that plant size, it will incur costs corresponding to the ATC curve associated
with that plant size.
4. What are economies of scale and diseconomies of scale? How do they arise? What do they
imply for the shape of the long-run average cost curve?
Economies of scale are features of a firm’s technology that lead to falling long-run average cost (LRAC) as
output increases. As plant size increases, the minimum attainable average total cost (ATC) for each plant
size falls with output. Diseconomies of scale are features of a firm’s technology that lead to rising LRAC as
output increases. As plant size increases, the minimum attainable ATC for each plant size rises with output.
A firm initially experiences economies of scale up to some output level and over this range of output the
LRAC curve is downward sloping as output increases. Beyond that output level, it may move toward
diseconomies of scale. When there are diseconomies of scale, the LRAC slopes upward as output increases,
resulting in a U-shaped LRAC curve.
5. What is a firm’s minimum efficient scale?
Minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest
level. If the long-run average cost curve has the typical U shape, the minimum point of the LRAC identifies
the level of output that represents the firm’s minimum efficient scale.

Copyright © 2010 Pearson Education Canada

174 CHAPTER 11

Answers to the Problems and Applications

1. Which of the following news items involves a short-run decision and which involves a long-
run decision? Explain
January, 31, 2008: Starbucks will open 75 more stores abroad than originally predicted, for a
total of 975.
This decision is a long-run decision. It increases the quantity of all of Starbucks’ factors of production,
labour and the size of Starbucks’ plant.
February, 25, 2008: For three hours on Tuesday, Starbucks will shut down every single one of its
7,100 stores so that baristas can receive a refresher course.
This decision is a short-run decision. It involves increasing the quality of Starbucks’ labour and so only one
factor of production—labour—changes and all the other factors remain fixed.
June, 2, 2008: Starbucks replaces baristas with vending machines.
This decision is a short-run decision. It involves changing two of Starbucks’ factors of production, labour
and one type of capital. But other factors of production, such as Starbucks’ land and other capital inputs
such as the store itself, remain fixed.
July, 18, 2008: Starbucks is closing 616 stores by the end of March.
This decision is a long-run decision. It decreases the quantity of all of Starbucks’ factors of production,
labour and the size of Starbucks’ plant.
2. The table sets out Sue’s Surfboards’ total product schedule. Labour Output
(workers (surfboards
a. Draw the total product curve.
To draw the total product curve measure labour on the x-axis and
per week) per week)
output on the y-axis. The total product curve is upward sloping 1 30
and is illustrated in Figure 11.1. 2 70
b. Calculate the average product of labour and draw the 3 120
average product curve. 4 160
The average product of labour is equal to total product divided 5 190
by the quantity of labour employed. For example, when 3 6 210
workers are employed, they produce 120 surfboards a week, so 7 220
average product is 40 surfboards per worker. As Figure
11.2 (on the next page) shows, the average product curve is
upward sloping when up to 3 workers are hired and then is
downward sloping when more than 4 workers are hired.
c. Calculate the marginal product of labour and draw
the marginal product curve.
The marginal product of labour is equal to the increase in
total product that results from a one-unit increase in the
quantity of labour employed. For example, when 3
workers are employed, total product is 120 surfboards a
week. When a fourth worker is employed, total product
increases to 160 surfboards a week. The marginal product
of increasing the number of workers from 3 to 4 is 40
surfboards. We plot the marginal product at the halfway
point, so at a quantity of 3.5 workers, the marginal
product is 40 surfboards per worker per week. As Figure
11.2 (on the next page) shows, the marginal product curve

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 175

is upward sloping when up to 2.5 workers a week

are employed and it is downward sloping when
more than 2.5 workers a week are employed.
d. Over what output range does the firm enjoy
the benefits of increased specialization and
division of labour?
The firm enjoys the benefits of increased
specialization and division of labour over the range
of output for which the marginal cost decreases.
This range of output is the same range over which
the marginal product of labour rises. For Sue’s
Surfboards, the benefits of increased specialization
and division of labour occur until 2.5 workers are
employed.
e. Over what output range does the firm
experience diminishing marginal product of
labour?
The marginal product of labour decreases after 2.5
workers are employed.
f. Over what output range does this firm experience an increasing average product of labour
but a diminishing marginal product of labour?
The marginal product of labour decreases and the average product of labour increases between 2.5 and 3.5
workers.
g. Explain how it is possible for a firm to experience simultaneously an increasing average
product but a diminishing marginal product.
As long as the marginal product of labour exceeds the average product of labour, the average product of
labour rises. For a range of output the marginal product of labour, while decreasing, remains greater than
the average product of labour, so the average product of labour rises. Each additional worker, while
producing less than the previous worker hired is still producing more than the average worker.
3. Sue’s Surfboards, in problem 2, hires workers at $500 a week and its total fixed cost is $1,000
a week.
a. Calculate total cost, total variable cost, and total fixed cost of each output in the table. Plot
these points and sketch the short-run total
cost curves passing through them.
Total cost is the sum of the costs of all the factors
of production that Sue’s Surfboards uses. Total
variable cost is the total cost of the variable
factors. Total fixed cost is the total cost of the
fixed factors. For example, the total variable cost
of producing 120 surfboards a week is the total
cost of the workers employed, which is 3 workers
at $500 a week, which equals $1,500. Total fixed
cost is $1,000, so the total cost of producing 120
surfboards a week is $2,500. Figure 11.3 shows
these total cost curves.

Copyright © 2010 Pearson Education Canada

176 CHAPTER 11

b. Calculate average total cost, average fixed cost, average variable cost, and marginal cost of
each output in the table. Plot these points and sketch the short-run average and marginal
cost curves passing through them.
AFC AVC ATC MC
Output (dollars per (dollars per (dollars per (dollars per
(surfboards) surfboard) surfboard) surfboard) surfboard)
30 33.33 16.67 50.00
12.50
70 14.29 14.29 28.58
10.00
120 8.33 12.50 20.83
12.50
160 6.25 12.50 18.75
16.67
190 5.26 13.16 18.42
25.00
210 4.76 14.29 19.05
50.00
220 4.55 15.91 20.46
Average fixed cost is total fixed cost per unit of
output. Average variable cost is total variable cost
per unit of output. Average total cost is the total
cost per unit of output. For example, take the case
in which the firm makes 160 surfboards a week.
Total fixed cost is $1,000, so average fixed cost is
$6.25 per surfboard; total variable cost is $2,000, so
average variable cost is $12.50 per surfboard; and,
total cost is $3,000, so average total cost is $18.75
per surfboard. Marginal cost is the increase in total
cost divided by the increase in output. For example,
when output increases from 120 to 160 surfboards
a week, total cost increases from $2,500 to $3,000,
an increase of $500. This $500 increase in total cost
means that the increase in output of 40 surfboards
increases total cost by $500. Marginal cost is equal
to $500 divided by 40 surfboards, which is $12.50
a surfboard. The table shows these data schedules
and the curves are plotted in Figure 11.4.

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 177

c. Illustrate the connection between Sue’s AP, MP, AVC, and MC curves in graphs like those in
Fig. 11.6 in the textbook.
AP MP AVC MC
Labour Output (surfboards (surfboards (dollars per (dollars per
(workers) (surfboards) per worker) per worker) surfboard) surfboard)
1 30 30.0 16.67
40.0 12.50
2 70 35.0 14.29
50.0 10.00
3 120 40.0 12.50
40.0 12.50
4 160 40.0 12.50
30.0 16.67
5 190 38.0 13.16
20.0 25.00
6 210 35.0 14.29
10.0 50.00
7 220 31.4 15.91
The table sets out the AP and MP data used to
draw the curves. Figure 11.5 shows the curves and
the relationships. When the AP curve rises the AVC
curve falls and vice versa. When the MP curve rises
the MC curve falls and vice versa.

Copyright © 2010 Pearson Education Canada

178 CHAPTER 11

4. Sue’s Surfboards, in problems 2 and 3, rents the factory building and the rent is increased by
$200 a week. If other things remain the same, how do Sue’s Surfboards’ short-run average cost
curves and marginal cost curve change.
The rent is a fixed cost, so total fixed cost increases. The increase in total fixed cost increases total cost but
does not change total variable cost. Average fixed cost is total fixed cost per unit of output. The average
fixed cost curve shifts upward. Average total cost is total cost per unit of output. The average total cost
curve shifts upward. The marginal cost curve and average variable cost curve do not change.
5. Workers at Sue’s Surfboards, in problems 2 and 3, negotiate a wage increase of $100 a week
for each worker. If other things remain the same, explain how Sue’s Surfboards’ short-run
average cost curve and marginal cost curve change.
The increase in the wage rate is a variable cost, so total variable cost increases. The increase in total variable
cost increases total cost but total fixed cost does not change. Average variable cost is total variable cost per
unit of output. The average variable cost curve shifts upward. Average total cost is total cost per unit of
output. The average total cost curve shifts upward. The marginal cost curve shifts upward. The average
fixed cost curve does not change.
6. Sue’s Surfboards, in problem 2, buys a second plant and the output produced by each worker
increases by 50 percent. The total fixed cost of operating each plant is $1,000 a week. Each
worker is paid $500 a week.
a. Calculate the average total cost of producing 180 and 240 surfboards a week when Sue’s
Surfboards operates two plants. Graph these points and sketch the ATC curve.
To calculate the average total cost when two plants
are operated, recall that total cost is the cost of all
the factors of production. For example, when 4
workers are employed they now produce 240
surfboards a week. With 4 workers, the total
variable cost is $2,000 a week and the total fixed
cost is (coincidentally also) $2,000 a week. Hence
the total cost is $4,000 a week. The average total
cost of producing 240 surfboards is $16.67 a
surfboard. Similarly the average total cost of
producing 180 surfboards is $19.44. To graph the
ATC curve the average total costs at all the
quantities are required. Figure 11.6 shows the
average total cost curve, ATC2 when Sue’s operates
two plants. (It also shows Sue’s average total cost
curve, ATC1, when Sue operates one plant.)
b. To produce 180 surfboards a week, is it
efficient to operate one or two plants?
The long-run average cost curve is made up of the
lowest parts of the firm's short-run average total cost curves when the firm operates one plant and two
plants. The long-run average cost curve is illustrated in Figure 11.6 as the darker part of the two ATC
curves. At lower levels of output the LRAC curve is derived from operating one plant while at higher levels
it is derived from operating two plants. The LRAC curve shows that to produce 180 surfboards it is
efficient to operate 1 plant.
c. To produce 160 surfboards a week, is it efficient for Sue’s to operate one or two plants?
The LRAC curve shows that to produce 160 surfboards it is efficient to operate 1 plant.

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 179

7. Airlines Seek Out New Ways to Save on Fuel as Costs Soar

The financial pain of higher fuel prices is particularly acute for airlines because it is their
single biggest expense. … [Airlines] pump about 7,000 gallons into a Boeing 737 and as much
as 60,000 gallons into the bigger 747 jet. … Each generation of aircraft is more efficient. At
Northwest, the Airbus A330 long-range jets use 38 percent less fuel than the DC-10s they
replaced, while the Airbus A319 medium-range planes are 27 percent more efficient than DC-
9s. …
The New York Times, June 11, 2008
a. Is the price of fuel a fixed cost or a variable cost for an airline?
The price of fuel is a variable cost for an airline.
b. Explain how an increase in the price of fuel changes an airline’s total costs, average costs,
and marginal cost.
An increase in the price of fuel raises an airline’s total cost, its average total cost, its average variable cost,
and its marginal cost. It does not change the airline’s average fixed cost or total fixed cost.
c. Draw a graph to show the effects of an increase in the price of fuel on an airline’s TFC, TVC,
AFC, AVC, and MC curves.
Figure 11.7 shows an airline’s TFC and TVC curves; Figure 11.8 shows an airline’s AFC, AVC, and MC
curves. The increase in the price of fuel has no effect on the airlines fixed cost, so the TFC and AFC curves
do not change. The increase in the price of fuel raises the firm’s variable costs and its total costs. As a result
the firm’s TVC, AVC and MC curves shift upward as illustrated in the figures from the curves labelled
“0”to the curves labelled “1”.

d. Explain how a technological advance that makes an airplane’s engines more fuel efficient
changes an airline’s total product, marginal product, and average product.
This situation is an example of technological change that is embodied in capital. This change will allow the
airline to produce more output—passenger miles—using fewer resources. Hence the airline’s total product,
marginal product, and average product all increase.

Copyright © 2010 Pearson Education Canada

180 CHAPTER 11

e. Draw a graph to illustrate the effects of more fuel efficient aircraft on an airline’s TP, MP,
and AP curves.
Figure 11.9 shows the airline’s TP curves. The new engines shift the TP curve upward from TP0 to TP1.
Figure 11.10 shows the airline’s MP and AP curves. These curves also shift upward as a result of the new
fuel efficient engines.

f. Explain how a technological advance that makes an airplane’s engines more fuel efficient
changes an airline’s average variable cost, marginal cost and average total cost.
The airline’s average variable cost and marginal cost both decrease. The new engines that use the new
technology are presumably more expensive than the older, less fuel efficient engines. The engines are a
fixed cost. So at lower levels of output the new average total cost is higher than the old average total cost
while at larger levels of output the new average total cost is lower than the old average total cost.
g. Draw a graph to illustrate how a technological
advance that makes an airplane engine more
fuel efficient changes an airline’s AVC, MC, and
ATC curves.
Figure 11.11 illustrates these changes. The airline’s
AVC and MC curves shift downward as indicated by
the shift from the grey curves labelled “0” to the black
curves labelled “1”. At lower levels of output the ATC
curve shifts upward and at larger levels of output the
ATC curve shifts downward.

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 181

8. The table shows the

Labour Output
production function of
(workers (rides per day)
Jackie’s Canoe Rides.
per day) Plant 1 Plant 2 Plant 3 Plant 4
Jackie’s pays $100 a
day for each canoe it 10 20 40 55 65
rents and $50 a day 20 40 60 75 85
for each canoe 30 65 75 90 100
operator it hires. 40 75 85 100 110
Canoes 10 20 30 40
a. Graph the ATC
curve for Plant 1 and Plant 2.
To find the average total cost for each plant, at the
different levels of output add the cost of the
workers, $50 per worker, and the fixed cost, the
cost of the canoes, $100 per canoe. So for plant 1,
the total cost for 20 rides is $1,500; for 40 rides is
$2,000; and, for 65 rides is $2,500. The average
total cost is calculated by dividing the total cost by
the quantity of rides. These average total costs are
plotted in Figure 11.12. (The average total cost
curve for one plant, ATC1, is the same as the thicker
curve through the first 4 points.)
b. On your graph in a, plot the ATC curve for
Plant 3 and Plant 4.
These are drawn in Figure 11.12.
c. On Jackie’s LRAC curve, what is the average
cost of producing 40, 75, and 85 rides a week?
The long-run average total cost curve is illustrated
in Figure 11.12 as the thicker curve. It is comprised
of the parts of the short-run average total cost curves that are the minimum average total cost for the
different levels of output. From this curve, the average cost of producing 40 rides is $50; of producing 75
rides is $40; and the average cost of producing 85 rides is $47.06.
d. What is Jackie’s minimum efficient scale?
Jackie’s minimum efficient scale is the smallest quantity at which the long-run average cost is the lowest.
Jackie’s minimum efficient scale is 65 canoe rides where, with one plant, the average total cost is $38.46.
e. Explain how Jackie’s uses its LRAC cost curve to decide how many canoe to rent.
Jackie’s will use its long-run average total cost curve by building the size of the plant that minimizes its
long-run average cost at the level of output that Jackie’s expects to produce.
f. Does Jackie’s production function feature economies of scale or diseconomies of scale?
Jackie’s has both economies of scale for up to 65 canoe rides and then diseconomies of scale for more than
65 canoe rides.
9. Business Boot Camp
At a footwear company called Caboots, sales rose from $160,000 in 2000 to $2.3 million in
2006. But in 2007 sales dipped to $1.5 million. Joey and Priscilla Sanchez, who run Caboots,
blame the decline partly on a flood that damaged the firm’s office and sapped morale.
Based on a Fortune article, CNN, April 23, 2008

Copyright © 2010 Pearson Education Canada

182 CHAPTER 11

If the Sanchezes are correct in their assumptions and the prices of footwear didn’t change
a. Explain the effect of the flood on the total product curve and marginal product curve at
Caboots.
The total product curve shifted downward as a result of the flood and sapped morale. That is, the factors of
production produced less footwear in 2007 than in 2006. The downward shift in the total product curve
decreased the marginal product so the marginal product curve also shifted downward.
b. Draw a graph to show the effect of the flood on the total product curve and marginal
product curve at Caboots.

Figure 11.13 shows the downward shift in the total product curve and Figure 11.14 shows the downward
shift in the marginal product curve. The flood and lack of morale shift the TP and MP curves downward
from TP1 to TP2 and from MP1 to MP2.
10. Passengers of Collapsed Discount Airline Seek New Flights
Thousands of travellers were trying to book other flights Friday after the sudden collapse of
Ottawa-based Zoom Airlines. ...
The airline owes more than $400,000 to the authority that runs the Calgary airport, along
with money to the airplanes’ owner, ground support and refuellers. The Halifax airport
authority is owed nearly $200,000 ... for unpaid landing fees, gate fees and other expenses. ...
Ian Lee, ... at Carleton University, said Zoom’s demise isn’t surprising. ... “They just don’t
have the economies of scale. They don’t have the capital, the deep pockets, to sustain these
brutal fuel prices,” he said.
CBC News, August 29, 2008
a. Of the costs noted in the news clip, which are fixed costs and which are variable costs?
A variable cost is a cost that varies as the quantity produced changes. The quantity of fuel used depends on
the distance travelled, so fuel is a variable cost. Landing fees are calculated per landing and gate fees are
calculated per use, so they are also variable costs.

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 183

b. Draw a graph to show your predicted effects

of “brutal fuel prices” on the airline’s short-
run total cost curves

Figure 11.15 shows the effect of a rise in the price

of fuel on the airlines total cost curve. An increase
in the price of fuel is an increase in total
variable cost. Total fixed cost does not change.
So TC curve shifts upwards.

c. Draw a graph to show your predicted effects

of “brutal fuel prices” on Zoom’s short-run
average cost and marginal cost curves.
Figure 11.16 shows the effect of rising fuel price on
ATC and MC curves. The rising fuel price is an
increase in variable cost, so average fixed cost does
not change but average total cost increases. The
marginal cost of a kilometre rises and the MC curve
shifts upward with the ATC curve.

d. Explain why small airlines such as Zoom “don’t

have economies of scale.”
Economies of scale are features of a firm's
technology that make average total cost fall as
output increases. Greater specialization of both
labour and capital is the main source of economies
of scale. Zoom is a relatively small airline and it
doesn't have economies of scale because it isn't large enough to have the output at which workers and
capital can specialize.
11. Grain Prices Go the Way of the Oil Price
Every morning millions of Americans confront the latest trend in commodities markets at
their kitchen table. … Rising prices for crops … have begun to drive up the cost of breakfast.
The Economist, July 21, 2007
Explain how the rising price of crops affects the average total cost and marginal cost of
producing breakfast cereals.
When producing cereal, the cereal crops used are a variable factor of production. An increase in the price of
these crops boosts the firms’ average total cost and the firms’ marginal cost of producing cereal.

Copyright © 2010 Pearson Education Canada

184 CHAPTER 11

12. Coffee King Starbucks Raises Its Prices

Blame the sour news at Starbucks this week on soaring milk costs. … The wholesale price [of ]
milk is up nearly 70% in the 12 months. …“There’s a lot of milk in those (Starbucks) lattes,”
notes John Glass, CIBC World Markets restaurant analyst.
USA Today, July 24, 2007
a. Is milk a fixed factor of production or a variable factor of production?
Milk is a variable factor of production.
b. Describe how the increase in the price of milk changes Starbucks’ short-run cost curves.
The increase in the price of milk shifts Starbucks’ short-run AVC, ATC, and MC curves upward.
13. Bill’s Bakery has a fire and Bill loses some of his TP AFC AVC ATC MC
cost data. The bits of paper that he recovers 10 120 100 220
after the fire provide the information in the 80
table (all the cost numbers are dollars). Bill asks 20 A B 150
you to come to his rescue and provide the 90
missing data in the five spaces identified as A, B, 30 40 90 130
C, D, and E. 130
A is the average fixed cost, AFC, when the output is
40 30 C D
20. Average fixed cost equals total fixed cost divided
E
by output, or AFC = TFC ÷ Q. Rearranging gives
TFC = AFC × Q. So the total fixed cost for the 50 24 108 132
problem equals $120 × 10, which is $1,200. A equals $1,200, TFC, divided by 20, Q, which is $60.

B is the average variable cost, AVC, when output is 20. Use the result that AFC + AVC = ATC by
rearranging to give AVC = ATC − AFC, so average variable cost equals $150 − $60, which is $90.

D is the average total cost, ATC, when output, Q, equals 40. Average total cost equals total cost divided by
output, or ATC = TC ÷ Q. Rearranging gives TC = ATC × Q. So the total cost when 30 units are
produced is $130 × 30, which is $3,900. Marginal cost, MC, equals the change in total cost divided by the
change in quantity, or MC = ΔTC ÷ ΔQ. Rearranging gives ΔTC = MC × ΔQ, so the change in total cost
between Q = 30 and Q = 40 is $130 × 10, or $1,300. Therefore the total cost when Q equals 40 is $3,900
+ $1,300, or $5,200. The average total cost when Q is 40 is $5,200 ÷ 40, or $130.

C is the average variable cost, AVC, when output, Q, equals 40. Use the result that AFC + AVC = ATC by
rearranging to give AVC = ATC − AFC. As a result, average variable cost equals $130 − $30, which is
$100.

E is the marginal cost, MC, when output increases from 40 units to 50 units. Marginal cost, MC, equals
the change in total cost divided by the change in quantity, or MC = ΔTC ÷ ΔQ. To calculate marginal
cost, the total cost when output is 40 and the total cost when output is 50 are needed. Average total cost
equals total cost divided by output, or ATC = TC ÷ Q. Rearranging gives TC = ATC × Q. So the total cost
when 40 units are produced is $130 × 40, which is $5,200 and total cost when 50 units are produced is
$132 × 50, which is $6,600. So the marginal cost equals ($6,600 − $5,200) ÷ 10, which equals $140.

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 185

14. ProPainters hires students at $250 a week to paint houses.

It leases equipment at $500 a week. The table sets out its Output
total product schedule. Labour (houses painted
(students) per week)
a. What is total cost, average total cost, and marginal cost if
1 2
ProPainters paints 12 houses a week?
To paint 12 houses, ProPainters hires 4 students. The total
2 5
variable cost is $1,000 (paid to the students) and the total fixed 3 9
cost is $500 (the leased equipment). Therefore the total cost is 4 12
$1,500. The average total cost equals $1,500/12, which is $125 5 14
per house. The marginal cost of 10½ houses is $83.33 and the 6 15
marginal cost of 13 houses is $125.00. These mean that the
marginal cost of 12 houses is $108.33.
b. At what output is average total cost a minimum?
Using the data in the table, the average total cost is at its minimum of $125 per house when 13 houses are
painted.
c. Explain why the gap between total cost and total variable cost is the same at all outputs.
The gap between total cost and total variable cost is total fixed cost. Because the fixed cost is the same at all
levels of output, the difference between the total cost and total variable cost is constant.
15. ProPainters hire students at $250 a week to paint houses. It leases equipment at $500 a week.
Suppose that ProPainters doubles the number of students it hires and doubles the amount of
equipment that it leases. ProPainters experiences diseconomies of scale.
a. Explain how the ATC curve with one unit of equipment differs from that when ProPainters
uses double the amount of equipment.
Because ProPainters experiences diseconomies of scale, when ProPainters doubles its inputs the minimum
average cost is higher than when it uses the lesser quantities of inputs. Even so, at high levels of output the
average total cost of producing the large level of output with the greater quantities of inputs is lower than
the average total cost of producing this large level of output with the smaller quantities of inputs.
b. Explain what might be the source of the diseconomies of scale that ProPainters experience.
ProPainters might experience diseconomies of scale because when it gets larger the complexity of operating
the business increases, which increases the costs of running the business and making decisions.
16. The table shows the
Labour Output
production function of
(workers (rides per day)
Bonnie’s Balloon
per day) Plant 1 Plant 2 Plant 3 Plant 4
Rides. Bonnie’s pays
10 4 10 13 15
$500 a day for each
20 10 15 18 20
balloon it rents and
30 13 18 22 24
$25 a day for each
40 15 20 24 26
balloon operator it
50 16 21 25 27
hires.
Balloons 1 2 3 4
a. Graph the ATC curve
for Plant 1 and Plant 2.
To find the average total cost for each plant, at the different levels of output add the variable cost, which is
the cost of the workers or $25 per worker, to the fixed cost, which is the cost of the balloons or $500 per
balloon. For Plant 1, the total cost for 4 rides is $750; for 10 rides is $1,000; for 13 rides is $1,250; for 15
rides is $1,500; and, for 16 rides is $1,750. The average total cost is calculated by dividing the total cost by
the quantity of rides. These average total costs are plotted in Figure 11.18.

Copyright © 2010 Pearson Education Canada

186 CHAPTER 11

b. On your graph in a, plot the ATC curve for Plant 3 and Plant 4.
Figure 11.17 shows these ATC curves.
c. On Bonnie’s LRAC curve, what is the average cost of
producing 18 rides and 15 rides a day?
The long-run average total cost curve is illustrated in Figure
11.17 as the darker line. The long-run average cost curve is
comprised of the segments of the different short-run
average total cost curves that have the minimum average
total cost for the different levels of output. For 15 rides a
day the average cost is $100 and for 18 rides a day the
average cost is $97.22.
d. Explain how Bonnie’s uses its long-run average cost
curve to decide how many balloons to rent.
Bonnie’s will use its long-run average total cost curve by
building the size of the plant that minimizes its long-run
average cost at the number of balloon rides that Bonnie’s
expects to produce.
17. A firm is producing at minimum average total cost with its current plant. Sketch the firm’s
short-run average total cost curve and long-run average cost curve for each of the following
situations and explain, using the concepts of economies of scale and diseconomies of scale, the
circumstances in which the firm
a. Can lower its average total cost by increasing its plant.
Figure 11.18 illustrates this case at the point labelled
A. Here the firm experiences economies of scale, so if
it increases the size of its plant and also all its other
inputs by the same proportion, its average total cost
can be lowered.
b. Can lower its average total cost by decreasing its
plant.
Figure 11.18 illustrates this case at the point labelled
B. Here the firm experiences diseconomies of scale, so
if it decreases the size of its plant and also all its other
inputs by the same proportion, its average total cost
can be lowered.
c. Cannot lower its average total cost.
Figure 11.18 illustrates this case at the point labelled
C. Here the firm is already producing at the minimum
of its long-run average cost. In this case, the firm’s
average cost increases no matter if the firm increases or
decreases the size of its plant and all its other inputs.
18. Starbucks Unit Brews Up Self-Serve Espresso Bars
… automated, self-serve espresso kiosks are in grocery stores. … The machines, which grind
their own beans, crank out lattes, … and drip coffees … take credit and debit cards, [and]
cash. … Concordia Coffee, a small Bellevue coffee equipment maker, builds the self-serve
kiosks and sells them to Coinstar for just under $40,000 per unit. Coinstar installs them …
and provides maintenance. The kiosks use [Starbuck’s] Seattle’s Best Coffee. … The self-serve

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 187

kiosks remove the labour costs of having a barista. … Store personnel handle refills of coffee
beans and milk. …
MSNBC, June 1, 2008
a. What is Coinstar’s total fixed cost of operating one self-serve kiosk?
The fixed costs are the cost of the machine itself, $40,000.
b. What are Coinstar’s variable costs of providing coffee at a self-serve kiosk?
The variable costs include the cost of the coffee beans and other ingredients and, presuming that the kiosks
need more maintenance the heavier their use, the cost of maintaining the kiosks.
c. Assume that a coffee machine operated by a barista costs less than $40,000. Explain how the
fixed costs, variable costs, and total costs of barista-served and self-served coffee differ.
The fixed cost of the Coinstar machine exceeds that of the barista-operated machine. The variable cost of
the barista-operated machine exceeds that of the Coinstar machine. The total cost of the Coinstar machine
is probably higher than that of the barista-operated machine at lower levels of output and is probably lower
at higher level of outputs.
d. Sketch the marginal cost and average cost curves implied by your answer to c.
Figure 11.19 shows the different marginal costs and
average total cost curves. The costs with the barista-
operated machine are labelled “1” and the costs with the
Coinstar are labelled “2”. The average total cost of the
Coinstar machine is higher than that of the barista-
operated machine at low levels of output and is lower than
the average total cost of the barista-operated machine at
high levels of output. The marginal cost of the Coinstar
machine is lower than the marginal cost of the barista-
operated machine.
19. A Bakery on the Rise
Some 500 customers a day line up to buy Avalon’s
breads, scones, muffins, and coffee. … Staffing and
management are worries. Avalon now employs 35 …
[and] it will hire 15 more. … Payroll will climb by
30% to 40%. … As new CEO, Victor has quickly
executed an ambitious agenda that includes the move
to a larger space. … Avalon’s costs will soar. … Its
monthly rent, for example, will leap to $10,000, from $3,500.
CNN, March 24, 2008
a. Which of Avalon’s decisions described in the news clip is a short-run decision and which is a
long run decision.
Hiring the additional 15 workers is a short-run decision; increasing the size of its space, that is, the size of
its plant, is a long-run decision.
b. Why is Avalon’s long-run decision riskier than its short run decision?
Avalon’s long-run decision is riskier than its short-run decision because it is more difficult to change the
long-run decision. In particular if Avalon decides to reverse its short-run decision to hire more workers, it
is straightforward to fire the workers. However to reverse the long-run decision of increasing the size of its
plant is more difficult and takes much longer to do.

Copyright © 2010 Pearson Education Canada

188 CHAPTER 11

c. By how much will Avalon’s short-run decision increase its total variable cost?
Avalon’s short-run decision to increase its workforce increases its total variable cost (its payroll) by 30
percent to 40 percent. The increase in workers boosts Avalon’s output and leads to a movement along its
total variable cost curve.
d. By how much will Avalon’s long-run decision increase monthly total fixed cost?
Avalon’s long-run decision to increase the size of its plant (its space) increases its total fixed cost by $6,500.
Avalon’s TFC curve shifts upward.
e. Draw a graph to illustrate Avalon’s short-run cost curves before and after the events
described in the news clip.
Figure 11.20 shows Avalon’s short-run AVC and
ATC curves before and after. The old cost curves are
labelled with a “1” and the new cost curves, after the
expansion, are labelled with a “2”, At lower levels of
output Avalon’s new average cost curves lie above its
old average cost curves and at higher levels of output
Avalon’s new average cost curves lie below its old
average cost curves. (In the figure the new minimum
average total cost equals the old minimum, so
Avalon has constant returns to scale.)
20. Gap Will Focus on Smaller Scale Stores
Gap has too many stores that are 12,500 square
feet … deemed too large. … “Stores are larger
than we need.” … The target size of stores
should be 6,000 square feet to 10,000 square
feet. In addition, the company plans to combine
previously separate concept stores. Some Gap
body, adult, maternity, baby and kids stores will be combined in one, rather than in separate
spaces as they have been previously.
CNN, June 10, 2008
a. Thinking of a Gap store as a production plant, explain why Gap is making a decision to
reduce the size of their stores.
Gap believes that its stores are too large and that it is operating where it has diseconomies of scale. By
reducing the size of its plant (its stores) Gap can slide down its LRAC curve and decrease its average cost.
b. Is Gap’s decision a long-run decision or a short-run decision? Explain.
Gap’s decision is a long-run decision because it involves the size of the firm’s plant.
c. How might combining Gap’s concept stores into one store help better take advantage of
economies of scale?
At 12,500 square feet Gap’s stores were too large and Gap was incurring diseconomies of scale. When Gap
combines its separate Gap concept stores into a smaller space, Gap will use fewer resources, particularly less
capital and less labour. Gap’s costs will be less as a result. Additionally Gap’s sales will be less but the
proportionate decrease in cost will exceed the decrease in Gap’s production. In this case Gap’s average costs
will decrease so that Gap can reap economies of scale it currently is not enjoying.

Copyright © 2010 Pearson Education Canada

 OUTPUT AND COSTS 189

21. The Sunk-Cost Fallacy

You have good tickets to a basketball game an hour’s drive away. There’s a blizzard raging
outside, and the game is being televised. You can sit warm and safe at home by a roaring fire and
watch it on TV, or you can bundle up, dig out your car, and go to the game. What do you do?
Slate, September 9, 2005
a. What type of cost is your expenditure on tickets?
At the time of the game, the cost of the ticket is a sunk cost.
b. Why is the cost of the ticket irrelevant to your current decision about whether to stay at
home or go to the game?
The cost of the ticket is a sunk cost; that is, the cost of the ticket has already been incurred. Because the
cost of the ticket is the same regardless if you attend the game or stay at home, the cost of the ticket is
irrelevant to your decision whether to attend or stay at home.
22. Study Reading Between the Lines on pp. 266-267 and then answer the following questions.
a. Sketch the AFC, AVC, and ATC curves for electricity production using seven technologies: (i)
nuclear, (ii) coal, (iii) gas, (iv) hydro (v) wind, (vi) SUNRGI’s new solar system, and (vii)
today’s solar technology.

Copyright © 2010 Pearson Education Canada

190 CHAPTER 11

The figures above show the average cost curves. In Figure 11.26 the higher cost curves are for solar power;
the lower cost curves are for SUNRGI’s new solar system.
b. Sketch the marginal cost curves for electricity production using seven technologies: (i)
nuclear, (ii) coal, (iii) gas, (iv) hydro (v) wind, (vi) SUNRGI’s new solar system, and (vii)
today’s solar technology.
The figures above show the marginal cost curves.
c. Given the cost differences among the different methods of generating electricity, why do you
think we use more than one method? If we could use only one method, which would it be?
The different methods have minimum average total costs at different amounts of output. Hence depending
on the level of output, in different locales different methods of producing electricity have the lowest cost.
Additionally in one locale a coal plant, for example, might provide ¾ of the electricity demanded when it is
producing at its minimum average total cost. But to produce the remaining ¼ of the electricity with
another coal plant might have higher average total cost than if the quantity was produced with a gas plant.
Hence one locale might have several different plants depending on the quantity of electricity demanded
and the plants’ minimum average total costs. Finally, the price of natural gas, coal, oil, and nuclear fuel can
vary tremendously over time. By having different types of plants some protection is gained against having a
concentration in a type of plant whose costs happened to soar. If we could use only one method, setting
aside the costs of storing used nuclear fuel, it appears that nuclear plants generate electricity at the lowest
average total cost.

Copyright © 2010 Pearson Education Canada