Assignment on Production and Costs

Course Title: ECO101.15

Submitted To: Ms. Kanti Ananta Nuzhat

Assistant Professor, North South University

Submitted By: Nargis Hamid Monami

Student ID: 2021503630

Date of Submission: 20th May, 2021

Question 1: The owner of a small retail store does her own accounting work.
How would you measure the opportunity cost of her work?

Answer: The opportunity cost of her work is an example of implicit cost.

There are two types of cost we can see while identifying a firm’s cost. One is
Explicit cost and the other one is Implicit cost. Explicit costs are those where an
actual monetary payment is made. Whereas, the implicit cost has no monetary
value, but that doesn’t mean it doesn’t have any value. It’s the value of resources
used behind the production of the firm for which no monetary payment has been
made. For example, the owner of the store does her own accounting work. Here,
the owner of the store is contributing to the business for which no monetary
payment is made. Maybe she had given up her other accounting job at a firm to do
the work at her own shop, that would be a cost too, even if it may or may not has
any monetary payment.

This implicit cost will be included in the economic profit of the shop, whereas it
will not be included in the accounting profit of the shop.

Question 2: Please explain whether the following statements are true or false.

a. If the owner of a business pays himself no salary, then the accounting cost is
zero, but the economic cost is positive.

b. A firm that has positive accounting profit does not necessarily have positive
economic profit.

c. If a firm hires a currently unemployed worker, the opportunity cost of utilizing

the worker’s services is zero.

Answer:

a) True.
Explanation: When the owner of a business doesn’t pay himself salary, the
firm may not cause any accounting cost, but the owners work has a value,
 too. Here, implicit cost comes again. “The owner of a business doesn’t pay
himself a salary” is another example of implicit cost.
However, when we measure accounting cost, we don’t count the implicit
cost. In accounting cost, only the explicit cost matters.
But when we measure the economic cost, we also count the implicit cost
along with the explicit cost.
Thus, if the owner of a business pays himself no salary, then the accounting
cost is zero, but the economic cost is positive.

b) True.
Explanation: As we know, economic profit is usually lower than the
accounting profit as economic profit include both explicit and implicit cost.

Accounting Profit = Total Revenue – Explicit Cost

Economic Profit = Total Revenue – (Explicit Cost + Implicit Cost)

Suppose, A company’s total revenue is $200,000. Its’ explicit cost is

$99,000. The Accounting profit of the company would be $101,000, which
is positive.
What if the implicit cost of the company is $102,000? The economic profit
of the company would be negative.
Thus, the economic profit of a company can be negative while the
accounting profit of a company can be positive.

c) False.
Explanation: There’s no service of which the opportunity cost is zero. By
hiring someone who were unemployed before, the opportunity cost of this
service would be less than that of hiring someone who were employed
before, but the opportunity cost won’t be zero. For example, the worker
could have spent time with his family if he wasn’t working for the firm,
hence, the opportunity cost of the service would be spending time with
family. It may have no monetary exchange, but it’s still valuable.
Thus, the opportunity cost of utilizing the worker’s service can’t be zero. In
the economics language, “There’s no free lunch.”
Question:3- Suppose that labor is the only variable input to the production
process. If the marginal cost of production is diminishing as more units of
output are produced, what can you say about the marginal product of labor?
Draw diagrams as required.

Answer: Marginal Cost is the change of total cost that results from a change in
quantity of output, and the marginal product of labor is the change in output that
results from changing the number of workers by one unit, whereas all other factors
are fixed.

In the case mentioned, the marginal cost of production is diminishing as more units
of output are produced. As we know, Marginal Cost (MC) is equal to ΔTotal Cost/
ΔQuantity of output. Whereas, Marginal Product of Labor is equal to Δ Quantity of output/
ΔLabor. Hence, MPP and MC always works in the opposite direction. That implies
that, if the marginal cost of production is diminishing, the marginal product of
labor would be increasing.

In reverse, The Law of Diminishing Marginal Return also works in this. The law of
diminishing marginal returns says that, as more units of the variable input are
added, each one has fewer units of the fixed input to work with. Thus, the output
will be decreasing.

Here, the MC curve is downward sloping, thus, the MPP of labor curve would be
upward sloping.
Question 4: Assume that the marginal cost of production is increasing. Can you
determine whether the average variable cost is increasing or decreasing?
Explain. Draw diagrams as required.

Answer: No, I cannot determine because of insufficient information.

Explanation: An average variable cost (AVC) is total variable cost divided by

quantity of output. Marginal cost is the change in the total cost divided by the
change in quantity of output.

Marginal cost can be increasing while average variable cost is either increasing or
decreasing. When the quantity of output increases, to some point, both the
marginal cost and the average variable cost decreases. But because of the Law of
Diminishing Marginal Return, both marginal cost and the average variable cost
start increasing again. Hence, I can’t determine from what point both of them
started increasing together unless I know if the marginal cost is lesser or more than
average variable cost.

Here’s a table of a firms Quantity of outputs, AVC, Total cost, and marginal cost.
We can see, when the quantity of the output was 6, the AVC started to increase
again, and when the quantity of outputs was 5, The MC started increasing again.
And it happens because of the Law of Diminishing Marginal Return.

Here, in this table, the marginal cost is less than average variable cost till the
quantity of output is 5, hence the average cost decreased to that point. Again,
Marginal cost in greater than average variable cost from the quantity of output
number 6, there, the average variable cost started increasing. Therefore, we need to
know whether marginal cost is greater than average variable cost to determine
whether the AVC is increasing or decreasing in this case.

Quantity of Average Variable Average Total Marginal Cost

Outputs Cost cost
 1 50 150 50
2 40 90 30
3 33.33 66.67 20
4 27.50 52.50 10
5 26 46.00 20
6 26.67 43.33 30
7 28.57 42.86 40
8 31.25 43.75 50
9 34.44 45.56 60
10 38.00 48.00 70

According to the table, the diagrams of the MC and AVC would be like this:
Question 5: Assume that the marginal cost of production is greater than the
average variable cost. Can you determine whether the average variable cost is
increasing or decreasing? Explain.

Answer: The average variable cost is increasing.

Explanation: The relation between Average Variable Cost and Marginal Cost is
consistent with average marginal rule. According to average marginal rule, if the
marginal cost is less than average variable cost, then average variable cost will be
falling, and when the marginal cost is greater than average variable, the average
variable cost will be rising.

For example, if a company’s average variable cost is $170. If the marginal cost is
$275, then the average variable cost will be $175, more than before. Again, if the
marginal cost is $65, then the average variable cost will be $165 which is less than
before. Hence, we can say-

Marginal < Average = decreasing Average

Marginal> Average= Increasing Average

In the graph below, in area 1, marginal cost is below average variable cost and
average variable cost is falling. Whereas, in area 2, the marginal cost is above the
variable cost, thus the average variable cost is increasing.
Question 6- If the firm’s average cost curves are U-shaped, why does its average
variable cost curve achieve its minimum at a lower level of output than the
average total cost curve?

Answer: Because of the average fixed cost, average variable cost curve achieves its
minimum at a lower level of output than the average total cost curve.

In this case, we can assume, the firm is in short run as the average total cost curves
are u shaped. As it’s a short run firm, it must have fixed costs.

As we know, total cost is the summation of fixed cost and variable cost, and
average total cost is the summation of average fixed cost and average variable cost.
As we know, average variable cost continues to fall as more output is produced,
but at some point, it starts to increase. However, the average total cost is still
decreasing when the average variable cost begins to increase. That happens,
because the fixed cost of the firm doesn’t increase and the average total cost of the
firm decreases.
For example, suppose, this a table of the firms Quantity of outputs, AVC, and
Total cost.
Quantity of Average Variable Average Total
Outputs Cost cost
1 50 150
2 40 90
3 33.33 66.67
4 27.50 52.50
5 26 46.00
6 26.67 43.33
7 28.57 42.86
8 31.25 43.75
9 34.44 45.56
10 38.00 48.00

The graph below is done with the numbers from this table.
Question 7- If a firm enjoys economies of scale up to a certain output level, and
cost then increases proportionately with output, what can you say about the
shape of the long-run average cost curve?

Answer: In a Long run, there are three concepts, Economies of Scale, Constant
returns to scales, and diseconomies of scale. A long run curve shows the lowest
cost in which a firm can produce any given level of output.

However, if a firm enjoys economies of scale up, that means, if the firm is
increasing it’s input by a percentage, the outputs are increasing by a greater
percentage. Which causes the unit costs to fall. Therefore, the long run average
cost curve is downward slopping.

When the firm experiences the cost increasing proportionately with output, it is
called the constant return to the scale, because the unit costs remain constant.
Therefore, the long run average curve would be horizontal.

Here’s the visual representation of the long run curve of the firm-

Figure: The long run curve of the firm.

Question 8- Joe quits his computer programming job, where he was earning a
salary of $50,000 per year, to start his own computer software business in a
building that he owns and was previously renting out for $24,000 per year. In his
first year of business he has the following expenses: salary paid to himself,
$40,000; rent, $0; other expenses, $25,000. Find the accounting cost and the
economic cost associated with Joe’s computer software business.

Answer: Let’s find out the accounting cost first. We know, accounting cost only
includes explicit costs. Here, joe’s explicit costs are-

Joe’s salary, which is $40,000 and his other expenses, which is $25,000.

Therefore, the accounting cost is- ($40,000 + $25,000) = $65,000.

Now, the economic cost is bit complicated as it includes both explicit cost and
implicit cost. The implicit costs of Joe are, $24,000 Joe gave up by not renting the
Building, and the amount of money joe’s losing because of the difference between
current and the last salary. That is, ($50,000-$40,000) = $10,000.
So, the implicit cost of Joey is, ($24,000+ $10,000) = $34,000
Hence, the economic cost would be, ($65,000 + $34,000) = $99,000.

Question 9: 9. (a) Fill in the blanks in the table:

Answer:

(1) (2) (3) (4) (5) (6) (7) (8)

Units Fixed Variable Cos Total Marginal Average Average Average

of t Cost
Cost Variable
Output Cost =d(4)/d(1) Fixed
Total
Cost
= Cost Cost
(2)+(3) = (6)+(7)
= (2)/(1) = (3)/ (1)

0 100 0 100 - - - -
 1 100 25 125 25 100 25 125

2 100 45 145 20 50 22.5 72.5

3 100 57 157 12 33.33 19 52.33

4 100 77 177 20 25.00 19.25 44.25

5 100 102 202 25 20.00 20.40 40.40

6 100 136 236 34 16.67 22.67 39.33

7 100 170 270 34 14.28 24.29 38.57

8 100 226 326 56 12.50 28.25 40.75

9 100 298 398 72 11.11 33.11 44.22

10 100 390 490 92 10.00 39 49.00

Question 9 (b)- Draw a graph that shows marginal cost, average variable cost,
and average total cost, with cost on the vertical axis and quantity on the
horizontal axis.
Answer: A graph that shows marginal cost, average variable cost, and average total
cost of the table this given below. Here, MC means marginal cost, ATC means
average total cost, AVC means average vertical cost.
This graph represents the average-marginal rule perfectly. In the area A1, the MC
curve is below the AVC curve, hence, the AVC decreases. In the area A2, the MC
curve is above the AVC curve and thus, the AVC increases.
 Area A2 also represents the relation between ATC and MC. In the area A2, the MC
curve is below the ATC curve and ATC decreases. Whereas, in area A3, MC curve
is above the ATC curve and thus, the ATC increases.

Question 10- Suppose a firm must pay an annual tax, which is a fixed sum,
independent of whether it produces any output.
a. How does this tax affect the firm’s fixed, marginal, and average costs?

b. Now suppose the firm is charged a tax that is proportional to the number of
items it produces. Again, how does this tax affect the firm’s fixed, marginal, and
average costs?
Answer: a) Here, the firm must pay an annual tax. As this is a must for them, with
a fixed sum, and doesn’t depend on whether the firm produce any output or not, the
tax is a fixed cost. Therefore, the tax increases the total fixed cost of the firm.
Nevertheless, as the tax doesn’t depend on the output produced by the firm, it
doesn’t affect the marginal cost of the firm.
We know, average total cost is the summation of average fixed cost and average
variable cost. As the fixed cost increases, average fixed cost increases too, which
leads the average total cost to increase. Thus, the average cost of the firm
increases.

b) As the amount of charge depends on the number of items it produces, the tax
would be the variable cost of the firm.
Now, as the variable cost increase, and the fixed cost doesn’t, the tax would not
affect the fixed cost of the firm.
However, as the variable cost increases, the total cost of the firm increases, too. As
we know, marginal cost depends on the change in the total cost, and the change in
the output, the marginal cost of the firm would increase, too.
We know, average total cost is the summation of average fixed cost and average
variable cost. As the variable cost increases, the average variable cost increases
too, which leads the average total cost to increase. Thus, the average cost of the
firm increases.

Question 11- A recent issue of Business Week reported the following:

During the recent auto sales slump, GM, Ford, and Chrysler decided it was
cheaper to sell cars to rental companies at a loss than to lay off workers. That’s
because closing and reopening plants is expensive, partly because the auto
makers’ current union contracts obligate them to pay many workers even if
they’re not working.
When the article discusses selling cars “at a loss,” is it referring to
accounting profit or economic profit? How will the two differ in this case?
Explain briefly.
 Answer: In this case, the accounting profit is lower than the economic profit
hence the article is referring to accounting profit by mentioning “At a lost.”
As we know, economic profit measurement includes both price and the opportunity
cost. Here, the company has to pay the workers even if they don’t work. Thus, if
the workers don’t work and because of the sales slump there is no incentive for
producing cars, the monetary payment for the workers would be sunk cost. Hence,
they decided to sell cars to rental companies at a cheaper cost.

Here, the difference between accounting and economic cost is the cost of labor.
The opportunity cost for the workers is less and as the wages for the workers
would be included in accounting costs, the accounting costs would be higher than
the economic costs. This would lower the accounting profit than the economic
profit of the companies.