Review Questions: Costs of Productions
1) What are economic costs?
Economic costs = IRS (accounting costs) + opportunity costs
2) Distinguish between implicit costs and explicit costs.
Explicit
Implicit
direct payments to factors of production
indirect payments such as depreciation or opportunity costs
3) What is the “law of diminishing returns”?
With
(some fixed input), the MPi (some variable input) must eventually decline.
4) Derive the relationship between MPL and MC algebraically. Why is this relationship critical
to showing how the law of diminishing returns affects our expectations regarding SR costs?
MPi =
MC =
=
= Pi
So, if MPi , MC
&
MPi , MC
5) How is MC related to AVC? How is MC related to TVC?
If MC > AVC
If MC
If MC
AVC
TVC
TVC
at a
at a
If MC < AVC then AVC
rate
rate
6) Suppose the equation form MC is MC =2Q. On one set of axes, plot MC. On another set of
axes, plot TVC. What is TVC when Q=100?
If MC = 2Q, TVC = Q2
MC
$6
$9
4
4
2
1
1
2
3
Q
1
2
3
Q
7) What is an expenditure (isocost) line?
K
TC/PK
Line showing input combinations that yield the same
costs.
L
TC/PL
8) For a given level of output, the cost minimizing level of inputs implies MPL/ PL= MPK/ PK?
In words, explain why this equation also makes “sense” from the perspective of maximizing
output for a given cost.
If MPL/PL ≠ MPK/PK then the firm could increase output (with the same TC) by choosing
more of the input that has the higher marginal product per dollar spent.
9) What is the expansion path?
K
EP
Line showing the combination of inputs that maximize
output at alternative levels of spending (TC)
L
10) Using isocost lines and an isoquant, show how one would show the “substitution effect” for
labor following an increase in the price of labor.
k
TC/Pk
L1 L2 ( employment of labor) is the substitution
effect after the P of labor, holding .
Q1
L2
L1 TC/P
L2
TC/PL1 L
11) How is the concept of “returns to scale” related to the shape of the LRAC curve?
a)
returns to scale
LRAC
b) Constant returns to scale
1) If EP linear, LRAC constant
2) IF EP non-linear, LRAC
c)
returns to scale
1) If EP linear, LRAC
2) If EP non-linear, LRAC may be
or
or constant.
12) Suppose the LR cost function can be represented as: TC = 100Q – 10Q2 + .4Q3
a) What is the function form of the ATC and MC functions?
ATC = TC/Q = 100 - 10Q
b) Using Excel, compute TC, ATC, and MC for Q=1, 5, 10, 15, 20, 25, 30.
c) Using Excel, plot TC.
d) Using Excel, plot ATC and MC.