Assignment 4

INSTITUTE OF BUSINESS MANAGEMENT

COLLEGE OF BUSINESS MANAGEMENT ECO 401 Micro and Macro Economics Due Date: on the day of 2nd hourly exam

Assignment # 4

Short-Run Cost Q. 6. Your aunt is thinking about opening a hardware store. She estimates that it would cost $500,000 per year to rent the location and buy the stock. In addition, she would have to quit her $50,000 per year job as an accountant. a. Define opportunity cost. Ans: The opportunity cost of something is what must be forgone to acquire it. b. What is your aunt’s opportunity cost of running a hardware store for a year? If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain. Ans: The opportunity cost of running the hardware store is $550,000, consisting of $500,000 to rent the store and buy the stock and a $50,000 opportunity cost, since aunt would quit her job as an accountant to run the store. Since the total opportunity cost of $550,000 exceeds revenue of $510,000, aunt should not open the store, as her profit would be negative, she would lose money. Use the following data to work Problems 7 to 11. Saif’s Surfboards, in Problem 2, hires workers at $500 a week and its total fixed cost is $1,000 a week. Q. 7. 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. Ans: The total variable cost = Number of Workers x Wage Per Week = 3 X 500 = $1500 Total fixed cost = $1,000, Total Cost = TVC + TFC = 1500 + 1000 = $2,500 The plot is shown as follows: Q. 8. 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. Ans: Average total cost, average fixed cost, average variable cost, and marginal cost are tabulated as follows:

Output (surfboards) 30

AFC (dollars per surfboard) 33.33

AVC (dollars per surfboard) 16.67

ATC (dollars per surfboard) 50.00

70

14.29

14.29

28.58

120

8.33

12.50

20.83

160

6.25

12.50

18.75

MC (dollars per surfboard) 12.50 10.00 12.50

16.67 190

5.26

13.16

18.42

210

4.76

14.29

19.05

220

4.55

15.91

20.46

25.00 50.00 The short-run average and marginal cost curves are shown in below Figure:

Q. 9. Illustrate the connection between Saif’s AP, MP, AVC, and MC curves in graphs. Ans: 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. Labor (workers)

Output (surfboards)

AP (surfboards per worker)

1

30

30.0

2

70

35.0

3

120

40.0

4

160

40.0

5

190

38.0

6

210

35.0

7

220

31.4

MP (surfboards per worker)

AVC (dollars per surfboard)

MC (dollars per surfboard)

16.67 40.0

12.50 14.29

50.0

10.00 12.50

40.0

12.50 12.50

30.0

16.67 13.16

20.0

25.00 14.29

10.0

50.00 15.91

Q. 10. Saif’s Surfboards rents a factory building. If the rent is increased by $200 a week and other things remain the same, how do Saif’s Surfboards’ short run average cost curves and marginal cost curve change? Ans: 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. Q. 11. Workers at Saif’s Surfboards negotiate a wage increase of $100 a week for each worker. If other things remain the same, explain how Saif’s Surfboards’ short-run average cost curves and marginal cost curve change. Ans: 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. Q. 12. You are the chief financial officer for a firm that sells digital music players. Your firm has the following average-total-cost schedule: Quantity 600 Players 601 Players

Average Total Cost $300 $301

Your current level of production is 600 devices, all of which have been sold. Someone calls, desperate to buy one of your music players. The caller offers you $550 for it. Should you accept the offer? Why or why not? Ans: If the firm produces 600 units, total cost is 600x300=$180,000 An increase in extra unit will cost the firm 601x301=$180,901 The marginal cost is 180,901-180,000=$901 more than the offered price of $550. It should decline the offer. Note: The Assignment should be hand written on A4 paper.