EC 252 UNA Costs of Producing & Supply of Goods Worksheet

Description

Instructions1) Complete the following table:QuantityTVCTFCTCAVCAFCATCMCPRICE 0050 80150 80290 803110 804150 805210 806290 807410 80After which quantity level does diminishing marginal returns begin?Which level of production (quantity) maximizes profit for a perfectly-competitive firm?What would be the profit at the profit maximizing level of output?After answering the above questions and completing the table, compose a 3-page write up explaining the essentials of production cost to your manager who doesn’t understand why you would not continue to increase output infinitely. Be sure in your write up to, not only address the questions above but, include the following:Why the cost of production diminishes at first and then risesWhy some costs remain constant at all levels of productionWhat the profit maximizing level of output means and why it is not necessarily at the maximum level of workers given in the tableWhat happens if you continue to increase output above the profit maximizing levelWhether this is a long run view or a short run view

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Module 5 Video Instruction
Short-Run Costs
This video explains the costs of production including fixed costs, variable
costs, total cost, and marginal cost. Make sure that you know how to calculate
the per unit costs: AVC, AFC, and ATC.

Module 5 Required Reading
•
Gwartney, Stroup, Sobel and Macpherson Chapter 20: “Consumer
Choice and Elasticity”

Costs in the Short Run


https://thismatter.com/economics/firm-production-and-costs.htm
http://www.ukm.my/hairun/Ecn3100/cost%20of%20production.pdf
Notes from AmoxWeb Encyclonomic: Production Cost
The opportunity cost of using labor, capital, land, and entrepreneurship in the
production of goods and services. The price received by a seller must be high
enough to cover production cost. The law of supply is based on the
proposition that production cost increases with an increase in the quantity
produced and supplied.
Production cost is important to the supply side of the market. Sellers base
supply decisions on the cost of production. In that production cost generally
increases as more of a good is production, the supply price also tends to rise
with the quantity supplied.
All Sorts of Expenses
Production cost includes the opportunity cost of using the four factors of
production (labor, capital, land, and entrepreneurship). It includes those
expense items that are traditionally considered as the “cost of doing
business.” However, it also includes other less obvious costs.
To run through the assortment of costs, consider the production of Wacky
Willy Stuffed Amigos, a cute and cuddly line of collectible stuffed creatures.
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Labor: At the top of almost any list of business expenses are the wages
paid to labor. This includes hourly wages, monthly salaries, and fringe
benefits. It includes anything and everything that compensates workers
for the opportunity cost of foregone production. The Wacky Willy
Company incurs the cost of employing thousands of workers, including
those doing the actual production as well as assorted executives,
accountants, and other administrators.
Materials: Another noted expense for production operations like Wacky
Willy Stuffed Amigos is for the materials that make up the product. This
includes fabric, stuffing, thread, and cute little buttons for the eyes. The
payments for these materials are typically used by another firm to pay
its production cost.
Capital: The opportunity cost of using capital goods–buildings,
machinery, tools, vehicles, and assorted equipment–is also important,
but not always evident. The Wacky Willy Company, for example,
borrowed money to purchase sewing machines. The interest expense
on the loan is a key part of the cost of the capital. Other producers might
incur a production cost for renting factory space, office space, or
vehicles from another company.
Entrepreneurs: The organizing risk takers also incur an opportunity
cost in the production of a good. The entrepreneur responsible for
Wacky Willy Stuffed Amigos is William J. Wackowski. He undertook the
risk of launching The Wacky Willy Company and producing the adorable
stuffed creatures. The opportunity cost of his entrepreneurial effort is
profit–specifically a normal profit. A normal profit is the profit that could
be earned in the next best alternative production operation.
More Than Transformation
The production cost incurred in the physical transformation of materials into a
finished product tends to be extremely important for most suppliers. However,
the act of production includes more than transformation. It also includes
transportation, moving things around. As such, production cost also includes
the cost of transporting inputs and outputs, getting the materials to the factory
and getting the finished product to the buyers.
Production cost also includes administrative cost, marketing cost, and any
other expense needed to supply a good, to offer it for sale to buyers.
Explicit and Implicit
Most production cost for most firms involves out-of-pocket payments to
resource owners, what is technically termed explicit cost. However, some
opportunity cost of production is implicit cost, which does not involve an outof-pocket payment. Implicit cost can be either internal or external.
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Internal: The most important internal implicit cost is a normal profit to
compensate entrepreneurship for the opportunity cost of foregone
production. However, labor, capital, and land resources also can incur
implicit opportunity cost. For example, William J. Wackowski was not
explicitly paid for his labor and sewing machine, when he produced the
first Wacky Willy Stuffed Amigos in his garage.
External: External implicit cost is that incurred beyond the confines of
the production process and the producer. This often involves a biproduct or waste material discharged into the environment that imposes
an opportunity cost on others. For example, The Wacky Willy Company
blows excess, unneeded stuffing fibers out through an exhaust pipe.
Unfortunately this waste fiber creates breathing problems and medical
expenses for people living around the factory. They incur the cost. The
Wacky Willy Company does not.
The Law of Supply
Production cost forms the foundation of supply and the law of supply. Sellers
must receive a price high enough to cover production cost if they are to supply
a good. Two notions are particularly important in this regard.
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Only Internal Cost: First, the supply decision relies only on internal
cost, both explicit and implicit. A seller is willing and able to offer a good
for sale if the price is sufficient to cover all internal cost. This includes
both explicit and implicit cost as long as they are incurred by the firm.
The supply price is, in effect, the minimum price needed by a seller to
cover all internal cost. Most important is the internal implicit cost of a
normal profit. Supply price also includes a normal profit.
Increasing Cost: Second, production cost generally increases with the
production of a good. This is often explained through the law of
increasing opportunity cost associated with the production possibilities
curve or the law of diminishing marginal returns underlying the analysis
of short-run production. If production cost increases with the quantity
produced and supplied, then so too does the supply price, which results
in the law of supply.
Notes from AmoxWeb Encyclonomic: Variable Cost
In general, cost that changes with changes in the quantity of output produced.
More specifically, variable cost is combined with the adjectives “total” and
“average” to indicate the overall level of variable cost or the per unit variable
cost. Variable cost depends on the amount produced. If there is no
production, then there is no variable cost.
Variable cost is cost that depends on the quantity produced. If production is
greater, then variable cost is greater. Variable cost is affected by short-run
production principles, especially the law of diminishing marginal returns.
Variable Inputs
Variable cost usually includes the cost of using variable inputs, assorted
resources that are variable in the short run, especially labor and material
inputs. However, in practice, variable cost includes any and all cost that varies
with the quantity of output.
For example, Waldo’s TexMex Taco World operates in the short run with labor
(the workers) as a variable input and capital (the restaurant and equipment)
as a fixed input. In this case, the cost associated with labor is a prime
candidate to be a variable cost. This includes hourly wage payments to the
workers and any fringe benefits paid on behalf of the workers.
While labor is usually isolated as THE variable input in the short run, most
short-run production has other variable inputs, too. Waldo’s TexMex Taco
World undoubtedly has an assortment of other variable inputs, all of which are
part of variable cost–including meat, lettuce, sour cream, and jalapenos that
make up the tacos; paper napkins, packaging material, and plastic utensils
that customers use when consuming the tacos; and electricity and other
energy sources needed to prepare the tacos. When Waldo’s make more
tacos, they incur a greater cost for these inputs.
Total and Average
The two most common manifestations of variable cost are total variable cost
and average variable cost.
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Total Variable Cost: This is the total amount of variable cost incurred in
the production of a good. It combines all variable opportunity cost.
Average Variable Cost: This is the per unit variable cost, which is
calculated by dividing total variable cost by the quantity of output
produced.
Notes from AmoxWeb Encyclonomic: Fixed Cost
In general, cost that does not change with changes in the quantity of output
produced. More specifically, fixed cost is combined with the adjectives “total”
and “average” to indicate the overall level of fixed cost or the per unit fixed
cost. Fixed cost is incurred whether of not any output is produced. The
contrast to fixed cost is variable cost, cost which does change with the
quantity produced.
Fixed cost is cost that does not depend on the quantity of output produced. In
other words, the same fixed cost is incurred at any and all output levels. This
means that total fixed cost is, in fact, FIXED. However, it also means that
average fixed cost, or fixed cost per unit, declines as the output level
increases. Spreading $100 over 1,000 units gives a lower per unit fixed cost
than spreading $100 over 10 units.
Fixed Inputs
For a firm, fixed cost usually includes the cost of using fixed inputs, assorted
resources that are held fixed in the short run, especially capital and land.
However, in practice, fixed cost includes any and all cost that does not vary
with the quantity of output. This also includes overhead cost, administrative
salaries, loan repayment expenses, and even marketing costs.
For example, Waldo’s TexMex Taco World operates in the short run with labor
(the workers) as a variable input and capital (the restaurant and equipment)
as a fixed input. As such, the cost associated with the capital input is likely to
be fixed cost. This includes payments for the use of the restaurant building-rent if the building is not owned by Waldo’s TexMex Taco World or interest
payments if funds were borrowed to purchase the restaurant.
Other fixed cost, however, might not be directly associated with short-run fixed
inputs. For example, administrative salaries, such as that to the President of
Waldo’s TexMex Taco World (Waldo Millbottom), are paid whether Waldo’s
TexMex Taco World produces 1 taco or 1 billion tacos. This cost is not, strictly
speaking, associated with a fixed input, but it is a fixed cost.
Total and Average
The two most common manifestations of fixed cost are total fixed cost and
average fixed cost.
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Total Fixed Cost: This is the total amount of fixed cost incurred in the
production of a good. It combines all fixed opportunity cost.
Average Fixed Cost: This is the per unit fixed cost, which is calculated
by dividing total fixed cost by the quantity of output produced. Because
total fixed cost is fixed, average fixed cost declines as quantity
increases.
Notes from AmoxWeb Encyclonomic: Marginal Cost
and Marginal Product
The U-shape of the marginal cost curve is closely related to the hump-shape
of the marginal product curve. The increasing portion of the marginal product
curve corresponds with the decreasing portion of the marginal cost curve. The
decreasing portion of the marginal product curve corresponds with the
increasing portion of the marginal cost curve. The peak of the marginal
product curve corresponds with the minimum of the marginal cost curve.
Because variable cost is largely associated with the cost of employing a
variable input in the short run, it is possible to identify a connection between
the marginal cost curve and the marginal product curve.
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The quantity of output in which marginal cost is at a minimum is the
same quantity of output produced by the variable input when the
marginal product of the variable input is at a maximum.
Over the range of production in which marginal product increases and
the variable input experiences increasing marginal returns, the marginal
cost curve declines.
Over the range of production in which marginal product increases and
the variable input experiences decreasing marginal returns brought on
by the law of diminishing marginal returns, the marginal cost curve is
rising.
The correspondence between the marginal product and marginal cost curves
indicates that the law of diminishing marginal returns is the key reason for
increasing marginal cost. This further implies that the law of supply and the
positively-sloped supply curve can be explained in the short run by increasing
marginal cost.
This diagram displays the marginal product and marginal cost for the
production of Wacky Willy Stuffed Amigos (those cute and cuddly armadillos,
tarantulas, scorpions, and rattlesnakes). The top panel presents the marginal
product of the variable input used to produced Stuffed Amigos. The bottom
panel contains the marginal cost of producing Stuffed Amigos.
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The marginal product curve in the upper panel has a distinctive humpshape, with marginal product rising, reaching a peak, then falling. The
rising portion of the marginal product curve is the result of increasing
marginal returns. The falling portion is attributable to decreasing
marginal returns, and in particular, the law of diminishing marginal
returns.
The marginal cost curve in the lower panel has a distinctive U-shape,
with marginal cost falling, reaching a minimum, then rising. The falling
portion of the marginal product curve is the result of increasing marginal
returns. The rising portion is attributable to decreasing marginal returns,
and in particular, the law of diminishing marginal returns.
How does this work?
The marginal cost curve can be thought of as something of a “reflection” of
the marginal product curve. This reflection is not a perfect image, but it
captures the essence of the shape.
Stage I: Increasing Marginal Returns
In production Stage I, with increasing marginal returns, marginal cost declines.
Because each additional worker is increasingly more productive, a given
quantity of output can be produced with fewer variable inputs. Consider an
extreme example.
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Suppose that the first worker employed by The Wacky Willy Company
has a marginal product of one Stuffed Amigo and is paid $5 an hour. In
this case, the marginal cost of producing the first Stuffed Amigo is $5.
One worker, working one hour, produces one Stuffed Amigo, and the
cost is $5.
Now suppose, with increasing marginal returns, that the second worker
has a marginal product of 2 Stuffed Amigos, but is paid $5 per hour like
the first worker. In this case, the marginal cost of producing the second
Stuffed Amigo is only $2.50. With a greater marginal product, the
second worker needs to work only half-an-hour to produce one Stuffed
Amigo, at a marginal cost of $2.50. One worker, working half-an-hour,
produces one Stuffed Amigo, and the cost is $2.50.
The bottom line: With an increasing marginal product, marginal cost
decreases.
Stage II: Decreasing Marginal Returns
In production Stage II, with decreasing marginal returns, marginal cost
increases. Because each additional worker is less productive, a given quantity
of output needs more variable inputs. Consider what happens as The Wacky
Willy Company produces enough to succumb to the law of diminishing
marginal returns.
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Suppose that the 101st worker employed by The Wacky Willy Company
has a marginal product of 10 Stuffed Amigos and again is paid $5 an
hour. In this case, the marginal cost of producing the one Stuffed Amigo
is $0.50. One worker, working one-tenth of an hour, produces one
Stuffed Amigo, and the cost is $0.50.
Now suppose, with decreasing marginal returns, that the 102nd worker
has a marginal product of 5 Stuffed Amigos, but is also paid $5 per hour
like the other workers. In this case, the marginal cost of producing the
one Stuffed Amigo is only $1. With a declining marginal product, the
102nd worker needs to work one-fifth of an hour to produce one Stuffed
Amigo, at a marginal cost of $1.
The bottom line in this case: With a decreasing marginal product, marginal
cost increases. The prime conclusion is that the positively-sloped portion of
the marginal cost curve is directly attributable to the law of diminishing
marginal returns.

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Supply of Goods

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