QUESTION 1

A firm’s product sells for $4 per unit in a highly competitive market. The firm
produces output using capital (which it rents at $25 per hour) and labor (which is
paid a wage of $30 per hour under a contract for 20 hours of labor services).
Complete the following table and use that information to answer the questions that
follow.
K L Q MPK APK APL (Q/L) VMPK
(∆Q/∆K) (Q/K) ($4X MPK)
0 20 0 - - - -
1 20 50 50 50 2.50 200
2 20 150 100 75 7.50 400
3 20 300 150 100 15 600
4 20 400 100 100 20 400
5 20 450 50 90 22.50 200
6 20 475 25 79.17 23.75 100
7 20 475 0 67.86 23.75 0
8 20 450 -25 56.25 22.50 -100
9 20 400 -50 44.44 20 -200
10 20 300 -100 30 15 -400
11 20 150 -150 13.64 7.50 -600

a. Identify the fixed and variable inputs.

The fixed input is Labor (L) that is 20
The Variable input is capital (K)
b. What are the firm’s fixed cost?

Cost of the labor = $30 per hour

So, the fixed cost = $ 30 x 20 = $ 600

c. What is the variable cost of producing 475 units of output?

The variable cost for producing 475 units of output

$25 x 6 = $150

d. How many units of the variables input should be used to maximize profits?

6 units of the variable input should be used to maximize profits.

VMPK > $25
Thus 6 units of the variable input should be used to maximize profit.
e. What are the maximum profits this firm can earn?

Sale of 6 units= $4×475 = $1900.

Fixed cost = $30×20 = $600.
Variable cost of 6 units= $ 25×6= $150.
Thus the maximum profits this firm can earn is
$1900 - $600- $150 = $1,150

f. Over what range of the variable input usage do increasing marginal returns
exist?

When the capital (K) is between 0 and 3.

g. Over what range of the variable input usage do decreasing marginal returns
exist?
When the capital (K) is greater than 3
h. Over what range of input usage do negative marginal returns exist?

When the capital (K) is greater than 7

QUESTION 2

An economist estimated that the cost function of a single product firm is:
C(Q) = 100 + 20Q + 15Q2 + 10Q3
Based on this information, determine:

a) The fixed cost of producing 10 units of output

100

b) The variable cost of producing 10 units of output

20Q + 15Q2 + 10Q3 = 20(10) + 15(100) + 10(1000) = 11700

c) The total cost of producing 10 units of output

100 + 20Q + 15Q2 + 10Q3 = 100 + 20(10) + 15(100) + 10(1000) = 11800

d) The average fixed cost of producing 10 units of output

Total fixed cost/no. of units = 100/10 = 10

e) The average variable cost of producing 10 units of output

Total variable cost/no. of units = 11700/10 = 1170

f) The average total cost of producing 10 units of output

Total cost/no. of units = 11800/10 = 1180

g) The marginal cost when Q = 10

20 + 30Q + 30Q2 = 20 + 30(10)+30(100) = 3320
QUESTION 3

The Blair Company's three assembly plants are located in California, Georgia and
New Jersey. Previously, the company purchased a major subassembly, which
becomes part of the final product, from an outside firm. Blair has decided to
manufacturer the subassemblies within the company and must now consider
whether to rent one centrally located facility (e.g in Missouri, where all the
subassemblies would be manufactured) or to rent three separate facilities, each
located near one of the assembly plants, where each facility would manufacturer
only the subassemblies needed for the nearby assembly plant. A single, centrally
located facility, with a production capacity of 18,000 units per year, would have fixed
costs of $900,000 per year and a variable cost of $250 per unit. Three separate
decentralized facilities, with production capacities of 8,000, 6,000 and 4,000 units per
year would have fixed costs of $475,000, $425,000, and $400,000, respectively and
variable costs per unit of only $225 per unit, owing primarily to the reduction in
shipping costs. The current production rates at the three assembly plants are 6,000,
4,500 and 3,000 units respectively.

a. Assuming that the current production rates are maintained at the three
assembly plants, which alternative should management select?

Plant Single Three

Location California Georgia New Jersey

Fixed Cost (FC) $900,000 $475,000 $425,000 $400,000

Variable Cost (VC) $250 $225 $225 $225

Production Capacity (Q) 18,000 8,000 6,000 4,000

Current Production (Q) 13,500 6,000 4,500 3,000

Single plant will have total costs = FC + VC*Q

TC = 900,000 + 250*(6,000+4,500+3,000)
= $4,275,000.

Three plants will have total costs

TC = (475,000+225*6000) + (425,000+225*4500) + (400,000+225*3000)
= $4,337,500
So, management should select the first alternative.

b. If demand for the final product were to increase to production capacity, which
alternative would be more attractive?

Single plant will have total costs TC = FC + AVC*Q

900,000 + 250*18,000
= $5,400,000.

Three plants will have total costs TC = FC + AVC*Q

(475,000+225*8000) + (425,000+225*6000) + (400,000+225*4000)
= $5,350,000

So, in this case the second alternative would be more attractive.

c. What additional information would be useful before making a decision?

Marginal cost. In economics, marginal cost is the change in the total

cost that arises when the quantity produced is incremented by one unit;
that is, it is the cost of producing one more unit of a good.