Chapter 8: Costs

103
costs associated with time use (is a farmers own food really free? Is
sweat equity really a good idea for homeowners?). Differences in taxation
of cash versus in kind income might also be mentioned.
C. Glossary Entries in the Chapter
- Accounting Cost
- Average Cost
- Economic Cost
- Economic Profits
- Economies of Scope
- Expansion Path
- Fixed Costs
- Long Run
- Marginal Cost
- Opportunity Cost
- Rental Rate (v)
- Short Run
- Sunk Cost
- Variable Costs
- Wage Rate (w)


SOLUTIONS TO CHAPTER 8 PROBLEMS
8.1 a.

RTS = 1/2 since if L is increased by one, K can be reduced by 1/2 while holding
q constant.
b. Since RTS = 1/2 < w/v = 1, the manufacturer will use only K. For q = 20, K =
10; q = 40, K = 20; q = 60, K = 30. The manufacturers expansion path is sim-
ply the K axis.
c. If v = $3, RTS = 1/2 > w/v = 1/3, the manufacturer will use only L. For q = 20,
L = 20; q = 40, L = 40; q = 60, L = 60. Now the manufacturers expansion path
is the L axis.
8.2 MC = kq where k is a constant to be determined.
If q = 8, AC = MC = 1,000. Consequently k = 125.
If q = 9, MC = 125(9) = 1125.
Chapter 8: Costs

104
8.3 a. This is a cubic cost curve. It resembles Figure 8.3d.
b. AC = TC/q = q
2
40q + 430
This is a parabola. It reaches a minimum at the axis of symmetry:
q = (40)/2 = 20
At q = 20, AC = 400 800 + 430 = 30.
c. At q = 20, MC = 3(400) 1,600 + 430 = 30.
d.


8.4 a. q = 2 H q/2 = H
2
4
q
H =
TC = wage rate H = 2q
2

AC = TC/q = 2q
b. q = 4 TC = 2(4)
2
= 32
q = 6 TC = 2(6)
2
= 72
q = 8 TC = 2(8)
2
= 128
q = 4 AC = 2(4) = 8
q = 6 AC = 2(6) = 12
q = 8 AC = 2(8) = 16
c. The TC and AC curves are shown in the graph. Notice that the convex shape of
TC implies that AC is always increasing.

Chapter 8: Costs

105

8.5 a. q = 2 K L K = 100, q = 2 100 . L q = 20 . L

2
2
20 400
100
100
q q
L so L
q
STC vK wL
= =
= + = +

b.

50
25, 106.25, 4.25 0.5
50, 125, 2.5, 1
100, 200, 2, 2
200, 500, 2.5, 4
q
SMC
If q STC SAC SMC
If q STC SAC SMC
If q STC SAC SMC
If q STC SAC SMC
=
= = = =
= = = =
= = = =
= = = =

c.

d. The curves intersect at q = 100. As long as the marginal cost of producing one
more unit is below the average cost curve, average costs will be falling. Simi-
larly, if the marginal cost of producing one more unit is higher than the average
cost, then average costs will be rising. Therefore, the SMC curve must intersect
the SAC curve at its lowest point.


8.6 a. q = 900

= J

J = 25 q = 150
J = 100 q = 300
J = 225 q = 450
b. Cost = 12J = 12q
2
/900
MC can be found by calculus or by taking limits:
TC(q) = 12q
2
/900
TC(q + x) = 12(q
2
+ 2qx + x
2
)/900

0 0
( ) ( ) 12 2
(2 )
lim lim
900 75 x x
TC q x TC q q
MC q x
x
+
= = + =
Chapter 8: Costs

106
Hence: q = 150 MC = 4
q = 300 MC = 8
q = 450 MC = 12
8.7 To minimize, costs should equate the marginal productivities of labor in each plant. If
labor were more productive in one plant than another, costs could be lowered by
moving workers.
a. MP
L1
= MR
L2
. 5/2
1
L = 5/
2
L .
2
1
L =
2
L . L
2
= 4 L
1
.
q
1
= 5
1
L ; q
2
= 10
2
L = 10
1
4L = 20
1
L .
Hence
2 1
4 q q =
b.
2
1 1
2
2
( 1) 25 25 25
( 2) 100 /100
STC plant wL q
STC plant q
= + = +
= +

STC = STC (Plant 1) + STC (Plant 2)

1 2
4
Since and
5 5
q q
q q = =
Substitution yields:

2 2 2 2
1 2
0.8
125 125 125
25 100 100 125
125
125
2
125
q q q q
STC
q
AC
q
q
MC
= + + = + = +
= +
=

MC(100) = $1.60 MC (125) = $2.00 MC (200) = $3.20.
c. In the long run because of constant returns to scale, can change K so it doesnt
really matter where production occurs. Could split evenly or produce all output
in one plant.
TC = K + L = 2q. AC = 2 = MC
d. If there were decreasing returns to scale, then should let each firm have equal
share of production. AC and MC, not constant any more, are increasing func-
tions of q so do not want either plant to be too large.
8.8 v = 1, w = 3
TC = vK + wL = K + 3L
and L = 2K for cost minimization.
a. TC = K + 3L = K + 6K = 7K
since q/K = 10, TC = 7q/10 = 0.7q
Chapter 8: Costs

107
AC = TC/q = 0.7
MC = 0.7
b. K = 10 so L = 20 (since K/L = )
and q = 100 = 5L

3
3 , 10 10
5 5
q q
STC K L L K STC = + = = = +
SAVC = 10 + 3
q 5
MC = 3/5 regardless of q.
8.9 a. Now K = L so q = 20 L.
TC = vK + wL = 5K + 5L = 10L.
so TC = 0.5q
AC = TC/q = 0.50
MC = ATC/Aq = 0.50.
These costs are half what they were before.
b. All costs will fall at the rate of r per year.
8.10 a. Since w/v = 10/10 = 1, the expansion path would be unchanged. All costs
would be twice what they were before: TC = 2q, AC = MC = 2.
b. If w = 20, v = 5, w/v = 4 and the firm will operate on a new expansion path.
Since cost minimization requires
RTS = w/v = 4 = K/L, K = 4L and
q = 10 KL = 20L = 5K.
TC = 5K + 20L = q + q = 2q.
Hence, AC = MC = 2.
Multiplication of the wage by 4 only doubles costs because the firm substitutes
K for L.