1. What are Guy’s explicit costs for running the business 1. What are Guy’s explicit costs for running the business? List the actual cost in dollars where you can, but list other explicit costs that Guy has also (ones for which you weren’t given the actual dollar amounts). Think of as many as you can. Cost of the truck, trailer, and garage ($1200/month). Costs of labor ($100/day per worker). Cost of gasoline, oil, and other materials and parts needed for maintenance and operation. The garage space he rents.   2. What are Guy’s implicit costs for running the business? You probably can’t put a dollar value on these, but list his implicit costs. Money he could make working at another job. Money he could make for running another business. Money he could make renting out or selling his truck, trailer, and equipment.

3. In this case, would an economist say that Guy is entitled to a “normal profit?” Explain what that means in this case. Yes, Guy is entitled to be paid for running the business. This must be comparable to what he could make running some other business of a similar size or it is not worth Guy’s time to run the lawn service.   4. How much money would Guy have to make in order to make an economic profit? You can’t answer in a specific dollar amount, so describe the concept. Enough to cover his explicit costs and his implicit costs, including a normal profit. Any amount over that would be economic profit.

5. As Guy adds more workers, what can we expect to happen to the number of lawns he is able to cut each week? His productivity will increase at first, and increase at an increasing rate. At some point, the rate of increase will slow down until, eventually, his total productivity will actually go down with each additional worker.

# of Lawns Cut per Day (Total Product) Number of Workers # of Lawns Cut per Day (Total Product) Marginal Product (MP) Average Product (AP) X 1 3 2 8 5 4 15 7 20 23 4.6 6 25 4.17 21 -4

7. Graph total product on the first graph below 7. Graph total product on the first graph below. Graph marginal product and average product on the second graph. Remember to graph marginal product between the numbers on the horizontal axis. For example, (0.5,3) for the first one.

Total Variable Cost (TVC) Average Variable Cost (AVC) Total Product (TP) (Lawns) Total Fixed Cost (TFC) Total Variable Cost (TVC) Total Cost (TC) Average Fixed Cost (AFC) Average Variable Cost (AVC) Average Total Cost (ATC) Marginal Cost (MC) 40 X 3 100 140 13.33 33.33 46.67 8 200 240 5 25 30 20 15 300 340 2.67 22.67 14.29 400 440 2 22 23 500 540 1.75 21.74 23.5 600 640 1.6 24 25.6 50

9. Plot Total Fixed Cost (TFC), Total Variable Cost (TVC) and Total Cost (TC) on the graph below: a. What happens to total fixed cost as quantity increases?  It doesn’t change – it’s FIXED.  b. What is the difference between total variable cost and total cost? It is always total fixed cost, at every point on the curve.

10. Graph Average Fixed Cost (AFC), Average Variable Cost (AVC), Average Total Cost (ATC) and Marginal Cost (MC) on the graph below. If you want to get it exactly right, graph Marginal Cost at the midpoints on the X-axis. For example (1.5, 3) and not (3, 3): 50 MC 40 Cost ($) 30 ATC 20 AVC 2013 Version 10 AFC 0 2 4 6 8 10 12 14 16 18 20 22 24 Quantity (Lawns/Day)

It is always Average Fixed Cost at every point on the curve. 11. What is the difference between Average Variable Cost (AVC) and Average Total Cost (ATC)? It is always Average Fixed Cost at every point on the curve.  12. Why does Average Fixed Cost (AFC) decrease as quantity increases? Because you are spreading a constant fixed cost over a larger and larger quantity.  13. Why does marginal cost decrease at first, and then increase as quantity increases? Because of the law of marginal returns. At first, marginal returns increase, but eventually they begin to decrease, causing increased marginal cost.  14. Where does the marginal cost curve intersect the average variable cost curve and the average total cost curve? Explain why. It crosses both the AVC and the ATC curves at their minimum point. This is because, if marginal cost is less than average cost, the average costs will be going down. Once marginal cost crosses the AVC and ATC curves, then marginal cost is greater than average costs, which will pull average cost up.

15. Or anything else that maintains these key characteristics of the curves. 1. AFC is always declining. 2. Distance between AVC and ATC is always = AFC. 3. ATC is always greater than AVC (by the amount of AFC). 4. MC always slopes down at first and then slopes up. It intersects AVC and ATC at their lowest points.

1 2 3 4 5 6 7 8 9 Marginal Cost Average Total Cost 105 100 90 80 70 60 50 40 30 20 10 1 2 3 4 5 6 7 8 9 Marginal Cost Average Total Cost Average Variable Cost Note: This is just another example of these four curves and their correct relationship to each other. Average Fixed Cost

Yet another example of the four curves and their proper relationships.

Discussion Question 3 Inputs of Labor Total Product Marginal Product Average Product X 1 15 2 34 19 17 3 51 4 65 14 16.25 5 74 9 14.8 6 80 13.33 7 83 11.86 8 82 -1 10.25

1 2 3 4 5 6 7 8 Total Product Average Product Marginal Product 90 80 70 60 50 40 30 20 10 1 2 3 4 5 6 7 8 Total Product Average Product Marginal Product

When marginal product is rising, marginal cost is falling When marginal product is rising, marginal cost is falling. And when marginal product is diminishing, marginal cost is rising. Explain and illustrate graphically. As long as the MP curve is rising, MC will be decreasing, because you are getting more output out of each additional worker, meaning each unit of output is cheaper. Once MP starts to decline, than each additional unit of output is getting more costly, because it takes more additional workers to increase production.

If you struggled with this question, read The Law of Diminishing Returns on p. 200 – 202.

AP Review Question 5 Total Product Total Fixed Cost Total Variable Cost Total Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost 60 1 45 105 2 85 145 30 42.5 72.5 40 3 120 180 20 35 4 150 210 15 37.5 52.5 5 185 245 12 37 49 6 225 285 10 47.5 7 270 330 8.6 38.6 47.1 8 325 385 7.5 40.6 48.1 55 9 390 450 6.7 43.3 50 65 465 525 46.5 75

1 2 3 4 5 6 7 8 9 10 Total Cost Total Variable Cost Total Fixed Cost 550 500 450 400 350 300 250 200 150 100 50 1 2 3 4 5 6 7 8 9 10 RQ #5 a. Total Cost Point of diminishing returns Total Variable Cost Total Fixed Cost

1 2 3 4 5 6 7 8 9 Marginal Cost Average Total Cost 105 100 90 80 70 60 50 40 30 20 10 1 2 3 4 5 6 7 8 9 RQ #5 b. Marginal Cost Average Total Cost Average Variable Cost Average Fixed Cost

AP Review Question 6 Decide if the change affects fixed costs or variable costs. Any change in fixed costs will change the average fixed cost curve and the average total cost curve only. Any change in variable costs will change the marginal cost curve, the average variable cost curve, and the average total cost curve. So: a. Reduction in business property taxes = fixed ↓ * b. Increase in nominal wages = variable ↑ * c. Decrease in price of electricity = variable ↓ d. Increase in insurance rate = fixed ↑ * e. Increase in transportation costs = variable ↑ *Only b, c, & e would affect marginal cost.

1. Identify each of the curves in this diagram.

2. If the marginal cost of producing the first unit of some good is $30 and the marginal cost of producing the second unit is $50, what is the average variable cost of producing 2 units?

Quantity Total Cost $50 1 62 2 71 3 77 4 88 3. The table above shows a firm’s total cost of producing various units of output. What is the average variable cost of producing three units?

4. If the average variable cost of producing 5 units of a good is $30 and the average variable cost of producing 6 units is $40, what is the marginal cost of increasing output from 5 to 6 units?

5. Assume that a firm uses only one variable input 5. Assume that a firm uses only one variable input. If a firm is experiencing increasing marginal returns, what is happening to marginal cost as output increases? Once you are comfortable with this material, go to the Moodle and take the Production and Costs Quick Quiz. You can take the quiz up to two times. Your grade will be the higher of the two.

Homework: Read page 209 - 216.             1. Take quick quiz on 210 and check yourself (before you wreck yourself).             2. Explain economies of scale and diseconomies of scale.             3. Explain why the long-run average total cost curve tends to be u-shaped.             4. How do economies of scale affect the long-run average total cost curve?             5. DQ #6; APR #8, What is a sunk cost? (p 206) Provide an example of a sunk cost other than one from the textbook. Why are such costs irrelevant in making decisions about future actions?             6. Write Down any questions you have about this chapter so far! You will have a quiz on this chapter on Wednesday.