PRODUCTION AND COSTS
Practice problems

1. The "Greasy Wrench" shop specializing in auto repairs rents a building at the corner of 77th and Moonawalker. In the short run, it can vary its output (the number of cars fixed) only by varying the number of mechanics it employs. Each Greasy Wrench employee is paid a fixed wage.
Over the years, Wu Wei, the owner of "Greasy Wrench", has tried hiring different numbers of workers. The data about the average productivity of each worker (also known as the Average Product of Labor) for each number of workers are given in the table below.
Number of workers
Average productivity
Total Product
Marginal Product
1
5
.
.
2
7
.
.
3
10
.
.
4
11
.
.
5
10
.
.
6
9
.
.

a. Complete the table by calculating the Total Product of Labor (total output of the firm) and Marginal Product of Labor corresponding to each number of workers.

b. At which worker does the Law of Diminishing Marginal Returns start working? How do you know?

c. Using the Greasy Wrench example, explain why every firm, as it hires more people in an attempt to increase its output, will sooner or later hit the range of diminishing marginal returns.

d. When Mr. Wei's son looked at the table, he said to his dad: "Hiring 5th and 6th person makes no sense!" Do you agree? Explain.

e. Currently, "Greasy Wrench" employs 3 workers, each of whom is paid $200 a day. Determine the average labor cost of repairing a car.

2. The information about the costs of a firm is given below.

Output
AFC, $
AVC, $
1
50.00
100.00
2
25.00
80.00
3
16.67
66.67
4
12.50
65.00
5
10.00
68.00
6
8.37
73.33
7
7.14
80.00
8
6.25
87.50

Answer the following questions:

a. What is the firm's fixed cost?

b. If the firm produces five units, what is the average total cost?

c. What is the total cost of producing four units?

d. If the firm closes down and produces no output, what will be its total cost?

e. If the firm decides to increase its output from 6 to 7 units, by how much will its total cost increase?

Your success in answering the above questions will depend on whether you know how to use the provided data to derive all the other costs (ATC, VC, FC, TC, and MC).

3. Imagine a firm using only one variable input. When the Marginal Product of using every next unit of this input is decreasing, the Marginal Cost (MC) of every next unit of output will be necessarily increasing. -- True or False?

4. Which of the following will cause the average fixed cost curve of making cigarettes to shift?
a) A $5 million penalty charged to each cigarette maker.
b) A $1 per pack tax on cigarettes.
c) A $3 per hour wage increase in tobacco industry.
d) An increase in the demand for cigarettes.

5. True or False? The short run is the time period in which the level of output is fixed.

 



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