266

COST CURVES

(Ch. 21)

Chapter 21

NAME

Cost Curves
Introduction. Here you continue to work on cost functions. Total cost
can be divided into xed cost, the part that doesnt change as output changes, and variable cost. To get the average (total) cost, average xed cost, and average variable cost, just divide the appropriate cost function by y, the level of output. The marginal cost function is the derivative of the total cost function with respect to outputor the rate of increase in cost as output increases, if you dont know calculus. Remember that the marginal cost curve intersects both the average cost curve and the average variable cost curve at their minimum points. So to nd the minimum point on the average cost curve, you simply set marginal cost equal to average cost and similarly for the minimum of average variable cost.

AC, MC 40 Red line 30

20 AC=MC=20 10

10

20

30

Example: A rm has the total cost function C(y) = 100 + 10y. Let us
nd the equations for its various cost curves. Total xed costs are 100, so the equation of the average xed cost curve is 100/y. Total variable costs are 10y, so average variable costs are 10y/y = 10 for all y. Marginal cost is 10 for all y. Average total costs are (100 + 10y)/y = 10 + 10/y. Notice that for this rm, average total cost decreases as y increases. Notice also that marginal cost is less than average total cost for all y.

40 Output

(d) Suppose Otto has to pay $b a year to produce obnoxious television commercials. Ottos total cost curve is now T C(y) = average cost curve is now AC(y) = curve is M C(y) =

cy + b ,

his

c + b/y , and his marginal cost c.

21.1 (0) Mr. Otto Carr, owner of Ottos Autos, sells cars. Otto buys autos for $c each and has no other costs.

(e) If b = $100, use red ink to draw Ottos average cost curve on the graph above. 21.2 (0) Ottos brother, Dent Carr, is in the auto repair business. Dent recently had little else to do and decided to calculate his cost conditions. He found that the total cost of repairing s cars is T C(s) = 2s2 + 10. But Dents attention was diverted to other things . . . and thats where you come in. Please complete the following: Dents Total Variable Costs:

(a) What is his total cost if he sells 10 cars? cars?

10c.

What if he sells 20

20c.

Write down the equation for Ottos total costs assuming

he sells y cars: T C(y) =

cy. c.
For every

2s2 .

(b) What is Ottos average cost function? AC(y) =

Total Fixed Costs:

10. 2s. 10/s. 2s + 10/s.

additional auto Otto sells, by how much do his costs increase? Write down Ottos marginal cost function: M C(y) =

c. c.

Average Variable Costs: Average Fixed Costs: Average Total Costs:

(c) In the graph below draw Ottos average and marginal cost curves if c = 20.

Marginal Costs:

4s.

NAME

267

268

COST CURVES

(Ch. 21)

21.3 (0) A third brother, Rex Carr, owns a junk yard. Rex can use one of two methods to destroy cars. The rst involves purchasing a hydraulic car smasher that costs $200 a year to own and then spending $1 for every car smashed into oblivion; the second method involves purchasing a shovel that will last one year and costs $10 and paying the last Carr brother, Scoop, to bury the cars at a cost of $5 each. (a) Write down the total cost functions for the two methods, where y is output per year: T C1 (y) =

imized?

500.

At this level of output, how much is average cost?

$2.
(c) If she has 1,000 square feet of oor space, write down her marginal cost function:

M C = y/500 1,000.

and her average cost function: At what amount of output is

y + 200 , T C2 (y) = 5y + 10. 1 + 200/y

and a

AC = (1, 000/y) + y/1, 000.

average cost minimized? is average cost?

At this level of output, how much

(b) The rst method has an average cost function marginal cost function

$2.

1.

For the second method these costs are

5 + 10/y

and

5.

(c) If Rex wrecks 40 cars per year, which method should he use?

(d) Use red ink to show Marys average cost curve and her marginal cost curves if she has 200 square feet. Use blue ink to show her average cost curve and her marginal cost curve if she has 500 square feet. Use black ink to show her average cost curve and her marginal cost curve if she has 1,000 square feet. Label the average cost curves AC and the marginal cost curves M C.

Method 2.
he use?

If Rex wrecks 50 cars per year, which method should What is the smallest number of cars per year

Dollars 4 mc 3 Red lines Blue lines ac mc Black lines mc ac LRMC=LRAC (yellow line) 1

Method 1.

for which it would pay him to buy the hydraulic smasher?

48 cars

per year.
21.4 (0) Mary Magnolia wants to open a ower shop, the Petal Pusher, in a new mall. She has her choice of three dierent oor sizes, 200 square feet, 500 square feet, or 1,000 square feet. The monthly rent will be $1 a square foot. Mary estimates that if she has F square feet of oor space and sells y bouquets a month, her variable costs will be cv (y) = y 2 /F per month. (a) If she has 200 square feet of oor space, write down her marginal cost y function: M C = and her average cost function: AC = 100 y 200 + 200 . At what amount of output is average cost minimized? y

ac

200

400

600

800

1000

1200

Bouquents
(e) Use yellow marker to show Marys long-run average cost curve and her long-run marginal cost curve in your graph. Label them LRAC and LRMC. 21.5 (0) Touchie MacFeelie publishes comic books. The only inputs he needs are old jokes and cartoonists. His production function is Q = .1J 2 L3/4 ,
1

200.

At this level of output, how much is average cost?

$2.

(b) If she has 500 square feet, write down her marginal cost function:

M C = y/250 (500/y) + y/500.

and her average cost function:

AC =

At what amount of output is average cost min-

NAME

269

270

COST CURVES

(Ch. 21)

where J is the number of old jokes used, L the number of hours of cartoonists labor used as inputs, and Q is the number of comic books produced. (a) Does this production process exhibit increasing, decreasing, or constant returns to scale? Explain your answer.

(b) This would cost

18.7

dollars.

It exhibits

(c) Given our production function, the cheapest proportions in which to use jokes and labor are the same no matter how many comic books we print. But when we double the amount of both inputs, the number of comic books produced is multiplied by

increasing returns to scale since f (tJ, tL) = t

5/4

25/4 .

f (J, L) > tf (J, L). MP =

21.8 (0) Consider the cost function c(y) = 4y 2 + 16. (a) The average cost function is

(b) If the number of old jokes used is 100, write an expression for the marginal product of cartoonists labor as a function of L.

AC = 4y + M C = 8y.

16 y.

3 Is the marginal product of labor decreasing or increasing as the 4L1/4 amount of labor increases?

(b) The marginal cost function is

Decreasing.

(c) The level of output that yields the minimum average cost of production is

21.6 (0) Touchie MacFeelies irascible business manager, Gander MacGrope, announces that old jokes can be purchased for $1 each and that the wage rate of cartoonists labor is $2. (a) Suppose that in the short run, Touchie is stuck with exactly 100 old jokes (for which he paid $1 each) but is able to hire as much labor as he wishes. How much labor would he have to hire in order produce Q comic books?

y = 2. AV C = 4y.

(d) The average variable cost function is

(e) At what level of output does average variable cost equal marginal cost?

Q4/3 .

At y = 0.

(b) Write down Touchies short-run total cost as a function of his output

21.9 (0) A competitive rm has a production function of the form Y = 2L + 5K. If w = $2 and r = $3, what will be the minimum cost of producing 10 units of output?

2Q4/3 + 100.
(c) His short-run marginal cost function is

$6.

8Q1/3 /3. 2Q1/3 + 100/Q.

(d) His short-run average cost function is

Calculus

21.7 (1) Touchie asks his brother, Sir Francis MacFeelie, to study the long-run picture. Sir Francis, who has carefully studied the appendix to Chapter 19 in your text, prepared the following report. (a) If all inputs are variable, and if old jokes cost $1 each and cartoonist labor costs $2 per hour, the cheapest way to produce exactly 4/5 one comic book is to use 10 (4/3)3/5 7.4 jokes and

104/5 (3/4)2/5 5.6

tainly allowable.)

hours of labor. (Fractional jokes are cer-

272

FIRM SUPPLY

(Ch. 22)

Chapter 22

NAME

Dollars

Firm Supply

80 Supply 60 ac Revenue 40 mc

Introduction. The short-run supply curve of a competitive rm is the

portion of its short-run marginal cost curve that is upward sloping and lies above its average variable cost curve. The long-run supply curve of a competitive rm is the portion of its short-run marginal cost curve that is upward-sloping and lies above its long-run average cost curve.

20

Example: A rm has the long-run cost function c(y) = 2y 2 + 200 for

y > 0 and c(0) = 0. Let us nd its long-run supply curve. The rms marginal cost when its output is y is M C(y) = 4y. If we graph output on the horizontal axis and dollars on the vertical axis, then we nd that the long-run marginal cost curve is an upward-sloping straight line through the origin with slope 4. The long-run supply curve is the portion of this curve that lies above the long-run average cost curve. When output is y, long-run average costs of this rm are AC(y) = 2y + 200/y. This is a Ushaped curve. As y gets close to zero, AC(y) becomes very large because 200/y becomes very large. When y is very large, AC(y) becomes very large because 2y is very large. When is it true that AC(y) < M C(y)? This happens when 2y + 200/y < 4y. Simplify this inequality to nd that AC(y) < M C(y) when y > 10. Therefore the long-run supply curve is the piece of the long-run marginal cost curve for which y > 10. So the long-run supply curve has the equation p = 4y for y > 10. If we want to nd quantity supplied as a function of price, we just solve this expression for y as a function of p. Then we have y = p/4 whenever p > 40. Suppose that p < 40. For example, what if p = 20, how much will the rm supply? At a price of 20, if the rm produces where price equals long-run marginal cost, it will produce 5 = 20/4 units of output. When the rm produces only 5 units, its average costs are 2 5 + 200/5 = 50. Therefore when the price is 20, the best the rm can do if it produces a positive amount is to produce 5 units. But then it will have total costs of 5 50 = 250 and total revenue of 5 20 = 100. It will be losing money. It would be better o producing nothing at all. In fact, for any price p < 40, the rm will choose to produce zero output. 22.1 (0) Remember Ottos brother Dent Carr, who is in the auto repair business? Dent found that the total cost of repairing s cars is c(s) = 2s2 + 100. (a) This implies that Dents average cost is equal to his average variable cost is equal to
0

;;;;;;;;;;;; ;;;;;;;;;;;; Profit ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;; Costs ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;; ;;;;;;;;;;;;
5 10 15

avc

20 Output

(b) If the market price is $20, how many cars will Dent be willing to repair? repair?

5. 10.

If the market price is $40, how many cars will Dent

(c) Suppose the market price is $40 and Dent maximizes his prots. On the above graph, shade in and label the following areas: total costs, total revenue, and total prots.
Calculus

22.2 (0) A competitive rm has the following short-run cost function: c(y) = y 3 8y 2 + 30y + 5. (a) The rms marginal cost function is M C(y) =

3y 2 16y + 30. y 2 8y +

(b) The rms average variable cost function is AV C(y) =

30.

(Hint: Notice that total variable costs equal c(y) c(0).)

(c) On the axes below, sketch and label a graph of the marginal cost function and of the average variable cost function. (d) Average variable cost is falling as output rises if output is less than

2s + 100/s ,

and rising as output rises if output is greater than

4. 4.

2s

, and his marginal cost is (e) Marginal cost equals average variable cost when output is

equal to 4s. On the graph below, plot the above curves, and also plot Dents supply curve.