Survey of ECON 2nd Edition Sexton Solutions Manual

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Chapter 6 – Production and Costs

Use the Section Summaries to preview the chapter's content.

Section Summaries
The following section summaries appear on the Student Review Cards.

6-1 – Firms and Profits: Total Revenues Minus Total Costs

Explicit costs are the input costs that require a monetary payment. Implicit costs do not
require an outlay of money. Accountants do not include implicit costs in the firm’s total
cost; economists do.
Economists generally assume that the ultimate goal of every firm is to maximize
its profits, the difference between what they give up for their inputs and the amount they
receive for their goods and services. A zero economic profit means that the firm is
covering both explicit and implicit costs—the total opportunity costs of its resources.
Sunk costs should be ignored when making economic decisions, because they have
already been incurred and cannot be recovered.

6-2 – Production in the Short Run

The short run is defined as a period too brief for some production inputs to be varied. The
long run is a period in which a firm can adjust all production inputs. The production
function illustrates the relationship between the quantity of inputs and the quantity of
outputs.
The marginal product (MP) of any input is the increase in the quantity of output
obtained from one additional unit of input used. The initial rise in the marginal product is
the result of more effective use of fixed inputs as the number of workers increases. As
additional workers are added, machines are brought into efficient operation and thus the
marginal product of the workers rises. Adding more and more of a variable input to a
fixed input, however, will eventually lead to diminishing marginal product. A point will
ultimately be reached beyond which marginal product will decline.

6-3 – Costs in the Short Run

The short-run total costs of a business fall into two distinct categories: fixed costs and
variable costs. Fixed costs are those costs that do not vary with the level of output, such
as insurance premiums or property taxes. The sum of the firm’s fixed costs is called the
total fixed cost (TFC). Variable costs, such as expenditures for wages and raw materials,
vary with the level of output, increasing as output increases. The sum of the firm’s

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76
variable costs is called the total variable cost (TVC). The sum of the total fixed costs and
total variable costs is called the firm’s total cost (TC).
Sometimes we find it convenient to discuss these costs on a per-unit-of-output or
average basis. Average total cost (ATC) is the per-unit cost of operation; total cost
divided by output. Average fixed cost (AFC) is the per-unit measure of fixed costs; fixed
costs divided by output. Average variable cost (AVC) is the per-unit measure of variable
costs; variable costs divided by output. Marginal cost (MC) shows the change in total cost
associated with a change in output by one unit.

6-4 – The Shape of the Short-Run Cost Curves

If an additional worker’s marginal product is lower (higher) than that of previous
workers, marginal costs increase (decrease). The relationship between the marginal and
the average amount is simply a matter of arithmetic; when a number (the marginal cost)
being added into a series is smaller than the previous average of the series, the new
average will be lower than the previous one. Likewise, when the marginal number is
larger than the average, the average will rise. A declining average fixed cost is the
primary reason for the decline in the average total cost curve. The average total cost rises
at high levels of output because of diminishing marginal product. When the average
variable cost is falling, marginal costs must be less than the average variable cost; and
when the average variable cost is rising, marginal costs are greater than the average
variable cost. The same relationship holds for the marginal cost curve and the average
total cost curve.

6-5 – Cost Curves: Short-Run versus Long-Run

The main difference between short-run and long-run cost curves is that in the long run,
firms can substitute lower-cost capital. In the short run, however, firms can only increase
output by increasing variable inputs, such as workers and raw materials.
By examining the long-run average total cost curve for a firm, we can see three
possible production patterns. Economies of scale occur in an output range where the
long-run average total cost falls as output increases. Firms that expand beyond a certain
point encounter diseconomies of scale; that is, they incur rising per-unit costs as their
output grows. Firms experience constant returns to scale when their per-unit costs remain
stable as output grows.

Use the Teaching Tips to plan what key concepts you wish to emphasize.

Teaching Tips
You can also find selected teaching tips located on your Chapter 6 Instructor Prep Card.

 A good classroom illustration of implicit versus explicit costs is comparing freeways

and tollways. Ask students whether it is cheaper to drive on a freeway or a tollway,
then guide them to see that under some circumstances it could be cheaper to drive on
a tollway when you include both the explicit toll and the difference in the opportunity
cost of the time involved from the different levels of congestion.

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 To make sure students avoid a very common error, help them recognize that a firm
could earn zero economic profits (earning a normal rate of return on a large
investment) or even losses (earning a below-normal rate of return on a large
investment) at the same time it is earning large accounting profits.
 A good illustration of sunk costs is guilt. If someone feels guilty, and that guilt leads
them to change their behavior, then the benefits of guilt may outweigh the costs.
However, if someone just felt guilty about something in the past but didn’t change
what they did in the present or future, they would just be committing the sunk cost
fallacy.
 Emphasize to students that there are many different costs that are fixed over different
periods of time, so that there can be several different short runs for different
decisions.
 Do more than one simple in-class illustration of the intuition of a production function.
For example, if a factory with 100 machines hires less than 100 workers, some
workers will have to move between multiple machines; with 100 workers, each
worker can employ one machine; with more than 100 workers, you could expand up
to two or three shifts of workers (deferring maintenance); beyond 300, some must
share machines, even if there are three shifts of workers working each day.
 Make sure students understand the important graphical relations because we will later
presume students know them when we cover market models. Be sure to emphasize
the verbal logic (intuition) of the concepts and illustrations as an anchor for
understanding. Otherwise, students will memorize the definitions and the graphs but
be unable to understand well enough to apply the material to any real-world
situations.
 Emphasize that the long run can best be thought of as dealing with a point in time
prior to a firm being in an industry because it does not yet face any fixed factors of
production. For firms already in an industry, there is never a point in time in which
there are zero fixed costs.
 The question of how many firms there would be in an industry and how large they
would be should be related to whether there are economies of scale, diseconomies of
scale, or constant returns to scale in the industry.
 Food courts (rather than stand-alone restaurants) in shopping malls are good familiar
examples of economies of scale. A good historical illustration of economies of scale
is when railroads dramatically lowered transportation costs, allowing much larger
optimal production scales and lower delivered prices because large firms were now
able to outcompete higher-cost, local producers from a single location.
 At one time in California when they had just added large amounts of new electrical
generating capacity, the electrical utility mounted a “live better electrically”
campaign. Ask students what would happen to electricity rates if that campaign were
phenomenally successful and electrical usage quickly grew, assuming there are large
economies of scale in electricity generation.

If you wish to use the PowerPoint slides, use the Chapter Outline to plan your
lecture.

Chapter Outline
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 PowerPoint Slides 6-1 – Firms and Profits: Total Revenues Minus Total Costs
3–4

PowerPoint Slide 5 Costs are a key determinant in pricing and production decisions. But what
Firms and Profits exactly are costs?

PowerPoint Slide 6 A. Explicit Costs

Explicit Costs
Explicit costs are the opportunity costs of production that require monetary
payment.

PowerPoint Slides B. Implicit Costs

7–9
Implicit Costs Implicit costs are the opportunity costs of production that do not require
monetary payment. For a farmer or small business owner, the value of
alternative earnings forgone represents an implicit opportunity cost.
Whenever we talk about costs—explicit or implicit—we are talking about
opportunity costs.

PowerPoint Slide 10 C. Profits

Profits
Profits are the difference between total revenues and total costs. Firms try to
maximize their profits.

PowerPoint Slide 11 D. Are Accounting Profits the Same as Economic Profits?

Accounting Profits
and Economic Profits Accounting profits equal total revenues minus total explicit costs.
Economic profits equal total revenues minus total explicit and implicit
costs.
PowerPoint Slide 12
Exhibit 6.1 Ex. 6.1 – Accounting Profits versus Economic Profits

PowerPoint Slide 13
A Zero Economic E. A Zero Economic Profit Is a Normal Profit
Profit Is a Normal
Profit At zero economic profit, the firm is covering both implicit and explicit costs;
therefore this is a normal profit. Zero economic profit does not mean zero
accounting profit.
PowerPoint Slide 14
Sunk Costs F. Sunk Costs

Sunk costs have been incurred and cannot be recovered. Sunk costs are
irrelevant for any future action.
PowerPoint Slide 15
Section Check 1
PowerPoint Slides 6-2 – Production in the Short Run
16–17

PowerPoint Slides A. The Short Run versus the Long Run

18–20
The Short Run versus We must distinguish between the short and the long run. The short run is a
the Long Run period too brief for some production inputs to be varied. Inputs that do not
change with output are called fixed inputs. The long run is a period over

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
79
 which all production inputs are variable. The length of the long run varies
from industry to industry.
PowerPoint Slides
21–22 B. Production in the Short Run
Production in the
Short Run The production function is the relationship between the quantity of inputs
and the quantity of outputs. Total output (Q) is the total amount of output of
a good produced by the firm. As the amount of the variable input increases,
total output increases until further increases become more and more difficult.
PowerPoint Slide 23
Exhibit 6.2 Ex. 6.2 – Moe's Production Function with One Variable, Labor

PowerPoint Slide 24
Rising Marginal C. Diminishing Marginal Product
Product
Marginal product (MP) is the change in total output of a good that results
from a one-unit change in input. As the result of more effective use of fixed
inputs, MP first rises and then falls.
PowerPoint Slides
25–26 Ex. 6.3 parts a and b – Total Output and Marginal Product
Exhibit 6.3 a and b

PowerPoint Slides
27–28 Diminishing marginal product means that, as a variable input increases,
Diminishing with other inputs fixed, a point will be reached at which the additions to
Marginal Product output will eventually decline. The fixed input becomes crowded with more
and more of the variable input. A firm never knowingly allows itself to reach
the point at which marginal product becomes negative.
PowerPoint Slide 29
Section Check 2

PowerPoint Slides 6-3 – Costs in the Short Run

30–31

PowerPoint Slide 32 A business' short-run total costs divide into fixed and variable costs.
Costs in the Short
Run

PowerPoint Slides A. Fixed Costs, Variable Costs, and Total Costs

33–35
Fixed Costs, Variable Fixed costs do not vary with the level of output. In the short run, fixed costs
Costs, and Total cannot be avoided. Total fixed cost (TFC) equals the sum of the firm's fixed
Costs costs. Variable costs change with the level of output. Total variable cost
(TVC) equals the sum of the firm's variable costs. Total cost (TC) equals the
sum of the firm's total fixed costs and total variable costs.

PowerPoint Slide 36 B. Average Total Costs

Average Total Costs
Sometimes we find it convenient to discuss costs on a per-unit-of-output, or
average, basis. Average total cost (ATC) is a per-unit cost of operation: total
cost divided by output.

PowerPoint Slide 37 Average fixed cost (AFC) is a per-unit measure of fixed costs: fixed costs
Average Fixed Cost divided by output. Average variable cost (AVC) is a per-unit measure of
and Average Variable variable costs: variable costs divided by output.
Cost

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 PowerPoint Slides C. Marginal Costs
38–39
Marginal Costs The most important single cost concept is marginal cost. Marginal cost
(MC) equals the change in total costs resulting from a one-unit change in
output. Marginal costs are the incremental costs associated with the “last”
unit of output produced.

PowerPoint Slide 40 D. How Are These Costs Related?

How Are These
Costs Related? Use Exhibits 6.4 and 6.5 to summarize.

PowerPoint Slide 41 Ex. 6.4 – A Summary of the Short-Run Cost Concept

Exhibit 6.4

PowerPoint Slide 42 Ex. 6.5 – Cost Calculations for Pizza Shack Company
Exhibit 6.5

PowerPoint Slides The TFC curve is always a horizontal line. The TC curve is the summation
43–44 of the TVC and TFC curves. The TC curve lies above the TVC curve by a
How Are These fixed (vertical) amount.
Costs Related?

PowerPoint Slide 45 Ex. 6.6 – Total and Fixed Costs

Exhibit 6.6

PowerPoint Slides The AFC curve constantly declines, approaching—but never reaching—zero.
46–47 The MC curve crosses the AVC and ATC curves at those curves’ lowest
How Are These points. At higher output levels, high marginal costs pull up the average
Costs Related? variable cost and average total cost curves, while at low output levels, low
marginal costs pull the curves down.

PowerPoint Slide 48 Ex. 6.7 – Average and Marginal Costs

Exhibit 6.7

PowerPoint Slide 49 Section Check 3

PowerPoint Slides 6-4 – The Shape of the Short-Run Cost Curves

50–51

PowerPoint Slides A. The Relationship between Marginal Costs and Marginal Product
52–53
Marginal Costs and Initially, as the firm adds more workers (variable input), the marginal
Marginal Product product of labor tends to rise. When the MP of labor is rising, MC are
falling. Each additional worker adds more to the total product than the
previous worker.
PowerPoint Slide 54
Exhibit 6.8 Ex. 6.8 – Marginal Product and Marginal Costs

PowerPoint Slides
55–56 B. The Relationship between Marginal and Average Amounts
The Relationship
between Marginal It is simply arithmetic. When a number (the marginal cost) being added into
and Average a series is smaller (larger) than the previous average, the new average will be
Amounts lower (higher) than the previous one.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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 PowerPoint Slides
57–60 C. Why Is the Average Total Cost Curve U-Shaped?
The U-Shaped
Average Total Cost The average cost per unit declines as output expands, but then starts
Curve increasing again as output expands still further beyond a certain point. When
output is very small, high AFC causes high ATC. Then, declining AFC
causes declining ATC. Diminishing marginal product sets in at the very
bottom of the marginal cost curve. Increasing MC eventually causes the AVC
PowerPoint Slide 61 and ATC curves to rise.
Exhibit 6.9
Ex. 6.9 – U-Shaped Average Total Cost Curve
PowerPoint Slides
62–63
Marginal Costs, D. The Relationship between Marginal Costs and Average Variable and
Average Variable Average Total Costs
Costs, and Average
Total Costs When AVC is falling, MC must be less than AVC. When AVC is rising, MC
must be greater than AVC. MC is equal to AVC at the lowest point on the
PowerPoint Slide 64 AVC curve. The same is true for the ATC curve.
Exhibit 6.10
Ex. 6.10 – Marginal Cost and Average Variable Cost
PowerPoint Slide 65
Exhibit 6.11
Ex. 6.11 – Marginal Cost and Average Total Cost
PowerPoint Slide 66

Section Check 4

PowerPoint Slides 6-5 – Cost Curves: Short-Run versus Long-Run

67–68

PowerPoint Slide 69 A. Why Are Long-Run Cost Curves Different from Short-Run Cost Curves?
Cost Curves: Short-
Run versus Long- Over long enough time periods, firms can vary all of their productive
Run inputs. However, in the short run a firm can only expand output by
employing more variable inputs.

In the long run, the firm can expand its factories, build new ones, or shut
PowerPoint Slide 70 down unproductive ones.
Why Are Long-Run
Cost Curves
Different from Short-
Run Cost Curves?
The time it takes for a firm to get to the long run varies from firm to firm.
PowerPoint Slide 71 The LRATC curve lies equal to or below the SRATC curves.
Long-Run Cost
Curves versus Short-
Run Cost Curves
Ex. 6.12 – Short- and Long-Run Average Total Costs
PowerPoint Slide 72
Exhibit 6.12
In the short run, the firm is restricted to the current plant size, but in the
PowerPoint Slides long run it can choose the short-run cost curve for the level of production it
73–74 is planning on producing. In the long run, costs are lower because firms
have greater flexibility in changing inputs that are fixed in the short run.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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 Long-Run Cost
Curves versus Short- B. What Are Economies of Scale?
Run Cost Curves
Economies of scale occur in an output range where LRATC falls as output
PowerPoint Slides increases. The minimum efficient scale is the output level where economies
75–76 of scale are exhausted and constant returns to scale begin. Diseconomies of
Economies of Scale scale occur in an output range where LRATC rises as output increases.
Constant returns to scale occur in an output range where LRATC does not
change as output varies.

C. Why Do Economies and Diseconomies of Scale Occur?

Economies of scale may exist because a firm can use mass production
PowerPoint Slide 77 techniques or capture gains from further labor specialization not possible at
Why Do Economies lower levels of output. Diseconomies of scale may occur as a firm finds it
and Diseconomies of increasingly difficult to handle the complexities of large-scale
Scale Occur? management.

Section Check 5

PowerPoint Slide 78

Key Terms

accounting profits explicit costs profits

average fixed cost (AFC) fixed costs short run
average total cost (ATC) implicit costs sunk costs
average variable cost (AVC) long run total cost (TC)
constant returns to scale marginal cost (MC) total fixed cost (TFC)
diminishing marginal marginal product (MP) total output (Q)
product
diseconomies of scale minimum efficient total variable cost
scale (TVC)
economic profits production function variable costs
economies of scale

Key Formulas
The Student Review Card Deck has a card devoted to the key economic formulas covered
in this text. The following are the key formulas in Chapter 6:

Profits
profit = total revenue − total cost

Accounting Profits
accounting profits = total revenue − total explicit costs

Economic Profits

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 economic profits = total revenue – (explicit costs + implicit costs)

Marginal Product (MP)

marginal product = change in total output of a good that results from a one-unit
change in input
MP = ∆Q/∆V

Total Cost (TC)

total cost = total fixed cost + total variable cost
TC = TFC + TVC

Average Total Cost (ATC)

average total cost = total cost/output
ATC = TC/Q

Average Fixed Cost (AFC)

average fixed cost = total fixed cost/output
AFC = TFC/Q

Average Variable Cost (AVC)

average variable cost = total variable cost/output
AVC = TVC/Q

Marginal Cost (MC)

marginal cost = change in total cost resulting from a one-unit change in output
MC = ∆TC/∆Q

You can use the following videos to supplement the discussion of topics discussed in
this chapter. You can find them at www.cengagebrain.com. At the home page,
search for the ISBN of your title (from the back cover of your book) using the
search box at the top of the page. This will take you to the product page where the
videos can be found.

Videos

BBC Video
1. Outsourcing Jobs – Something to think about as you watch the video: Do you
know of someone who lost their job when it was outsourced? What does
outsourcing mean for the labor market that you will one day face when you
graduate?
2. The Dilemma of Improved Productivity – Something to think about as you
watch the video: What accounts for improvements in the productivity of the
American workforce? When workers become more productive it benefits
business but does it benefit the workers?
Ask the Instructor Videos

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 1. What do we mean by fixed versus variable costs? – Often it is useful to
distinguish costs that a firm incurs which do not vary with quantity produced
of some good or service versus costs that do vary with rate of output. The
period of time—short run versus long run—becomes the determining factor
when deciding if a particular expenditure is a fixed or variable cost. In the
long run all costs are variable whereas many are fixed in the short run.
2. Why can’t we feed the world from a flower pot? – The short answer is the so-
called law of diminishing returns. This law predicts what will happen if more
of one or more variable factors of production are added to a fixed factor of
production. The prediction is that output will increase, but that output will
eventually increase at a decreasing rate.
3. Why do economists and accountants disagree? – Accountants treat as a cost
any expenditure by the firm. Economists agree but go further. In addition to
such explicit costs, economists view any foregone opportunity as a cost. Thus,
in general economic cost is greater than accounting cost because economic
cost consists of both explicit and implicit components. As a result, economic
profit is less than accounting profit.
Graphing Workshop
1. Production and Cost – This tutorial explores the relationship between
production and cost at Pete’s Pretzels, a small snack food firm.

You can use the Self-Review as a check of student learning. If students cannot
answer questions for a section, plan to reteach that content.

Chapter 6 – Self-Review: Questions and Answers

You can find the following quiz on page 127 at the end of Chapter 6. Students can find
answers to this quiz online at www.cengagebrain.com.

6-1–Firms and Profits: Total Revenues Minus Total Costs

1. If you turn down a job offer of $45,000 per year to work for yourself, what is the
opportunity cost of working for yourself?
Other things being equal, you incur a $45,000 per year implicit cost of working for
yourself in this case because it is what you give up when you choose to turn down the
alternative job offer. If you turned down even better offers, your opportunity cost of
working for yourself would be even higher.

6-2–Production in the Short Run

2. True or False: All inputs vary in the long run.
True. All inputs are variable in the long run by definition because the long run is
defined as that time period necessary to allow all inputs to be varied.
3. What relationship does a production function represent?
A production function represents the relationship between different combinations of
inputs and the maximum output of a product that can be produced with those inputs,
with given technology.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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4. Draw a typically shaped total output curve.

6-3–Costs in the Short Run

5. True or False: Average variable cost is the relevant cost to consider when a
producer is deciding whether to produce more or less of a product.
False. Marginal cost is the relevant cost. Marginal cost is the additional cost of
increasing output by one unit. That is, it is the cost relevant to the choice of whether
to produce and sell one more unit of a good. For producing and selling one more unit
of a product to increase profits, the addition to revenue from selling that output
(marginal revenue) must exceed the addition to cost from producing it (marginal
cost).
6. If your season batting average going into a game was .300 (three hits per ten at
bats) and you got two hits in five at bats during the game, would your season
batting average rise or fall as a result?
Your “marginal” batting average in the game was .400 (two hits per five at bats),
which was higher than your previous batting average. As a consequence, because that
game’s marginal results were above your previous average, it raises your season
batting average.
7. A one-day ticket to visit the Screaming Coasters theme park costs $36, but you
can also get a two-consecutive-day ticket for $40. What is the average cost per
day for the two-day ticket? What is the marginal cost of the second consecutive
day?
The average cost per day equals $20 for the two-day pass. The marginal cost of the
second day is $4.
8. If your university pays lecture note takers $20 per hour to take notes in your
economics class and then sells subscriptions for $15 per student, is the cost of the
lecture note taker a fixed or variable cost of selling an additional subscription?
The note taker’s wage is a fixed cost, which does not vary with the number of
subscriptions sold.

6-4–The Shape of the Short-Run Cost Curves

9. True or False: Average total cost rises as output expands over low-output
ranges.

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 False. Average total cost falls as output expands over low-output ranges because
average fixed cost declines sharply with output at low levels of output.
10. Why does the average total cost rise at some point as output expands further?
Average total cost begins to rise at some point as output expands further because of
the law of diminishing marginal product, also called the law of increasing costs. Over
this range of output, adding more variable inputs does not increase output by the same
proportion, so the average cost of production increases over this range of output.

6-5–Cost Curves: Short-Run versus Long-Run

11. True or False: The LRATC curve has a shallower U shape than the SRATC
because some inputs are fixed in the long run.
False. Some inputs are fixed in the short run, such as the size of the physical plant or
certain machinery. Once a firm has chosen its plant size, it is fixed in the short run. In
the long run, firms can increase their capital inputs (fixed in the short run) as well as
their inputs that are variable in the short run. So the short-run costs are at least as high
as the long-run costs and higher if the wrong level of capital is chosen in the short
run. Thus, the long-run curve has a shallower U shape curve than the short run.
Remember, the firm can adjust all factors in the long run, which allows it to keep its
costs lower.
12. What may cause economies or diseconomies of scale?
Economies of scale may occur because of gains from specialization. For example,
workers might be more productive if they concentrated on a few specific tasks rather
than on many different tasks. Diseconomies of scale may occur as the firm finds it
increasingly difficult to handle the complexities of large-scale management. For
example, information and coordination problems tend to increase when a firm
becomes very large.

You can use the following questions and exercises to work with students as part of
your in-class discussion. You might also use them as an in-class quiz or give them to
students as an independent homework assignment.

Class Exercises
1. As a farmer, you work for yourself using your own tractor, equipment, and farm
structures, and you cultivate your own land. Why might it be difficult to calculate
your profits from farming?

Answer: To calculate economic profit, one must consider all relevant costs,
both explicit and implicit. It may be difficult to calculate your economic
profits from farming because you must estimate the implicit opportunity cost
of your time, tractor, equipment, farm structures, and land.

2. Say that your firm’s total product curve includes the following data: one worker
can produce 8 units of output; two workers, 20 units; three workers, 34 units; four
workers, 50 units; five workers, 60 units; six workers, 70 units; seven workers, 76
units; eight workers, 78 units; and nine workers, 77 units.

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 a. What is the marginal product of the seventh worker?
b. When does the law of diminishing product set in?
c. Under these conditions, would you ever choose to employ nine workers?

Answers:
a. The marginal product of the seventh worker equals 6 units of output.
b. The law of diminishing product begins with the fifth worker hired.
c. A firm would never choose to hire nine workers because the marginal
product of the ninth worker is negative.

3. Why does the law of diminishing marginal product imply the law of increasing
costs?

Answer: As a variable factor, such as labor, is added to a given amount of the

fixed factor, such as capital or land, the marginal product of that factor will
eventually diminish. Once the marginal product begins to diminish, an
increasing amount of the variable factor must be added in order to boost the
output of a good by a particular increment in the short run. An increasing
amount of output from alternative productive activities must be sacrificed
(an increasing opportunity cost).

4. As a movie exhibitor, you can choose between paying a flat fee of $5,000 to show
a movie for a week and paying a fee of $2 per customer. Will your choice affect
your fixed and variable costs? How?

Answer: Your choice will affect your fixed and variable costs. If you choose
to pay the flat fee, your fixed costs for the film will equal $5,000 for the week.
Your variable costs associated with the leasing of the film would then equal
zero. If you choose to pay $2 per customer, then the costs associated with
leasing the film will be all variable.

5. Buffalo Bill has a potato chip company, Buffalo’s Chips. He is currently losing
money on every bag of chips he sells. Mrs. Bill, who has just completed an
economics class, tells Bill he could make a profit if he adds more machines and
produces more chips. How could this be possible? What is Mrs. Bill assuming
about the output range in which Bill is currently producing?

Answer: Mrs. Bill is assuming that Buffalo Bill is operating in the range of
economies of scale. If this were the case, increasing his output would lower
average total costs. She also recognizes that Bill is operating in the short run
and that given time he can reduce his per unit costs by substituting capital
(chip machines) for labor. These changes may lower average total costs below
the price Bill receives for his chips.

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