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Lecture 6

ECON 103 Lecture Notes - Lecture 6: Average Cost, Average Variable Cost, Marginal Cost

Course Code
ECON 103
Junjie Liu

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Econ 103 Tutorial #6 Week 11
1. Joe runs a small boat factory. He can make ten boats per year and sell them for $35,000 each.
It costs Joe $250,000 for the raw materials (fiberglass, wood, paint, and so on) to build the
ten boats. Joe has invested $500,000 in the factory and equipment needed to produce the
boats: $200,000 from his own savings and $300,000 borrowed at 10 percent interest (assume
that Joe could have loaned his money out at 10 percent, too). Joe can work at a competing
boat factory for $60,000 per year.
a. What is the total revenue Joe can earn in a year?
b. What are the explicit costs Joe incurs while producing ten boats?
c. What are the total opportunity costs of producing ten boats (explicit and implicit)?
d. What is the value of Joe’s accounting profit?
e. What is the value of Joe’s economic profit?
- $10,000
f. Is it truly profitable for Joe to operate his boat factory? Explain.
No. Joe could make $60,000 plus 10 percent interest on his $200,000 savings for a total
of $80,000 if he worked for competing boat factory. His factory makes an accounting
profit of only $70,000 per year, after taking into account the implicit costs he will lose
$10,000 to run his own factory.

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Econ 103 Tutorial #6 Week 11
2. Fill in the type of cost that best completes each phrase below:
a. The true cost of taking some action is its opportunity cost .
b. Average total cost (or average variable cost) is falling when marginal cost is below it,
and rising when marginal cost is above it.
c. A cost that does not depend on the quantity produced is a(n) fixed cost .
d. In the ice-cream industry in the short run, variable cost includes the cost of
cream and sugar, but not the cost of the factory.
e. Profits equal total revenue less total cost .
f. The cost of producing an extra unit of output is the marginal cost .
3. If a firm is operating in the area of constant returns to scale, what will happen to average total
costs in the short run if the firm expands production? Why? What will happen to average
total costs in the long run? Why?
In the short run, the size of the production facility is fixed so the firm will experience
diminishing returns and increasing average total costs if the firm expands production. In the
long run, the firm will expand the size of the factory and the number of workers together, and
if the firm experiences constant returns to scale, average total costs will stay at the minimum.
4. When a small firm expands the scale of its operation, why does it usually first experience
increasing returns to scale? When the same firm grows to be extremely large, why might a
further expansion of the scale of operation generate decreasing returns to scale?
As a small firm expands the scale of operation, the higher production level allows for greater
specialization of the workers and long-run average total costs fall. As a large firm continues
to expand, it will likely develop coordination problems and long-run average total costs begin
to increase.
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