Exercise 7.

1
Suppose 40 employee-hours can produce 80
units of output. Assuming the law of diminishing
marginal returns is present, to produce 160 units
of output will require

A)
an additional 40 employee-hours.

B)
a total of 80 or less employee-hours.

C)
less than 40 additional employeehours.

D)
a total of 81 or more employee-hours.

E)
a total of 80 employee-hours.
1

Answers to Exercise 7.1

The correct answer is (D).
Diminishing returns means the workers
are less productive due to insufficient
physical capital.
Since 40 hours is needed to produce
the first 80 units of output, it will take
more than 40 hours to produce another
80 units of output to reach 160 units.
2

Exercise 7.2
If the firm spends $200 to produce 17 units of
output and spends $455 to produce 34 units,
then the marginal cost of increasing production
from 17 to 34 units is

(A) $13.38.

(B) $15.

(C) $7.50.

(D) $11.76.

(E) impossible to calculate due to a lack of

information.
3

Answers to Exercise 7.2

The correct answer is (B).
Marginal cost is change in total cost
divided by change in output
Change in total cost is $455 - $200 =
$255
Change in output is 34 units 17 units
= 17 units
So MC = $255/17 = $15
4

Exercise 7.3
Economies of scale exist when

A) constant returns to scale are

present.

B) input prices are falling.

C) average costs fall as the scale of

production grows.

D) a 10% increase in all inputs causes

a 9% increase in output.

E) firms become extremely large.

5

Answers to Exercise 7.3

The correct answer is (c).
Economies of scale means when the
scale of production increases, total output
increases by more than total cost due to
efficiency in using resources
Thus the average total cost decreases
Cost

Long run ATC

Output

Exercise 7.4
Suppose, a firm has $1500 of variable
costs and $500 of fixed cost when it
produces 500 units of output and sells
them for $5 per unit.
(1) Calculate the average fixed cost,
average variable cost and average total
cost at this output level.
(2) Is this firm making a profit or incurring a
loss at this output?
7

Answers to Exercise 7.4

Total fixed cost (TFC) = $500, Total
variable cost (TVC) = $1500, Total output
(Q) = 500 units
(1) AFC = TFC/Q = $500/500 = $1
AVC = TVC/Q = $1500/500 = $3
ATC = AFC + AVC = $4
(2) Total revenue = $5 X 500 = $2500
Total cost = $500 + $1500 = $2000
The firm is making a profit of $500
8

Exercise 7.5

Complete the following table and explain

the relationship between marginal cost and
average total cost.
Q

TVC

TC

MC

AFC

AVC

ATC

60

80

120

140

200

300

500
9

Answer to Exercise 7.5

The completed table is shown below:
Q

TVC

TC

MC

AFC

AVC

ATC

60

80

140

80

60

80

140

120

180

40

30

60

90

140

200

20

20

46.67 66.67

200

260

60

15

50

65

Answers to Exercise 7.5

The figures show that when MC is less

than ATC, ATC is decreasing.
Note that when MC is higher than ATC,
ATC is increasing.
When MC equals ATC, ATC is at its
minimum.
MC
Cost

ATC
AVC
Output