Answers to the questions in Quiz 10: 1.

Definition of Efficient Scale: the quantity of output that minimizes average total cost (ATC).

That is Q* in the above figure. 2. When economists speak of a firms cost of production, they include all the opportunity costs of making its output of goods and services. This is consistent with Principle #2 that the cost of something is what you give up to get it. Total opportunity cost includes both implicit and explicit costs. That is, Total opportunity cost = implicit cost + explicit cost Definition of explicit costs: input costs that require a payment of money by the firm. Definition of implicit costs: input costs that do not require a payment of money by the firm. 3. Marginal cost (MC) is the cost of an extra unit of output produced. Definition of MC: the additional cost (or the increase in total cost) that arises from producing an extra unit of production. The marginal cost is the slope of total cost curve. That is,
Change in total cost Change in output total cost output

Marginal cost = =

Note that the total cost curve slopes up at an increasing rate. The increasing rate refers to the fact that MC is an increasing function of output (Q).

4. Definition of Economic Profit: total revenue minus total cost, including both explicit and implicit costs. That is, Economic profit = total revenue (explicit costs + implicit costs) Accountants, however, do not consider implicit costs as part of the total cost. Thus, Accounting profit = total revenue explicit costs Accordingly, we can write Accounting Profit = economic profit + implicit costs and that when economic profit is zero, accounting profit will be equal to implicit cost as follows: Accounting Profit = 0 + implicit costs 5&6. Definition of AFC: fixed costs (FC) divided by the quantity of output (Q). Definition of AVC: variable costs (VC) divided by the quantity of output (Q). Definition of ATC: total costs (TC) divided by the quantity of output (Q). FC AFC = ; Q and that VC AVC = ; Q TC ATC = . Q

ATC = AFC + AVC

As shown in the above figure, AFC is continuously decreasing as output is increasing. At the low levels of output, AFC decreases at a very rapid rate and pulls down ATC. As a result, ATC keeps declining. At higher levels of output AFC is still decreasing but at a very slow rate and loses its ability to pull down ATC. As a result ATC starts increasing as output increases.

7&8.

The relationship between marginal cost (MC) and average total cost (ATC) is as follows: (i) (ii) (iii) when marginal cost is less than average total cost, average total cost is falling. That is, when MC < ATC, then ATC . when marginal cost is more than average total cost, average total cost is rising. That is, when MC > ATC, then ATC . Marginal cost crosses average total cost at the minimum of the average total cost (the efficient scale.) That is, when MC = ATC, then ATC is minimum.

9&10.

The graph of the production function slopes up at a decreasing rate. The slope is the marginal product of labor, and it is decreasing because of diminishing marginal product of labor. As a result, the total cost curve slopes up at an increasing rate. The slope of the total cost curve is marginal cost. The increase in the slope of the total cost curve or marginal cost is due to diminishing marginal product.