CIX1001/ CBEB1107

Tutorial 7

1. Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of
$5,000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own
funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000
per year if alternatively invested. He has been offered $15,000 per year to work as a potter
for a competitor. He estimates his entrepreneurial talents are worth $3,000 per year. Total
annual revenue from pottery sales is $72,000. Calculate the accounting profit and the
economic profit for Gomez’s pottery firm.

2. Joe quits his computer programming job, where he was earning a salary of RM50,000 per
year, to start his own computer software business in a building that he owns and was
previously renting out for RM24,000 per year. In his first year of business he has the
following expenses: salary paid to him, RM40,000; rent, RM0; other expenses, RM25,000.
Find the (i) accounting cost and (ii) economic cost associated with Joe’s computer software
business.

3. The table above shows Randy's Shirts' short-run production function. Randy hires workers at
a wage rate of RM50 a day and his total fixed cost is RM100.
Total product
Labor (shirts per
(workers) day)
0 0
1 20
2 36
3 48
4 56
5 60

a) What is the marginal product of the 3rd worker?

b) What is Randy's average fixed cost if 48 shirts are produced?
c) What is Randy's average variable cost if 56 shirts are produced?
d) What is Randy's marginal cost of producing the 52nd sweater?
e) What is Randy's average total cost if 48 sweaters are produced?

4. The table below gives the total cost schedule for oil changes at the local Jiffy Lube.
Output
Total cost
(oil changes per
(dollars per hour)
hour)
0 10
1 20
2 35
3 50
4 80

a) What is Jiffy Lube's total fixed cost?

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Tutorial 7

b) What is the total variable cost of 2 oil changes?

c) What is the average variable cost of 4 oil changes?

d) What is the average fixed cost of 2 oil changes?

e) What is the marginal cost of the 3rd oil change?

5. Suppose a firm has only three possible plant-size options, represented by the ATC curves
shown in the accompanying figure. What plant size will the firm choose in producing (a) 50,
(b) 130, (c) 160, and (d) 250 units of output? Draw the firm’s long-run average-cost curve on
the diagram and describe this curve.

6. The table shows the production function of Jackie’s Canoe Rides. Jackie’s pays $100 a day
for each canoe it rents and $50 a day for each canoe operator it hires.

Labor Output
(workers (rides per day)
per day) Plant 1 Plant 2 Plant 3 Plant 4
10 20 40 55 65
20 40 60 75 85
30 65 75 90 100
40 75 85 100 110
Canoes 10 20 30 40

a. Graph the ATC curves for Plant 1 and Plant 2. Explain why these ATC curves differ?
b. Graph the ATC curves for Plant 3 and Plant 4. Explain why these ATC curves differ?
c. On Jackie’s LRAC curve, what is the average cost of producing 40, 75, and 85 rides a
week?
d. What is Jackie’s minimum efficient scale?
e. Explain how Jackie’s uses its LRAC curve to decide how many canoes to rent.
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Tutorial 7

f. Does Jackie’s production function feature economies of scale or diseconomies of scale?

7. Dollah quit his job at the Tri-City bank where he earned MYR 50,000 a year to start his own
business, a bank marketing company. He estimates his entrepreneurial talent or forgone
entrepreneurial income to be MYR 5,000 a year. He used MYR 100,000 in savings that
earned 5 percent interest annually to finance the new business. In the first year, the firm
earned revenue of MYR 250,000. The costs for rent, supplies, and employees salary were
MYR 200,000. (Explain your calculations for both questions)

a. What was the accounting profit for the new business?

b. What was the economic profit (or loss)?

8. Izati quit her job at IBM where she earned MYR50,000 a year. She cashed in MYR50,000 in
corporate bonds that earned 10% interest annually to buy a mini-bus. Izati has decided to
buy the mini-bus and set up a commuter service between Taiping and Parit Buntar. There are
1000 people who will pay MYR400 a year each for the commuter service; MYR280 from
each person goes for gas, maintenance, insurance, and depreciation. She estimates that her
entrepreneurial skills would have typically yielded a normal profit of MYR5,000 in another
business.

(i) What are Izati’s total revenues?

(ii) What are Izati’s explicit costs?

(iii) What is her accounting profit?

(iv) List the important implicit costs that Izati has not included and what is the total
implicit cost?

(v) What is Izati’s pure economic profit (loss)?

9. The following are three short-run average total cost schedules for the only three possible
plant sizes, 1, 2, and 3.

Plant Size 1 Plant Size 2 Plant Size 3

Q ATC Q ATC Q ATC
10 $1.00 20 $ .95 40 $1.00
20 .90 30 .80 50 .87
30 .85 40 .76 60 .84
40 .88 50 .79 70 .85
50 .93 60 .83 80 .95
60 1.05 70 .90 90 1.05
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Tutorial 7

(i) Find the long-run average cost schedule and show the result in the table below.
Long Run
Q 10 ? ? ? ? ? ? ? 90
AC $? ? ? ? ? ? ? ? ?

(ii) At what range of output level that the minimum efficient scale (MES) occur in the
above scenario?

(iii) Why must normal profits be counted as a cost, according to economists?

10. For each of the following situations, determine whether it is concerned with a short-run or a
long-run production decision. Explain briefly in each case.

(i) The Global Operations Chief Executive at Adidas wishes to acquire Glad Foot Inc. in
order to expand the company’s sport shoe line to include specialty shoes designed for
table tennis, a type of shoe for which Glad Foot is the global leader.

(ii) The vice president of Wal-Mart decides not to build another distribution center in
Virginia, instead choosing to extend hours of operation by 7 percent at each one of
the 14 distribution centers in the greater Richmond, Virginia area.

(iii) GemCon Direct, a diamond brokerage firm in Beirut, lays off five of its brokers in
response to declining demand for its services.

(iv) Tampa International Airport announced that it will add a fifth concourse in order to
meet the growing demand for air travel in west-central Florida.

11. Suppose your business is currently employing 750 workers, the only variable input, at a wage
rate of MYR48. The average product of labor is 96, the last worker added 6 units to total
output, and total fixed cost is MYR12,000.

(i) What is marginal cost?

(ii) What is average variable cost?

(iii) How much output is being produced?

(iv) What is average total cost?

(v) Is average variable cost increasing, constant, or decreasing? What about average total
cost?