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Tutorial 5

The document provides solutions to 4 problems related to cost analysis under perfect competition. Problem 1 defines cost measures like average total cost, fixed cost, variable cost, and marginal cost based on a total cost function. It finds that average total cost is minimized at an output of 20 units. Problem 2 discusses how marginal cost and average total cost relate to economies and diseconomies of scale. Problem 3 calculates cost measures for a company and finds average total cost is minimized at an output of 50 units. Problem 4 defines economies of scope and scale, and calculates the degree of economies of scope from joint production.

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84 views3 pages

Tutorial 5

The document provides solutions to 4 problems related to cost analysis under perfect competition. Problem 1 defines cost measures like average total cost, fixed cost, variable cost, and marginal cost based on a total cost function. It finds that average total cost is minimized at an output of 20 units. Problem 2 discusses how marginal cost and average total cost relate to economies and diseconomies of scale. Problem 3 calculates cost measures for a company and finds average total cost is minimized at an output of 50 units. Problem 4 defines economies of scope and scale, and calculates the degree of economies of scope from joint production.

Uploaded by

biresaw birhanu
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Tutorial 5 - Perfect Competition

March 2014

PROBLEM 1

A firm’s total cost function is given by the equation:


TC = 16000 + 20Q + 40Q2

Based on the TC function above, write the value or the expression (formula) for each of the
following cost measures:

Average total cost (ATC)


Fixed cost (FC)
Average fixed cost (AFC)
Variable cost (VC)
Marginal cost (MC)

Please explain how to determine the quantity that minimizes the average total costs and calculate it.
SOLUTION

Average total cost (ATC) = (16000 + 20Q +40Q2) /Q


Fixed cost (FC) = 16000
Average fixed cost (AFC) = 16000/Q
Variable cost (VC) = 20Q + 40Q2
Marginal Cost (MC) = 20 + 40Q

b. ATC is minimized where MC = ATC:


Equating MC to ATC yields:
(16000 + 20Q +40Q2) /Q = 20 + 80Q
16000 + 20Q +40Q2 = 20Q + 80Q2
16000 = 40Q2
400 = Q2
Q = 20
So, ATC is minimized at 20 units of output.

PROBLEM 2

If marginal cost is > average total cost, what will be the behavior of the average total cost? In such
a situation we will have economies or diseconomies of scale?

SOLUTION

When MC > ATC  ATC is rising.


That is due by the fact that the cost of producing an additional unit of the good will be higher than
the average total cost per unit of output already realized.
This makes the average total cost increase.

In this case we can say that we are observing diseconomies of scale, because the increase of units of
output makes my average total costs increase (The ATC curve is upward sloping)

PROBLEM 3

The Carter Enterprise that produces cutlery wants to assess which is the right level of production
that will allow it to minimize its average production costs in order to make its business more
efficient.
The use of the plant and the machineries costs 250.000$ while for each unit produced the cost to be
substained is 50Q + 100Q2

a)Which is the cost function for the Carter Enterprise?

b)Calculate fixed costs, average fixed costs, variable costs and marginal costs for the production
function of Carter enterprise.

c)How can we determine the quantity to be produced in order to minimize costs?

d)Calculate the quantity that minimizes the average total costs.

SOLUTION

a) The cost function for Carter Enterprise is: 250000 + 50Q + 100Q2

b) Fixed Costs = 250000


Variable Costs = 50Q + 100Q2
Average Total Costs = (250000 + 50Q + 100Q2)/Q
Marginal Costs= 50 + 200Q

c) To determine the quantity to be produced in order to minimize the average total costs we have to
calculate the quantity that makes marginal costs equal average total costs.

(250000 + 50Q +100Q2) /Q = 50 + 200Q


250000 + 50Q +100Q2 = 50Q + 200Q2
250000 = 100Q2
2500 = Q2
Q = 50
So, ATC is minimized at 50 units of output.

PROBLEM 4

Define what is meant by “economies of scope” and “economies of scale”.

Calculate the degree of economies of scope for DELTA enterprise obtained by producing jointly
1000 Belts and 1000 Shoes given that their joint production function is:
C(B,S)= 64000 + 40B + 20S

Derive the individual production function.

SOLUTION

By “economies of scope” we mean the cost reduction obtained by the joint production of two
goods. If producing the goods together yields a reduction in costs compared to the separate
production of the same goods we can say we have an economy of scope.

By economies of scale we mean the average total cost decreases as the quantity produced increase.

C(B)= 64000 + 40B

C(S)= 64000 + 20S

C(B,S)= 64000 + 40*1000 + 20*1000 = 124000

C(B) + C(S) = 64000 + 40B + 64000 + 20S = 64000 + 40*1000 + 64000 + 20*1000 =

=104000 + 84000 = 188000

The degree of economies of scope is given by:

[C(B)+C(S) – C(B,S)]/C(B,S) = (188000-124000)/124000 = 51,6%

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