Unit 7 AB224 | Microeconomics Unit 7 Assignment: Cost Elements of a Business Name: Course Number and Section: AB224–0X Date: General Instructions for all Assignments 1. Unless specified differently by your course instructor, save this assignment template to your computer with the following file naming format: Course number_section number_Last_First_unit number 2. At the top of the template, insert the appropriate information: Your Name, Course Number and Section, and the Date 3. Insert your answers below, or in the appropriate space provided for in the question. Your answers should follow APA format with citations to your sources and, at the bottom of your last page, a list of references. Your answers should also be in Standard English with correct spelling, punctuation, grammar, and style (double spaced, in Times New Roman, 12–point, and black font). Respond to questions in a thorough manner, providing specific examples of concepts, topics, definitions, and other elements asked for in the questions. 4. Upload the completed Assignment to the appropriate Dropbox. 5. Any questions about the Assignment, or format questions, should be directed to your course instructor. Assignment In this Assignment, you will define and calculate the remaining six major cost elements of a business, when given the Total Costs and the Quantity Produced, as well as to use the computed costs to determine a minimum cost output level for that business. In addition, you will also clearly explain how the Average Total Cost of a new output level is affected by its share of Fixed Costs and Variable Costs. Questions 1. When Total Costs (TC) are known, explain how to calculate each of the following: a. Fixed Costs (FC) 1 of 4 Unit 7 AB224 | Microeconomics b. Variable Costs (VC) c. Average Variable Costs (AVC) d. Average Total Costs (ATC) e. Average Fixed Costs (AFC) f. Marginal Costs (MC) 2. Table 1. shows the hourly production and Total Cost estimates for a new manufacturing firm wishing to enter the smart phone market. Fill in the blank cells in columns a., b., c., d., and e. on the table by computing the appropriate values. Table 1. Smart cell phones produced in an hour Total Cost (TC) Variable Costs (VC) a. 0 15 30 45 $3,200 $3,525 $3,875 $4,250 60 $4,650 75 $5,075 90 $5,525 105 120 $6,725 $8,210 Average Variable Costs (AVC) Average Total Costs (ATC) Average Fixed Cost (AFC) Marginal Cost (MC) b. n/a c. n/a d. n/a e. n/a 2 of 4 Unit 7 135 AB224 | Microeconomics $9,950 3. Based on your calculations in completing the table in Question 2, what is this manufacturer’s minimum cost output level? Explain your answer. 4. According to our textbook (page 341) when one additional unit is produced, two factors directly impact the change in average total costs, the Spreading effect and the Diminishing Returns effect. In the following two situations explain how the factors of the Spreading effect and the Diminishing Returns effect cause the average total cost to be different. a. Production of the 10th Gizmo resulted in an average total cost (ATC) of $20, but production of the 11th Gizmo resulted in an average total cost of $22. b. Production of the 10th Gizmo resulted in an average total cost (ATC) of $20, but production of the 11th Gizmo resulted in an average total cost of $18. Table 2.a. shows an LED light bulb manufacturer’s total cost of producing LED light bulbs. Table 2.a. Cases of LED light bulbs produced in an hour Total Cost 0 10 20 $4,500 $4,900 $5,100 3 of 4 Unit 7 AB224 | Microeconomics 30 40 50 60 70 80 90 $5,300 $5,400 $5,700 $6,700 $7,900 $9,700 $11,800 5. What is this manufacturer’s fixed cost? Explain why. 6. Assuming that you only know the Total Costs (TC) (as is shown in the Table 2.a. above) explain how you would calculate each of the following: a. Variable Cost (VC); b. Average Variable Cost (AVC); c. Average Total Cost (ATC); d. Average Fixed Cost (AFC); and, e. Marginal Costs (of a single case). 7. In Table 3.a., for each level of output, insert into the table the values for: a. the Variable Cost (VC); b. the Average Variable Cost (AVC); 4 of 4 Unit 7 AB224 | Microeconomics c. the Average Total Cost (ATC); and, d. the Average Fixed Cost (AFC). Table 3.a. Cases of LED light bulbs produced in an hour Total Cost Variable Costs a. 0 10 20 30 40 50 60 70 80 90 $4,500 $4,900 $5,100 $5,300 $5,400 $5,700 $6,700 $7,900 $9,700 $11,800 Average Variable Costs Average Total Costs Average Fixed Cost b. n/a c. n/a d. n/a e. Given the information you computed in Table 3.a., what is the minimum cost output Level? Explain why. 8. Brenda Smith operates her own farm, raising chickens and producing eggs. She sells her eggs at the local farmers’ market, where there are several other egg producers’ also selling eggs by the dozen. (Brenda operates in a perfectly competitive market in which she is a “price taker.”) In order to make sure she does not lose money on selling eggs, she does an analysis of her costs for producing eggs as shown on Table 4.a. Table 4.a. 5 of 4 Unit 7 AB224 | Microeconomics Dozens of eggs Fixed Cost Total Cost Variable Costs Average Variable Costs per dozen Average Total Costs per dozen 0 $3.35 $3.35 n/a n/a n/a 10 $3.35 $10.50 $7.15 $0.72 $1.05 20 $3.35 $16.40 $13.05 $0.65 $0.82 30 $3.35 $23.10 $19.75 $0.66 $0.77 40 $3.35 $30.00 $26.65 $0.67 $0.75 50 $3.35 $36.50 $33.15 $0.66 $0.73 60 $3.35 $48.00 $44.65 $0.74 $0.80 70 $3.35 $64.40 $61.05 $0.87 $0.92 80 $3.35 $80.00 $76.65 $0.96 $1.00 90 $3.35 $135.00 $131.65 $1.46 $1.50 a. What is Brenda’s break-even price for a dozen of eggs? Explain how you found that answer. b. What is Brenda’s shut-down price for a dozen of eggs? Explain how you found that answer. c. If the market price of a dozen eggs at the local farmers’ market is $1.45 per dozen, will Brenda make an economic profit? Explain how you determined your answer. d. If the market price of a dozen eggs at the local farmers’ market is $1.45 per dozen, should Brenda continue producing eggs in the short run? Explain how you determined your answer. 6 of 4 Unit 7 AB224 | Microeconomics e. If the market price of a dozen eggs at the local farmers’ market is 72 cents per dozen, will Brenda make an economic profit? Explain how you determined your answer. f. If the market price of a dozen eggs at the local farmers’ market is 72 cents per dozen, should Brenda continue producing eggs in the short run? Explain how you determined your answer. g. If the market price of a dozen eggs at the local farmers’ market is 64 cents per dozen, will Brenda make an economic profit? Explain how you determined your answer. h. If the market price of a dozen eggs at the local farmers’ market is 64 cents per dozen, should Brenda continue producing eggs in the short run? Explain how you determined your answer. 9. The Gulf Sea Turtle Conservation Group (GSTCG), a 501(c) (3) non–profit group of volunteers working to collect data on nesting sea turtles and to promote sea turtle conservation, is considering creating a video to educate people about sea turtle conservation. The cost of duplicating the video on a DVD and mailing the DVD is $6.58. In a GSTCG member meeting, the video plan was discussed. Table 1. shows the expected demand for the DVD at different suggested donation levels, and they can act as a single-price monopolist if they choose to. The receipts will be used to fund GSTCG supplies for their data collection and conservation work. At the end of each sea turtle nesting season, any excess funds are donated by the GSTCG to a local non-profit sea turtle research and rehabilitation facility. 7 of 4 Unit 7 AB224 | Microeconomics Table 1. Suggested Donation per DVD Request Anticipated Number of DVD Requests $19.00 0 $15.00 2 $9.50 4 $7.75 10 $3.00 15 $0.00 20 a. Complete Table 2. by computing the Total Revenue, Marginal Revenue, and Profit columns. Table 2. Suggested Donation per DVD Request Anticipated Number of DVD Requests $19.00 0 $15.00 2 $9.50 4 $7.75 10 $3.00 15 $0.00 20 Total Revenue Marginal Revenue PROFIT b. The President wants the GSTCG to provide videos to generate the most possible donations (Total Revenue). What price is the President of the GSTCG favoring and how many people will receive the DVD if this becomes the price of the suggested donation? Explain your answers. c. The Education Outreach Committee wants the GSTCG to provide videos to the most possible number of people. What price is the Educational Outreach 8 of 4 Unit 7 AB224 | Microeconomics Committee favoring and how many people will receive the DVD if this becomes the price of the suggested donation? Explain your answers. d. The Treasurer of the GSTCG wants the DVD program to be as efficient as possible so that the marginal revenue equals marginal cost. What price is the Treasurer favoring and how many people will receive the DVD if this becomes the price of the suggested donation? Explain your answers. e. The Fund Raising Committee wants the DVD program to generate as much profit in donations as possible. What price is the Fund Raising Committee favoring and how many people will receive the DVD if this becomes the price of the suggested donation? Explain your answers. 10. A business has been created to provide needed services to its market. As the only provider of this service, it functions as a monopoly, with the ability to set prices and having the entire market demand schedule as its demand curve. Because the monopoly is newly formed, there is no government intervention into the monopoly’s pricing actions. Examine Diagram 2. and answer each of the following questions with complete explanations: 9 of 4 Unit 7 AB224 | Microeconomics a. What is quantity (a) and why is it important? b. What is the value at point (b) and why is it important? c. What is the value at point (c) and why is it important? d. What is the value at point (d) and why is it important? e. What is the meaning of the green rectangle labeled (e)? f. If there were no monopoly and this was a perfectly competitive market, what would quantity at point (f) be and why is it important? g. If there were no monopoly and this was a perfectly competitive market, what would point (g) be and why is it important? 10 of 4 Unit 7 AB224 | Microeconomics h. For the market in which the monopoly now operates, what does the red triangle labeled (h) mean, and why is it important? 11. A governmental regulating agency was created to oversee the monopoly in Question 2’s operations and pricing. Diagram 3. depicts a new price ceiling set by the regulators. Answer each of the following questions with complete explanations: a. What is quantity (a) and why is it important? b. What is the value at point (b) and why is it important? c. At what level was the price ceiling set? d. What is the value at point (c) and why is it important? 11 of 4 Unit 7 AB224 | Microeconomics e. At this price ceiling level, will the monopoly make any monopoly profits? f. At this price ceiling level, will the monopoly cover its costs? g. At this price ceiling level, will the monopoly continue in business in the long run? 12. Diagram 4. Depicts a different price ceiling set by the regulators for the monopoly in Question 2. Answer each of the following questions with complete explanations: a. What is quantity (a) and why is it important? b. What is the value at point (b) and why is it important? 12 of 4 Unit 7 AB224 | Microeconomics c. At what level was the price ceiling set? d. At this price ceiling level, will the monopoly make any monopoly profits? e. At this price ceiling level, will the monopoly cover its costs? f. At this price ceiling level, will the monopoly continue in business in the long run? 13. Explain your understanding of how price effect contributes to the fact that, for a monopoly, marginal revenue is always less than the price. 14. Explain your understanding of how quantity effect contributes to the fact that, for a monopoly, marginal revenue is always less than the price. -------------------------------------------References: 13 of 4 Unit 7 AB224 | Microeconomics 14 of 4 Unit 7 AB224 | Microeconomics Unit 7 Assignment: Cost Elements of a Business Grading Rubric Content Full Assignment Overall Writing: Correct coversheet information at the top of 1st page APA format for answers Correct citations Standard English, no errors At least one, or more, references Answers: provides complete information demonstrating analysis and critical thinking: Individual Questions: 1. a. - Explain the calculation of variable cost. 1. b. - Explain the calculation of average variable cost. 1. c. - Explain the calculation of average total cost. 1. d. - Explain the calculation of average fixed cost 1. e. - Explain the calculation of marginal cost 2. a. - Calculate this manufacturer’s variable cost. 2. b. - Calculate this manufacturer’s average variable cost. 2. c. - Calculate this manufacturer’s average total cost. 2. d. - Calculate this manufacturer’s average fixed cost 2. e. - Calculate this manufacturer’s marginal cost 3. - Identify this manufacturer’s minimum cost output level. 4. a. - Explain why the average total cost of 11th Gizmo is $22. 4. a. - Explain why the average total cost of 11th Gizmo is $18. Percent Points Possible Possible 100% 40 20% 8 5% 3% 3% 4% 5% 80% 2.00 1.20 1.20 1.60 2.00 32 6% 2.40 6% 2.40 6% 2.40 6% 6% 2.40 2.40 6% 2.40 6% 2.40 6% 2.40 6% 2.40 6% 2.40 6% 2.40 7% 2.80 7% 2.80 15 of 4 Hints for Unit 7 assignment Review Some definitions to remember: a. Fixed costs are the Total costs incurred even if NO items are manufactured b. Variable cost for that unit is the total cost for that unit minus the total cost of producing ZERO units. c. Average variable cost for that unit is the variable cost for that number of units divided by the number of units d. Average total cost is the total costs for that number of units divided by the number of units. e. Average fixed cost is the fixed cost when NO units are produced divided by the number of units produced. f. The minimum-cost output is the number of units produced when the average total cost is the LOWEST. g. Marginal cost is the total cost for a particular number or units minus the total cost for one LESS of the same number of units. 2. 3. 4. 5. 6. 7. 8. 9. - Fixed cost (FC) = total costs (TC) when NOTHING is produced - Variable cost (VC) = total cost(TC) MINUS fixed cost(FC) - Total costs (TC) = fixed cost (FC) PLUS variable costs (VC) - Average variable cost (AVC) = Variable cost (VC) divided by the NUMBER of units - Average total cost (ATC) = total cost (TC) divided by the NUMBER of units - Average fixed cost (AFC) = fixed cost (FC) divided by the NUMBER of units -Minimum cost output = the number of units you would produce when your costs are the LOWEST. It is found by finding the LOWEST AVERAGE TOTAL cost and making that NUMBER of units. 10. - Break-even price is the PRICE that is the same as your LOWEST AVERAGE TOTAL COST . Any price ABOVE the breakeven price will create an economic PROFIT for the business. 11. -Shut-down price is the PRICE that is the same as your LOWEST AVERAGE VARIABLE COST. Any price below that shut-down price will mean that you are not even getting enough revenue to cover even the variable cost (ingredients to make your product). 12. Note: any price between the shut-down price and the break-even price creates enough revenue to cover variable costs (ingredients to make your product), and will make a contribution to your fixed costs (like the rent for the building), but will not cover ALL of your FIXED costs and will NOT create any economic PROFIT . 13. Price effect is the difference in revenue caused by changing the price on existing customers. 14. Quantity effect is the difference in revenue caused by a change in the total number of customers 15. Using a bakery example, assume you are selling pies and you have 50 customers a week and they pay $10.00 per pie for a total revenue of $500. 16. You figure that if you lower your price to $8 per pie that you will sell more, so you lower your price. The next week you have 70 customers, each paying $8 per pie, and giving you a total revenue of $560. You gained $60 on that change in price. 17. The original 50 customers now paying $8 each give you revenue of $400. The price effect is a loss of $100 ($500 the 50 were paying last week, minus the $400 that those same 50 customers are now paying this week = $100 PRICE effect loss). 18. The 20 NEW customers are paying $8 each giving you an additional $160 in revenue from new customers; we call that $160 of new customer revenue the QUANTITY effect gain in revenue. 19. Total Revenue = Number of sales multiplied by the price 20. Marginal Revenue at each price = Total revenue at the price minus the total revenue at the previous price for the last SINGLE sale (must divide difference in total cost by the number of units sold at that price). 21. Quantity produced = the quantity at which the Marginal COST is equal to the Marginal REVENUE 22. Monopoly price (with NO government intervention) = HIGHEST price at which buyers will buy the SAME quantity produced (see the demand schedule/curve) when Marginal Cost is equal to Marginal Revenue. 23. Monopoly profits are maximized at a quantity at which marginal cost is equal to marginal revenue. 24. Monopoly profits exist when the price is ABOVE the Average Total cost for that quantity. 25. Monopoly Deadweight loss occurs because the monopoly quantity produced is LESS than the quantity that would be what consumers would demand at a PRICE that equals Marginal Cost. 26. If a price ceiling is imposed on a monopoly and the price ceiling is equal to, or above, the Average Total Cost for the quantity at which PRICE equals the Demand schedule/curve, then the monopolist will continue to produce. Any price ceiling below Average Total Cost will result in shutdown over the long run. 27. The area of a triangle is computed by the formula: 28. (base * height)/2 29. where Height = high price – low price 30. and Base = high quantity - low quantity -------------------------------------------------The textbook states that “increasing output has two opposing effects on average total cost”. (Krugman, 2013, p. 329) The spreading effect (the effect of spreading the fixed costs over additional units) is one effect. The other effect is that of the diminishing returns effect (the effect of increasing variable costs as the number of unit’s increases). As more units are produced each additional unit’s share the FIXED costs gets smaller and smaller, because we are spreading that FIXED cost over so many units (spreading effect). As production is increased, there comes a level of production in which that share of the fixed costs is so small that it is drastically outweighed by the change in average VARIABLE costs, which, because of diminishing returns to labor (like our farming example of adding more and more workers, but only increasing output by a little bit), causes the VARABLE costs to increase significantly. As long as the share of FIXED costs is much smaller than the share of VARIABLE costs, we would see average total costs DECREASING. At the level of production in which the next unit’s share of fixed costs is much smaller than its share of VARIABLE costs, we will see its average begin to INCREASE. total costs