A firm faces the following costs: total cost of capital = $2,500; price paid for
ID: 1208933 • Letter: A
Question
A firm faces the following costs: total cost of capital = $2,500; price paid for labor = $14 per labor unit; and price paid for raw materials = $5 per raw-material unit.
Instructions: In parts a and b, round your answers to 2 decimal places. In part c, enter your answer as a whole number.
a. Suppose the firm can produce 6,500 units of output this year by combining its fixed capital with 100 units of labor and 450 units of raw materials. What are the total cost and average total cost of producing the 6,500 units of output?
TC = $.
ATC = $.
b. Now assume the firm improves its production process so that it can produce 7,250 units of output this year by combining its fixed capital with 100 units of labor and 450 units of raw materials. What are the total cost and average total cost of producing the 7,250 units of output?
TC = $.
ATC = $.
c. If units of output can always be sold for $1 each, then by how much does the firm’s profit increase after it improves its production process? $.
d. Suppose that implementing the improved production process would require a one-time-only cost of $850.
If the firm only considers this year’s profit, would the firm implement the improved production process? (Click to select)YesNo.
What if the firm considers its profit not just this year but in future years as well? (Click to select)NoYes.
Explanation / Answer
(a) Cost of capital = $2,500
Price of Labor = $14 per unit
price of raw material = $5 per unit
Output produced = 6,500 units
Calculate Total Cost -
Total Cost = Cost of capital + Cost of labor + Cost of raw material
Total Cost = $2,500 + 100 * $14 + 450 * $5 = $6,150
The Total cost of producing 6,500 units is $6,150.
Calculate Average Total Cost -
ATC = TC/Q = $6,150/6,500 = $0.95 per unit
The Average total cost of producing 6,500 units is $0.95 per unit.
(b) Cost of capital = $2,500
Price of Labor = $14 per unit
price of raw material = $5 per unit
Output produced = 7,250 units
Calculate Total Cost -
Total Cost = Cost of capital + Cost of labor + Cost of raw material
Total Cost = $2,500 + 100 * $14 + 450 * $5 = $6,150
The Total cost of producing 7,250 units is $6,150.
Calculate Average Total Cost -
ATC = TC/Q = $6,150/7,250 = $0.85 per unit
The Average total cost of producing 7,250 units is $0.85 per unit.
(c) Calculate profit when 6,500 units are produced -
Total cost of producing 6,500 units = $6,150
Price per unit = $1
Total Revenue = 6,500 * $1 = $6,500
Profit = TR - TC = $6,500 - $6,150 = $350
When 6,500 units are produced, profit is $350.
Calculate profit when 7,250 units are produced -
Total cost of producing 7,250 units = $6,150
Price per unit = $1
Total Revenue = 7,250 * $1 = $7,250
Profit = TR - TC = $7,250 - $6,150 = $1,100
When 7,250 units are produced, profit is $1,100.
Increase in profit = $1,100 - $350 = $750
The firm’s profit increase by $750 after it improves its production process.
(d) The improvement in production process requires a one-time only cost of $850. However, such improvement is increasing the profit by only $750.
So, if the firm only considers this year's profit, it would not implement the improved production process.
The answer is No.
This improvement in production process will increase the profit by $750 in every future year. However, cost has to be incurred only once.
So, if the firm considers its profit not just this year but in future years as well then it will implement the improved production process.
The answer is Yes.
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