Now suppose the decision maker in Technical Problem 6 faces a fixed cost of $24.

Question

Now suppose the decision maker in Technical Problem 6 faces a fixed cost of $24. Fill in the blanks in the following table to answer the questions below. AC is the average cost per unit of activity.

a. How does adding $24 of fixed costs affect total cost? Net benefit? b. How does adding $24 of fixed cost affect marginal cost? c. Compared to A* in Technical Problem 6, does adding $24 of fixed cost change the optimal level of activity? Why or why not? d. What advice can you give decision makers about the role of fixed costs in finding A *? e. What level of activity minimizes average cost per unit of activity? Is this level also the optimal level of activity? Should it be? Explain. f. Suppose a government agency requires payment of a one-time, nonrefundable license fee of $100 to engage in activity A, and this license fee was paid last month. What kind of cost is this? How does this cost affect the decision maker’s choice of activity level now? Explain.

A TB TC NB MB MC AC    0   $ 0    — –$24                   1    —    —       3 $35 $—     $32    2    65     —    —    —    10       —    3    85    54     —    —    —       —    4    —    —     27    —    14       —    5    —    —     —      8    — 16.80    6    —    —           5    20       

Explanation / Answer

Working notes:

(1) NB = TB - TC

(TB = NB + TC and TC = TB - NB)

(2) MB = Change in TB / Change in A

(3) MC = Change in TC / Change in A

(3) AC = TC / A

(a) Fixed cost will increase TC and NB by $24 at every level of A.

(b) Addition of fixed cost will not affect MC.

(c) Adding fixed cost will not change optimal activity, because optimal output is obtained by equating marginal revenue (MR or MB) with MC, and since fixed costs don't affect MC, optimal output is unchanged.

(d) Since fixed costs don't determine or decide the optimal A, fixed costs should be kept out of consideration.

(e) AC is minimized (= $16.8) when A = 5.

This is not the optimal activity because MB and MC are unequal when A = 5. It is also not expected that optimal activity and AC-minimizing activity levels should be equal unless it is a perfectly (or monopolistically) competitive firm operating in the long run equilibrium.

Note: First 6 sub-parts are answered.

A TB ($) TC ($) NB ($) MB ($) MC ($) AC ($) 0 0 24 -24 1 35 32 3 35 8 32 2 65 42 23 30 10 21 3 85 54 31 20 12 18 4 95 68 27 10 14 17 5 103 84 19 8 16 16.8 6 108 104 4 5 20 17.33

Related Questions

Navigate

• Browse (All)
• Browse N
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.