Case / Fair Chapter 7: 1-6

CHAPTER 7

1. Total revenue is $50,000 ($10 x 5,000). The opportunity cost of the capital is 10% of $100,000 annually or $10,000. Total cost, including opportunity costs, is $45,000 for labor plus $10,000 for capital or $55,000. Profit is TR – TC or $50,000 – $55,000 = –$5,000. The firm is suffering a $5,000 loss in economic terms.

2.   They are not earning economic profits; they are not considering opportunity costs. The opportunity cost of capital is 10 percent of $50,000 annually, or $5,000. Because simple revenue minus cost yields an accounting profit of only $2,000, adding $5,000 in opportunity cost means the firm is suffering losses of at least $3,000. In addition, it is not considering the opportunity cost of its own labor.

3.         The size of the theater is the fixed factor. Decisions include how to divide up the tickets, what price to charge, what shows to put on, and what kind of stage sets to use. All are constrained by the scale of the theater. In the long run, you might be able to raise money and build or acquire a bigger theater. There is no fixed factor in the long run; you can think big!

4.   (a)  The marginal product decreases as a single variable factor increases, holding all other factors constant.

      (b)  The table does exhibit diminishing returns because the marginal product of labor falls as labor increases:

L	TP	MP
0	0	—
1	5	5
2	9	4
3	12	3
4	14	2
5	15	1

5.   (a)  Total costs of each technique are as follows:

Tech A	$9	$12	$24	$30	$36
Tech B	$12	$19	$26	$33	$38

            Technique A is cheaper at all levels of output.

      (b)  Labor and capital employed would be as follows:

Q	L	K
1	5	2
2	10	1
3	14	5
4	18	6
5	20	8

      (c)

      (d)  With the price of labor rising to $3:

Tech A	$19	$32	$52	$66	$76
Tech B	$16	$25	$34	$43	$50

            Labor and capital employed would be as follows:

Q	L	K
1	2	5
2	3	8
3	4	11
4	5	14
5	6	16

           

6.   Clearly, the labor-intensive way would be to carry the boxes down the hall and up the stairs one at a time. She could get a friend or two to help. If the dorm has an elevator and she can borrow a hand truck, the job would be easy. She would be using capital to raise her productivity. To go three miles across campus, a car (capital) or a truck (more capital) would be nice, although she could carry the boxes one at a time across campus as well. In the developing world, where capital is scarce, people carry most of their stuff. To get the boxes to a new campus, she would probably mail them or ship them UPS. In this case, they would go in a big truck or an airplane (a great deal of capital).