CH11

1.

Which of the following news items involves a short-run decision

and which involves a long-run decision? Explain
January, 31, 2008: Starbucks will open 75 more stores abroad than
originally predicted, for a total of 975.
This decision is a long-run decision. It increases the quantity
of all of Starbucks factors of production, labor and the size
of Starbucks plant.

February, 25, 2008: For three hours on Tuesday, Starbucks will

shut down every single one of its 7,100 stores so that baristas
can receive a refresher course.
This decision is a short-run decision. It involves increasing the
quality of Starbucks labor and so only one factor of
productionlaborchanges and all the other factors remain fixed.

June, 2, 2008: Starbucks replaces baristas with vending

machines.
This decision is a short-run decision. It involves changing two
of Starbucks factors of production, labor and one type of capital.
But other factors of production, such as Starbucks land and other
capital inputs such as the store itself, remain fixed.

July, 18, 2008: Starbucks is closing 616 stores by the end of

March.
This decision is a long-run decision. It decreases the quantity
of all of Starbucks factors of production, labor and the size
of Starbucks plant.

2.

The table sets out Sues Surfboards

total product schedule.
a. Draw the total product curve.
To draw the total product curve
measure labor on the x-axis and output
on the y-axis. The total product curve
is upward sloping and is illustrated
in Figure 11.1.

b. Calculate the average product of

labor and draw the average product
curve.

Labor

Output

(workers

(surfboards

per week)

per week)

30

70

120

160

190

210

220

The average product of

labor is equal to total
product divided by the
quantity of labor
employed. For example,
when 3 workers are
employed, they produce
120 surfboards a week, so
average product is 40
surfboards per worker. As
Figure 11.2 (on the next
page) shows, the average
product curve is upward
sloping when up to 3 workers are hired and then is downward sloping
when more than 4 workers are hired.

c. Calculate the marginal product of labor and draw the marginal

product curve.
The marginal product of labor is
equal to the increase in total
product that results from a
one-unit increase in the quantity
of labor employed. For example,
when 3 workers are employed, total
product is 120 surfboards a week.
When a fourth worker is employed,
total product increases to 160
surfboards a week. The marginal
product of increasing the number of
workers from 3 to 4 is 40 surfboards.
We plot the marginal product at the
halfway point, so at a quantity of 3.5 workers, the marginal product
is 40 surfboards per worker per week. As Figure 11.2 (on the next
page) shows, the marginal product curve is upward sloping when
up to 2.5 workers a week are employed and it is downward sloping
when more than 2.5 workers a week are employed.

d. Over what output range does the firm enjoy the benefits of
increased specialization and division of labor?
The firm enjoys the benefits of increased specialization and
division of labor over the range of output for which the marginal
cost decreases. This range of output is the same range over which
the marginal product of labor rises. For Sues Surfboards, the
benefits of increased specialization and division of labor occur
until 2.5 workers are employed.

e. Over what output range does the firm experience diminishing

marginal product of labor?
The marginal product of labor decreases after 2.5 workers are
employed.

f. Over what output range does this firm experience an increasing

average product of labor but a diminishing marginal product
of labor?
The marginal product of labor decreases and the average product
of labor increases between 2.5 and 3.5 workers.

g. Explain how it is possible for a firm to experience

simultaneously an increasing average product but a
diminishing marginal product.
As long as the marginal product of labor exceeds the average product
of labor, the average product of labor rises. For a range of output
the marginal product of labor, while decreasing, remains greater
than the average product of labor, so the average product of labor
rises. Each additional worker, while producing less than the
previous worker hired is still producing more than the average
worker.

3.

Sues Surfboards, in problem 2, hires workers at $500 a week

and its total fixed cost is $1,000 a week.
a. Calculate total cost, total
variable cost, and total
fixed cost of each output in
the table. Plot these points
and sketch the short-run
total cost curves passing
through them.
Total cost is the sum of the
costs of all the factors of

production that Sues Surfboards uses. Total variable cost is the

total cost of the variable factors. Total fixed cost is the total
cost of the fixed factors. For example, the total variable cost
of producing 120 surfboards a week is the total cost of the workers
employed, which is 3 workers at $500 a week, which equals $1,500.
Total fixed cost is $1,000, so the total cost of producing 120
surfboards a week is $2,500. Figure 11.3 shows these total cost
curves.

b. Calculate average total cost, average fixed cost, average

variable cost, and marginal cost of each output in the table.
Plot these points and sketch the short-run average and
marginal cost curves passing through them.

AFC

AVC

ATC

MC

Output

(dollars

(dollars

(dollars

(dollars

(surfboards)

per

per

per

per

surfboard)

surfboard)

surfboard)

surfboard)

33.33

16.67

50.00

30

12.50
70

14.29

14.29

28.58
10.00

120

8.33

12.50

20.83
12.50

160

6.25

12.50

18.75
16.67

190

5.26

13.16

18.42
25.00

210

4.76

14.29

19.05
50.00

220

4.55

15.91

20.46

Average fixed cost is total fixed cost per unit of output. Average
variable cost is total variable cost per unit of output. Average
total cost is the total cost per unit of output. For example, take
the case in which the firm makes 160 surfboards a week. Total fixed
cost is $1,000, so average fixed cost is $6.25 per surfboard; total
variable cost is $2,000, so average variable cost is $12.50 per
surfboard; and, total cost is $3,000, so average total cost is
$18.75 per surfboard. Marginal cost is the increase in total cost
divided by the increase in output. For example, when output
increases from 120 to 160 surfboards a week, total cost increases
from $2,500 to $3,000, an increase of $500. This $500 increase
in total cost means that
the increase in output of
40 surfboards increases
total cost by $500.
Marginal cost is equal to
$500 divided by 40
surfboards, which is
$12.50 a surfboard. The
table shows these data
schedules and the curves
are plotted in Figure 11.4.

c. Illustrate the connection between Sues AP, MP, AVC, and MC

curves in graphs like those in Fig. 11.6.
AP
Labor

Output

MP

(surfboards (surfboards

(workers) (surfboards) per worker) per worker)

AVC

MC

(dollars

(dollars

per

per

surfboard) surfboard)
1

30

30.0

16.67
40.0

70

35.0

12.50
14.29

50.0
3

120

40.0

10.00
12.50

40.0
4

160

40.0

12.50
12.50

30.0
5

190

38.0

16.67
13.16

20.0
6

210

35.0

25.00
14.29

10.0
7

220

31.4

The table sets out the AP and MP

data used to draw the curves.
Figure 11.5 shows the curves and
the relationships. When the AP
curve rises the AVC curve falls
and vice versa. When the MP curve
rises the MC curve falls and vice
versa.

4.

Sues Surfboards, in problems 2

and 3, rents the factory
building and the rent is
increased by $200 a week. If
other things remain the same,
how do Sues Surfboards
short-run average cost curves
and marginal cost curve change.
The rent is a fixed cost, so total
fixed cost increases. The

50.00
15.91

increase in total fixed cost increases total cost but does not
change total variable cost. Average fixed cost is total fixed cost
per unit of output. The average fixed cost curve shifts upward.
Average total cost is total cost per unit of output. The average
total cost curve shifts upward. The marginal cost curve and average
variable cost curve do not change.

5.

Workers at Sues Surfboards, in problems 2 and 3, negotiate

a wage increase of $100 a week for each worker. If other things
remain the same, explain how Sues Surfboards short-run
average cost curve and marginal cost curve change.
The increase in the wage rate is a variable cost, so total variable
cost increases. The increase in total variable cost increases
total cost but total fixed cost does not change. Average variable
cost is total variable cost per unit of output. The average variable
cost curve shifts upward. Average total cost is total cost per
unit of output. The average total cost curve shifts upward. The
marginal cost curve shifts upward. The average fixed cost curve
does not change.

6.

Sues Surfboards, in problem 2, buys a second plant and the

output produced by each worker increases by 50 percent. The
total fixed cost of operating each plant is $1,000 a week. Each
worker is paid $500 a week.
a. Calculate the average total cost of producing 180 and 240
surfboards a week when Sues Surfboards operates two plants.
Graph these points and sketch the ATC curve.
To calculate the average total cost when two plants are operated,
recall that total cost is the cost of all the factors of production.
For example, when 4 workers are employed they now produce 240
surfboards a week. With 4 workers, the total variable cost is $2,000
a week and the total fixed cost is (coincidentally also) $2,000
a week. Hence the total cost is $4,000 a week. The average total
cost of producing 240 surfboards is $16.67 a surfboard. Similarly
the average total cost of producing 180 surfboards is $19.44. To
graph the ATC curve the average total costs at all the quantities
are required. Figure 11.6 shows the average total cost curve, ATC2
when Sues operates two plants. (It also shows Sues average total
cost curve, ATC1, when Sue operates one plant.)

b. To produce 180 surfboards a week, is it efficient to operate

one or two plants?

The long-run average cost curve is made up of the lowest parts
of the firm's short-run average total cost curves when the firm
operates one plant and two plants. The long-run average cost curve
is illustrated in Figure 11.6 as the darker part of the two ATC
curves. At lower levels of output the LRAC curve is derived from
operating one plant while at higher levels it is derived from
operating two plants. The LRAC curve shows that to produce 180
surfboards it is efficient to operate 1 plant.

c. To produce 160 surfboards a week, is it efficient for Sues

to operate one or two plants?
The LRAC curve shows that to produce 160 surfboards it is efficient
to operate 1 plant.

7.

Airlines Seek Out New Ways to Save on Fuel as Costs Soar

The financial pain of higher fuel prices is particularly acute
for airlines because it is their single biggest expense.
[Airlines] pump about 7,000 gallons into a Boeing 737 and as
much as 60,000 gallons into the bigger 747 jet. Each
generation of aircraft is more efficient. At Northwest, the
Airbus A330 long-range jets use 38 percent less fuel than the
DC-10s they replaced, while the Airbus A319 medium-range planes
are 27 percent more efficient than DC-9s.
The New York Times, June 11, 2008
a. Is the price of fuel a fixed cost or a variable cost for an
airline?
The price of fuel is a variable cost for an airline.

b. Explain how an increase in the price of fuel changes an

airlines total costs, average costs, and marginal cost.
An increase in the price of fuel raises an airlines total cost,
its average total cost, its average variable cost, and its marginal
cost. It does not change the airlines average fixed cost or total
fixed cost.

c. Draw a graph to show the effects of an increase in the price

of fuel on an airlines TFC, TVC, AFC, AVC, and MC curves.

Figure 11.7 shows an airlines TFC and TVC curves; Figure 11.8
shows an airlines AFC, AVC, and MC curves. The increase in the
price of fuel has no effect on the airlines fixed cost, so the
TFC and AFC curves do not change. The increase in the price of
fuel raises the firms variable costs and its total costs. As a
result the firms TVC, AVC and MC curves shift upward as illustrated
in the figures from the curves labeled 0to the curves labeled
1.

d. Explain how a technological advance that makes an airplanes

engines more fuel efficient changes an airlines total product,
marginal product, and average product.
This situation is an example of technological change that is
embodied in capital. This change will allow the airline to produce
more outputpassenger milesusing fewer resources. Hence the
airlines total product, marginal product, and average product
all increase.

e. Draw a graph to illustrate the effects of more fuel efficient

aircraft on an airlines TP, MP, and AP curves.

Figure 11.9 shows the airlines TP curves. The new engines shift
the TP curve upward from TP0 to TP1. Figure 11.10 shows the airlines
MP and AP curves. These curves also shift upward as a result of
the new fuel efficient engines.

f. Explain how a technological advance that makes an airplanes

engines more fuel efficient changes an airlines average
variable cost, marginal cost and average total cost.
The airlines average variable cost and marginal cost both
decrease. The new engines that use the new technology are
presumably more expensive than the older, less fuel efficient
engines. The engines are a fixed cost. So at lower levels of output
the new average total cost is higher than the old average total
cost while at larger levels of output the new average total cost
is lower than the old average total cost.

g. Draw a graph to illustrate how a

technological advance that makes
an airplane engine more fuel
efficient changes an airlines
AVC, MC, and ATC curves.
Figure 11.11 illustrates these
changes. The airlines AVC and MC
curves shift downward as indicated
by the shift from the grey curves

labeled 0 to the black curves labeled 1. At lower levels of

output the ATC curve shifts upward and at larger levels of output
the ATC curve shifts downward.

8.

The table shows

the production
function of

Labor

Output

(workers

(rides per day)

per day)

Plant 1

Plant 2

10

20

40

55

65

20

40

60

75

85

30

65

75

90

100

40

75

85

100

110

10

20

30

40

Jackies Canoe
Rides. Jackies
pays $100 a day for
each canoe it
rents and $50 a day
for each canoe

Canoes

Plant 3

Plant 4

operator it hires.
a. Graph the ATC curve for Plant 1 and Plant 2.
To find the average total cost for each plant, at the different
levels of output add the cost of the workers, $50 per worker, and
the fixed cost, the cost of the canoes, $100 per canoe. So for
plant 1, the total cost for 20 rides is $1,500; for 40 rides is
$2,000; and, for 65 rides is
$2,500. The average total cost
is calculated by dividing the
total cost by the quantity of
rides. These average total
costs are plotted in Figure
11.12. (The average total cost
curve for one plant, ATC1, is
the same as the thicker curve
through the first 4 points.)

b. On your graph in a, plot the

ATC curve for Plant 3 and
Plant 4.
These are drawn in Figure 11.12.

c. On Jackies LRAC curve, what is the average cost of producing

40, 75, and 85 rides a week?
The long-run average total cost curve is illustrated in Figure
11.12 as the thicker curve. It is comprised of the parts of the
short-run average total cost curves that are the minimum average
total cost for the different levels of output. From this curve,

the average cost of producing 40 rides is $50; of producing 75

rides is $40; and the average cost of producing 85 rides is $47.06.

d. What is Jackies minimum efficient scale?

Jackies minimum efficient scale is the smallest quantity at which
the long-run average cost is the lowest. Jackies minimum
efficient scale is 65 canoe rides where, with one plant, the average
total cost is $38.46.

e. Explain how Jackies uses its LRAC cost curve to decide how
many canoe to rent.
Jackies will use its long-run average total cost curve by building
the size of the plant that minimizes its long-run average cost
at the level of output that Jackies expects to produce.

f. Does Jackies production function feature economies of scale

or diseconomies of scale?
Jackies has both economies of scale for up to 65 canoe rides and
then diseconomies of scale for more than 65 canoe rides.

9.

Business Boot Camp

At a footwear company called Caboots, sales rose from $160,000
in 2000 to $2.3 million in 2006. But in 2007 sales dipped to
$1.5 million. Joey and Priscilla Sanchez, who run Caboots,
blame the decline partly on a flood that damaged the firms
office and sapped morale.
Based on a Fortune article, CNN, April 23, 2008
If the Sanchezes are correct in their assumptions and the prices
of footwear didnt change
a. Explain the effect of the flood on the total product curve
and marginal product curve at Caboots.
The total product curve shifted downward as a result of the flood
and sapped morale. That is, the factors of production produced
less footwear in 2007 than in 2006. The downward shift in the total
product curve decreased the marginal product so the marginal
product curve also shifted downward.

b. Draw a graph to show the effect of the flood on the total product
curve and marginal product curve at Caboots.

Figure 11.13 shows the downward shift in the total product curve
and Figure 11.14 shows the downward shift in the marginal product
curve. The flood and lack of morale shift the TP and MP curves
downward from TP1 to TP2 and from MP1 to MP2.

10. No Need for Economies of Scale

Illinois Tool Works Inc. might not seem like an incubator for
innovation. The 93-year-old company manufactures a hodgepodge
of mundane products, from automotive components and industrial
fasteners to zip-strip closures for plastic bags and
dedicates production lines and resources to high-volume
products. A line will run only those three or four products.
Runs are much longer and more efficient. By physically linking
machines they are able to eliminate work in process and
storage areas All the material handling and indirect costs
are reduced.
Business Week, October 31, 2005
a. How would you expect physically linking machines to affect
the firms short-run product curves and short-run average cost
curves?
By physically linking machines, for any amount of labor the firm
can produce more than before. The plants total product increases
so the short-run total product curve shifts upward. The marginal
product and average product curves also shift upward. As a result
of the increase in the average product, the firms short-run
average variable cost and average total cost both decrease so that

the average variable cost curve and average total cost curve shift
downward.

b. Draw a graph to show your predicted effects of physically

linking machines on the firms short-run product curves and
cost curves.

Figure 11.15 shows the effect

of physically linking
machines on Illinois Tools
total product curve. The total
product curve shifts upward
from TP1 to TP2. Figure 11.16
shows the effects on Illinois
Tools marginal product and
average product curves. These
curves shift upward from AP1 to
AP2 for the average product of
labor and from MP1 to MP2 for
the marginal product of labor. Figure 11.17 shows the effect of
physically linking machines on Illinois Tools cost curves. The
costs fall so that all the cost curves shift downwards: The average
variable cost curve shifts downward from AVC1 to AVC2, the average
total cost curve shifts downward from ATC1 to ATC2, and the marginal
cost curve shifts downward from MC1 to MC2.

c. Explain how concentrating production lines and resources to

high-volume products can influence long-run average cost as
the output rate increases.
By specializing in high-volume products the firm will be able
to enjoy economies of scale. In other words, with this
specialization, as the firm increases its production its long-run
average costs will decline.

11. Grain Prices Go the Way of the Oil Price

Every morning millions of Americans confront the latest trend
in commodities markets at their kitchen table. Rising prices
for crops have begun to drive up the cost of breakfast.
The Economist, July 21, 2007
Explain how the rising price of crops affects the average total
cost and marginal cost of producing breakfast cereals.
When producing cereal, the cereal crops used are a variable factor
of production. An increase in the price of these crops boosts the
firms average total cost and the firms marginal cost of producing
cereal.

12. Coffee King Starbucks Raises Its Prices

Blame the sour news at Starbucks this week on soaring milk
costs. The wholesale price [of ] milk is up nearly 70% in
the 12 months. Theres a lot of milk in those (Starbucks)
lattes, notes John Glass, CIBC World Markets restaurant
analyst.
USA Today, July 24, 2007
a. Is milk a fixed factor of production or a variable factor of
production?
Milk is a variable factor of production.

b. Describe how the increase in the price of milk changes

Starbucks short-run cost curves.
The increase in the price of milk shifts Starbucks short-run AVC,
ATC, and MC curves upward.

13. Bills Bakery has a fire and

TP

AFC

AVC

ATC

10

120

100

220

MC

Bill loses some of his cost

data. The bits of paper that he
80
recovers after the fire
20

150

provide the information in the

90
table (all the cost numbers are
30

40

90

130

dollars). Bill asks you to come

130
to his rescue and provide the
40

30

missing data in the five spaces

E
identified as A, B, C, D, and
50

24

108

132

E.
A is the average fixed cost, AFC, when the output is 20. Average
fixed cost equals total fixed cost divided by output, or AFC =
TFC Q. Rearranging gives TFC = AFC Q. So the total fixed cost
for the problem equals $120 10, which is $1,200. A equals $1,200,
TFC, divided by 20, Q, which is $60.
B is the average variable cost, AVC, when output is 20. Use the
result that AFC + AVC = ATC by rearranging to give AVC = ATC
AFC, so average variable cost equals $150 $60, which is $90.
D is the average total cost, ATC, when output, Q, equals 40. Average
total cost equals total cost divided by output, or ATC = TC Q.
Rearranging gives TC = ATC Q. So the total cost when 30 units
are produced is $130 30, which is $3,900. Marginal cost, MC,
equals the change in total cost divided by the change in quantity,
or MC = TC Q. Rearranging gives TC = MC Q, so the change
in total cost between Q = 30 and Q = 40 is $130 10, or $1,300.
Therefore the total cost when Q equals 40 is $3,900 + $1,300, or
$5,200. The average total cost when Q is 40 is $5,200 40, or
$130.
C is the average variable cost, AVC, when output, Q, equals 40.
Use the result that AFC + AVC = ATC by rearranging to give AVC
= ATC AFC. As a result, average variable cost equals $130 $30,
which is $100.
E is the marginal cost, MC, when output increases from 40 units
to 50 units. Marginal cost, MC, equals the change in total cost
divided by the change in quantity, or MC = TC Q. To calculate
marginal cost, the total cost when output is 40 and the total cost
when output is 50 are needed. Average total cost equals total cost

divided by output, or ATC = TC Q. Rearranging gives TC = ATC

Q. So the total cost when 40 units are produced is $130 40,
which is $5,200 and total cost when 50 units are produced is $132
50, which is $6,600. So the marginal cost equals ($6,600 $5,200)
10, which equals $140.

14. ProPainters hires students at $250 a

week to paint houses. It leases
equipment at $500 a week. The table

Output
Labor

(houses

(students)

painted

sets out its total product schedule.

a. What is total cost, average total

per week)
1

cost, and marginal cost if

ProPainters paints 12 houses a week?

To paint 12 houses, ProPainters hires

12

4 students. The total variable cost is

14

$1,000 (paid to the students) and the

15

total fixed cost is $500 (the leased

equipment). Therefore the total cost is $1,500. The average total
cost equals $1,500/12, which is $125 per house. The marginal cost
of 10 houses is $83.33 and the marginal cost of 13 houses is $125.00.
These mean that the marginal cost of 12 houses is $108.33.

b. At what output is average total cost a minimum?

Using the data in the table, the average total cost is at its minimum
of $125 per house when 13 houses are painted.

c. Explain why the gap between total cost and total variable cost
is the same at all outputs.
The gap between total cost and total variable cost is total fixed
cost. Because the fixed cost is the same at all levels of output,
the difference between the total cost and total variable cost is
constant.

15. ProPainters hire students at $250 a week to paint houses. It

leases equipment at $500 a week. Suppose that ProPainters
doubles the number of students it hires and doubles the amount
of equipment that it leases. ProPainters experiences
diseconomies of scale.
a. Explain how the ATC curve with one unit of equipment differs
from that when ProPainters uses double the amount of
equipment.
Because ProPainters experiences diseconomies of scale, when
ProPainters doubles its inputs the minimum average cost is higher
than when it uses the lesser quantities of inputs. Even so, at
high levels of output the average total cost of producing the large
level of output with the greater quantities of inputs is lower
than the average total cost of producing this large level of output
with the smaller quantities of inputs.

b. Explain what might be the source of the diseconomies of scale

that ProPainters experience.
ProPainters might experience diseconomies of scale because when
it gets larger the complexity of operating the business increases,
which increases the costs of running the business and making
decisions.

16. The table shows the

production function
of Bonnies Balloon

Labor

Output

(workers

(rides per day)

per day)

Plant 1

Plant 2

Plant 3

Plant 4

10

13

15

Rides. Bonnies pays

10

$500 a day for each

20

10

15

18

20

30

13

18

22

24

40

15

20

24

26

50

16

21

25

27

Balloons

balloon it rents and

$25 a day for each
balloon operator it
hires.
a. Graph the ATC curve
for Plant 1 and Plant 2.

To find the average total cost for

each plant, at the different levels
of output add the variable cost,
which is the cost of the workers or
$25 per worker, to the fixed cost,
which is the cost of the balloons or
$500 per balloon. For Plant 1, the
total cost for 4 rides is $750; for
10 rides is $1,000; for 13 rides is
$1,250; for 15 rides is $1,500; and,
for 16 rides is $1,750. The average
total cost is calculated by dividing
the total cost by the quantity of
rides. These average total costs are plotted in Figure 11.18.

b. On your graph in a, plot the ATC curve for Plant 3 and Plant
4.
Figure 11.18 shows these ATC curves.

c. On Bonnies LRAC curve, what is the average cost of producing

18 rides and 15 rides a day?
The long-run average total cost curve is illustrated in Figure
11.18 as the darker line. The long-run average cost curve is
comprised of the segments of the different short-run average total
cost curves that have the minimum average total cost for the
different levels of output. For 15 rides a day the average cost
is $100 and for 18 rides a day the average cost is $97.22.

d. Explain how Bonnies uses its long-run average cost curve to

decide how many balloons to rent.
Bonnies will use its long-run average total cost curve by building
the size of the plant that minimizes its long-run average cost
at the number of balloon rides that Bonnies expects to produce.

17. A firm is producing at minimum average total cost with its

current plant. Sketch the firms short-run average total cost
curve and long-run average cost curve for each of the following
situations and explain, using the concepts of economies of
scale and diseconomies of scale, the circumstances in which
the firm
a. Can lower its average total cost by increasing its plant.

Figure 11.19 illustrates this case

at the point labeled A. Here the firm
experiences economies of scale, so
if it increases the size of its plant
and also all its other inputs by the
same proportion, its average total
cost can be lowered.

b. Can lower its average total cost by

decreasing its plant.
Figure 11.19 illustrates this case
at the point labeled B. Here the firm
experiences diseconomies of scale,
so if it decreases the size of its
plant and also all its other inputs by the same proportion, its
average total cost can be lowered.

c. Cannot lower its average total cost.

Figure 11.19 illustrates this case at the point labeled C. Here
the firm is already producing at the minimum of its long-run average
cost. In this case, the firms average cost increases no matter
if the firm increases or decreases the size of its plant and all
its other inputs.

18. Starbucks Unit Brews Up Self-Serve Espresso Bars

automated, self-serve espresso kiosks are in grocery
stores. The machines, which grind their own beans, crank out
lattes, and drip coffees take credit and debit cards, [and]
cash. Concordia Coffee, a small Bellevue coffee equipment
maker, builds the self-serve kiosks and sells them to Coinstar
for just under $40,000 per unit. Coinstar installs them and
provides maintenance. The kiosks use [Starbucks] Seattles
Best Coffee. The self-serve kiosks remove the labor costs
of having a barista. Store personnel handle refills of coffee
beans and milk.
MSNBC, June 1, 2008
a. What is Coinstars total fixed cost of operating one
self-serve kiosk?
The fixed costs are the cost of the machine itself, $40,000.

b. What are Coinstars variable costs of providing coffee at a

self-serve kiosk?
The variable costs include the cost of the coffee beans and other
ingredients and, presuming that the kiosks need more maintenance
the heavier their use, the cost of maintaining the kiosks.

c. Assume that a coffee machine operated by a barista costs less

than $40,000. Explain how the fixed costs, variable costs,
and total costs of barista-served and self-served coffee
differ.
The fixed cost of the Coinstar machine exceeds that of the
barista-operated machine. The variable cost of the
barista-operated machine exceeds that of the Coinstar machine.
The total cost of the Coinstar machine is probably higher than
that of the barista-operated machine at lower levels of output
and is probably lower at higher level of outputs.

d. Sketch the marginal cost and average cost curves implied by

your answer to c.
Figure 11.20 shows the different
marginal costs and average total
cost curves. The costs with the
barista-operated machine are
labeled 1 and the costs with the
Coinstar are labeled 2. The
average total cost of the Coinstar
machine is higher than that of the
barista-operated machine at low
levels of output and is lower than
the average total cost of the
barista-operated machine at high
levels of output. The marginal cost
of the Coinstar machine is lower than the marginal cost of the
barista-operated machine.

19. A Bakery on the Rise

Some 500 customers a day line up to buy Avalons breads, scones,
muffins, and coffee. Staffing and management are worries.
Avalon now employs 35 [and] it will hire 15 more. Payroll
will climb by 30% to 40%. As new CEO, Victor has quickly
executed an ambitious agenda that includes the move to a larger

space. Avalons costs will soar. Its monthly rent, for

example, will leap to $10,000, from $3,500.
CNN, March 24, 2008
a. Which of Avalons decisions described in the news clip is a
short-run decision and which is a long run decision.
Hiring the additional 15 workers is a short-run decision;
increasing the size of its space, that is, the size of its plant,
is a long-run decision.

b. Why is Avalons long-run decision riskier than its short run

decision?
Avalons long-run decision is riskier than its short-run decision
because it is more difficult to change the long-run decision. In
particular if Avalon decides to reverse its short-run decision
to hire more workers, it is straightforward to fire the workers.
However to reverse the long-run decision of increasing the size
of its plant is more difficult and takes much longer to do.

c. By how much will Avalons short-run decision increase its

total variable cost?
Avalons short-run decision to increase its workforce increases
its total variable cost (its payroll) by 30 percent to 40 percent.
The increase in workers boosts Avalons output and leads to a
movement along its total variable cost curve.

d. By how much will Avalons long-run decision increase monthly

total fixed cost?
Avalons long-run decision to increase the size of its plant (its
space) increases its total fixed cost by $6,500. Avalons TFC curve
shifts upward.

e. Draw a graph to illustrate Avalons short-run cost curves

before and after the events described in the news clip.
Figure 11.21 shows Avalons
short-run AVC and ATC curves before
and after. The old cost curves are
labeled with a 1 and the new cost
curves, after the expansion, are
labeled with a 2, At lower levels
of output Avalons new average cost
curves lie above its old average cost
curves and at higher levels of output

Avalons new average cost curves lie below its old average cost
curves. (In the figure the new minimum average total cost equals
the old minimum, so Avalon has constant returns to scale.)

20. Gap Will Focus on Smaller Scale Stores

Gap has too many stores that are 12,500 square feet deemed
too large. Stores are larger than we need. The target
size of stores should be 6,000 square feet to 10,000 square
feet. In addition, the company plans to combine previously
separate concept stores. Some Gap body, adult, maternity, baby
and kids stores will be combined in one, rather than in separate
spaces as they have been previously.
CNN, June 10, 2008
a. Thinking of a Gap store as a production plant, explain why
Gap is making a decision to reduce the size of their stores.
Gap believes that its stores are too large and that it is operating
where it has diseconomies of scale. By reducing the size of its
plant (its stores) Gap can slide down its LRAC curve and decrease
its average cost.

b. Is Gaps decision a long-run decision or a short-run decision?

Explain.
Gaps decision is a long-run decision because it involves the size
of the firms plant.

c. How might combining Gaps concept stores into one store help
better take advantage of economies of scale?
At 12,500 square feet Gaps stores were too large and Gap was
incurring diseconomies of scale. When Gap combines its separate
Gap concept stores into a smaller space, Gap will use fewer
resources, particularly less capital and less labor. Gaps costs
will be less as a result. Additionally Gaps sales will be less
but the proportionate decrease in cost will exceed the decrease
in Gaps production. In this case Gaps average costs will decrease
so that Gap can reap economies of scale it currently is not
enjoying.

21. The Sunk-Cost Fallacy

You have good tickets to a basketball game an hours drive away.
Theres a blizzard raging outside, and the game is being
televised. You can sit warm and safe at home by a roaring fire
and watch it on TV, or you can bundle up, dig out your car,

and go to the game. What do you do?

Slate, September 9, 2005
a. What type of cost is your expenditure on tickets?
At the time of the game, the cost of the ticket is a sunk cost.

b. Why is the cost of the ticket irrelevant to your current

decision about whether to stay at home or go to the game?
The cost of the ticket is a sunk cost; that is, the cost of the
ticket has already been incurred. Because the cost of the ticket
is the same regardless if you attend the game or stay at home,
the cost of the ticket is irrelevant to your decision whether to
attend or stay at home.

22. Study Reading Between the Lines on pp. 266-267 and then answer
the following questions.
a. Sketch the AFC, AVC, and ATC curves for electricity production
using seven technologies: (i) nuclear, (ii) coal, (iii) gas,
(iv) hydro (v) wind, (vi) SUNRGIs new solar system, and (vii)
todays solar technology.

C:\Users\user\A ppData\Local\Temp\Temp1_Park in_GE_9e_SM.zip\Micro\Figures\microCH11sm22iiiiii.tif

The figures above show the average cost curves. In Figure 11.27
the higher cost curves are for solar power; the lower cost curves
are for SUNRGIs new solar system.

b. Sketch the marginal cost curves for electricity production

using seven technologies: (i) nuclear, (ii) coal, (iii) gas,
(iv) hydro (v) wind, (vi) SUNRGIs new solar system, and (vii)
todays solar technology.
The figures above show the marginal cost curves.

c. Given the cost differences among the different methods of

generating electricity, why do you think we use more than one
method? If we could use only one method, which would it be?
The different methods have minimum average total costs at
different amounts of output. Hence depending on the level of output,
in different locales different methods of producing electricity
have the lowest cost. Additionally in one locale a coal plant,
for example, might provide of the electricity demanded when it
is producing at its minimum average total cost. But to produce
the remaining of the electricity with another coal plant might
have higher average total cost than if the quantity was produced
with a gas plant. Hence one locale might have several different
plants depending on the quantity of electricity demanded and the
plants minimum average total costs. Finally, the price of natural
gas, coal, oil, and nuclear fuel can vary tremendously over time.
By having different types of plants some protection is gained
against having a concentration in a type of plant whose costs
happened to soar. If we could use only one method, setting aside
the costs of storing used nuclear fuel, it appears that nuclear
plants generate electricity at the lowest average total cost.