Theory question 101
Theory of Costs and RevenueThe output and cost of production of rice (in bags) are presented in the table below. Use the information in the table to answer the questions that follow:
Output of rice (in bags) | 0 | 1 | 2 | 3 | 4
Total Variable Cost (TVC) $ | 0 | 5 | 7 | 10 | 20
Total Cost (TC) $ | 7 | 12 | 14 | 17 | 27
(a) Calculate the (i) Average Fixed Cost (AFC) at output levels 0, 2 and 4. (ii) Marginal Cost (MC) at all levels of output.
(b) If the price of a bag of rice were $10, (i) calculate the profit/loss at all levels of output. (ii) at what output level(s) is the maximum profit made?
(c) Draw the marginal cost curve (the use of graph sheet is essential).
Show the model answer
(a)(i) Fixed cost = TC − TVC = $7. AFC = 7/Q: at 0, 7/0 is undefined (infinitely large); at 2, $3.50; at 4, $1.75.
(ii) MC = TCn − TCn−1: 1st bag $5; 2nd $2; 3rd $3; 4th $10.
(b)(i) Profit = TR − TC: 0 bags: 0 − 7 = −$7 (loss); 1: 10 − 12 = −$2; 2: 20 − 14 = $6; 3: 30 − 17 = $13; 4: 40 − 27 = $13.
(ii) Maximum profit of $13 at 3 and 4 bags (the 4th bag has MC = $10 = price, adding nothing to profit).
(c) Output on the horizontal axis, cost on the vertical axis; plot MC 5, 2, 3, 10 against outputs 1–4 (at mid-points or at each output) and join: a curve that falls then rises; label MC.
Fixed cost is TC at zero output; profit is greatest where MC = price.