Question

Is Jill Johnson correct when she states the following: "I am currently producing 20,000 pizzas per month at a total cost of \(\$ 75,000\). If I produce 20,001 pizzas, my total cost will rise to \(\$ 75,002\). Therefore, my marginal cost of producing pizzas must be increasing." Draw a graph to illustrate your answer.

Short answer

No, Jill Johnson is incorrect. The marginal cost of producing pizzas in her case is not increasing, but remains constant at \$2 per additional pizza.

Step-by-step solution

Define Marginal Cost

The first step is to define the concept of Marginal Cost. Essentially, Marginal Cost (MC) refers to the increase in cost that results from producing one additional unit of a product.

Calculate Marginal Cost

Next, apply this definition to Jill's case. The cost of producing 20,000 pizzas is \$75,000, while the cost of producing 20,001 pizzas is \$75,002. The additional cost to produce one more pizza (marginal cost) is therefore \$75,002 - \$75,000 = \$2.

Assess the Statement

With a calculated MC of \$2 per additional pizza, that would contradict Jill’s statement that the marginal cost of production is increasing. The marginal cost remains constant with each additional pizza at \$2 per pizza.

Draw the Graph

On the y-axis, plot the Marginal Cost (MC) and on the x-axis, plot the Quantity (Q). As the MC is constant at \$2, draw a horizontal line at this level that corresponds with the quantities ranging from 20,000 to 20,001 pizzas. This would show that the MC is not increasing as Jill claimed, but is constant.

Key concepts

Economic Principles

Understanding economic principles is crucial when analyzing decisions in the business world, as it involves how choices are made with limited resources. When Jill Johnson considers the production of additional pizzas, she is looking at how the allocation of her resources affects the cost and her profit margin.

In economic terms, we turn to concepts like marginal cost to help determine the efficiency and potential profitability of producing one more unit – in this case, a pizza. Economists look at marginal cost as a guiding principle for several key decisions, such as setting the optimal level of production and pricing. If the marginal cost is lower than the price at which the product can be sold, it indicates that increasing production could be beneficial up to the point where marginal cost begins to rise significantly.

Cost Analysis

Cost analysis is an essential tool for businesses to understand the financial implications of their production strategies. It involves breaking down the total costs into fixed and variable components and examining how these costs behave as production levels change.

When Jill evaluates her pizza production cost, it's important to distinguish between the costs that stay the same regardless of the number of pizzas made (fixed costs) and costs that vary with production quantity (variable costs). The marginal cost calculation is a form of cost analysis that exclusively zeroes in on the variable costs associated with producing one more unit. Since Jill’s incremental increase is constant at $2, the analysis suggests that, at least between 20,000 and 20,001 pizzas, the variable costs are stable, and she is likely not encountering economies or diseconomies of scale.

Production Costs

Production costs are the cumulative expenses incurred from creating a product or service. They include direct materials, direct labor, and overhead. For Jill’s pizza business, direct materials would be the ingredients for the pizza, direct labor the kitchen staff's wages, and overhead might include utilities and rent for the pizza kitchen.

Understanding how these costs behave as production volume changes is crucial. In Jill's case, the minimal difference between producing 20,000 and 20,001 pizzas indicates that her production costs are subject to constant returns to scale in this range, meaning the cost per pizza remains unchanged. For her business to thrive, it’s important she maintains a close eye on these production costs, seeking ways to optimize and potentially reduce them, while ensuring that the quality of her pizzas remains consistent.