Question

Indicate how each of the following would shift the (1) marginal-cost curve, (2) average-variable-cost curve, (3) average-fixed-cost curve, and (4) average-total-cost curve of a manufacturing firm. In each case specify the direction of the shift. a. \(A\) reduction in business property taxes. b. An increase in the nominal wages of production workers. c. A decrease in the price of electricity. d. An increase in insurance rates on plant and equipment. e. An increase in transportation costs.

Short answer

- Reduction in business property taxes shifts AFC and ATC downward. - Wage increases shift MC, AVC, and ATC upward. - Lower electricity prices shift MC, AVC, and ATC downward. - Higher insurance rates shift AFC and ATC upward. - Higher transportation costs shift MC, AVC, and ATC upward.

Step-by-step solution

Analyzing the Impact of Business Property Taxes

A reduction in business property taxes affects fixed costs. Fixed costs do not influence the marginal cost (MC) or average variable cost (AVC), so both curves remain unchanged. However, lower fixed costs mean that the average fixed cost (AFC) curve and the average total cost (ATC) curve, which includes fixed costs, will shift downward.

Assessing Wage Increases

An increase in nominal wages of production workers directly impacts variable costs, as wages are part of these costs. This causes the marginal cost (MC) and average variable cost (AVC) curves to shift upward. The increase in variable costs also raises the average total cost (ATC) curve. The average fixed cost (AFC) remains unchanged.

Evaluating Decrease in Electricity Prices

A decrease in electricity prices reduces variable costs. This will shift the marginal cost (MC) and average variable cost (AVC) curves downward, leading to lowered production costs. Since fixed costs are unaffected, the average fixed cost (AFC) curve remains the same, but the average total cost (ATC) curve moves downward due to the reduction in variable costs.

Impact of Higher Insurance Rates

An increase in insurance rates affects fixed costs. This does not affect the marginal cost (MC) or the average variable cost (AVC). However, the average fixed cost (AFC) and the average total cost (ATC) curves will both shift upward as a result of higher fixed costs.

Considering Higher Transportation Costs

An increase in transportation costs is an addition to variable costs. This results in an upward shift in the marginal cost (MC) and average variable cost (AVC) curves. Higher transportation costs increase total production costs, causing the average total cost (ATC) curve to shift upward, while the average fixed cost (AFC) remains constant.

Key concepts

Marginal Cost

Marginal cost is the cost of producing one additional unit of output. It’s crucial for understanding how production cost changes with varying activity levels.
In economics, marginal cost includes both variable and fixed components; however, it reflects only the variable cost component in the short run. If variable costs rise, such as an increase in wages or transportation costs, the marginal cost will go up, causing the marginal cost curve to shift upward.
Conversely, if there is a reduction in variable costs, such as a decrease in electricity prices, the marginal cost decreases, and the curve will shift downward. Fixed costs, on the other hand, don't directly affect the marginal cost, so changes in business property taxes or insurance rates don't shift this curve.

Average Variable Cost

Average variable cost (AVC) is calculated by dividing the total variable costs by the quantity of output. This metric is important for assessing how cost-efficient a business is at different levels of production.
When something like wages for production workers increases, the entire AVC curve shifts upward due to higher expenses per unit of output.
Similarly, an increase in transportation costs represents higher variable costs and shifts the AVC curve upward. However, if there are cost savings, such as through cheaper electricity, the curve will shift downward, showing reduced per-unit variable costs.
Like the marginal cost, fixed costs, including changes in taxes or insurance, do not influence the AVC.

Average Fixed Cost

Average fixed cost (AFC) is derived by dividing total fixed costs by the quantity of output. This cost per unit diminishes as production increases due to spreading the fixed costs over more units.
Alterations in fixed costs impact the AFC curve directly. For example, a reduction in business property taxes or an increase in insurance rates will cause the AFC curve to shift accordingly. Reduced fixed costs shift the curve downward, making it more cost-effective at all production levels, while increased fixed costs shift it upward.
It’s important to note that fixed costs do not change with levels of output, so they don’t influence the marginal or average variable costs.

Average Total Cost

Average total cost (ATC) is the sum of average fixed and average variable costs. It's divided by the quantity of output produced and provides a complete picture of the cost to produce each unit.
Increases in variable costs, such as higher wages or transportation costs, raise the ATC, leading the curve to shift upward. Reductions in variable costs, like cheaper electricity, result in the ATC curve shifting downward.
Fixed costs also influence the ATC. A decrease in business property taxes will lower the ATC curve, reflecting cost savings, whereas an increase in insurance rates will push it higher.
Understanding these interactions helps businesses strategize to minimize costs and maximize efficiency.