Question

Indicate how each of the following would shift the (1) marginalcost 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

a) AFC, ATC down; MC, AVC no effect. b) MC, AVC, ATC up; AFC no effect. c) MC, AVC, ATC down; AFC no effect. d) AFC, ATC up; MC, AVC no effect. e) MC, AVC, ATC up; AFC no effect.

Step-by-step solution

Understanding Cost Curves

Before diving into the specific scenarios, let's understand what each cost curve represents. The marginal cost (MC) curve shows the cost of producing one more unit of output. The average variable cost (AVC) curve represents all variable expenses per unit. The average fixed cost (AFC) curve represents all fixed expenses per unit. The average total cost (ATC) curve is the sum of AFC and AVC, representing total cost per unit.

Scenario a: Reduction in Business Property Taxes

Business property taxes affect fixed costs because they are not dependent on the level of production. A reduction in these taxes decreases the average fixed cost (AFC), causing the AFC curve to shift downward. Since average total cost (ATC) includes average fixed costs, ATC also shifts downward. There is no effect on variable costs, so marginal cost (MC) and average variable cost (AVC) remain unchanged.

Scenario b: Increase in Nominal Wages of Production Workers

Wage increases impact variable costs because wages are typically tied to the level of production. An increase in wages raises the marginal cost (MC), shifting this curve upward, as the cost to produce each additional unit increases. It also raises the average variable cost (AVC), causing an upward shift. Consequently, the average total cost (ATC), which includes AVC, also shifts upward. The average fixed cost (AFC) is unaffected.

Scenario c: Decrease in the Price of Electricity

Electricity costs are variable, so decreasing the price of electricity lowers variable costs. Thus, the marginal cost (MC) decreases, shifting the curve downward, and the average variable cost (AVC) shifts downward as well. With lower variable costs, the average total cost (ATC) also shifts downward. The average fixed cost (AFC) is not affected by changes in electricity pricing.

Scenario d: Increase in Insurance Rates on Plant and Equipment

Insurance costs are typically considered fixed costs, so an increase raises the average fixed cost (AFC), causing this curve to shift upward. The average total cost (ATC), which includes AFC, also shifts upward. Marginal cost (MC) and average variable cost (AVC) remain unchanged, as they are not directly impacted by fixed cost changes.

Scenario e: Increase in Transportation Costs

Transportation costs are variable, impacting both marginal and average variable costs. An increase in transportation costs raises the marginal cost (MC), causing the curve to shift upward, as it costs more to produce and deliver each additional unit. Similarly, it raises the average variable cost (AVC), leading to an upward shift. The average total cost (ATC) also shifts upward because it includes AVC. Average fixed cost (AFC) remains unchanged.

Key concepts

Marginal Cost

Marginal cost (MC) is an important concept in economic analysis that focuses on the additional cost incurred when producing one more unit of a product. It's crucial because it directly affects production decisions, helping firms determine the optimal level of output. The MC curve is typically upward-sloping, reflecting increasing marginal costs as production expands.

Changes in marginal cost usually stem from variations in variable costs, such as raw materials or labor. For instance, if the cost of wages for production workers rises, each additional unit produced becomes more costly, shifting the marginal cost curve upward.

Conversely, if costs like electricity decrease, the cost to produce each extra unit drops, thus shifting the MC curve downward. Understanding these shifts helps firms make informed choices about pricing and output levels.

Average Variable Cost

Average variable cost (AVC) is the variable cost per unit of output produced. It captures the expenses that change with the level of production, such as labor or raw materials. The AVC curve generally has a U-shape due to initially decreasing costs with increased output, followed by rising costs as capacity limits are approached.

Any factors affecting variable costs will influence the AVC curve. For example, a reduction in electricity prices would lower the AVC, shifting the curve downward. This happens because production becomes cheaper, impacting the overall cost structure.

On the other hand, an increase in transportation costs signifies higher expenses per unit, thus shifting the AVC curve upward. The behavior of the AVC is closely linked to production efficiency and can be pivotal in cost management strategies.

Average Fixed Cost

Average fixed cost (AFC) is the fixed cost per unit of output. Fixed costs are those that do not change with the level of production, such as rent or insurance. The AFC curve slopes downward as output increases, reflecting the spreading of fixed costs over more units.

Changes in fixed costs will directly alter the AFC. For instance, a reduction in business property taxes reduces fixed costs, causing the AFC curve to shift downward. With lower fixed expenses, the cost per unit decreases, benefiting the firm's financial performance.

Alternatively, an increase in insurance rates would raise fixed costs, shifting the AFC curve upward. Firms must carefully manage fixed costs, as high fixed costs can become a burden during times of low production.

Average Total Cost

Average total cost (ATC) is the sum of average fixed cost (AFC) and average variable cost (AVC). It provides a comprehensive view of the cost per unit of output, combining both fixed and variable expenses. The ATC curve typically forms a U-shape because it reflects both the spreading effect of fixed costs and the impact of variable costs.

The ATC curve is sensitive to changes in both fixed and variable costs. For example, a drop in electricity prices (a variable cost) will lower the ATC, as both AVC and consequently ATC decrease. This results in a downward shift of the ATC curve.

Similarly, an increase in production worker wages will raise the AVC, and thus the ATC, causing an upward shift in the curve. Understanding ATC is crucial for pricing strategies and ensuring profitability in competitive markets.