Question

Refer to Figure 1.3. Suppose that the cost of cheese falls so that the marginal cost of producing pizza decreases. Will the MC curve shift up or down? Will the optimal amount of pizza increase or decrease? Explain.

Short answer

Yes, the marginal cost curve for pizza will shift down.

The optimal amount of pizza will increase.

Step-by-step solution

Shift in the marginal cost curve

As the cost of cheese falls, the cost of pizza will also decline because cheese is an ingredient for pizza. The marginal cost, which is a derivative of the total cost, will also decline according to the total cost.

$$\begin{gathered} MC=\frac{dC}{dQ} \\ M{C}^{*}=\frac{d{C}^{*}}{dQ} \end{gathered}$$

Here, C* is the declined total cost, and MC* is the declined marginal cost.

Optimal amount of pizza

As the marginal cost curve (MC) shifts down, the equilibrium point also shifts down along the marginal benefit (MB) curve. So, the optimal amount of pizza will increase.

Initially, the optimal pizza produced was 20,000 at equilibrium point e, where the marginal benefit (MB) was equal to the marginal cost (MC). Now, the marginal cost has declined, with the marginal benefit being constant. Suppose the new marginal cost curve is MC*.

The new marginal cost (MC*) is equal to the marginal benefit at the new equilibrium point e*. The optimal amount of pizza produced at this point will be 20,000 + Q*.