Question

Assume a firm faces these costs: total cost of capital $4,000; price paid for labor = $20 per labor unit; and price paid for raw materials = $8 per raw-material unit.
a. If the firm can produce 2000 units of output by combining its fixed capital with 200 units of labor and 500 units of raw materials, then what are the total cost and average total cost of producing the 2,000 units of output?
b.The firm now improves its production process so that it can produce 3,000 units of output by combining its fixed capital with 100 units of labor and 500 units of raw materials. What are the total cost and average total cost of producing the 3,000 units of output?
c.Based on the data, what conclusion can you draw about the effect of process innovation on economic efficiency?

Answer 1

Answer:

A) total cost = (200 labor hours x $20) + (500 units of raw materials x $8) + $4,000 cost of capital = $12,000

average total cost per unit = $12,000 / 2,000 units = $6 per unit

B) new total cost = (100 labor hours x $20) + (500 units of raw materials x $8) + $4,000 cost of capital =  $2,000 + $4,000 + $4,000 = $10,000

average total cost per unit = $10,000 / 3,000 units = $3.33 per unit

C) When process innovation occurs, total productivity and efficiency increase, decreasing the average cost per unit. In this case the total cos decrease, but even if total costs do not decrease, higher efficiency and productivity can be achieved by production more units at the same total costs. Process innovations, usually related to new technologies, are responsible for the greatest increases in productivity and efficiency which result in higher economic output and growth.