67 Dalned to Soved Probiem 11.6 on poge 361 Suppone that Il Johnson has to choos
ID: 1166355 • Letter: 6
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67 Dalned to Soved Probiem 11.6 on poge 361 Suppone that Il Johnson has to choose between building a maller restaurant and larger restaurant In the following graph, the relationship between costs and output for the smaler restaurant is represented by the carve ATC, and the rela- tlonship between costs and output for the larger restaurant is represented by the curve ATC Average ATC total cost (dollars per plzza ATC o 5,000 5,200 5,500 7,500 Quantity (pizzas per week a. If Jill expects to produce 5,100 pizzas per week, should she build a smaller restaurant or a larger restaurant? Briefly explain. b. If Ji Il expects to produce 6,000 pizzas per week, should she build a smaller restaurant or a larger restaurant? Briefly explain c. A student asks, "If the average cost of producing piz-zas is lower in the larger restaurant when Jill produces 7,500 pizzas per week, why isn't it also lower when Jill produces 5,200 pizzas per week?" Give a brief answer to the student's questionExplanation / Answer
(a) If Jill expects to produce 5100 pizzas per week, then she should build a smaller restaurant. The reason is, if Jill is supposed to be producing anywhere below 5500 units, the average cost of production is lower in ATC1 (smaller restaurant) than in ATC2 (larger restaurant).
(b) If Jill expects to produce 6000 pizzas per week, then she should build a larger restaurant. The reason is (analogous to part-a), if Jill is supposed to be producing anywhere greater than 5500 units, the average cost of production is lower in ATC2 (larger restaurant) than in ATC1 (smaller restaurant).
(c) It can be said that in a larger restaurant, the increasing returns to scale works. The increasing returns to scale takes place as the production expands and the scale of production is supposed to be increased, in terms of machines, building, and other infrastructures as well. But, with the same increase in returns to scale, the overall cost of prodcution also increases in terms of increase in fixed cost. The decreasing average cost attributes to the average fixed cost (AFC) of the production, which offsets the increasing average variable cost (AVC), the extent where the average cost reaches its minimum. Now, as the AFC can no more offset the AVC, the incerasing AVC increases the average cost. That is why, in a larger restaurant, the AFC offsets the AVC slowly, as the fixed cost is more, while the AFC offsets the AVC more quickly, as the fixed cost is less in the smaller restaurant. Hence, the lower average cost in smaller restaurant before 5500 units would decrease Jill's cost more if she build smaller restaurant, and the lower average cost in larger restaurant after 5500 units would decrease Jill's cost more if she builds a larger restaurant. And that is why, it would be wiser to produce 5200 pizzas in a smaller restaurant, while it would be wiser to produce 7500 pizzas in a larger restaurant.
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