A firm finds that at an output level of 7 units, its total cost is $1834; at 8 u

Question

A firm finds that at an output level of 7 units, its total cost is $1834; at 8 units of output, its cost is $2048.

a. measuring eocnomies of scale calculate the value of S for this firm at 8 units of output

b. Are there economies of scale at 8 units of output? Explain your reasoning.

c. Explain what the value of S tells you about the relationship between increasing output and increasing costs for this firm. Be as specific as possible in your answer.

Course: Industrial Organization Theroy by Waldman

Explanation / Answer

At 7 units of output, total cost is $1834

and at 8 units of output, total cost is $2048.

Thus marginal Cost = difference in total cost / difference in output level = 2048-1834 / 8-7 = $214.

It means by increasing one more unit of production total cost increases by $214.

a) Economies of scale refers that if a firm increases its level of production and produces more output, then its average cost gets reduced over all. Here at 7 units average cost = 1834/7 = $262

and at 8 units average cost = 2048/8 = $256

thus Average cost reduces with increase in output by 262-256 = $6 that is value of S.

b) Yes there exists economies of scale because increasing production gives lesser average cost than before.

c) The value of S tells that as the firm increases its production, with each unit increment in production, average cost will reduce by $6 to some point of production. To which the marginal costs will be decreasing with successive addition in output to some point. Thus total cost will be increasing at decreasing rate with increase in output to some point of production.

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