3. Assume a firm faces these costs: total cost of capital $4,000; price paid for

Question

3. 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?

Explanation / Answer

Cost of Capital = $4000

Price paid for labor = $20 per labor

Price paid for raw materials = $8 per raw material unit

a. Production of 2000 units of output

Labor expense = 200*20 = $4000

Expense for raw materials = 500*8 = $4000

Capital cost =   $4000

Total cost = $12000

Average cost of producing 2000 units = $(12000/2000) = $6

b. Production of 3000 units with improve in production process

Capita cost = $4000

Labor cost = 100*20 = $2000

Raw materials cost = 500*8 = $4000

Total cost = $10000

Average cost of producing 3000 units = $(10000/3000) = $3.33

c. With the improve in production procedure, more output can be drawn from the same raw materials input and even with less labor factors. Improvement or innovation in production technology requires less labor for the production purpose. This brings down the total and average cost of producing to a very lower level than before with more production units. Which will significantly effect the average cost of production with economic efficiency to the company.

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