Production and Costs worksheet

Production and Costs: answer key

1. 1. (B) Each additional worker still adds to output -- just less than the previous one did. Total product keeps climbing, it just climbs more slowly. Option A mixes up diminishing returns with negative returns, which is the more extreme case where MP actually drops below zero. Option C has the direction wrong since total cost rises as you produce more. Option D is backward because AFC always falls -- a fixed dollar amount divided by more units can only get smaller.

2. 2. (B) When MC is below ATC, each new unit is cheaper than the current average, so ATC falls. Once MC rises above ATC, each new unit costs more than average, pushing ATC up. The crossover happens right at ATC's minimum -- same logic as your GPA being pulled up or down by this semester's grades. Option A doesn't really apply to a U-shaped curve in any meaningful way. Option C occurs only at zero variable cost, which isn't a useful production point. Option D confuses where MC bottoms out with where MC crosses ATC; MC reaches its minimum at a lower quantity and then climbs up to eventually pass through ATC's minimum.

3. 3. (D) When price drops below AVC, each unit sold fails to cover even the wages and materials that went into making it. Producing actively makes losses worse compared to just shutting down and paying fixed costs with zero revenue coming in. Price below ATC does mean losses, sure -- but the firm should still operate as long as revenue covers variable costs and partially offsets fixed costs. AFC isn't a meaningful threshold for shutdown decisions. MC tells you how much to produce, not whether to produce at all.

4. 4. (C) AFC = TFC / Q. Take a constant $1,000 and divide it by 10 units -- that's $100 per unit. Divide it by 100 units and AFC drops to $10. It never stops falling; it just approaches zero without ever reaching it. Option A would require fixed costs themselves to increase, which contradicts the definition of fixed. Option B confuses total fixed cost (which is constant) with average fixed cost (which declines as output rises). Option D describes a U-shaped curve like ATC or AVC, but AFC doesn't have that shape.

5. 5. (B) Economies of scale are strictly a long-run concept about what happens when a firm scales up its entire operation -- bigger plant, more equipment, the works. LRATC falls because of things like bulk purchasing, deeper specialization, and spreading R&D over millions of units. Falling MC is a short-run pattern tied to increasing marginal returns, which can happen without any change to the firm's overall size. Short-run ATC at its minimum just means the firm is producing efficiently at its current plant size. TC below TR means the firm is profitable, which is a completely different question.

6. 6. (C) MP and MC move in opposite directions. If worker 5 produces 20 units and worker 6 produces 25, each wage dollar is yielding more output -- so the cost per additional unit of output is falling. Option A flips the relationship backward. Option B would require each successive worker to add exactly the same output, which doesn't match increasing MP. Option D would mean additional units are free, which doesn't happen in any real production setting.

7. 7. (B) Since ATC = AVC + AFC, the still-declining AFC keeps dragging ATC downward even after AVC has started to rise. ATC doesn't bottom out until the upward pull from rising AVC finally overwhelms the downward pull from declining AFC. Option A is a true statement but doesn't explain why their minimums occur at different quantities. Option C describes the consequence (MC hits AVC first) rather than the underlying reason. Option D contradicts what fixed costs are -- they don't change with output by definition.

8. 8. (C) A competitive firm sets output where P = MC, but it only produces when price covers variable costs. Below minimum AVC the firm shuts down entirely. Above it, the firm traces along its MC curve. So the supply curve is the portion of MC at or above minimum AVC. Option A includes the region below AVC where the firm wouldn't operate -- that's the most common wrong answer on this type of question. Options B and D reference the wrong curves altogether.

9. 9. (B) MC ($30) exceeds ATC ($25), so producing that 101st unit pulls the average up. You can verify: new TC = ($25 x 100 + $30) = $2,530. New ATC = $2,530 / 101 = $25.05. It went up. Option A is partially true -- spreading fixed costs does lower AFC -- but the $30 MC exceeding the $25 ATC is the dominant force here. Option C is wrong because every single additional unit affects the average; one unit can absolutely change it. Option D has the direction completely backward.

10. 10. (C) All inputs doubled and output more than doubled, which means LRATC is falling. That's economies of scale -- bulk purchasing, deeper specialization, and spreading large upfront investments across more units. Diminishing marginal returns is a short-run concept about adding one variable input to fixed inputs; here all inputs changed proportionally. Diseconomies of scale would mean output less than doubles. Constant returns would mean output exactly doubles.

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