# Cost and production analysis Essay

S2210 (Microeconomics)

On Line Problem Assignment Sheet Chapter 20 Production Costs                                         Gary Hawkins

INTRODUCTION:

I have been using the “Widget Exercise” as a teaching aid in my traditional classes for several sessions. Although we will not have the ability to share in the class collaboration of this exercise, I believe it can still be beneficial for on-line students as a teaching aid to better understand production costs.

THE EXERCISE:

The goal of this exercise is to build widgets and understand how various types of production costs vary as our classroom Widget Manufacturing Co. produces incrementally additional output of widgets. A widget is a piece of paper, folded vertically, then folded horizontally and stapled in the upper left hand corner. In class, I begin by placing a stapler and a large stack of paper on a table. This initial “round” is referred to on the attached spreadsheet as Round 0. I then ask a student to be a timer for the game. Each round of production is limited to 45 seconds. We then begin Round 1 by asking a student to build widgets. At the end of the 45 seconds of production, the widgets are counted and entered in the spreadsheet under the

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column Total Product. We continue the exercise by adding additional students for each 45 second production rounds. After each round, we record the Total Product, or the number of widgets our production company produced. We continue the game until nine production workers (students) have been added to the process.

ASSUMPTIONS:

Here are our assumptions for the game:

1.  Our production process is in the economic short run.

2.  Fixed costs are the stapler.

3. Variable costs include: paper, staplers, and labor.

4. We do not count scrap or non completed widgets in our production counts.

ON-LINE ASSIGNMENT:

To successfully complete this assignment, you will need to familiarize yourself with the various actual costs we have assigned each cost element. (These can be found under the assumptions on the Widget Spreadsheet). Review the meaning of the economic term short run, and all the specific costs definitions used in the spreadsheet. When you have completed your review, prepare answers to the following questions. Prepare your answers on the corresponding assignment sheet.

Question 1: Why does the total product of widgets decline as we add more students. What economic law does this demonstrate?

Question 2: What is the definition of marginal product? Why does marginal product increase from 0 to 8 widgets, then decline from 8 to -4? What economic law does this demonstrate?

Question 3: Why do fixed costs constantly remain at \$10 for all nine rounds of production?

Question 4: AFC (Average fixed costs) are \$5.00 in Round 1 and \$.83 in Round 9. Why?

Question 5: ATC (Average total costs) are \$7.65 in Round 1. ATC declines until Round 7. Why did the costs decline and why did the costs begin to increase in Rounds 7, 8, and 9?

S2210 (Microeconomics)

On Line Problem Assignment Sheet Chapter 20 Production Costs                                         Gary Hawkins

1.       It demonstrates the law of diminishing marginal returns which states that as we employ more and more labor    (students in our case), the marginal productivity decreases. In extreme cases, the marginal productivity becomes negative which causes the total product to decline.

The law of diminishing marginal returns is demonstrated here.

2.      The marginal product refers to the extra output produced by one more unit of an input (labor represented by students in our case).

When marginal product increases from 0 to 8 widgets, the law of increasing marginal returns is demonstrated. It happens because of the scope for specialization and division of labor.

However, there comes a point when increasing the number of labor units will cause the total product to decline or we have negative marginal product. The law of diminishing marginal returns is demonstrated here. It happens because of overcrowding.

3.      Fixed costs are one time costs and do not change when we increase or decrease labor. They are independent of the activities and do not depend on production.

4.      The average fixed costs are the total costs divided by the total product. In other words, it is the distribution of the fixed costs among the number of units produced. Average fixed costs are inversely proportional to the total product.

The total fixed costs remain \$10 irrespective of the number of units produced or the production round.

However, as the production increases, the average fixed costs decrease as the total fixed costs get distributed over a large number of units produced.

In the first round, average fixed costs= (total fixed costs)/(total product) = \$10/2 = \$5

Round 9, average fixed costs= \$10/12 =  \$0.83

5.      Average total costs are the summation of average variable costs and average fixed costs.

ATC= AVC +ATC = {(TVC + TFC)/TP}

Till round 7, the total product was increasing, which caused the average variable costs and average fixed costs to decline and thus, average total costs to decline.

However, after round 7, the total product begins to decline, which cause the average variable costs and average fixed costs to increase and thus, the average total costs to increase.

it simply means that after round 7, the total product begins to decline because of negative marginal product. Thus, the average costs were bound to increase.

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