microeconomics book solution 12

# microeconomics book solution 12 -...

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Solution Behind the Supply Curve: Inputs and Costs 1. Changes in the prices of key commodities can have a significant impact on a compa- ny’s bottom line. According to a September 27, 2007, article in the Wall Street Journal, “Now, with oil, gas and electricity prices soaring, companies are beginning to realize that saving energy can translate into dramatically lower costs.” Another Wall Street Journal article, dated September 9, 2007, states, “Higher grain prices are taking an increasing financial toll.” Energy is an input into virtually all types of production; corn is an input into the production of beef, chicken, high-fructose corn syrup, and ethanol (the gasoline substitute fuel). a. Explain how the cost of energy can be both a fixed cost and a variable cost for a company. b. Suppose energy is a fixed cost and energy prices rise. What happens to the compa- ny’s average total cost curve? What happens to its marginal cost curve? Illustrate your answer with a diagram. c. Explain why the cost of corn is a variable cost but not a fixed cost for an ethanol producer. d. When the cost of corn goes up, what happens to the average total cost curve of an ethanol producer? What happens to its marginal cost curve? Illustrate your answer with a diagram. 1. a. Energy required to keep a company operating regardless of how much output is produced represents a fixed cost, such as the energy costs of operating office buildings, factories, and stores that must be maintained independent of the amount of output produced. In addition, energy is a variable cost because produc- ing more output almost always requires using more energy. b. When fixed costs increase, so will average total costs. The average total cost curve will shift upward. In panel (a) of the accompanying diagram, this is illustrated by the movement of the average total cost curve from its initial position, ATC 1 , to its new position, ATC 2 . The marginal cost curve is not affected if the variable costs do not change. So the marginal cost curve remains at its initial position, MC. Cost of unit Cost of unit Quantity Quantity MC MC 2 MC 1 ATC 2 ATC 2 ATC 1 ATC 1 (b) A Rise in the Price of Corn (a) A Rise in the Price of Energy S-171 12 chapter: S171-S184_Krugman2e_PS_Ch12.qxp 9/16/08 9:22 PM Page S-171

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Solution c. Since corn is an input into the production of ethanol, producing a larger quantity of ethanol requires a larger quantity of corn, making corn a variable cost. d. When variable costs increase, so do average total costs and marginal costs. Both curves will shift upward. In panel (b) of the accompanying diagram, the move- ment of the average total cost curve is illustrated by the shift from its initial posi- tion, ATC 1 to its new position, ATC 2 . The movement of the marginal cost curve is illustrated by the shift from its initial position, MC 1 , to its new position, MC 2 .
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