In each case specify the direction of the shift.
a. A reduction in business property taxes
b. An increase in the nominal wages of production workers
c. A decrease in the price of electricity
d. An increase in insurance rates on plant and equipment
e. An increase in transportation costs
Answer (2)
A reduction in business property taxes decreases AFC and ATC.
An increase in nominal wages of production workers increases MC, AVC, and ATC.
A decrease in the price of electricity decreases MC, AVC, and ATC.
An increase in insurance rates on plant and equipment increases AFC and ATC.
An increase in transportation costs increases MC, AVC, and ATC.
Explanation
Problem Analysis We are asked to determine how various changes in costs affect a firm's cost curves: Marginal Cost (MC), Average Variable Cost (AVC), Average Fixed Cost (AFC), and Average Total Cost (ATC). We will analyze each scenario individually.
Reduction in Property Taxes a. A reduction in business property taxes:
Property taxes are a fixed cost. A reduction in fixed costs will decrease Average Fixed Cost (AFC) and Average Total Cost (ATC). Marginal Cost (MC) and Average Variable Cost (AVC) are not affected by fixed costs.
AFC: Decreases
ATC: Decreases
MC: No change
AVC: No change
Increase in Wages b. An increase in the nominal wages of production workers:
Wages of production workers are a variable cost. An increase in variable costs will increase Marginal Cost (MC), Average Variable Cost (AVC), and Average Total Cost (ATC). Average Fixed Cost (AFC) is not affected by variable costs.
MC: Increases
AVC: Increases
ATC: Increases
AFC: No change
Decrease in Electricity Price c. A decrease in the price of electricity:
The price of electricity is a variable cost. A decrease in variable costs will decrease Marginal Cost (MC), Average Variable Cost (AVC), and Average Total Cost (ATC). Average Fixed Cost (AFC) is not affected by variable costs.
MC: Decreases
AVC: Decreases
ATC: Decreases
AFC: No change
Increase in Insurance Rates d. An increase in insurance rates on plant and equipment:
Insurance rates on plant and equipment are a fixed cost. An increase in fixed costs will increase Average Fixed Cost (AFC) and Average Total Cost (ATC). Marginal Cost (MC) and Average Variable Cost (AVC) are not affected by fixed costs.
AFC: Increases
ATC: Increases
MC: No change
AVC: No change
Increase in Transportation Costs e. An increase in transportation costs:
Transportation costs are a variable cost. An increase in variable costs will increase Marginal Cost (MC), Average Variable Cost (AVC), and Average Total Cost (ATC). Average Fixed Cost (AFC) is not affected by variable costs.
MC: Increases
AVC: Increases
ATC: Increases
AFC: No change
Examples
Understanding how different costs affect a business is crucial for making informed decisions. For example, if a company knows that property taxes are going to decrease, they can anticipate a reduction in their average fixed costs and average total costs. This could lead them to lower prices, increase production, or invest in other areas of the business. Similarly, if wages are expected to rise, the company can prepare for an increase in marginal cost, average variable cost, and average total cost, and adjust their strategies accordingly to maintain profitability.
Each situation affects cost curves differently based on whether the costs are fixed or variable. A reduction in fixed costs decreases certain averages, while increases in variable costs raise those averages. Understanding these shifts helps businesses make informed financial decisions.
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