Suppose you run a bakery in Omaha. Business is good, you always run out of bread each day (assume you have no market power – that is, your supply has no influence on price). You’ve thrown more labor at the problem, but at this point they are getting in the way. You and your business partners are trying to decide how to meet demand. You have a number of options: the space next to you has been abandoned (and you can knock down the wall between the two spaces) as well as the space across the street. The space across the street is less expensive.
1. Using a production function you learned in class, explain why ‘throwing more labor the problem’ isn’t working?
2. Connecting to (1), how does this relate to marginal cost (solve for marginal cost using the production function you have chosen)?
3. Now, considering expansion decision, what must you need to know to determine the answer to this question. Given the production function you chose in (1), what is the right decision (if you are using a general form, under what condition is expanding to the space next door the right decision)? Explain by determining the total cost equation.