Classroom Expernomics: Volume 10 (Fall 2001)

A Production and Cost Experiment for Use in the Principles of Microeconomics

Paul M. Mason
Department of Economics
University of North Florida


Abstract

This paper presents a new, hands-on production and cost experiment that instructors can use in principles of microeconomics to introduce the fundamental concepts of revenues, production, and costs. The experiment provides an opportunity for the students to become directly involved in a production process (with incentives to maximize profits), and then facilitates the derivation of the production function and all of the standard short-run cost relationships based on data that the class generated. Students assimilate the theory more rapidly and comprehensively this way, allowing the instructor to cover these issues more effectively in preparation for their application in the market models. However, careful construction can also provide empirical exposure to quality control, innovations in production, specialization of labor, just-in-time delivery, etc. Several microeconomics experiments have been presented by others to explain supply and demand, collusion, scarcity, and monopoly behavior. This paper introduces a comprehensive new experiment to identify cost curves and production concepts similar to others available on this site and elsewhere, but more extensive in its coverage and flexibility.

Introduction

Experimental techniques can improve both attention and performance in almost all classes and particularly principles of economics classes. In addition, such innovative, interesting techniques can enhance the recruitment of economics majors both to sustain our discipline, and to increase the analytical skills of college students.

This paper seeks to add to the discipline's list of experimental techniques by delineating a production and cost experiment that has proved extremely successful in my classes.[1] As an interesting aside, I first developed and used the experiment without knowledge of similar procedures developed by Neral (1993) and Bergstrom and Miller (1997 & 2000). Naturally, the reader will have to form his/her own opinion, but I believe that my experiment is superior to those mentioned for several reasons. This exercise involves more inputs and produces more complex outputs. Consequently, student effort is more substantial in planning strategies regarding the production rounds, in completing the production tasks, and calculating the outcomes of the experiment. In addition, the greater complexity is more likely to produce the expected production and cost relationships (i.e., cost curves with the right shapes, production functions exhibiting diminishing returns). The group structure allows for management decision making, analysis of the most efficient labor and capital resources, corporate espionage, and a more competitive atmosphere. It is also valuable that the experiment can be used to lead into long run costs, and perfect competition.

The students who participated in the experiment discussed here, as well as during the other eight semesters the experiment has been employed clearly enjoyed the endeavor and learned the material quite effectively. The remainder of this paper outlines the experiment and its results, with the intent of providing sufficient detail and support materials so that other economics professors at a variety of levels can replicate it in their classrooms. Attached as an appendix to this paper are an instruction sheet for professors and a preliminary handout for students that can be provided either at the start of the experiment class period, or at the end of the previous class.

Popsicle Sticks, Inc.

The primary goal of this experiment is to introduce students to the production function and the various total, average, and marginal cost relationships that are normally derived after discussing consumer behavior, but before the presentation of market models. As all authors dating back to Chamberlin (1948) imply, the lecture material regarding the topic should follow the experiment, so that the students see that the expected outcomes occur even without any prior knowledge of what theory implies. As an outgrowth of the results of the experiment, the theory flows more effectively both by interrelating production and cost concepts, and by defining those terms.

Specifically, the experiment entails the creation of manufacturing units (given that 45 students who attended the day the experiment was conducted, five firms were created) to produce squares using popsicle sticks and double-sided sticky tabs.[2] Each four-stick square represents a unit of output that can be sold in the marketplace for $2. The use of a constant price, and specifying that all units can be sold at that market price, is a precursor of perfect competition—the next topic in the standard progression of the course.

The students are instructed that each member of the group that generates the largest profits from the endeavor will receive two extra points on their final exam grade as compensation.[3] This was meant to be an effective way to motivate the students to maximize their efficiency, to act competitively, and to maximize profits, which is exactly what happened.

The experiment was designed to contain 5 construction rounds with a discussion period of 15 minutes prior to the first round and approximately five minutes prior to each subsequent round. Initially only one member of each group actually produced the squares. Then, two, three, four and finally all of the group members could participate in the production process, although increasing numbers of production personnel were not required. Naturally, all members of the group participate in each round of discussion. Each round was three minutes long. As a result, the production portion of the experiment fits into a 50 minute class period.

The materials involved in the square construction were the sticks, the tabs, scissors (to cut the tabs), the workers, and desks on which to do the work. Consequently, there were 3 types of variable costs (workers, tabs, and sticks) and two fixed costs (the scissors and the desks).

The primary justification for this specific production process was simple: it was inexpensive to conduct. A box of 1000 popsicle sticks cost $1.99. The tabs cost $0.37 per package of 50, and the students were told that they could cut the tabs to dimensions of their choosing. However, the finished products had to remain square and together while being transported across the room and acceptable squares were prohibited from exposing any of the tab, otherwise they could not be sold. The entire experiment used less than five full packages of tabs, so the entire experiment cost $5.10 plus tax, in materials.

The students were provided with costs for each of the materials (including their labor) required for production. The specific input prices were $0.50 per pair of scissors, $1.00 per desk used, $0.10 per stick, $0.05 per corner for tabs used, and $0.40 per worker, per round for labor. These prices remained constant throughout the rounds.

To mimic quality control, five inspectors were designated to approve or disapprove the output, like Bergstrom and Miller. After the transportation of the squares, and while the next round was being discussed, the inspectors evaluated the output for quality. The inspectors were thorough (since they too had extra credit at stake) and actively rejected inferior squares.[4] The inspectors were seated next to one another so that each could see how the other inspectors were operating. This controlled the fervor of their activity. If a unit was rejected by the inspector (unsalable defective output), the firm incurred production costs without realizing any sales revenue, and profits suffered. The inspectors also served as recording secretaries. During the experiment's five rounds, only the first six columns of Table 1 were recorded. The remaining columns were reserved for the discussion during the next class period. At the beginning of the next class period, each student was provided with a hard copy of Table 1 on which to record the outcomes.

 

TABLE 1: Experiment Template

Round # Produced Cost of Desks Cost of Scissors Cost of Sticks Cost of Tabs Cost of Labor Total Fixed Costs Total Variable Costs TC TR AFC AVC ATC MC p

1

                             
                               

2

                             
                               

3

                             
                               

4

                             
                               

5

                             

As indicated above, the longest discussion period was allowed prior to the first round since the best strategies were unfamiliar. Immediately, the students were forced to plan under considerable uncertainty. They had to choose the "best worker," decide upon the order of activity, discuss strategies for carry-overs to future rounds, and make decisions regarding how to maximize output in the time period given.

The first round results were as expected. All of the groups produced either no units or one unit. Having to switch functionsfrom cutting, to peeling, to pasting, to quality control, to carryingreduced efficiency and slowed production, particularly since everything was new. Each group therefore incurred fixed costs of $1.50 for scissors and desks, but variable costs that varied from $0.40 to $1.00 worth of sticks, tabs and labor cost.

In the second round, two workers were permitted, with everything else as in round one. Thereafter, the number of workers per round was determined by the groups. Production innovations occurred, mostly associated with specialization in tasks (presumably taking advantage of the relative strengths of the group members). Each group, apparently independently, recognized the advantage of transporting production at the very end as the remaining time was counted down. A beautiful example of just-in-time delivery was therefore developed. In addition, some groups stockpiled cut tabs, since inventory costs were zero and partial production could be carried over to future rounds.[5] Others used just-in-time inventory management. Most groups eventually recognized that labor was expensive relative to the single pair of scissors, so not all group members actually produced in any group. The other rounds proceeded as expected.

In the post-experiment discussion during the next class period, key points from the experiment were outlined. First, I emphasized that this was a short-run experiment, and that some costs were fixed and some were variable. Students easily identified each. Second, the data for the individual groups allowed for identification of the shape of the production function. Specifically, the results illustrated the diminishing marginal productivity of labor after a period of increasing returns, and production phases and appropriate operating locations on production functions could therefore be discussed. Table 2 presents the results for one of the groups, the one I showed in class, but not the profit-maximizing group. Rather than prepare the entire figure for this group, we collectively filled in beyond the first six columns. As the class filled in each column (beginning with total fixed costs, total variable costs and total costs), the associated shapes were discussed. The non-linearities in variable and total costs were emphasized, as was the constancy of total fixed costs.

Next, the class collectively completed Table 3, which presents the results of the five rounds of the experiment for each group in aggregate (which I did in preparation for class), and all of the associated cost concepts for the aggregated data were then entered collectively. Thereafter, we considered the average and marginal cost concepts and graphs, with emphasis on how the average concepts relate to the total ones both within the experiment, and on the graphs. The discussion concluded the same way that it always did without the experiment, emphasizing the universal nature of short-run cost attributes across production processes, and indicating that we would assume that all of the firms in the market model section of the course would exhibit these cost characteristics. I was careful to conceal the revenue results until the end to keep the class in suspense regarding the winning group. The class learned that producing defective output is costly, that slow production hurts revenues, that specialization is advantageous, that worker skills differ, etc., but mostly they learned the production and cost concepts in a way that they are more likely to remember.

Conclusions

The goal of any experimental classroom technique in economics should be to involve the students directly in deriving postulated relationships. Preferably, this task should be completed before the students have been introduced to the theory so that it is clear that the results were not biased by a priori expectations or knowledge of the process. The Popsicle Stick, Inc. experiment accomplishes this task and also facilitates the discussion of the shapes of production and cost curves, and how the total and average cost concepts are related. In addition, the students are more interested in the outcomes and the interrelationships of the cost concepts since they are introduced to them through a production effort that they have participated in directly.

I can almost hear your concern that this must have taken much more time than a traditional lecture on the costs of production. However, the experiment took only two, 50 minute class periods to complete, including the post-experiment discussion.[6] Historically, without the experiment, three or more 50 minute class periods were necessary to discuss short-run costs of production, so that some efficiency gain must be attributable to the experiment. I fervently believe that because the students were personally involved in developing the relationships, they more quickly assimilated the implications of these cost concepts, requiring less reinforcement than historically has been necessary.

Ultimately, because the students were given the opportunity to engage in interactive learning, they became more involved, and were more impressed by the applicability of these basic microeconomic concepts. I recommend that professors try this experiment, as well as Holt's 1996 experiment and several others that have been outlined elsewhere (e.g., Wells (1991), Davis and Holt (1993), and Williams and Walker (1993)).

Economists face a daunting task. The students in college classes are increasingly less analytical. Further, students are more accustomed to interactive activities as the result of video games, interactive television, and computer software. Classroom presentations need to correct the former, and adapt to the latter. This experiment, and classroom experiments in general, can be effective tools for preparing students to be more productive workers. Such techniques may even motivate more students to recognize the extensive benefits to economics education. Experimental techniques require extra planning, and may limit the coverage of certain material. However, the rewards of having more motivated students, and more analytical ones, should encourage any instructor.

TABLE 2: Experiment Template

Round # Produced Cost of Desks Cost of Scissors Cost of Sticks Cost of Tabs Cost of Labor Total Fixed Costs Total Variable Costs TC TR AFC AVC ATC MC p

1

0

$1.00

$.50

$.00

$.00

$.40

$1.70

$.40

$2.10

$.00

---

---

---

 

$-2.10

                               

2

1

$1.00

$.50

$.40

$.20

$.80

$1.50

$1.40

$2.90

$2.00

$1.50

$1.40

$2.90

$.80

$-0.90

                               

3

5

$1.00

$.50

$2.00

$1.00

$1.20

$1.50

$4.20

$5.70

$8.00

$.30

$.84

$1.14

$.70

$2.30

                               

4

9

$1.00

$.50

$3.60

$1.80

$1.60

$1.50

$7.00

$8.50

$12.00

$.17

$.78

$.95

$.70

$3.50

                               

5

12

$1.00

$.50

$4.80

$2.40

$2.40

$1.50

$9.60

$11.10

$22.00

$.125

$.80

$0.93

$.87

$10.90

 

TABLE 3: Experiment Template---Aggregate Results

Round # Produced Cost of Desks Cost of Scissors Cost of Sticks Cost of Tabs Cost of Labor Total Fixed Costs Total Variable Costs TC TR AFC AVC ATC MC p

1

17

$5.00

$2.50

$6.80

$3.40

$3.60

$7.50

$13.80

$21.30

$34.00

$.44

$.81

$1.25

 

$12.70

                               

2

21

$5.00

$2.50

$8.40

$4.20

$4.00

$7.50

$16.60

$24.10

$38.00

$.35

$.79

$1.14

 

$13.90

                               

3

18

$5.00

$2.50

$7.20

$3.60

$2.80

$7.50

$13.60

$21.10

$26.00

$.41

$.75

$1.16

 

$4.90

                               

4

27

$5.00

$2.50

$10.80

$5.40

$6.40

$7.50

$23.60

$31.10

$44.00

$.28

$.87

$1.15

 

$12.90

                               

5

20

$5.00

$2.50

$8.00

$4.00

$4.00

$7.50

$16.00

$23.50

$40.00

$.38

$.80

$1.18

 

$16.50


Appendix: Popsicle Instructions


References

Bergstrom, T.C. and Miller, J.H. 1997. Experiments with Economic Principles. New York: McGraw Hill.

Bergstrom, T.C. and Miller, J.H. 2000. Experiments with Economic Principles, Microeconomics,2nd Edition. New York: McGraw Hill.

Chamberlin, E. H. 1948. An Experimental Imperfect Market. Journal of Political Economy. LVI, No. 2. (April): 95-108.

Holt, C. A. and Davis, D. D. 1993. Experimental Economics. (Princeton, N.J.: Princeton University Press).

Holt, C. A. 1996. Classroom Games: Trading in a Pit Market. Journal of Economic Perspectives. 10, No. 1. (Winter): 193-203.

Joseph, M. L. 1965. Role Playing in Teaching Economics. American Economic Review. LV, No. 2. (May): 556-65.

Neral, J. 1993. Widget Production in the Classroom. Classroom Expernomics 2 (1): 7-8.

Smith, V. L. 1962. An Experimental Study of Competitive Market Behavior. Journal of Political Economy. LXX, No. 2. (April): 111-37.

Wells, D. A. 1991. Laboratory Experiments for Undergraduate Instruction in Economics. Journal of Economic Education. 22 (Summer): 293-300.

Williams, A.W. and J.M. Walker. 1993. Computerized Laboratory Exercises for Microeconomics Education: Three Applications Motivated by the Methodology of Experimental Economics. Journal of Economic Education (Fall): 291-315.


1.For purposes of simplicity I only discuss the outcome of the experiment for one of my classes in the Spring of 1998. Each application of the experiment is somewhat different, but this particular class provided interesting and consistent results.

2.Tabs, rather than glue, are recommended so that the squares remain together. Glue will not set sufficiently rapidly to allow the experiment to proceed expeditiously.

3.Some may object to using extra credit to motivate the students to perform in the experiment. However, previous experience convinced me that without the incentive to comp ete against the other group or groups, the students did not execute their tasks with sufficient fervor to generate the desired outcomes. Besides, competition between firms is how markets operate, and the experiment provides a precursor of this reality. An instructor concerned about the impact of the extra credit on grades can simply replace this inducement with some small prize such as candy or food.

4.The five inspectors' names were put in a hat and one name was drawn to receive extra credit of two points. In this way they had no incentive to favor or disfavor the group they were evaluating. The five inspectors chosen were picked because they arrived late to class!

5.Some readers of earlier versions of this paper object to the allowance of inventory carry-overs. If you are among them, do not allow carry-overs. I have found that allowing them enhances the strategic development and even improves the conformance with expected results.

6.Having time between the experiment and the discussion actually improves the process, since the instructor has time to prepare support materials regarding the results to better emphasize the outcomes. For example, a graphing program can be used to plot the output and cost relationships and to create transparency over lays to exhibit the cost curves without need for blackboard drawing. To add simultaneity to the process, the data can be entered into a computer program between classes and the curves drawn right in front of the student's eyes using computer projection technology.


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