Chapter 12The Firm: Production and Costs

TRUE/FALSE 1. Explicit costs include both wages paid to workers and the opportunity cost of using ones own land, labor, or capital. ANS: F PTS: 1

2. Because implicit costs do not represent an explicit outlay of money, they are not real costs. ANS: F PTS: 1

3. When economists say firms try to maximize profits, they mean that firms try to maximize the difference between what they receive for their goods and services in total revenue and what they give up for their inputs in total costs (explicit and implicit). ANS: T PTS: 1

4. Economic profits equal actual revenues minus all explicit and implicit costs. ANS: T PTS: 1

5. Economists consider a zero economic profit to be less than a normal profit rate. ANS: F PTS: 1

6. Earning zero economic profit is different from earning zero accounting profit. ANS: T PTS: 1

7. Sunk costs are irrelevant for any future action. ANS: T PTS: 1

8. The short run is defined as a period too brief for some inputs to be varied. ANS: T PTS: 1

9. In the long run, the inputs that do not change with output are called fixed inputs or fixed factors of production. ANS: F PTS: 1

10. The long run can vary considerably in length from industry to industry. ANS: T PTS: 1

11. Total product will typically start at a low level and increase slowly at first and then more rapidly as the amount of the variable input increases. ANS: F PTS: 1

12. Marginal product first rises as the result of more effective use of fixed inputs and then falls. ANS: T PTS: 1

13. Diminishing marginal product stems from the crowding of the fixed inputs with more and more of the variable input. ANS: T PTS: 1

14. A firm never knowingly allows itself to reach the point where the marginal product becomes negative. ANS: T PTS: 1

15. If a firm were producing at the level where the marginal product of an input was negative, its profits would be lower as a result. ANS: T PTS: 1

16. Fixed costs for a given period have to be paid only if a firm produces output in that period. ANS: F PTS: 1

17. Variable costs vary with the level of output, while fixed costs do not. ANS: T PTS: 1

18. Marginal cost shows the change in total costs associated with a change in output by one unit, or the cost of producing one more unit of output. ANS: T PTS: 1

19. Marginal costs are really just a useful way to view changes in fixed costs as output changes. ANS: F PTS: 1

20. The total cost curve is the summation of the total variable cost and total fixed cost curves. ANS: T PTS: 1

21. The average fixed cost curve is always a horizontal line, because fixed costs do not change with output. ANS: F PTS: 1

22. The marginal cost curve crosses the average variable cost and average total cost curves at those curves lowest points. ANS: T PTS: 1

23. At output levels where average total cost is rising, marginal cost must be greater than average total cost.

ANS: T

PTS: 1

24. The average fixed cost curve declines whether the marginal cost curve is rising or falling. ANS: T PTS: 1

25. The average total cost curve is usually U-shaped. ANS: T PTS: 1

26. It is the declining average variable cost curve that is primarily responsible for the falling segment of the average total cost curve. ANS: F PTS: 1

27. Diminishing marginal product first sets in at the minimum point of the average total cost curve. ANS: F PTS: 1

28. Diminishing marginal product causes the marginal cost curve to increase, eventually causing the average variable cost and average total cost curves to rise. ANS: T PTS: 1

29. MC is equal to AVC at the lowest point on the AVC curve, and it is equal to ATC at the lowest point on the ATC curve. ANS: T PTS: 1

30. Over long enough time periods, firms can vary all of their productive inputs. ANS: T PTS: 1

31. As we move along the LRATC, the factory size changes with the quantity of output. ANS: T PTS: 1

32. A typical firm experiences economies of scale at low levels of output, constant returns to scale at higher levels of output, and diseconomies of scale at still higher levels of output. ANS: T PTS: 1

33. Diseconomies of scale may exist because a firm can use mass production techniques or capture gains from further labor specialization not possible at lower levels of output. ANS: F PTS: 1

34. When input prices or technology changes, the cost curves of a firm will shift. ANS: T MULTIPLE CHOICE PTS: 1

1. An explicit cost a. is an opportunity cost. b. is an out-of-pocket expense. c. does not require an outlay of money. d. is characterized by both a and b. e. is characterized by both a and c. ANS: D PTS: 1

2. Which of the following is false? a. Explicit costs are input costs that require a monetary payment. b. Implicit costs do not represent an explicit outlay of money. c. Both implicit and explicit costs are opportunity costs. d. Sunk costs are irrelevant for any future action. e. All of the above are true. ANS: E PTS: 1

3. Which of the following is false? a. Profits are a firms total revenue minus its total costs. b. Accounting profits are actual revenues minus actual expenditures of money. c. Economic profits are actual revenues minus all explicit and implicit costs. d. If a firm has any implicit costs, its economic profits exceed its accounting profits. e. All of the above are true. ANS: D PTS: 1

4. The crucial difference between how economists and accountants analyze the profitability of a business has to do with whether or not are included when calculating total production costs. a. implicit costs b. cash payments c. sunk costs d. explicit costs ANS: A PTS: 1

5. Which of the following is true? a. If a firms implicit costs are zero, accounting profits equal economic profits. b. If a firms implicit costs are positive, accounting profits exceed economic profits. c. If a firms implicit costs are positive, economic profits exceed accounting profits. d. Both a and b are true. e. Both a and c are true. ANS: D PTS: 1

6. Cassie produces and sells 300 jars of homemade jelly each month for $3 each. Each month, she pays $200 for jars, pays $150 for ingredients, and uses her own time, with an opportunity cost of $300. Her economic profits each month are a. $250. b. $400. c. $550. d. $600. e. minus $350. ANS: A PTS: 1

7. Sunk costs a. should be included when weighing the marginal costs of production against the marginal benefits received. b. have already been incurred and cannot be recovered. c. plus variable costs equal the total costs of production. d. are relevant to future decisions and should be carefully considered. ANS: B PTS: 1

8. The short run a. is a period too brief for any inputs to be varied. b. is a period that involves no fixed costs. c. is normally a period of one year. d. is none of the above. ANS: D PTS: 1

9. The long run a. is a period in which a firm can adjust all its inputs. b. can vary in length from industry to industry. c. is a period in which all costs are variable costs. d. is characterized by all of the above. ANS: D PTS: 1

10. The long-run production period a. is a time when all inputs are variable. b. varies in length according to how capital goods are specialized. c. is likely to be longer for a steel manufacturer than for a retailer who sells watches off a cart at the local mall. d. is characterized by all of the above. ANS: D PTS: 1

11. Which of the following most accurately describes the long-run period? a. The long run is a period of time in which a firm is unable to vary some of its factors of production. b. In the long run, a firm is able to expand output by utilizing additional workers and raw materials, but not physical capital. c. The long run is of sufficient length to allow a firm to alter its plant capacity and all other factors of production. d. The long run is of sufficient length to allow a firm to transform economic losses into economic profits. e. Both a and b most accurately describe the long-run period. ANS: C PTS: 1

12. Production in the short run a. is subject to the law of diminishing marginal product. b. involves some fixed factors. c. can be increased by employing another unit of a variable input, as long as the marginal product of that input is positive. d. is characterized by all of the above. e. is characterized by none of the above. ANS: D PTS: 1

13. A production function shows the relationship between a. variable inputs and fixed inputs. b. variable inputs and output. c. costs and output. d. inputs and costs. e. production and sales revenue. ANS: B PTS: 1

14. Diminishing marginal product a. occurs in the long run but not in the short run. b. occurs in the short run but not in the long run. c. occurs both in the long run and the short run. d. occurs in neither the long run nor the short run. ANS: B PTS: 1

15. Diminishing marginal productivity in a frozen-pizza company means that a. hiring additional workers causes the total output of pizza to fall. b. hiring additional workers does not change the total output of pizza produced. c. hiring additional workers adds fewer and fewer pizzas to total output. d. the average total cost of production must be decreasing. ANS: C PTS: 1

16. If the marginal product of a firms only variable input is negative, a. its total product is growing at a decreasing rate. b. it will use more of the variable input until its marginal product is again positive. c. it will reduce its use of the variable input. d. its total product is minimized. e. none of the above would be true. ANS: C PTS: 1

17. Total fixed costs a. do not vary with the level of output. b. cannot be avoided in the short run without going out of business. c. do not exist in the long run. d. are characterized by all of the above. ANS: D PTS: 1

18. Which of the following is most likely a variable cost for a business? a. the loan payment on funds borrowed when a new building is constructed b. payments for electricity c. the lease payment on a warehouse used by the business d. the opportunity cost of the heavy equipment installed in a factory ANS: B PTS: 1

19. The change in total cost that results from the production of one additional unit of output is called a. marginal revenue. b. average variable cost. c. marginal cost. d. average total cost.

e. average fixed cost. ANS: C PTS: 1

20. Which short-run curve typically declines continuously as output expands? a. average variable cost b. average total cost c. average fixed cost d. marginal cost e. none of the above ANS: C PTS: 1

21. Which of the following is true? a. The short-run ATC exceeds the short-run AVC at any given level of output. b. If the short-run ATC curve is rising, the short-run AVC curve is also rising. c. The short-run AFC is always falling with increased output, whether the short-run MC curve is greater or less than short-run AFC. d. If short-run MC is less than short-run AVC, short-run AVC is falling. e. All of the above are true. ANS: E PTS: 1

22. Which of the following is false in the short run? a. ATC is usually U-shaped. b. Declining AFCs are the primary reason ATC decreases at low levels of output. c. ATC increases at high levels of output because of diminishing marginal product. d. Diminishing marginal product sets in at the minimum point of ATC. e. All of the above are true in the short run. ANS: D PTS: 1

23. Typically, what is the shape of the average total cost curve for a firm in the short run? a. Typically, an average total cost curve is U-shaped. b. Typically, an average total cost curve constantly slopes upward as output expands and eventually approaches an infinite dollar amount at high rates of output. c. Typically, an average total cost curve is a vertical line. d. Typically, an average total cost curve slopes downward as output expands and approaches the X-axis when output is very large. ANS: A PTS: 1

24. Which of the following is true in the short run? a. MC equals ATC at the lowest point of ATC. b. MC equals AVC at the lowest point of AVC. c. When AVC is at its minimum point, ATC is falling. d. When ATC is at its minimum point, AVC is rising. e. All of the above are true. ANS: E PTS: 1

25. Which of the following is always true? a. When marginal cost is less than average total cost, average total cost is increasing. b. When average fixed cost is falling, marginal cost must be less than average fixed cost. c. When average variable cost is falling, marginal cost must be greater than average variable cost.

d. When marginal cost is greater than average total cost, average total cost is increasing. ANS: D PTS: 1

26. When marginal product is increasing, a. marginal cost is increasing. b. marginal cost is decreasing. c. average variable cost is increasing. d. average total cost is increasing. e. total cost is decreasing. ANS: B PTS: 1

27. If a taxi service is operating in the region of diminishing marginal product and more taxi service is added in the short run, what will happen to the marginal cost of providing the additional service? a. It is impossible to say anything about marginal cost with the information provided. b. Marginal cost will decrease. c. Marginal cost will increase. d. Marginal cost will stay the same. ANS: C PTS: 1

28. If the Burger Huts city permit to operate rose by $3,000 per year, a. its MC curve would shift upward. b. its AVC curve would shift upward. c. its ATC curve would shift upward. d. its MC, AVC, and ATC curves would shift upward. ANS: C PTS: 1

29. If a firms ATC is falling in the long run, then a. it is subject to economies of scale over that range of output. b. it is subject to diseconomies of scale over that range of output. c. it is subject to constant return to scale over that range of output. d. it has reached the minimum efficient scale of production. e. both c and d are true. ANS: A PTS: 1

30. In the long run, a. the average fixed cost curve is U-shaped. b. average fixed cost exceeds the average variable cost of production. c. all costs are variable. d. all costs are fixed. e. none of the above is correct. ANS: C PTS: 1

31. When a firm experiences economies of scale in production, a. long-run average total cost declines as output expands. b. long-run average total cost increases as output expands. c. marginal cost increases as output expands. d. the marginal product of an input diminishes with increased utilization. ANS: A PTS: 1

32. The lowest level of output at which a firms goods are produced at minimum long-run average total cost is called a. the point of zero marginal cost. b. the point of diminishing returns. c. the minimum total product. d. the minimum efficient scale. e. plant capacity. ANS: D PROBLEM 1. What happens to the cost of growing strawberries on your own land if a housing developer offers you three times what you thought your land was worth? ANS: Since the opportunity cost (foregone alternative) of using your land triples, the cost of using your land to grow strawberries will increase. PTS: 1 2. As a farmer, you work for yourself using your own tractor, equipment, and farm structures, and you cultivate your own land. Why might it be difficult to calculate your profits from farming? ANS: To calculate economic profit, one must consider all relevant costs, both explicit and implicit. It may be difficult to calculate your economic profits from farming, since you must estimate the implicit opportunity cost of your time, tractor, equipment, farm structures and land. PTS: 1 3. Say that your firms total product curve includes the following data: one worker can produce 8 units of output; two workers, 20 units; three workers, 34 units; four workers, 50 units; five workers, 60 units; six workers, 70 units; seven workers, 76 units; eight workers, 78 units; and nine workers, 77 units. a. What is the marginal product of the seventh worker? b. When does the law of diminishing product set in? c. Under these conditions, would you ever choose to employ nine workers? ANS: a. The marginal product of the seventh worker equals 6 units of output. b. The law of diminishing product begins with the fifth worker is hired. c. A firm would never choose to hire 9 workers, since the marginal product of the ninth worker is negative. PTS: 1 4. Why does the law of diminishing marginal product imply the law of increasing costs? ANS: PTS: 1

As a variable factor, such as labor, added to a given amount of the fixed factor, such as capital or land, the marginal product of that factor will eventually diminish. Once the marginal product begins to diminish, an increasing amount of the variable factor must be added in order to boost the output of a good by a particular increment in the short run. An increasing amount of output from alternative productive activities must be sacrificed (an increasing opportunity cost). PTS: 1 5. What is likely to happen to your marginal costs when adding output requires working beyond an eighthour day, if workers must be paid time-and-a-half wages beyond an eight-hour day? ANS: Marginal costs will increase by as much as 50% when workers must be paid time-and-a-half beyond an eight-hour day. (If labor is the only variable input, marginal cost will increase by exactly 50%.) If workers are less productive after 8 hours of work, marginal costs will be even higher beyond 8 hours of work. PTS: 1 6. A one-day ticket to visit the Screaming Coasters theme park costs $36, but you can also get a twoconsecutive-day ticket for $40. What is the average cost per day for the two-day ticket? What is the marginal cost of the second consecutive day? ANS: The average cost per day equals $20 for the two-day pass. The marginal cost of the second day is $4. PTS: 1 7. As a movie exhibitor, you can choose between paying a flat fee of $5,000 to show a movie for a week and paying a fee of $2 per customer. Will your choice affect your fixed and variable costs? How? ANS: Your choice will affect your fixed and variable costs. If you choose to pay the flat fee, your fixed costs for the film will equal $5,000 for the week. Your variable costs associated with the leasing of the film would then equal zero. If you choose to pay $2 per customer, then the costs associated with leasing the film will be all variable. PTS: 1 8. If your university pays lecture note takers $20 per hour to take notes in your economics class and then sells subscriptions for $15 per student, is the cost of the lecture note taker a fixed or variable cost of selling an additional subscription? ANS: The note taker's wage is a fixed cost, which does not vary with the number of subscriptions sold. PTS: 1 9. How might a university cafeteria cooking for 400 students rather than for 3 students be subject to economies of scale in the long run? ANS:

In the long run, a food service company can vary the size of the kitchen and its food preparation equipment. When cooking for a large number of students, food preparers can utilize mass production techniques to cook large quantities of food at each meal. Food preparers can specialize at particular culinary tasks and thereby become more proficient at them. As a result, the average total cost of producing meals is likely to decrease in the long run as the number of students served increases. PTS: 1 10. Fill in the rest of the production function for Candys Candies from the information provided. Labor (workers) 0 1 2 3 4 5 6 a. b. Total Product (pounds) 0 20 44 62 78 Marginal Product (pounds)

12 6

Candys Candies begins to experience diminishing marginal product with which worker? Does Candys Candies ever experience negative marginal product? If so, with the addition of which worker?

ANS: Labor (workers) 0 1 2 3 4 5 6 a. b. Total Product (pounds) 0 20 44 62 74 80 78 Marginal Product (pounds) 20 24 18 12 6 -2

Candys Candies begins to experience diminishing marginal product with the third worker, the first one for which marginal product begins to fall. Candys Candies experiences a negative marginal product beginning with the sixth worker.

PTS: 1 11. Draw a typically shaped total product curve and the marginal product curve derived from it, and indicate the ranges of increasing, diminishing, and negative marginal product. ANS:

PTS: 1 12. Illustrate how the shape of the marginal product curve relates to the shape of the marginal cost curve. ANS:

PTS: 1 13. Use the graph to answer the following questions. a. Curve A represents which cost curve? b. Curve B represents which cost curve? c. Curve C represents which cost curve?

d. Curve D represents which cost curve? e. Why must curve D pass through the minimum points of both curve B and curve C? f. What significance does the point where curve A intersects curve D have? ANS: a. Average Fixed Cost (AFC). b. Average Variable Cost (AVC). c. Average Total Cost (ATC). d. Marginal Cost (MC). e. Where MC is less than AVC, AVC is falling, when MC equals AVC, AVC does not change, and when MC exceeds AVC, AVC is rising, so the intersection of MC and AVC is at the minimum point of AVC; where MC is less than ATC, ATC is falling, when MC equals ATC, ATC does not change, and when MC exceeds ATC, ATC is rising, so the intersection of MC and ATC is at the minimum point of ATC. f. The point where MC equals AFC has no economic significance. PTS: 1 14. Fill in the rest of the cost function for Bobs Bowling Balls.
Output 1 2 3 4 5 6 7 8 Total Fixed Costs 200 Total Total Variable Costs Costs 60 100 120 128 180 252 316 436 Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost

ANS:
Output 1 2 3 4 5 6 7 8 Total Fixed Costs 200 200 200 200 200 200 200 200 Total Total Variable Costs Costs 60 260 100 300 120 320 128 328 180 380 252 452 316 516 436 636 Average Average Fixed Cost Variable Cost 200 60 100 50 66.66 40 50 32 40 36 33.33 42 28.57 45.14 25 54.50 Average Marginal Total Cost Cost 260 60 150 40 106.66 20 82 8 76 52 75.33 72 73.71 64 79.50 120

PTS: 1