Chapter 8

three major reasons why planning a larger volume of output generally reduces, at least initially, unit costs:

(1)economies accompanying the use of mass-production methods, (2)higher productivity as a result of specialization and "learning by doing," and (3)economies in promotion and purchasing.

The business firm is an entity designed to organize raw materials, labor, and machines with the goal of producing goods and/or services. Firms....

(1)purchase productive resources from households and other firms, (2)transform them into a different commodity, and (3)sell the transformed product or service to consumers.

proprietorship

A business firm owned by an individual who possesses the ownership right to the firm's profits and is personally liable for the firm's debts.

corporations

A business firm owned by shareholders who possess ownership rights to the firm's profits, but whose liability is limited to the amount of their investment in the firm.

partnership

A business firm owned by two or more individuals who possess ownership rights to the firm's profits and are personally liable for the debts of the firm.

long run

A time period long enough to allow the firm to vary all of its factors of production.

short run

A time period so short that a firm is unable to vary some of its factors of production. The firm's plant size typically cannot be altered in the short run.

$2,600 $2000 from loss in worth one year from now $600 from loss in investment

Consider a machine purchased one year ago for $18,000. The machine is being depreciated $3,000 per year throughout a six-year period. Its current market value is $6,000, and the expected market value of the machine one year from now is $4,000. If the interest rate is 10 percent, the expected cost of holding the machine during the next year is...

sunk costs

Costs that have already been incurred as a result of past decisions. They are sometimes referred to as historical costs.

diseconomies of scale

Increases in the firm's per-unit costs associated with increases in firm size due to inefficiencies and monitoring problems.

explicit costs

Payments by a firm to purchase the services of productive resources.

economies of scale

Reductions in the firm's per-unit costs associated with the use of large plants to produce a large volume of output.

highly

Residual claimants have a strong incentive to supply goods that consumers value ____________ relative to cost

diseconomies of scale

Suppose that as a pizza company increases the number of pizza parlors it operates in the long run, inefficiencies and monitoring problems increase the per-unit cost of a pizza. This is an example of...

diseconomies of scale

Suppose that when a firm increases its overall plant size, its long-run per-unit costs also increase. Which of the following best explains this phenomenon? Diseconomies of scale or the law of demising returns

Investors will continue to supply equity capital to a firm if they earn a 10% (or greater) return on their equity capital.

Suppose the normal return on financial capital is 10%. Which of the following statements best describes investor behavior?

marginal cost (MC)

The change in total cost required to produce an additional unit of output.

total cost

The costs, both explicit and implicit, of all the resources used by the firm. Total cost includes a normal rate of return for the firm's equity capital.

economic profit

The difference between the firm's total revenues and its total costs, including both the explicit and implicit cost components.

marginal product

The increase in the total product resulting from a unit increase in the employment of a variable input. Mathematically, it is the ratio of the change in total product to the change in the quantity of the variable input.

implicit cost

The interest he could earn by selling his pizza ovens, and placing that money in the bank or investing it in the stock market, is an implicit or explicit cost?

opportunity cost of capital

The normal rate of return on equity capital is also known as

interest payments incurred in obtaining the funds

The opportunity cost of borrowed funds is the...

implicit costs

The opportunity costs associated with a firm's use of resources that it owns. These costs do not involve a direct money payment. Examples include wage income and interest forgone by the owner of a firm who also provides labor services and equity capital to the firm.

law of diminishing returns

The postulate that as more and more units of a variable resource are combined with a fixed amount of other resources, using additional units of the variable resource will eventually increase output only at a decreasing rate. Once diminishing returns are reached, it will take successively larger amounts of the variable factor to expand output by one unit.

opportunity cost at equity capital

The rate of return that must be earned by investors to induce them to supply financial capital to the firm.

accounting profits

The sales revenues minus the expenses of a firm over a designated time period, usually one year. Accounting profits typically make allowances for changes in the firm's inventories and depreciation of its assets. No allowance is made, however, for the opportunity cost of the equity capital of the firm's owners, or other implicit costs.

total fixed costs

The sum of the costs that do not vary with output. They will be incurred as long as a firm continues in business and the assets have alternative uses.

total variable cost

The sum of those costs that rise as output increases. Examples of variable costs are wages paid to workers and payments for raw materials.

total product

The total output of a good that is associated with each alternative utilization rate of a variable input.

average product

The total product (output) divided by the number of units of the variable input required to produce that output level.

average variable cost

The total variable cost divided by the number of units produced.

average total cost (ATC)

Total cost divided by the number of units produced. It is sometimes called per-unit cost.

average fixed cost

Total fixed cost divided by the number of units produced. It always declines as output increases.

True

True or False: The firm's accounting statement does not take implicit costs into account.

true

Under current tax law, firms can record the opportunity cost of borrowed funds as an expense, but cannot do the same for the opportunity cost of equity capital. True or False: The tax structure encourages debt rather than equity financing.

cost returns to scale

Unit costs that are constant as the scale of the firm is altered. Neither economies nor diseconomies of scale are present.

Long-run average total cost

Which of the following are relevant to a firm's decision to increase output in the long run: Long-run average total cost Short-run average variable cost Short-run fixed costs

b) The opportunity costs associated with a firm's use of resources that it owns.

Which of the following best describes implicit costs? a) Costs that have already been incurred as a result of past decisions. b) The opportunity costs associated with a firm's use of resources that it owns. c) Payments by a firm to purchase the services of productive resources. d) The costs of all the resources used by the firm.

They are necessary to keep resources in the industry

Why do economists consider normal returns to financial capital to be a cost of equity capital?

normal profit rate

Zero economic profit, providing just the competitive rate of return on the capital (and labor) of owners. An above-normal profit will draw more entry into the market, whereas a below-normal profit will lead to an exit of investors and capital.

team production

a production process which employees work together under the supervision of the owner or the owner's representative.

residual claimants

individuals who personally receive the excess, if any, of revenues over costs. Residual claimants gain if the firm's costs are reduced or revenues increase.

falls

long-run economies of scale exist when the long-run average cost curve ________.

principal-agent problems

the incentive problem that occurs when the purchaser of services (the principal) lacks full information about the circumstances faced by the seller (the agent) and cannot know how well the agent preforms the purchased services. The agent may to some extent work toward objectives other than those sought by the principal paying for the service.

shirking

working at less than the expected rate of productivity, which reduces output. Shirking is more likely when workers are not monitored, so that the cost of lower outputs fall on others.