Managerial economics - Chapter 3

When a firm ignores the opportunity cost of capital when making investment or shutdown decisions, this is a case of a. fixed-cost fallacy. b. sunk-cost fallacy. c. hidden-cost fallacy. d. none of the above.

Correct: c. Hidden-cost fallacy

The fixed-cost fallacy occurs when a. a firm considers irrelevant costs. b. a firm ignores relevant costs. c. a firm considers overhead or depreciation costs to make short-run decisions. d. both a and c.

Correct: d -Both a and c. A firm considers irrelevant costs & A firm considers overhead or depreciation costs to make short-run decisions (It occurs when costs are considered even though they do not vary with the consequence of the decision)

A business owner makes 1,000 items a day. Each day she contributes eight hours to produce those items. If hired, elsewhere she could have earned $250 an hour. The item sells for $15 each. Production does not stop during weekends. If the explicit costs total $150,000 for 30 days, the firm's accounting profit for the month equals a. $300,000. b. $60,000. c. $450,000. d. $240,000.

Correct: a. $300,000 $15*(1000*30) = $450,000. We know the explicit costs ($150,000) The accounting profit: $450,000-$150,000=$300,000

Mr. D's Barbeque of Pickwick, TN, produces 10,000 dry-rubbed rib slabs per year. Annually Mr. D's fixed costs are $50,000. The average variable cost per slab is a constant $2. The average total cost per slab then is a. $7. b. $2. c. $5. d. impossible to determine.

Correct: a. $7

Opportunity costs arise due to a. resource scarcity. b. lack of alternatives. c. limited wants. d. abundance of resources.

Correct: a. Resource scarcity Without scarce resources (time, labor, money, etc), the pursuit of another alternative does not require one to give up anything in return.

After graduating from college, Jim had three choices, listed in order of preference: (1) move to Florida from Philadelphia (2) work in a car dealership in Philadelphia (3) play soccer for a minor league in Philadelphia. His opportunity cost of moving to Florida includes a. the benefits he could have received from playing soccer. b. the income he could have earned at the car dealership. c. both a and b. d. cannot be determined from the given information.

Correct: b. The income he could have earned at the car dealership (Opportunity cost reflects the value of the best foregone alternative, in this case the car dealership salary)

All the following are examples of variable costs, except a. hourly labor costs. b. cost of raw materials. c. accounting fees. d. electricity cost.

Correct: c. Accounting fees Accounting fees do not vary with the amount that is produced. They are paid regardless of output.

Economic Value Added helps firms avoid the hidden-cost fallacy a. by ignoring the opportunity costs of using capital. b. by differentiating between sunk and fixed costs. c. by taking all capital costs into account, including the cost of equity. d. none of the above.

Correct: c. By taking all capital costs into account, including the cost of equity When taking all cost into account the firm can estimate their economic profit and the opportunity cost associated with some of their current assets

The U.S. government bought 112,000 acres of land in southeastern Colorado in 1968 for $17,500,000. The cost of using this land today exclusively for the reintroduction of the black-tailed prairie dog a. is zero, because they already own the land. b. is zero, because the land represents a sunk cost. c. is equal to the market value of the land. d. is equal to the total dollar value the land would yield if used for farming and ranching.

Correct: c. Is equal to the market value of the land. The cost of a decision includes the cost of the best foregone option. In this case, this is the amount the government could sell the land for if they did not use if for prairie dog introduction

A business owner makes 1,000 items a day. Each day she contributes eight hours to produce those items. If hired, elsewhere she could have earned $250 an hour. The item sells for $15 each. Production does not stop during weekends. If the explicit costs total $150,000 for 30 days, the firm's economic profit for the month equals a. $300,000. b. $60,000. c. $450,000. d. $240,000.

Correct: d. $240,000 When finding economic profit one need to include opportunity costs (labour: $250*8*30=$60,000) The next step is to remove the explicit cost total from total revenue as well as removing the opportunity cost $450,000 ($15*(1000*30)) - $150,000 - $60,000 This leaves us with $240,000 as the economic profit

If a firm is earning negative economic profits, it implies a. that the firm's accounting profits are zero. b. that the firm's accounting profits are positive. c. that the firm's accounting profits are negative. d. that more information is needed to determine accounting profits.

Correct: d. More information is needed to conclude about accounting profits (It is impossible to find the relationship between economic and accounting profit without information on the economic costs involved)

Opportunity costs

The profit you would have received had you chosen the next best option

Accounting profit

profit as shown on a company's financial statements. E.g opportunity cost of capital

Economic profit

total revenue minus total cost, including both explicit and implicit costs

Relevant benefits/costs

all benefits/costs that vary with the consequence of a decision

Fixed-cost fallacy

consideration of costs that do not vary with the consequences of your decision (also known as sunk-cost fallacy). In other words, you consider irrelevant costs. A common example of this is to let overhead or depreciation costs influence short-run decisions.

Hidden-cost fallacy

occurs when you ignore irrelevant costs (costs that do vary with the consequence of your decision). A common example is to ignore the opportunity cost of capital when making investment or shutdown decisions.