EC 205 Test #2 Practice
What cost measure is equal to AFC +AVC?
average total cost
Compare the demand for water with the demand for wine. The demand for wine is likely
relatively more elastic because wine is a luxury.
According to a news story, during the summer of 2015, gasoline prices were expected to decline by 32 percent, while "U.S. drivers are expected to consume slightly more gasoline, a 1.6 percent increase, during the summer." the price elasticity of demand for gasoline is The demand is
-0.05 price inelastic because the absolute value is less than one.
One description of the costs of operating a railroad makes the following observation: "The fixed . . . expenses which attach to the operation of railroads . . . are in the nature of a tax upon the business of the road; the smaller the [amount of] business, the larger the tax." In what sense is this tax smaller when the amount of business is larger?
As production increases, fixed costs can be allocated over a greater amount of output, decreasing the average cost of the tax.
Consider the markets for BP supreme-grade gasoline, all BP grades of gasoline, and all gasoline. For which of these three markets will demand be most elastic? Demand will be most elastic for
BP supreme-grade gasoline, then for all BP grades of gasoline, and then for all gasoline.
What is the main reason that firms eventually encounter diseconomies of scale as they keep increasing the size of their store or factory?
Firms have difficulty coordinating production
In which of the following situations does the law of diminishing marginal utility not hold?
For methamphetamine addicts, the more dosages of the illegal drug, the more euphoric they become.
Suppose the price elasticity of demand for cereal is −0.82.
If so, then the demand for cereal is inelastic.
According to the U.S. Energy Information Administration, the average price of heating oil fell to under $3.00 a gallon during the winter of 2014-2015, the lowest price in more than four years. About 6.2 million U.S. households in the Northeast rely on the fuel to heat their homes. For the following questions, assume that no factor that affects the demand for heating oil, other than its price, changed during the winter of 2014-2015. If households in the Northeast decreased their consumption of heating oil in the winter of 2014-2015, can we conclude that for these households, heating oil was an inferior good? If households in the Northeast decreased their consumption of heating oil in the winter for 2014-15, we can conclude that for these households heating oil is
No. To conclude that heating oil is an inferior good, we would have to know that less heating oil was consumed as the incomes of Northeast households rose. a Giffen good because when the price fell less was consumed.
If a 25 percent increase in the price of Cheerios causes a 22 percent reduction in the number of boxes of cereal demanded, the price elasticity of demand for Cheerios is -0.88.
The demand for Cheerios is inelastic.
What would need to be true for a demand curve to be upward sloping?
The good would have to be an inferior good, and the income effect would have to be larger (in absolute value) than the substitution effect.
Which of the following is true of the relationship between the average product of labor and the marginal product of labor?
Whenever the marginal product of labor is less than the average product of labor, the average product of labor must be decreasing.
Why do single firms in perfectly competitive markets face horizontal demand curves?
With many firms selling an identical product, single firms have no effect on market price.
Assume the price of CDs is $12 and the price of DVDs is $22. At those prices, Isabel consumes 12 CDs and 17 DVDs. Her marginal utility from the last CD consumed is 133 and her marginal utility from the last DVD consumed is 208.
Without changing the combined amount spent on CDs and DVDs, Isabel can increase her utility by consuming more CDs and fewer DVDs.
The marginal cost of production shows the change in a firm's total cost from producing one more unit of a good or service. What is the shape of the marginal cost curve? Graphically, the marginal cost curve is
a U shape, initially falling when the marginal product of labor is rising and then eventually rising when the marginal product of labor is falling.
A market demand curve is derived by
adding horizontally the individual demand curves.
What is the law of diminishing returns? The law of diminishing returns states that Does it apply in the long run?
adding more of a variable input to the same amount of a fixed input will eventually cause the marginal product of the variable input to decline. NO
What is the difference in the short run and the long run? In the short run,
at least one of the firm's inputs is fixed, while in the long run, the firm is able to vary all its inputs, adopt new technology, and change the size of its physical plant.
What are the key determinants of the price elasticity of demand for a product? The key determinants of the price elasticity of demand for a product are:
availability of close substitutes, passage of time, necessities versus luxuries, definition of the market, and share of the good in the consumer's budget.
All of the following cost measures reach their minimum points when they are equal to the value of marginal cost, except one. Which cost measure is the exception?
average fixed cost
How does perfect competition lead to allocative and productive efficiency? Perfect competition leads to allocative and productive efficiency
because prices reflect consumer preferences. because firms are motivated by profit.
One study found that the price elasticity of demand for soda is −0.78, while the price elasticity of demand for Coca-Cola is −1.22. The price elasticity of Coca-Cola is
greater than it is for soda as a product because there are more substitutes for Coca-Cola than soda.
Compare the demand for pepper with demand for food. The demand for pepper is likely
more inelastic because pepper tends to represent a smaller fraction of a consumer's budget.
Marginal utility is more useful than total utility in consumer decision making because
optimal decisions are made at the margin.
A sportswriter writing about the Cleveland Indians baseball team made the following observation: "If the Indians suddenly slashed all tickets to $10, would their attendance actually increase? Not all that much and revenue would drop dramatically." The sportswriter is assuming that the demand for Indians tickets is
relatively price inelastic.
Does the market system result in allocative efficiency? In the long run, perfect competition
results in allocative efficiency because firms produce where price equals marginal cost.
As output increases, the vertical distance between average total cost and average variable cost curves gets _______ and equals _______.
smaller; average fixed cost
What is the production function? The production function is the relationship between
the inputs employed by a firm and the maximum output it can produce with those inputs.
How are prices determined in perfectly competitive markets? In perfectly competitive markets, prices are determined by
the interaction of market demand and supply because firms and consumers are price takers.
What is minimum efficient scale? Minimum efficient scale is
the level of output at which the long−run average cost of production no longer decreases with output.
What is likely to happen in the long run to firms that do not reach minimum efficient scale? A firm that does not reach its minimum efficient scale
will lose money if it remains in business.
In perfect competition, long-run equilibrium occurs when the economic profit is
zero
A company that provides home-care for the elderly is able to provide monthly services for 44 patients at a total cost of $4,000 and monthly services for 55 patients at a cost of $4,350. What is the marginal cost of providing monthly services for a 55th patient? The marginal cost is
$350
Suppose that the market for gluten-free spaghetti is in long-run equilibrium at a price of $3.50 per box and a quantity of 4 million boxes sold per year. Assume that the production of gluten-free spaghetti is a constant-cost industry. If the demand for gluten-free spaghetti increases permanently, which of the following combinations of equilibrium price and equilibrium quantity would you expect to see in the long run? a. A price of $3.50 per box and a quantity of 4 million boxes. b.A price of $3.50 per box and a quantity of more than 4 million boxes. c.A price of more than $3.50 per box and a quantity of more than 4 million boxes. d.A price of less than $3.50 per box and a quantity of less than 4 million boxes.
After demand increases, and supply increases, the quantity will be more than 4 million boxes, but the price will return to its initial level.
A firm producing good Y recently increased monthly production from 1,500 units to 2,000 units. This had no impact on the market price of good Y. At the new production level of 2,000 units, the firm's average cost is $3.5 while its marginal cost of production is $4. The marginal revenue however is fixed at $5 for all levels of output. Jake Williamson is the operations head of the firm. Jake feels that, since the firm has the capacity, it should have increased production further to 2,500 units which would have maximized profits. On the other hand, Mathew Hayden of the market research team anticipates an increase in price to $5.5 in the near future. He therefore claims that the firm may not be maximizing economic profit in the short run even at 2,500 units. Which of the following is most strongly implied by this information?
At the current level of production, the firm is making a profit of $3,000.
What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?
A firm's marginal cost curve is equal to its supply curve for prices above average variable cost.
Bob consumes food and housing. Suppose his marginal utility from an additional unit of food is 40 and his marginal utility from an additional unit of housing is 140. Furthermore, suppose the price of a unit of food is $1.00 and the price of a unit of housing is $4.00. Can Bob increase his utility without changing his total expenditures on food and housing? Holding expenditures constant,
Bob can increase utility by spending more on food and less on housing.
For which of the following reason(s) may firms experience economies of scale?
Both managers and workers may become more specialized and hence more productive as output expands. Firm's production may increase with a smaller proportional increase in at least one input. Large firms may be able to purchase inputs at lower costs than smaller competitors; they can also borrow money at a lower interest rate.
Telesca Inc., a manufacturer of telescopes, currently produces10,000 units per week. The firm's average cost of production has been declining so far. Labor is the only variable input used in production. The operations research team at this firm reports that the marginal cost of producing 10,000 telescopes is lower than both the average total cost and the average variable cost of production. The team believes that average cost will decrease further if production is increased beyond 10,000 units. When the firm manufactures a total of 12,000 telescopes each week, its average cost equals its marginal cost of production. Which of the following conclusions can most reasonably be drawn from this information?
Both the average variable cost and the average total cost would increase if the firm increases production beyond 12,000 telescopes.
Charles has decided to open a lawn-mowing company. To do so, he purchases mowing equipment for $4,000, buys gasoline ($1.80 in gas is required to mow each yard), and pays a helper $10.00 per yard. Prior to opening the lawn company, Charles earned $5,000 as a lifeguard at the neighborhood swimming pool. Assume the money he used to purchase the mowing equipment could otherwise have earned 44 percent per year in the bank and that the mowing equipment depreciates at 25 percent per year. Charles plans to mow 400 yards per year. What is Charles's implicit cost of production?
Charlie's implicit cost of production is $6160.
In deciding between consuming more goods now or saving money, consumers should do which of the following?
Choose an amount of current spending on goods and savings so that the marginal utility per dollar of both are equal.
A firm sells 10,000 units of X per month at the market price of $10. There are many other firms in this industry producing the same variety of X. With all firms producing an identical product, each firm is a price taker in this market. Farah Mahmood and her friend Daniela Rodriguez, both students of economics, are debating the impact of a recent increase in the demand for X. Farah feels that the demand faced by each firm will shift to the right. This in turn will increase the market price. Daniela meanwhile is not sure how much the price will rise because she thinks that the immediate response to the higher demand will be a rightward shift in each firm's supply curve. There were fifteen other firms producing 10,000 units of X per month at $10. When the demand increased, the equilibrium price went up to $11 and two new firms entered the market for X. In spite of this new entry, the supply of X by each firm increased to 10,500 units per month. Which of the following is most strongly supported by this information?
Each firm faces a perfectly elastic demand curve at $11.
When are firms likely to enter an industry? When are they likely to exit?
Economic profits attract firms to enter an industry, and economic losses cause firms to exit an industry.
Suppose a study shows that the demand for Goodyear tires is more elastic than the demand for all tires. What could be a likely explanation for this? The demand for Goodyear tires could be more elastic than the demand for all tirestires because
Goodyear tires are more narrowly defined.
Considering only the income effect, if the price of an inferior good declines, would a consumer want to buy a larger quantity or a smaller quantity of the good?
If the price of a good declines, the consumer has greater purchasing power, so he would want to purchase less of an inferior good.
The chapter states that: "When the price of a normal good falls, the income and substitution effects work in the same direction." This statement means:
If the price of a normal good falls, the income effect will increase quantity demanded while the substitution effect will increase quantity demanded, so these two effects are in the same direction.
Bob is a general contractor in the construction industry. Suppose the construction industry is perfectly competitive. In the short run, assume the marginal cost of building new homes equals the market price of a new home when Bob builds 10 new homes. At this level of output, Bob's average fixed cost of building a new home is $280,000 and his average variable cost is $160,000 per home (so his average total cost is $440,000 per home). If new homes are selling for $230,000, should he continue to produce 10 new homes in the short run or shut down?
In the short run, Bob should produce and lose $2,100,000.
When does the law of diminishing marginal utility hold true?
It holds true in most situations involving the consumption of a good.
Suppose Jill Johnson operates her pizza restaurant in a building she owns in the center of the city. Similar buildings in the neighborhood rent for $4,000 per month. Jill is considering selling her building and renting space in the suburbs for $3,000 per month. Jill decides not to make the move. She reasons, "I would like to have a restaurant in the suburbs, but I pay no rent for my restaurant now, and I don't want to see my costs rise by $3,000 per month." What do you think of Jill's reasoning?
Jill is incorrectly ignoring the opportunity cost of using the building she owns.
Is Jill Johnson correct when she says the following: "I am currently producing 10,000 pizzas per month at a total cost of $70,000. If I produce 10,001 pizzas, my total cost will rise to $70,050. Therefore, my marginal cost of producing pizzas must be increasing."
Jill's average total cost of production is increasing, so her marginal cost of producing pizzas must be increasing.
Which of the following statements is true when the difference between TR and TC is at its maximum positive value?
MR=MC Slope of TR=Slope of TC
Is it possible for a firm to experience a technological change that would increase the marginal product of labor while leaving the average product of labor unchanged? Explain.
No. An increase in the marginal product of labor will increase the average product of labor.
Sally looks at her college transcript and says to you, "How is this possible? My grade point average (GPA) for this semester's courses is higher than my GPA for last semester's courses, but my cumulative GPA still went down from last semester to this semester." Explain to Sally how this is possible.
Sally's GPA for this semester is lower than her cumulative GPA.
What is the difference between technology and technological change?
Technology is the process of using inputs to make output, while technological change is when a firm is able to produce more output using the same inputs.
Older oil wells that produce fewer than 10 barrels of oil a day are called "stripper" wells. Suppose that you and a partner own a stripper well that can produce eight barrels of oil per day and you estimate that the marginal cost of producing another barrel of oil is $80. In making your calculation, you take into account the cost of labor, materials and other inputs that increase when you produce more oil. Your partner looks over your calculation of marginal cost and says: "You forgot about that bank loan we received two years ago. If we take into account the amount we pay on that loan, its adds $10 per barrel to our marginal cost of production." Which of the following statements is most true?
The bank loan should not be included in marginal cost because it cannot be avoided by not producing another barrel.
What is the definition of marginal utility?
The change in utility from consuming an additional unit of a good or service.
A firm producing good Y recently increased monthly production from 1,500 units to 2,000 units. This had no impact on the market price of good Y. At the new production level of 2,000 units, the firm's average cost is $3.5 while its marginal cost of production is $4. The marginal revenue however is fixed at $5 for all levels of output. Jake Williamson is the operations head of the firm. Jake feels that, since the firm has the capacity, it should have increased production further to 2,500 units which would have maximized profits. On the other hand, Mathew Hayden of the market research team anticipates an increase in price to $5.5 in the near future. He therefore claims that the firm may not be maximizing economic profit in the short run even at 2,500 units. Jake and Mathew will most likely agree on which of the following?
The firm should increase production from the current level.
Suppose a pizza parlor has the following production costs: $5.00 in labor per pizza, $1.00 in ingredients per pizza, $0.50 in electricity per pizza, $3,000 in restaurant rent per month, and $250 in insurance per month. What is the fixed cost of production (per month)?
The fixed cost of production is $3250.
When XYZ firm entered the market for good A two years back, it kept the price of its product low to attract customers away from its leading competitor. The firm has now established itself and has a market share of 20 percent. The management of XYZ is planning to increase price of A from the current $6 per unit to $7 per unit. Timothy Walters, the marketing head, however, feels this is not a good idea because it will reduce quantity demanded drastically from the current 1,200 units to 900 units. His colleague and the head of the sales department, Jake Mayers, feels that the quantity demanded would only decline by 250 units. According to Jake, the firm can afford to increase the price because even after the price increase they would still have significant market share. Which of the following, if true, would imply that the firm is operating in the inelastic portion of the demand curve?
The quantity demanded declines by 10 percent in response to the $1 price increase.
A student in a principles of economics course makes the following remark: "The economic model of perfectly competitive markets is fine in theory but not very realistic. It predicts that in the long run, a firm in a perfectly competitive market will earn no profits. No firm in the real world would stay in business if it earned zero profits." Is this remark correct or incorrect?
The remark is incorrect because the student has confused accounting profit and economic profit. Firms in a perfectly competitive market earn accounting profit, but no economic profit.
Briefly explain whether you agree with the following observation: "Technological change refers only to the introduction of new products, so it is not relevant to the operations of most firms."
The statement is incorrect. Technology includes firm operations such as the training of its workers. The statement is incorrect. Technology includes firm operations such as the efficiency of its equipment.
Suppose a pizza parlor has the following production costs: $5.00 in labor per pizza, $1.00 in ingredients per pizza, $0.50 in electricity per pizza, $3,000 in restaurant rent per month, and $250 in insurance per month. Assume the pizza parlor produces 6,000 pizzas per month. What is the variable cost of production (per month)?
The variable cost of production is $39000.
Why are firms willing to accept losses in the short run but not in the long run?
There are sunk costs in the short run but not in the long run.
The Statistical Abstract of the United States is published each year by the U.S. Census Bureau. It provides a summary of business, economic, social, and political statistics. It is available for free online, and a printed copy can also be purchased from the U.S. Government Printing Office for $39. Because government documents are not copyrighted, anyone can print copies of the Statistical Abstract and sell them. Each year, one or two companies typically will print and sell copies for a significantly lower price than the U.S. Government Printing Office does. The copies of the Statistical Abstract that these companies sell are usually identical to those sold by the government, except for having different covers. How can these companies sell the same book for a lower price than the government and still cover their costs?
These companies decrease their average cost of production by increasing production from low levels.
Does purchasing a smaller (larger) quantity demanded when price falls (rises) mean that demand curves for inferior goods should slope upward?
This does not mean that the demand curves for inferior goods should slope upward as we must also take into account the substitution effect.
The Commerce Ministry of a country conducts regular surveys on goods and services sold within the country. Researchers at the Ministry study consumer behavior through the choices the consumers make while deciding what to buy. Their report on the industry for beverages last year indicated that the price elasticity of demand for fruit juices in the country was -0.8, while the price elasticity of demand for a particular brand called Fruit Drops was -1.2. According to the report, an average consumer spends about 1 percent of his monthly income on fruit juices. A student of economics, Julio, however feels that the current price elasticity of demand for Fruit Drops is actually higher than -1.2, based on his own experience in purchasing fruit juices. Which of the following, if true, would support Julio's view that the price elasticity of demand for Fruit Drops is higher?
Three new brands have been introduced in the market for fruit juices in the last month.
For which of the following products is the price elasticity of demand (in absolute value) the largest?
Tide liquid detergent
Explain how a downward-sloping demand curve results from consumers adjusting their consumption choices to changes in price.
When the price of a good declines, the ratio of the marginal utility to price rises, leading consumers to buy moremore of that good.
Suppose you decide to open a copy store. You rent store space (signing a one-year lease), and you take out a loan at a local bank and use the money to purchase 10 copiers. Six months later, a large chain opens a copy store two blocks away from yours. As a result, the revenue you receive from your copy store, while sufficient to cover the wages of your employees and the costs of paper and utilities, doesn't cover all of your rent and the interest and repayment costs on the loan you took out to purchase the copiers. Should you continue operating your business?
Yes, because you are covering your variable costs.
Suppose you have a monthly entertainment budget that you use to rent movies and purchase CDs. You currently use your income to rent 5 movies per month at a cost of $5.00 per movie and to purchase 5 CDs per month at a cost of $10.00 per CD. Your marginal utility from the fifth movie is 50 and your marginal utility from the fifth CD is 90. Are you maximizing utility? What could you do to increase utility?
You are not maximizing utility because the marginal utility per dollar spent on movies is not equal to the marginal utility per dollar spent on CDs. You could increase utility by consuming more movies and fewer CDs
The substitution effect is the change in the quantity demanded of a good that results from ______________, holding constant the effect of the price change on consumer purchasing power.
a change in price making the good more or less expensive relative to other goods
What is a price taker? A price taker is
a firm that is unable to affect the market price.
What is the difference between a firm's shutdown point in the short run and its exit point in the long run? In the short run, a firm's shutdown point is the minimum point on the
average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average total cost curve.
How is the market supply curve derived from the supply curves of individual firms? The market supply curve is derived
by horizontally adding the individual firms' supply curves.
Suppose Farmer Lane grows and sells cotton in a perfectly competitive industry. The market price of cotton is $1.44 per kilogram, and his marginal cost of production is $1.65 per kilogram, which increases with output. Assume Farmer Lane is currently earning a profit. Can Farmer Lane do anything to increase his profit in the short run? Farmer Lane
can increase his profit by producing less output.
Suppose a consumer is trying to decide how much to spend on housing and how much to spend on all other (non-housing) consumption. The economic model of consumer behavior predicts that the consumer will
choose the combination of housing and non-housing consumption that makes her as well off as possible from among the combinations of housing and non-housing items she can afford.
The law of diminishing marginal utility suggests that
consumers experience diminishing additional satisfaction as they consume more of a good or service.
According to a news story, the Boston-based game company Proletariat launched its first mobile game, World Zombination, after having "spent nearly 18 months and $2 million to develop it." In the first three months following the game's release in February 2015, it was downloaded more than three 3 million times. Yet the firm was just breaking even on the game. If game companies can only break even on the mobile games they develop, in the long run, we would expect them to
continue to develop mobile games because they can cover all costs of production if they break even.
Which of the following is most likely to a variable cost for a business firm?
cost of shipping products
If the demand for orange juice is inelastic, will a decrease in the price of orange juice increase or decrease the revenue received by orange juice sellers? If the price of orange juice decreases, revenue will
decrease.
As the level of output increases, what happens to the difference between the value of average total cost and average variable cost? As the level of output increases, the difference between the value of average total cost and average variable cost
decreases because average fixed cost decreases as output increases.
Maya spends her $50 budget on two goods, cans of tuna and bottles of ginger ale. Initially, the marginal utility per dollar she spends on tuna is equal to the marginal utility per dollar she spends on ginger ale. Then the price of ginger ale decreases, while her income and the price of tuna does not change. Her marginal utility from consuming ginger ale The marginal utility per dollar she spends on ginger ale Because of the substitution effect, Maya will buy more ginger ale. Can we conclude that ginger ale is a normal good? As Maya adjusts to the change in the price of ginger ale, her marginal utility per dollar spent on tuna will
does not change. increases No, because normal and inferior good designations are related to the income effect, not the substitution effect. increase because she will buy less tuna.
If a 20 percent increase in the price of Red Bull energy drinks results in a decrease in the quantity demanded of 25 percent, demand for Red Bull is _______ in this range.
elastic
According to an article in the Wall Street Journal, as a result of U.S. consumers increasing their demand for beef, in 2015 world beef prices increased. For example, according to the article, "Australian beef prices are up 40% this year, while New Zealand prices are 17% higher." The article observed, "The gains show no signs of stopping, given the [increasing] U.S. demand...." If U.S. demand for beef continues to increase, in the long run, beef prices will
fall because the supply of beef will increase as new firms enter the industry.
Any cost that remains unchanged as output changes represents a firm's
fixed cost.
The short-run average cost can never be less the long-run average costs because
in the long run, all inputs are adjusted including the ones that are fixed in the short run.
The income effect causes quantity demanded to ________ when the price of a normal good decreases, and causes quantity demanded to ________ when the price of an inferior good decreases.
increase; decrease
According to a news story about the bus system in the Lehigh Valley in Pennsylvania, "Ridership fell 14 percent in 2012 after a 33 percent increase" in bus fares The demand for bus trips is The best explanation for this result is that
inelastic bus trips are a necessity for those without cars.
Coca-Cola has been focusing on selling more 7.5-ounce cans in displays near supermarket checkout lines. Previously, Coke had relied more heavily on 20-ounce bottles displayed in the beverage sections of supermarkets. A news story noted that, "The smaller 7.5 ounce mini-cans are typically priced at five to seven cents an ounce, compared with three or four cents an ounce for 12-ounce cans." It quoted a Coca-Cola executive as arguing about consumers that, "They don't care about the price. They will pick it up if you put Coke within arm's reach". The Coca-Cola executive is assuming that the demand for Coke is If the Coca-Cola executive is correct, the effect of this marketing strategy should be to The executive believed that having the cans "within arm's reach" in the checkout line was important because it could result in
inelastic because he says consumers "don't care about the price." increase the firm's revenue. more impulse buying on the part of shoppers, reinforcing the elasticity of demand.
Is the demand for agricultural products elastic or inelastic? Why? The demand for agricultural products is
inelastic because such products represent a small share in the consumer's budget.
Which of the following is most likely to be a fixed cost for a farmer?
insurance premiums on property.
The price elasticity of demand in the United States for crude oil has been estimated to be −0.061 in the short run and −0.453 in the long run. The demand for crude oil
is more price elastic in the long run than in the short run because in the long run a substitute for crude oil may be found.
When the price of a product changes,
it changes the relative price of the product causing a substitution effect and at the same time it changes the purchasing power of the buyer causing an income effect as well.
When are firms likely to be price takers? A firm is likely to be a price taker when
it represent a small fraction of the total market.
The price elasticity of demand for a particular brand of raisin bran is, in absolute value,
larger than the price elasticity of demand for all breakfast cereals.
An article in the Wall Street Journal discussed the purchase of the small Zipcar rental car firm by the much larger Avis. The article predicted that the purchase would be successful because of the "efficiencies gained by putting the two companies together." The article also observed that: "On its own, Zipcar is too small to achieve economies of scale." A rental car company can realize benefits from economies of scale by How are efficiencies realized when combining two firms? If Avis and Zipcar, before the merger, each were already as efficient as possible as stand alone companies, would a merger provide any additional possible efficienies for the combined company?
leveraging its purchasing power when buying new cars. Cutting the overlap between the two firms and leveraging fixed costs across greater quantities. Yes, because economies of scale would increase.
According to an article in Forbes, the cost of materials in Apple's iPhone 6 with 16 gigabytes of memory was estimated to be $227. Apple was selling the iPhone 6 for $650. Most phone carriers, like AT&T and Verizon, made payments to Apple that reduced the price to consumers to $200. Can we conclude from this information that Apple is making a profit of about $423 per iPhone? Briefly explain. Apple's profit is
likely less than $423 per iPhone because Apple also has fixed costs of production.
What are the three conditions for a market to be perfectly competitive? For a market to be perfectly competitive, there must be
many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market.
What effect will firms exiting have on the market price? When firms exit,
market supply will decrease, increasing price.
Ardenia is a small, open economy. Its market for breakfast cereals can be considered competitive, with many producers and limited product differentiation. At the current market price of $10, a representative firm supplies 1,000 twenty-ounce packs of cereals per month. This allows the firm to earn $1,500 in economic profits. When the demand for cereals increased and the price went up to $10.5 per twenty-ounce pack, an industry analyst claimed that this would ensure a higher market share for each existing producer. This conclusion is flawed because:
new firms are likely to enter the market and compete away the profits.
A firm producing good Y recently increased monthly production from 1,500 units to 2,000 units. This had no impact on the market price of good Y. At the new production level of 2,000 units, the firm's average cost is $3.5 while its marginal cost of production is $4. The marginal revenue however is fixed at $5 for all levels of output. Jake Williamson is the operations head of the firm. Jake feels that, since the firm has the capacity, it should have increased production further to 2,500 units which would have maximized profits. On the other hand, Mathew Hayden of the market research team anticipates an increase in price to $5.5 in the near future. He therefore claims that the firm may not be maximizing economic profit in the short run even at 2,500 units. Mathew is assuming that:
no new firms enter the market in the short run.
A firm sells 10,000 units of X per month at the market price of $10. There are many other firms in this industry producing the same variety of X. With all firms producing an identical product, each firm is a price taker in this market. Farah Mahmood and her friend Daniela Rodriguez, both students of economics, are debating the impact of a recent increase in the demand for X. Farah feels that the demand faced by each firm will shift to the right. This in turn will increase the market price. Daniela meanwhile is not sure how much the price will rise because she thinks that the immediate response to the higher demand will be a rightward shift in each firm's supply curve. Farah's claim that each firm's demand curve will shift right is flawed because:
she is confusing the demand curve faced by the firm with the market demand curve.
A study analyzed the costs to a pharmaceutical firm of developing a prescription drug and receiving government approval. An article in the Wall Street Journal noted that included in the firm's costs was "the return that could be gained if the money [used to develop the drug] were invested elsewhere." Briefly explain whether you agree that this return should be included in the firm's costs. This return
should be included in the firm's costs because the opportunity cost of the firm's investment is one of the firm's implicit production costs.
If the marginal product of labor is falling, is the marginal cost of production rising or falling? Briefly explain. If the additional output from each new worker is falling,
the marginal cost of that output is rising because the only additional cost to producing more output is the additional wages paid to hire more workers.
Explain why it is true that for a firm in a perfectly competitive market, the profit-maximizing condition MR = MC is equivalent to the condition P = MC. When maximizing profits, MR = MC is equivalent to P = MC because
the marginal revenue curve for a perfectly competitive firm is the same as its demand curve.
How is the price elasticity of demand measured? The price elasticity of demand is measured as
the percentage change in the quantity demanded divided by the percentage change in price.
An article in the Wall Street Journal about the financial problems of the New York Metropolitan Opera contained the observation that "a ticket-price increase in 2012 backfired." The observation that an increase in ticket prices to the opera "backfired' means that The demand for opera tickets to the Metropolitan Opera is
total revenue from ticket sales decreased following the price increase. elastic because total revenue from ticket sales decreased following the price increase.
Any cost that changes as output changes represents a firm's
variable cost.
Consider the market for Post raisin bran cereal. The demand for this product would become more elastic if it
were defined more narrowly.
Economies of scale occur
when a firm's long-run average costs decrease with output.
What are diseconomies of scale? Diseconomies of scale is
when a firm's long-run average costs increase with output.
Explain why the marginal cost curve intersects the average total cost curve at the level of output where average totaltotal cost is at a minimum. The marginal cost curve intersects the average total cost curve at the level of output where average total cost is at a minimum because
when the marginal cost of the last unit produced is below the average, it pulls the average down, and when the marginal cost is above the averge, it pulls the average up.
