ECON-2302 Inquizitive Ch. 8 - Business Costs & Production
Match the type of scale to the situation it describes.
A national movie theater chain has advantages in advertising costs but has high payroll costs because of its many levels of management ~N/A A large computer company hires many specialists to produce its product and is able to save money by buying supplies in bulk ~economies of scale [In this case, costs decline as output expands] A national car company increases the number of dealerships but has to hire more labor so the costs of running each dealership remains the same ~constant returns to scale [In this situation, costs remain the same as output expands] An international investment banking company has a huge bureaucracy that slows down the decision-making process and increases costs ~diseconomies of scale [In this situation, costs and output expand in the long run] *[Companies strive to achieve economies of scale in order to keep costs down and production up]
What are examples of the factors of production that affect the output of a car repair shop?
Affects the Output ~the amount of space available to accommodate cars in the garage [This is an example of land: if the shop is small, only a few vehicles can be serviced at any one time] ~the number of mechanics at the shop [This is an example of labor: if more people work at the shop, cars can be fixed faster] ~the tools in the garage [This is an example of capital: if the shop does not have tools, it cannot fix cars] Does Not Affect the Output ~the number of people who own cars near the shop [Although this could affect demand, it does not affect the potential output of the shop] ~the number of competing car repair shops nearby [More competition could lower the market price for car repair, but it does not affect the potential output of the shop] *[The company can increase or decrease the number of inputs to raise or lower its output]
Yael decides that she no longer enjoys her job, and she quits to open a gluten-free, dairy-free kosher bakery. She pays a monthly rent for her store of $2,000. Her labor costs for one month are $4,500, and she spends $6,000 a month on nut flours, sugar, and other supplies. Yael was earning $2,500 a month working as a bank teller. These are her only costs. Her monthly revenue is $14,000. Which of the following statements about Yael's costs and profit are correct?
Correct Answer(s) ~An economist would tell her that she is experiencing a loss [Economic profit subtracts all costs (explicit and implicit) from total revenue] ~Her explicit costs include the labor, rent, and supplies for her store [Explicit costs are paid out-of-pocket] ~An accountant would say she is earning a monthly profit of $1,500 [Accounting profit subtracts only explicit costs from total revenue] ~Her implicit costs are $2,500 a month [Implicit costs are opportunity costs, and she is sacrificing her income as a bank teller] Incorrect Answer(s) ~Her economic profit is $1,500 a month [Economic profit subtracts all costs (explicit and implicit) from total revenue] ~Her total costs are $12,500 a month [Total costs include both explicit and implicit costs] *[Accountants and economists view profit differently because economists include the value of all implicit costs of doing business. A business owner may be earning an accounting profit but experiencing an economic loss]
What are examples of explicit costs?
Explicit Cost ~paying for gas for a company vehicle [If a business owner has a company vehicle, the cost to fill it with gas is a tangible expense incurred to run the business] ~paying an employee's wages [Every month business owners must pay their employees a specific wage] Not an Explicit Cost ~the amount of money an owner could have made by raising prices [This hypothetical situation is not an explicit cost, which requires an outlay of money] ~the amount of money the owner of a new business could have made by investing in the purchase of stocks and bonds instead of putting the funds into the business [This is an example of an implicit cost] ~the cost of the business owner's time and labor [Many owners do not earn a direct salary, so they must take into account the income they could make if they worked someplace else] *[Explicit costs are tangible out-of-pocket expenses. Explicit costs are much more easily calculated than implicit costs]
Jeff works at a grocery store in the summer. One year he considers the possibility of operating and owning a hot dog stand instead of working at the store. What are some of the implicit costs Jeff might have to consider when thinking about his new business venture?
Implicit Cost To Consider ~the income he would lose from not working at the grocery store [Jeff does not know how much he will make from the hot dog stand, but he already knows he would lose income if he does not work at the grocery store] ~how much his time is worth [Since Jeff will own and operate his own hot dog stand, it is likely he will have to put in many hours to prepare and clean the stand and buy supplies. He will need to consider how much his personal time is worth, because he will be spending much of it on his business] Not an Implicit Cost To Consider ~the cost of hot dogs [This is an explicit cost. Jeff will have to buy the hot dogs with money] ~the cost of fuel for the cart [This is an explicit cost. Jeff will have to buy the fuel with money] ~the purchase price of the hot dog cart [This is an explicit cost. Jeff will have to buy the cart with money] *[Jeff will have to spend money on the explicit costs of running his business (on the cart, hot dogs, fuel, etc.) and then he will also consider his implicit costs and determine if he can make an economic profit worth quitting his job]
Carla owns a small cake shop with three inexperienced employees and would like to lower her costs in the long run to make her company more efficient. Which of the following is true about her desire to lower her average total costs in the long run?
True Statement(s) ~Carla can purchase supplies in bulk for a lower price [By buying in bulk, Carla will save money and decrease her average variable cost, thus increasing her chances of operating with an economy of scale] ~Carla can negotiate better rent terms with her shop's landlord [In the long run, even fixed costs such as rent are variable] ~Carla can expand the size of her shop and hire a master baker to improve efficiency [If Carla hires expert employees, she can attempt to achieve an economy of scale because her efficiency will increase through specialization, and the total cost per output will decrease] False Statement(s) ~Carla can hire an accountant firm to double-check her financial records [For such a small company, extra layers of management would cause Carla's cost to increase without expanding her output, thus forcing her into a diseconomy of scale] ~It is not possible to lower costs significantly in the long run [In the long run all costs are variable; thus, it is possible for a firm to raise or lower its costs] *[Carla's company is small, but by taking the right steps it is possible to lower costs in the long run and achieve an economy of scale]
Carolina used to work as a teacher, and she would make $4,000 a month. She now owns and runs Carolina's Cupcake Shoppe. In the month of April this year, Carolina spent $1,100 on ingredients (eggs, flour, sugar, etc.) and $400 on utilities (electricity, water, etc.). Her labor costs were $3,000. She owns and uses a storefront for her shop that she previously rented out for $1,500. Lastly, Carolina brought in $10,000 in revenue in April. Based on this information, select whether the following statements are true or false.
True Statement(s) ~Ingredients and utilities would be considered variable costs [Costs that change with the amount of output are variable] ~The storefront rental is an implicit cost [The opportunity cost of running the cupcake shop is forgoing the money that Carolina could earn by renting it out] False Statement(s) ~Carolina's economic profit is $0, so her shop's bank account remains unchanged [Revenue ($10,000) - explicit costs ($4,500) = $5,500 (the accounting profit). Carolina is adding to her shop's bank account with her profits. Economic profit considers opportunity costs; it does not factor into your bank account balance] ~The accounting profit is $4,500 [Accounting profit is revenue - explicit costs. Determine how you would describe each of the costs, make a list, and then determine the profit (economic and accounting)] ~The total explicit costs are $6,000 [To get $6,000 in total explicit costs, an implicit cost must have been added. Explicit costs are only "out of pocket."] *[Carolina is making an accounting profit of $5,500, but because her implicit costs ($1,500 + $4,000) total $5,500, she has $0 economic profit. That does not mean she would choose to close her shop. If she closed her shop, she could make $4,000 as a teacher and collect $1,500 in rent, but then the implicit cost would be the $5,500 profit she would not earn selling cupcakes. Her economic profit is $0 in both cases]
What are some of the variable costs of running a flower shop?
Variable Cost ~cost of inventory [The owner will carry a different amount of plants and flowers depending on the demand] ~water for plants [The owner will use a different amount of water each month, depending on the weather and the amount of inventory on hand] ~cost of plant food [If the owner has more flowers on hand, more plant food may be needed] Not a Variable Cost ~insurance [The shop owner's insurance payments will not change based on the number of flowers sold] ~rent [Rent for the shop is a fixed cost] ~property taxes [Property taxes are based on the value of the property and not the amount of flowers sold on the property] *[It is easy to plan for fixed costs, because the manager will know what they are each month. Variable costs are harder to plan for, because they are constantly changing, depending on the rate of output]
Consider a restaurant operating during the COVID-19 pandemic. Identify each cost as either fixed or variable in the short run.
additional cleaning supplies to combat the spread of the coronavirus ~variable [These are variable costs. Would the company have to purchase these if it had no customers?] a tent rental to enable curbside pickup due to local social distancing regulations ~fixed [The rental is not a consumable, a product that gets used up in the production of restaurant meals. Therefore, the owner would have to pay the rental for the tent regardless of whether he or she had zero customers or 100 customers] rent ~fixed [Rent for the restaurant will be a fixed cost] the salary paid to a firm to create a mobile app menu ~fixed [This cost is not impacted by the number of meals a restaurant produces, so it is a fixed cost] insurance ~fixed [Insurance is not impacted by the number of meals a restaurant sells in a given period] disposable menus ~variable [An increase in customers requires an increase in disposable menus] *[If the cost of the resources varies with the amount of output the restaurant produces, then the cost is variable. On the other hand, if the amount of output the restaurant produces does not change the cost of the resource, the cost is fixed]
A firm considers hiring more workers. Where on the graph does hiring another worker increase total output and where on the graph does hiring another worker decrease total output? Apply the correct labels to each part of the graph.
green area ~increase [The marginal product of labor is increasing here. More workers will increase the total output per worker] yellow area ~increase [The marginal product of labor is decreasing but still positive in this area, and each additional worker still increases the total output] red area ~decrease [At this point, adding workers will actually lower production] *[When the marginal product of labor is positive, hiring an additional worker will increase total output]
What is the relationship between the marginal product of labor and total output? Drag the marginal product labels to the appropriate sections of the total product graph.
green area ~increasing marginal product [When marginal product increases, total output rises at an increasing rate] yellow area ~diminishing marginal product [When marginal product is diminishing but still positive, total output rises at a slower rate] red area ~negative marginal product [When marginal product becomes negative, total output falls] *[Because the marginal product is the change in output associated with one additional unit of input, the rate of change in the marginal product determines how much total output can be produced with additional inputs]
In the long run, firms can control their costs by adjusting the scale of their production process. Drag the appropriate description of the relationship between output and cost to the end of the correct long-run average total cost curve.
orange slope ~With more output comes higher costs [Firms on this curve experience diseconomies of scale. Their costs will increase as their production expands] red slope ~Costs remain constant regardless of output [Firms on this curve experience constant returns to scale. They can compete with large firms and small firms as their costs are all the same] purple slope ~As output expands, cost declines [Firms on this curve experience economies of scale. Their costs decrease as output expands] *[It is not always better to be a large firm. Some industries experience very high costs when firms are large]
Label each resource with the factor of production it represents.
the size of a college campus ~land [If a college has more land, it can build more academic buildings to serve more students] a personal trainer for a gym ~labor [A gym needs personal trainers to help the customers exercise] a drum set for a band ~capital [A band needs instruments in order to play shows] a team of volunteer homebuilders ~labor [Volunteer labor is still labor] *[The factors of production will influence the total output of a firm. If a company has too much or too little of any one factor, its total output could be hurt]
Jean decides to operate a painting business out of his home. Which of the following types of costs would represent fixed costs and variable costs for his painting business?
wages for workers ~variable [The more painting he does, the more workers he will need] tires and oil changes ~variable [The more he drives his truck, the more he will need to spend on truck maintenance] truck payment ~fixed [The monthly truck payment is the same no matter how many customers he serves] paints, brushes, and supplies ~variable [The more painting he does, the more he will have to spend on painting supplies] cell phone plan with unlimited usage ~fixed [The monthly cell phone plan costs the same no matter how many clients he serves] mortgage payment ~fixed [The monthly mortgage payment is the same no matter how many customers he serves] *[Fixed costs stay constant no matter how much output is produced. Variable costs increase as the amount of output increases]
Match each factor of production with its definition.
workers ~labor money, in the form of cash, stocks, bonds, etc. ~N/A physical resources used to create the final product ~capital [Rubber used to make soles for boots would be an example of capital] a geographic location used in production ~land
Calculate the monthly implicit costs for a business owner who devotes 200 hours per month to his business that could be spent working at $50/hour for someone else.
~$10,000 [This is income the owner passes up by being in business for himself] *[200*50=10000]
The table below lists Bruno's Custom Bike Shop's costs and revenue for the month of May: Bike Parts: $5,000 Shop Rent: $1,000 Large Print Sign Advertisements: $50 Electric Bill: $150 Total Bike Sales: $9,000 Based on this information, determine Bruno's Custom Bike Shop's accounting profit for the month of May.
~$2,800 [The accounting profit would be $9,000 (the total revenue) - $6,200 (the sum of the explicit costs) = $2,800]
A company that manufactures computers has a monthly fixed cost of $1,000. If it sells 400 computers each month, what is its average fixed cost?
~$2.5 [If the company wants to reduce its average fixed costs, it can increase its output] *[1000/400=2.5]
Calculate the weekly profit for a company with a total cost of $10,000 and a total revenue of $30,000.
~$20,000 [Calculate the profit by subtracting the total cost from the total revenue. In this case, $30,000 - $10,000 = $20,000]
Place the numbers in the appropriate locations to complete the table showing total output and marginal product of labor, where diminishing marginal product begins with the third worker. Number of workers 0, 1, 2, 3, 4, 5 Total output (number of meals served per hour) 0, 5, -, -, -, 52 Marginal labor of product 5, 10, 15, -, 10
~15 ~30 ~42 ~12 [The "marginal product of labor" column shows the sequence of differences in the "total output" column]
This graph shows a production function as more workers are added. Select the workers whose marginal product increases output by 15 units.
~2 [The marginal product of the second worker is 15 (25, output of second worker minus 10, output of first worker). In this region of workers, adding another worker adds more to output than the previous worker did] ~6 [The marginal product of labor for the sixth worker is 15 (96, output of sixth worker minus 81, output of fifth worker). In this region of workers, adding another worker adds less to output than the previous worker did] *[An additional worker can add to total output, but while it may start with increasing marginal product, the rate of adding to the total output eventually slows. The addition of one more input (labor) will reach diminishing marginal product]
Calculate the marginal product of labor for a car repair shop that adds two mechanics and begins fixing five extra cars each week.
~2.5 [This means that each additional mechanic was responsible for increasing the output by 2.5 cars each week] *[5/2=2.5]
A television production firm is able to produce TVs according to the short-run production table below. With the hiring of which worker would the diminishing marginal product begin? Select the correct number on the table. Number of workers 0, 1, 2, 3, 4, 5, 6, 7, 8, 9 Total output of TV per day 0, 30, 70, 125, 185, 225, 250, 260, 255, 240 Marginal product 0, 30, 40, 55, 60, 40, 25, 10, -5, -15
~5 | 225 [Diminishing marginal product begins to occur when the next worker hired produces less additional output than the previous worker] *[The third column shows the marginal product of labor. The marginal product is highest with the fourth worker and begins to fall with the hiring of the fifth worker]
Perry's Pie Shop will produce only the possible number of pies listed in the chart. Given the fixed and variable cost, determine which positive output will result in the lowest average total cost (ATC). Quantity (Q = Pies) 0, 10, 20, 30, 40, 50, 60, 70, 80, 90, 100 Total variable cost (TVC) 0, 30, 50, 65, 77, 87, 100, 120, 160, 220, 300 Total fixed cost (TFC) 60
~70 [180 divided by 70 would be 2.57, so this would result in the lowest ATC] *[To find the output with the lowest ATC, you first need to calculate ATC. To find ATC, divide the total cost (TC) by the quantity (Q)]
The graph below represents the short run cost functions for a firm. At an output of 50 units, which vertical portion of the costs represents the average fixed costs (AFC)?
~A to B [At 50 units: A to 0 represents ATC, while B to 0 represents the average variable cost (AVC), so average total cost (ATC) - AVC = AFC, which is A to B]
Bill owns a grocery store chain with 2,000 total employees. Nine hundred of his employees are managers. What can we assume about the total productivity of Bill's chain?
~Bill is in danger of experiencing a diseconomy of scales [Almost half of Bill's employees are managers of some kind. This will reduce his company's productivity and cause costs to increase as output expands]
Fill in the blanks to explain the difference between economic profit and accounting profit. - is calculated by subtracting both the explicit and the implicit costs from the total revenue. - is calculated by subtracting the explicit costs from the total revenue. Economic profit is always - than accounting profit, because it considers implicit costs as part of the -.
~Economic profit ~Accounting profit ~less ~total cost *[Economic profit gives a more complete assessment of how a firm is doing, because it takes into account all types of costs incurred by the company]
Fill in the blanks to explain how costs are different in the long run compared with the short run. In the long run, - costs are variable and firms have - control over their costs. In the short run, costs are related to -. In the long run, costs are related to -.
~all ~more ~diminishing marginal product ~scale *[In the short run managers can only control variable costs, such as how many employees to hire or how much inventory to have on hand. In the long run, managers can vary all their costs and can expand or decrease the size of their operation to best suit their production goals]
Which statement accurately describes the relationship between average fixed costs and output?
~average fixed costs will always decline as the output increases [As output expands, a firm's total fixed costs are spread over more units, thus decreasing the average fixed costs]
Darla started a business making designer dog houses. In year 1, the total yearly costs were $10,000 and she produced 125 dog houses. In year 2, Darla decided to expand her business, and total yearly costs increased to $14,000 and she produced 175 houses. In year 3, success encouraged her to expand her business again; total yearly costs increased to $18,000 and she produced 225 dog houses. On what part of the long-run average total cost curve (LRATC) is Darla operating?
~constant return to scale [From year 1 to 3 the average cost remains $80 (TC/Q = LRATC). The output is expanding but the LRATC remains unchanged]
Fill in the blanks to explain whether it is better to have an accounting profit or economic profit, and why this is the case. It is better for a company to have an - profit because it means both - costs have been - the total revenue and the company is still profitable. An - profit only takes into consideration the explicit costs of doing business.
~economic ~implicit and explicit ~subtracted from ~accounting *[Economic profit is important to understand because the implicit costs of doing business can sometimes be very high. Accounting profit only takes into consideration the explicit costs]
In the long run, average costs can change depending on the output. Order the types of scales from falling long-run average total cost to rising long-run average total cost.
~economies of scale [Economies of scale occur when a firm is able to lower its LRATC as its output expands] ~constant returns to scale [When a firm's LRATC remains constant regardless of a higher output, the company will experience a constant return to scale] ~diseconomies of scale [When LRATC increase as output expands, a firm will experience diseconomies of scale] *[When a firm has fewer layers of bureaucracy and employees who specialize in what they do, it is likely that the firm will experience economies of scale because the company is running very efficiently]
Fill in the blanks to describe how expanding the scale of production affects production costs. Arnold and Helga decide to start selling homemade jewelry on Etsy to earn some extra income. However, the materials they use are expensive, and it takes them a long time to finish each piece of jewelry because they bicker about how it should look. This results in several attempts to redesign many pieces of jewelry. In short, their process is not -. Their daughter Phillipa suggests that they design the pieces before they start making the jewelry to help increase their -. They are able to make the jewelry more quickly and decrease their - cost of production. When Arnold and Helga are able to expand the size of their operation, they are able to experience -.
~efficient ~productivity ~average total ~economies of scale *[Economies of scale exist when the average total cost per unit of production decreases as the size, or scale, of production increases]
It is always good to have a high output because it spreads the total fixed costs over more units.
~false [As output increases, the total variable costs will also begin to increase until they cause the average total cost of each unit to increase]
In the long run, firms generally experience diseconomies of scale, first because the large initial costs are spread over a small amount of output. Eventually, economies of scale decrease the long-run average total costs (LRATC) as output increases.
~false [Diseconomies of scale (increasing LRATC) is unlikely to occur at the first levels of output. It is usually a result of a firm getting "too big" and becomes less effective when producing large amounts]
Hosea decides to support an entrepreneur on a new business venture. He sells $500,000 worth of stocks to put into the new business. By the end of the first year, he earns a rate of return of $25,000 on his financial investment in the business. Based on the average rate of return to stocks from the table below, Hosea made a good choice to support this new business. stocks 7% bonds 3% savings account @ financial institution 2%
~false [If Hosea had kept his money in stocks, he would have earned an average 7% return that year which is $35,000 ($500,000 × .07 = $35,000)]
Profit is the dollar amount a firm collects from its customers after selling its goods or services.
~false [Profit is the difference between the revenues collected from the sale of goods and services and the costs of producing those same goods and services]
Fill in the blanks to complete the passage about why firms do not always increase their production. Firms use cost data to make decisions about how many units to produce based on their - costs. Increasing production may not always lead to an increase in profit. Increasing production will cause a firm's - costs to increase, which could outweigh any benefits that were previously gained by lowering their overhead—which is determined by their - costs in the short run.
~fixed and variable [These make up total costs] ~variable ~average fixed
Fill in the blanks to explain what happens to total fixed and total variable costs as production increases. For every output created, a firm needs to spend money on capital, labor, and other -. Thus, - will increase with increasing output. The - are not tied to the rate of output. Those costs - in the - run.
~inputs ~total variable costs ~total fixed costs ~do not change ~short *[Firms must consider both the total variable costs and the total fixed costs to determine the average total cost of each output they create]
Examine the data on the chart, and select the production level where the average variable cost first begins to increase.
~quantity: 70, TVC: 120, TFC: 100, TC: 220, AVC: 1.71 [At this point, the average variable cost has begun to rise above its lowest point] *[Average variable costs can be a useful signal for firms that are deciding how much output to produce]
On the graph below, all costs have been removed except the average total cost (ATC) curve. The lowest point on the ATC curve, indicated by the black dot, occurs when the marginal cost (MC) curve intersects the ATC curve. Select the area of the graph where you would expect the marginal cost of producing a unit to be greater than the average total cost of producing the unit.
~right side of graph [Marginal cost always leads (or pulls) average variable cost and average total cost along]
Fill in the blanks to explain what a firm should do once it realizes it is in a situation with a diminishing marginal product. The firm - stop producing additional units. If marginal product is -, the firm should continue production if it can sell the output for more than the -costs.
~should not necessarily ~still high ~input [If a firm has a negative marginal product, total output will fall, but a diminishing marginal product is not always a bad thing]
Fill in the blanks to explain why it can be bad for a company to have too much labor. A company can take advantage of -, as the - of the first group of workers will increase, but at a certain point it will decline. At this point, - will continue to increase, but marginal product will diminish with each additional worker. Eventually there will be too many workers and not enough - to keep them busy, inevitably slowing down production and reducing output.
~specialization ~marginal product ~total output ~capital resources *[It is important for managers to determine how many employees to hire in order to maximize the company's resources without standing idle and decreasing output]
Which situation describes a company experiencing an accounting loss?
~the explicit costs are higher than total revenue [If a company spends more than it makes, it will incur a loss. This would also result in an economic loss since implicit costs would be added to explicit costs]
How do you calculate total cost?
~total cost = explicit costs + implicit costs [Although it is difficult to calculate implicit costs, both the explicit and implicit costs of doing business must be accounted for]
Review the table below, which shows the costs of producing Big Macs. Why does the total cost equal $100 even when there are zero Big Macs produced?
~total cost includes both fixed and variable costs, and fixed costs are incurred even when they are not producing [Fixed costs for inputs such as rent, property taxes, and insurance must be paid even when nothing is being produced. There are no variable costs when there is no output produced]
The efficient scale is the production quantity at which marginal cost equals average total cost.
~true [The efficient scale is the point of minimum average total cost. So long as each additional unit costs less than the average total cost, adding units drives the average total cost down. When each additional unit begins to cost more than the average total cost, adding units starts driving the average total cost back up]
