Econ 2102 Test 2 Prep

(Figure 21.5) Economies of scale occur in the following range of factory sizes

#1 through #3. Reductions in minimum average costs that come about through increases in the size (scale) of plants and equipment occur over the range of plant sizes 1 through 3.

If an additional unit of labor costs $20 and has a MPP of 15 units of output, the marginal cost is

$1.33.

(Table 21.2) The marginal cost per unit between 20 and 30 units of output is

$1.80.

(Table 21.5) The total variable cost of 2 units of output is

$12.

(Table 21.4) At 2 units of output, the average variable cost is

$13 AVC is equal to VC ($42 − $16) divided by quantity (2), which is $13.

(Table 21.5) Total fixed costs are equal to

$15.

(Table 21.4) At 4 units of output, total fixed costs are

$16.00.

(Table 21.5) The total cost of 3 units of output is

$30.

(Figure 21.2) What is the total cost of 120 units?

$34,560

(Table 21.5) The total variable cost of the first unit of output is

$8

(Table 22.1) Suppose the entrepreneur could earn $1,000 as an employee elsewhere. This means the accounting profit is

$925.

(Table 22.1) The accounting profit is equal to

$925.

(Table 21.4) For the output levels, the minimum of the average variable cost curve occurs at a production rate of

2 units per day. AVC is equal to VC divided by quantity. The AVC is $14, $13, $14, and $15.5 with output levels of 1 through 4, respectively. Therefore, AVC is minimized at 2 units of output.

(Table 21.1) What is the marginal physical product of the second unit of labor?

20

(Figure 22.1) The profit-maximizing output for this firm is

200 units.

(Table 21.4) For the output levels, the minimum of the average total cost curve occurs at a production rate of

3 units per day.

(Table 21.3) How many units of output can be produced when one unit of labor is employed?

30 Because the marginal physical product of the first worker is 30, the total units of output increased from 0 to 30 with the employment of one worker.

(Figure 22.3) For a perfectly competitive firm, at a market price of $23, the total profits are maximized at an output of

39

a. Compute the marginal physical product. b. At what amount of labor input does the law of diminishing returns first become apparent in the table of marginal physical product? c. Is total output still increasing when MPP begins to diminish? d. What is the value of MPP when output no longer increases?

A production function is the technological relationship expressing the maximum quantity of a good attainable from different combinations of factor inputs. Given three sewing machines, the production function is the number of jeans that can be produced with various numbers of workers. Refer to the given information in the table: jeans output for three sewing machines with labor inputs of 0 to 8 workers. a. Marginal physical product = Change in total output ÷ Change in labor input For example, the marginal physical product associated with the second worker is 29 [= (50 − 21) ÷ (2 − 1)]. You can see the law of diminishing returns, sometimes called the law of diminishing marginal productivity: The marginal physical product of a variable input declines as more of it is employed with a given quantity of other (fixed) inputs. b. The law of diminishing returns says that the marginal physical product of any factor of production, such as labor, will diminish at some point as more of it is used in a given production setting. In this case, marginal physical product initially increases; however, with the addition of the third worker, marginal physical product is smaller (or diminishes) compared to the marginal physical product of the previous worker. c. Marginal physical product diminishes at three units of labor, yet at three units of labor total output is increasing. Diminishes means simply to get smaller—it does not mean to become negative. As long as marginal physical product is positive, total physical product is increasing. d. Total output stops increasing with the eighth worker. Total output does not increase when the marginal physical product is zero and will decrease when marginal physical product is negative.

(Figure 21.4) A firm that produces between 600 and 800 units per period should choose a plant with a short-run average total cost function of

ATC2 only.

(Figure 21.4) A firm that produces over 800 units of output should choose a plant with which short-run average total cost function?

ATC3 only

Which of the following statements about the relationship between economic costs and accounting costs is true?

Accounting costs are always less than or equal to economic costs.

Complete the following table for a perfectly competitive firm and assume the firm can only produce in 5-unit increments (i.e., 5, 10, 15, 20, or 25 units).

Average total cost: ATC = Total cost ÷ Quantity Marginal cost: MC = Change in total cost ÷ Change in quantity = (TC2 − TC1) ÷ (Q2 − Q1) Average variable cost: AVC = Variable cost ÷ Quantity • Variable cost = Total cost − Fixed cost • Fixed cost = Total cost when Q = 0 (in this example, fixed cost = $100) • Therefore, AVC = (Total cost − Fixed cost) ÷ Quantity = (Total cost − $100) ÷ Quantity a. Any firm will maximize total profit (or minimize loss) at the output rate where marginal cost (MC) = marginal revenue (MR). Perfect competition is unique among the market structures because marginal revenue equals price for the firm. Therefore, the profit maximization for a perfectly competitive firm can also be identified as the output rate where price (p) = marginal cost (MC). If marginal cost is less than price, the firm can increase profits by producing more. If marginal cost exceeds price, the firm should reduce output. In this case, since price = $12, profit maximization with p = MC occurs at an output of 20 units. b. Total profit (or loss) = Total revenue − Total cost Total revenue = Price × Quantity Total cost is given in the table. In this case, the profit-maximizing price is $12 and the profit-maximizing quantity is 20 units. Total revenue is $240 (= $12 × 20), and total cost is $220. Therefore, the firm's profits is $20 (= $240 − $220). c. A firm may incur a loss even at the optimal rate of output. It shouldn't shut down, however, so long as price exceeds average variable cost. If revenues at least cover variable costs, the firm's operating loss is less than its fixed costs. Firms will continue to operate as long as their average variable cost is less than marginal revenue (or price.) Alternatively, a firm will shut down when the price falls below the minimum of the average variable costs. The minimum of the average variable cost occurs at $2.

(Figure 22.2) For a perfectly competitive firm, the profit-maximizing quantity of output is

D. A firm will maximize profit at a quantity where marginal revenue is equal to marginal cost.

Megan used to work at the local pizzeria for $15,000 per year but quit in order to start her own deli. To buy the necessary equipment, she withdrew $20,000 from her inheritance (which paid 8 percent interest). Last year she paid $25,000 for ingredients and $500 per month rent but had revenue of $50,000. She asked her dad the accountant and her mom the economist to calculate her costs for her.

Dad says her cost is $31,000, and Mom says her cost is $47,600.

Which of the following is the best explanation of why the law of diminishing returns does not apply in the long run?

In the long run, firms can increase the availability of space and equipment to keep up with the increase in variable inputs.

A competitive firm should always continue to operate in the short run as long as

MR > AVC.

Profit per unit is equal to

P - ATC.

If the marginal cost curve is rising, which of the following must be true?

Total costs must be rising.

Diminishing returns occur because

a firm increases the amount of a variable input without changing a fixed input.

a. Complete the following cost schedule by computing marginal cost, average fixed cost, average variable cost, and average total cost.

a. Marginal cost = Change in total cost ÷ Change in output For example, at output level 1, marginal cost = $50 [= ($350 − $300) ÷ (1 − 0)]. At output level 2, marginal cost = $150 [= ($500 − $350) ÷ (2 − 1)], and so on. Average fixed cost: Keep in mind that total cost = fixed cost + variable cost. When a firm is not producing any output (Q = 0), variable cost = $0. We can use this information to identify a firm's fixed costs. In this example, when Q = 0, fixed cost = $300. Total cost = Fixed cost + Variable cost $300 = Fixed cost + $0 Fixed cost = $300 Average fixed cost = Fixed cost ÷ Output At output level 1, average fixed cost = $300 (= $300 ÷ 1). At output level 2, average fixed cost = $150 (= $300 ÷ 2), and so on. Average variable cost: Keep in mind that total cost = fixed cost + variable cost. When a firm is not producing any output (Q = 0), variable cost = $0. We can use this information to identify a firm's variable cost. A firm's variable cost = total cost − fixed cost. In this example, fixed cost = $300. Then simply subtract this fixed cost from the total cost at every level of output to calculate variable cost. Average variable cost = Variable cost ÷ Output At output level 1, average variable cost = $50 (= $50 ÷ 1]. Average total cost = Total cost ÷ Output At output level 1, average total cost = $350 (= $350 ÷ 1]. At output level 2, average total cost = $250 (= $500 ÷ 2], and so on. b. Average total cost is minimized when average total costs are at their minimal or smallest level. In this case, the smallest average total cost occurs at output level of 3.

a. Calculate marginal physical product (MPP). b. When does marginal productivity first diminish?

a. Marginal physical product (MPP), also called marginal productivity, is the change in total output associated with one additional unit of input. MPP = Change in total output ÷ Change in input quantity = (Q2 − Q1) ÷ (Labor2 − Labor1) For example, the third worker's marginal productivity is 150 [= (1,350 − 1,200) ÷ (3 − 2) = 150 ÷ 1]. b. The law of diminishing returns says that the marginal physical product of any factor of production, such as labor, will diminish at some point as more of it is used in a given production setting. In this example, diminishing returns (or diminishing productivity) starts when worker 2 is hired. In other words, the additional output from hiring worker 2 is less than the previous worker.

Suppose a company incurs the following costs: labor, $12,000; equipment, $4,000; and materials, $6,500. The company owns the building, so it doesn't have to pay the usual $2,300 in rent.

a. The accounting cost is associated with explicit dollar costs only. This means accounting costs would include the cost of labor, the cost of equipment, and the cost of materials. Accounting costs = $12,000 + $4,000 + $6,500 = $22,500. b. The total economic cost is calculated as the explicit costs plus the implicit costs. In this example, the explicit costs were calculated in part a (= $22,500). The implicit or opportunity cost in this example is the $2,300 in rent that the firm did not have to pay because it owned the building. Although the firm did not have to write a check for rent, the $2,300 must be included because it is the opportunity cost for the firm to stay in the building. Economic cost refers to the value of all resources used in the production process, which includes all implicit as well as explicit costs. Economic costs = $12,000 + $4,000 + $6,500 + $2,300 = $24,800. c. (i) Accounting costs would increase by $2,300 to $24,800. If the company has an additional monthly explicit payment of $2,300 for the lease, the accounting costs would increase by $2,300. (ii) Economic costs do not change; if the company sold its building and then leased it back, the implicit cost of renting the building would become an explicit cost. The total economic cost would not change; more specifically, the value of all resources used in the production process would not change and therefore economic cost would not change.

Assume the price of silk ties in a perfectly competitive market is $21 and that the typical firm confronts the following costs:

a. The profit-maximizing output is 8 units (where p = MC). If the price of ties is $21, the profit-maximizing output is when marginal cost = $21 (= 8 units). See the table below. b. The profit associated with the profit-maximizing output of 8 units is $46. See the table below. c. The profit-maximizing output is 9 units (where p = MC). If the price of ties is $23, the profit-maximizing output is when marginal cost = $23 (= 9 units). See the table below. d. A firm may incur a loss even at the optimal rate of output. It shouldn't shut down, however, so long as price exceeds average variable cost. If revenues at least cover variable costs, the firm's operating loss is less than its fixed costs. When price is $7, output would be 1 unit (p = MC). This would yield a profit of $7 − $17 = −$10. This is the same as the fixed cost of −$10. It is not necessary for the firm to shut down until price is less than $7, when the loss is equal to the lowest average variable cost.

(Figure 21.5) Diseconomies of scale begin to occur

after the third factory.

(Figure 22.3) For a perfectly competitive firm, if the market price is $10,

an economic loss will occur.

Implicit costs

are the value of resources used for which no monetary payment is made.

Technical efficiency is achieved when a firm produces

at an amount indicated by a point on the production function.

The marginal physical product is the

change in total output associated with one additional unit of input.

A firm that makes zero economic profits

covers all its costs, including a provision for normal profit.

In making a production decision, an entrepreneur

decides what level of output will maximize profits.

The average fixed cost (AFC) curve

declines as long as output increases.

When the short-run marginal cost curve is upward-sloping,

diminishing returns occurs with greater output.

Greater-than-normal profit represents

economic profit.

As In-N-Out Burger increases the number of employees for a specific restaurant, the

efficiency will suffer as the restaurant becomes too crowded with employees.

In defining economic costs, economists emphasize

explicit and implicit costs while accountants recognize only explicit costs.

Which of the following costs do not change when output changes in the short run?

fixed costs

Sam's surf shop has total costs of $2,000 when it is not producing any surfboards. This means that

fixed costs are $2,000.

In the short run, when a firm produces zero output, the total cost equals

fixed costs.

Which of the following is a factor of production for the Little Biscuit Bread Company?

flour

The short run is the time period

in which some costs are fixed.

Economic cost

includes both implicit and explicit costs.

For perfectly competitive firms, price

is equal to marginal revenue.

Marginal cost

is the change in total cost associated with a one-unit increase in production.

In the short run, which of the following is most likely a variable cost?

labor and raw materials costs

Economic profit is

less than accounting profit by the amount of implicit cost.

Intel's chief executive says the company might expand the technology it is using in its planned $2.5 billion chip-manufacturing factory in China if the U.S. government allows it, underscoring the technology giant's ambitions in the world's fourth-biggest economy. The Intel executive is making a

long-run decision and therefore an investment decision.

If the marginal physical product (MPP) is falling, then the

marginal cost of each unit of output is rising.

Ceteris paribus, the law of diminishing returns states that beyond some point, the

marginal physical product of a factor of production diminishes as more of it is employed with a given quantity of other inputs.

The most desirable rate of output for a firm is the output that

maximizes total profit.

The profit motive can encourage businesses to do all of the following except

mistreat customers.

Market structure is determined by the

number and relative size of the firms in an industry.

The measure of the most desired goods and services that is foregone in order to obtain something else is the

opportunity cost.

A firm's total revenue can be determined by

price times quantity.

The fact that a perfectly competitive firm's total revenue curve is an upward-sloping straight line implies that

product price is constant at all levels of output.

Which of the following is most likely a fixed cost?

property taxes

Which of the following is generally a fixed cost?

property taxes on land used in production

In the long run, which of the following is likely to be a variable cost?

rent, wages, and all other costs in the long run

Marginal cost

rises as a direct result of diminishing returns.

The market price for any good or service sold in a perfectly competitive market is determined by

supply and demand.

Which of the following is always downward-sloping?

the average total cost curve when it is above the marginal cost curve

Normal profit implies that

the factors employed are earning as much as they could in the best alternative employment.

(Figure 22.3) For a perfectly competitive firm, if the market price is $23,

the firm will have above-normal profits.

Which of the following is the slope of the production function with respect to an input?

the marginal physical product of the input

The best measure of the economic cost of doing your homework is

the most valuable opportunity you give up when you do your homework.

Which of the following is most likely a fixed cost?

the rent for a factory

Which of the following should not be included when calculating accounting profit?

the return on the next best alternative investment opportunity

Competitive firms cannot individually affect market price because

their individual production is insignificant relative to the production of the industry.

Economies of scale are reductions in average

total cost that result from using operations of larger size.

The sum of fixed cost and variable cost at any rate of output is the

total cost.

Economic profit is the difference between

total revenues and total economic costs.

At any given rate of output, the difference between total cost and fixed cost is

variable cost.

In the short run, when a firm produces zero output, the variable cost equals

zero.