Chapter 7
Profit Formula
TOTAL REVENUE - TOTAL COST = PROFIT
Marginal Cost
The cost of producing one more unit of a good. The additional cost of producing one more unit of a good
Total Cost
The sum of Fixed and Variable costs. Used in the Profit formula
What are the types of costs that are measured in a cost analysis?
Fixed Costs Sunk Costs Marginal Costs Variable Costs Total Cost Average Costs
In 1906, Will Keith Kellogg founded the Battle Creek Toasted Corn Flake Company, better known today as Kellogg's. From a company with only 44 employees, Kellogg's has grown to have thousands of stockholders. Kellogg's is a: partnership. corporation. sole proprietorship. franchise.
corporation. Kellogg's is a corporation.
Which of the following is an explicit cost? wages the owner could have made at his or her old job depreciation of a work truck interest that could have been earned with start-up capital wages paid to employees
wages paid to employees Explicit costs are paid directly to another economic entity.
A company has increasing marginal returns. If the first worker adds 11 units to total production, how much must the fourth worker add to total production to keep marginal returns increasing? 11 units no units between 1 and 11 units 12 or more units
12 or more units Increasing marginal returns occur when a new worker adds more to total output than the previous new worker, so that both average and marginal products are rising.
Profit-Maximizing Rule
Profit is maximized when marginal cost equals marginal revenue.
ECONOMIC PROFIT
TOTAL REVENUE - EXPLICIT COST - IMPLICIT COST = ECONOMIC PROFIT
Accounting Profit Formula
TOTAL REVENUE - EXPLICIT COST = ACCOUNTING PROFIT
When a firm has _____ its long-run average total costs increase with increased output. economies of scale diseconomies of scale constant returns to scale economies of scope
diseconomies of scale When a firm has diseconomies of scale, its long-run average total costs increase with increased output. Diseconomies of scale can result from a firm becoming so big that management cannot efficiently control its operations.
Have you ever had a Famous Amos cookie? Wally Amos already had a reputation for baking great cookies when he opened a cookie store in Los Angeles. By its second year of operation the store was doing over 1 million dollars in sales. Amos, the only owner, is running a: sole proprietorship. partnership. corporation. franchise.
sole proprietorship. Amos is an entrepreneur who started a sole proprietorship.
Suppose Ted's Lawn Care hired a new employee. If the company saw total output decrease, there were _____ marginal returns. increasing negative diminishing It is not possible that hiring another worker would cause a reduction in output.
negative Negative marginal returns occur when adding a worker actually leads to less total output than previous new worker.
A company has increasing marginal returns. Total production is 10 units when the first worker is hired. Total production rises to 22 units when the second worker is hired. What must happen to total production when the third work is hired to maintain increasing marginal returns? Total production must be between 23 and 34 units. Total production must be 35 or more units. Total production must be 22 units. Total production must be less than 22 units.
Total production must be 35 or more units. Increasing marginal returns occur when a new worker adds more to total output than the previous new worker, so that both average and marginal products are rising.
A company has diminishing marginal returns. If the third worker adds 5 units to total production, how much does the fourth worker add to total production? between 1 and 4 units between 6 and 10 6 units no units
between 1 and 4 units Diminishing marginal returns occur when an additional worker adds to total output but at a diminishing rate.
Willco Manufacturing had to raise its prices recently because it became so large that management became inefficient and costs increased. This is because of: constant returns to scale. diseconomies of scale. economies of scale. economies of scope.
diseconomies of scale. Diseconomies of scale occur at a range of output at which AVERAGE TOTAL COST BEGIN TO INCREASE because of a lack of efficiency on the part of management.
Willco Manufacturing hired a new employee, after which it saw diminishing marginal returns. In this case, Total output _____ at a(n) _____ rate. increases; increasing decreases; increasing decreases; diminishing increases; diminishing
increases; diminishing Diminishing marginal returns occur when an additional worker adds to total output but at a diminishing rate.
Willco Manufacturing hired a new employee, after which it saw increasing marginal returns. In this case, average product _____ and marginal product _____. increases; decreases decreases; increases increases; increases decreases; decreases
increases; increases Increasing marginal returns occur when a new worker adds more to total output than the previous new worker, so that both average and marginal products are rising.
Explicit Cost
Accounting Cost Expenses that are paid to another economic entity. Ex. Cost of Rent, wages, raw materials and utilities. those paid to some other economic entity. Cost that can be documented by a receipt or an invoice.
A company has diminishing marginal returns. Total production is 5 units when the first worker is hired. Total production rises to 11 units when the second worker is hired. What should happen to total production when the third work is hired if the company continues to have diminishing marginal returns? Total production should be between 12 and 16 units. Total production should be 18 units. Total production should be more than 18 units. Total production should be less than 11 units.
Total production should be between 12 and 16 units. Diminishing marginal returns occur when an additional worker adds to total output but at a diminishing rate.
Average product is: calculated by dividing the total output by the number of workers. the change in output that results from a change in labor. the amount of product being produced. fixed cost plus variable cost.
calculated by dividing the total output by the number of workers. Average product is calculated by dividing the total output by the number of workers.
The third worker adds 5 units to total production. When the fourth worker is hired, she adds 1 unit to total production. The company has: increasing marginal returns. decreasing marginal returns. constant marginal returns. diminishing marginal returns.
diminishing marginal returns. Diminishing marginal returns occur when an additional worker adds to total output but at a diminishing rate.
In May of 2011, Bayer announced that it was open to merging with another pharmaceutical firm. Jim Edwards, writing for BNET (the CBS Interactive Business Network), said that such a merger would benefit Bayer, but would be to the detriment of the merger partner. He wrote, "Once a drug company reaches a certain size there are built in inefficiencies that no amount of cost cutting can get rid of." Edwards is referring to: economies of scale. diseconomies of scale. economies of scope. constant returns to scale.
diseconomies of scale. Diseconomies of scale occur at a range of output at which average total costs begin to increase because management loses efficiency. Edwards refers to these as diseconomies of scale; as he explains it, "The more drugs you sell, the more drug factories, brand managers and lawyers you need to manage those sales. You can't just live without them."
Which of the following is considered an explicit cost? payment of the electric bill depreciation of a work truck depletion of a prepaid service contract opportunity cost of the firm's capital
payment of the electric bill Explicit costs are paid directly to another economic entity; they include wages, lease payments, taxes, and utilities.
Ted's Lawn Care has total variable costs of $200,000 and an output of 50,000 units. What is Ted's Lawn Care's average variable cost? $1 $2 $3 $4
$4 Average variable cost is determined by dividing the total variable costs by the output. The solution is $200,000/50,000 = $4.
If LMS Manufacturing sold 250,000 units and its total revenue was $1 million, what was the price per unit? $2 $1 $3 $4
$4 Total revenue equals price per unit times quantity sold. Price can be found by rearranging the total revenue formula to Price = Total revenue/Quantity. The solution is $1 million/250,000 = $4.
Sullivan Landscaping had a profit of $20,000 in 2009. If its total revenue was $540,000, what was its total cost? $54,000 $520,000 $540,000 $560,000
$520,000 Profit equals total revenue minus total costs. The equation is TR − Profit = TC, or $540,000 − $20,000 = $520,000.
diseconomies of scale.
When a firm has diseconomies of scale, its long-run average TOTAL COST INCREASE WITH INCREASED OUTPUT. Diseconomies of scale can result from a firm becoming so big that management cannot efficiently control its operations.
economies of scale
When a firm has economies of scale, its long-run average total costs decrease with increased output. Economies of scale can result from specialization of labor and management, better use of capital, and increased possibilities for making several products that utilize complementary production techniques.
Which of the following is a fixed cost? malted barley purchased by a brewery jet fuel for an airline a 1-year lease on a building fabric for a clothing company
a 1-year lease on a building Fixed costs do not change as a firm's output expands or contracts.
When a firm has _____ its long-run average total costs decrease with increased output. diseconomies of scale economies of scale constant returns to scale economies of scope
economies of scale When a firm has economies of scale, its long-run average total costs decrease with increased output. Economies of scale can result from specialization of labor and management, better use of capital, and increased possibilities for making several products that utilize complementary production techniques.
Apple, Inc., has been successful in taking its expertise in designing hardware and software for computers and applying this knowledge to other products, such as smartphones. This is because of: diseconomies of scale. economies of scope. constant returns to scale. economies of scale.
economies of scope. When firms produce a number of products, it is often cheaper for them to produce another product whose production processes are interdependent. These economies are called economies of scope.
Lonnie Warner is better known to New York City police as "Lonnie Loosie." Mr. Warner buys cigarettes by the carton (smuggled in from states like Virginia, where they cost $50 a carton) and sells the individual cigarettes (called "loosies") for $1. According to an April 2011 New York Times story (http://www.nytimes.com/2011/04/05/nyregion/05loosie.html), Mr. Warner and his two partners sell about 2,000 cigarettes (about 10 cartons) a day. If the cigarettes were sold individually for $1 each, how much profit would the three men together make in a day? $2,000 $1,500 $1,000 $500
$1,500 Profit equals total revenue minus total costs. The total revenue is $2,000, and the total cost is $500, so the equation is $2,000 − $500 = $1,500.
Ted's Lawn Care has total variable costs of $100,000 when output is 50,000 units. When output is increased to 100,000 units, the total variable costs increase to $175,000. What is Ted's Lawn Care's MARGINAL COST? $1 $1.50 $1.75 $2
$1.50 Marginal cost is determined by dividing the change in total variable costs by the change in output. The equation is ($175,000 − $100,000)/(100,000 − 50,000), or 75,000/50,000, or $1.50.
Ted's Lawn Care has total costs of $500,000 and an output of 50,000 units. What is Ted's Lawn Care's average total cost? $10 $4 $11 $5
$10 Average total cost is determined by dividing the total costs by the output. The equation is $500,000/50,000 = $10.
If Carolyn owns $10,000 worth of stock in Omega Construction and Omega loses a lawsuit for $50 million, what is the greatest amount that Carolyn can lose in that suit? $50 million $10,000 She cannot lose anything. $50 million minus the amount of stock that she owns
$10,000 In a corporation, the stockholders' risk is limited to loss of their investment.
Sullivan Landscaping had a profit of $10,000 in 2009. If its total revenue was $200,000, what was its total cost? $190,000 $210,000 $150,000 $170,000
$190,000 Profit equals total revenue minus total costs. The solution is $200,000 − $10,000 = $190,000.
If LMS Manufacturing sold 300,000 units and its total revenue was $900,000, what was the price per unit? $4 $1 $2 $3
$3 Total revenue equals price per unit times quantity sold. Price can be found by rearranging the formula. Price = Total revenue/Quantity. The solution is $900,000/300,000 = $3.
Willco Manufacturing hired another production employee. After this employee started working, the company's production increased from 200 units to 210 units. What is the marginal product in this case? 10 −410 410 −10
10 The marginal product is 10. Marginal product is determined by dividing the change in output by the change in labor. The solution is (210 − 200)/1 = 10/1 = 10.
Zero Economic Profit
A business can stay in business if it has zero economic profit. The firm is doing just as well if it used the best alternative of it resources. All opportunity costs are covered. Ex. A firm that is meeting its investors' minimum expectations and covering its opportunity costs.
How would a business owner use information about marginal revenue versus marginal cost and price versus average total cost?
A business would use the information about marginal revenue vs marginal cost to determine whether or not their profit is maximized. A business would use the information regarding price vs average total cost to evaluate whether or not the business is profitable. The profit maximizing rule (marginal revenue equal to marginal cost) tells the business owner the level of output and price that will maximize the firm's profits, though not its level of profits (or losses). Price less average total cost indicates to the business owner the level of profit (or loss) per unit of output the firm is realizing.
If a business has revenue of $100,000, explicit costs of $50,000, and implicit costs of $60,000, it is earning an economic profit. True or False
False Because economic profit includes both explicit costs (paid to another economic entity) and implicit costs (the opportunity cost, not otherwise captured, of resources supporting the business), this example would produce a loss ($100,000 − $50,000 − $60,000 = −$10,000).
When a business sells an excess factory, it is incurring a sunk cost. True or False
False Because this business is recovering at least a portion of its fixed costs by selling the factory, the fixed costs associated with the factory are not a sunk cost. Sunk costs are not recoverable.
Implicit Cost
Opportunity Cost of using resources in a business. opportunity costs of the resources used by the firm.
If a firm's total cost increases by $25 when it produces an additional unit of output, an economist would say that the marginal cost for that unit is $25. True or false
True The marginal cost for a unit of output is the additional cost the firm incurs to produce that additional unit.
Average Cost
Used to determine the overall efficiency of a business. Includes average fixed cost, average variable cost, and average total cost. AVERAGE "VARIABLE" COST = "VARIABLE" COST/ OUTPUT
constant returns to scale.
When a firm has constant returns to scale, its long-run average total costs STAY THE SAME with increased output. This can be the case in some types of businesses, such as restaurants, in which the cost of replicating the business in any community is roughly the same.
Which of the following is a fixed cost? hourly wages for the administrative assistant electricity to run the office equipment a 1-year lease payment on office equipment office supplies the administrative assistant purchases
a 1-year lease payment on office equipment Fixed costs do not change as a firm's output expands or contracts; these costs are often called overhead.
Sunk Cost
a cost that can't be recovered. Ex. Tuition payment (no refund)
Total output divided by the number of workers is: total product. marginal product. average product. total cost.
average product. Average product is calculated by dividing the total output by the number of workers.
A company has diminishing marginal returns. If the third worker adds 7 units to total production, how much does the fourth worker add to total production? between 7 and 15 units between 1 and 6 units 8 units no units
between 1 and 6 units Diminishing marginal returns occur when an additional worker adds to total output but at a diminishing rate.
Fixed Cost
expenses that does not change with the amount of output in the short run. doesn't change with the level of output in the short run. Ex. Lease payment
Variable Cost
expenses that increase with the amount of production. These include Raw materials, utilities, and labor wages because greater output requires more resources to be used. increase as the level of production increases.
A firm is an economic institution that transforms _____ into outputs for consumers. inputs revenue explicit costs profit
inputs A firm is an economic institution that transforms inputs, or factors of production, into outputs for consumers.
A corporation: is subject to unlimited liability. is a business in which stockholders' risk is limited to loss of their investment. is a business in which stockholders' risk is not limited to loss of their investment. has the same liability as a partnership.
is a business in which stockholders' risk is limited to loss of their investment. A corporation is a business structure that has most of the legal rights of individuals and can issue stock to raise capital. Its stockholders' risk is limited to loss of their investment
Which of the following is a fixed cost? raw material purchases for a construction company liability insurance for a lawn care company supermarket cashiers' wages gasoline for a delivery service
liability insurance for a lawn care company Fixed costs do not change as a firm's output expands or contracts; such costs are often called overhead. These payments include items such as lease payments, administrative expenses, property taxes, and insurance.
What illustrates the lowest unit cost at which any particular output can be produced in the long run? short-run average total cost short-run average fixed cost long-run average fixed cost long-run average total cost
long-run average total cost The long-run average total cost is the lowest unit cost at which any particular output can be produced in the long run, when a firm is able to adjust all of the factors of production.
Smaller plants will have _____ short-run average costs at lower levels of output as (than) medium-size or large plants. the same higher lower Smaller plants will have no short-run average costs
lower Smaller plants will have lower short-run average costs at lower levels of output.
The change in output that results from a change in labor is: average product. marginal product. total product. total cost.
marginal product. Marginal product is the change in output that results from a change in labor.
A firm that is generating zero economic profit after implicit costs are factored in is earning: implicit profits. normal profits. explicit profits. economic profits.
normal profits. A firm that is generating zero economic profit after implicit costs are factored in is earning normal profits.
Which of the following is a variable cost? insurance for a company vehicle per unit wages for a carpenter lease payments on a company vehicle salary for a manager
per unit wages for a carpenter Variable costs, including expenses such as labor and material costs, fluctuate with output.
Martha has a 1-year lease on the facility where she produces confections. If she shuts down her business before the year is up, she still has to pay for the entire lease. Because of this, her lease is characterized as a(n): economic cost. normal cost. implicit cost. sunk cost.
sunk cost. Sunk costs have already been incurred and cannot be recovered.
Lonnie Warner is better known to New York City police as "Lonnie Loosie." Mr. Warner buys cigarettes by the carton (smuggled in from states like Virginia, where they cost about $50 a carton) and sells the individual cigarettes (called "loosies") for $0.75 each or two for $1. According to an April 2011 New York Times story (http://www.nytimes.com/2011/04/05/nyregion/05loosie.html), Mr. Warner and his two partners each take home anywhere from $120 to $150 profit a day on sales of about 2,000 cigarettes (about 10 cartons), most of them sold two at a time. These sales are illegal, and Lonnie has been arrested and sentenced either to jail or to community service. Which of the following is considered an implicit cost for Lonnie when he is arrested? the sales he could have been making if he wasn't doing time the taxes that are paid to the state every quarter the cost of the cigarettes the fines he pays
the sales he could have been making if he wasn't doing time Implicit costs are opportunity costs, so for Lonnie it's the lost time and therefore the lost sales.