Econ topcoat m9

Small "Mom and Pop firms," like inner city grocery stores, sometimes exist even though they do not earn economic profits. How can you explain this?

A firm need not earn economic profits to exist. Since leisure time is counted as an implicit cost, a firm can break even economically, and still earn an accounting profit, while paying acceptable wages to all its employees.

What is the difference between fixed costs and variable costs?

A fixed cost is one that does not vary with output, such as the cost of a building or land, whereas a variable cost increases with output, such as labor or supplies.

What is a long-run average cost curve?

A long-run average cost curve assumes no fixed costs, because in the long run all costs are variable.

What shape of a long-run average cost curve illustrates economies of scale, constant returns to scale, and diseconomies of scale?

A long-run average cost curve illustrating economies of scale will be downward sloping, constant returns to scale will be horizontal and diseconomies of scale will be upward sloping

What are explicit and implicit costs?

An explicit cost is one that you consciously pay, whereas an implicit cost is a foregone opportunity to do something else with your resources.

What are diminishing marginal returns as they relate to costs?

Diminishing marginal returns describe the reduced productivity that comes from employing additional workers or capital. Since additional workers have lower productivity, it takes more workers to raise the same quantity of output that fewer workers did before. Thus, diminishing marginal returns lead to an increase in marginal costs.

What is the difference between economies of scale, constant returns to scale, and diseconomies of scale?

Economies of scale occur when average costs decrease with increases in output. Constant returns to scale show no such decrease, and diseconomies of scale show increase in average costs as output rises.

In choosing a production technology, how will firms react if one input becomes relatively more expensive?

If, for example, the price of labor rises, firms will substitute to a production technology that uses more capital instead of labor.

How would an improvement in technology, like the high-efficiency gas turbines or Pirelli tire plant, affect the long-run average cost curve of a firm? Can you draw the old curve and the new one on the same axes? How might such an improvement affect other firms in the industry?

Improvements in technology reduce the costs of production, but they can also change the structure of an industry or the size of a firm. For this reason, it is often not possible to draw both curves on the same graph. If other firms had access to the same technology, the effects for them would be similar. However, if the technology was proprietary, other firms might be forced to drop out of the market due to their competitor's lower prices.

A common name for fixed cost is "overhead." If you divide fixed cost by the quantity of output produced, you get average fixed cost. Supposed fixed cost is $1,000. What does the average fixed cost curve look like? Use your response to explain what "spreading the overhead" means.

Since fixed costs do not increase with output, the average fixed cost curve is continually downward sloping. Spreading the overhead means increasing output so that the fixed cost per unit is very small.

Which costs are measured on per-unit basis: fixed costs, average cost, average variable cost, variable costs, and marginal cost?

Marginal costs, average costs, and average variable costs are measure on a per-unit basis.

Suppose the cost of machines increases to $55, while the cost of labor stays at $40. How would that affect the total cost of the three methods? Which method should the firm choose now?

technology 2

Do you think that the taxicab industry in large cities would be subject to significant economies of scale? Why or why not?

Most of the costs involved in the taxicab industry vary at a constant rate with output, such as driver wages, gasoline and the cars themselves. To increase output, more cars have to be bought, more drivers employed and more gasoline purchased. Given this, it does not seem likely that there are significant economies of scale in the taxi industry.

Return to Figure. What is the marginal gain in output from increasing the number of barbers from 4 to 5 and from 5 to 6? Does it continue the pattern of diminishing marginal returns?

The marginal gain in output from increasing the number of barbers from 4 to 5 is 8 haircuts. From 5 to 6 it is 4 haircuts, and the pattern of diminishing marginal returns continues.

Why will firms in most markets be located at or close to the bottom of the long-run average cost curve?

The minimum of the long run average cost curve represents an efficient level of output. Producing less than this misses out on cost savings, whereas producing more is overly costly, so most markets will be located near the minimum value on the curve.

Continuing from Exercise, the firm's factory sits on land owned by the firm that could be rented out for $30,000 per year. What was the firm's economic profit last year?

20,000

A firm had sales revenue of $1 million last year. It spent $600,000 on labor, $150,000 on capital and $200,000 on materials. What was the firm's accounting profit?

50,000

What is a production technology?

A production technology is the combination of capital and labor used to produce a good.

What is the difference between accounting and economic profit?

Accounting profit is the different between revenues and explicit costs, whereas economic profit is the difference between revenues and total costs, explicit and implicit.

It is clear that businesses operate in the short run, but do they ever operate in the long run? Discuss. Responses

Businesses that plan to be around for a long time may indeed operate in the long run. One famous example is the makers of Guinness Stout, who signed a 9,000 year lease for their brewery in 1759, at the rate of 45 pounds a year, a very forward-thinking decision.

How does fixed cost affect marginal cost? Why is this relationship important?

Fixed cost only has an effect on marginal cost at certain key points. For example, you would have to incur huge fixed costs to produce one car, but once the factory is built, the marginal cost of the second car is very small and fixed costs have no effect on marginal cost. Fixed cost only effects marginal cost again when output becomes too great for the factory to manage, and a second one has to be purchased as well.

What shapes would you generally expect each of the following cost curves to have: fixed costs, variable costs, marginal costs, average total costs, and average variable costs?

Fixed costs are represented by a horizontal line, variable costs slope upward, marginal costs tend to slope upward, average total costs are U-shaped and average variable costs are U-shaped as well and lie below average total costs.

Compute the average total cost, average variable cost, and marginal cost of producing 60 and 72 haircuts. Draw the graph of the three curves between 60 and 72 haircuts.

For 60 haircuts, the average total cost is (160 + 240)/60 = $6.67. The average variable cost is 240/60 = $4. The marginal cost is (400-300)/20 = $5. For 72 haircuts, the average total cost is (160 + 320)/72 = $6.94. The average variable cost is 320/72 = $4.44. And the marginal cost is (500-400)/12 = $8.33.

Would an interest payment on a loan to a firm be considered an explicit or implicit cost?

Interest payments are explicit costs, because the firm has to consciously pay them out of pocket.

Are fixed costs also sunk costs? Explain.

Many fixed costs are also sunk costs. For example, when making the decision of whether to keep his restaurant open another hour, the businessman should not factor in the rent on his building, which will be the same regardless of whether he closes early.

How is each of the following calculated: marginal cost, average total cost, average variable cost?

Marginal cost is the additional cost of producing one more unit. Average total cost is total cost divided by units produced and average variable cost is total variable cost divided by units produced.

A small company that shovels sidewalks and driveways has 100 homes signed up for its services this winter. It can use various combinations of capital and labor: lots of labor with hand shovels, less labor with snow blowers, and still less labor with a pickup truck that has a snowplow on front. To summarize, the method choices are:Method 1: 50 units of labor, 10 units of capitalMethod 2: 20 units of labor, 40 units of capitalMethod 3: 10 units of labor, 70 units of capitalIf hiring labor for the winter costs $100/unit and a unit of capital costs $400, what production method should be chosen? What method should be chosen if the cost of labor rises to $200/unit?

Since labor is significantly cheaper than capital, Method 1 should be chosen. The total costs of production in Method 1 are $9,000 compared to $18,000 for Method 2 and $29,000 for Method 3. If the price of labor rises to $200, Method 1 is still the cheapest, as labor is still twice as cheap as capital.

A firm is considering an investment that will earn a 6% rate of return. If it were to borrow the money, it would have to pay 8% interest on the loan, but it currently has the cash, so it will not need to borrow. Should the firm make the investment? Show your work.

Since the bank is able to command an 8% rate of return on its loans, presumably the firm should be able to do the same. To invest at only a 6% rate of return would result in an economic loss, due to the foregone opportunity to earn 8%.

Average cost curves (except for average fixed cost) tend to be U-shaped, decreasing and then increasing. Marginal cost curves have the same shape, though this may be harder to see since most of the marginal cost curve is increasing. Why do you think that average and marginal cost curves have the same general shape?

The average cost curve depends directly on the marginal cost curve, since rising marginal costs must necessarily increase average costs.

Are there fixed costs in the long-run? Explain briefly.

There are no fixed costs in the long run, because anything can eventually be sold, expanded, modified or improved as necessary to vary with output.