Chapter 7
Joe quits his computer programming job, where he was earning a salary of $70,000 per year, to start his own computer software business in a building that he owns and was previously renting out for $24,000 per year. In his first year of business he has the following expenses: salary paid to himself, $42,500; rent, $0; and other expenses, $35,000. Find the accounting cost and the economic cost associated with Joe's computer software business. 1. The accounting cost of Joe's business is __ 2. The economic cost of Joe's business is __ (Enter your responses as integers.)
1. $77500 2. $129000
Suppose that a paving company produces paved parking spaces (q) using a fixed quantity of land (T) and variable quantities of cement (C) and labor (L). The firm is currently paving 1,000 parking spaces. The firm's cost of cement is $30.00 per acre covered (c) and its cost of labor is $16.00/hour (w). For the quantities of C and L that the firm has chosen, MPC=60 and MPL=4. 1. Is this firm minimizing its cost of producing parking spaces? 2. Does the firm need to alter its choices of C and L to decrease cost?
1. No since MPL/w does not equal MPC/c. 2. Yes, they need to increase C which would cause MPL to increase and MPC to decrease.
What is the difference between economies of scale and returns to scale?
Economies of scale define how cost changes with output, and returns to scale define how output changes with input usage.
Assume that the marginal cost (MC) of production is decreasing. Can you determine whether the average variable cost (AVC) is increasing or decreasing? Explain.
Regardless of whether MC is decreasing, AVC could be increasing or decreasing depending on whether MC is greater than or less than AVC.
An isocost line shows
all the input combinations that can be purchased at a given total cost.
If a firm enjoys economies of scale up to a certain output level, and cost then increases proportionally with output, what can you say about the shape of the long-run average cost curve? The long-run average cost curve
decreases initially and then is horizontal.
There is no direct relationship between economies of scale and economies of scope because
economies of scale pertain to one output and economies of scope pertain to more than one output.
Firm 1 produces product A only, and firm 2 produces product B only. Firm 3 produces the same amount of A as firm 1 AND the same amount of B as firm 2. All three firms use state-of-the-art production techniques, but firm 3's total costs are less than the sum of the other two firms' total costs. We can conclude that there are
economies of scope in producing products A and B.
Isocost lines are straight because the slope of such lines ___________________.
equals the ratio of input prices, and this ratio is fixed
[T/F] If a firm hires a currently unemployed worker, the opportunity cost of utilizing the worker's services is zero. This statement is
false because the worker's time otherwise spent in unpaid household work has value.
A firm pays its accountant an annual retainer of $25,000. Is this an economic cost? The annual retainer
is an economic cost because it is an explicit cost.
Suppose that labor is the only variable input to the production process. If the marginal cost of production is increasing as more units of output are produced, what can you say about the marginal product of labor? If the marginal cost of production is increasing as more units of output are produced, then the marginal product of labor
is diminishing.
Suppose a chair manufacturer finds that the marginal rate of technical substitution (MRTS) of capital for labor in her production process is substantially greater than the ratio of the wage rate for assembly-line labor (w) to the rental rate on machinery (r). How should she alter her use of labor and capital to minimize the cost of production? Holding output constant, the chair manufacturer should use [less/more] labor and [less/more] capital.
more ; less
Jose rents office space for $20,000 per year. He uses the office to fill out tax returns for 1,000 clients per year. If the office rent increases to $25,000 per year, the marginal cost of filling out tax returns will
not change.
How does a change in the price of one input change the firm's long-run expansion path? If the price of an input changes, then the
slope of the isocost lines will change, and the firm will substitute away from the relatively more expensive input, pivoting the expansion path toward the axis of the relatively cheaper input.
When the cost minimizing combination of inputs is being used and there is no corner solution,
the isoquant line is tangent to the isocost line.
[T/F] If the owner of a business pays himself no salary, then the accounting cost is zero, but the economic cost is positive. This statement is
true because economic costs include opportunity costs such as the value of the business owner's time.
[T/F] A firm that has positive accounting profit does not necessarily have positive economic profit. This statement is
true because economic costs will be greater than accounting costs if implicit costs exist.
A firm uses 80 hours of labor and 6 units of capital to produce 10,000 gadgets per day. Labor's marginal product is 4 gadgets per hour and the marginal product of capital is 20 gadgets per unit. Each unit of labor costs $8 per hour and each unit of capital costs $50 per unit. If the firm wants to continue producing 10,000 gadgets per day at the lowest possible cost, it should
use more labor and less capital.
Is the firm's expansion path always a straight line? A firm's expansion path
will not be a straight line if the ratio of inputs used changes with output.
Fred quits his job with a big accounting firm, where he was earning $90,000 per year, to start his own accounting business in a building he owns. He previously rented the building to someone who paid him rent of $28,000 per year, but now Fred collects no rent because he is using the building himself. Fred pays himself a salary of $35,000 per year and has other expenses of $27,000 per year. The yearly economic cost for Fred's accounting business is ___. (Enter your response as an integer.)
$145000
Distinguish between economies of scale and economies of scope. Why can one be present without the other? Economies of scale occur when
output can be doubled for less than a doubling of cost; however, economies of scope occur when joint output is less costly than the sum of the costs of producing multiple outputs separately.