Chapter 7

Prospective sunk costs

Are relevant to economic decision making

Jim left his previous job as a sales manager and started his own sales consulting business. He previously earned $70,000 a year but now he pays himself $25,000 per year while he is building the new business. What is the economic cost of the time he contributes to the new business?

$45,000 per year

Suppose that the price of labor (PL) is $10 and the price of capital (Pk) is $20. What is the equation of the isocost line corresponding to a total cost of $100

100=10L+20k

An isocost line reveals the

Input combinations that can be purchased with a given outlay of funds

The learning curve is graphically represented as a plot of

Labor per unit on the vertical axis and total number of units produced on the horizontal axis

A Cobb Douglas production function

Can exhibit constant, increasing, or decreasing returns to scale

The cost output elasticity is used to measure

Economies of scale

A variable cost function of the form VC=23+q+7q2 implies a marginal cost curve that is

Linear

The total cost (TC) of producing computer software diskettes (Q) is given as TC= 200+5Q what is the variable cost

5Q... 200 is the fixed cost and the marginal cost is 5, the ATC is 5+(200/Q)

A firms expansion path is

A curve that shows the least cost combination of inputs needed to produce each level of output for given input prices

A cubic cost function implies

A U-shaped average variable cost curve, a U-shaped marginal cost curve, a U-shaped average cost curve

To model the input decisions for a production system we plot labor on the horizontal axis and capital on the vertical axis. In the short run, labor is a variable input and capital is fixed. The short run expansion path for this production system is

A horizontal line

We typically think of labor as a variable cost, even in the very short run. However some labor costs may be fixed. Which of the following items represents an example of a fixed labor cost?

A salaried manager who has a three year employment contract

Which of the following statements is true regarding the differences between economic and accounting costs

Accounting costs include only explicit costs

Which of the following situations is not possible

All of the above are possible: SAC and LAC are both increasing for some output levels. SAC is increasing but LAC is decreasing for some output levels. SAC is decreasing but LAC is increasing for some output levels. SAC and LAC are both decreasing for some output levels

Which of the following cost always declines as output increases

Average fixed cost

In the short run suppose average total cost is a straight line and marginal cost is positive and constant. Then we know that

Average total cost is positive and constant, average total cost equals marginal cost

Which of the following busines combinations is likely to exhibit economies of scope

Banking services for individuals and banking services for other business, retail clothing stores and electronic clothing sales, hospitals that perform heart surgery and hospitals that perform cosmetic surgery

In a short run production process the marginal cost is rising and the average total cost is falling as output is increased. Thus marginal cost is

Below average total cost

A firm produces leather handbags and leather shoes. If there are economies of scope, the product transformation curve between handbags and shoes will be

Bowed outward (concave)

Bubba burgers has discovered there are economies of scope available to the restarting. Which is most likely to be a response to this discovery

Bubba adds grilled chicken sandwiches to the menu

The scale economies index (SCI) is equal to

One minus the cost output elasticity

Fixed costs are fixed with respect to changes in

Output

Carolyn knows the average total cost and average variable cost for a given level of output. Which of the following costs can she not determine given this info

Carolyn can determine all of the above costs : AFC, FC, VC

Which of the following is not a reason for average costs to fall according to the learning curve

Competing firms leave the industry as the learning firm becomes more efficient

A firm employs 100 workers at a wage rate of $10 per hour and 50 units of capital at a rate of $21 per hour. The marginal product of labor is 3, and the marginal product of capital is 5. The firm

Could reduce the cost of producing its current output level by employing more labor and less capital

Assume that a firms production process is subject to increasing returns to scale over a broad range of outputs. Long run average costs over this output will tend to

Decline

Two firms each producing different goods can achieve a greater output than one firm producing both goods with the same inputs. We can conclude that the production process involves

Diseconomies of scope

When a product transformation curve for a firm is bowed inward there are blank in production

Diseconomies of scope

When a product transformation curve is bowed outward, there are blank in production

Economies of scope

In the short run suppose average total cost is a straight line and marginal cost is positive and constant. Then we know that fixed cost must

Equal zero

In the long run, which of the following is considered a variable cost

Expenditures for wages, expenditures for research and development, expenditures for raw materials, expenditures for capital machinery and equipment

In order for a taxi cab to be operated in New York it must have a medallion on its hood. Medallions are expensive, but can be resold and are therefor and example of

Fixed cost

Suppose our firm produces chartered business flights with capital (planes) and labor (pilots) in fixed proportion (one pilot for each plane) the expansion path for this business will:

Follow the 45 degree line from the origin

The presence of a learning curve may induce a decision maker in a startup firm to choose

High levels of output to shift the average cost curve down over time

If a factory has a short run capacity constraint the marginal cost of production becomes blank at the capacity constraint

Infinite

Generally economies of scope are present when

Joint output is greater from a single firm producing two goods than could be achieved by two different firms each producing single product (assuming equivalent production inputs in both situations)

A learning curve may be expressed as a relationship between the labor per unit (L) and the total number of units produced (N) which of the following learning curves exhibits a faster reduction in cost of production due to learning (1) L=10+N-1 or (2) L=10+N-.5

Learning curve one

The cost output elasticity can be written and calculated as

MC/AC

When there are economies of scale

MC<AC so cost output elasticity is less than 1

Which of the following is not an expression for the cost minimizing combination of inputs

MRTS=MPL/MPK

Incremental cost is the same concept as blank cost

Marginal

In a short run production process the marginal cost is rising and the average variable cost is falling as output is increased thus,

Marginal cost is below average variable cost

The key assumption required for us to use a linear variable cost function of the form VC=by is that

Marginal cost must be constant and equal to b

When we solve the firms cost minimization problem by the method of Lagrange multipliers the optimal value of the Lagrange multiplier equals the

Marginal cost of production

For the firms cost minimization problem, one of the key assumptions for each input is that

Marginal product is increasing at a decreasing rate

When we solve the firms dual production problem by the method of Lagrange multipliers, the optimal value of the Lagrange multiplier equals the

Marginal product per unit cost of each variable input

A group of friends recently started manufacturing specialty T-shirts. The business has grown rapidly with monthly production up from 50 to 250 in the first 6 months. During this same period, average production cost has been cut in half. The firms long run average cost curve over this range of output

May be any of the above, downward sloping, horizontal, upward sloping

For a given pair of production outputs, the degree of economies of scope

May increase or decrease with output

Economies of scope refer to

Multi product firms

For any given level of output

None of the above is necessarily correct

When an isocost line is just tangent to an isoquant we know that

Output is being produced at minimum cost

Which of the following relationships is NOT valid

Rising marginal cost implies that average total cost is also rising

Which of the following is true of cost curves

The MC curve goes through the minimum of both the AVC curve and the ATC curve

With its currrent levels of input use, a firms MRTS is 3 (when capital is on the vertical axis and labor is on the horizontal axis) this implies

The marginal product of labor is 3 times the marginal product of capital

The difference between the economic and accounting costs of a firm are

The opportunity costs of the factors of production that the firm owns

Suppose our firm produced chartered business flights with capital (planes) and labor (pilots) in fixed proportion (one pilot for each plane). If the wage rate paid to the pilots increases relative to the rental rate of capital for the airplanes then

The optimal capital labor ratio should decrease

A firm wants to minimize the total cost of producing 100 tons of dynamite. The firm uses two factors of production, chemicals and labor. The combination of chemicals and labor that minimizes production costs can be found where

The production of an additional unit of dynamite costs the same regardless of whether chemicals or labor are used

A plant uses machinery and waste water to produce steel. The owner of the plant wants to maintain and output of 10,000 tons a day even though the government has just imposed a $100 per gallon tax on using waste water. The reduction in the amount of waste water that results from the imposition of this tax depends on

The ratio of the marginal product of waste water to the marginal product of machinery

A firms short run average cost curve is U-shaped. Which of these conclusions can be reached regarding the firms returns to scale

The short run average cost curve reveals nothing regarding returns to scale

At the optimum combination of two inputs

The slopes of the isoquant and isocost curves are equal, costs are minimized for the production of a given output, the marginal rate of technical substitution equals the ratio of input prices

At every output level a firms short run average cost equal or exceeds long run average cost because

There are at least as many possibilities for substitution between factors of production in the long run as in the short run

The cost output elasticity equals 1.4. This implies that

There are diseconomies of scale

At the current level of output, long run marginal cost is $50 and long run average cost is $75. This implies that

There are economies of scale

Which of the following is true regarding the relationship between returns to scale and economies of scope

There is no definite relationship between returns to scale and economies of scope

Which always increases as output increases

Total cost and variable cost

Consider the following statements when answering this question

With convex isoquants a firms expansion path cannot be negatively sloped. If a firm uses only two factors of production one of whose marginal product becomes negative when its use exceeds a certain level then a cost minimizing firms expansion path will have vertical or horizontal segments

The total cost of producing a given level of output is

minimized when the ratio of marginal product to input price is equal for all inputs.