Chapter 5 Production and Cost Analysis in the Short Run
1) The text lists all of the following as outcomes of McDonald's experimental adoption of remote
order taking except:
A) a decrease in accuracy in filling orders.
B) increased speed at the drive through window.
C) an increase in the costs associated with the drive-through portion of McDonald's business.
D) employee dissatisfaction with constant monitoring and the stress of the process.
Answer: C
Diff: 1
Topic: Costs and production
2) A firm's production function is the relationship between:
A) the inputs employed by the firm and the resulting costs of production.
B) the factors of production and the resulting outputs of the production process.
C) the demand for a firm's output and the quantity it is able to produce with available resources.
D) the firm's production costs and the amount of revenue it receives from the sale of its output.
Answer: B
Diff: 1
Topic: Production function
3) In the context of a production function, the remote order takers in the fast food industry would
be classified as:
A) a fixed input.
B) a marginal input.
C) a variable input.
D) an inframarginal input.
Answer: C
Diff: 2
Topic: Variable inputs
4) Consider the production function for bottled water. All of the following would be considered
variable inputs except:
A) the plastic bottles.
B) the water the bottles are filled with.
C) the machine used to fill each bottle.
D) the electricity used to power the machine used to fill the bottles.
Answer: C
Diff: 2
Topic: Variable inputs
5) The term "fixed input" refers to:
A) inputs to production that do not vary with respect to quality.
B) inputs to production that do not vary in price.
C) inputs to production that yield a constant or "fixed" marginal product.
D) inputs to production, the quantity of which cannot be varied in the short run.
Answer: D
Diff: 1
Topic: Fixed inputs
6) Which of the following inputs is most likely to be "fixed" in the short run?
A) Labor.
B) Capital.
C) Energy.
D) Raw Material.
Answer: B
Diff: 2
Topic: Fixed inputs
7) The main difference between the short run and the long run is that:
A) in the short run all inputs are fixed, while in the long run all inputs are variable.
B) in the short run the firm varies all of its inputs to find the least-cost combination of inputs.
C) in the short run, at least one of the firm's input levels is fixed.
D) in the long run, the firm is making a constrained decision about how to use existing plant and
equipment efficiently.
Answer: C
Diff: 1
Topic: Short run versus long run
8) Which of the following would be classified as a short-run decision?
A) A firm's decision to decrease the amount of electricity used in day-to-day operations by
encouraging employees to adopt conservation strategies, e.g., shut off lights when leaving a
room.
B) A restaurant's decision to increase the number of patrons it can accommodate by adding on a
new dining room.
C) A trucking firm's decision to move to a smaller facility.
D) A university's decision to add a new residence hall.
Answer: A
Diff: 2
Topic: Short run versus long run
9) Assume a factory that currently employs 25 workers is considering adding another 5 workers
to its payroll. Economists would classify this as:
A) a short-run decision.
B) a long-run decision.
C) neither a short-run nor a long-run decision.
D) both a short-run and a long-run decision.
Answer: A
Diff: 2
Topic: Short run versus long run
10) Assume a factory that currently employs 25 workers and owns a factory with 10,000 square
feet of floor space is considering doubling the size of its factory. Economists would classify this
as:
A) a short-run decision.
B) a long-run decision.
C) neither a short-run nor a long-run decision.
D) both a short-run and a long-run decision.
Answer: B
Diff: 2
Topic: Short run versus long run
11) In the mathematical formulation of the short-run production function:
A) the quantity of output is usually assumed to be fixed.
B) the quantity of capital employed is usually assumed to be fixed.
C) the quantity of both labor and capital employed are usually assumed to be fixed.
D) the quantity of both labor and capital must be allowed to vary so that output can vary in the
short run.
Answer: B
Diff: 1
Topic: Short run
12) The amount of output a firm can produce with a given quantity of fixed and variable inputs is
called:
A) total product.
B) average variable product.
C) marginal product.
D) total fixed product.
Answer: A
Diff: 1
Topic: Total product
13) The amount of output produced with an additional unit of variable input is referred to as:
A) total product.
B) average variable product.
C) marginal product.
D) average fixed product.
Answer: C
Diff: 1
Topic: Marginal product
14) The average product of a variable input is calculated as:
A) total product divided by total output.
B) the change in total product divided by the change in the variable input.
C) total product divided by the change in the variable input.
D) total product divided by the total quantity of the variable input.
Answer: D
Diff: 1
Topic: Variable product
15) The marginal product of a variable input is calculated as:
A) the change in total product divided by the change in output.
B) total product divided by the change in the variable input.
C) the change in total product divided by the change in the variable input.
D) total product divided by the total quantity of the variable input.
Answer: C
Diff: 1
Topic: Marginal product
16) Assume that after the fifth worker, each additional worker a firm hires is less productive than
the previous worker. Based on this information, we can conclude that beyond the fifth worker,
the average product of labor will:
A) increase.
B) stay the same.
C) decrease.
D) cannot be determined without additional information.
Answer: D
Diff: 3
Topic: Average product
Scenario 1: The following is a hypothetical short-run production function:
Hours of Total
Labor
Output
0
___
1
100
2
___
3
240
Marginal
Product
___
100
80
___
17) Refer to Scenario 1. What is the total output when 2 hours of labor are employed?
A) 80
B) 100
C) 180
D) 200
Answer: C
Diff: 2
Topic: Total output
18) Refer to Scenario 1. What is the marginal product of the third hour of labor?
A) 60
B) 80
C) 100
D) 240
Answer: A
Diff: 2
Topic: Marginal product
19) Refer to Scenario 1. What is the average product of the first three hours of labor?
A) 60
B) 80
C) 100
D) 240
Answer: B
Diff: 2
Topic: Average product
20) Refer to Scenario 1. The production function illustrated in the table:
A) incurs diminishing marginal returns beyond the first unit of labor.
B) incurs diminishing marginal returns beyond the second unit of labor.
C) incurs diminishing marginal returns beyond the third unit of labor.
D) does not incur diminishing marginal returns because marginal product is positive for each unit
of labor employed.
Answer: A
Diff: 2
Topic: Diminishing marginal returns
21) Which of the following is true of the typical relationship between marginal product (MP) and
average product (AP)?
A) If MP is greater than AP, then AP is falling.
B) The AP curve intersects the MP curve at minimum MP.
C) The MP curve intersects the AP curve at maximum AP.
D) If MP is less than AP, then AP is increasing.
Answer: C
Diff: 1
Topic: Average versus marginal product
22) Marginal product equals 0 when:
A) average product equals zero.
B) total product equals average product.
C) average product reached its minimum value.
D) total product reaches its maximum value.
Answer: D
Diff: 2
Topic: Total versus marginal product
23) The "law of diminishing marginal returns" applies to:
A) the short run, but not the long run.
B) the long run, but not the short run.
C) both the short run and the long run.
D) neither the short run nor the long run.
Answer: A
Diff: 1
Topic: Diminishing marginal returns
24) Diminishing marginal returns occur when:
A) units of a variable input are added to a fixed input and total product falls.
B) units of a variable input are added to a fixed input and marginal product falls.
C) the size of the plant is increased in the long run.
D) the quantity of the fixed input is increased and returns to the variable input fall.
Answer: B
Diff: 1
Topic: Diminishing marginal returns
25) All else constant, an increase in productivity has the effect of causing:
A) the marginal product of labor to increase and no effect on the average product of labor.
B) the average product of labor to increase and no effect on the marginal product of labor.
C) the marginal product of labor to increase and the average product of labor to decrease.
D) both the marginal and average product of labor to increase.
Answer: D
Diff: 2
Topic: Productivity, average product, and marginal product
26) Which of the following statements is correct?
A) Workers employed by General Motors are approximately twice as productive as their
Japanese counterparts.
B) Between 1979 and 1998, Chrysler and Ford eliminated the productivity gap between all of
their production facilities and their Japanese counterparts.
C) The increase in productivity Japanese manufacturers experienced in the early 1980s was the
result primarily of changes in management focusing on inventory systems and plant layout.
D) Auto workers in the United States are less productive than their Japanese counterparts
primarily due to the higher wages U.S. workers receive.
Answer: C
Diff: 2
Topic: Productivity in the U.S. versus Japan
27) Data on productivity gains in the 1990s in the United States strongly suggest that a
significant share of those gains was attributable to:
A) improvements in education and training.
B) improvements in information technology.
C) substantial reductions in labor costs.
D) increased demand for goods and services.
Answer: B
Diff: 2
Topic: Productivity in the U.S.
28) Which of the following is not a determinant of a firm's cost functions?
A) The production function.
B) The price of labor.
C) The productivity of the firm's capital stock.
D) The price of the firm's output.
Answer: D
Diff: 2
Topic: Determinants of costs
29) The amount of money a firm pays to lease a building it uses for office space is called:
A) the full opportunity cost of production.
B) an explicit cost.
C) a real cost of production.
D) an implicit cost.
Answer: B
Diff: 2
Topic: Explicit costs
30) The payment of wages by a firm is an example of:
A) an explicit cost of production.
B) an implicit cost of production.
C) an irreversible cost of production.
D) a long-run cost of production.
Answer: A
Diff: 2
Topic: Explicit costs
31) An implicit cost is defined as:
A) the opportunity cost of using a resource that is not explicitly paid out by the firm.
B) the difference between an input's explicit cost and its actual cost.
C) the amount by which economic profit exceeds accounting profit.
D) the amount by which the money spent on an input to production exceeds its opportunity cost.
Answer: A
Diff: 1
Topic: Implicit costs
32) Which of the following is an example of an "implicit cost"?
A) Interest that could have been earned on retained earnings used by the firm to finance
expansion.
B) The payment of rent by the firm for the building in which it is housed.
C) The interest payment made by the firm for funds borrowed from a bank.
D) The payment of wages by the firm.
Answer: A
Diff: 2
Topic: Implicit costs
33) Which of the following statements regarding historical costs is correct?
A) Historical costs represent what the firm paid for an input when it was purchased, adjusted for
inflation.
B) Historical costs vary depending on the method of depreciation a firm uses.
C) Historical costs are a good indicator of the current opportunity cost of a piece of capital.
D) Using historical costs can cause true economic profit to be under or over stated.
Answer: D
Diff: 2
Topic: Historical costs
34) Which of the following is the best example of "depreciation"?
A) An individual worker becoming tired at the end of an eight-hour work day.
B) The notion that individuals obtain less utility from paying taxes than giving to charities.
C) A truck used by a pizzeria to make deliveries is worth less at the end of one year.
D) A rise in prices depreciating the value of consumers' real incomes.
Answer: C
Diff: 2
Topic: Depreciation
35) Economic profit is equal to the difference between:
A) total revenue and the full opportunity cost of all the resources used in production.
B) total revenue and implicit costs.
C) accounting profit and explicit costs.
D) implicit and explicit costs.
Answer: A
Diff: 1
Topic: Economic versus accounting profit
36) Which of the following statements is false?
A) Economic costs include the opportunity costs of the resources owned by the firm.
B) Accounting costs typically include only explicit costs.
C) Economic profit will always be less than accounting profit if resources owned and used by the
firm have any opportunity costs.
D) Accounting profit is equal to total revenue minus implicit costs.
Answer: D
Diff: 2
Topic: Economic versus accounting profit
37) Suppose a sole proprietorship is earning total revenues of $100,000 and is incurring explicit
costs of $75,000. If the owner could work for another company for $30,000 a year, we would
conclude that:
A) the firm is incurring an economic loss.
B) implicit costs are $25,000.
C) the total economic costs are $100,000.
D) the individual is earning an economic profit of $25,000.
Answer: A
Diff: 2
Topic: Calculating economic profit
38) Fred is considering opening a ski shop in Colorado. Assume Fred will incur the following
costs: building rent = $100,000/year, inventory = $250,000/year, energy = $50,000/year, and
labor (one clerk) = $10,000/year. In addition, Fred's current income as a computer programmer is
$40,000 per year. Assuming Fred would earn $460,000 in revenues, he could expect to earn:
A) an accounting profit of $10,000 per year.
B) an accounting profit of $60,000 per year.
C) an economic profit of $10,000 per year.
D) an economic profit of $50,000 per year.
Answer: C
Diff: 2
Topic: Calculating economic and accounting profit
39) All else constant, as the amount of a firm's implicit costs increases, the difference between
economic profit and accounting profit will:
A) increase.
B) stay the same.
C) decrease.
D) cannot be determined without more information.
Answer: A
Diff: 2
Topic: Economic versus accounting profit
40) From the manager's perspective:
A) it is important to treat implicit costs as explicit in order to make sound strategic decisions.
B) implicit costs are simply a theoretical construct and should be ignored in the decision-making
process.
C) only explicit costs matter because accounting profit is based on explicit costs.
D) there is no difference between implicit and explicit costs. As such, treating implicit costs as
explicit would result in double counting and an overstatement of total costs.
Answer: A
Diff: 2
Topic: Implicit costs and profit
41) Which of the following statements concerning the relationships among the firm's total cost
functions is false?
A) TC = TFC + TVC
B) TVC = TFC - TC
C) TFC = TC - TVC
D) TC = TFC when output = 0.
Answer: B
Diff: 2
Topic: Total cost functions
42) Which of the following statements is true of the relationship among the average cost
functions?
A) ATC = AFC - AVC
B) AVC = AFC + ATC
C) AFC = ATC + AVC
D) AFC = ATC - AVC
Answer: D
Diff: 2
Topic: Average cost functions
43) So long as a firm is enjoying increasing marginal returns, a one unit increase in output will
cause marginal costs to ________ and total costs to ________.
A) increase; increase
B) decrease; increase
C) increase; decrease
D) decrease; decrease
Answer: B
Diff: 2
Topic: Output changes and total costs
44) Marginal cost is defined as:
A) the change in total cost due to a one unit change in output.
B) total cost divided by output.
C) the change in output due to a one unit change in an input.
D) total product divided by the quantity of input.
Answer: A
Diff: 1
Topic: Marginal cost
45) Marginal cost is defined as the change in ________ cost when output changes by one unit. In
the short run, marginal cost can also be measured by the change in ________ cost when output
changes by one unit.
A) total; fixed
B) variable; fixed
C) fixed; variable
D) total; variable
Answer: D
Diff: 2
Topic: Marginal cost
46) Which of the following statements is correct?
A) In the short run, if a firm chooses to produce no output (i.e., shut down) its total costs of
production will equal its total fixed costs.
B) If a firm decides to shut down, its short-run total costs will equal 0.
C) As a firm increases output in the short run, the change in total costs is equal to the change in
total variable costs.
D) A firm minimizes its total costs of production when average variable cost is minimized.
Answer: C
Diff: 2
Topic: Production and total costs
Scenario 2:
Output (Q):
Total Cost (TC):
0
$24
1
$33
2
$41
3
$48
4
$54
5 6
$61 $69
47) Refer to Scenario 2. The average fixed cost of 2 units of output is:
A) $8.00.
B) $8.50.
C) $12.00.
D) $20.50.
Answer: C
Diff: 2
Topic: Average fixed costs
48) Refer to Scenario 2. The marginal cost of the sixth unit of output is:
A) $1.33.
B) $7.50.
C) $8.00.
D) $45.00.
Answer: C
Diff: 2
Topic: Marginal cost
49) Refer to Scenario 2. Diminishing marginal returns starts to occur between units:
A) 2 and 3.
B) 3 and 4.
C) 4 and 5.
D) 5 and 6.
Answer: C
Diff: 2
Topic: Diminishing marginal returns
Scenario 3:
Total Product (Q):
Total Cost (TC):
0
$50
1
$80
2
$105
3
$125
4
$155
5
6
$195 $250
50) Refer to Scenario 3. The average variable cost of producing three units of output is:
A) $15.
B) $25.
C) $41.67 (approximate).
D) $75.
Answer: B
Diff: 2
Topic: Average variable costs
51) Refer to Scenario 3. The marginal cost of producing the sixth unit of output is:
A) $33.33 (approximate).
B) $55.
C) $200.
D) $250.
Answer: B
Diff: 2
Topic: Marginal cost
52) Refer to Scenario 3. The average total cost of 5 units of output is:
A) $8.
B) $10.
C) $29.
D) $39.
Answer: D
Diff: 2
Topic: Average total cost
53) Refer to Scenario 3. Diminishing marginal returns are incurred when output is increased
from:
A) 1 to 2 units of output.
B) 2 to 3 units of output.
C) 3 to 4 units of output.
D) 4 to 5 units of output.
Answer: C
Diff: 2
Topic: Diminishing marginal returns
54) Assume a firm is currently producing 100 units of output, total fixed costs are $10,000, and
average variable costs are $8. Based on this information we can conclude, with certainty, that the
firm's:
A) marginal costs are $8.
B) total variable costs are $8000.
C) average fixed costs are $2.
D) total costs are $10,800.
Answer: D
Diff: 2
Topic: Average cost functions
55) For a particular production function, over the range of output where marginal product rises as
units of the variable input are added to the fixed input, marginal cost will be:
A) increasing.
B) constant.
C) decreasing.
D) cannot be determined without additional information.
Answer: C
Diff: 2
Topic: Marginal cost versus marginal product
56) Which of the following is true of the relationship between the marginal cost function and the
average total cost and average variable cost functions?
A) If MC is greater than ATC and AVC, then ATC and AVC will increase.
B) The ATC and AVC curves intersect the MC curve at minimum MC.
C) The MC curve, ATC curve, and AVC curve all intersect at the same point.
D) At each level of output, MC is equal to difference between AVC and ATC.
Answer: A
Diff: 2
Topic: Marginal cost versus average cost
57) Assume there is an improvement in technology that increases the marginal product of each
unit of labor. This would have the effect of:
A) reducing the average total cost, average variable cost, and marginal cost of production.
B) increasing the average total cost, average variable cost, and marginal cost of production.
C) reducing the average variable cost and marginal cost of production, but average total cost
would be unchanged.
D) reducing the average total cost and average variable cost of production, but marginal cost
would be unchanged.
Answer: A
Diff: 3
Topic: Marginal product and costs
58) If a firm experiences constant returns to the variable input in the short run:
A) marginal product will be greater than average variable product, but the two will become more
equal as output increases.
B) marginal product will be less than average variable product, but the two will become more
equal as output increases.
C) marginal product will be greater than average variable product, and the difference between
the two will become larger as output increases.
D) marginal product and average variable product will be equal over the range of output in
question.
Answer: D
Diff: 2
Topic: Average versus marginal product
59) If a firm experiences constant returns to the variable input in the short run:
A) marginal cost will be greater than average variable cost, but the two will become more equal
as output increases.
B) marginal cost will be less than average variable cost, but the two will become more equal as
output increases.
C) marginal cost will be greater than average variable cost, and the difference between the two
will become larger as output increases.
D) marginal cost and average variable cost will be equal over the range of output in question.
Answer: D
Diff: 3
Topic: Marginal versus average variable cost
60) Production functions A and B result in the same average total costs of production. However,
production function A is twice as capital intensive as production function B. In this case, all else
constant:
A) marginal costs will be higher in A than they are in B.
B) marginal costs will be higher in B than they will in A.
C) because total costs are equal, marginal costs will be equal for the two production functions as
well.
D) there is no way to say anything about the relative marginal costs of production in the two
production functions without additional information.
Answer: B
Diff: 3
Topic: Marginal costs versus fixed costs
61) Much of the empirical evidence on the behavior of costs for real-world firms suggests that:
A) average costs functions are U-shaped as suggested by economic theory.
B) for most firms, marginal costs are declining in the range in which the firms operate.
C) for many firms, marginal and average variable costs are constant over wide ranges of output.
D) there is no relationship between the marginal and average variable costs of production.
Answer: C
Diff: 1
Topic: Cost functions in the real world
62) One of the interesting findings of a survey of firm managers by Blinder et al. is that:
A) the vast majority of firms pay considerable attention to marginal costs in making decisions
about how much output to produce.
B) the majority of respondents suggested that fixed costs are a relatively unimportant
consideration when making output decisions.
C) approximately 75 percent of respondents indicated that their marginal costs of production are
rising over the relevant range of output.
D) a significant percentage of respondents to the survey did not appear to understand the concept
of marginal cost.
Answer: D
Diff: 2
Topic: Cost functions in the real world
63) A firm's production function is the relationship between the factors of production and the
resulting outputs of the production process.
Answer: TRUE
Diff: 1
Topic: Production function
64) According to the text, much of the increase in productivity that has occurred more recently in
the fast food industry was the result of improvements in capital and technology.
Answer: TRUE
Diff: 1
Topic: Productivity
65) The typical short-run production function is incapable of distinguishing among the different
types of labor that might be hired by the firm.
Answer: FALSE
Diff: 1
Topic: Short-run production function
66) The "long run" is defined as a period of time long enough for the quantities of all of the
inputs to production to vary.
Answer: TRUE
Diff: 1
Topic: Long run
67) The term "variable input" is used to refer to inputs that vary in terms of quality and,
therefore, productivity.
Answer: FALSE
Diff: 1
Topic: Variable inputs
68) A firm's decision to expand the size of its production facility would be considered a short-run
decision so long as the expansion can be completed in less than a year.
Answer: FALSE
Diff: 2
Topic: Short run versus long run
69) For a particular farmer and a single growing season, the amount of seed that is planted would
be considered a variable input.
Answer: TRUE
Diff: 2
Topic: Variable inputs
70) Because it is a machine, a personal computer should be treated as a fixed input in the typical
firm's short-run production function.
Answer: FALSE
Diff: 3
Topic: Fixed inputs
71) By definition, in the typical firm's short-run production function all inputs are fixed in
amount.
Answer: FALSE
Diff: 1
Topic: Short-run production
72) The marginal product of a variable input is calculated by dividing total product by the change
in the variable input.
Answer: FALSE
Diff: 1
Topic: Marginal product
73) For a typical short-run production function, so long as marginal product is increasing,
average product will be increasing as well.
Answer: TRUE
Diff: 1
Topic: Average product
74) If, for a particular short-run production, we observe that marginal product is decreasing we
can conclude that average product is decreasing as well.
Answer: FALSE
Diff: 3
Topic: Marginal versus average product
75) Once a firm incurs diminishing marginal returns, total product will begin to decline as more
of the variable input is employed.
Answer: FALSE
Diff: 2
Topic: Diminishing marginal returns
76) At the point where a firm incurs diminishing marginal returns, total product will begin to
decline.
Answer: FALSE
Diff: 2
Topic: Marginal versus total product
77) The law of diminishing returns is a result of the fact that more and more units of a variable
input are being added to a fixed input. Because of the limitations imposed by the fixed input, at
some point the productivity of additional units of the variable input must decline.
Answer: TRUE
Diff: 2
Topic: Diminishing marginal returns
78) All else constant, an improvement in technology would cause a firm's total, average and
marginal product functions to increase (graphically, shift up).
Answer: TRUE
Diff: 2
Topic: Production and productivity
79) The full opportunity costs of production are calculated as the sum of both explicit and
implicit costs.
Answer: TRUE
Diff: 1
Topic: Explicit and implicit costs
80) When a firm is considering whether to buy a new piece of equipment with retained earnings,
the amount of interest that could be earned on that money is an explicit cost and should be
treated as such.
Answer: FALSE
Diff: 2
Topic: Implicit costs
81) Economists recognize what is sometimes referred to as "psychic income" such as the value
some people attach to being their own boss. As such, failure to factor in psychic income when
calculating economic profit could result in an understatement of the actual economic profit
received from a particular enterprise.
Answer: TRUE
Diff: 3
Topic: Implicit costs and economic profit
82) All else constant, if the use of historic costs understates the opportunity costs associated with
using a particular piece of capital, economic profit will be overstated.
Answer: TRUE
Diff: 2
Topic: Historic costs and economic profit
83) All else constant, if the use of historic costs understates the opportunity costs associated with
using a particular piece of capital, accounting profit will be understated.
Answer: FALSE
Diff: 2
Topic: Historic costs and accounting profit
84) After the former CEO of the Coca-Cola Company began requiring employees to treat the rate
of return on shareholder equity as an explicit cost, Coke's profits increased considerably.
Answer: TRUE
Diff: 1
Topic: Explicit versus implicit costs
85) A firm's short-run cost functions depend primarily on the firm's production function and the
prices of the inputs to production.
Answer: TRUE
Diff: 1
Topic: Costs and production
86) So long as marginal cost is greater than average variable cost, both average variable cost and
average total cost must increase as output is increased.
Answer: FALSE
Diff: 2
Topic: Marginal versus average costs
87) All else constant, an improvement in technology would cause a firm's marginal, average
variable, and average total cost functions to increase (graphically, shift up).
Answer: FALSE
Diff: 2
Topic: Input process and production costs
88) In the short run, a firm can minimize its total costs of production by operating at the
minimum of its average total cost curve.
Answer: FALSE
Diff: 3
Topic: Cost minimization
89) Assume that at the current level of output a firm's marginal cost and average variable cost of
production are both decreasing. Based on this, we can conclude that the marginal product and
average product of the firm's variable input(s) are both increasing.
Answer: TRUE
Diff: 3
Topic: Productivity and costs
90) Empirical evidence indicates that most firms operate where marginal and average variable
costs are constant.
Answer: TRUE
Diff: 1
Topic: Cost functions in the real world
91) According to a study by Blinder et al., on average, fixed costs account for about 44 percent
of firms' total costs of production, suggesting that fixed costs are more important to many firms'
decision-making processes than standard theory would suggest.
Answer: TRUE
Diff: 1
Topic: Cost functions in the real world
92) Economic theory provides insights into the range of possibilities for cost relationships.
Studies such as those by Blinder et al. provide insights into where, within that range, many firms
operate. Thus, there is no real conflict between theory and reality, as some people might try to
claim.
Answer: TRUE
Diff: 2
Topic: Cost functions in the real world
93) Explain the difference between the short run and the long run as it relates to the firm's
production function. Why is this distinction important to a firm's manager?
Answer: In the short run, the amount of at least one input employed by the firm, usually capital,
is fixed while other inputs are allowed to vary. This reflects the fact that it is usually difficult or
impossible to change the amount of capital employed by the firm in a shorter amount of time. In
contrast, the amount of inputs such as labor that are employed can be changed almost
instantaneously. In the long run, all of the inputs employed by the firm, including capital, can be
varied. This distinction is important because it defines the set of possible responses a firm's
manager can employ in response to a change in market conditions, such as a sudden decrease in
demand. In the short run, the manager is limited to adjusting the amounts of variable inputs
employed, while in the long run all of the inputs employed by the firm can be adjusted.
Diff: 2
Topic: Production function
94) Use the following information on a hypothetical short-run production function to answer
questions a-c.
Units of Labor/Day
Units of Output/Day
5
120
6
7
140 155
8
165
9
168
The price of labor is $20 per day. Ten units of capital are used each day, regardless of output
level. The price of capital is $50 per unit.
a. Calculate the marginal and average variable product of each unit of labor input.
b. Calculate total, average total, average variable, and marginal costs.
c. Can you tell where diminishing marginal returns sets in?
Answer: a. b.
Labor Output MP
AP
TC
ATC AVC MC
5
120
-24
$600 $5
$0.83 -6
140
20
23.3 $620 $4.43 $0.86 $1
7
155
15
22.14 $640 $4.13 $0.9 $1.33
8
165
10
20.63 $660 $4
$0.97 $2
9
168
3
18.67 $680 $4.05 $1.07 $6.67
c. Diminishing marginal returns sets in at some point prior to the 5th unit of labor. Note that MP
is declining for 5-9 units of labor.
Diff: 3
Topic: Production and costs
95) When demand for a firm's product decreases, the firm can take a number of steps to adjust
costs and quantities supplied to the market. Some are listed below. Which actions are short run
and which are long run? Explain your reasoning.
a. Layoff 25 percent of the firm's existing employees.
b. Declare bankruptcy and sell all of the firm's plant and equipment.
c. Require management personnel to take a significant cut in pay.
d. Furlough employees for 3 days each month.
e. Move to a smaller production facility.
Answer: Options a, c, and d are all short-run options because they all involve changes in
variable inputs only (quantity of labor and labor costs). Options b and e are long-run options
because they involve changes in fixed factors, i.e., plant and equipment.
Diff: 2
Topic: Short run versus long run
96) Distinguish between implicit and explicit costs and give examples of each. In addition,
explain how explicit and implicit costs affect the distinction between economic profit and
accounting profit. What explains the distinction between the two measures of profit?
Answer: Explicit costs are those that a firm pays out of pocket, i.e., for which monetary
payments are made. In contrast, implicit costs are the opportunity of resources owned by the firm
that are used in production but for which no explicit monetary payment is made. Examples of
implicit costs include the cost of energy (electricity and natural gas) and payments made for
labor services. Examples of implicit costs include the amount of money the owner of a firm
could earn in his next best opportunity and the amount of rent the owner could receive from a
building that he owns and uses in his own business. Generally speaking, accounting profit is
calculated as the difference between total revenues and total explicit costs. In contrast, economic
profit is calculated as the difference between total revenues and the sum of explicit and implicit
costs.
Accounting profit is calculated to facilitate the determination of tax liabilities. Economic profit is
concerned with the net return after all opportunity costs are accounted for.
Diff: 2
Topic: Explicit vs implicit costs and economic vs accounting profit
97) Florence is considering going into business for herself and has developed the following
estimates of monthly costs and revenues to aid her in her decision-making process. She has
decided to house the business in a building that she already owns, although she could rent the
building to someone else for $1,000 per month. Estimated payments for utilities (electricity,
natural gas, water, and telephone) are $475 per month. She will hire one employee at a total cost
of $1,100 per month. Inventory is estimated to cost $2,800 per month. Finally, Florence earns
$3,000 a month in her current job.
a. How much monthly revenue would Florence have to take in to earn 0 economic profit?
b. Assume that Florence has estimated her monthly revenue to be $9,000. In this case, Florence
would earn an accounting profit (loss) of ________, and an economic profit (loss) of ________.
c. Assume instead that Florence does not own a building, and that she will have to rent a building
for $1,000 per month (all other estimates remain the same). In this case (assuming estimated
monthly revenue is still $9,000), Florence would earn an accounting profit (loss) of ________,
and an economic profit (loss) of ________.
Answer:
a. $8375.
b. Accounting profit = $4,625. Economic profit = $625.
c. Accounting profit = $3,625. Economic profit = $625.
Diff: 2
Topic: Explicit vs implicit costs and economic vs accounting profit
98) In the general textbook treatment, the firm's short run average variable and average total cost
curves are U-shaped, while the average fixed cost curve is downward sloping over the entire
range of output. Explain why.
Answer: The U-shaped AVC and ATC curves reflect the effects of diminishing marginal
returns. When a firm incurs diminishing returns, marginal costs increase. So long as marginal
cost is less than average total cost and average variable cost, they will decrease. However, when
marginal costs rise above average total and average variable costs, the average costs must
necessarily increase. In contrast, when calculating average fixed cost, total fixed cost is being
spread over an increasingly larger amount of output. As this happens, the average cost per unit
decreases.
Diff: 2
Topic: Short-run cost functions
99) Complete the table below, which represents the production costs for a typical firm. (Round
numbers to the nearest tenth.)
TP
0
1
2
3
4
5
6
7
TFC
$20
___
___
___
___
___
___
___
TVC
$0
27.5
46.8
63.3
82.5
106.7
139.7
181
TC
$__
___
___
___
___
126.7
___
___
AFC
--$__
___
___
5.0
___
___
___
AVC
--$__
23.4
___
___
___
___
___
ATC
--$__
___
___
___
___
___
28.7
MC
--$27.5
___
___
___
___
___
___
At what level of output do diminishing returns set in? How do you know?
Answer: TP TFC TVC TC
AFC AVC ATC MC
0
$20 $ 0
$20
--------1
20 27.5
47.5 $20 $27.5 $47.5 $27.5
2
20 46.8
66.8 10
23.4 33.4 19.3
3
20 63.3
83.3
6.7 21.1 27.8 16.5
4
20 82.5 102.5
5
20.6 25.6 19.2
5
20 106.7 126.7
4
21.3 25.3 24.2
6
20 139.7 159.7
3.3 23.3 26.6 33
7
20 181
201
2.9 25.9 28.7 41.3
Diminishing returns set in between 3 units and 4 units of output. This is the point at which
marginal costs begin to increase.
Diff: 2
Topic: Short-run costs and diminishing returns
100) Use the following table to answer questions a-c.
Output (Q):
Total Cost (TC):
0
$36
1
$45
2
$52
3
$61
4
$74
5
$91
6
$110
a. What is the average fixed cost of producing 4 units of output?
b. What is the marginal cost of producing the third unit of output?
c. At what level of output does the firm encounter diminishing marginal returns? How do you
know?
Answer:
a. $9
b. $9
c. Between 2 and 3 units of output. This is the point at which MC begins to increase.
Diff: 2
Topic: Short-run costs and diminishing returns
101) Explain how the value of marginal cost affects the values of average variable cost and
average total cost and what this means for the relationship between the marginal cost curve and
the average variable and total cost curves.
Answer: So long as the value of marginal cost is less than the value of average variable (total)
cost, an increase in output will cause average variable (total) cost to decrease. When marginal
cost is greater than the value of average variable (total) cost, an increase in output will cause
average variable (total) cost to increase. The result is that the the marginal cost curve will
intersect the average variable and average total cost curves at their respective minimum points.
Diff: 2
Topic: Marginal versus average costs