Chapter 7
Production Costs
1. A firm has $200 million in total revenue and explicit costs of $190 million. Suppose its
owners have invested $100 million in the company at an opportunity cost of 10 percent
interest rate per year. The firm's economic profit is
a. $400 million.
b. $100 million.
c. $80 million.
d. zero.
ANS
a. Incorrect. Economic profit = total revenue - (explicit costs + implicit costs); $200 - ($190 +
.10 x $100); $200 - $200 = zero.
b. Incorrect. Economic profit = total revenue - (explicit costs + implicit costs); $200 - ($190 +
.10 x $100); $200 - $200 = zero.
c. Incorrect. Economic profit = total revenue - (explicit costs + implicit costs); $200 - ($190 +
.10 x $100); $200 - $200 = zero.
d. Correct. Economic profit = total revenue - (explicit costs + implicit costs); $200 - ($190 +
.10 x $100); $200 - $200 = zero.
2. If the units of variable input in a production process are 1, 2, 3, 4, and 5, and the
corresponding total outputs are 30, 34, 37, 39, and 40, respectively. The marginal product of
the fourth unit is
a. 2.
b. 1.
c. 37.
d. 39.
ANS
a. Correct. The marginal product of 39 - 37 = 2.
b. Incorrect. The marginal product of 39 - 37 = 2.
c. Incorrect. The marginal product of 39 - 37 = 2.
d. Incorrect. The marginal product of 39 - 37 = 2.
3. The situation in which the marginal product of labor is greater than zero and declining as
more labor is hired is called the law of
a. negative response.
b. inverse return to labor.
c. diminishing returns.
d. demand.
ANS
a. Incorrect. This is a meaningless term.
b. Incorrect. This is a meaningless term.
c. Correct. The law of diminishing returns occurs when the marginal product declines as units
of labors are added to a fixed factor.
d. Incorrect. The law of demand refers to the inverse relationship between price and quantity
demanded.
4. Which of the following is true if the total variable cost curve is rising?
a. Average fixed cost is increasing.
b. Marginal cost is decreasing.
c. Marginal cost is increasing.
d. Average fixed cost is constant.
ANS
a. Incorrect. Average fixed cost is not included in total variable cost.
b. Incorrect. The marginal-average rule states that when marginal cost is above average cost it
rises.
c. Correct. The marginal-average rule states that when marginal cost is above average cost it
rises.
d. Incorrect. The marginal-average rule states that when marginal cost is above average cost it
rises.
5. If the minimum points of all the possible short-run average total cost curves become
successively lower as quantity of output increases, then
a. the firm should try to produce less output.
b. total fixed costs are constant along the LRAC curve.
c. there are economies of scale.
d. the firm is probably having significant management problems.
ANS
a. Incorrect. Output depends on both demand and cost conditions.
b. Incorrect. In the long run, there are no fixed costs.
c. Correct. Economies of scale occur when the minimum points of all the possible short-run
average total cost curves become successively lower as quantity of output increases.
d. Incorrect. Economies of scale do not indicate management problems.
6. A young chef is considering opening his own sushi bar. To do so, he would have to quit his
current job, which pays $20,000 a year, and take over a store building that he owns and
currently rents to his brother for $6,000 a year. His expenses at the sushi bar would be
$50,000 for food and $2,000 for gas and electricity. What are his explicit costs?
a. $26,000.
b. $66,000.
c. $78,000.
d. $52,000.
ANS
a. Incorrect. See calculation in answer d.
b. Incorrect. See calculation in answer d.
c. Incorrect. See calculation in answer d.
d. Correct. Explicit costs equals $50,000 + $2,000 for food, gas, and electricity.
7. An economist left her $100,000-a-year teaching position to work full-time in her own
consulting business. In the first year, she had total revenue of $200,000 and business expenses
of $150,000. She made an
a. implicit profit.
b. economic loss.
c. economic profit.
d. accounting loss but not an economic loss.
ANS
a. Incorrect. See calculation in answer b.
b. Correct. Economic loss= $200,000 - $100,000 -$150,000 = -$50,000.
c. Incorrect. See calculation in answer b.
d. Incorrect. See calculation in answer b.
8. Which of the following best describes total fixed cost?
ANS
a. The change in total cost when one additional unit of output is produced.
b. Total cost divided by the quantity of output produced.
c. Total variable cost divided by the quantity of output produced.
d. Total fixed cost divided by the quantity of output produced.
e. Costs that do not vary as output varies.
ANS
a. Incorrect. This is marginal cost.
b. Incorrect. This is average total cost.
c. Incorrect. This is average variable cost.
d. Incorrect. This is average fixed cost.
e. Correct. Total fixed cost remains constant regardless of output.
9. A farm can produce 10,000 bushels of wheat per year with 5 workers and 13,000 bushels
with 6 workers. The marginal product of the sixth worker for this farm is
a. 10,000 bushels.
b. 3,000 bushels.
c. 500 bushels.
d. 23,000 bushels.
ANS
a. Incorrect. See calculation in answer b.
b. Correct. The marginal product for the sixth worker is 13,000 - 10,000 = 3,000 bushels.
c. Incorrect. See calculation in answer b.
d. Incorrect. See calculation in answer b.
10. The law of diminishing returns applies to which of the following segments of the marginal
product of labor curve?
a. The entire curve.
b. The downward-sloping segment only.
c. The upward sloping segment only.
d. The point where labor input is zero.
ANS
a. Incorrect. The law of diminishing returns applies to only the downward-sloping segment of
the marginal product of labor curve.
b. Correct. The law of diminishing returns applies to only the downward-sloping segment of
the marginal product of labor curve.
c. Incorrect. The law of diminishing returns applies to only the downward-sloping segment of
the marginal product of labor curve.
d. Incorrect. The law of diminishing returns applies to only the downward-sloping segment of
the marginal product of labor curve.
11. Which of the following is true at the point where diminishing returns set in?
a. Both marginal product and marginal cost are at a maximum.
b. Both marginal product and marginal cost are at a minimum.
c. Marginal product is at a maximum and marginal cost is at a minimum.
d. Marginal product is at a minimum and marginal cost is at a maximum.
ANS
a. Incorrect. The slope of the marginal cost curve is the reverse of the marginal cost curve.
b. Incorrect. The slope of the marginal cost curve is the reverse of the marginal cost curve.
c. Correct. The slope of the marginal cost curve is the reverse of the marginal cost curve.
d. Incorrect. The slope of the marginal cost curve is the reverse of the marginal cost curve.
12. In the long run, total fixed cost
a. falls.
b. rises.
c. is constant.
d. does not exist.
ANS
a. Incorrect. Total fixed cost only exists in the short run.
b. Incorrect. Total fixed cost only exists in the short run.
c. Incorrect. Total fixed cost only exists in the short run.
d. Correct. Total fixed cost only exists in the short run.
13. Which of the following is considered to be a fixed cost of operating an automobile?
a. Gasoline
b. Tires
c. Oil change
d. Maintenance
e. Registration fees
ANS
a. Incorrect. This cost varies with use of an automobile.
b. Incorrect. This cost varies with use of an automobile.
c. Incorrect. This cost varies with use of an automobile.
d. Incorrect. This cost varies with use of an automobile
e. Correct. Registration fees must be paid regardless of the number of miles the car travels.
14. Which of the following is an example of a fixed cost for a fishing company?
a. The cost of hiring a fishing crew
b. The fuel costs of running the boat
c. The monthly loan payment on the boat
d. The supply of nets, hooks, and fishing lines
ANS
a. Incorrect. This cost varies with fishing.
b. Incorrect. This cost varies with fishing.
c. Correct. The monthly loan payment is paid regardless of the use of the boat.
d. Incorrect. This cost varies with fishing.
15. The decreasing portion of a firm’s long run average cost curve is attributable to
a. increasing marginal cost.
b. economies of scale.
c. diseconomies of scale.
d. constant returns to scale.
ANS
a. Incorrect. Marginal cost does not exist in the long run.
b. Correct. The decreasing portion of a firm’s long run average cost curve is attributable to
economies of scale.
c. Incorrect. This refers to the upward sloping portion of the long-run average cost. curve.
d. Incorrect. This refers to the flat portion of the long-run average cost curve.
16. Diseconomies of scale exists over the range of output for which the long-run average cost
curve is
a. constant.
b. falling.
c. rising.
d. none of the above answers are correct.
ANS
a. Incorrect. This refers to constant returns to scale.
b. Incorrect. This refers to economies of scale.
c. Correct. Diseconomies of scale exist over the range of output for which the long-run
average cost curve is rising.
d. Incorrect. Answer c. is correct.
17. Assume both the marginal cost and the average variable cost curves are U-shaped. At the
minimum point on the AVC curve, marginal cost must be
a. greater than the average variable cost.
b. less than the average variable cost.
c. equal to the average variable cost.
d. at its minimum.
ANS
a. Incorrect. The marginal cost curve intersects the minimum point on the average variable
cost.
b. Incorrect. The marginal cost curve intersects the minimum point on the average variable
cost.
c. Correct. The marginal cost curve intersects the minimum point on the average variable cost.
d. Incorrect. Define the different cost concepts and express them graphically.
Exhibit 10 Costs Schedules for Producing Pizza
Pizzas
0
1
2
3
4
5
6
7
Fixed
Cost
$
Variable
Cost
$
Total
Cost
$
Marginal
Cost
$
5
13
10
100
140
20
85
215
18. By filling in the blanks in Exhibit 10, the total cost of producing zero pizzas is shown to
be equal to
a. zero.
b. $100.
c. $5.
d. $105.
e. $95.
ANS
a. Incorrect. At zero pizzas, the only cost is total fixed cost (TFC).
b. Correct. At zero pizzas, the only cost is total fixed cost (TFC).
c. Incorrect. At zero pizzas, the only cost is total fixed cost (TFC).
d. Incorrect. At zero pizzas, the only cost is total fixed cost (TFC).
e. Incorrect. At zero pizzas, the only cost is total fixed cost (TFC).
19. By filling in the blanks in Exhibit 10, the fixed cost of producing 6 pizzas is shown to be
equal to
a. $100.
b .$150.
c .$200.
d .$185.
e. $85.
ANS
a. Correct. The TFC for 6 pizzas is the same for 0-7 pizzas.
b. Incorrect. The TFC for 6 pizzas is the same for 0-7 pizzas.
c. Incorrect. The TFC for 6 pizzas is the same for 0-7 pizzas.
d. Incorrect. The TFC for 6 pizzas is the same for 0-7 pizzas.
e. Incorrect. The TFC for 6 pizzas is the same for 0-7 pizzas.
20. By filling in the blanks in Exhibit 10, the average variable cost of producing 4 pizzas is
shown to be equal to
a. $10.
b. $15.
c. $20.
d. $40.
e. $85.
ANS
a. Correct. TVC=TC-TFC=$140-$100=$40; AVC=TVC/4=$40/4=$10.
b. Incorrect. TVC=TC-TFC=$140-$100=$40; AVC=TVC/4=$40/4=$10.
c. Incorrect. TVC=TC-TFC=$140-$100=$40; AVC=TVC/4=$40/4=$10.
d. Incorrect. TVC=TC-TFC=$140-$100=$40; AVC=TVC/4=$40/4=$10.
e. Incorrect. TVC=TC-TFC=$140-$100=$40; AVC=TVC/4=$40/4=$10.
21. By filling in the blanks in Exhibit 10, the average total cost of producing 5 pizzas is
shown to be equal to
a. $12.
b. $15.
c $32.
d. $85.
e. $160.
ANS
a. Incorrect. TC of 5 pizza equals TC of 4 pizzas + MC of the 5th pizza; $140 + $20 = $160;
ATC=TC/5 = $160/5 = $32.
b. Incorrect. TC of 5 pizza equals TC of 4 pizzas + MC of the 5th pizza; $140 + $20 = $160;
ATC=TC/5 = $160/5 = $32.
c. Correct. TC of 5 pizza equals TC of 4 pizzas + MC of the 5th pizza; $140 + $20 = $160;
ATC=TC/5 = $160/5 = $32.
d. Incorrect. . TC of 5 pizza equals TC of 4 pizzas + MC of the 5th pizza; $140 + $20 = $160;
ATC=TC/5 = $160/5 = $32.
e. Incorrect. . TC of 5 pizza equals TC of 4 pizzas + MC of the 5th pizza; $140 + $20 = $160;
ATC=TC/5 = $160/5 = $32.
22. By filling in the blanks in Exhibit 10, the marginal cost of the fourth pizza is shown to be
equal to
a. $10.
b. $15.
c. $17.
d. $23.
e. $40.
ANS
a. Incorrect. TC at 2 pizzas equals $100 + $13 = $113; Since MC = $10 at 3 pizzas, TC at 3
pizzas equals $113 + $10 = $123, MC of 4 pizzas = $140 - $123 = $17.
b. Incorrect. TC at 2 pizzas equals $100 + $13 = $113; Since MC = $10 at 3 pizzas, TC at 3
pizzas equals $113 + $10 = $123, MC of 4 pizzas = $140 - $123 = $17.
c. Correct. TC at 2 pizzas equals $100 + $13 = $113; Since MC = $10 at 3 pizzas, TC at 3
pizzas equals $113 + $10 = $123, MC of 4 pizzas = $140 - $123 = $17.
d. Incorrect. TC at 2 pizzas equals $100 + $13 = $113; Since MC = $10 at 3 pizzas, TC at 3
pizzas equals $113 + $10 = $123, MC of 4 pizzas = $140 - $123 = $17.
e. Incorrect. TC at 2 pizzas equals $100 + $13 = $113; Since MC = $10 at 3 pizzas, TC at 3
pizzas equals $113 + $10 = $123, MC of 4 pizzas = $140 - $123 = $17.
Exhibit 11 Long-run average cost curves
23. In Exhibit 11, which firm's long-run average cost curve experiences constant returns to
scale?
a. Firm A
b. Firm B
c. Firm C
d. Firms A and C
ANS
a. Incorrect. Firm A has no flat segment in its LRAC.
b. Correct. The flat portion of Firm B’s long-run average cost curve reflects constant returns
to scale.
c. Incorrect. Firm C has no flat segment in its LRAC.
d. Incorrect. Neither Firm A nor Firm C has a flat segment in it LRAC.
24. Which firm in Exhibit 11 displays a long-run average cost curve with diseconomies of
scale beginning at 2,000 units of output per week?
a. Firm A
b. Firm B
c. Firm C
d. Firms A and C
ANS
a. Correct. The upward-sloping portion of a long-run average cost curve reflects diseconomies
of scale at 2,000 units of output.
b. Incorrect. At 2,000 units of output, Firm B has constant returns to scale.
c. Incorrect. At 2,000 units of output, Firm C has economies of scale.
d. Incorrect. The statement is correct for Firm A, but Firm C has economies of scale.
25. Which firm in Exhibit 11 displays a long-run average cost curve with economies of scale
throughout the range of output shown?
a. Firm A
b. Firm B
c. Firm C
d. Firms A and B
ANS
a. Incorrect. Firm A’s LRAC is not downward sloping throughout.
b. Incorrect. Firm B’s LRAC is not downward sloping throughout.
c. Correct. The downward-sloping portion a long-run average cost curve reflects economies of
scale.
d. Incorrect. Neither Firm A nor Firm B has a downward-sloping LRAC throughout.