BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
Lahore School of Economics
Microeconomics I
Winter Term 2009
Quiz 4: BSc. 2, Section B
Which of the following statements is true regarding the differences between economic and
accounting costs?
a.
b.
c.
d.
Accounting costs include all implicit and explicit costs.
Economic costs include implied costs only.
Accountants consider only implicit costs when calculating costs.
Accounting costs include only explicit costs.
Which of the following statements correctly uses the concept of opportunity cost in decision
making?
I. “Because my secretary's time has already been paid for, my cost of taking on an additional project
is lower than it otherwise would be."
II. "Since NASA is running under budget this year, the cost of another space shuttle launch is lower
than it otherwise would be."
a.
b.
c.
d.
I is true, and II is false.
I is false, and II is true.
I and II are both true.
I and II are both false.
The total cost (TC) of producing computer software diskettes (Q) is given as: TC = 200 + 5Q. What
is the average fixed cost?
a.
b.
c.
d.
e.
500
5Q
5
5 + (200/Q)
none of the above
Carolyn knows average total cost and average variable cost for a given level of output. Which of the
following costs can she not determine given this information?
a.
b.
c.
d.
e.
total cost
average fixed cost
fixed cost
variable cost
Carolyn can determine all of the above costs given the information provided.
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BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
Use the following two statements to answer this question:
I.The average cost curve and the average variable cost curve reach their minima at the same level of
output.
IIThe average cost curve and the marginal cost curve reach their minima at the same level of output.
a.
b.
c.
d.
Both I and II are true.
I is true, and II is false.
I is false, and II is true.
Both I and II are false.
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
a.
b.
c.
d.
below average total cost.
above average total cost.
between the average variable and average total cost curves.
below average fixed cost.
Which always increase(s) as output increases?
a.
b.
c.
d.
e.
Marginal Cost only
Fixed Cost only
Total Cost only
Variable Cost only
Total Cost and Variable Cost
Which of the following is NOT an expression for the cost minimizing combination of inputs?
a.
b.
c.
d.
e.
MRTS = MPL /MPK.
MPL/w = MPK/r.
MRTS = w/r.
MPL/MPK = w/r.
None of these.
At the optimum combination of two inputs,
a.
b.
c.
d.
e.
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.
all of the above.
(a) and (c) only.
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BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
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
a. is producing its current output level at the minimum cost.
b. could reduce the cost of producing its current output level by employing more capital and less
labor.
c. could reduce the cost of producing its current output level by employing more labor and
less capital.
d. could increase its output at no extra cost by employing more capital and less labor.
e. both (b) and (d) are true.
A firm's short-run average cost curve is U-shaped. Which of these conclusions can be reached
regarding the firm's returns to scale?
a.
b.
c.
d.
The firm experiences increasing returns to scale.
The firm experiences increasing, constant, and decreasing returns in that order.
The firm experiences first decreasing, then increasing returns to scale.
The short-run average cost curve reveals nothing regarding returns to scale.
The cost-output elasticity equals 1.4. This implies that:
a.
b.
c.
d.
there are neither economies nor diseconomies of scale.
there are economies of scale.
there are diseconomies of scale.
marginal cost is less than average cost.
At the current level of output, long-run marginal cost is $50 and long-run average cost is $75. This
implies that:
a.
b.
c.
d.
there are neither economies nor diseconomies of scale.
there are economies of scale.
there are diseconomies of scale.
the cost-output elasticity is greater than one.
Consider the following statements when answering this question.
I."Investment in new technology generates learning by doing."
II.Economies of scale cannot shift the long-run average cost curve down, whereas learning by doing
can.
a.
b.
c.
d.
I is true, and II is false.
I is false, and II is true.
Both I and II are true.
Both I and II are false.
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BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
At the profit-maximizing level of output, what is true of the total revenue (TR) and total cost (TC)
curves?
a.
b.
c.
d.
e.
They must intersect, with TC cutting TR from below.
They must intersect, with TC cutting TR from above.
They must be tangent to each other.
They cannot be tangent to each other.
They must have the same slope.
If current output is less than the profit-maximizing output, then the next unit produced
a.
b.
c.
d.
e.
will decrease profit.
will increase cost more than it increases revenue.
will increase revenue more than it increases cost.
will increase revenue without increasing cost.
may or may not increase profit.
Subjective
1. A firm's total cost function is given by the equation:
TC = 4000 + 5Q + 10Q2.
Determine the quantity that minimizes average total cost. Demonstrate that the predicted
relationship between marginal cost and average cost holds. (3 + 3)
Solution:
ATC is minimized where MC is equal to ATC.
Equating MC to ATC
4000  5Q  10Q 2
 5  20Q
Q
4000  5Q  102  5Q  20Q 2
4000  10Q 2
Q 2  400
Q  20
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BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
ATC is minimized at 20 units of output. Up to 20, ATC falls, while beyond 20 ATC rises.
MC should be less than ATC for any quantity less than 20.
For example, let Q = 10:
MC = 5 + 20(10) = 205
4000  510   1010
 505
10
2
ATC 
MC is indeed less than ATC for quantities smaller than 20.
MC should exceed ATC for any quantity greater than 20.
For example, let Q = 25:
MC = 5 + 20(25) = 505
4000  525  1025
 415
25
2
ATC 
MC is indeed greater than ATC for quantities greater than 20.
2. Davy Metal Company produces brass fittings. Davy's engineers estimate the production function
represented below as relevant for their long-run capital-labor decisions.
Q = 500L0.6K0.8,
where Q = annual output measured in pounds,
L = labor measured in person hours,
K = capital measured in machine hours.
The marginal products of labor and capital are:
MPL = 300L-0.4K0.8
MPK = 400L0.6K-0.2
Davy's employees are relatively highly skilled and earn $15 per hour. The firm estimates a rental
charge of $50 per hour on capital. Davy forecasts annual costs of $500,000 per year, measured in
real dollars.
a. Determine the firm's optimal capital-labor ratio, given the information above. (3)
b. How much capital and labor should the firm employ, given the $500,000 budget? Calculate the
firm's output. (3 + 3)
Solution:
a.
.
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BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
K 0.8
MPL  300L K  300 0.4
L
L0.6
0.6
 0.2
MPK  400L K
 400 0.2
K
0.8
K
300 0.4
0.8
0.2
L  0.75 K K
MRTS 
L0.6
L0.4 L0.6
400 0.2
K
K
MRTS  0.75
L
w 15
Equate to  .
r 50
K 15
0.75 
L 50
K
0.75  0.3
L
K
 0.4; K = 0.4L
L
 0.4
0.8
b.
C = 500,000
C = wL + rK
500,000 = 15L + 50K
K = 0.4L from optimal ratio
500,000 = 15L + 50(0.4L)
500,000 = 15L + 20L
500,000 = 35L
L = 14,285.71 or 14,286 hours
Substitute to solve for K.
500,000 = 15(14286) + 50K
500,000 = 214,290 + 50K
285,710 = 50K
K = 5714.20
or K = 5714
Q = 500(14,286)0.6(5,714)0.8
Q = 157,568,191
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BSc II – Section B
Microeconomics Winter 2009
Quiz 4 (A)
3. Estimates of the industry long-run average cost of producing a type of plastic hook were made in
1970 and again in 1985. Estimates of these relationships are presented as:
LAC70 = 10 - 0.3Q + 0.05Q2
LAC85 = 8 - 0.6Q + 0.04Q2,
where Q is output in hundreds of cases per day, and LAC is average cost in dollars per unit.
Assume that costs are expressed in inflation adjusted or constant dollars. From the information
available, can you learn anything about economies of scope, economies of scale, and a learning curve
in this industry? Explain. (2 + 3+ 4)
Solution:
Nothing can be learned about economies of scope, given that only one product is being produced.
For 1970:
LAC70 = -0.3 + 0.1Q = 0
Q = 3.0
(in hundreds of cases)
For 1985:
LAC85 = -0.6 + 0.08Q = 0
Q = 7.5
(in hundreds of cases)
The LAC70 at Q = 3 is 10 - 0.3(3) + 0.05(3)2 = $9.55/case.
The LAC85 at Q = 7.5 is 8 - 0.6(7.5) + 0.04(7.5)2 = $5.75/case.
We see that LAC is minimized at positive levels of Q in 1970 and in 1985. Also, we see that LAC
is minimized at a higher level of output in 1985 than in 1970. Over time the rate of production in
the industry that represented the optimum scale of plant increased. The fact that LAC decreased
time for various levels of output (LAC70 vs. LAC85) indicates that technology changed (improved)
and/or that there was a learning process in progress (learning curve). The data given do not allow
one to separate the two effects. Since both LAC functions have minimums, economies of scale are
evident. Economies occur to Q = 3 (1970) and Q = 7.5 (1985).
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