Deck 7: The Production Process: the Behavior of Profit-Maximizing Firms

Question 1

Using the table below explain why the economic profit and the accounting profit of this firm may be different.

Answer 1

Economic profit is calculated by taking total revenue and subtracting all economic costs including implicit costs or opportunity costs. In the above example this firm incurs total economic costs of $31,000 and therefore the firm would experience negative economic profit. Alternatively the accounting profit would be positive since only the explicit costs of $29,000 would be counted and the firm would enjoy an accounting profit of $1,000.

Question 2

Why might a firm remain in operation even if it is earning zero economic profit?

Answer 2

If a firm is earning zero economic profit, it is earning a normal rate of return. Thus, the opportunity costs of all factors of production have been covered.

Question 3

How do economists define the time period known as the long run?

Answer 3

The long run is the period of time for which there are no fixed factors of production. Firms can increase or decrease their scale of operation, and firms can enter or exit the industry.

Question 4

What assumptions do economists make about the time period known as the short run?

Question 5

A firm sells 150 units of output at a price of $8 each. The economic cost of producing the 150 units of output is $1,000. Calculate the firm's level of economic profit.

Question 6

Define the normal rate of return. If a business has fairly steady revenues and the future looks secure, what should the normal rate of return equal? Why?

Question 7

Explain what is meant by the term production.

Question 8

Fred's Bar and Grill hires you to determine the company's status. The data below provides information on the company's annual costs and revenues.
Fred spends at least 40 hours a week at his place of business. If he closed the bar, he could work for his competitor and earn $30,000 per year. He also owns the building that houses the bar and could rent it out for $24,000 per year if he closes his business. Calculate the economic cost and economic profit for Fred's Bar and Grill.

Question 9

Mitzi's Pet Salon hires you to determine the company's status. The data below provides information on the company's annual costs and revenues.
Mitzi spends at least 40 hours a week at her place of business. If she closed the salon, she could work for her competitor and earn $15,000 per year. She also owns the building that houses the salon and could rent it out for $18,000 per year if she closes her business. Calculate the economic cost and economic profit for Mitzi's Pet Salon. Would an accountant come to the same conclusion about the profitability of this firm? Explain.

Question 10

Why might certain industries have a long run and a short run that is not separated by very much time?

Question 11

Evaluate the following statement. "I used my own money, my own land and my own equipment to start my business. Therefore I don't have any costs associated with running my business".

Question 12

Your friend Harry has quit his $20,000-a-year job to start a business that rents fishing boats. He asks you to lend him $50,000 and agrees to pay you a 10% return on your $50,000 if he earns a profit. During the first year Harry's total revenue is $120,000 and his total cost for equipment and supplies are $100,000. Harry tells you that he cannot pay you any interest this year because he did not earn a profit. Is your friend Harry trying to cheat you?

Question 13

How does a firm measure its profit?

Question 14

What is the difference between accounting cost and economic cost?

Question 15

What are the three decisions that all firms must make?

Question 16

What role do business firms play in output markets and in factor markets?

Question 17

Suppose your neighbor owns a restaurant and boasts that he is able to turn a handsome accounting profit because of his low labor costs. He attributes this to the fact that he uses his sons and daughters as cooks and waiters. His point is that he offers them below-market wages. How would you respond to your neighbor's statement? What would you tell him to expect as his children continue to work for him while they are in college and beyond?

Question 18

What two things determine the cost of production?

Question 19

What is a firm?

Question 20

A lawyer quits his job at a top legal firm where he was making $100,000 per year. He was just informed that his late aunt has bequeathed to him $1 million in cash. He decides to use all of the money to open and run his own hardware store. Assume at the end of the first year of business that his accountant has informed him that he earned a $90,000 accounting profit. Why would an economist not be quite as impressed? Explain.

Question 21

Suppose a manager of a company is told by his staff that marginal productivity has risen above the average productivity over the last six months of operation. What can this manager conclude is happening to the overall average productivity of the company? Explain.

Question 22

Explain what is meant by marginal product.

Question 23

How is the average product of labor calculated?

Question 24

Explain how it is possible for marginal product to fall while average product is rising?

Question 25

If marginal product is decreasing what can we say about what is happening to average product? Explain.

Question 26

The data below shows the relationship between total output and the amount of labor hired at Papa's Pizza Shop:

Question 27

As a manager of a dry-cleaning establishment, you estimate that the total product of labor used to clean shirts varies according to the following data:
Fill in the table above.

Question 28

Assume that a company is producing at a point beyond where diminishing returns has already set in. If the firm cuts back on production what would you expect should happen to the marginal product of labor and why?

Question 29

What three pieces of information do firms need to know to make production decisions?

Question 30

Assume that a very unusual production process involves increasing marginal productivity that appears to have no end. What would the total productivity function look like? Comment on the likelihood of such a function in the real world.

Question 31

Use the two graphs below to explain the relationship between total product and marginal product.

Question 32

Barney's Beds currently hires 14 workers. The average product of labor is 2 beds per day, and the marginal product of a 15th worker is expected to be three beds per day. If the firm hires the 15th worker, what will happen to the average product of labor? Explain.

Question 33

Explain the law of diminishing returns.

Question 34

Assume the marginal product for a particular good is constant. Describe the shape of the total product function that would accompany it.

Question 35

Using the table below calculate the marginal product and the average product. Show where diminishing marginal productivity sets in.

Question 36

The data below shows the relationship between total output and the amount of labor hired at Jack's Quick Lube Station:

Question 37

Does the production function in the table above exhibit diminishing returns? Explain.

Question 38

Assume that for whatever reason there is a manufacturing firm exhibits a constant marginal product of labor over a certain range of production. Armed with only this information what would you be able to say about the average product and total product of labor curves of this firm.

Question 39

What is production technology?

Question 40

Using an example, explain the difference between a labor-intensive technology and a capital-intensive technology.

Question 41

Comment on the following statement: "Diminishing returns occur when total output falls as additional units of labor are combined with fixed inputs in the production process."

Question 42

On the figure below, indicate the level of labor where diminishing returns set in.

Question 43

Evaluate the following statement. "As the marginal product function falls it will eventually cut the average product function where average product is rising."

Question 44

There is a famous economics saying that argues "if diminishing marginal productivity never set in then the world could be fed from a flower pot." Explain what this means economically.

Question 45

Comment on the following statement: "When average product and marginal product are equal, marginal product is at its maximum."

Question 46

Rhonda's Rug Company can produce 50 rugs using the following five combinations of labor and capital:
If the price of capital is $2 per unit and the price of labor is $1 per unit, calculate the total cost of producing 50 rugs under each technology. Which is the cost-minimizing technology?

Question 47

A corporate executive makes the following statement - "The company must keep hiring more workers up to the point where the marginal productivity of the last worker we hire is zero. This way we can maximize the total productivity of the firm." Critically evaluate this statement. Also comment on whether this is the correct objective function for the firm.

Question 48

Label each of the three graphs below X, Y and Z as either the marginal product, average product or total product of labor and explain the relationship between each of them.

Question 49

As a manager of a shoe-repair shop, you estimated that the total product of labor used to repair shoes varies according to the following data but some of your figures were deleted by a clerk:
Fill in missing data in the table above.

Question 50

What is the relationship between the marginal product curve and the total product curve?

Question 51

Martha owns a factory which can produce 150 coffee mugs using the following five combinations of labor and capital:
If the price of capital is $5 per unit and the price of labor is $3 per unit, calculate the total cost of producing 150 coffee mugs under each technology. Which technology would a profit-maximizing firm use?

Question 52

If marginal product is a constant what can we conclude about the shape of the average product function and why?

Question 53

A manager of a small company makes the following statement - "We need to keep hiring additional workers up to the point where the marginal productivity of the last worker we hire is at its maximum. This way we can maximize the total productivity of the firm." Critically evaluate this statement.

Question 54

What do economists mean when they say that capital can labor can be both complementary inputs and substitutes.

Question 55

Evaluate the following statement. "If marginal product is falling it will bring down the average product."

Question 56

Use the table below to answer the following questions. Calculate the total cost of production if labor and capital costs are equal at a $1 each. The recalculate the costs when only the price of labor rises to $5 but capital costs remain at $1. Identify the least cost technology in both cases.

Question 57

Referring to the table below, identify the unit of labor where diminishing returns has set in. Explain your answer.

Question 58

What is the relationship between marginal product and average product?

Question 59

What does it mean when economists say that labor and capital are complementary inputs?

Question 60

Wally's Widgets currently hires 8 workers. The average product of labor is 15 widgets per day, and the marginal product of a 9th worker is expected to be 13 widgets per day. If the firm hires the 9th worker, what will happen to the average product of labor? Explain.

Question 61

Comment on the following statement: "Isoquants must be downward sloping."

Question 62

What is the marginal technical rate of substitution?

Question 63

What is an isoquant?

Question 64

If the marginal product of labor is equal to 5 and the marginal product of capital is 2, what is the marginal technical rate of substitution?