Deck 6: Costs

Question 1

Jet fuel is a major operating expense of an airline. Consider two airlines: Luna hedged fuel at US$50 per barrel, while Solis buys fuel on the spot market. The current spot price is US$70 per barrel. How should the difference in fuel expense affect their pricing and capacity planning?

A) Solis' marginal cost is higher and so it should set higher prices than Luna.
B) Both Luna and Solis face the same opportunity cost of fuel, which is the spot market price, and should price the same way.
C) Insufficient information to answer.

Answer 1

B

Question 2

Your family owns a piece of empty land near the city centre. What is the opportunity cost of holding the empty land?

A) The cost of redeveloping the land into the best possible use.
B) The income from using the land for the best possible purpose.
C) Both a and b.
D) Neither a nor b.

Answer 2

B

Question 3

Consider the investments in setting up a new fine dining restaurant. Which of the following expenses would be sunk costs?
(i) Construction and decoration of the dining and kitchen areas.
(ii) Kitchen utensils.
(iii) Furniture.
(iv) Dinner ware and cutlery.
(v) Website design.

A) (i) and (ii).
B) (ii) and (v).
C) (iii) and (iv).
D) (iv) and (ii).
E) (v) and (i).

Answer 3

E

Question 4

Even after a company shuts its business, it may still have to pay pensions. Referring to the taxonomy of costs (Figure 6.1 in the text), how would you describe the cost of the pensions?

A) Avoidable cost.
B) Sunk cost.
C) Fixed cost.
D) Variable cost.

Question 5

Which of the following concepts explains the economies of scale in the software industry?

A) Avoidable cost.
B) Sunk cost.
C) Fixed cost.
D) Variable cost.

Question 6

At the time of writing, the top three providers of exchange-traded funds in the United States were Blackrock, Vanguard, and State Street which accounted for almost 80% of the market. Which of the following concepts explains the market concentration?

A) Economies of scale.
B) Diseconomies of scale.
C) Economies of scope.
D) Diseconomies of scope.

Question 7

A newspaper and television station can share news produced by reporters. What concept of cost does this illustrate?

A) Fixed cost.
B) Variable cost.
C) Joint cost.
D) Specific cost.

Question 8

The cost of researching and developing a new drug are fixed with respect to the number of units produced. Luna Pharmaceutical would like to sell drugs to poor countries "at cost." Suppose that Luna is subject to the fixed cost fallacy and calculates the cost of the drugs as the average cost, which includes the average fixed cost. What is a consequence of the fallacy?

A) Luna would under-price the drugs to poor countries.
B) Luna would over-price the drugs to poor countries.
C) Luna should price according to the marginal cost.
D) None of the above.

Question 9

Accounting statements do not report opportunity costs. Businesses in existence for longer time would have more assets that have appreciated in value. Explain why such businesses would be more likely to suffer from status quo bias.

A) These older businesses may not be aware of alternative uses of their assets which would yield more profit. So, they would remain in status quo.
B) The assets that have appreciated in value would have substantial opportunity costs.
C) Owing to status quo bias, older businesses would overlook the opportunity costs of appreciated assets.
D) None of the above.

Question 10

Jet fuel is a major operating expense of an airline. Consider two airlines: Luna hedged fuel at US$50 per barrel, while Solis buys fuel on the spot market. The current spot price is US$70 per barrel. How should the difference in fuel expense affect their pricing and capacity planning?

Question 11

Your family owns a piece of empty land near the city centre. What is the opportunity cost of holding the empty land?

Question 12

Consider the investments in setting up a new fine dining restaurant. Which of the following expenses would be sunk costs?
(i) Construction and decoration of the dining and kitchen areas.
(ii) Kitchen utensils.
(iii) Furniture.
(iv) Dinner ware and cutlery.
(v) Website design.

Question 13

Even after a company shuts its business, it may still have to pay pensions. Referring to the taxonomy of costs (Figure 6.1 in the text), how would you describe the cost of the pensions?

Question 14

Use the concepts of fixed and variable costs to explain the economies of scale in the software industry.

Question 15

At the time of writing, the top three providers of exchange-traded funds in the United States were Blackrock, Vanguard, and State Street which accounted for almost 80% of the market. How does such concentration relate to economies of scale?

Question 16

A newspaper and television station can share news produced by reporters. What concept of cost does this illustrate?

Question 17

Use the concepts of joint and specific costs to explain the economies of scope across the transportation of passengers and freight by rail.

Question 18

The cost of researching and developing a new drug are fixed with respect to the number of units produced. Luna Pharmaceutical would like to sell drugs to poor countries "at cost." Suppose that Luna is subject to the fixed cost fallacy. Explain why it would over-price the drugs.

Question 19

Businesses in existence for longer time would have more assets that have appreciated in value. Explain why such businesses would be more likely to suffer from status quo bias.