Deck 8: B: Costs and the Supply of Goods

Question 1

Kim used to work at "The Big One" accounting firm, and she earned $50,000 a year. She saved her money and has now invested $100,000 in her own firm. Profit is $20,000 a year, which Kim receives as her only compensation. She concludes that this is great because a 20 percent return is much better than the 8 percent she could get in another investment (the opportunity cost of the funds). What is wrong with this line of thinking?

Answer 1

While Kim is correct in understanding the opportunity cost of her invested funds, she is ignoring the opportunity cost of her time. Presumably this opportunity cost is $50,000, so her total implicit cost would be this amount plus the $8,000 in foregone interest. Note that this analysis ignores taxes, which could alter the calculations.

Question 2

Mr. Jones pays his employees by the hour. He believes they purposely work slowly to maximize their personal satisfaction. What can he do to provide them with a stronger incentive to work efficiently?

Answer 2

Mr. Jones needs to do something that would change worker incentives. One option would be to link pay to output or to the firm's profitability. He could pay bonuses for increased output, or he might tie all employee income to the profit the firm earns. This would make the employees residual claimants, giving them a stake in the firm's well-being.

Question 3

The AB Manufacturing Company has hired an economist to evaluate its financial situation. She explains to the board of directors that the company is making zero economic profit. Should the company go out of business?

Answer 3

The company should remain operating. Earning zero economic profit implies that the firm has an accounting profit equal to what the firm could be making at its highest valued alternative. A situation where zero economic profit is made would be considered normal.

Question 4

James opened a baseball manufacturing operation, and initially the more balls he made, the lower the per-unit cost. Now, as output expands, his per-unit costs are rising. He concludes that diseconomies of scale have set in. Is he correct? Why?

Question 5

If the ABC Company decides to take over the XYZ Corporation by purchasing all of the stock of XYZ, what does this tell us about the view ABC holds of XYZ?

Question 6

Suppose you are planning to open a lemonade stand. List separately all the explicit and implicit costs that might be involved.

Question 7

Andy wants to maximize his grade-point average. Having spent six hours studying for his final exam in economics, Andy calculates his grade and discovers that even with a perfect score on the final, he will not pass the course. He decides to study two more hours so he will not have wasted the first six hours. Is this a good decision? Why or why not?

Question 8

The boss observes that her 10 workers produce 1,000 widgets a day. She concludes that she can employ 20 workers and make 2,000 widgets, 30 to make 3,000, or 40 to make 4,000. Explain why this observation is either correct or incorrect.