Deck 6: Cost Analysis

Question 1

Assume that an investor invests $100,000 in a business venture. He earns an economic profit of $5,000. If the rate of return on an investment of equal risk is 10%, then the rate of return earned on the investment in the business venture is:

A) 25%
B) 15%
C) 10%
D) 5%
E) 20%

Answer 1

B

Question 2

The following figure shows the long-run average cost curve of a firm.
Figure 6-1

Refer to Figure 6-1. The production function of the firm displays constant returns to scale when output is increased from _____.

A) A to E
B) C to D
C) D to E
D) A to B
E) B to D

Answer 2

B

Question 3

If short-run average cost is increasing then:

A) average fixed cost must be increasing.
B) marginal cost must be decreasing.
C) marginal cost must be greater than short-run average cost.
D) the production function displays decreasing returns to scale.
E) average variable cost must be decreasing.

Answer 3

C

Question 4

When average total cost is at its minimum point:

A) marginal cost is also at its minimum point.
B) marginal cost is equal to zero.
C) marginal cost is constant.
D) average total cost is equal to marginal cost.
E) the firm is maximizing profit.

Question 5

Amanda invests $500,000 in a new business venture. Which of the following correctly identifies the relevant opportunity cost that she faces?

A) The potential profits from the business
B) The discounted present value of future profits from the business
C) The rate of interest that could have been earned on an a comparably risky $500,000 investment.
D) The probability of losing the initial investment of $500,000
E) The rate of return on $500,000 invested in the business

Question 6

Which of the following is true of a firm's fixed costs?

A) A firm should shut down if it cannot cover its fixed costs.
B) Fixed costs are incurred regardless of the firm's level of output.
C) Fixed costs are the same as a firm's total costs.
D) Fixed costs are reduced to zero if the firm produces no output.
E) Accounting profit equals economic profit when fixed costs fall to zero.

Question 7

A firm that produces and sells toys has a factory located in New Town built on a 50,000 square feet plot of land. The following table gives information about the costs of production and output of the firm.
Table 6-1
$\begin{array}{|l|l|}\hline \text { Cost of plant and machinery } & \$ 20,000 \\\hline \text { Wages paid to labor } & \$ 4,000 \\\hline \text { Annual factory rent } & \$ 10,000 \\\hline \begin{array}{l}\text { Annual registration fees paid to an industry } \\\text { association }\end{array} & \$ 1,000 \\\hline \text { Marketing Costs } & \$ 20,000 \\\hline \text { Cost of raw materials used in production } & \$ 3,000 \\\hline \text { Cost of packaging used for the final product } & \$ 400 \\\hline \text { Number of toys produced per day } & 1,000 \\\hline \text { The price of a toy } & \$ 30 \\\hline\end{array}$


-Refer to Table 6-1. What is the average variable cost of producing a toy?

A) $4.00
B) $7.40
C) $9.80
D) $8.00
E) $8.60

Question 8

The average fixed cost for a firm

A) is constant at all levels of output.
B) is increasing over all levels of output.
C) first increases at an increasing rate and then declines.
D) first decreases and then increases as output increases.
E) is decreasing over all levels of output.

Question 9

Which of the following is true of the long run?

A) The average fixed cost is higher in the long run than in the short run.
B) All inputs costs are variable in the long run.
C) The firm produces at a higher cost in the long run than in the short run.
D) All inputs to production are kept fixed in the long run.
E) Answers the average fixed cost is higher in the long run than in the short run and all inputs costs are variable in the long run are both correct.

Question 10

A law firm will be paid $500 to send one of its lawyers to a client to take a routine deposition. The firm can send a 2nd year lawyer whose usual billing rate is $150 per hour and who is currently working on a lucrative tax deal, or it can send a 4th year associate (billing rate $200 per hour) who is currently overseeing the selection and hiring of law students as summer associates. Based on this information, the firm should send:

A) the 2^nd year lawyer because his billable rate is lower.
B) the 4^th year lawyer because her billable rate is higher.
C) the 2^nd year lawyer because he is currently more productive.
D) either one since the firm receives the same $500 fee.
E) the 4^th year lawyer because her current work is less valuable to the firm.

Question 11

Bill gives up his present job in Delaware to pursue a graduate school program in New York. What is the opportunity cost of his decision?

A) The difference between the cost of living in New York and in Delaware
B) The total tuition cost of the program
C) The increase in wages that he can expect as a result of higher educational qualifications
D) The wages that he forgoes when he quits his job
E) The cost of relocating to New York from Delaware

Question 12

In the short run, if the marginal product of labor is decreasing, then:

A) marginal cost must be increasing.
B) the marginal revenue of the firm must be decreasing.
C) average total cost must be increasing.
D) average variable cost must be decreasing.
E) average total cost must be decreasing. the marginal revenue product of labor must be increasing.

Question 13

The economic profit on an investment is zero when:

A) the total revenue from the investment exceeds the costs of the investment.
B) the revenue from the investment just covers the fixed cost of the investment.
C) the accounting profit and economic profit are equal.
D) the investment earns a normal rate of return.
E) the sunk cost of the investment is zero.

Question 14

When a firm's production function exhibits constant returns to scale:

A) the short-run average cost curve will be horizontal.
B) the long-run average cost curve will be U-shaped.
C) the long-run marginal cost curve will be upward sloping.
D) the short-run average variable cost curve will be downward sloping.
E) the long-run average cost curve will be horizontal.

Question 15

A firm that produces and sells toys has a factory located in New Town built on a 50,000 square feet plot of land. The following table gives information about the costs of production and output of the firm.
Table 6-1
$\begin{array}{|l|l|}\hline \text { Cost of plant and machinery } & \$ 20,000 \\\hline \text { Wages paid to labor } & \$ 4,000 \\\hline \text { Annual factory rent } & \$ 10,000 \\\hline \begin{array}{l}\text { Annual registration fees paid to an industry } \\\text { association }\end{array} & \$ 1,000 \\\hline \text { Marketing Costs } & \$ 20,000 \\\hline \text { Cost of raw materials used in production } & \$ 3,000 \\\hline \text { Cost of packaging used for the final product } & \$ 400 \\\hline \text { Number of toys produced per day } & 1,000 \\\hline \text { The price of a toy } & \$ 30 \\\hline\end{array}$


-Refer to Table 6-1. What is the average fixed cost of producing a toy?

A) $38
B) $20
C) $40
D) $51
E) $30

Question 16

Accounting profit differs from economic profit because:

A) accounting cost does not include sunk cost.
B) economic cost includes all relevant opportunity costs.
C) accounting cost includes the implicit costs of production.
D) accounting cost does not include fixed cost.
E) economic cost does not include the explicit costs of production.

Question 17

The money that a firm has already spent on research and development for a project should be categorized as _____ when the firm is deciding whether to make an additional investment in the project.

A) an implicit cost
B) a variable cost
C) a sunk cost
D) a marginal cost
E) an overhead cost

Question 18

Dana, who is a trained yoga instructor, spends 4 hours on Monday baking and packing 10 boxes of cookies. She sells the cookies for $10 a box. Given that she can also teach yoga for $80 an hour, what is her opportunity cost of baking cookies?

A) $320
B) $100
C) $220
D) $420
E) $800

Question 19

A firm produces 100 units of output at an average variable cost of $5 and incurs a total fixed cost of $700. Which of the following is true?

A) The firm's average total cost is $12.
B) The firm's total variable cost is $1,200.
C) The firm's marginal cost is constant and equal to $5.
D) The firm's average fixed cost is $5.
E) The firm's total cost is $500.

Question 20

If a firm were to stop production of its only product, the firm's total cost will be equal to

A) zero.
B) its total fixed cost
C) its total variable cost.
D) its opportunity cost.
E) its average cost.

Question 21

A firm's long-run average cost curve is estimated by the equation: LAC = 1,000 - 2.5Q + .005Q2. What is the minimum efficient scale of production?

Question 22

The following figure shows the long-run average cost curve of a firm.
Figure 6-1

Refer to Figure 6-1. The production function of the firm displays decreasing returns to scale at all levels of output between _____.

A) A to E
B) C to D
C) D to E
D) A to B
E) B to D

Question 23

The following figure shows the long-run average cost curve of a firm.
Figure 6-1

Refer to Figure 6-1. What is the quantity that the firm will produce if it is operating at minimum efficient scale?

A) E
B) A
C) C
D) D
E) B

Question 24

The average variable cost of producing 1, 2, 3, and 4 units of a product is respectively equal to $5, $6, $7, and $8. Find the marginal cost of producing the fourth unit of output.

Question 25

Assume that the minimum efficient scale for a typical firm in an industry is 2 million units. The estimated output for the whole industry is 6 million units. Therefore, one can conclude that:

A) the industry is a natural monopoly.
B) the output produced in the industry is less than the perfectly competitive output.
C) the industry experiences increasing returns to scale.
D) the industry is likely to support 3 firms, each producing at minimum efficient scale.
E) the price in the industry is higher than the perfectly competitive price.

Question 26

A profit-maximizing firm should shut down in the short run if:

A) price is greater than marginal cost.
B) total revenue is less than total variable cost.
C) the firm is earning less than a normal rate of return.
D) the firm is not able to cover its overhead expenses.
E) marginal cost is higher than average cost.

Question 27

Briefly describe the economic cost of a college graduate serving two years in the Peace Corps, an American volunteer program, in a remote South American village.

Question 28

A firm will continue to operate in the long run only if:

A) it earns a positive rate of return.
B) it earns a nonnegative economic profit.
C) it makes a positive accounting profit.
D) average cost exceeds price.
E) the average variable cost exceeds price.

Question 29

A profit-maximizing firm will produce at the level where:

A) marginal cost equals average revenue.
B) the per unit cost is minimized.
C) price equals average fixed cost.
D) marginal revenue equals marginal cost.
E) price equals average cost.

Question 30

When the long-run average cost is at its minimum, the long-run marginal cost:

A) is also at its lowest value.
B) is decreasing.
C) is greater than long-run average cost.
D) is at its highest value.
E) is equal to long-run average cost.

Question 31

What is meant by economies of scope?

A) Economies of scope refers to the cost advantages from the joint production of multiple goods.
B) Economies of scope refers to the profits that firms earn when they practice price discrimination across market segments.
C) Economies of scope refers to efficiency that firms gain when they specialize in the production of one good.
D) Economies of scope refers to the efficiency gains from specialization and division of labor.
E) Economies of scope refers to the reduction in cost that accrues to a firm due to cumulative production experience and learning.

Question 32

"All fixed costs are sunk costs and all sunk costs are fixed costs." Examine the validity of this statement.

Question 33

The minimum efficient scale is important in determining:

A) the optimum level of input usage by a firm.
B) the allocation of output between the multiple plants owned by a firm.
C) the output elasticity of firms in the market.
C) whether the firm's production function exhibits increasing, constant, or decreasing returns to scale.
E) how many firms can profitably operate in a particular market.

Question 34

If the price of a product consistently exceeds its average cost, one can definitely conclude that the firm:

A) is earning a normal rate of return.
B) is maximizing its long-run profit.
C) is producing at its most efficient level of output.
D) is earning a positive economic profit.
E) is producing at the minimum efficient scale.

Question 35

Mexico is capable of producing 20 auto tires or 16 microcircuits per labor hour. Brazil is capable of producing 24 auto tires or 24 microcircuits per labor hour. Based on this information, we can conclude that:

A) Brazil has an absolute advantage in both goods.
B) Brazil will export both goods to Mexico.
C) Mexico has a comparative advantage in tires.
D) Answers Brazil has an absolute advantage in both goods and Mexico has a comparative advantage in tires are both correct.
E) Answers Brazil has an absolute advantage in both goods, Brazil will export both goods to Mexico, and Mexico has a comparative advantage in tires are all correct.

Question 36

A lawyer is contemplating quitting her current job with a major corporation (where she earns an annual salary of $110,000) to open her own law practice. She estimates that the total cost of operating the office will be approximately $118,000 per year. The potential revenue is estimated as $200,000 per year. Compute her accounting cost, accounting profit, economic cost, and economic profit.

Question 37

A firm's production function is given by Q = 2K2 + 6L. Does this production function exhibit constant returns to scale?

Question 38

The following figure shows the long-run average cost curve of a firm.
Figure 6-1

Refer to Figure 6-1. The production function of the firm displays increasing returns to scale at all levels of output between _____.

A) A to E
B) C to D
C) D to E
D) A to C
E) B to E

Question 39

Which of the following correctly defines the minimum efficient scale for a firm?

A) The output level at which the firm earns an abnormal profit
B) The minimum point of the firm's learning or experience curve
C) The lowest output at which minimum average cost can be achieved
D) The output level where average fixed cost is at its minimum point
E) The level of output produced when the firm is operating at full production capacity

Question 40

A firm's short-run average cost is described by the equation: SAC = 2,000/Q + 60 + .2Q. Determine the equation for the firm's marginal cost. What is the MC of producing the tenth unit of output?

Question 41

Three college students consider the option of forming a lawn care and landscaping business during their summer vacation. They estimate the following costs:
$\begin{array} { | l | l | } \hline \text { Insurance } & \$ 2,600 \\\hline \text { Equipment Rental Fees } & \$ 1,000 \\\hline \text { Fuel and Supplies } & \$ 4 \text { per lawn } \\\hline \text { Miscellaneous Expenses } & \$ 2 \text { per lawn } \\\hline\end{array}$ Their projected revenue depends on the number of lawns serviced. The price per job is $30. The going wage for a typical unskilled college student is about $2,400 for the summer months. Derive an equation for total accounting profit and total economic profit. Should the students launch the business if they expect to service about 200 lawn jobs during the summer?

Question 42

Explain the economic logic of the short-run shutdown rule. Why does it sometimes make sense to operate at a loss?

Question 43

Explain the relationship between short-run average cost and long-run average cost. Draw an appropriate graph to illustrate your explanation. Assume constant returns to scale.

Question 44

A firm produces output at two plants that are at different locations but are otherwise identical. The firm's cost function is C(q) = 5.3√q, where q is the quantity produced at the plant. To satisfy demand at the current market price, the firm needs to produce a total of 202,500 units of output. How should the firm divide production between the two plants in order to minimize the cost of production? Is it more profitable to produce all 202,500 units at one plant?

Question 45

The production manager of a clothing manufacturer estimates that the total annual cost of producing men's suits is given by the equation: C = 5,000 + 4,100Q - 8Q2 + .004Q3. If the market price of suits is constant, what is the shutdown level of output in the short run? What is the minimum price the firm can accept?

Question 46

DigiWatch plans to open a new production facility to produce digital watches. Based on previous experience, the firm estimates that the fixed costs of the plant will be $366,000 per year, and that average variable cost will be: AVC = 7.00 + .002Q.
(a) Compute the total cost and average cost for the first year of production at an output of 6,000 watches.

Question 47

A firm produces 100 units of good A at a total cost of $1,500 and separately 200 units of good B at a cost of $2,000. By combining the production of A and B, it is possible to produce the same quantities of A and B respectively at a combined total cost of $2,800. Compute the economies of scope experienced by this firm.

Question 48

A firm's total cost function is: C = 50 + 6Q + 2Q2.
(a) Compute the level of output that minimizes average total cost AC.

Question 49

The table gives the short-run production data for a manufacturing firm. Compute average cost and marginal cost for the output levels shown in the table.

Question 50

Doorway Computers manufactures PCs, and also produces the special DVD drives that go into each PC. Demand for computers is estimated to be: P = 2,000 - .1Q, where Q denotes units sold per month, and P is the price of the PC. The firm's total cost is C = 40,000 + 800Q + CD, where CD denotes the firm's total cost of producing drives. Currently, CD = 100QD, that is, the firm's cost per drive is $100.
(a) If there is no external market for DVD drives, how many computers should Doorway produce and sell in order to maximize profit? What transfer price should the firm set for disk drives?

Question 51

(a) Firm K is a leading maker of light-weight, water-proof outerwear. During the winter months, demand for its main line of water-proof coats is given by: P = 800 - 0.2Q, where P denotes price in dollars and Q is quantity of units sold per month. The firm produces coats in a single plant (which it leases by the year). The total monthly cost of producing these coats is estimated to be: C = 150,000 + 400Q. Leasing the plant accounts for almost all of the $150,000 fixed cost. What is the firm's marginal cost? Find the firm's profit-maximizing output and price. If the firm's other outerwear products generate $50,000 in contribution, what is the firm's total monthly profit?

Question 52

A firm produces three products A, B, and C. Long-run projected sales per year are 10,000 units of A, 12,000 units of B, and 8,000 units of C.
(a) Determine whether the firm should remain in business under the following conditions:
Good A sells at $5 per unit, and average variable cost (AVC) is $3.5. Good B sells at $7.5 per unit, and AVC is $5. Good C sells at $10 per unit, and AVC is $7.50. Total fixed cost is $60,000 per year.
(b) If the firm allocates fixed cost using standard accounting practices, what is the total accounting profit for each good?

Question 53

Explain how each of the following events will affect the average and marginal cost curves of a firm:
i) An increase in labor costs
ii) An increase in lease payments for a facility
iii) A decrease in the cost of utilities (electricity, water heat)
iv) Stricter environmental regulation requiring installation of scrubbers on smokestacks