Multiple-Choice
1. Wade recently opened a winery after he left his job as a teacher, from which he earned
$35,000/year. Instead of renting out his land for $5,000/year, he now uses it for his
winery. He spent $50,000 on materials and $15,000 on an assistant. He leased a machine
for $10,000/year. He made $160,000 this year making wine. His explicit costs are
a.
b.
c.
d.
$50,000.
$15,000.
$75,000.
$160,000.
Answer: c
Feedback: Explicit costs are also called “accounting costs,” and those are book costs. In
this case, explicit costs are $50,000 + $15,000 + $10,000 = $75,000.
2. Total cost is equal to
a.
b.
c.
d.
Variable costs of production.
Revenues minus total cost.
Opportunity cost minus product markup.
Fixed plus variable costs of production.
Answer: d
Feedback: Total cost is customarily broken into fixed and variable costs by economists.
3. An example of a variable cost of production is
a.
b.
c.
d.
Leases on equipment.
Property taxes.
Packaging and delivery.
Administrative salaries.
Answer: c
Feedback: Variable costs are costs that are related to level of production. In this case,
more output means more packaging and delivery costs. Costs associated with equipment
leases, administrative salaries, and property tax will remain the same regardless of output.
4. The short run is a period
a.
b.
c.
d.
That always lasts six months for all firms.
That always lasts one year for all firms.
That has at least one fixed factor of production.
In which all resources can be changed.
Answer: c
Feedback: The short run is not a calendar period. Instead it is the time that elapses until a
firm can change the level of one of its fixed factors of production.
5. Which of the following represents a hidden opportunity cost, or implicit cost?
a.
b.
c.
d.
Payments made to suppliers.
Medical insurance payments made on behalf of employees.
A salary given up by the owner of a firm by operating his or her own company.
Payments made to IBM for computers.
Answer: c
Feedback: When a person owns his or her own company, it is hard to determine
opportunity costs because people value their time in a uniquely individual way.
6. The law of diminishing marginal returns occurs because
a.
b.
c.
d.
Labor cannot be increased.
The size of a plant can be increased but not decreased.
As more labor is hired, each worker has less capital to work with.
As more labor is hired, worker quality decreases.
Answer: c
Feedback: This law occurs because as additional workers are hired, each worker has less
capital to work with. Thus, marginal productivity falls with new hires.
7. Average total cost
a.
b.
c.
d.
Always falls with a greater quantity of output.
Is equal to average variable cost plus fixed costs.
Always rises with more output.
Is equal to total cost divided by quantity of output.
Answer: d
Feedback: This is the definition of average total cost.
8. The short-run average total cost curve is U-shaped because
a. Variable costs fall with more output.
b. Fixed costs dominate at low levels of output, whereas variable costs dominate at high
levels of output.
c. Average variable cost falls as output level rises.
d. Output hits a minimum halfway through production.
Answer: b
Feedback: When production levels are low, both average fixed costs and average variable
costs decrease as production increases. However, there is a point where average variable
costs will begin to increase faster than average fixed costs decrease. When this happens,
average total costs begin to increase with average variable costs and continue to increase
as output increases.
9. Marginal cost is the
a.
b.
c.
d.
Change in average fixed cost from a one-unit increase in output.
Change in average total cost from a one-unit increase in output.
Change in total cost from a one-unit increase in output.
Change in fixed costs from a one-unit increase of output.
Answer: c
Feedback: This is the definition of marginal cost.
10. Economies of scale occur when
a.
b.
c.
d.
The firm uses more specialized technology in production.
Labor and management specialize in their activities more.
The firm can take advantage of volume discounts.
All of the answers are correct.
Answer: d
Feedback: The chief source of economies of scale is specialization of workers and
equipment. Volume discounts also allow lower average costs when output scale
increases.
Auxiliary Problems
1. Suppose the following production function refers to a bicycle shop:
Quantity of Labor
---------------------0
1
2
3
4
5
6
Bicycles Assembled (per day)
--------------------------------0
5
12
20
27
32
34
a) What is the marginal physical product of the first worker? The second worker? The fifth
worker?
b) At what point does the law of diminishing returns become apparent?
2. Ms. Ramirez runs a small consulting firm. She rents a building for $4,000, the cost of two
secretaries is $40,000 and the annual cost of electricity and gas is $6,000. There is great
demand for her work and her total revenue is $150,000. She was offered a job with another
firm for $75,000 salary, but she refused the offer. The money (all of which is her own)
invested in her company could have been put in a bank and could earn her $4,000 per year in
interest. Calculate the accounting and economic profits for Ms. Ramirez’s consulting firm.
3. Suppose (A) the hourly wage rate is $12 in the U.S. and $2 in China, and (B) productivity is
20 units per hour in the U.S. and 2 units per hour in China. What are unit labor costs in:
a) The United States?
b) China?
4. What is the difference between the long run and the short run with respect to fixed and
variable inputs?
5. What is the difference between the terms “average total cost” and “marginal cost”?
Answers:
1. a) Marginal Physical Product (MPP) of the first worker is 5, the second worker 7, and the
fifth worker 5.
b) Diminishing marginal returns become apparent from the fourth worker onwards.
2. Explicit costs = $4,000 + $40,000 + $6,000 = $50,000
Implicit costs = $75,000 + $4,000 = $79,000
Economic costs = $50,000 + $79,000 = $129,000
Accounting costs = $50,000
Economic Profit = $150,000 - $129,000 = $21,000
Accounting Profit = $150,000 - $50,000 = $100,000
3. a) Unit labor costs in United States = $12/20 = $0.60 per unit.
b) Unit labor costs in China = $2/2 = $1.00 per unit.
c) If China’s productivity doubles, unit labor costs will halve to $0.50 and for U.S. to
compete with them, wages must drop to $10 ($10/20 = $0.50 per unit).
4. In the short run, some inputs are variable but at least one is fixed. In the long run, however,
all inputs are variable.
5. Average total cost (ATC) is calculated by dividing the total cost by the number of units
produced, whereas marginal cost is the change in total cost when one additional unit is
produced.
1. Which of the following is most likely a fixed cost?
A. Raw materials cost.
B. Labor cost.
C. Energy cost.
D. Property taxes.
Property tax is an example of a fixed cost. Once you purchase land, you're obligated to pay for it
whether or not you use it. Labor, energy, and raw material costs will vary with output.
2. If the marginal cost curve is rising, which of the following must be true?
A. The average total cost curve must be rising.
B. The average total cost curve must be below the marginal cost curve.
C. The average total cost curve must be above the marginal cost curve.
D. Total costs must be rising.
Marginal cost is the increase in total cost associated with a one-unit increase in production. So as
long as MC is positive, the total costs must be rising. Average total cost can be decreasing and
can be either above or below the marginal cost curve when the marginal cost curve is upwardsloping.
3. Sam's surf shop has total costs of $2,000 when it is not producing any surfboards. This means
that
A. Variable costs are $2000.
B. Fixed costs are $2,000.
C. The shop is very inefficient in its production.
D. Fixed costs are zero.
The initial dominance of falling AFC, combined with the later resurgence of rising AVC (due to
increasing MC), is what gives the ATC curve its characteristic U shape.
4.
At 4 units of output in Table 21.4, total fixed costs are
A. $78.00.
B. $19.50.
C. $16.00.
D. $20.00.
The total fixed cost is $16 at any unit of output because total cost is $16 at 0 units of output.
5.
The marginal cost of the fourth unit of output in Table 21.4 is
A. $4.00.
B. $20.00.
C. $16.00.
D. $19.50.
Marginal cost is equal to the change in total cost ($78 - $58) divided by the change in quantity (4
- 3), which is $20.
6.
At 2 units of output in Table 20.4, the average variable cost is
A. $13.
B. $6.
C. $12.
D. $21.
AVC is equal to VC ($42 - $16) divided by quantity (2), which is $13.
7.
At 4 units of output in Table 21.4, the total variable cost is
A. $5.00.
B. $20.00.
C. $19.50.
D. $62.00.
VC is equal to TC ($78) minus FC ($16), which is $62.
8.
At 3 units of output in Table 21.4, average fixed costs are
A. $16.00.
B. $19.50.
C. $5.33.
D. $15.50.
AFC is equal to FC ($16) divided by quantity (3), which is $5.33.
9.
For the output levels in Table 21.4, the minimum of the average total cost curve occurs at a
production rate of
A. 2 units per day.
B. 3 units per day.
C. 4 units per day.
D. Zero units per day.
ATC is equal to TC divided by quantity. The ATC is $30, $21, $19.3, and $19.5 with output
levels of 1 through 4 respectively. Therefore, ATC is minimized at 3 units of output.
10.
For the output levels in Table 21.4, the minimum of the average variable cost curve occurs at a
production rate of
A. 3 units per day.
B. 2 units per day.
C. 4 units per day.
D. Zero units per day.
AVC is equal to VC divided by quantity. The AVC is $14, $13, $14, and $15.5 with output
levels of 1 through 4 respectively. Therefore, AVC is minimized at 2 units of output.