Practice 7

A. Multiple choice

1. Economists normally assume that the goal of a firm is to

(i) sell as much of its product as possible.
(ii) set the price of the product as high as possible.
(iii) maximize profit.
a. (i) and (ii) only
b. (ii) and (iii) only
c. (iii) only
d. (i), (ii), and (iii)

2. When a firm is making a profit-maximizing production decision, which of the following principles
of economics is likely to be most important to the firm's decision?
a. The cost of something is what you give up to get it.
b. A country's standard of living depends on its ability to produce goods and services.
c. Prices rise when the government prints too much money.
d. Governments can sometimes improve market outcomes.

3. The things that must be forgone to acquire a good are called

a. implicit costs.
b. opportunity costs.
c. explicit costs.
d. accounting costs.

4. Kelly has decided to start his own business giving sailing lessons. To purchase equipment for the
business, Kelly withdrew $1,000 from his savings account, which was earning 3% interest, and
borrowed an additional $2,000 from the bank at an interest rate of 7%. What is Kelly's annual
opportunity cost of the financial capital that has been invested in the business?
a. $30
b. $140
c. $170
d. $300

5. Pete owns a shoe-shine business. Which of the following costs would be implicit costs?
(i) shoe polish
(ii) rent on the shoe stand
(iii) wages Pete could earn delivering newspapers
interest that Pete’s money was earning before he spent his savings to set up the
(iv)
shoe-shine business

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 a. (i) and (ii) only
b. (iv) only
c. (iii) and (iv) only
d. (i), (ii), (iii), and (iv)

6. Katherine gives piano lessons for $20 per hour. She also grows flowers, which she arranges and sells
at the local farmer’s market. One day she spends 5 hours planting $50 worth of seeds in her garden.
Once the seeds have grown into flowers, she can sell them for $150 at the farmer’s market. Katherine’s
accounting profits are
a. $100, and her economic profits are $100.
b. $100, and her economic profits are $0.
c. $0, and her economic profits are $100.
d. $0, and her economic profits are $-100.

Scenario 1
Ariana withdrew $400,000 out of her personal savings account and used it to start her new Internet
cafe. The savings account pays 3 percent interest per year. During the first year of her business, Ariana
sold 2,000 cups of coffee for $2.50 per cup and 4,000 hours of Internet time, also at $2.50 per hour.
During the first year, the business made monetary outlays of $9,000. You may assume that there is no
opportunity cost to Ariana’s time.

7. Refer to Scenario 1. Ariana's accounting profit for the year was

a. $-394,000.
b. $-6,000.
c. $6,000.
d. $12,000.

8. Refer to Scenario 1. Ariana’s economic profit for the year was

a. $-394,000.
b. $-6,000.
c. $3,000.
d. $6,000.

9. Bubba is a shrimp fisherman who can catch 4,000 pounds of shrimp per year. Bubba is considering
hiring his cousin Bobby to work for him. Bobby can catch 3,000 pounds of shrimp per year. If Bubba
hires Bobby, what will be the total output of his shrimp business?
a. 7,000 pounds
b. 3,500 pounds
c. 3,000 pounds
d. 1,000 pounds

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10. The marginal product of labor is equal to the
a. incremental cost associated with a one unit increase in labor.
b. incremental profit associated with a one unit increase in labor.
c. increase in labor necessary to generate a one unit increase in output.
d. increase in output obtained from a one unit increase in labor.

11. On a 100-acre farm, a farmer is able to produce 3,000 bushels of wheat when he hires 2 workers.
He is able to produce 4,400 bushels of wheat when he hires 3 workers. Which of the following
possibilities is consistent with the property of diminishing marginal product?
a. The farmer is able to produce 5,600 bushels of wheat when he hires 4 workers.
b. The farmer is able to produce 5,800 bushels of wheat when he hires 4 workers.
c. The farmer is able to produce 6,000 bushels of wheat when he hires 4 workers.
d. Any of the above could be correct.

Table 1. Wooden Chair Factory

Output
(chairs Marginal
Number of Number of
produced Product of Cost of Cost of
Workers Machines Total Cost
per hour) Labor Workers Machines
1 2 5
2 2 10
3 2 20
4 2 35
5 2 55
6 2 70
7 2 80

12. Refer to Table 1. Each worker at the Wooden Chair Factory costs $12 per hour. The cost of each
machine is $20 per day regardless of the number of chairs produced. If the factory produces at a rate of
70 chairs per hour and operates 8 hours per day, what is the factory’s total labor cost per day?
a. $72
b. $112
c. $576
d. $616

13. Refer to Table 1. Each worker at the Wooden Chair Factory costs $12 per hour. The cost of each
machine is $20 per day regardless of the number of chairs produced. What is the total daily cost of
producing at a rate of 55 chairs per hour if the factory operates 8 hours per day?
a. $480
b. $576

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 c. $520
d. $616

14. Refer to Table 1. Each worker at the Wooden Chair Factory costs $12 per hour. The cost of each
machine is $20 per day regardless of the number of chairs produced. Assume the number of machines
does not change. If the factory produces at a rate of 78 chairs per hour, what is the total machine cost
per day?
a. $20
b. $40
c. $240
d. We are unable to determine total machine costs from the information given.

15. Refer to Table 1. Each worker at the Wooden Chair Factory costs $12 per hour. The cost of each
machine is $20 per day regardless of the number of chairs produced. If the factory produces at a rate of
35 chairs per hour, what is the total labor cost per hour?
a. $40
b. $48
c. $384
d. $424

16. Which of the following statements about a production function is correct for a firm that uses labor
to produce output?
a. The production function depicts the relationship between the quantity of labor and the
quantity of output.
b. The slope of the production function measures marginal product.
c. The slopes of the production function and the total cost curve are inversely related; if one is
increasing, the other is decreasing.
d. All of the above are correct.

17. For a construction company that builds houses, which of the following costs would be a fixed cost?
a. the $50,000 per year salary paid to a construction foreman
b. the $30,000 per year salary paid to the company's bookkeeper
c. the $10,000 per year premium paid to an insurance company
d. All of the above are correct.

18. Sonia opened a yoga studio where she teaches classes and sells yoga clothing. Fixed costs for
Sonia's yoga studio include the cost of the
(i) tank tops.
(ii) wages paid to the other yoga instructors.
(iii) lease on the studio space.

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(iv) insurance that the landlord requires Sonia to carry for the studio.
a. (i) only
b. (i) and (ii) only
c. (iii) and (iv) only
d. (i), (ii), (iii), and (iv)

19. For a large firm that produces and sells automobiles, which of the following costs would be a
variable cost?
a. the unemployment insurance premium that the firm pays to the state of Missouri that is
calculated based on the number of worker-hours that the firm uses
b. the cost of the steel that is used in producing automobiles
c. the cost of the electricity of running the machines on the factory floor
d. All of the above are correct.

20. Cindy’s Car Wash has average variable costs of $2 and average fixed costs of $3 when it produces
100 units of output (car washes). The firm's total cost is
a. $100.
b. $200.
c. $300.
d. $500.

21. Brady Industries has average variable costs of $1 and average total costs of $3 when it produces
500 units of output. The firm's total fixed costs equal
a. $2.
b. $4.
c. $1,000.
d. $2,000.

22. Suppose that for a particular firm the only variable input into the production process is labor and
that output equals zero when no workers are hired. In addition, suppose that when four units of output
are produced, the total cost is $175, and the average variable cost is $33.75. What would the average
fixed cost be if ten units were produced?
a. $4
b. $10
c. $40
d. $135

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Table 2. The Flying Elvis Copter Rides
Average Average Average
Total Fixed Variable Marginal
Quantity Fixed Variable Total
Cost Cost Cost Cost
Cost Cost Cost
0 $50 $50 $0 -- -- -- --
1 $150 A B C D E F
2 G H I $120 J K L
3 M N O P Q $120 R

23. Refer to Table 2. What is the value of D?

a. $25
b. $50
c. $100
d. $200

24. Refer to Table 2. What is the value of E?

a. $25
b. $50
c. $100
d. $150

25. Refer to Table 2. What is the value of G?

a. $30
b. $120
c. $220
d. $270

26. A firm has a fixed cost of $500 in its first year of operation. When the firm produces 100 units of
output, its total costs are $3,500. When it produces 101 units of output, its total costs are $3,750. What
is the marginal cost of producing the 101st unit of output?
a. $250
b. $275
c. $340.91
d. $350

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Figure 1

27. Refer to Figure 1. Which of the figures represents the total cost curve for a typical firm?
a. Figure 1
b. Figure 2
c. Figure 3
d. Figure 4

28. Refer to Figure 1. Which of the figures represents the marginal cost curve for a typical firm?
a. Figure 1
b. Figure 2
c. Figure 3
d. Figure 4

Figure 2

29. Refer to Figure 2. Which of the following statements is correct?

a. Marginal cost is rising for quantities higher than D because marginal cost is higher than
average total cost.
b. Average variable cost is declining for quantities less than B because marginal cost is lower
than average variable cost.

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 c. Marginal cost is minimized at B because at that quantity, marginal cost equals average
variable cost.
d. All of the above are correct.

30. Refer to Figure 2. Which of the following statements is correct?

a. Average total cost is rising for quantities higher than D because marginal cost is higher than
average total cost.
b. Average variable cost is declining for quantities less than B because marginal cost is lower
than average variable cost.
c. Average variable cost is minimized at B because at that quantity, marginal cost equals
average variable cost.
d. All of the above are correct.

31. Economies of scale occur when

a. long-run average total costs rise as output increases.
b. long-run average total costs fall as output increases.
c. average fixed costs are falling.
d. average fixed costs are constant.

32. The Big Blue Sky jet company has long-run total costs of $20 million if it produces 5 jets and long-
run total costs of $24 million if it produces 6 jets. The Big Blue Sky jet company is experiencing
a. economies of scale.
b. constant returns to scale.
c. diseconomies of scale.
d. negative profits.

33. When a firm experiences diseconomies of scale,

a. short-run average total cost is minimized.
b. long-run average total cost is minimized.
c. long-run average total cost increases as output increases.
d. long-run average total cost decreases as output increases.

Table 3. Consider the following table of long-run total cost for four different firms:

Quantity 1 2 3 4 5 6 7
Firm 1 $180 $350 $510 $660 $800 $930 $1,050
Firm 2 $120 $250 $390 $540 $700 $870 $1,050
Firm 3 $150 $300 $450 $600 $750 $900 $1,050
Firm 4 $210 $340 $490 $660 $850 $1,060 $1,290

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34. Refer to Table 3. Which firm has constant returns to scale over the entire range of output?
a. Firm 1
b. Firm 2
c. Firm 3
d. Firm 4

35. Refer to Table 3. Which firm has diseconomies of scale over the entire range of output?
a. Firm 1 only
b. Firm 2 only
c. Firms 1 and 2 only
d. Firm 3 only

B. Problem solving

1. Describe how an accounting firm could experience economies of scale.

2. See Table as follows:

Labor Output Marginal Product Variable Cost Fixed Cost

0 0 -- $0 $10
1 200 200 $20 $10
2 350 $40 $10
3 450 $60 $10
4 50 $80 $10
5 25 $100 $10
6 530 $120 $10

a. What is the marginal product of the third worker?

b. What is the total output of four workers?

c. What is the total output of five workers?

d. What is the marginal product of the sixth worker?

e. What is the shape of the firm’s total-cost curve?

f. What is the average total cost of producing 525 units of output?

g. What is the average variable cost of producing 500 units of output?

h. What is the average fixed cost of producing 450 units of output?

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i. What is the shape of the average-fixed-cost curve?

j. What is the shape of the average-variable-cost curve?

k. What is the shape of the average-total-cost curve?

l. What is the shape of the marginal-cost curve?

3. You are the production manager of a large plant, and are preparing a report for your superiors.
Unfortunately, you have lost some of the numbers you wish to report. You have the data below. Complete
the following table by computing the missing numbers from those that are given.

Q Total Cost Variable Cost Average Cost Marginal Cost

0 $35
1 $5
2 $9
3 $15.67
4 $3
5 $4
6 $24
7 $30
8 $9
9 $8.89

4. Carefully define increasing and decreasing returns to scale. How are increasing and decreasing
returns to scale related to average cost?

5. Given the total cost equation: C = 32 + 2Q2, derive equations for

a. Average total cost.
b. Average variable cost.
c. Marginal cost.
d. Average fixed cost
e. What level of Q yields the minimum level of total average cost of production?

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