PE Chapter 13+14+15 Review Flashcards
PS4
Which of the following is an implicit cost? (i) the owner of a firm forgoing an opportunity to earn a large salary working for a Wall Street brokerage firm (ii) interest paid on the firm’s debt (iii) rent paid by the firm to lease office space
a. (ii) and (iii)
b. (i) and (iii)
c. (i) only
d. (iii) only
c. (i) only
The question is about implicit costs, which are opportunity costs that do not involve direct monetary payments
(i) This is an implicit cost because it represents an opportunity cost (the income the owner could have earned elsewhere)
(ii) This is an explicit cost because it involves an actual monetary payment
(iii) This is also an explicit cost because it involves a direct payment
Zach took $400,000 out of the bank and used it to start his new cookie business. The bank account pays 3 percent interest per year. During the first year of his business. Zach sold 6,000 boxes of cookies for $2.50 per box. Also, during the first year, the cookie business incurred costs that required outlays of money amounting to $9,000.
Zach’s accounting profit for the year was
a. $494,000
b. -$6,000
c. $6,000
d. $12,000
c. $6,000
accounting profit = total revenue - explicit costs
Zach took $400,000 out of the bank and used it to start his new cookie business. The bank account pays 3 percent interest per year. During the first year of his business. Zach sold 6,000 boxes of cookies for $2.50 per box. Also, during the first year, the cookie business incurred costs that required outlays of money amounting to $9,000.
Zach’s economic profit for the year was
a. -$506,000
b. -$6,000
c. $3,000
d. $6,000
b. -$6,000
Economic profit = accounting profit - implicit costs
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. All of the above are correct
a. The farmer is able to produce 5,600 bushels of wheat when he hires 4 workers
The property of diminishing marginal product states that as more workers are hired, the additional output (marginal product) from each extra worker eventually decreases.
Marginal product of the 3rd worker = 1400 bushels
The average total cost (ATC) curve
The average total cost (ATC) curve is typically U-shaped, as it first decreases due to spreading fixed costs over a larger quantity and increasing efficiency, then increases due to diminishing marginal returns
The average total cost (ATC) curve is typically U-shaped, as it first decreases due to spreading fixed costs over a larger quantity and increasing efficiency, then increases due to diminishing marginal returns
The average variable cost (AVC) curve
The average variable cost (AVC) curve is typically U-shaped, like the average total cost (ATC) curve, but lies below the ATC curve because it does not include fixed costs
The marginal cost (MC) curve
The marginal cost (MC) curve typically has a U-shaped and intersects both the average total cost (ATC) and average variable cost (AVC) curves at their minimum points
Understanding Economies/ Diseconomies of Scale
Economies of scale occur when increasing production leads to a lower average total cost (ATC). This happens in the downward-sloping portion of the ATC curves
- If ATC is decreasing as output increases -> Economies of Scale
- If ATC is constant -> Constant Returns to Scale
- If ATC is increasing as output increases -> Diseconomies of Scale
Some reasons that firms may experience diseconomies of scale include that
a. The firm is too small to take advantage of specialization
b. Large management structures may be bureaucractic and inefficient
c. If there are too many employees, the work place becomes crowded and people become less productive
d. Average fixed costs begin to rise again
Bureaucratic: involving complicated rules and processes that make something slow and difficult
b. Large management structures may be bureaucractic and inefficient
Diseconomies of scale occur when increasing production leads to higher average total costs (ATC). This typically happens due to
- Management inefficiencies in large organizations
- Overcrowding of resources, leading to reduced productivity
- Communication and coordination issues in large firms
a. This relates to economies of scale, not diseconomies
b. Bureaucracy slows decision-making, increasing costs
c. Overcrowding reduces efficiency, increasing costs
d. Fixed costs do not typically rise with output; they are spread over more units
A profit-maximizing firm in a competitive market will always make marginal adjustments to production as long as
a. Average revenue is greater than average total cost
b. Average revenue is equal to marginal cost
c. Marginal cost is greater than average total cost
d. Price is above or below marginal cost
b. Average revenue is equal to marginal cost
- In a perfectly competitive market, firms adjust output based on marginal cost (MC) and marginal revenue (MR)
- Since P=MR in perfect competition, the firm produces where P = MC to maximize profit
- The firm will increase production if P > MC and decrease production if P < MC
a. While this means the firm is profitable, it does not determine marginal adjustments to production
b. In perfect competition, average revenue (AR) = price (P), and firms adjust output until P = MC
c. This condition alone does not dictate production decisions
d. Firms not only adjust output until P = MC, not when price is still different from MC
The short-run supply curve for a form in a perfectly competitive market is
a. Horizontal
b. Likely to slope downward
c. Determined by forces external to the firm
d. The portion of its marginal cost curve that lies above its average variable cost
d. The portion of its marginal cost curve that lies above its average variable cost
- In a competitive market, a firm will continue operating in the short run as long as it can cover its average variable cost (AVC), even if it’s making losses
- However, if the price (P) falls below AVC, the firm should shut down because it can’t even cover its variable costs, and operating would lead to greater losses
a. When a firm shuts down, it no longer incurs variable costs, but it still has to pay fixed costs (rent, machinery)
c. Even if average revenue (price) > marginal cost, the firm must cover AVC to justify continuing operations
d. Fixed costs are irrelevant in the short-run shutdown decision; what matters is covering AVC
