Essentials of Economics Bradley Schiller 11e - Test Bank

Essentials of Economics Bradley Schiller 11e – Test Bank

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Sample Questions Are Posted Below

Chapter 05 Test Bank KEY

The factors of production include

wages, rent, and profit.
profit and wages.
land, labor, capital, and entrepreneurship.
computers and machinery.

The four factors of production are land, labor, capital, and entrepreneurship.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Capacity Constraints: The Production Function

Flour would be considered which of the following factors of production?

land
capital
labor
entrepreneurship

Flour would be included in capital. Labor captures workers, entrepreneurship captures ideas, and land captures the space and natural resources used in production. Capital includes raw materials, and flour would fit into this category because it is not a naturally occurring resource.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Capacity Constraints: The Production Function

Terry’s Taco Patio uses corn tortillas, meat, a large property, and workers to make their tacos. Which of the following factors of production is not included as part of this list?

land
labor
capital
entrepreneurship

Corn tortillas and meat would both be considered capital. The large property would be considered land, while workers would be labor. As a result, the only thing missing from this list of inputs is Terry, the entrepreneur who has uniquely combined them to make Terry’s Taco Patio.

Land, labor, capital, and entrepreneurship are called

factors of production.
factors of demand.
fixed costs.
variable costs.

The four factors of production are land, labor, capital, and entrepreneurship.

Which of the following are inputs to production for a typical college?

sporting event tickets
tuition
parking fees
the library

Sporting event tickets, tuition, and parking fees are sources of revenue for the college but the library would be included in capital and is thus an input to production.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Capacity Constraints: The Production Function

The maximum output that can be produced from a set of inputs is measured by

the production function.
the demand schedule.
fixed costs.
marginal costs.

A production function gives the maximum amount of output with a given amount of inputs.

Which of the following statements concerning the relationship between total product (TP) and marginal physical product (MPP) is not correct?

TP will continue to rise even though MPP is falling but greater than zero.
TP is increasing at an increasing rate if MPP is increasing.
TP will fall if MPP is negative.
TP will fall if MPP is falling.

So long as MPP is greater than zero, it will be adding to TP at a decreasing rate.

AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Capacity Constraints: The Production Function

The limits to the production of any good are reflected in the

law of demand.
capacity curve.
demand curve.
production function.

A production function shows the potential total output available by using various amounts of inputs.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Capacity Constraints: The Production Function

When a firm produces a level of output on the production function

marginal physical product is zero.
maximum efficiency is achieved.
opportunity cost for resources is at a maximum.
profits are maximized.

A point on the production function represents a maximum efficient output for that amount of inputs.

If the first, second, third, and fourth worker employed by the firm add 15, 21, 12, and 8 units of total product respectively, we can conclude that

the marginal product of all four workers is 14.
the total product of two workers is 42.
after the second worker marginal product declines.
adding a fourth worker will cause total product to decline.

At first marginal physical product increases, but eventually the law of diminishing returns will cause marginal physical product to decline.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 05-02 Explain why the law of diminishing returns applies.
Topic: Capacity Constraints: The Production Function

The law of diminishing returns means that

total product will eventually increase at a decreasing rate as more inputs are employed.
the marginal product will increase at an increasing rate.
average total costs are rising and then falling as output is increased.
average fixed cost will fall as production increases.

Total product will at first increase at an increasing rate but because of the law of diminishing returns, will eventually increase at a decreasing rate until it turns negative.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 05-02 Explain why the law of diminishing returns applies.
Topic: Capacity Constraints: The Production Function

The change in total output that results from one additional unit of input is the

marginal physical product.
average product of the input.
unit cost of the input.
input price.

Marginal physical product is equal to the change in total product divided by the change in the quantity of resource applied.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-02 Explain why the law of diminishing returns applies.
Topic: Capacity Constraints: The Production Function

Marginal physical product is

equal to the average output of a worker.
the additional utility a consumer gets from the last unit of a product.
the additional output from using one more unit of labor.
equal to the total product of labor.

Marginal physical product is equal to the change in total product divided by the change in the quantity of resource applied.

The law of diminishing returns can explain why

marginal cost eventually increases in the short run as more output is produced.
the demand curve is typically downward-sloping.
the average fixed-cost curve declines as long as output increases.
marginal cost decreases as more output is produced.

The extra cost of producing one more unit of output increases because it takes more and more of a variable input to produce the same increase in output when some inputs are fixed.

AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-02 Explain why the law of diminishing returns applies.
Topic: Capacity Constraints: The Production Function

Ceteris paribus, the law of diminishing returns states that beyond some point the

return on stocks and bonds diminish as more are purchased.
addition to total utility declines as more units are consumed.
marginal physical product of a variable input declines as more of it is used.
output of any good or service increases as more variable input is used.

By varying one factor while holding all other factors of production constant, less and less additional output will be produced.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-02 Explain why the law of diminishing returns applies.
Topic: Capacity Constraints: The Production Function

If more of an input factor is used, while holding other inputs constant, a firm will eventually experience

diminishing returns.
falling marginal cost.
rising marginal physical product.
rising consumer demand.

The fixed factors of production become spread thin if their quantity remains the same while the amount of a variable input increases. This would leave less fixed factors of production available for each variable input and, as a result, an increase in a variable input yields less returns as more is added.

As more labor is hired in the short run, diminishing returns are observed because

the new workers tend to be worse at their job than previously hired workers.
each new worker has less capital and land (fixed inputs) to use at work.
all the workers begin to socialize more and work less.
the new workers are less skilled.

The fixed factors of production must be used with more and more units of the variable factor and, beyond some point, additional amounts of input will yield less and less additional output.

The law of diminishing returns indicates that the marginal physical product of an input declines as more

output is produced with the most efficient combination of inputs.
of the input is used, holding output constant.
of the input is used, holding other inputs constant.
of the good is consumed.

The fixed inputs of production must be used with more and more units of a variable input and therefore there is some point that additional amounts of a variable input will yield less and less additional output.

Assume a toy company hires an additional worker to assemble toys, and the size of the factory and amount of equipment remain constant. As a result, the level of output increases but by a smaller amount than when the previous additional worker was hired. This is an example of

the law of poor planning.
the law of diminishing returns.
Say’s Law.
the law of substitution.

Assume a restaurant hires an additional chef who is as qualified as the current chefs. As a result, the level of output increases but by a smaller amount than when the previous additional chef was hired. Which of the following best explains this occurrence?

The chefs are working with a fixed amount of space and equipment and they get in each other’s way.
The additional wages cause profit to decrease.
The amount of food available for preparation is limited so output decreases.
The two chefs do not agree on food preparation and spend too much time arguing.

Since the other factors of production are fixed, they must be shared by more chefs, which means that, while the total output will increase, each chef will yield less output.

Which of the following is the best explanation of why the law of diminishing returns does not apply in the long run?

All inputs to production are variable in the long run.
The marginal physical product does not change in the long run.
In the long run, firms have enough time to find more qualified workers.
All inputs to production are fixed in the long run.

In the short run, only the variable inputs can be changed whereas in the long run, all inputs to production can be changed.

Total revenue minus total cost equals

profit.
variable costs.
economic costs.
marginal revenue.

While profit can be negative or positive, it is the difference between total revenue and total costs.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.
Topic: Costs of Production

Profit is the difference between

total cost and variable cost.
total revenue and total cost.
marginal cost and fixed cost.
average total cost and economic cost.

Total revenue minus total costs equals profit and if total revenue is greater than total costs, then profit will be positive.

A firm can be identified as profitable if the

sum of total revenue and total costs is high.
difference between its total revenue and total costs is negative.
difference between its total revenue and total costs is positive.
total costs and marginal costs are low.

If total revenue is greater than total costs, then its profit is positive.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.
Topic: Costs of Production

For most firms, the most desirable rate of output is the one that

minimizes total costs.
maximizes total profit.
minimizes marginal costs.
maximizes total revenue.

Most firms are private, for-profit enterprises. Their goal is then to maximize the profits they make.

The market value of all resources used in producing a good or service is expressed by

implicit costs.
total costs.
fixed costs.
variable costs.

Whether the firm purchases a resource or uses one that it owns, the market value of those resources will equal total costs.

Which of the following is equivalent to total cost?

fixed costs plus variable costs
variable costs plus marginal costs
economic costs plus accounting costs
marginal costs plus implicit costs

Total cost is equal to all costs paid in a time period, both fixed and variable.

The sum of fixed cost and variable cost at any rate of output is equal to

average total cost.
total profit.
total cost.
marginal cost.

Total cost is equal to variable cost plus fixed cost.

Which of the following will always increase as output increases?

total cost
average total cost
marginal cost
fixed costs

Since total cost is composed of fixed costs (which will not change in the short run) and variable costs (which will change in the short run as output rises), an increase in output will increase variable cost and therefore total costs.

AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.
Topic: Costs of Production

Costs of production that do not change with the rate of output are

nonexistent.
variable costs.
fixed costs.
marginal costs.

Fixed costs in the short run are constant and do not vary with output as a firm will have to pay them regardless of their level of production.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.
Topic: Costs of Production

Which of the following is most likely a fixed cost?

raw material costs.
labor costs.
shipping costs.
property taxes.

Property taxes would likely be fixed costs because they are not related to production volume and would not change in amount if a firm cannot change the amount of land it owns/rents. Given land is often considered a fixed input in the short run, it is likely that land-based costs are fixed in value.

Total cost is equal to _____ cost at an output level of zero.

variable
fixed
economic
marginal

Since fixed costs are constant at all levels of output then at an output of zero they would equal total costs. This represents the idea that even if the firm chooses to produce nothing, it will still have to pay these fixed costs.

It is impossible to:

Determine total costs in the short run.
Identify variable costs in the long run.
Identify variable costs in the short run.
Avoid fixed costs in the short run.

While fixed costs do not factor in to short-run production decisions, a certain amount of fixed capital is necessary for any amount of production.

Costs of production that change with the rate of output are

sunk costs.
fixed costs.
opportunity costs.
variable costs.

Variable costs are related to production volume and will increase with increased output.

When producing jeans, which of the following are not a variable cost in the short run?

wage payments to labor
zipper costs for each jean
rent paid for the use of a factory
denim material costs for each jean

Factory rent would not normally be related to production output and would be defined as fixed costs since the amount of rent paid would be the same even if the firm opted not to produce anything.

Which of the following is most likely a variable cost in the short run?

labor payments
property taxes
rent payments
a business license fee

Since labor would be directly related to levels of production, it would most likely be a variable cost.

If a firm increases output, total costs will rise because of a change in

fixed costs.
absolute costs.
variable costs.
regular costs.

Since variable costs are related to changes in volume and total costs is the sum of both fixed and variable costs, total costs will increase with increased volume.

Average total cost is defined as

total cost divided by the quantity produced.
the change in total cost because of a one-unit increase in output.
the change in total output divided by the change in total cost.
total output times total cost.

Average total cost represents total costs divided by the level of output and represent the average amount the firm must pay for each unit produced.

Which of the following is equivalent to average total cost?

fixed cost plus variable cost
fixed cost and variable cost added together and then divided by output
the change in total cost divided by the change in output
marginal cost plus variable cost

Since total costs are equal to variable cost plus fixed costs and average total cost is defined as total costs divided by the quantity produced, fixed cost plus variable costs divided by the quantity produced would equal average total cost.

The general shape of the average total cost curve is

upward-sloping.
u-shaped.
flat.
downward-sloping.

The average total cost curve falls at first because both the average variable cost curve and the average fixed cost curve are falling. Since the average variable cost curve will start to rise beyond some point in production volume (because of the law of diminishing returns), the average total cost curve will also rise as this diminishing returns effect begins to outweigh the gains from specialization and as fixed costs become more spread out.

The reason the average total cost curve declines initially is because of

falling average fixed costs.
falling average variable costs.
falling marginal costs.
both falling average fixed costs and falling average variable costs.

The average total costs curve falls at first because both the average variable cost curve and the average fixed cost curve are falling. Since the average variable cost curve will start to rise beyond some point in production volume (because of the law of diminishing returns), average total cost curve will also rise as this diminishing returns effect begins to outweigh the gains to specialization and fixed costs becoming more spread out.

Marginal cost is equal to

total cost divided by output.
the change in total cost divided by the change in output.
the change in total cost divided by the change in price.
total cost divided by total revenue.

The increase in total costs divided by the change in output is defined as marginal cost. These represent an estimate of the additional cost incurred from producing the next unit of output.

Marginal cost will increase with greater output if

marginal physical product is decreasing.
marginal physical product is increasing.
total variable cost is decreasing.
total fixed cost is increasing.

If the additional output per unit of labor is declining, then in order to attain the same gains to output, more additional labor will be required. This results in an increasing marginal cost as a firm has to pay greater amounts to increase output by a certain number of units.

If an additional unit of labor costs $30 and has an marginal physical product of 50 units of output per worker, the marginal cost is

$0.60 per unit.
$1.66 per unit.
$15.00 per unit.
$1500.00 per unit.

Marginal cost is found by dividing the change in total cost per variable input unit by the change in output gained per input unit. Each additional worker costs $30 and the additional output gain is 50 units per worker. This means marginal cost can be found by dividing $30 per worker by 50 units per worker ($30/50 units = $0.60 per unit).

If an additional unit of labor costs $40 and has a marginal physical product of 50 units of output, the marginal cost is

$2,000.00 per unit.
$40.00 per unit.
$1.25 per unit.
$0.80 per unit.

Marginal cost is found by dividing the change in total cost per variable input unit by the change in output gained per input unit. Each additional worker costs $40 and the additional output gain is 50 units per worker. This means marginal cost can be found by dividing $40 per worker by 50 units per worker ($40/50 units = $0.80 per unit).

If an additional unit of labor costs $25 and has a marginal physical product of 40 units of output, the marginal cost is:

$0.63.
$1.60.
$25.00.
$1,000.00.

Marginal cost is found by dividing the change in total cost per variable input unit by the change in output gained per input unit. Each additional worker costs $25 and the additional output gain is 40 units per worker. This means marginal cost can be found by dividing $30 per worker by 50 units per worker ($25/40 units = $0.63 per unit).

Marginal cost

is the change in fixed cost divided by the change in quantity.
may initially decline and then increase as more output is produced.
may initially increase and then fall as more output is produced.
is fixed cost and variable cost added together and then divided by quantity.

Marginal cost may initially decline because the marginal physical product initially increases from specialization and additional labor increases unit output, however marginal physical product will start to decline at some point due to diminishing returns and then marginal cost will then start to rise.

Rising marginal costs result from

rising marginal physical product.
falling prices of variable inputs.
falling marginal physical product.
rising prices of fixed inputs.

Since each additional unit of labor yields less additional output, each worker added is less productive and so labor cost (marginal cost) rises.

Rising marginal costs are the result of

increasing returns to scale.
rising marginal physical product.
the law of variable returns.
the law of diminishing returns.

Since any factor of production will be affected by the law of diminishing returns, more of each factor will be required to produce the same additional output and so additional costs will rise.

The selection of the short-run rate of output is the

production decision.
investment decision.
marginal decision.
industrial decision.

In the short run, a producer can only make changes to variable factors of production. When these are changed, only current levels of output change.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-04 Illustrate the difference between production and investment decisions.
Topic: Supply Horizons

The short-run supply decision focuses on

marginal output versus price.
marginal cost versus price.
average total cost versus marginal revenue.
variable costs versus fixed costs.

In the short run, a producer will want to operate at a level where the price is at least greater than or equal to the marginal cost. The reason is that firms will only want to produce one more unit if they are able to charge a high enough price to cover the cost of that last unit.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-04 Illustrate the difference between production and investment decisions.
Topic: Supply Horizons

In the short run, a manufacturer should produce the next unit of output as long as

marginal cost is greater than price.
price is greater than total cost.
price is greater or equal than marginal cost.
price equals total cost.

For a manufacturer, if the price is greater than or equal to the marginal cost then economic profit will increase if it chooses to produce the next unit. The manufacturer would still choose to produce the unit if price were equal to marginal cost because this would increase accounting profit.

If price is greater than marginal cost for the last unit produced

profit is increasing as output rises.
profit is decreasing as output rises.
only economic costs are being covered.
average total cost is covered.

If the additional revenue (price) added is greater than the additional cost, profits will become more positive.

If price is greater than marginal cost but not average total cost, then

total revenues are greater than total costs.
the firm is earning a profit.
eventually the firm will go out of business.
the firm is experiencing diminishing marginal utility.

Because price is greater than marginal cost, a firm would find each unit produced to be profitable. However, because price is not higher than average cost, the firm would still make negative economic profits from production because unit sales are not high enough to make profits positive. The firm will likely go out of business in the long run.

AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-04 Illustrate the difference between production and investment decisions.
Topic: Supply Horizons

In the long run, a company will stay in business as long as price is

greater than or equal to marginal costs.
equal to variable costs.
equal to marginal physical product.
greater than or equal to average total costs.

Since profit can be rewritten as: Profit = (Price – Average Total Cost) × Quantity Produced, if price is greater than or equal to average total cost, then economic profits will be greater than or equal to zero so the firm would remain in the industry.

When a firm makes an investment decision, it views all inputs as

variable over the long run.
variable over the short run.
fixed over the long run.
fixed over the short run.

Investment decisions happen in the long run when all inputs are viewed as variable.

The decision to build, buy, or lease a plant is known as the

output decision.
profit-maximizing decision.
production decision.
investment decision.

Unlike a production decision, investment decisions treat all factors of production as variable, even the ones that would be considered fixed in the short run.

Which of the following must be considered in long-run planning?

production choices
fixed costs
investment choices
declining marginal physical product

In the short run firms focus on production choices, but in the long run all decisions are considered investment choices.

Which of the following is NOT a long-run investment decision?

Whether to buy or lease equipment.
The size of the factory.
Whether or not to enter into the industry.
How intensively to use the existing plant.

How intensively to use an existing plant is a short-run production decision. The rest of the choices correspond to choices regarding short-run fixed costs and these are therefore investment decisions.

The main difference to an economist between “short run” and “long run” is that

variable costs are short-run investment decisions whereas fixed costs are long-run production decisions.
in the short run, all resources are fixed whereas in the long run all resources are variable.
in the long run, all resources are variable whereas in the short run at least one resource is fixed.
fixed costs are more important than variable costs in the short run.

In the long run capital investment decisions are considered, while in the short run the emphasis is on making production decisions.

The planning period over which at least one resource input is fixed in quantity is the

long run.
production run.
short run.
investment decision.

In the short run, we assume that only the variable factors of production can be changed.

Which of the following is most true about the short run?

Some inputs are fixed.
It is less than one year.
It is one to two years.
All inputs are variable.

The short run is defined as a period of time in which only variable factors of production can be changed.

During the short run

all inputs can be changed.
some inputs are fixed.
factory size can be changed.
the number of workers cannot be changed.

Although in the short run variable factors of production can be changed, fixed factors of production cannot.

The long run refers to

a time period longer than one year.
a time period less than one year.
a period of time long enough for all inputs to be varied.
the time period required for a firm to cycle its inventory.

Unlike the short run, where only variable factors can be changed, the long run assumes that all factors of production can be changed.

During the long run

output is limited by the law of diminishing returns.
the firm can build or lease any size factory.
some inputs are fixed and some are variable.
there are no economic costs.

Unlike the short run, where only variable factors can be changed, the long run assumes that all factors of production can be changed.

Explicit costs

include only payments to labor.
are the sum of actual monetary payments made for resources used to produce a good.
include the market value of all resources used to produce a good.
are the total value of resources used to produce a good but for which no monetary payment is actually made.

Explicit costs are the monetary payments that a firm must make. If a check could be written for a cost, it is an explicit cost.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Discuss how accounting costs and economic costs differ.
Topic: Economic Versus Accounting Costs

Economic cost is

equal to explicit costs minus implicit costs.
the same as dollar costs.
equal to the accounting cost minus implicit costs.
the value of all resources, both explicit and implicit, used to produce a good or service.

Economic costs equal both the explicit and implicit costs to produce a good or service.

In defining costs, economists recognize

explicit and implicit costs, while accountants recognize only implicit costs.
explicit and implicit costs, while accountants recognize only explicit costs.
only explicit costs, while accountants recognize only implicit costs.
only explicit costs, while accountants recognize explicit and implicit costs.

Economic cost includes those costs which must be made with a monetary payment (explicit) and those that the firm pays by using its own resources (implicit).

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Discuss how accounting costs and economic costs differ.
Topic: Economic Versus Accounting Costs

Economic and accounting costs will differ

whenever there is more than one factor of production.
whenever the firm fails to maximize its profits.
whenever any factor of production is not paid an explicit factor payment equal to its market value.
in every case.

Accounting costs are those in which actual dollars for an input are paid. Economic costs include accounting costs as well as the opportunity costs of production, which are estimates of the value of resources used that the firm owns (implicit costs).

AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-05 Discuss how accounting costs and economic costs differ.
Topic: Economic Versus Accounting Costs

Economic costs are greater than accounting costs

only if implicit costs are greater than zero.
only if explicit costs are greater than implicit costs.
only in the long run.
in the short run but not the long run.

Since implicit costs are costs for which no monetary payment is made, they would not be counted in accounting costs, but would be included in economic costs.

The best measure of the economic cost of doing your homework is

the tuition you pay for the class.
the amount you would have to pay to get someone else to do it.
your instructor’s salary.
the best opportunity you give up when you do your homework.

Economic costs are best measured by what you must give up in order to receive the good or service. They could be monetary or non-monetary in nature.

Which of the following definitions is correct?

Economic Costs + Accounting Costs = Profit
Economic Profit = Accounting Profit – Implicit Costs.
Economic Profit – Implicit Costs = Accounting Profits.
Economic Costs + Explicit Costs = Implicit Costs.

Economic profit would generally be less than accounting profit by the amount of implicit costs since these would not be counted in accounting costs.

Economic profit is equal to total revenue minus

explicit costs.
implicit costs.
both implicit costs and explicit costs.
marginal costs.

Economic profit is total revenue minus costs that are paid with firm’s resources and those costs, which exist but are not paid by monetary means.

Suppose a firm incurred explicit costs of $900 and implicit costs of $200 during a day. If that day the firm sold 8 units at $300 per unit its accounting profits are

$1,500 and its economic profits are $1,700.
$1,500 and its economic profits are $1,300.
$1,300 and its economic profits are $1,700.
$1,300 and its economic profits are $1,300.

Economic profit is $200 less than accounting profit by the amount of implicit costs, which would total $1,300.

AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-05 Discuss how accounting costs and economic costs differ.
Topic: Economic Versus Accounting Costs

Suppose a firm has the following expenditures per day: $240 for wages, $150 for materials, and $80 for equipment rental. The owner of the firm owns the building in which it operates. If the firm were not operating in the building, he could rent the building for $70 per day. Total daily revenue is $600.What are the daily accounting costs for the firm described above?

$320
$390
$470
$540

Accounting costs would be those costs for which the firm directly paid money. Only the revenue and implicit cost of money that could be earned by renting out the building are not counted as part of accounting costs.

Suppose a firm has the following expenditures per day: $240 for wages, $150 for materials, and $80 for equipment rental. The owner of the firm owns the building in which it operates. If the firm were not operating in the building, he could rent the building for $70 per day. Total daily revenue is $600.What are the daily explicit costs for the firm described above?

$320
$390
$400
$470

Explicit costs are the same as accounting costs, which are those costs for which the firm directly paid money. Only the revenue and implicit cost of money that could be earned by renting out the building are not counted as part of accounting costs.

Suppose a firm has the following expenditures per day: $240 for wages, $150 for materials, and $80 for equipment rental. The owner of the firm owns the building in which it operates. If the firm were not operating in the building, he could rent the building for $70 per day. Total daily revenue is $600.What are the daily implicit costs for the firm described above?

$70
$80
$150
$220

Implicit costs are the monetary income that a firm sacrifices when it uses a resource that it owns. The remaining values are either explicit costs paid out directly by the firm or revenue the firm is actually earning.

Based on the law of diminishing returns, if the number of workers increases and capital investments do not keep pace then, ceteris paribus,

marginal physical product of labor will increase.
marginal physical product of labor will decrease.
the production function will definitely shift upward.
the average total cost curve will definitely decrease.

Worker productivity is tied to the amount of capital per worker and if the amount of capital relative to labor decreases then so too will worker productivity.

A firm’s rising factor costs can be offset by

increases in productivity.
diminishing marginal product.
diminishing marginal utility.
rising marginal cost.

As firm factor costs rise, hiring an additional factor of production becomes more expensive. If the firm wants to produce the same amount and keep costs the same, the only way it could do so is if each factor of production employed becomes more productive.

AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Policy Perspectives

Which of the following government policies is least likely to increase productivity?

subsidies for schools
greater provision of student loans
tax incentives for firms that invest in capital
transfer payments to unemployed workers

While unemployment benefits may be a good safety net, they do not add to the nation’s stock of capital and therefore will not increase productivity. Whether it is greater access to education or a policy that allows firms to invest in better capital equipment, there should be a resulting boost to labor productivity. Transfer payments do not affect the productivity of currently employed workers.

If government policies to increase productivity are successful, then the

production function will shift upward.
marginal cost curve will shift upward.
average total cost curve will shift upward.
variable cost curve will shift upward.

If productivity increases, then output will be greater at each level of input and the production function will shift upward.

Advances in managerial knowledge shift the production function

and the marginal cost curve upward.
and the average total cost curve downward.
upward and the average total cost curve downward.
downward and the marginal cost curve upward.

When a factor of production such as managerial knowledge becomes more productive, then the marginal physical product of that factor will increase causing the average total cost curve to decrease and the production function to shift upward.

Improvements in technology shift the

production function downward.
marginal cost curve downward.
average total cost curve upward.
fixed cost curve upward.

Improvements in technology will cause the marginal physical product of that factor to increase and therefore cause marginal cost to decrease at all quantities.

Which of the following would cause a firm’s production function to shift upward?

an increase in production by the firm
hiring more workers
increased investment in capital
an increase in wages

Increased investment in capital would improve the marginal efficiency of capital whereas the other changes would be a movement along the production function curve. Since both labor (variable input) and output are on the axes of a production function, the production function remains in the same place, but there would be a movement along the curve. The reason wage increases are not correct is that if wages rise, the firm would likely have to use less labor which would also generate a movement along a given production function.

An investment in human and non-human capital will result in

an increase in the marginal physical product of labor.
an increase in marginal costs.
a decrease in the production function.
a decrease in production possibilities.

An investment in human and non-human capital will improve the efficiency of labor as each worker would have more capital at their disposal and this would cause an increase in the marginal physical product of labor.

Labor and Output Data

Units of Labor	Units of Output
0	0
1	14
2	30
3	42
4	51

Based on the Labor and Output Data table, what is the marginal physical product of the first unit of labor?

0 output per worker
14 output per worker
16 output per worker
30 output per worker

Since output at zero units of labor is 0 units of output per worker and output at one unit of labor is 14 units of output per worker, the marginal physical product is the change in output per one unit of input which is 14 units of output per worker. See Table 5.1 in the textbook.

AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-02 Explain why the law of diminishing returns applies.
Topic: Capacity Constraints: The Production Function

Labor and Output Data

Units of Labor	Units of Output
0	0
1	14
2	30
3	42
4	51

Based on the Labor and Output Data table, what is the marginal physical product of the second unit of labor?

12 output per worker
14 output per worker
16 output per worker
30 output per worker

Since output at one unit of labor is 14 units of output per worker and output at two units of labor is 30 units of output per worker, the marginal physical product is the change in output per one unit of input, which is 16 units of output per worker. See Table 5.1 in the textbook.

Labor and Output Data

Units of Labor	Units of Output
0	0
1	14
2	30
3	42
4	51

Based on the Labor and Output Data table, what is the marginal physical product of the fourth unit of labor?

51 output per worker
42 output per worker
12 output per worker
9 output per worker

Since output at three unit of labor is 42 units of output per worker and output at four units of labor is 51 units of output per worker, the marginal physical product is the change in output per one unit of input, which is 9 units of output per worker. See Table 5.1 in the textbook.

Labor and Output Data

Units of Labor	Units of Output
0	0
1	14
2	30
3	42
4	51

Based on the Labor and Output Data table, where is there evidence of diminishing returns to labor?

first worker
second worker
third worker
fourth worker

Prior to the third unit, marginal physical product is increasing. The third worker contributes less to output (12 units) than the second worker (16 unites) and so this represents diminishing returns to labor. See Table 5.1 in the textbook.

Jeans Production

Rate of Output (jeans per day)	Total Cost
0	$60.00
10	102.50
15	122.50
20	135.00
30	180.00
40	290.00

What is the marginal cost of the 15th pair of jeans?

$8.17 per unit
$20.00 per unit
$1.33 per unit
$4.00 per unit

The change in cost from the 10th to the 15th units is $20 and the change in units is five so the marginal cost would be the change in cost divided by the change in output or ($20 / 5 units) = $4 per unit. See Table 5.2 in the textbook.

AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.
Topic: Costs of Production

Jeans Production

Rate of Output (jeans per day)	Total Cost
0	$60.00
10	102.50
15	122.50
20	135.00
30	180.00
40	290.00

Based on the information in the table, what is the marginal cost of the 30th pair of jeans?

$4.50 per unit
$45.00 per unit
$6.00 per unit
$1.50 per unit

The change in cost from the 20th to the 30th units is $45 and the change in units is ten so the marginal cost would be the change in cost divided by the change in output, or ($45 / 10 units) = $4.50 per unit. See Table 5.2 in the textbook.

Jeans Production

Rate of Output (jeans per day)	Total Cost
0	$60.00
10	102.50
15	122.50
20	135.00
30	180.00
40	290.00

Based on the information in the table, what is the marginal cost of the 40th pair of jeans?

$7.25 per unit
$11.00 per unit
$110.00 per unit
$2.75 per unit

The change in cost from the 30th to the 40th units is $110 and the change in units is ten so the marginal cost would be the change in cost divided by the change in output, or ($110 / 10 units) = $11.00 per unit. See Table 5.2 in the textbook.

Jeans Production

Rate of Output (jeans per day)	Total Cost
0	$60.00
10	102.50
15	122.50
20	135.00
30	180.00
40	290.00

Based on the information in the table, if the firm receives $7.00 for each pair of jeans, in the short run it should

produce 30 pairs of jeans
produce 40 pairs of jeans.
produce 20 pairs of jeans.
only produce jeans if the price is greater than average total cost.

Since the marginal cost of producing at a rate of 30 pairs of jeans in $4.50 the firm would make a profit of $2.50 per pair of jeans whereas at a rate of 40 pairs of jeans the firm would lose $4.00 per pair of jeans at a price of $7.00. See Table 5.2 in the textbook.

Jeans Production

Rate of Output (jeans per day)	Total Cost
0	$60.00
10	102.50
15	122.50
20	135.00
30	180.00
40	290.00

Based on the information in the table, if the firm can sell jeans for $7.00 per pair, the total profit from producing 30 pairs is

$13.
$3.
$30.
$210.

The profit would be calculated by subtracting the total costs of $180 from the total revenue ($7.00 × 30 = $210 − $180). See Table 5.2 in the textbook.

Jeans Production

Rate of Output (jeans per day)	Total Cost
0	$60.00
10	102.50
15	122.50
20	135.00
30	180.00
40	290.00

Based on the information in the table, if the firm can sell jeans for $7.00 per pair, the total profit from producing 40 pairs is

$−10.
$10.
$290.
$280.

The profit is calculated by subtracting the total costs of $290 from the total revenue ($7.00 × 40 = $280 − $290). See Table 5.2 in the textbook.

Yearbook Costs

(This table shows the total cost of producing yearbooks using a school’s print shop.)

Number of Yearbooks	100	200	300	400	500	600
School Print Shop Cost ($/year)	1,200	1,600	1,800	2,200	3,000	4,800

According to the Yearbook Costs table, the production rate at which the lowest possible average total cost for yearbooks is achieved would be

200 yearbooks per year.
300 yearbooks per year.
400 yearbooks per year.
500 yearbooks per year.

The average total cost would be $2,200 divided by 400 yearbooks, or $5.50 per yearbook. This is the lowest average total cost that exists for the given information.

Yearbook Costs

(This table shows the total cost of producing yearbooks using a school’s print shop.)

Number of Yearbooks	100	200	300	400	500	600
School Print Shop Cost ($/year)	1,200	1,600	1,800	2,200	3,000	4,800

According to the Yearbook Costs table, the marginal cost per yearbook between 100 and 200 yearbooks is equal to

$400 per yearbook.
$4 per yearbook.
$16 per yearbook.
$12 per yearbook.

The change in costs is $400 and the change in quantity is 100 yearbooks so the marginal cost would be $4.00 per yearbook ($400 divided by 100 yearbooks).

Yearbook Costs

(This table shows the total cost of producing yearbooks using a school’s print shop.)

Number of Yearbooks	100	200	300	400	500	600
School Print Shop Cost ($/year)	1,200	1,600	1,800	2,200	3,000	4,800

According to the Yearbook Costs table, marginal cost is minimized when

the first 100 yearbooks are produced.
output increases from 300 to 400 yearbooks.
output increases from 100 yearbooks to 200 yearbooks.
output increases from 200 to 300 yearbooks.

In the table, output always increases by the same increment so marginal cost would be minimized when the change in costs is smallest between production levels. The smallest change in costs ($200) is between 200 and 300 yearbooks.

Plant Costs

This table shows total costs at different output levels for a given plant.

Output (units per day)	0	10	20	30	40
Total Cost ($ per day)	40	65	88	120	180

According to the Plant Costs table, fixed costs

are equal to $40.
are equal to zero.
increase as output increases.
decrease as output increases.

At zero output, variable cost is zero and since total costs are equal to $40, fixed cost is $40.

Plant Costs

This table shows total costs at different output levels for a given plant.

Output (units per day)	0	10	20	30	40
Total Cost ($ per day)	40	65	88	120	180

According to the Plant Costs table, variable cost

is equal to $25 at an output of 10 units.
is the greatest at an output of zero units.
decreases as output increases.
is equal to $40 at every output level.

Since fixed cost is $40 at zero and total cost is $65 at 10 units of output variable cost must equal $25, or the difference between total cost and fixed cost.

Plant Costs

This table shows total costs at different output levels for a given plant.

Output (units per day)	0	10	20	30	40
Total Cost ($ per day)	40	65	88	120	180

According to the Plant Costs table, marginal cost is lowest when

the first 10 units are produced.
output increases from 10 units to 20 units.
output increases from 20 units to 30 units.
output increases from 30 units to 40 units.

Plant Costs

This table shows total costs at different output levels for a given plant.

Output (units per day)	0	10	20	30	40
Total Cost ($ per day)	40	65	88	120	180

According to the Plant Costs table, the lowest average total cost occurs at a production rate of

10 units per day.
20 units per day.
30 units per day.
40 units per day.

The lowest average total cost occurs at $4.00 per unit ($120 / 30 units). All other remaining average total costs are higher.

Production Costs

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	10	_____
1	_____	_____	19	_____
2	_____	_____	_____	3
3	_____	15	_____	_____

According to the Production Costs table, the marginal cost of the first unit of output is

$19 per unit.
$10 per unit.
$9 per unit.
$3 per unit.

Total cost at zero level of output is $10 and at one unit of output it is $19 so the change is $9 for the first unit.

Production Costs

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	10	_____
1	_____	_____	19	_____
2	_____	_____	_____	3
3	_____	15	_____	_____

According to the Production Costs table, the total cost of 2 units is

$3.
$10.
$12.
$22.

Since the additional cost from two to three units is $3 and the total cost of two units is $19, the total cost of three units is $22 ($3 + $19).

Production Costs

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	10	_____
1	_____	_____	19	_____
2	_____	_____	_____	3
3	_____	15	_____	_____

According to the Production Costs table, the total cost of 3 units is

$25.
$15.
$10.
$3.

Total cost is equal to fixed cost plus variable cost. At 3 units of production the fixed cost is $10 and the variable cost is $15 so total cost is $25 ($10 + $15).

Production Costs

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	10	_____
1	_____	_____	19	_____
2	_____	_____	_____	3
3	_____	15	_____	_____

According to the Production Costs table, the variable cost of the first unit is

$9.
$10.
$19.
$29.

Since the fixed cost is $10 and the total cost at the first unit is $19, the variable cost is $9. This is because variable cost is equal to the difference between total cost and fixed cost at any level of production ($19 − $10).

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.
Topic: Costs of Production

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

In the Production Costs 2 Table, fixed costs are equal to

$0, because the problem involves the long run.
$4.
$15.
$23.

At a zero output, total cost equals $15 and since variable cost at that level of output would be zero, fixed cost equals $15.

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

According to the Production Costs 2 table, the marginal cost of the third unit of output is

$3.
$5.
$6.
$15.

Since the marginal cost of the second unit of output is $4 then the total cost of two units of output is $27. The total cost of three units of output is the sum of the fixed cost and variable cost. Fixed costs are always $15 and so total cost at three units is $30. This means that between the second and third units, costs rise by $3 so the marginal cost of the third unit is $3.

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

According to the Production Costs 2 table, the total cost of 2 units of output is

$4.
$6.
$12.
$27.

The total cost of two units of output would be equal to the total cost of one unit ($23) plus the marginal cost of the second unit or $4.

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

According to the Production Costs 2 table, the total cost of 3 units of output is

$5.
$10.
$15.
$30.

Since the variable cost of the third unit of output is $15 and the fixed cost is $15, the total cost of three units is $30.

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

According to the Production Costs 2 table, the variable cost of 2 units of output is

$8.
$12.
$15.
$27.

Variable cost can be described by the difference between total cost and fixed cost at any level of output. Since the total cost of 2 units is $27 and the fixed cost is $15 the variable cost would be $12.

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

According to the Production Costs 2 table, the variable cost of one unit of output is

$8.
$12.
$15.
$23.

Variable cost can always be calculated as the difference between total cost and fixed cost at a given level of production. Since fixed cost is $15 and the total cost at 1 unit of output is $23, variable cost is $8 ($23 − $15).

Production Costs 2

Quantity (units)	Fixed Cost ($)	Variable Cost ($)	Total Cost ($)	Marginal Cost ($/unit)
0	_____	_____	15	_____
1	_____	_____	23	_____
2	_____	_____	_____	4
3	_____	15	_____	_____

According to the Production Costs 2 table, the average variable cost of 3 units of output is

$3.
$5.
$15.
$30.

Average variable cost divides variable cost by the quantity of units produced. Since the variable cost at 3 units is $15 the average variable cost is $5 ($15 / $3).

114.

According to the graph, the marginal physical product of the third unit of labor is

8 units per worker.
12 units per worker.
28 units per worker.
40 units per worker.

The total product of 2 units is 28 and the total product of 3 units is 40 so the change is 12 units per worker.

115.

According to the graph, the marginal physical product of the fourth unit of labor is

6 units per worker.
12 units per worker.
40 units per worker.
46 units per worker.

The total product of 3 units is 40 and the total product of 4 units is 46 so the change is 6 units per worker.

116.

According to the graph, the diminishing marginal returns first occur with the

second worker
third worker
fifth worker
sixth worker

The additional product of the second worker is 16 units whereas the additional product of the third worker is 12 units. This decline indicates that diminishing marginal returns have set in.

117.

Refer to the figure. What is the marginal cost of the 12th unit of output?

$6.00 per unit
$20.00 per unit
$52.00 per unit
$72.00 per unit

The marginal cost of the 12th unit is $72 unit and occurs at the intersection with the average total cost curve, which also equals $72 at an output level of 12.

118.

Refer to the figure. What is the fixed cost?

$20.00
$240.00
$740.00
$864.00

In general, we know that average fixed cost would be given by average total cost minus average variable cost. Once we know average fixed cost, we can multiply by quantity to find total fixed cost. Given the graph, there are two candidates to make this calculation, either 10 or 12 units of production. At 10 units of production, average total cost is $74 per unit and average variable cost is $50 per unit. Subtracting the two gives an average fixed cost of $24 per unit. Multiplying this difference by 10 units gives us total fixed cost of $240.

119.

Refer to the figure. What is the total cost of 10 units?

$240.00
$288.00
$500.00
$740.00

With information about output and average total cost, we can find total cost by multiplying average total cost and output together. Since at 10 units of output the average cost would be $74, the total cost would be $740 ($74 per unit × 10 units).

120.

Refer to the figure. What is the total variable cost when output is 10 units?

$500.00
$520.00
$720.00
$740.00

If average variable cost and output levels are known, we can find total variable cost by multiplying the two. At 10 units of output, the average variable cost would be $50 per unit so the total variable cost would be 10 units times $50 per unit, or $500.

121.

Refer to the figure. What is the total variable cost when output is 12 units?

$500.00
$624.00
$720.00
$864.00

If we know average variable cost and the level of output, we can find total variable cost by multiplying average variable cost and output together. The average variable cost at 12 units would be $52 per unit and so the variable cost would be 12 units × $52 per unit, or $624.

The production function indicates how much output producers will actually produce.

FALSE

The production function indicates the potential output producers can produce. It only indicates how much a firm could produce when using inputs efficiently.

A production function shows the maximum amount of a particular good or service that can be produced with different combinations of resources.

TRUE

The production function is a schedule that gives the different amounts of output that can be produced with various combinations of inputs.

Actual output will always equal the limit described by the production function.

FALSE

Actual output may be less then potential output. This would happen if a firm does not use resources efficiently.

Marginal physical product is the change in total output associated with an additional unit of input.

TRUE

Marginal physical product is the additional output produced when one additional unit of a resource is employed.

Total output may continue to rise even though marginal physical product is decreasing.

TRUE

Although marginal physical product may be decreasing, it can still be adding to total physical product at a decreasing rate.

If the marginal physical product of an input is decreasing, output will also be decreasing.

FALSE

If the marginal physical product is currently still positive but decreasing, this means it is still adding to output but at a decreasing rate.

According to the law of diminishing returns, the marginal physical product of a variable input declines as more of it is employed with a given quantity of other inputs.

TRUE

Since all of the other factors are fixed, the variable input will yield less and less output.

The short run implies that all factor inputs are fixed.

FALSE

The short run assumes that at least one factor is fixed while at least one other is variable. In the short run capital is usually fixed while labor is considered a variable input.

In the long run, all costs are variable.

TRUE

The long run implies that all factor inputs are variable.

Profit is equal to total revenue minus total cost.

TRUE

The difference between total revenue and total cost is the profit.

Fixed costs are the same as total costs at a production rate of zero units in the short run.

TRUE

In the short run, fixed costs exist and are the same at all levels of production. As a result, at zero units of output, fixed costs would equal total costs.

Fixed costs can be avoided in the short run.

FALSE

Fixed costs cannot be avoided because a certain amount of capital and land are necessary and will be the same at all levels of production.

In the short run, when output is zero, total costs are zero.

FALSE

Fixed costs exist at all levels of production and when output is zero fixed cost equal total costs.

Marginal cost is equal to the change in variable costs divided by the change in output.

TRUE

Marginal cost is equal to the change in total costs divided by the change in output and since in the short run fixed costs are constant marginal cost is equal to variable cost changes divided by change in output.

In the short run, if marginal cost is less than price for the last unit produced, the firm should expand output.

TRUE

If the price is greater than the additional cost then the firm’s profit will rise if it expands output.

The choice of how intensively to use existing plant and equipment is a long-run investment decision.

FALSE

The more intensively existing plant and equipment is used is related to the amount of variable inputs used and is therefore a short-run production decision.

Long-run choices imply that all factors are variable.

TRUE

In the long run, all inputs are variable.

Investment decisions are long-run decisions.

TRUE

Investment decisions involve changes in plant and equipment and are therefore long-run decisions.

Economic costs are the value of all resources used to produce a good or service.

TRUE

Economic costs include monetary payments for resources and use of the firm’s own resources (non-monetary) that contribute to a firm’s ability to produce a good or service.

Economic and accounting costs differ by the amount of explicit costs.

FALSE

Economic and accounting costs differ by the amount of implicit costs.

Economic costs include only the explicit payments made for a factor of production.

FALSE

Economic costs include both implicit and explicit payments made for a factor of production.

When implicit costs exist, economic profit will be less than accounting profit.

TRUE

Implicit costs payments are not counted in accounting costs or accounting profit, but they are in economic profit. As a result, when they exist this will mean that economic profit is always lower as these additional costs act as an additional drag on economic profit.

School subsidies and capital investment tax incentives are examples of government policy designed to increase productivity.

TRUE

Spending on human capital increases productivity as workers with more knowledge are likely more able to produce more output per hour of work.

A firm’s production function will shift downward if worker productivity increases.

FALSE

A firm’s production function will shift upward if worker productivity increases.

AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-01 Explain what the production function reveals.
Topic: Policy Perspectives

When the marginal physical product curve shifts upward because of technological advances, the marginal cost curve shifts downward.

TRUE

If marginal physical product increases, then marginal cost will decrease.

Why in the short run does marginal physical product increase but beyond some point start to decrease and eventually become negative?

At first when the fixed inputs are relatively plentiful, more intensive utilization of fixed inputs by variable inputs may increase the marginal physical product through specialization. However, beyond some point, each variable input has on average fewer units of the fixed input with which to work and the increase in intensity of use of the fixed input yields progressively less and less additional returns. Eventually, as variable inputs are added returns can become negative.

Explain (a) how the firm’s total cost curve would change if the wage rate paid to the labors increases versus the effect when the firm’s property taxes are doubled? (b) What would happen to the firm’s profits assuming the revenue does not change? (c) What might the firm do in the long run verses the short run?

In the short run a wage increase would affect variable costs where as an increase in property taxes would affect fixed costs. A change in a variable cost would reduce output because the marginal cost would increase at each level of output and so to maximize profits a firm would cut back output so as to reduce marginal cost at or below the market price. A change in a fixed cost would not affect marginal costs and so the firm would keep the same production level.
Both changes would reduce profit but a change in variable costs would also reduce output.
In the long run if a firm’s ATC curve was still downward sloping it might want to increase fixed cost by using more efficient fixed inputs thereby increasing the efficiency of the variable inputs. If economic profits are less than zero the firm might want to exit the market.

What is the relationship between increasing returns to scale and decreasing long-run average total costs?

In the long run, when adding an additional unit of a capital increases the output per unit of labor input, then the same unit of output will cost less to produce since the additional cost of the input is spread over more of the output. As a result, the average total cost, which includes average variable costs, will decline.

What happens along the average total cost curve as: (a) Marginal product is increasing? (b) Marginal cost is decreasing? (c) Average variable costs are decreasing? (d) Total product increases at a decreasing rate?

When marginal product increases, average total costs would be falling because average fixed costs would be falling and average variable costs would also be falling because the inputs were becoming more efficient.
If the marginal cost of the next unit is less than the previous then average total costs will be decreasing.
Since average total cost is the sum of average fixed cost and average variable cost and since both would be falling so to would average total cost.
If total product was increasing at a decreasing rate, marginal physical product would be decreasing and marginal cost would be increasing at the point marginal cost was greater than average total cost, average total cost would start to increase.

(a) Distinguish between explicit and implicit costs and give an example of each. (b) Why would accounting profit be greater than or equal to economic profit?

Explicit costs are a monetary payment that a firm must pay to obtain a resource whereas implicit costs are the monetary income that a firm sacrifices when it uses a resource it owns rather than selling the resource on the open market.
Accounting profit only includes explicit costs whereas economic profit includes implicit cost and so economic profit will always be less than or equal to accounting profit when implicit costs exist.

Within a given company, the question of how much can be produced is mostly a(n)

economic problem.
engineering problem.
managerial problem.
engineering problem and a managerial problem.

How much that can be produce will depend on proper management decisions and how engineering technology can be utilized to maximize production.

As more output is produced, a firms production cost rises. This will affect the firm’s _______decisions.

shutdown
production
demand
availability

When costs are rising and threatening the profitability of a firm, the firm will analyze its production decisions.

Joe’s Bar and Grill hires six workers to prepare the meals in the kitchen for his restaurant. They are able to prepare on average 89 meals per day. If it hires another worker for the kitchen, the number of meals prepared increases to 94. As his business grows, he hires the eighth worker and the number of meals prepared decreases to 91 meals per day. How can you explain this in terms of productivity? How does the marginal physical product of his last worker affect Joe’s decisions? What could Joe do to make it feasible to hire the eighth worker at his business?

The additional production from the eighth worker is the marginal physical product. It decreases by 3 meals per day. Thus the marginal physical product is now negative with the eighth worker and it is not feasible to hire him. Joe actually has fewer meals prepared in his kitchen, possibly from the workers not having access to the cooking appliances when they need them. There are too many workers for his kitchen and it causes productivity to decrease to the point that output itself actually falls. Unless Joe is unable to expand the size of his kitchen, he will not employ the eighth worker. He may decide to use that eight worker in another part of his restaurant, serving customers, bartending, etc.

Explain why fixed costs exist only in the short run but not in the long run.

The short run is too short of time for certain costs to change. Usually there are lease commitments that exist in the short run but are subject to change over time, for example. In the long run, the assumption is that enough time has passed such that firms can flexibly decide to do whatever they want.

Given the following production costs for a bakery for September 2018:

Flour costs = $900, electricity = $550, employee wages = $4500, other ingredients = $400, rent = $1200, the usual standard city service fees = $60. The bakery produces and sells 6000 loaves of bread during the month of September.

What is the total cost of producing 6000 loaves of bread this month?

$7,610
$1.27
$0.21
$1.06

What are the average total costs per loaf of bread?

$7,610
$1.27
$0.21
$1.06

What are the average fixed costs per loaf of bread?

$7,610
$1.27
$0.21
$1.06

What are the average variable costs per loaf of bread?

$7,610
$1.27
$0.21
$1.06

The total costs include all of the costs listed above. $7610/6000 equals $1.27 per loaf. The usual standard city services of $60 plus rent ($1200) equals $1260 for fixed costs. $1260/6000 equal average fixed costs of $0.21. The average fixed costs are all other costs added ($6350). $6350/6000 equals average variable costs ($1.06).

Economic profit equals

total revenue minus explicit costs.
total revenue minus implicit costs.
total revenue minus explicit and implicit costs.
total revenue minus the difference between explicit and implicit costs.

Economic profit equals total revenue minus all economic costs, whether they be explicit or implicit.

A production function describes

the maximum amount of output attainable from a given combination of factor inputs.
the quantity of output demanded by consumers
the profits that result from various production outputs.
how management and labor work in cooperation to increase production.

A production function expresses the maximum quantity of a good attainable from different combinations of factor inputs.

Which of the following is a possible way to increase productivity?

greater levels of education
vocational training
increased capital investment
All of these choices are correct.

All of these are possible ways to increase productivity by improving both human capital and physical capital.

The selection of output in the short run is referred to as

the production function.
the production decision.
the production chain.
the investment decision.

The selection of the short-run rate of output is the production decision.

You are cramming for a key economics exam, and your only concern is to earn the maximum possible grade, regardless of the cost. Accordingly, you should continue to study

until your marginal physical product starts to diminish.
as long as your marginal physical product is greater than zero.
only as long as your marginal physical product is greater than the average physical product.
only as long as average physical product is rising.

It makes sense to keep studying as long as your marginal physical product is positive or greater than zero (if studying is your only form of production).

Average (total) costs are

total costs divided by number of inputs.
total costs divided by total output.
total costs divided by marginal productivity.
total costs divided by total revenue.

Average costs are calculated by dividing total costs by total output.

When more resources are added, the additional output that these resources produce decreases. This is called the

law of diminishing marginal utility.
law of diminishing returns.
law of demand.
law of supply.

The law of diminishing returns says that as additional resources are added, the increase in output will eventually diminish.

As output increases, fixed costs

increase.
decrease.
do not change.
More information is needed to describe the response of fixed costs.

Fixed costs are constant, or fixed, regardless of the level of output in the short run. If it is not the short run then fixed costs do not exist and they still will not change.

An average total cost curve is U-shaped because

specialization and the spreading of fixed costs initially contribute to declining average costs until diminishing returns set in.
it starts high, then falls, then rises again due to production decisions.
it is determined by dividing total revenue by total costs.
All of these choices are correct.

Average total cost is high at low levels of output due to fixed costs and high at high levels of output due to variable costs, making it U-shaped. Initially, the spreading effect on fixed costs outweighs any diminishing returns, but especially in the short-run diminishing returns set in and cause the upward-sloping portion of the average total cost curve.

Which of these statements about variable costs is incorrect?

Variable costs increase as output increases.
Variable costs are equal to total costs minus fixed costs.
Variable costs occur even when there is no output.
Variable costs are associated with variable inputs.

Only fixed costs exist when no output is produced and so variable costs cannot exist if output is zero.

You have just begun a lawn care business and have purchased one electric lawn mower, one trimmer, and one rake. You have hired two employees to help with the work. Why might you begin experiencing diminishing returns as you hire additional workers?

You do not have enough contracts to keep all your workers busy.
Lawn care jobs are seasonal.
You do not have sufficient capital resources to support the additional workers.
Both you do not have enough contracts and lawn care is seasonal.

Once you have more workers than tools for them to use, the workers will be less productive because they have to wait to use the tools.

Which of the following terms represents the cost of an additional unit of output?

total cost
average total cost
marginal cost
fixed cost

Marginal cost is the extra, or additional, cost to produce one more unit of a good.

The investment decision involves

decisions in the long run.
the decision to buy or lease plants or equipment.
the decision to enter or exit an industry.
All of these choices are correct.

The investment decision is the decision to build, buy, or lease plants or equipment and whether to enter or exit an industry in the long run.

Which of the following is NOT a factor of production?

your economics professor
your college campus
your laptop computer
your money in the bank

The factors of production are land, labor, capital, and entrepreneurship. Money in the bank can help contribute the existence of these factors, but it is not a factor of production by itself.

Last year, Dr. Lopez quit his $100,000 job at the MegaMall Dental Clinic and opened his own dental practice. His revenue for the first year was $400,000. He paid $80,000 in rent for the dental office, $60,000 for his office manager’s salary, $25,000 for the dental hygienist, $150,000 for insurance, and $10,000 for other miscellaneous expenses. Based on this information, which of these statements is correct?

His implicit costs are $100,000.
His accounting profit is $75,000.
His economic profit is −$25,000.
All of these choices are correct.

Dr. Lopez’s explicit costs equal $325,000; therefore his accounting profit is $75,000 ($400,000 − $325,000). Because economic profit subtracts both implicit costs ($100,000 in foregone salary) and explicit costs ($325,000), Dr. Lopez has experienced an economic loss of $25,000 ($400,000 − $425,000) or economic profit of −$25,000.

Chapter 05 Test Bank Summary

Category	# of Questions
AACSB: Analytical Thinking	25
AACSB: Knowledge Application	40
AACSB: Reflective Thinking	106
Accessibility: Keyboard Navigation	171
Blooms: Analyze	25
Blooms: Apply	42
Blooms: Remember	38
Blooms: Understand	66
Difficulty: 1 Easy	42
Difficulty: 2 Medium	64
Difficulty: 3 Hard	65
Learning Objective: 05-01 Explain what the production function reveals.	25
Learning Objective: 05-02 Explain why the law of diminishing returns applies.	29
Learning Objective: 05-03 Describe the nature of fixed, variable, and marginal costs.	73
Learning Objective: 05-04 Illustrate the difference between production and investment decisions.	25
Learning Objective: 05-05 Discuss how accounting costs and economic costs differ.	19
Topic: Capacity Constraints: The Production Function	46
Topic: Costs of Production	77
Topic: Economic Versus Accounting Costs	19
Topic: Policy Perspectives	11
Topic: Supply Horizons	18

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