ANSWERS:

 

1.  E

Ø      In the short run, you’ll eventually reach a point at which you experience less returns when you add additional inputs to a fixed input.  When this happens, you’ll begin to experience increasing costs.

2.  E

Ø      A property tax is an example on a fixed cost.  Thus, an increase in a company’s property tax will only affect average total cost.  There has been no change in variable costs.  Thus, marginal costs and average variable costs will remain unchanged.

3.  D

Ø      In order to make an economic profit, the firm must be bringing in more revenue that its’ costs.  Thus, it must operate at a point where AR > ATC.  This occurs at P4 and Q4.

4.  D

Ø      Economies of scale exist as a firm expands in both plant size and the number of workers.  As a firm becomes larger, it allows for specialization of labor, management, and capital.  Thus, long-run average total costs decrease.  However, diseconomies of scale occur as a firm becomes too large and distant management results in inefficiency.

5.  C

Ø      Marginal Revenue (MR) = D Total Revenue / D Output

6.  C

Ø      The only condition for a perfectly competitive firm in the long run is that of zero economic profits, also known as a normal profit.  If a firm were to be making economic profits, others would enter the industry thereby squeezing out all profits.  Likewise, if firms were making economic losses in an industry, some of them would exit the industry causing the losses to disappear.

7.  E

Ø      By looking at the data, we see that both price and quantity decreased from 1985 to 1986.  These results would be consistent with a decrease in demand, while supply remained unchanged.

8.  A

Ø      A firm will produce where MR = MC.  Since MR = AR and AR > ATC, the firm is currently making economic profits.  Thus, in the long run, firms will enter the industry.  As firms enter the industry, supply increases (shifts to the right) causing product price to fall.

9.  C

Ø      This problem is an application of the equimarginal or utility maximization rule.  According to this rule, MUhotdogs / Photdogs = MUsoda / Psoda.  Since, 50/1 < 200/2, you should purchase more soda.  As you purchase and consume more soda, your marginal utility from each additional bottle of soda declines thereby bringing the equation into equilibrium.

10. C

Ø      As you consume more and more of a good, each additional unit eventually brings you less and less satisfaction.  Thus, if we used the dollar as the unit of measurement of utility, we will have a downward sloping demand curve.

11. D

Ø      Total utility is simply the summation of each apple’s marginal utility.  Thus, if we add the marginal utility of the first and second apples (8 + 6 = 14) we’ll have the total utility of consuming 2 apples.

12. C

Ø      If apples are free, you will consume them as long as they bring you some satisfaction (utility).  You will not consume an additional apple if it makes you worse off.  Therefore, you will consume 3 apples.  You will not consume more than 3 apples since the 4th apple would bring you negative utility.

13. A

Ø      If you decide to see more movies and go to fewer soccer games, the marginal utility of the last dollar spent on movies must be more than the marginal utility of the last dollar spent on soccer games.  If the marginal utility of the last dollar spent on movies and soccer games were equal, you would keep viewing the same amount of movies and soccer games.  This is another application of the equimarginal (utility maximization) rule.

14. A

Ø      Economic profit = Accounting Profit – Implicit Costs.  In this example, Freddie’s implicit costs are the forgone income of $30,000 and the forgone interest income of 10%(100,000) = $10,000.  Therefore, we know that his economic profits were $60,000 – $30,000 - $10,000 = $20,000.

15. A

Ø      Diminishing marginal returns occurs once marginal product starts to decrease as you add additional inputs to a fixed resource like capital (in the short run).  Marginal product = D Total Product (Output) / D Labor (Input).  After calculating the marginal product for each additional laborer, you’ll see that productivity begins to diminish after the second worker (or with the addition of the third worker).

16. C

Ø      A firm will not hire more workers if they don’t benefit the firm at all.  Thus, if the marginal productivity of an additional worker is less than zero, the firm will not hire that worker.  This firm would therefore hire no more than 5 workers.  If they would hire a 6th worker, total product (output) would actually decline.

17. D

Ø      The AP curve and MP curve intersect where AP is at a maximum.  Thus, if the company were to hire an additional worker, then the AP and MP of workers would both become less than 50 since the AP and MP curves are both downward sloping to the right of 50 workers.

18. B

Ø      Stage 1 of production is where AP is increasing.  During Stage 1, MP is increasing and decreasing.  Stage 2 starts when AP = MP and ends when MP = 0.  Stage 3 is where MP < 0.

19. B

Ø      If you take away capital from workers, productivity will decline.  Likewise, if you give labor more capital, productivity increases.

20. C

Ø      Average Total Cost (ATC) = Total Cost (TC) / Output (Q) = ($500 + $700) / 4 = $1200 / 4 = $300.

21. A

Ø      Marginal Cost (MC) = D Total Variable Cost (TVC) / D Output (Q) = ($1800-$1000) / (6-5) = $800 / 1 = $800.

22. B

Ø      Total Fixed Cost is the cost you incur regardless of how much you produce.  Thus, Total Fixed Cost is the cost when you produce nothing.  So, Total Fixed Cost = 100.  When 8 units are produced, the Total Cost = $430.  Since TFC = $100, we know that the Total Variable Cost of producing 8 units is $330.  Therefore, the Average Variable Cost (AVC) = Total Variable Cost (TVC) / Output (Q) = $330 / 8 = $41.25.

23. B

Ø      Average total cost intersects the marginal cost curve at its minimum.  Thus, if we are currently at the point where ATC = MC and we decide to increase output, we know that marginal cost and average total cost are both rising.

24. D

Ø      Diminishing returns occurs when marginal productivity begins to decline.  As productivity declines, costs begin to rise.  Diminishing returns sets in after the point where marginal product is at a maximum (or where marginal cost is at a minimum).

25. D

Ø      If you pay $100 for season tickets, that $100 represents a fixed cost.  After you pay the $100, the cost is incurred or sunk.  Therefore, the cost of you going to any one game is $0.

26. A

Ø      Marginal Cost (MC) = D Total Cost / D Output = D Total Variable Cost / D Output.  This is true since total fixed cost do not change when you add additional variable inputs.  The information on fixed costs is irrelevant to this problem. 

27.

Ø      Fixed Cost = $10 (Total Cost when output is zero).

Ø      Average Fixed Cost at 4 units = TFC / Q = $10 / 4 = $2.50

Ø      Variable Cost at 3 units = TC – TFC = $60 - $10 = $50

Ø      Average Variable Cost at 5 units = TVC / Q = $120 / 5 = $24

Ø      Marginal Cost = D TC / DQ = ($130-$90) / (5-4) = $40 / 1 = $40

Ø      The firm’s best operating output is where it maximizes profits (MR = MC):  3 units

Ø      Profit = Total Revenue – Total Cost = $75 - $60 = $15

28. B

Ø      $100 is the lowest amount the family would be willing to accept since that would cover the costs of “wear and tear” on the house.  If the family does not rent out their house, they will still have to pay the $300 mortgage.  This is why they would be willing to accept a minimum of $100.

29. D

Ø      This is the law of diminishing returns.  As you add additional variable inputs to a fixed input, you’ll eventually reach a point where the returns on that input will begin to decline.

30. B

Ø      This is the profit maximization rule.  A firm will produce where MR = MC if it desires to maximize profit.

31. C

Ø      Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Output (Q) = $24 / 4 = $6.

32. B

Ø      Total Variable Cost (TVC) = Total Cost (TC) – Total Fixed Cost (TFC) = $69 - $24 = $45.

Ø      Average Variable Cost (AVC) = Total Variable Cost (TVC) / Output (Q) = $45 / 6 = $7.50.

33. B

Ø      Marginal Cost (MC) = D Total Cost (TC) / DOutput (Q) = ($61-$54) / (5-4) = $7 / 1 = $7

34. E

Ø      The only equilibrium condition for a perfectly competitive firm in the long run is that of zero economic profits.  Therefore, total revenue (TR) = total cost (TC) in the long run.

35. D

Ø      If marginal costs are greater than average costs, they will pull up the average.  Likewise, if marginal costs are less than average costs, they will cause average costs to decrease.

36.

Ø      Explicit Costs include direct $ payments such as insurance payments, wages, interest payments for loans to buy capital, and rent.

Ø      Implicit Costs represent an opportunity cost.  Such costs include potential rent, potential salary, or potential interest if all capital was liquidated and the money was put into the bank.

37.

Ø      Variable Costs are any costs that change as output changes.  These are the costs associated with variable inputs.  Examples include the cost of resources used in production like wages, electric bills, etc.

Ø      Fixed Costs are any costs that do NOT change as output changes.  These are the costs associated with fixed inputs.  Examples include mortgage payments, insurance payments, property tax, etc.

38.

Ø      In the long run, there is enough time to build a new plant / factory.

39.

Ø      Economic profits occur when AR > ATC.  The firm will produce where MR = MC.  For a perfectly competitive firm, this also happens to be where P = MC since P = MR = AR in this type of market.

40.

Ø      An increase in variable costs will cause all of the curves to shift up since variable costs have changed.

 

 

SAMPLE WRITTEN RESPONSE QUESTION:

 

II.  Since the price of cookies decreased, the demand for milk will increase (shift to the right) since milk

and cookies are complements.

A.     The milk industry’s output and price will both increase due to the increased demand for milk.

B.     Dairy Deets’ output will also increase since Deets now receives a higher price for her milk.  In addition, Deets is now making economic profits because AR > ATC.

III. Firms will enter this industry in the long run causing profits to be squeezed out.

A.     The milk industry’s output will increase and price will decrease due to the increased number of firms (supply shifted to the right).

B.     Dairy Deets’ output decreases as Deets now receives a lower price for her milk.  In addition, Deets is now making zero economic profit since AR = ATC.

C.     Dairy Deets should stay in business because AR = ATC.  All of Dairy Deets costs are covered so there’s no reason not to stay in business.