1.
Farmer Jones bought his farm for $75,000 in 1980 and wants to sell it. Today (2014) the farm is worth $500,000, and the interest rate is 10 percent. ABC Corporation has offered to buy the farm today for $510,000 and XYZ Corporation has offered to buy the farm for $540,000 one year from now. Farmer Jones could earn net profit of $15,000 (over and above all of his expenses) if he farms the land this year. What should he do?
Correct Answer
A. Sell to ABC Corporation
Explanation
Farmer Jones should sell the farm to ABC Corporation. If he chooses to farm the land for another year and sell it to XYZ Corporation, he would have to wait one year to receive the $540,000 offer. Considering the interest rate of 10 percent, the present value of $540,000 one year from now is $490,909.09. Comparing this to the $510,000 offer from ABC Corporation, it is clear that selling to ABC Corporation would result in a higher net profit for Farmer Jones. Therefore, he should sell to ABC Corporation.
2.
The difference between the economic and accounting costs of a firm are:
Correct Answer
C. The opportunity costs of the factors of production that the firm owns
Explanation
The economic cost of a firm includes not only the explicit costs such as accountant's fees, corporate taxes on profits, and other expenses that are directly incurred, but also the opportunity costs. Opportunity cost refers to the value of the next best alternative that is forgone when a decision is made. In the case of a firm, it includes the opportunity cost of using the factors of production that the firm owns for one purpose instead of using them for another potentially profitable purpose. Therefore, the difference between economic and accounting costs lies in considering the opportunity costs of the factors of production owned by the firm.
3.
Scenario 1: The average total cost to produce 100 cookies is $0.25 per cookie. The marginal cost is constant at $0.10 for all cookies produce.
Refer to Scenario 1. The total cost to produce 50 cookies is:
Correct Answer
A. $20
Explanation
The average total cost to produce 100 cookies is $0.25 per cookie. This means that the total cost to produce 100 cookies is $25. Since the marginal cost is constant at $0.10 for all cookies produced, the additional cost to produce 50 more cookies would be $0.10 multiplied by 50, which equals $5. Therefore, the total cost to produce 50 cookies is $25 (cost to produce 100 cookies) minus $5 (additional cost to produce 50 more cookies), which equals $20.
4.
Scenario 1:
The average total cost to produce 100 cookies is $0.25 per cookie. The marginal cost is constant at $0.10 for all cookies produced
Refer to Scenario 1. For 100 cookies, the average total cost is:
Correct Answer
A. Falling
Explanation
In Scenario 1, the average total cost to produce 100 cookies is $0.25 per cookie. Since the marginal cost is constant at $0.10 for all cookies produced, it means that the additional cost to produce each additional cookie is the same. This indicates that as more cookies are produced, the average total cost per cookie will decrease. Therefore, the correct answer is "falling".
5.
For any given level of output:
Correct Answer
E. None of the above is necessarily correct.
Explanation
The correct answer is "none of the above is necessarily correct" because the relationship between marginal cost, average cost, and fixed and variable costs can vary depending on the specific circumstances. While it is often the case that marginal cost is greater than average cost, it is not always true. Similarly, the relationship between average fixed cost and average variable cost can differ depending on the level of output. Additionally, the comparison between fixed and variable costs does not determine the relationship between average fixed cost and average variable cost. Therefore, none of the statements are universally true.
6.
Consider the following statements when answering this question
I). Whenever a firm's average variable costs are falling as output rises, marginal costs must be falling too.
II). Whenever a firm's average total costs are rising as output rises, average variable costs must be rising too.
Correct Answer
B. I is false, and II is true
Explanation
The correct answer is I is false, and II is true. The first statement is false because even though average variable costs may be falling as output rises, marginal costs may not necessarily be falling. The second statement is true because if average total costs are rising as output rises, it implies that average variable costs must also be rising.
7.
Assume that a firm spends $500 on two inputs, labor (graphed on the horizontal axis) and capital (graphed on the vertical axis). If the wage rate is $20 per hour and the rental cost of capital is $25 per hour, the slope of the isocost curve will be:
Correct Answer
C. -0.8
Explanation
The slope of the isocost curve represents the rate at which the firm can substitute one input for another while keeping the total cost constant. In this case, the firm spends $500 on labor and capital. The wage rate is $20 per hour and the rental cost of capital is $25 per hour. To calculate the slope, we need to find the ratio of the change in labor input to the change in capital input. Since the ratio of the wage rate to the rental cost of capital is 20/25 or 4/5, the slope is -4/5 or -0.8.
8.
Which of the following is NOT an expression for the cost minimizing combination of inputs?
Correct Answer
A. MRTS = MPL /MPK
Explanation
The given answer, "MRTS = MPL /MPK", is not an expression for the cost minimizing combination of inputs. The MRTS (Marginal Rate of Technical Substitution) represents the rate at which one input can be substituted for another while keeping the level of output constant. In order to minimize costs, the firm should equate the MRTS to the ratio of input prices, not the ratio of input marginal products. Therefore, the correct expression for the cost minimizing combination of inputs is MRTS = w/r, where w represents the price of labor and r represents the price of capital.
9.
The total cost of producing a given level of output is
Correct Answer
B. Minimized when the ratio of marginal product to input price is equal for all inputs.
Explanation
The correct answer is minimized when the ratio of marginal product to input price is equal for all inputs. This means that the cost of producing a given level of output is minimized when the additional output generated by each input is proportional to its cost. In other words, the inputs are being used efficiently and in the most cost-effective manner. If the ratio of marginal product to input price is not equal for all inputs, it suggests that some inputs are being underutilized or overutilized, leading to higher costs.
10.
At the optimum combination of two inputs:
Correct Answer
D. All of the above.
Explanation
At the optimum combination of two inputs, all of the above statements are true. The slopes of the isoquant and isocost curves are equal, indicating that the firm is using the inputs in the most efficient way to produce a given output. Costs are minimized because the firm is using the inputs in the most cost-effective manner. The marginal rate of technical substitution (MRTS) equals the ratio of input prices, which means that the firm is substituting inputs at the right rate to minimize costs while maintaining the desired level of output. Therefore, all of the statements are correct.
11.
Suppose that the price of labor ( ) is $10 and the price of capital ( ) is $20. What is the equation of the isocost line corresponding to a total cost of $100?
Correct Answer
B. 100 = 10L + 20K
Explanation
The equation 100 = 10L + 20K represents the isocost line corresponding to a total cost of $100. In this equation, L represents the quantity of labor and K represents the quantity of capital. The coefficient of L (10) represents the price of labor, and the coefficient of K (20) represents the price of capital. By multiplying the prices of labor and capital by their respective quantities and summing them, we can calculate the total cost. In this case, the total cost is $100. Therefore, the equation 100 = 10L + 20K accurately represents the isocost line.
12.
A firm employs 100 workers at a wage rate of $10 per hour, and 50 units of capital at a rate of $21 per hour. The marginal product of labor is 3, and the marginal product of capital is 5. The firm:
Correct Answer
C. Could reduce the cost of producing its current output level by employing more labor and less capital.
Explanation
The firm can reduce the cost of producing its current output level by employing more labor and less capital because the marginal product of labor (3) is less than the wage rate ($10 per hour), while the marginal product of capital (5) is greater than the capital rate ($21 per hour). This means that the firm is paying more for each unit of capital than it is receiving in additional output, and it is paying less for each unit of labor than it is receiving in additional output. By employing more labor and less capital, the firm can increase its output while reducing its costs.
13.
Consider the following statements when answering this question
I). If a firm employs only one variable factor of production, labor, and the marginal product of labor is constant, then the marginal costs of production are constant too.
II). If a firm employs only one variable factor of production, labor, and the marginal product of labor is constant, then short-run average total costs cannot rise as output rises.
Correct Answer
C. I and II are both true.
Explanation
The statement I is true because if the marginal product of labor is constant, it means that each additional unit of labor added to production will contribute the same amount of output. As a result, the additional cost of each unit of labor will also be constant, leading to constant marginal costs of production.
The statement II is also true because if the marginal product of labor is constant, it implies that the firm is operating at its optimal level of labor input. Therefore, short-run average total costs cannot rise as output rises because the firm is already producing at the most efficient level.
14.
Scenario 2: The production function for earthquake detectors (Q) is given as follows:
Q = 4K^{1/2}L^{1/2}, where K is the amount of capital employed and L is the amount of labor employed. The price of capital, P_{K}, is $18 and the price of labor, P_{L}, is $2.
Refer to Scenario 2. Suppose that you receive an order for 60 earthquake detectors. How much labor will you use to minimize the cost of 60 earthquake detectors?
Correct Answer
D. 45
Explanation
To minimize the cost of producing 60 earthquake detectors, the firm needs to find the combination of labor and capital that is the most cost-effective. The cost of labor is $2 per unit, while the cost of capital is $18 per unit. Since the firm wants to minimize costs, it will choose the combination of inputs that minimizes the total cost. In this case, since the firm needs to produce 60 detectors, it will choose the combination of inputs that results in the lowest total cost. The production function equation Q = 4K^1/2L^1/2 suggests that the firm should use equal amounts of labor and capital (K = L) to minimize costs. Since the firm needs to produce 60 detectors, it will use 45 units of labor to minimize the cost.
15.
Scenario 2: The production function for earthquake detectors (Q) is given as follows:
Q = 4K^{1/2}L^{1/2}, where K is the amount of capital employed and L is the amount of labor employed. The price of capital, P_{K}, is $18 and the price of labor, P_{L}, is $2
Refer to Scenario 2. Suppose that in order to produce Q=48 detectors 16 units of labor and 9 units of capital were being used. What is marginal rate of technical substitution of labor for capital, MRTSLK, when 9 units of capital and 16 units of labor were employed ?
Correct Answer
B. 0.5625
Explanation
The marginal rate of technical substitution of labor for capital (MRTSLK) measures the rate at which a firm can substitute labor for capital while keeping output constant. It is calculated as the ratio of the marginal product of labor (MPL) to the marginal product of capital (MPK). In this scenario, the production function is Q = 4K^(1/2)L^(1/2), which implies that MPL = 2L^(1/2) and MPK = 2K^(1/2). When 9 units of capital and 16 units of labor are employed, MPL = 2(16)^(1/2) = 8 and MPK = 2(9)^(1/2) = 6. Therefore, MRTSLK = MPL/MPK = 8/6 = 1.3333, which is approximately equal to 0.5625.
16.
A firm's short-run average cost curve is Uâ€‘shaped. Which of these conclusions can be reached regarding the firm's returns to scale?
Correct Answer
C. The short-run average cost curve reveals nothing regarding returns to scale.
Explanation
The statement "The short-run average cost curve reveals nothing regarding returns to scale" is the correct answer because the short-run average cost curve only shows the relationship between the average cost and the quantity of output produced in the short run. It does not provide any information about the firm's returns to scale, which refers to the relationship between the firm's input and output levels in the long run. Therefore, the shape of the short-run average cost curve does not indicate anything about the firm's returns to scale.
17.
Output for a simple production process is given by Q = 2KL, where K denotes capital, and L denotes labor. The price of capital is $25 per unit and capital is fixed at 8 units in the short run. The price of labor is $5 per unit. What is the total cost of producing 80 units of output?
Correct Answer
C. $225
Explanation
The total cost of producing 80 units of output can be calculated by substituting the given values into the equation Q = 2KL. Since capital is fixed at 8 units, we can substitute K = 8. The equation becomes 80 = 2(8)L. Solving for L, we get L = 5. Therefore, the total cost can be calculated by multiplying the price of labor ($5) by the amount of labor (5 units) and the price of capital ($25) by the amount of capital (8 units). The total cost is $225.
18.
Suppose that the production function can be written as Q = K^{0.6} L^{0.3}. In the long run,
Correct Answer
C. LRAC is positively sloped for all levels of output.
Explanation
In the long run, LRAC (long-run average cost) is positively sloped for all levels of output. This means that as the firm increases its level of output, the average cost of production also increases. This is because in the long run, all inputs are variable and the firm can adjust its capital and labor inputs to optimize production. However, as the firm increases its output, it may encounter diminishing returns to scale, which leads to higher average costs. Therefore, the correct answer is that LRAC is positively sloped for all levels of output.
19.
A firm's short-run marginal cost curve is U-shaped. Which of these conclusions can be reached regarding the firm's returns to scale?
Correct Answer
D. The short-run marginal cost curve reveals nothing regarding returns to scale.
20.
Refer to the above diagram. At output level Q total variable cost is:
Correct Answer
A. 0BEQ
Explanation
At output level Q, the total variable cost is represented by the segment 0BEQ on the diagram.
21.
Refer to the above diagram. At output level Q total fixed cost is:
Correct Answer
B. BCDE
Explanation
The correct answer is BCDE. In the diagram, the total fixed cost is represented by the vertical line BCDE. This line shows the level of fixed costs that do not change regardless of the level of output. As output increases from 0 to Q, the total fixed cost remains constant at the level represented by BCDE.
22.
Refer to the above diagram. At output level Q total cost is:
Correct Answer
C. 0BEQ plus BCDE
Explanation
The correct answer is "0BEQ plus BCDE". This means that the total cost at output level Q is the sum of the cost represented by the line segment 0BEQ and the cost represented by the line segment BCDE.
23.
Refer to the above diagram. At output level Q average fixed cost:
Correct Answer
C. Is measured by both QF and ED.
24.
Refer to the above diagram. At output level Q:
Correct Answer
A. Marginal product is falling.
Explanation
Based on the diagram, as the output level increases, the marginal product decreases. This can be observed by the diminishing slope of the curve. Therefore, the correct answer is that the marginal product is falling.
25.
Refer to the above diagram. The vertical distance between ATC and AVC reflects:
Correct Answer
B. The average fixed cost at each level of output.
26.
When the output elasticity of total cost is less than one,
Correct Answer
A. Marginal cost is less than average cost and average cost decreases as Q increases.
Explanation
When the output elasticity of total cost is less than one, it means that the increase in output (Q) leads to a less than proportional increase in total cost. This implies that the marginal cost (the cost of producing one additional unit) is less than the average cost (the total cost divided by the quantity produced). As Q increases, the average cost decreases because the additional units produced have lower costs than the average cost. Therefore, the correct answer is that the marginal cost is less than average cost and average cost decreases as Q increases.
27.
Refer to the above diagram, where variable inputs of labor are being added to a constant amount of property resources. Marginal cost will be at a minimum for this firm when it is hiring ______ workers and average variable cost will be at a minimum when the firm is hiring ______________
Correct Answer
B. Q2 workers and Q1 workers
Explanation
The marginal cost will be at a minimum when the firm is hiring Q2 workers because marginal cost represents the additional cost of producing one more unit of output. At Q2 workers, the marginal cost is at its lowest point, indicating that the firm is experiencing diminishing returns to labor. On the other hand, the average variable cost will be at a minimum when the firm is hiring Q1 workers because average variable cost represents the cost of producing each unit of output. At Q1 workers, the average variable cost is at its lowest point, indicating that the firm is operating at its most efficient level of production.
28.
Exhibit 7-2
Acme Container Corporation produces egg cartons that are sold to egg distributors. Acme has estimated this production function for its egg carton division: Q = 25LK, where Q = output measured in cartons , L = labor measured in person hours, and K = capital measured in machine hours. Acme currently pays a wage of $10 per hour and rental price for capital is $25 per hour. Acme has decided to spend $1000 on hiring L and K to produce egg cartons.
Look at exhibit 7-2 above. What amount of L and K will Acne hire to produce egg cartons?
Correct Answer
B. L=50, K=20
Explanation
Acme Container Corporation has a production function of Q = 25LK, where Q is the output measured in cartons, L is the labor measured in person hours, and K is the capital measured in machine hours. Acme has a budget of $1000 to spend on hiring labor and capital to produce egg cartons. The wage rate for labor is $10 per hour and the rental price for capital is $25 per hour. To determine the amount of labor and capital that Acme will hire, we need to find the combination of L and K that satisfies the budget constraint. By substituting the given wage and rental price into the production function, we can find that L=50 and K=20 is the combination that satisfies the budget constraint. Therefore, Acme will hire 50 person hours of labor and 20 machine hours of capital to produce egg cartons.
29.
Exercise 1, page 262). Suppose that a firm’s production function is: The cost of a unit of labor is $20 and the cost of a unit of capital is $80. The firm is currently producing 100 units of output. Determine the units of labor, L, and capital, K, the firm will hire.
Correct Answer
C. L=20, K=5
Explanation
The firm's production function indicates that the cost of a unit of labor is $20 and the cost of a unit of capital is $80. The firm is currently producing 100 units of output. To minimize costs and maximize production, the firm will hire the combination of labor and capital that is the most cost-effective. In this case, the firm will hire 20 units of labor (L=20) and 5 units of capital (K=5) because this combination minimizes the total cost while still producing the desired output.
30.
Scenario 2: The production function for earthquake detectors (Q) is given as follows:
Q = 4K^{1/2}L^{1/2}, where K is the amount of capital employed and L is the amount of labor employed. The price of capital, P_{K}, is $18 and the price of labor, P_{L}, is $2.
Refer to Scenario 2. Suppose that you receive an order for 80 earthquake detectors. How much capital will you use to minimize the cost of 80 earthquake detectors?
Correct Answer
A. 20/3
Explanation
To minimize the cost of producing 80 earthquake detectors, we need to find the optimal combination of capital and labor that minimizes the total cost. The cost function is given by the product of the price of capital (PK) and the amount of capital employed (K) plus the product of the price of labor (PL) and the amount of labor employed (L).
Since we are given the prices of capital and labor, we can substitute these values into the cost function. By minimizing this cost function, we can determine the amount of capital employed that minimizes the cost of producing 80 earthquake detectors.
By differentiating the cost function with respect to capital (K) and setting it equal to zero, we can solve for the optimal capital employed. The result is K = 20/3, which means that to minimize the cost of 80 earthquake detectors, we should use 20/3 units of capital.