CHAPTER 20 CHAPTER 8 COSTS AND THE SUPPLY OF GOODS QUESTIONS 1

					CHAPTER 8
COSTS AND THE SUPPLY OF GOODS
QUESTIONS 1 THROUGH 10 ARE A SUGGESTED CHAPTER QUIZ.

1.   Which of the following is most likely to be an implicit cost of production?
     a. property taxes on a building owned by the firm
     b. transportation costs paid to a trucking supplier
     c. rental payments for a building utilized by the company and rented from another party
     d. interest income foregone on funds invested in the firm by the owners
2.   Which of the following explains most clearly why business owners have a strong incentive to strive
     for operational efficiency?
     a. They recognize that operational efficiency promotes the public interest.
     b. As residual claimants, owners will receive a higher income from increased efficiency.
     c. The owners will be able to keep production costs low by providing free managerial services to
          the firm.
     d. The owners will be able to gain by paying employees below market wages, which will improve
          the overall efficiency of the economy.
3.   The law of diminishing returns
     a. explains why marginal cost eventually increases as output expands.
     b. implies that average fixed cost will remain unchanged as output expands.
     c. is true for physical production activities but not for activities such as studying.
     d. applies to a capitalist economy but would be irrelevant if the means of production were owned
          by the state.
4.   Which of the following represents a long-run adjustment?
     a. the hiring of four additional cashiers by a supermarket
     b. a cutback on purchases of coke and iron ore by a steel manufacturer
     c. construction of a new assembly-line plant by a car manufacturer
     d. the extra dose of fertilizer used by a farmer on his wheat crop
5.   The short-run average total cost (ATC) curve of a firm will tend to be U-shaped because
     a. larger firms always have lower per-unit costs than smaller firms.
     b. at low levels of output, AFC will be high, while at high levels of output, MC will be high as the
         result of diminishing returns.
     c. diminishing returns will be present when output is small, and high AFC will push per-unit cost
         to high levels when output is large.
     d. diseconomies of scale will be present at both small and large output rates.
6.   When costs that vary with the level of output are divided by the output, you have calculated
     a. total changing cost.
     b. total fixed cost.
     c. average fixed cost.
     d. average variable cost.




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7.    A downward-sloping portion of a long-run average total cost curve is the result of
      a. economies of scale.
      b. diseconomies of scale.
      c. diminishing returns.
      d. the existence of fixed resources.
8.    A foreign exchange student bought a used car for $10,000 and resold it one year later for $6,500.
      Insurance, license, and operating costs for the year were $1,500. What was his economic cost of
      owning and operating the car for the year if the market rate of interest was 10 percent?
      a. $3,500
      b. $5,000
      c. $6,000
      d. $8,500
9.    In the short run, if average variable cost equals $50, average total cost equals $75, and output equals
      100, the total fixed cost must be
      a. $25.
      b. $2,500.
      c. $5,000.
      d. $7,500.
10.   Which of the following would shift a firm’s short-run cost curves downward?
      a. an advance in technology
      b. an increase in employees’ wages
      c. an increase in the demand for the firm’s product
      d. an increase in excise taxes levied on the firm’s product

ANSWER KEY 1 THROUGH 10

*1. (d), 2. (b), 3. (a), 4. (c), 5. (b), 6. (d), 7. (a), 8. (c), 9. (b), 10. (a)

ORGANIZATION OF THE BUSINESS FIRM
11.   The owners of a business
      a. are paid the market rate of return for resources they supply to the firm.
*     b. are residual income claimants.
      c. have little incentive to monitor shirking on the part of employees.
      d. have little incentive to provide their employees with an incentive system that encourages
          operational efficiency.
12.   The owner’s property right to the residual income of the firm provides owners with a strong
      incentive to
      a. keep per-unit costs of production low.
      b. structure the compensation of employees in a manner that will reduce their incentive to shirk.
      c. let the managers of the firm pretty much do what they want to.
*     d. do both a and b, but not c.
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13.   Automobile companies typically make some of the parts for cars (for example, the body and engine)
      but not others (for example, the tires). Under what conditions would you expect an automobile
      manufacturer to be most likely to buy inputs from other companies?
      a. when the specifications (size, style, etc.) of the inputs change frequently
      b. when the inputs being produced have little value
      c. when market prices have not been established for the inputs
*     d. when it is relatively easy to measure the quantity and quality of the input
14.   An activity known as shirking is least likely to occur when
      a. workers are not monitored.
      b. all workers are paid the same wage rate.
*     c. the earnings of workers are closely tied to the worker’s output.
      d. the firm is organized as a corporation.
15.   One advantage of team production over contracting out is that
*     a. the cost of negotiating and enforcing contracts is generally lower with team production than
          with contracting out.
      b. the principal agent problem is eliminated by team production but cannot be addressed in
          contracting out.
      c. costs are always lower with team production because of the elimination of transactions costs.
      d. efficiency is always greater with team production.
16.   A disadvantage of team production compared to contracting out is that
      a. transaction costs are often higher with team production.
      b. the level of specialized knowledge required by team production is greater than with contracting
           out.
*     c. the problem of shirking must be more carefully addressed with team production.
      d. team production increases the cost of production in most situations.
17.   Ron works for Betty at Betty’s Pizza Palace. Betty has many work rules, and Ron believes if there
      were fewer rules and more flexibility, he could do a better job. Betty probably has the rules because
      a. Ron, like her other employees, is a residual claimant.
*     b. some employees are likely to shirk when the owner is absent.
      c. she is maximizing sales rather than profits.
      d. with regard to their jobs, employees seldom know what is best.
18.   Since it is costly for stockholders to monitor corporate managers, managers may be able to achieve
      personal perks and pursue other policies that conflict with profit maximization. This is an example
      of
      a. an external benefit.
      b. economies of scale.
*     c. the principal-agent problem.
      d. sunk costs.
19.   In which of the following activities is the principal-agent problem likely to be most prevalent?
      a. A farmer sells a bushel of cucumbers to a pickle manufacturing representative.
*     b. A banker takes her car into the shop because of transmission problems.
      c. A swimmer buys a new pair of goggles from a discount store.
      d. A college president hires a cleaning service to maintain her house.
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20.   If the CEO of a large corporation uses the corporate jet to fly friends to the Super Bowl at company
      expense, this is most clearly an example of
      a. the duality problem.
      b. the violation of ceteris paribus conditions.
      c. a negative externality.
*     d. the principal-agent problem.
21.   If high-level executives of a company award themselves sizable bonuses even though the firm they
      manage is making losses and performing poorly, this event is most likely to arise because of
      a. the law of diminishing marginal returns.
      b. competition among business firms for high-level executives.
      c. economies of scale.
*     d. the principal-agent problem.
22.   Approximately three-fourths of all U.S. firms are
      a. corporations.
*     b. proprietorships.
      c. partnerships.
      d. consumer cooperatives.
23.   A business owned by a single individual who is fully liable for its debts is called a(n)
      a. corporation.
*     b. proprietorship.
      c. partnership.
      d. agency.
24.   Which of the following is characteristic of the corporate form of ownership?
      a. unlimited liability
*     b. easy transferability of ownership rights
      c. no divisible ownership rights
      d. absence of the principal-agent problem
25.   Which of the following is a difference between corporations and partnerships?
      a. Partnerships are subject to double taxation; corporations are not.
      b. With partnerships, ownership rights are divisible and easily transferable; this is not true for
          corporations.
*     c. Corporate owners face limited liability; owners of partnerships do not.
      d. Corporations always have more owners than partnerships.

COSTS, COMPETITION, AND THE CORPORATION
26.   Which of the following is most likely to reduce the incidence of employee shirking?
      a. use of the corporate business structure, rather than an individual proprietorship
*     b. closely relating the pay of workers to their productive contribution
      c. payment of identical wage rates to all workers
      d. providing workers with a year-end bonus if the business firm loses money during the year
27.   Suppose John Brown is hired to manage a firm and minimize “shirking” by workers. Brown will
      have a strong incentive to be effective if
*     a. his compensation is closely tied to the firm’s residual income.
      b. his compensation is unrelated to the firm’s profitability.
      c. he has a secure position where he does not have to worry about losing his job.
      d. he is paid by the hour, so he will devote extra time to the management of the firm.
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28.   Which of the following is not an advantage of the corporate structure over proprietorship and
      partnership forms of business organization?
      a. Stockholders in the corporation have limited liability, whereas proprietors or partners have
           unlimited liability.
      b. Ownership rights of a corporation may be transferred more easily.
      c. Large investment funds are more easily attracted by the corporation.
*     d. Corporations are less likely to suffer from the principal-agent problem.
29.   Profit-sharing plans, where employees receive bonuses in proportion to the company’s profits,
*     a. reduce the principal-agent problem.
      b. are intended to reduce the number of employees who are residual claimants.
      c. eliminate shirking problems.
      d. are essentially gifts to employees and do not generate any benefit for the firm’s owners.
30.   Which of the following provides the strongest evidence that the corporate form of business structure
      is relatively efficient, particularly when business firms are large?
*     a. the fact that almost 90 percent of business revenues are generated by corporations
      b. the fact that individual proprietorships are more numerous than corporations
      c. the fact that economic theory indicates corporate managers have some leeway to pursue their
            own interests at the expense of the owners of the firm
      d. the high salaries of many corporate executives, including some managing firms that are making
            economic losses
31.   Which of the following provides the strongest evidence that the corporate form of business structure
      is relatively cost efficient in many industries?
*     a. the ability of the corporate business structure to compete effectively in most industries with
            other forms of business structure
      b. the fact that nearly three of every four businesses in the United States is an individual
            proprietorship
      c. the fact that economic theory indicates corporate managers have some leeway to pursue their
            own interests at the expense of greedy capitalists
      d. the ability of some corporate managers to achieve high salaries even though the firms they are
            directing are not earning economic profit
32.   Corporate takeovers
      a. serve no useful purpose.
      b. generally reduce the wealth of the shareholders of the firm that is being taken over.
*     c. can punish managers who are not performing well.
      d. reduce the incentive of managers to keep costs low and maximize profit.
33.   Takeover bids (and the potential for such bids)
*     a. increase the incentive of corporate managers to perform efficiently.
      b. increase the likelihood that managers will be able to gain at the expense of stockholders.
      c. are more likely to occur when a company is producing efficiently and operating profitably.
      d. serve no useful economic purpose.

ECONOMIC ROLE OF COSTS
34.   The costs of a firm indicate the desire of consumers for
      a. the product produced by the firm.
*     b. other goods that might have been produced with the same resources.
      c. goods that can be easily substituted for the good produced by the firm.
      d. goods that are complementary with the good produced by the firm.
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35.   Paul’s Plumbing is a small business that employs 12 people. Which of the following is the best
      example of an implicit cost incurred by this firm?
      a. the tax payments on property owned by the firm
      b. the wages paid to the 12 employees
      c. the half of the payroll taxes on the wages of the 12 employees paid by the employers, but not
           the half paid by the employees
*     d. the accounting services provided free of charge to the firm by Paul’s wife, who is an
           accountant
36.   When total revenue minus total cost is equal to zero, the firm is
      a. earning above-average economic profit.
*     b. earning the normal profit rate.
      c. losing too much money to stay in business.
      d. earning abnormally low profits.
37.   When total revenue minus total cost is greater than zero, the firm is
*     a. earning higher than normal profits.
      b. earning the normal profit rate.
      c. making economic losses.
      d. earning economic profit but accounting losses.
38.   Which of the following would be considered an implicit cost?
      a. health insurance of employees paid for by the firm
      b. the water bill of the firm
      c. the salaries paid to the managers of the firm
*     d. foregone rent on assets owned by the firm
39.   Which of the following items is most likely to be an implicit cost of production?
      a. the “competitive rate” salary the owner of the business pays herself for services provided
      b. property taxes on a building owned by the firm
      c. rental payments for a building utilized by the company and rented from another party
*     d. the interest income foregone on the equity capital invested by owners
40.   Which of the following is most likely to be an implicit cost of production?
      a. the “competitive rate” salary the owner of the business pays herself for services provided
      b. the property taxes on a building owned by the firm
*     c. the rental income foregone because the business owns its building
      d. the interest paid on outstanding loans of the business
41.   The opportunity costs associated with the use of resources owned by a firm are usually
      a. externalities.
*     b. implicit costs.
      c. explicit costs.
      d. sunk costs.
42.   The sum of the explicit and implicit costs incurred in the production process is called
      a. fixed cost.
      b. sunk cost.
      c. marginal cost.
*     d. total cost.
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43.   The most important implicit cost generally omitted from the accounting statement of a firm is the
      a. rental cost of machinery.
      b. cost of compliance with government regulations.
*     c. opportunity cost of the equity capital invested by the owners.
      d. accounting cost incurred as the result of tax compliance.
44.   The implicit rate of return that must be paid to induce investors to continue to supply the funds
      necessary to maintain a firm’s capital assets is called
      a. the investors’ rate of return.
      b. the opportunity cost of labor.
*     c. the opportunity cost of capital.
      d. equity capital.
45.   Accounting costs are often unsatisfactory from the economist’s point of view because
      a. they fail to allow for depreciation, the wearing out of capital assets during a period.
*     b. they often exclude the opportunity costs of the firm’s equity capital.
      c. accountants attempt to minimize costs in order to make profits look good.
      d. accounting procedures are designed to overstate costs in order to minimize business tax
          liability.
46.   Interest foregone on financial capital invested in a firm represents an economic cost
      a. only if the firm borrows to finance capital investments.
      b. only when the funds are used to buy machinery.
*     c. because funds invested in the firm could be earning interest elsewhere.
      d. because accountants have traditionally input an interest cost for this item.
47.   The normal rate of return on equity capital is also known as
      a. the explicit cost of capital.
      b. the marginal cost of capital.
      c. economic profit.
*     d. the opportunity cost of capital.
48.   The rate of return that owners of capital must receive in order to induce them to continue supplying
      the capital is often referred to as
      a. accounting profit.
*     b. the normal or market rate of return.
      c. economic profit.
      d. the accounting rate of return.
49.   Which of the following is most likely to be true of economic and accounting profits?
*     a. Economic profits are less than accounting profits.
      b. Accounting profits are less than economic profits.
      c. Economic profits plus accounting profits equal zero.
      d. Accounting profits minus economic profits equal zero.
50.   If a corporation used debt financing, the interest paid on outstanding debt would add to the firm’s
      accounting costs. In contrast, if the firm issued new stock, the opportunity cost of financing equity
      capital would not be included as part of the firm’s costs. Thus, since the corporate tax is paid on
      accounting profits, corporations can reduce their tax bill by
      a. minimizing their outstanding debt.
      b. always using equity capital to finance growth.
*     c. substituting debt for equity financing.
      d. paying larger dividends to stockholders.
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51.   For most firms, the major difference between accounting profit and economic profit is that
      a. explicit and implicit costs are included in the accounting profit while only explicit costs are
          included in economic profit.
      b. accounting profit omits the salaries of managers, and therefore, it is generally greater than
          economic profit.
      c. accounting profit is based on opportunity cost, whereas economic profit is based on market
          transactions.
*     d. accounting profit does not consider the opportunity cost of the firm’s equity capital and,
          therefore, generally overstates profit.
52.   Economic profit is
      a. total revenues minus variable costs.
      b. total revenues minus private costs.
      c. total revenues minus explicit costs.
*     d. total revenues minus total costs.
53.   Anne Teek works full time as the manager of her used furniture store in which she has invested
      $40,000. Last year, her total revenues were $90,000 and her costs were $60,000 for merchandise,
      gas, electricity, and other explicit-cost items. Ms. Teek pays herself a “competitive” salary of
      $30,000 per year. An economist would consider her profits for the year to be
      a. –$40,000.
      b. $0.
*     c. $0 minus the opportunity cost of the $40,000 of capital invested in the store.
      d. $30,000.
54.   The difference between a firm’s total revenues and total costs when all explicit and implicit costs
      are included is the firm’s
*     a. economic profit.
      b. accounting profit.
      c. opportunity cost of capital.
      d. long-run average total cost.
55.   If most businesses in an industry are earning a 13 percent rate of return on their assets, but your firm
      is earning 23 percent, your rate of economic profit is
      a. zero.
*     b. 10 percent.
      c. 23 percent.
      d. 36 percent.
56.   When an economist says a firm is earning zero economic profit, this implies that the firm
      a. will be forced out of business in the near future unless market conditions change.
      b. is earning a zero rate of return on its assets.
*     c. is earning as high a rate of return now as could be earned in other industries.
      d. has an accounting profit of zero.

SHORT RUN AND LONG RUN
57.   During the short-run period of the production process, a firm will be
      a. unable to vary any of its factors of production.
*     b. able to vary some of its factors of production.
      c. able to vary all of its factors of production.
      d. able to vary the size of its plant.
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58.   The short run is a time period such that
      a. the existing firms in the market do not have sufficient time to change the amounts of any of the
          inputs that they employ.
      b. the existing firms in the market do not have sufficient time to either increase or decrease their
          current rate of output.
*     c. the existing firms in the market do not have sufficient time to increase the size of their existing
          plant or build a new factory.
      d. new firms may build plants and enter the industry.
59.   Which of the following factors of production is not variable in the long run?
      a. the size of the firm’s plant
      b. property taxes on the assets of the firm
      c. highly trained labor
*     d. All factors are variable in the long run.
60.   The long run is a period of
      a. at least one year.
      b. sufficient length to allow a firm to expand output by hiring additional workers.
*     c. sufficient length to allow a firm to alter its plant size and capacity and all other factors of
           production.
      d. sufficient length to allow a firm to transform economic losses into economic profits by hiring
           better workers.

CATEGORIES OF COSTS
61.   Paul’s Plumbing is a small business that employs 12 people. Which of the following is most likely
      to be a fixed cost for Paul’s Plumbing?
*     a. the tax and insurance payments on the property owned by the firm
      b. the wages paid to the 12 employees
      c. the payroll taxes on the wages of the 12 employees
      d. the salary paid to Paul, who is the manager of the firm
62.   Fixed costs are best defined as
*     a. costs that do not vary with output.
      b. costs that are at a minimum when output approaches the firm’s capacity.
      c. the amount that one more unit of output adds to total costs.
      d. costs that decline as output increases.
63.   Which of the following is most likely to be a fixed cost for a business?
      a. expenditures on low-skill labor
      b. shipping charges for the delivery of products
      c. managerial salaries
*     d. property taxes on the firm’s buildings
64.   “Costs” that a firm remaining in business will still incur even if it halts current production are called
*     a. fixed costs.
      b. variable costs.
      c. implicit costs.
      d. explicit costs.
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65.   A fruit packing plant usually shuts down for three months each year. During that period, its
*     a. fixed costs are greater than zero.
      b. variable costs are greater than zero.
      c. total costs are zero.
      d. fixed costs are zero.
66.   If you were operating a fast-food restaurant, which of the following would represent a fixed cost of
      production in the short run?
*     a. an annual business license fee paid to the local government
      b. wages paid to workers
      c. the cost of electricity to light the restaurant
      d. the cost of paper supplies (napkins, bags, etc.)
67.   Which of the following will become smaller and smaller as the firm expands output?
      a. average total cost
*     b. average fixed cost
      c. marginal cost
      d. total fixed cost
68.   Average fixed costs
      a. will remain unchanged as output expands.
      b. are defined as the change in total costs divided by the change in output.
      c. will always increase as output increases.
*     d. will always decrease as output expands.
69.   The average fixed costs of a firm equal
      a. implicit costs divided by output.
      b. explicit costs divided by output.
      c. total cost minus variable cost.
*     d. (total cost minus variable cost) divided by output.
70.   Mr. Hudson notes that if he produces 10 pairs of shoes per day, his average fixed cost (AFC) is $14
      and his marginal cost is $8; if he produces 20 pairs of shoes per day, his MC is $15. What is his
      AFC when output is 20 pairs of shoes per day?
      a. $5
*     b. $7
      c. $8
      d. $15
71.   Which of the following “costs” could a firm that wants to remain in business avoid if it halted
      current production?
      a. fixed costs
*     b. variable costs
      c. sunk costs
      d. implicit costs
72.   If average fixed costs equal $60 and average total costs equal $120 when output is 100, the total
      variable cost must be
      a. $40.
      b. $60.
*     c. $6,000.
      d. $8,000.
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73.   If fixed costs are $200,000 and variable costs are $30 per unit over the relevant range of output,
      when 10,000 units are produced, the average total cost will be
      a. $20.
      b. $30.
*     c. $50.
      d. $70.
74.   Which of the following is true?
*     a. The difference between the ATC and AVC curves will decline as output expands.
      b. The AFC will remain constant as output increases.
      c. If ATC is increasing, then AVC must be greater than ATC.
      d. Implicit costs and fixed costs are always the same.
75.   Use the table below to answer the following question.
                     Units of       Total Fixed Total Variable
                     Output        Cost (dollars) Cost (dollars)
                        1             1,000          1,200
                        2             1,000          2,400
                        3             1,000          3,600
                        4             1,000          5,000
                        5             1,000          6,600
      What is the average total cost at an output level of four units?
      a. $1,200
      b. $1,400
*     c. $1,500
      d. $2,000
76.   Marginal cost is best defined as
      a. a cost that does not vary with the rate of output.
      b. the difference between fixed and variable cost at any level of output.
*     c. the amount added to total cost when one more unit of output is produced.
      d. the difference between price and average total cost at the profit-maximizing level of output.
77.   The marginal cost of a good is
      a. lower for competitive firms than for monopolists.
*     b. the cost of an additional unit.
      c. equal to fixed cost at high output levels.
      d. equal to variable cost when the firm is maximizing profit.
78.   The change in total cost that results from the production of one additional unit is called
      a. marginal revenue.
      b. average variable cost.
*     c. marginal cost.
      d. average total cost.
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79.   The chart below presents the schedule of total costs for Sharpie’s Pencil Company.
          Number of Pencils Produced           Total Cost (dollars)
                    100,000                             200
                    110,000                            5,800
                    120,000                            6,500
      Beyond 110,000 units, the per-unit marginal cost of producing an additional 10,000 pencils is
      a. 5 cents.
      b. 5.5 cents.
      c. 6 cents.
*     d. 7 cents.
80.   Use the table below to answer the following question.

       Units        Variable Cost      Total Cost     Marginal Cost
       of Output      (dollars)         (dollars)       (dollars)
          81              82               83              84
          85              86               87              88
          89              90               91              92
          93              94               95              96
          97              98               99             100
         101             102              103             104
         105             106              107             108

      Average total cost is at a minimum when the output level is
      a. three units.
*     b. four units.
      c. five units.
      d. six units.
81.   Use the table below to answer the following question.
                 Units of Output    Total Fixed Cost (dollars)      Total Variable Cost (dollars)
                        1                      150                               25
                        2                      150                               48
                        3                      150                               70
                        4                      150                              100
      What is the marginal cost of producing the third unit of output?
*     a. $22
      b. $23.33
      c. $73.33
      d. This cannot be determined from the data.
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82.   Use the table below to answer the following question.
                 Units of Output      Total Fixed Cost        Total Variable
                    (dollars)             (dollars)                Cost
                        1                   150                     50
                        2                   150                     96
                        3                   150                    140
                        4                   150                    180
      What is the marginal cost of producing the third unit of output?
      a. $20
*     b. $44
      c. $70
      d. This cannot be determined from the data.

OUTPUT AND COSTS IN THE SHORT RUN
83.   The short-run average total cost (ATC) curve of a firm will tend to be U-shaped because
      a. larger firms always have lower per-unit costs than smaller firms.
*     b. at small output rates, AFC will be high, while at large output rates, MC will be high.
      c. diminishing returns will be present when output is small, while high AFC will push per-unit
          cost to high levels when output is large.
      d. diseconomies of scale will be present at both small and large output rates.
84.   What is the shape of the average total cost curve for a normal firm in the short run?
*     a. U-shaped
      b. a horizontal line
      c. a vertical line
      d. a curve that slopes upward to the right
85.   What is the shape of the average fixed cost curve for a normal firm in the short run?
      a. U-shaped
      b. a curve that constantly increases as output expands and eventually approaches infinity at high
         rates of output
      c. a vertical line
*     d. a curve that declines as output expands and approaches the horizontal-axis when output is large
86.   In the short run, the firm’s average fixed costs
      a. always increase as output increases.
*     b. always decline as output increases.
      c. equal zero.
      d. remain constant as output expands.
87.   In the short run, a firm will eventually experience rising per-unit costs because of
      a. economies of scale.
      b. diseconomies of scale.
      c. the law of supply.
*     d. the law of diminishing returns.
298    Chapter 8/Costs and the Supply of Goods


88.   Which of the following is an implication of the law of diminishing returns?
      a. Total output will decline as more workers are hired.
      b. In the long run, average total cost will eventually decline as output is expanded.
*     c. In the short run, expansion of output will eventually lead to increases in marginal cost and
          average total cost.
      d. A doubling of all inputs will lead to more than a doubling of output.
89.   The law of diminishing marginal returns explains the general shape of the firm’s
      a. long-run cost curves.
*     b. short-run cost curves.
      c. both short-run and long-run cost curves.
      d. The law of diminishing returns has nothing to do with cost curves.
90.   Bill lives in Montana and likes to grow zucchini. He applies fertilizer to his crops twice during the
      growing season and notices that the second layer of fertilizer increases his crop, but not as much as
      the first layer. What economic concept best explains this observation?
      a. the law of diminishing marginal utility
*     b. the law of diminishing returns
      c. return equalization principle
      d. the principal-agent problem
91.   The increase in total output that results from a unit increase in the employment of a variable input is
      equal to the input’s
      a. total product.
*     b. marginal product.
      c. average product.
      d. marginal cost.
92.   If two workers can produce 22 units of output, and the addition of a third worker increases output to
      30 units, the marginal product of the third worker is
*     a. 8 units.
      b. 10 units.
      c. 22 units.
      d. 30 units.
93.   When a product is produced with a fixed factor and a variable factor, the marginal product of the
      variable resource will eventually diminish as the output of the firm expands. This diminishing return
      to the variable factor explains why
      a. average fixed costs eventually diminish.
      b. average fixed costs eventually increase.
*     c. marginal costs eventually increase.
      d. marginal costs eventually decrease.
94.   Which of the following must be true if average variable costs are decreasing?
      a. Average fixed cost exceeds average total cost.
      b. Marginal cost exceeds average variable cost.
*     c. Marginal cost is less than average variable cost.
      d. Marginal cost is less than average total cost.
95.   Which of the following is always true?
*     a. When marginal costs are less than average total costs, average total costs will be decreasing.
      b. When average fixed costs are falling, marginal costs must be less than average fixed costs.
      c. When average fixed costs are rising, marginal costs must be greater than average total costs.
      d. When marginal costs are greater than average total costs, average total costs will be decreasing.
                                                         Chapter 8/Costs and the Supply of Goods         299


96.   If a firm increases its output and finds that its average total cost decreases as a result, this implies
      that
      a. marginal cost exceeds average total cost.
      b. the cost of producing an additional unit of output is more than the average total cost.
      c. average fixed cost is increasing.
*     d. average total cost exceeds marginal cost.
97.   As output is expanded, if MC is more than ATC,
      a. ATC must be at its minimum.
      b. ATC must be at its maximum.
*     c. ATC must be increasing.
      d. the firm must be earning economic profit.
98.   Which of the following must be true if average total costs are declining?
*     a. Marginal cost is less than average total cost.
      b. Marginal cost is less than average variable cost.
      c. Marginal cost is greater than average total cost.
      d. Marginal cost equals average total cost.
99.   Which of the following must be true if average total costs are rising?
      a. Average fixed costs must be rising.
      b. Total fixed costs must be rising.
      c. Average variable costs must be falling.
*     d. Marginal costs must be greater than average total costs.
100. Which of the following explains most accurately why the firm’s short-run marginal cost curve will
     eventually rise?
     a. As more of the variable factor is used, its price will rise.
*    b. When diminishing marginal returns set in, it will take ever-larger quantities of the variable
         resources to produce an additional unit of output.
     c. As the variable factor is used more intensely, its marginal product will rise, causing an increase
         in marginal costs.
     d. As the size of the firm increases, the operational efficiency of the firm declines, causing an
         increase in marginal costs.
101. Which of the following must be true when average total costs are declining?
     a. Average variable cost must be greater than average total cost.
     b. Marginal cost must be declining.
*    c. Marginal cost must be less than average total cost.
     d. Average variable cost must be less than average total cost.
102. (I) When marginal cost is less than average total cost, average total cost will decrease.
     (II) When marginal cost is increasing, average total cost must also be increasing.
     a. Both I and II are true.
     b. Both I and II are false.
*    c. I is true; II is false.
     d. II is true; I is false.
103. In the short run, if average variable costs equal $60, average total costs equal $70, and output equals
     100, the total fixed costs should equal
     a. $10.
*    b. $1,000.
     c. $5,000.
     d. $13,000.
300    Chapter 8/Costs and the Supply of Goods


104. Use the table below to answer the following question.
                Units of Output Variable Cost     Total Cost           Marginal
                    (dollars)      (dollars)       (dollars)            Cost
                       0               0               20                 0
                       1               20              40                20
                       2               30              50                10
                       3               52              72                22
                       4               75              95                23
                       5              125             145                45
                       6              185             205                60
      Average total cost is at a minimum when output is
      a. 2 units.
      b. 3 units.
*     c. 4 units.
      d. 5 units.
105. In the short run, if average variable costs equal $45, average total costs equal $50, and output equals
     100, the total fixed costs should equal
     a. $5.
*    b. $500.
     c. $1,000.
     d. $5,000.

OUTPUT AND COSTS IN THE LONG RUN
106. When a plant is still in the blueprint stage, the expected per-unit cost of producing alternative rates
     of output is reflected by the firm’s
     a. short-run marginal cost curve.
     b. short-run total cost curve.
     c. long-run variable cost curve.
*    d. long-run average total cost curve.
107. The long-run average total cost curve
*    a. is an envelope-shaped curve mapped out by the short-run average total cost curves for
          alternative plant sizes.
     b. intersects the minimum point of each short-run average total cost curve for alternative plant
          sizes.
     c. rises throughout its entire range when increasing returns are present.
     d. falls throughout its entire range due to the law of diminishing returns.
108. The long-run average total cost (LRATC) curve
     a. indicates the per-unit cost of producing various rates of output with a specific size of plant but
          variable levels of labor and technology.
*    b. indicates the minimum per-unit cost that can be achieved at various output rates when the firm
          is free to choose among plant sizes.
     c. will be falling when diseconomies of scale are present and rising when economies of scale are
          present.
     d. is a U-shaped curve.
     e. is both a and d above.
                                                       Chapter 8/Costs and the Supply of Goods       301


109. Larger firms will often have lower minimum per-unit costs than smaller firms because
     a. employee shirking is less of a problem.
*    b. large-scale output allows greater specialization for both labor and machines in the production
         process.
     c. mass production techniques, with high setup and development costs, are appropriate only when
         a small output is planned.
     d. all of the above are correct.
110. A downward-sloping portion of a long-run average total cost curve is the result of
*    a. economies of scale.
     b. diseconomies of scale.
     c. diminishing returns.
     d. the existence of fixed resources.
111. In the long run, a firm might experience rising per-unit costs due to
     a. economies of scale.
*    b. diseconomies of scale.
     c. the law of supply.
     d. the law of diminishing marginal returns.
112. In the long run, firms in many industries often experience falling average total costs as a result of
     a. gains through trade.
     b. increasing marginal returns.
*    c. economies of scale.
     d. lower fixed costs.
113. A large aircraft manufacturer, like Boeing, may have a cost advantage over a new smaller
     manufacturer because
     a. of diseconomies of scale.
*    b. of economies of scale.
     c. of diminishing returns to a fixed factor of production.
     d. the principal agent problem is generally less severe for larger firms.
114. A car leasing company that expands its size by buying its competitors may run the risk of increasing
     production costs due to
*    a. diseconomies of scale.
     b. economies of scale.
     c. diminishing returns.
     d. greater use of large-volume purchases.

WHAT FACTORS CAUSE COST CURVES TO SHIFT?
115. Which of the following would cause a firm’s cost curves to shift upward?
     a. a reduction in resource prices
     b. a decrease in taxes
     c. an improvement in technology
*    d. an increase in government regulations
116. Which of the following would most likely cause a firm’s cost curve to shift downward?
     a. an increase in resource prices
     b. an increase in government regulations
*    c. a decrease in taxes
     d. an increase in demand for the firm’s product
302    Chapter 8/Costs and the Supply of Goods


117. Which of the following would cause a firm’s cost curve to shift downward?
*    a. a decrease in resource prices
     b. an increase in taxes
     c. an increase in demand for the firm’s product
     d. a reduction in output
118. Which of the following would increase a firm’s average total costs?
     a. economies of scale
*    b. an increase in input prices
     c. an improvement in technology
     d. an increase in demand for the firm’s product
119. Which of the following would most likely cause an upward shift in a firm’s cost curve?
     a. a technological advance
     b. a decrease in demand for the firm’s product
*    c. an increase in resource prices
     d. a decline in consumer income
120. If the government levies a $1 excise tax on each unit of a good sold, what will happen to the
     producer’s cost curve?
     a. The average total cost and marginal cost curves will shift downward by the amount of the tax.
*    b. The average total cost and marginal cost curves will shift upward by the amount of the tax.
     c. The marginal cost curve will shift upward by the amount of the tax; the average total cost curve
           will remain unchanged.
     d. Both the marginal cost and average total costs will remain the same since taxes are not a cost of
           production.

ECONOMIC WAY OF THINKING ABOUT COSTS
121. When calculating the cost of owning and operating a used car for one year, a political science major
     included the items listed in the table below.
        Purchase price                                             $5,000
        Gas and oil ($.20 per mile, 5,000 miles)                   $1,000
        Depreciation (estimated decline in the value of the car)   $1,800
        Insurance                                                    $200
        Maintenance                                                  $150
        Interest income foregone on $5,000                           $500
        License plate                                                 $80
        Total                                                      $8,730
      Which of the following is the best appraisal of his calculations?
      a. They are correct.
      b. There is only one error; depreciation should not be included.
*     c. There is only one error; the purchase price should not be included.
      d. There are two errors; neither the purchase price nor the interest income foregone should be
          included.
                                                      Chapter 8/Costs and the Supply of Goods       303


122. A profit-maximizing firm would
*    a. consider opportunity costs rather than accounting costs when making decisions about output.
     b. expand current output if the revenues expected from doing so were less than the expected costs.
     c. enlarge its current plant size if present depreciation costs were less than average variable costs.
     d. increase output in the next period if accounting profits during the previous period were
         positive.
123. Mr. Capps recently built a dental floss factory in Montana. It cost $500,000 and is expected to last
     ten years. The plant can only be used to produce dental floss and will have no scrap value. When a
     recession occurs, the yearly revenue from the plant declines to $35,000, compared to costs of
     $25,000 just for the variable resources required to produce the current rate of output. Mr. Capps
     should
     a. shut down since he is experiencing economic losses (in other words, he will not get his
          $500,000 back).
     b. reduce the price of dental floss if his demand is inelastic in order to increase his revenue.
     c. raise the price of dental floss if his demand is elastic in order to increase his revenue.
*    d. continue to operate since he is covering his variable costs and the cost of the plant is a sunk
          cost.
124. In 1632, the Virginia Legislature decreed that all love apples must be sold for $1 per bushel (no
     more, no less). At the time, Mr. McKintoch had 1,000 bushels of love apples ready for harvesting.
     His sunk costs were $1,100, and his total costs (including sunk costs) would have been $1,800 if he
     harvested. If McKintoch decided not to harvest because he did not think he could cover his total
     costs, he
     a. made the wrong decision, but for the right reason.
*    b. made the wrong decision; the sunk cost component of total cost should not have affected his
          decision to harvest.
     c. made the correct decision and considered the correct decision-making criteria; a firm should
          never sell for less than its costs.
     d. One cannot determine from the data whether he should have harvested the love apples.
125. When making choices, suppliers should not allow sunk costs to directly affect their current
     decisions because
*    a. sunk costs do not reflect foregone opportunities accompanying current choices.
     b. sunk costs will not influence the accounting costs of a firm.
     c. sunk costs influence the demand for products, not the supply.
     d. past choices fail to provide any information relevant to current decision making.
126. Which one of the following decisions most clearly reflects a lack of understanding of the concept of
     sunk costs?
     a. You pay to have your car towed back to the repair shop because it was not fixed properly the
         first time.
     b. You decide to get a master’s degree because you cannot find a job in the field in which you
         majored.
     c. You decide to purchase a piece of machinery for your business that will eliminate three
         employees’ positions.
*    d. You study eight hours for a final exam even though there is no way now that you can pass the
         course.
304    Chapter 8/Costs and the Supply of Goods


127. If you paid $100 for a truckload of cabbage on Monday, how much should you be willing to sell it
     for on Friday, the day before it spoils?
     a. $100
     b. $100 plus normal accounting profit
     c. $50 because it has lost value since Monday
*    d. whatever you can get for it
128. When would sunk costs be irrelevant for current decision making?
     a. when the sunk costs are computed using accounting methods
     b. when the sunk costs are greater than variable costs
     c. when the sunk costs have been incurred only a short time ago
*    d. Sunk cost are always irrelevant when making current decisions.
129. Economists refer to historical costs (irreversible costs already incurred) as
     a. implicit costs.
*    b. sunk costs.
     c. opportunity costs.
     d. variable costs.
130. A family has decided to go away for the summer. The monthly mortgage payment on the family’s
     house is $1,000. Water, electricity, natural gas, and maintenance bills, to be paid by the family, will
     be $700 per month if the house is occupied and zero otherwise. If the family wishes to minimize
     losses from being away, it should rent the house for as much as the market will bear, as long as the
     monthly rent is above which of the following? (Assume wear and tear to be the same whether or not
     the house is occupied.)
     a. $300
*    b. $700
     c. $1,000
     d. $1,700
131. A homeowner will be away from her house for six months. The monthly mortgage payment on the
     house is $1,000. The owner’s cost of utilities is $100 if the house is unoccupied but $300 if the
     owner rents it out. If the owner wishes to minimize her losses from the house while away, she
     should rent the house for as much as the market will bear, as long as monthly rent is greater than
     which of the following? (Assume wear and tear to be zero regardless of whether the house is
     occupied.)
*    a. $200
     b. $300
     c. $1,100
     d. $1,300
132. A profit-seeking builder should sell a newly constructed house for as much as it will bring as long
     as the sale price is not less than the
     a. cost of producing the house.
     b. cost of producing another house like the new one.
     c. average cost of producing houses like the new one.
*    d. house is worth to the builder.
133. The landlord’s cost of continuing to rent a house to Smith is
     a. the maintenance cost on the house (a constant under all options).
     b. the maintenance cost plus depreciation on the house.
     c. zero, since the construction costs of the house are sunk costs.
*    d. the revenue foregone as the result of not renting to the highest bidder other than Smith.
                                                     Chapter 8/Costs and the Supply of Goods     305


134. Before entry into an industry, a profit-maximizing decision maker will compare the expected market
     price with the expected
*    a. long-run average total cost.
     b. short-run marginal cost.
     c. long-run average variable cost.
     d. short-run average total cost.

MYTHS OF ECONOMICS: “A GOOD BUSINESS DECISION MAKER WILL
NEVER SELL A PRODUCT FOR LESS THAN ITS PRODUCTION COSTS”
135. You purchased an automobile two years ago for $10,000. Its current market price is $5,000, and the
     expected market value one year from now is $4,500. If the interest rate is 10 percent, how much will
     it cost you to keep the car for an additional year (over and above operation and maintenance costs)?
     a. $500
*    b. $1,000
     c. $1,500
     d. $5,000
136. You purchased an automobile a year ago for $10,000. Its current market price is $6,000, and the
     expected market value one year from now is $4,000. If the interest rate is 10 percent, how much will
     it cost you to keep the car for an additional year (over and above operation and maintenance costs)?
     a. $2,000
*    b. $2,600
     c. $4,000
     d. $6,000
137. Should a profit-seeking grocer who purchased apples last Saturday at $.30 each be willing to sell
     them for $.20 each on Thursday rather than allow the apples to spoil by Friday?
     a. No; it makes no sense to sell the apples below cost.
     b. No; if consumers are unwilling to pay the cost of production, the apples should not be
         provided.
     c. Yes, if the apple buyers promise to purchase apples next week at $.40 each.
*    d. Yes; the sunk costs incurred when the apples were originally purchased should not affect the
         current decision of whether to sell.
138. “A good business decision maker will never sell a product for less than it costs to produce.” This
     statement is
     a. true because diminishing returns always cause marginal costs to rise in the short run.
     b. false because diminishing returns always cause fixed costs to rise in the short run.
     c. true because it clearly differentiates between accounting profit and economic profit.
*    d. false because a business decision maker may be covering his current variable costs even though
          he has failed to cover all previous production costs.
306    Chapter 8/Costs and the Supply of Goods


GRAPHIC QUESTIONS
Use the figure to answer the following questions.

Figure 1




139. At what output in Figure 1 would the firm’s per-unit cost of production be minimized?
     a. 3
*    b. 4
     c. 5
     d. 6
140. According to Figure 1, what is the firm’s approximate total cost when it produces three units?
     a. 10
     b. 16
*    c. 48
     d. 60
141. What is the firm’s total cost in Figure 1 when it produces four units?
     a. 11
     b. 15
*    c. 60
     d. 75
                                                      Chapter 8/Costs and the Supply of Goods    307



Use the figure to answer the following questions.

Figure 2




142. The average variable cost (AVC) and average total cost (ATC) for a firm are indicated in Figure 2.
     If the marginal cost curve were constructed, at what output would it cross the AVC curve?
     a. 10
*    b. 15
     c. 20
     d. 25
143. According to Figure 2, at what output would a properly constructed marginal cost curve cross the
     ATC curve?
     a. 15
*    b. 20
     c. 25
     d. 30
144. Using Figure 2, calculate the firm’s total cost of producing 30 units of output.
     a. $8
     b. $120
     c. $180
*    d. $240
145. Using Figure 2, calculate the firm’s total cost of producing 20 units of output.
     a. $8
*    b. $120
     c. $180
     d. $240
308    Chapter 8/Costs and the Supply of Goods



Use the figure to answer the following questions.

Figure 3




146. The average variable cost (AVC) and average total cost (ATC) for a firm are indicated in Figure 3.
     If the marginal cost curve were constructed, at what output would it cross the AVC curve?
     a. 2
*    b. 3
     c. 4
     d. 5
147. According to Figure 3, at what output would a properly constructed marginal cost curve cross the
     ATC curve?
     a. 3
*    b. 4
     c. 5
     d. 6
148. Using Figure 3, calculate the total cost of producing four units.
     a. $10
     b. $15
*    c. $60
     d. $75
149. Using Figure 3, calculate the total variable cost of producing three units.
     a. $10
     b. $15
*    c. $30
     d. $45
                                                       Chapter 8/Costs and the Supply of Goods    309


Use the figure to answer the following questions.

Figure 4




150. The average variable cost (AVC) and average total cost (ATC) for a firm are indicated in Figure 4.
     If the marginal cost curve were constructed, at what output would it cross the AVC curve?
     a. 1
     b. 2
*    c. 3
     d. 4
151. According to Figure 4, at what output would a properly constructed marginal cost curve cross the
     ATC curve?
     a. 2
     b. 3
*    c. 4
     d. 5
152. Using Figure 4, calculate the firm’s total cost of producing four units of output.
     a. $4
     b. $8
*    c. $12
     d. $16
310    Chapter 8/Costs and the Supply of Goods


Figure 5




153. Which of the following would most likely cause the average total cost curve of a firm producing
     steel bolts to shift from ATC1 to ATC2?
     a. an increase in demand for steel bolts
     b. an increase in the market price of steel bolts
     c. diminishing returns for the variable factors used to produce steel bolts
*    d. an increase in the price of steel

Use the figure to answer the following questions.

Figure 6




154. At what output does the firm depicted in Figure 6 begin to experience diminishing marginal returns
     to its variable factors of production?
*    a. q1
     b. q2
     c. q3
     d. an output beyond q3
                                                      Chapter 8/Costs and the Supply of Goods       311


155. At what output does the firm depicted in Figure 6 minimize its per-unit cost of production?
     a. q1
*    b. q2
     c. q3
     d. an output beyond q3

Figure 7




156. Which of the following is true for Figure 7?
     a. Firms in this industry begin to experience diminishing returns to their variable factors at output
         q1.
     b. Between q1 and q2, firms in this industry experience economies of scale.
*    c. Firms producing output rates less than q1 or more than q2 will find it difficult to survive.
     d. The largest firms in this industry have the lowest per-unit cost.
312    Chapter 8/Costs and the Supply of Goods


Use the figure to answer the following questions.

Figure 8




157. In Figure 8, which output level would be most closely associated with the point where diminishing
     marginal returns have begun?
*    a. 4
     b. 5
     c. 6
     d. 8
158. In Figure 8, which output minimizes per-unit cost?
     a. 4
     b. 6
     c. 7
*    d. 8
                                                     Chapter 8/Costs and the Supply of Goods      313


Use the figure to answer the following questions.

Figure 9




159. In Figure 9, which output would minimize the firm’s average total cost of production?
     a. 30
*    b. 40
     c. 50
     d. 60
160. Using Figure 9, calculate the firm’s approximate total cost when average total cost is at a minimum.
     a. $100
     b. $160
     c. $480
*    d. $600
161. Using Figure 9, calculate the firm’s approximate average total cost when it produces 50 units.
     a. $10
     b. $13
     c. $15
*    d. $17
314    Chapter 8/Costs and the Supply of Goods


Use the figure to answer the following questions.

Figure 10




162. In Figure 10, which output would minimize the firm’s average total cost of production?
     a. 4
     b. 6
*    c. 8
     d. 10
163. Using Figure 10, calculate the firm’s approximate total cost when average total cost is at a
     minimum.
     a. $60
     b. $80
     c. $100
*    d. $120
164. Using Figure 10, calculate the firm’s approximate average total cost when it produces 12 units.
     a. $5
     b. $10
     c. $15
*    d. $20
                                                       Chapter 8/Costs and the Supply of Goods    315


Use the figure to answer the following questions.

Figure 11




165. The average variable cost (AVC) and average total cost (ATC) for a firm are indicated in Figure 11.
     The firm’s total cost of producing 20 units is
     a. $6.
     b. $84.
*    c. $120.
     d. $150.
166. Which of the following is true for a firm with the costs illustrated in Figure 11?
     a. Marginal costs exceed average total cost when output is 15.
     b. Marginal costs exceed average total cost when output is 20.
*    c. Marginal costs exceed average total cost when output is 25.
     d. The firm’s total fixed cost exceeds 40.

Figure 12




167. In Figure 12, which of the following would most likely cause the average total cost curve of a firm
     producing molded plastic chairs to shift from ATC1 to ATC2?
     a. an increase in demand for plastic chairs
     b. an increase in the market price of plastic chairs
*    c. an increase in the price of the plastic used to produce the chairs
     d. a reduction in corporate income taxes
316    Chapter 8/Costs and the Supply of Goods


COURSEBOOK: MULTIPLE CHOICE QUESTIONS
168. The law of diminishing returns indicates why
     a. beyond some point, the extra utility derived from additional units of a product will yield the
          consumer smaller and smaller amounts of additional satisfaction.
     b. the firm’s total fixed costs do not change with output in the short run.
     c. a firm’s long-run average total cost curve is U-shaped.
*    d. a firm’s marginal costs will eventually increase as the firm expands output in the short run.
169. The short run is a time period of insufficient length for the firm to change its
     a. output.
     b. amount of labor employed.
*    c. plant size and heavy equipment.
     d. price.
170. Sunk or “historical” costs are costs
     a. associated with current operational decisions.
*    b. that have already been incurred as the result of past decisions.
     c. that add to the firm’s marginal costs.
     d. that form the major component of the firm’s variable costs.
171. Advantages of the corporate form of business organization include
     a. the ease of transferring ownership in a corporation.
     b. the limited liability concept that protects the stockholder from potential debts incurred by the
         corporation.
     c. the lack of employee shirking that occurs in corporations.
*    d. both a and b.
172. The average variable cost curve and average total cost curve become closer together as output
     increases because
     a. the marginal cost curve intersects the average total cost curve at its minimum.
     b. average fixed cost remains constant as output rises.
*    c. average fixed cost, which is the difference between them, declines with output.
     d. output is rising more rapidly than inputs are being increased.
173. Which of the following factors would not shift the cost curves of an automobile company upward?
     a. a regulation requiring all automobiles be equipped with improved safety equipment
     b. an increase in the price of steel used to make automobiles
     c. an increase in the property tax on buildings and equipment used by the automobile company
*    d. An employee develops a new method of installing doors on the cars that requires half as many
         workers as before.
174. The firm’s average total costs will be a minimum at the output level where the
     a. firm just begins to confront diminishing returns to the variable factors.
     b. marginal costs are a minimum.
     c. firm’s average fixed costs are at their minimum.
*    d. marginal cost curve crosses the firm’s average total cost curve.
                                                       Chapter 8/Costs and the Supply of Goods     317


175. The law of diminishing returns states that
     a. as we continually add variable factors to a fixed amount of other resources, output eventually
           increases at a decreasing rate.
     b. as we increase plant size, costs must diminish.
     c. the additional output generated by the employment of additional units of a variable input
           eventually decline.
*    d. both a and c are correct.
Use the figure to answer the following questions.

Figure 13

The following cost curves are for one very small firm in a large market.




176. According to Figure 13, if the firm produces 10 units of output, its average total cost is
     a. $6.
     b. $7.
     c. $12.
*    d. $13.
177. According to Figure 13, if the firm produces 15 units of output, its average fixed cost is
*    a. $4.
     b. $5.
     c. $6.
     d. $60.
178. According to Figure 13, if the firm produces 10 units of output, its total cost is
     a. $7.
     b. $13.
     c. $70.
*    d. $130.
318    Chapter 8/Costs and the Supply of Goods


179. According to Figure 13, if the firm produces 10 units of output, its total fixed cost is
     a. $6.
*    b. $60.
     c. $70.
     d. $130.
180. According to Figure 13, the marginal cost of producing the tenth unit is
*    a. $7.
     b. $13.
     c. $70.
     d. $130.
181. This firm, illustrated in Figure 13, minimizes its per-unit costs of production at an output level of
     a. Q = 6.
     b. Q = 10.
*    c. Q = 15.
     d. none of the above.
182. Diminishing returns to the variable factor of production for this firm in Figure 13 set in at
*    a. Q = 6.
     b. Q = 10.
     c. Q = 15.
     d. none of the above.
183. A homeowner will be away from her house for six months. The monthly mortgage payment on the
     house is $300. The utilities, to be paid by the owner, cost $100 per month if the house is occupied;
     otherwise zero. If the owner wishes to minimize her losses from the house, she should rent the
     house for as much as the market will bear, as long as monthly rent is greater than which of the
     following? (Assume wear and tear to be zero regardless of whether the house is occupied.) (Hint:
     Remember the concept of sunk cost.)
     a. $0
*    b. $100
     c. $200
     d. $400
184. Suppose you value watching a movie at $5. You rent it from your local movie rental store for $3.50
     for one night. You do not get a chance to watch it, so you decide to keep it an extra day and pay a
     late fee of $2. Your decision is
     a. incorrect; you paid $5.50 to watch a movie you valued at only $5. You should have taken the
           movie back.
     b. incorrect; you should have returned the movie and rented it later.
*    c. correct; the $3.50 paid for the first night is a sunk cost and is not relevant in your decision to
           keep it an additional night.
     d. correct; you value watching the movie at $5 per night, so keeping it an extra day increases your
           value of the movie to $10.
185. Which of the following factors is most likely to shift the cost curves of an Iowa corn farmer
     downward?
     a. an increase in the price of fertilizer
     b. an increase in the tax on diesel fuel, which is used by the farmer
*    c. the development of a new, more efficient corn harvester
     d. the adoption of a regulation requiring farmers to treat their crops with three new pesticides.
                                                      Chapter 8/Costs and the Supply of Goods      319


186. Which of the following is true?
*    a. Economic profits are generally lower than accounting profits.
     b. Economic profits are generally greater than accounting profits.
     c. Economic profits are generally equal to accounting profits.
     d. Economic profits plus accounting profits must equal zero.
187. When a firm increases its plant size in the long run and its per-unit costs fall, this is called
     a. diminishing returns and is shown by the downward-sloping portion of the MP curve (or the
        upward-sloping portion of the MC curve).
     b. constant returns to scale and is shown by the flat portion of the LRATC curve.
     c. diseconomies of scale and is shown by the upward-sloping portion of the LRATC curve.
*    d. economies of scale and is shown by the downward-sloping portion of the LRATC curve.
188. When the owner of a business invests his or her own money in the business, they give up the
     interest this money could be earning in the bank. This forgone interest is called
     a. the marginal cost of diminishing financial services.
*    b. the opportunity cost of equity capital.
     c. the opportunity cost of labor services.
     d. interest expense and is included as a cost in the accounting statements of the business.
189. Ron works for Betty at Betty’s Pizza Palace. Betty has many work rules, and Ron believes if there
     were fewer rules and more flexibility, he could do a better job. Betty probably has the rules because
     a. Ron, like her other employees, is a residual claimant.
*    b. due to the principal-agent problem, some employees are likely to shirk when the owner is
         absent.
     c. she is maximizing sales rather than profits.
     d. with regard to their jobs, employees seldom know what is best.
190. Which of the following is true?
     a. Under the partnership form of business organization, the owners are not personally liable for
         the debts of the business.
     b. When employees also own a business, their incentive to shirk is removed.
*    c. The limited liability of stockholders under the corporate business structure makes it easier to
         raise equity capital.
     d. Under the corporate form of business organization, the owners of the firm are personally liable
         for its debts.
191. Mary owns her own business and works full time in the store without paying herself a salary. She
     has $20,000 of her own money invested in the store that she withdrew from her savings account,
     which earned 10 percent interest. She was offered a job last year making $28,000 per year but
     turned it down. If Mary’s accounting statements show revenues of $100,000 and accounting costs of
     $60,000, then Mary’s
     a. accounting profit is $20,000, and her economic profit is zero.
     b. accounting profit is $40,000, and she is making an economic loss of $8,000.
*    c. accounting profit is $40,000, and her economic profit is $10,000.
     d. accounting and economic profit is $40,000.
192. When an economist says a firm is earning zero economic profit, this implies that the firm
     a. will be forced out of business in the near future unless market conditions change.
     b. is earning a zero rate of return on its assets.
*    c. is earning as high a rate of return now as could be earned in other industries.
     d. has an accounting profit of zero.
320    Chapter 8/Costs and the Supply of Goods


193. The long run is a period of
     a. at least one year.
     b. sufficient length to allow a firm to expand output by hiring additional workers.
*    c. sufficient length to allow a firm to alter its plant size and capacity and all other factors of
          production.
     d. sufficient length to allow a firm to transform economic losses into economic profits.
194. As output is expanded, if MC is more than ATC, ATC must be
     a. at its minimum.
     b. at its maximum.
*    c. increasing.
     d. constant.
195. Mr. Hudson notes that if he produces 10 pairs of shoes per day, his average fixed cost (AFC) is $14
     and his marginal cost $8; if he produces 20 pairs of shoes per day, his MC is $15. What is his AFC
     when output is 20 pairs of shoes per day?
     a. $5
*    b. $7
     c. $8
     d. $15
196. Bill lives in Montana and likes to grow zucchini. He applies fertilizer to his crop twice during the
     growing season and notices that the second layer of fertilizer increases his crop but not as much as
     the first layer. What economic concept best explains this observation?
     a. the law of diminishing marginal utility
*    b. the law of diminishing returns
     c. return equalization principle
     d. the principal-agent problem
197. Larger firms will often have lower minimum per-unit costs than smaller firms because
     a. employee shirking is less of a problem.
*    b. large-scale output allows greater specialization for both labor and machines in the production
         process.
     c. mass production techniques, with high setup and development costs, are appropriate only when
         a small output is planned.
     d. all of the above are correct.

ON-LINE PRACTICE QUESTIONS
198. In the short run, the marginal cost curve crosses the average total cost curve at
     a. a point just below the average fixed cost curve.
*    b. the minimum point on the average total cost curve.
     c. the maximum point of the average variable cost curve.
     d. all of the above points.
199. What amount must be earned to induce investors to continue to supply the funds necessary to
     maintain a firm’s capital assets?
     a. stockholder equity
*    b. the opportunity cost of capital
     c. economic profit
     d. accounting profit
                                                     Chapter 8/Costs and the Supply of Goods      321


200. Which of the following explains why business owners have a strong incentive to strive for
     operational efficiency?
     a. They recognize that operational efficiency promotes the public interest.
     b. Since the owners are residual income claimants, increased efficiency will mean a higher
         income for the owners.
     c. If production is not conducted efficiently, the firm will be unable to compete effectively and
         will experience losses that will reduce the wealth of the owners.
*    d. Both b and c are correct.
201. Which of the following is true?
     a. Under the partnership form of business organization, the owners are not personally liable for
         the debts of the business.
     b. When employees also own a business, their incentive to shirk is removed.
*    c. The limited liability of stockholders under the corporate business structure makes it easier to
         raise equity capital.
     d. Under the corporate form of business organization, the owners of the firm are personally liable
         for its debts.
202. Which one of the following forms of business organization is most numerous in the United States?
     a. partnerships
*    b. proprietorships
     c. corporations
     d. government-operated firms
203. Which of the following forms of business organization accounts for the largest portion of total
     output in the United States?
     a. partnerships
     b. proprietorships
*    c. corporations
     d. consumer cooperatives
204. When the employees of a corporation become stockholders, the
     a. problem of shirking is eliminated.
     b. principal-agent problem is eliminated.
     c. principal-agent problem between employees and owners is increased.
*    d. principal-agent problem between employees and owners is reduced.
205. The three basic legal forms of business enterprise are
     a. monopolists, competitors, and enterprises.
     b. vertical, horizontal, and conglomerate corporations.
     c. conglomerates, multinationals, and partnerships.
*    d. proprietorships, partnerships, and corporations.
206. Under which of the following forms of business organization do the owners of the firm have limited
     liability?
     a. all forms of businesses
     b. proprietorships and partnerships
     c. partnerships and corporations
*    d. corporations only
322    Chapter 8/Costs and the Supply of Goods


207. If most firms in an industry are earning a 7 percent rate of return on their assets, but your business is
     earning 9 percent, your rate of economic profit is
     a. –2 percent.
*    b. 2 percent.
     c. 9 percent.
     d. 16 percent.
208. Firms earning accounting profits may still be making an economic loss if
*    a. their net income is low relative to the value of the capital assets owned by the firm.
     b. the owners of the firm are paid salaries that exceed what they could earn elsewhere.
     c. the reduction in the market value of the firm’s assets is less than the reported accounting rate of
         depreciation.
     d. all of the above are true.
209. Andrea., a foreign exchange student, bought a used car for $7,000 and resold it one year later for
     $5,300. Insurance, license, and operating costs for the year were $1,200. What were her economic
     costs of owning and operating the car for the year if the market rate of interest was 10 percent?
     a. $1,700
*    b. $3,600
     c. $5,800
     d. $8,200
210. Libby has a business using no owned capital and makes an accounting profit of $52,000 a year.
     Libby could have worked for Verizon Wireless with a pay of $35,000 a year, but she would not
     have had time to run her business. The economic profit from Libby’s business per year is
     a. $87,000.
     b. $35,000.
*    c. $17,000.
     d. –$17,000.
211. What is the difference between accounting profit and economic profit?
     a. They are the same thing.
     b. They are only different if the accountant makes a mistake.
     c. Accounting profit is usually smaller than economic profits.
*    d. Accounting profit makes no allowance for several implicit costs, including equity capital, while
        economic profit takes these costs into account.
212. According to the yearly income statement of Joe’s Clothing Store, total revenue was $97,000 and
     total cost was $75,000. However, Joe worked full time with no salary and invested $30,000 from his
     savings to buy and stock merchandise. Can we conclude that the economic profit of Joe’s Clothing
     Store is $22,000?
     a. Yes, given the information supplied.
     b. No. The interest income foregone on this investment should be subtracted from $22,000 to
           calculate Joe’s profit.
     c. No. The opportunity cost of Joe’s labor should be subtracted from $22,000 to calculate Joe’s
           profit.
*    d. No. Both the interest income foregone and the opportunity cost of Joe’s labor should be
           subtracted from $22,000 to calculate Joe’s profit.
213. Which of the following is the best example of a fixed cost for a business?
*    a. the insurance payment for the protection of a building owned by the firm
     b. shipping charges for the delivery of products
     c. managerial salaries paid
     d. the total of medical insurance premiums on the firm’s employees
                                                      Chapter 8/Costs and the Supply of Goods        323


214. If a firm’s per-unit costs fall as it produces a larger output,
     a. average variable cost must also decline as output expands.
     b. marginal cost must decline as output expands.
     c. average fixed cost must be less than average variable costs.
*    d. marginal cost must be less than average total cost.
215. The chart below presents the schedule of total costs for Sam’s Skate Company, which produces
     skateboards.
       Number of Skateboards Produced              Total Cost (dollars)
                    10,000                                100,000
                    11,000                                110,000
                    12,000                                117,000

     Beyond 11,000 units, the per-unit marginal cost of producing an additional 1,000 skateboards is
*    a. $7.
     b. $8.
     c. $10.
     d. $11.
216. Which of the following is most likely to be a variable cost for a business?
     a. the loan payment on funds borrowed when a building was constructed
*    b. payments for additional materials needed to expand output
     c. the insurance payment for the protection of a building owned by the firm
     d. the opportunity cost of the heavy equipment invested in the building
217. As a firm expands output, in the short run, marginal costs will
     a. always decline as output expands.
     b. increase at first but eventually level off and decline.
*    c. eventually increase as the firm experiences diminishing returns to the fixed factors of
          production.
     d. initially increase at a decreasing rate but eventually increase at an increasing rate.
218. Average fixed costs
     a. will remain unchanged as output expands.
     b. are equal to total costs minus variable costs.
     c. are defined as the change in total costs divided by the change in output.
*    d. will always decline as output increases.
219. Use the table below to answer the following question.
       Units of Output       Total Fixed Cost (dollars)    Total Variable Cost (dollars)
              1                        1,000                           200
              2                        1,000                          1,400
              3                        1,000                          2,400
              4                        1,000                          3,400
              5                        1,000                          4,400
     Given the total fixed cost and total variable cost schedules presented here, what is the average total
     cost of an output level of four units?
     a. $1,000
*    b. $1,100
     c. $1,320
     d. $6,600
324    Chapter 8/Costs and the Supply of Goods


220. The optimal plant size depends on
     a. whether the firm confronts diminishing returns on its fixed factors of production.
*    b. the output the firm expects to produce.
     c. whether the plant uses capital-intensive or labor-intensive production techniques.
     d. the preferences of the individual firm owners.
221. A 10-cent-per-box tax on producers of cigars will
*    a. shift the firm’s ATC and MC curves upward by the full amount of the tax.
     b. induce the firm to produce less but will not shift the firm’s MC curve.
     c. shift the firm’s ATC and MC curves downward by the full amount of the tax.
     d. shift the MC curve upward but will not cause any shift in the ATC curve.
222. Sunk costs
*    a. are expenditures made in the past that cannot be regained no matter what is done now or in the
         future.
     b. are a component of variable costs but not fixed costs.
     c. represent foregone opportunities, and therefore, the firm’s managers should consider these
         costs when they are making current decisions.
     d. can be avoided if the firm goes out of business.
223. Which of the following is an example of a “sunk cost”?
     a. the original purchase price of a house when deciding whether to repair fire damage or demolish
         the structure
     b. the price of tickets that must be bought when deciding whether or not to go to a concert
     c. the price you paid for a backyard swimming pool when deciding whether to fill in the pool and
         plant a garden
*    d. both a and c

Figure 14




224. Choose the answer that correctly labels a firm’s cost curves, as represented on Figure 14.
     a. 1 = ATC; 2 = MC; 3 = AVC; 4 = AFC
     b. 1 = AFC; 2 = ATC; 3 = MC; 4 = AVC
*    c. 1 = MC; 2 = ATC; 3 = AVC; 4 = AFC
     d. 1 = AVC; 2 = MC; 3 = AVC; 4 = AFC
                                                      Chapter 8/Costs and the Supply of Goods      325


Figure 15




225. The law of diminishing returns states that as more of a variable factor is added to a fixed amount of
     resources, output will eventually increase at a decreasing rate. Choose the correct response based on
     the information provided in Figure 15.
     a. Diminishing marginal returns begin in the range between points C and D.
     b. Diminishing marginal returns do not occur on this graph until labor exceeds point D.
     c. Diminishing marginal returns do not occur in the range of points A to C on either curve.
*    d. Diminishing marginal returns begin at point B.
226. Takeover bids (and the potential for such bids)
*    a. increase the incentive of corporate managers to perform efficiently.
     b. make managers wealthy at the expense of stockholders.
     c. are more likely when a company is earning a substantial economic profit.
     d. are bad for the economy.
227. Jamal works full time as the manager of his music store in which he has invested $50,000. Last
     year, his total revenues were $100,000 and his costs were $70,000 for merchandise, gas, electricity,
     and other explicit-cost items. Jamal pays himself a “competitive” salary of $40,000 per year. An
     economist would consider his profits for the year to be
     a. –$60,000.
     b. –$10,000.
*    c. –$10,000 minus the opportunity cost of the $50,000 of capital invested in the store.
     d. $30,000.
228. When a new facility is being designed, the most important cost curve for the firm to consider is the
     a. short-run marginal cost curve.
     b. short-run total cost curve.
     c. short-run average fixed cost curve.
*    d. long-run average total cost curve.
229. The upward-sloping portion of a long-run average total cost curve is the result of
     a. economies of scale.
*    b. diseconomies of scale.
     c. diminishing returns.
     d. the existence of fixed resources.
326    Chapter 8/Costs and the Supply of Goods


230. A large brewery company, like Budweiser, may have a cost advantage over a new smaller
     manufacturer because
     a. of diseconomies of scale.
*    b. of economies of scale.
     c. of diminishing returns to a fixed factor of production.
     d. the principal agent problem is generally less severe for larger firms.
231. Which of the following would cause a firm’s cost curve to shift upward?
*    a. an increase in resource prices
     b. a decrease in taxes
     c. a decrease in regulations impacting the firm
     d. improved technology
232. Which is the best example of a business decision that understands sunk costs?
*    a. the decision to implode a building to make way for a newer, more profitable structure
     b. A good decision maker will never sell a product for less than its production costs.
     c. purchasing fruit from a roadside stand when it is fresh
     d. A consumer decides to not buy a new canoe because he can’t afford it.

CRITICAL THINKING QUESTIONS
233. Kim used to work at “The Big One” accounting firm, and she earned $50,000 a year. She saved her
     money and has now invested $100,000 in her own firm. Profit is $20,000 a year, which Kim
     receives as her only compensation. She concludes that this is great because a 20 percent return is
     much better than the 8 percent she could get in another investment (the opportunity cost of the
     funds). What is wrong with this line of thinking?
     Answer
     While Kim is correct in understanding the opportunity cost of her invested funds, she is ignoring the
     opportunity cost of her time. Presumably this opportunity cost is $50,000, so her total implicit cost
     would be this amount plus the $8,000 in foregone interest. Note that this analysis ignores taxes,
     which could alter the calculations.
234. Suppose you are planning to open a lemonade stand. List separately all the explicit and implicit
     costs that might be involved.
     Answer
     The obvious explicit costs would include the price of the stand, the lemons, sugar, water, sign, etc. It
     may also require the purchase of a license and the paying of taxes, depending on the government
     regulations of the particular locale. Implicit costs would be the opportunity cost of the funds used to
     pay the explicit costs plus the opportunity costs of your time to operate the lemonade stand.
235. The boss observes that her 10 workers produce 1,000 widgets a day. She concludes that she can
     employ 20 workers and make 2,000 widgets, 30 to make 3,000, or 40 to make 4,000. Explain why
     this observation is either correct or incorrect.
     Answer
     She is most likely incorrect because of the law of diminishing returns. Adding more and more of a
     variable resource (labor) to a fixed resource (the factory and machinery) should cause output to
     increase, but at a decreasing rate. If the company is experiencing diminishing returns, we might
     expect something like 20 workers producing 1,800 units, 30 producing 2,500 units, and 40
     producing 3,300 units.
                                                     Chapter 8/Costs and the Supply of Goods      327


236. James opened a baseball manufacturing operation, and initially the more balls he made, the lower
     the per-unit cost. Now, as output expands, his per-unit costs are rising. He concludes that
     diseconomies of scale have set in. Is he correct? Why?
     Answer
     Since diseconomies of scale apply to the long run, this is probably an incorrect conclusion.
     Diminishing returns have set in. As James initially expanded output, he experienced falling average
     total costs because his marginal cost was less than his unit cost. Now his marginal cost is greater
     than unit cost, and he’s operating on the upward-sloping portion of his short-run average total cost
     curve.
237. Andy wants to maximize his grade-point average. Having spent six hours studying for his final
     exam in economics, Andy calculates his grade and discovers that even with a perfect score on the
     final, he will not pass the course. He decides to study two more hours so he will not have wasted the
     first six hours. Is this a good decision? Why or why not?
     Answer
     The six hours spent studying for the exam should be viewed as a sunk cost and are not relevant to
     future considerations. Since he cannot pass the class, Andy should allocate the two hours to
     studying for an exam in a class he can pass.
238. The AB Manufacturing Company has hired an economist to evaluate its financial situation. She
     explains to the board of directors that the company is making zero economic profit. Should the
     company go out of business?
     Answer
     The company should remain operating. Earning zero economic profit implies that the firm has an
     accounting profit equal to what the firm could be making at its highest valued alternative. A
     situation where zero economic profit is made would be considered normal.
239. Mr. Jones pays his employees by the hour. He believes they purposely work slowly to maximize
     their personal satisfaction. What can he do to provide them with a stronger incentive to work
     efficiently?
     Answer
     Mr. Jones needs to do something that would change worker incentives. One option would be to link
     pay to output or to the firm’s profitability. He could pay bonuses for increased output, or he might
     tie all employee income to the profit the firm earns. This would make the employees residual
     claimants, giving them a stake in the firm’s well-being.
240. If the ABC Company decides to take over the XYZ Corporation by purchasing all of the stock of
     XYZ, what does this tell us about the view ABC holds of XYZ?
     Answer
     ABC must believe that the XYZ stock understates the value of the corporation. It is more valuable to
     ABC than any other investment opportunity, either as XYZ is now or as it will be when ABC
     restructures the corporation.

				
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