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Principles of Microeconomics for AP® Courses 2e

Steven A. Greenlaw, David Shapiro, Timothy Taylor

Chapter 7

Production, Costs and Industry Structure

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Problem 1

A firm had sales revenue of $\$ 1$ million last year. It spent $\$ 600,00$ on labor, $\$ 150,000$ on capital and $\$ 200,000$ on materials. What was the firm's accounting profit?

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Problem 2

Continuing from Exercise $7.1,$ the firm's factory sits on land owned by the firm that it could rent for $\$ 30,000$ per year. What was the firm's economic profit last year?

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Problem 3

The WipeOut Ski Company manufactures skis for beginners. Fixed costs are $\$ 30 .$ Fill in Table 7.16 for total cost, average variable cost, average total cost, and marginal cost.

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Problem 4

Based on your answers to the WipeOut Skic company in Exercise $7.3,$ now imagine a situation where the firm produces a quantity of 5 units that it sells for a price of $\$ 25$ each.
a. What will be the company's profits or losses?
b. How can you tell at a glance whether the company is making or losing money at this price by looking at average cost?
c. At the given quantity and price, is the marginal unit produced adding to profits?

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Problem 5

If two painters can paint 200 square feet of wall in an hour, and three painters can paint 275 square feet, what is the marginal product of the third painter?

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Problem 6

Return to the problem explained in Table 7.13 and Table 7.14 . If the cost of labor remains a $\$ 40,$ but the cost of a machine decreases to $\$ 50,$ what would be the total cost of each method of production? Which method should the firm use, and why?

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Problem 7

Suppose the cost of machines increases to $\$ 55,$ while the cost of labor stays at $\$ 40 .$ How would that affect the total cost of the three methods? Which method should the firm choose now?

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Problem 8

Automobile manufacturing is an industry subject to significant economies of scale. Suppose there are four domestic auto manufactures, but the demand for domestic autos is no more than 2.5 times the quantity produced at the bottom of the long-run average cost do you expect will happen to the domestic auto industy in the long run?

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Problem 9

What are explicit and implicit costs?

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Problem 10

Would you consider an interest payment on a loan to a firm an explicit or implicit cost?

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Problem 11

What is the difference between accounting and economic profit?

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Problem 12

What is a production function?

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Problem 13

What is the difference between a fixed input and a variable input?

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Problem 14

How do we calculate marginal product?

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Problem 15

What shapes would you generally expect a total product curve and a marginal product curve to have?

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Problem 16

What are the factor payments for land, labor, and capital?

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Problem 17

What is the difference between fixed costs and variable costs?

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Problem 18

How do we calculate each of the following: marginal cost, average total cost, and average variable
cost?

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Problem 19

1What shapes would you generally expect each of the following cost curves to have: fixed costs, variable
costs, marginal costs, average total costs, and average variable costs?

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Problem 20

Are there fixed costs in the long-run? Explain briefly.

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Problem 21

Are fixed costs also sunk costs? Explain.

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Problem 22

What are diminishing marginal returns as they relate to costs?

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Problem 23

Which costs are measured on per-unit basis: fixed costs, average cost, average variable cost, variable costs, and marginal cost?

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Problem 24

What is a production technology?

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Problem 25

In choosing a production technology, how will firms react if one input becomes relatively more
expensive?

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Problem 26

What is a long-run average cost curve?

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Problem 27

What is the difference between economies of scale, constant returns to scale, and diseconomies of scale?

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Problem 28

What shape of a long-run average cost curve illustrates economies of scale, constant returns to scale, and diseconomies of scale?

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Problem 29

Why will firms in most markets be located at or close to the bottom of the long-run average cost curve?

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Problem 30

Small Mom and Pop firms, like inner city grocery stores, sometimes exist even though they do not earn economic profits. How can you explain this?

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Problem 31

31. A common name for fixed cost is overhead. If you divide fixed cost by the quantity of output produced, you get average fixed cost. Supposed fixed cost is $\$ 1,000 .$ What does the average fixed cost curve look like? Use your response to explain what spreading the overhead means.

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Problem 32

How does fixed cost affect marginal cost? Why is this relationship important?

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Problem 33

Average cost curves (except for average fixed cost) tend to be U-shaped, decreasing and then increasing. Marginal cost curves have the same shape, though this may be harder to see since most of the marginal cost curve is increasing. Why do you think that average and marginal cost curves have the same general shape?

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Problem 34

What is the relationship between marginal product and marginal cost? (Hint: Look at the curves.) Why do you suppose that is? Is this relationship the same in the long run as in the short run?

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Problem 35

It is clear that businesses operate in the short run, but do they ever operate in the long run? Discuss.

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Problem 36

Return to Table 7.2 . In the top half of the table, at what point does diminishing marginal productivity kick in? What about in the bottom half of the table? How do you explain this?

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Problem 37

How would an improvement in technology, like the high-efficiency gas turbines or Pirelli tire plant, affect the long-run average cost curve of a firm? Can you draw the old curve and the new one on the same axes? How might such an improvement affect other firms in the industry?

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Problem 38

Do you think that the taxicab industry in large cities would be subject to significant economies of scale? Why or why not?

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Problem 39

A firm is considering an investment that will earn a 6$\%$ rate of return. If it were to borrow the money, it would have to pay 8$\%$ interest on the loan, but it currently has the cash, so it will not need to borrow. Should the firm make the investment? Show your work.

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Problem 40

Return to Figure $7.7 .$ What is the marginal gain in output from increasing the number of barbers from 4 to 5 and from 5 to 6 ? Does it continue the pattern of diminishing marginal returns?

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Problem 41

Compute the average total cost, average variable cost, and marginal cost of producing 60 and 72 haircuts. Draw the graph of the three curves between 60 and 72 haircuts.

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Problem 42

A small company that shovels sidewalks and driveways has 100 homes signed up for its services this winter. It can use various combinations of capital and labor: intensive labor with hand shovels, less labor with snow blowers, and still less labor with a pickup truck that has a snowplow on front. To summarize, the method choices are:
Method 1: 50 units of labor, 10 units of capital
Method $2 : 20$ units of labor, 40 units of capital
Method $3 : 10$ units of labor, 70 units of capital
If hiring labor for the winter costs $\$ 100 /$ unit and a unit of capital costs $\$ 400,$ what is the best production method? What method should the company use if the cost of labor rises to $\$ 200 /$ unit?

Srikar K.
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