Chapter 3: The Costs of Production and Profit Maximization

question

fixed costs FC

answer

Costs that do not vary with increases in the quantity produced are called fixed costs.

What expenses must be paid even if product equals zero?

question

variable costs VC

answer

Costs that do vary with increases in the quantity produced are called variable costs

question

sunk cost SC

answer

a cost that is already committed and cannot be recovered

question

short run

answer

is a time horizon where some fixed costs exist

question

long run

answer

the situation where the fixed costs (the inputs) become variable

question

average fixed cost AFC

answer

equals fixed cost divided by the quantity produced

question

average variable cost AVC

answer

equals the variable cost divided by the quantity produced

question

average total cost ATC

answer

equals the total cost divided by the quantity produced or the sum of average fixed cost plus average variable cost

question

marginal cost MC

answer

is equal to the change in the total cost that arises from an extra unit of production

question

total cost

answer

the sum of fixed costs and variable costs

question

total revenue

answer

is calculated by multiplying price and quantity

question

marginal revenue

answer

is the change in total revenue generated from an additional unit sold

question

profit maximizing rule

answer

states that a business maximizes profits when it produces where the marginal revenue from selling another unit equals the marginal cost of producing an additional unit

question

shut-down rule

answer

A business should shut down if production at the profit maximizing quantity generates total revenues that are less than variable costs, in all other cases the business should stay open

question

long run exit decision

answer

states that a business should exit the industry if production at the profit maximizing quantity generates total revenues that are less than total cost, otherwise stay open

question

price setters

answer

In a monopolistic industry, because there is only one seller of a product, the business owner actually goes through a process of setting the price of its product, a task that competitive firms are unable to do. Thus monopolistic firms are called price setters.

question

first constraint

answer

is described in the expense data and cost curves of section 2.

question

second constraint

answer

is the market demand

question

first decision

answer

is to determine the profit maximizing quantity to produce

question

second decision

answer

is to decide what price to charge

question

third decision

answer

is to decide whether to produce or to shut down the business for a short period of time

question

economics of scale

answer

Information technology such as Microsoft's operating system, a pharmaceutical pill, and even newspapers are all products that have economies of scale.

question

constant economies of scale

answer

is defined by constant average total cost as output increases

question

joint costs

answer

are costs that do not change with the scope of production

question

profit maximization

answer

the objective of every private business owner is to maximize her or his profits. He or she does this by using the profit maximizing rule. The profit maximizing rule states that a business maximizes profits when it produces where the marginal revenue from selling another unit equals the marginal cost of producing an additional unit.

question

short run

answer

is a time horizon within which a business is unable to adjust at least one input because there is a fixed cost of some kind.

question

perfect competition

answer

occurs in an industry in which there are many buyers and many sellers -- an industry in which the good is homogeneous, and an industry in which all who want to enter the industry are free to do so and any business may exit at a time of their choosing.

question

monopoly

answer

an industry that is controlled by a monopolist is called a monopoly. A monopolist is a firm that is the only seller of a good. The good the monopolist sells is heterogeneous (because they are the only one that sells the good). And the market that the monopolist sells its product in has barriers to entry.

question

the shut-down rule

answer

a business should shut down if production at the profit maximizing quantity (where MR=MC) generates total revenues that are less than variable costs. In all other cases the business should stay open.

question

T/F: A fixed cost is a cost that does not vary with changes in the quantity produced.

answer

True

question

T/F: Marginal cost is the increase in total cost that arises from an extra unit of production.

answer

True

question

T/F: A production process has economies of scale if average total cost decreases as production increases.

answer

True

question

T/F: A production process has diseconomies of scale if average total costs increase as output increases.

answer

True

question

T/F: If a company's average total costs remains constant as output increases, then the company has constant economies of scale.

answer

True

question

T/F: When an organization can produce several different products together at greater cost than could a group of single product firms operating independently, then the organization has economies of scale.

answer

False

question

T/F: A sunk cost is a cost that has already been committed and can be recovered.

answer

False

question

T/F: A business always maximizes profits when it produces where total revenue equals total cost.

answer

False

question

T/F: A business should shut down if production at the profit maximizing quantity generates total revenues that are less than total fixed costs. s

answer

False

question

The accountants hired by Costa, Costa & Costa Law Firm have calculated that at the profit maximizing quantity, total fixed costs equal $56,791, total variable costs equal $113,555, and total revenue equals $112,000. Because of this information, Costa, Costa & Costa Law Firm decides:

A. to exit the industry
B. to shut down
C. decides to stay open because shutting down would be more expensive
D. decides to stay open because they are making an economic profit

answer

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

Smith and Sons, Inc. is currently operating in the short run or in the long run?

answer

Short run

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

$__________ of Smith and Sons, Inc.'s fixed cost is not a sunk cost.

answer

$100,000 = fixed cost - sunk cost

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

The profit (or loss) at the current level of production is __________

answer

-$100,000 = total revenue - total cost

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

Smith and Sons, Inc., should:
A. shut down operations for a short period of time
B. stay open and continue operating at their profit maximizing level of production

answer

question

Banks and insurers both need distribution networks to sell products and serve their customers. Bank of America sells both insurance and banking services. Does the concept of economies of scope or the concept of economies of scale explain the business decision to combine banking and insurance services at Bank of America?

answer

economies of scope

question

At EYZ Corporation, a larger quantity of output means that individual workers can limit themselves to more specialized tasks and through this process they become more skilled and efficient at doing their specialized tasks. Does the concept of economies of scope or the concept of economies of scale best capture what is happening at EYZ Corporation?

answer

economies of scale

question

In a Wall Street Journal article it was reported that "Mitsubishi Motors is seeking a buyer for its U.S. operations, a move that may well signal the company's intent to exit the world's largest car market." The potential move by Mitsubishi is a matter of economies of scale or economies of scope?

answer

economies of scale

question

Consider the following decision made by Old Century Power Company. In electricity production, once electricity has been generated at a power plant, distribution networks are needed to bring electricity to the customer. Suppose Old Century Power Company has decided to build its own electricity generating plants and its own electricity distribution network. In making this decision, Old Century Power Company has calculated that economies of scale or economies of scope exist when electricity generation and electricity distribution are integrated under unified ownership?

answer

economies of scope

question

Consider the following decision made by New Century Power Company. In electricity production, once electricity has been generated at a power plant, distribution networks are needed to bring the electricity to the customer. Suppose the New Century Power Company has decided to build its own electricity distribution network, but it has also decided to purchase electricity from many different independent electric power producers. In making this decision, New Century Power Company has calculated that diseconomies of scale or diseconomies of scope exist when electricity generation and electricity distribution are integrated under unified ownership?

answer

diseconomies of scope

question

T/F: The profit maximizing rule states that a business maximizes profits when it produces where total revenue equals total cost.

answer

False

question

The accountants hired by Bling, Blong & Blatt Law Firm have calculated that at the profit maximizing quantity total fixed costs equal $56,272,000 total variable costs equal $213,235,000 and total revenue equals $213,236,000. Because of this information, ling, Blong & Blatt Law Firm decides

A. to exit the industry
B. to shut down
C. decides to stay open because shutting down would be more expensive
D. decides to stay open because they are making an economic profit

answer

question

T/F: The profit maximizing rule states that a business maximizes profits when it produces where marginal revenue equals average variable cost.

answer

False

1 of 51

question

fixed costs FC

answer

Costs that do not vary with increases in the quantity produced are called fixed costs.

What expenses must be paid even if product equals zero?

question

variable costs VC

answer

Costs that do vary with increases in the quantity produced are called variable costs

question

sunk cost SC

answer

a cost that is already committed and cannot be recovered

question

short run

answer

is a time horizon where some fixed costs exist

question

long run

answer

the situation where the fixed costs (the inputs) become variable

question

average fixed cost AFC

answer

equals fixed cost divided by the quantity produced

question

average variable cost AVC

answer

equals the variable cost divided by the quantity produced

question

average total cost ATC

answer

equals the total cost divided by the quantity produced or the sum of average fixed cost plus average variable cost

question

marginal cost MC

answer

is equal to the change in the total cost that arises from an extra unit of production

question

total cost

answer

the sum of fixed costs and variable costs

question

total revenue

answer

is calculated by multiplying price and quantity

question

marginal revenue

answer

is the change in total revenue generated from an additional unit sold

question

profit maximizing rule

answer

states that a business maximizes profits when it produces where the marginal revenue from selling another unit equals the marginal cost of producing an additional unit

question

shut-down rule

answer

A business should shut down if production at the profit maximizing quantity generates total revenues that are less than variable costs, in all other cases the business should stay open

question

long run exit decision

answer

states that a business should exit the industry if production at the profit maximizing quantity generates total revenues that are less than total cost, otherwise stay open

question

price setters

answer

question

first constraint

answer

is described in the expense data and cost curves of section 2.

question

second constraint

answer

is the market demand

question

first decision

answer

is to determine the profit maximizing quantity to produce

question

second decision

answer

is to decide what price to charge

question

third decision

answer

is to decide whether to produce or to shut down the business for a short period of time

question

economics of scale

answer

Information technology such as Microsoft's operating system, a pharmaceutical pill, and even newspapers are all products that have economies of scale.

question

constant economies of scale

answer

is defined by constant average total cost as output increases

question

joint costs

answer

are costs that do not change with the scope of production

question

profit maximization

answer

question

short run

answer

is a time horizon within which a business is unable to adjust at least one input because there is a fixed cost of some kind.

question

perfect competition

answer

question

monopoly

answer

question

the shut-down rule

answer

a business should shut down if production at the profit maximizing quantity (where MR=MC) generates total revenues that are less than variable costs. In all other cases the business should stay open.

question

T/F: A fixed cost is a cost that does not vary with changes in the quantity produced.

answer

True

question

T/F: Marginal cost is the increase in total cost that arises from an extra unit of production.

answer

True

question

T/F: A production process has economies of scale if average total cost decreases as production increases.

answer

True

question

T/F: A production process has diseconomies of scale if average total costs increase as output increases.

answer

True

question

T/F: If a company's average total costs remains constant as output increases, then the company has constant economies of scale.

answer

True

question

answer

False

question

T/F: A sunk cost is a cost that has already been committed and can be recovered.

answer

False

question

T/F: A business always maximizes profits when it produces where total revenue equals total cost.

answer

False

question

T/F: A business should shut down if production at the profit maximizing quantity generates total revenues that are less than total fixed costs. s

answer

False

question

answer

question

answer

Short run

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

$__________ of Smith and Sons, Inc.'s fixed cost is not a sunk cost.

answer

$100,000 = fixed cost - sunk cost

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

The profit (or loss) at the current level of production is __________

answer

-$100,000 = total revenue - total cost

question

Smith and Sons, Inc. is a profit maximizing company. The business's accountants have calculated the following costs and revenue at the company's current profit maximizing level of production:
Fixed cost: $150,000
Variable cost: $500,000
Sunk cost: $50,000
Total cost: $650,000
Total revenue: $550,000

Smith and Sons, Inc., should:
A. shut down operations for a short period of time
B. stay open and continue operating at their profit maximizing level of production

answer

question

answer

economies of scope

question

answer

economies of scale

question

answer

economies of scale

question

answer

economies of scope

question

answer

diseconomies of scope

question

T/F: The profit maximizing rule states that a business maximizes profits when it produces where total revenue equals total cost.

answer

False

question

answer

question

T/F: The profit maximizing rule states that a business maximizes profits when it produces where marginal revenue equals average variable cost.

answer

False

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