question
Compare accounting costs to economic costs. Which measures the total opportunity cost of a firm's production? Describe the difference between explicit costs and implicit costs. Which types of costs are included when we use the phrase, "total costs"?
answer
- Economic costs measures the total opportunity cost of a firm's production
- Explicit costs: costs of hiring labor, paying for natural resources, and also paying for capital stock
- Implicit costs: the phrase used for paying the entrepreneur for his/her time and effort in the business
- Total costs = Explicit + implicit costs
- Explicit costs: costs of hiring labor, paying for natural resources, and also paying for capital stock
- Implicit costs: the phrase used for paying the entrepreneur for his/her time and effort in the business
- Total costs = Explicit + implicit costs
question
Why does the economist believe the accountant's method of calculating profit is incomplete? Explain
answer
Economists see this as an incomplete method because the economist considers all opportunity costs of production, so the entrepreneur needs to be paid.
question
How does an economist determine economic profit?
answer
TR - explicit costs - implicit costs = economic profit
(Note: explicit and implicit costs are total costs)
(Note: explicit and implicit costs are total costs)
question
Discuss the difference between accounting profit and economic profit. Which category/categories of costs are included in the accountant's method? ...in the economist's method?
answer
-Accounting profit: Total revenue - explicit costs
-Economic profit: Profit that accounts for both explicit costs and opportunity costs.
-The accountant's method includes costs of hiring, paying for natural resources, and paying for capital stock.
-The economist's method includes costs of hiring, paying for natural resources, paying for capital stock, AND paying the entrepreneurs
-Economic profit: Profit that accounts for both explicit costs and opportunity costs.
-The accountant's method includes costs of hiring, paying for natural resources, and paying for capital stock.
-The economist's method includes costs of hiring, paying for natural resources, paying for capital stock, AND paying the entrepreneurs
question
Define normal profit or the normal rate of return. What is the return to the entrepreneur if the firm earns zero economic profit?
..... positive economic profit? .... incurs an economic loss?
..... positive economic profit? .... incurs an economic loss?
answer
-The Normal Rate of Return: A rate of return on capital that is just sufficient to keep owners and investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds.
-Zero economic profit: Entrepreneur earned his/her normal profit (implicit costs)
-Positive economic profit: Entrepreneur earns MORE than his normal profit
-Negative economic profit: Entrepreneur earns LESS than normal profit
-Zero economic profit: Entrepreneur earned his/her normal profit (implicit costs)
-Positive economic profit: Entrepreneur earns MORE than his normal profit
-Negative economic profit: Entrepreneur earns LESS than normal profit
question
What can we assume about the entry/exit of firms if there is zero economic profit? ... positive economic profit?..when there is economic loss?
answer
- 0 Economic Profit: No existing firms should exit, because they are making their minimum or normal profit. No new firms should enter, because this industry is making just its normal profit. There is no particular draw for a new firm to enter. This industry is stagnant, since the number of firms would not change.
- + Economic Profit: No existing firms should exit, because they are making their normal profit plus additional profit. But now, new firms will leave but new firms will enter.
- Economic Losses: some existing firms will need to leave, since some will not be able to handle losses for long. No new firms will want to enter, since the rate of return in this industry is below normal profit. This industry will contract, since firms will leave, but no new firms will enter.
- + Economic Profit: No existing firms should exit, because they are making their normal profit plus additional profit. But now, new firms will leave but new firms will enter.
- Economic Losses: some existing firms will need to leave, since some will not be able to handle losses for long. No new firms will want to enter, since the rate of return in this industry is below normal profit. This industry will contract, since firms will leave, but no new firms will enter.
question
Present the production function. What is L? What is K? What is the difference between the short run production function and the long run production function?
answer
- Quantity of production is a function of L and K. Or, Q = f (L, K)
- L: Labor
- K: Capital
- Short run production: defined as a period df time when K is fixed
- Long run production: defined as a period of time when both L and K are variable
- L: Labor
- K: Capital
- Short run production: defined as a period df time when K is fixed
- Long run production: defined as a period of time when both L and K are variable
question
What input is fixed in the short run? What input is variable in the short run?
answer
In the short run, K is fixed and L is variable
question
Is either input fixed in the long run? Explain.
answer
No, both L and K are variable.
question
Graphically, construct the three short run productivity curves (total product, average product, and marginal product). Explain how the three ranges of productivity affect the shape of any/all of the curves.
answer
Total product:
-From 0-L1, TP increases at an increasing rate, showing the curve exponentially going up. From L1-L3, TP increases at a DIMINISHING rate, meaning it slowly as labor increases.
increases then eventually branches off. From L3 and forward, we see TP decrease
Marginal product:
-Between 0 and L1 units of labor, each added employee causes production to rise, and hence the curve to rise, reaching the maximum MP. Between L1 and L3, we experience a diminishing marginal returns to labor, causing MP to decrease at a slower and slower pace (remains positive). L3 and so fourth, MP continues to decline but actually becomes negative.
-For average product, its simply TP / L, when it intersects MP that's the maximum AP and that's when productivity branches off
-From 0-L1, TP increases at an increasing rate, showing the curve exponentially going up. From L1-L3, TP increases at a DIMINISHING rate, meaning it slowly as labor increases.
increases then eventually branches off. From L3 and forward, we see TP decrease
Marginal product:
-Between 0 and L1 units of labor, each added employee causes production to rise, and hence the curve to rise, reaching the maximum MP. Between L1 and L3, we experience a diminishing marginal returns to labor, causing MP to decrease at a slower and slower pace (remains positive). L3 and so fourth, MP continues to decline but actually becomes negative.
-For average product, its simply TP / L, when it intersects MP that's the maximum AP and that's when productivity branches off
question
Describe the relationship between total product and marginal product, and present both curves graphically.
answer
The mathematical connection between marginal product and total product stating that marginal product is the slope of the total product curve.
question
Describe increasing (marginal) returns to labor, diminishing (marginal) returns to labor, and negative (marginal) returns to labor. Where does the firm experience each of these ranges in production? Explain.
answer
-From 0-L1, increasing marginal returns to labor occur (occurs when the addition of a variable input (like labor) to a fixed input (like capital) enables the variable input to be more productive))
-From L1-L2, we have diminishing returns to labor where each additional worker eventually causes a smaller increase in productivity, but note TP is still positive
-From L3 and so on, we have negative returns to labor where additional workers are still being hired but TP actually declined and MP becomes negative.
-From L1-L2, we have diminishing returns to labor where each additional worker eventually causes a smaller increase in productivity, but note TP is still positive
-From L3 and so on, we have negative returns to labor where additional workers are still being hired but TP actually declined and MP becomes negative.
question
Why is average product always positive? Why does marginal product intersect average product at the maximum point of average product?
answer
-Average product is always positive because to have a negative average product, total product must be negative, (it basically means you'd have a negative value for quantity or labor which doesn't make sense)
-At the point of intersection, the additional worker produces the same as the average product of the total workforce; there will be no change.
-At the point of intersection, the additional worker produces the same as the average product of the total workforce; there will be no change.
question
Describe the difference between a fixed cost and a variable cost. Give examples of each type of cost for a firm.
answer
-Fixed cost: business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as interest or rents being paid per month
-Variable cost: costs that change as the quantity of the good or service that a business produces changes. Variable costs are the sum of marginal costs over all units produced.
-Variable cost: costs that change as the quantity of the good or service that a business produces changes. Variable costs are the sum of marginal costs over all units produced.
question
Graphically, construct the three total cost curves (total costs, total variable costs, and total fixed costs). Explain how the three ranges of productivity affect the shape of any/all of the curves.
answer
- From 0 to Q1, Total costs increase by the TFC graph amount (vertical shift) and it starts at the TFC graph
- At Q3, firms can't hire any more so the TC and TVC graph curve backwards
- At Q3, firms can't hire any more so the TC and TVC graph curve backwards
question
Why do average variable cost and average total cost become closer in value as the quantity of output increases?
answer
Because average fixed cost gets less and less
question
Why does marginal cost intersect average variable cost and average total cost at their minimum points?
answer
The marginal cost curve always intersects the average total cost curve at its lowest point because the marginal cost of making the next unit of output will always affect the average total cost. As a result, so long as marginal cost is less than average total cost, average total cost will fall.
question
Give examples of an airline's fixed costs. What would be included in an airline's marginal costs when deciding whether or not to fly a particular flight?
answer
Fuel costs, cost of adding an extra passenger, and other labor/input costs.
question
Will an airline fly if there is an empty seat on a plane?
answer
Yes because the marginal cost of an additional passenger is small.
question
Once an airline has decided a flight is profitable, what is the marginal cost of adding another passenger on that flight? Is this marginal cost a small expense, or a large expense? What would be covered in this marginal cost?
answer
The marginal cost of adding another passenger is close to zero, and it is a small expense. Food and beverage costs would be covered in the marginal cost.
question
In reality, what is a reasonable estimate of the MC of adding one more passenger? Does a standby ticket price cover the actual MC of this extra passenger? Explain.
answer
The standby ticket does not cover the marginal costs of this extra passenger because it won't outweigh the fixed costs of the actual flight.
question
What expenses is the airline considering when Offering a standby ticket: the flight's ATC, its AFC, or the MC of adding one more passenger? Explain.
answer
Its average fixed costs because depending on how expensive the plane tickets are, their revenue needs to exceed those fixed costs.
question
Demonstrate how a firm's long run ATC curve could be drawn from a series of short run ATC curves.
answer
In long run there is flexibility in substituting inputs and use them in such efficient combinations that we can generate outputs at minimal cost so in order to know the cost at which we can produce output at minimal we study long run cost functions.
question
Why do we study the long run costs of the firm?
answer
- As the output (production) increases, long run average total cost curve decreases in economies of scale
- Example: Supermarket chain
- Example: Supermarket chain
question
Graphically and verbally, demonstrate a situation where an industry has economies of scale (increasing returns to scale). Give an example of this type of industry.
answer
- The cost disadvantages that economic actors accrue due to an increase in organizational size or on output, resulting in production of goods and services at increased per-unit costs.
- Example: if a product is made up of two components, gadget A and gadget B, diseconomies of scale might occur if gadget B is produced at a slower rate than gadget A. This forces the company to slow the production of gadget A, increasing its per-unit cost.
- Example: if a product is made up of two components, gadget A and gadget B, diseconomies of scale might occur if gadget B is produced at a slower rate than gadget A. This forces the company to slow the production of gadget A, increasing its per-unit cost.
question
Graphically and verbally, demonstrate a situation where an industry has diseconomies of scale (decreasing returns to scale). Give an example of this type of industry.
answer
-We don't become more profitable expanding our company, all firms of various sizes seem
to be profitable
-Example: if a company decreases all of their inputs by 15%, their outputs will also decrease by 15%
to be profitable
-Example: if a company decreases all of their inputs by 15%, their outputs will also decrease by 15%
question
Graphically and verbally, demonstrate a situation where an industry has constant returns to scale. Give an example of this type of industry.
answer
c. both methods consider explicit costs, but the accounting system ignores implicit costs.
question
When comparing the calculations for economic and accounting profit, we learned that:
a. accounting profit considers payments to the entrepreneur, while economic profit does not.
b. both methods consider both explicit and implicit costs.
c. both methods consider explicit costs, but the accounting system ignores implicit costs.
d. neither system considers implicit costs.
a. accounting profit considers payments to the entrepreneur, while economic profit does not.
b. both methods consider both explicit and implicit costs.
c. both methods consider explicit costs, but the accounting system ignores implicit costs.
d. neither system considers implicit costs.
answer
a. both marginal product and average product increase.
question
In increasing returns to labor, we find that:
a. both marginal product and average product increase.
b. total product increases at a constant rate.
c. total product increases at a declining rate.
d. average product declines.
a. both marginal product and average product increase.
b. total product increases at a constant rate.
c. total product increases at a declining rate.
d. average product declines.
answer
d. average product take on negative values.
question
When we observe firms in the short run, we will NOT see:
a. marginal product declining.
b. average product declining.
c. total product declining.
d. average product take on negative values.
a. marginal product declining.
b. average product declining.
c. total product declining.
d. average product take on negative values.
answer
b. variable costs.
question
Factors of production such as labor and copier paper would be examples of:
a. fixed costs.
b. variable costs.
c. unusual business costs.
d. expenses that remain the same from month-to-month.
a. fixed costs.
b. variable costs.
c. unusual business costs.
d. expenses that remain the same from month-to-month.
answer
b. AFC
question
_____________ is graphed as a horizontal line.
a. TFC.
b. AFC.
c. ATC.
d. MC.
a. TFC.
b. AFC.
c. ATC.
d. MC.
answer
a. TFC.
question
____________ represents "spreading the overhead" across the number of units produced.
a. TFC.
b. AFC.
c. ATC.
d. MC.
a. TFC.
b. AFC.
c. ATC.
d. MC.
answer
a. AFC.
question
The distance between ATC and AVC is:
a. AFC.
b. TFC.
c. constant.
d. increasing as quantity of production increases.
a. AFC.
b. TFC.
c. constant.
d. increasing as quantity of production increases.
answer
b. diseconomies of scale.
question
If a firm doubles its plant size in the long run and its unit costs of production increase, we can conclude that the firm is experiencing:
a. diminishing marginal returns to labor.
b. diseconomies of scale.
c. increasing marginal returns to labor.
d. economies of scale.
a. diminishing marginal returns to labor.
b. diseconomies of scale.
c. increasing marginal returns to labor.
d. economies of scale.
answer
c. this industry has constant returns to scale.
question
You observe an industry that has firms of various sizes, all appearing to be profitable. You conclude that:
a. these firms have no explicit costs.
b. this industry has diseconomies of scale.
c. this industry has constant returns to scale.
d. this industry does not have diminishing returns to labor.
a. these firms have no explicit costs.
b. this industry has diseconomies of scale.
c. this industry has constant returns to scale.
d. this industry does not have diminishing returns to labor.
answer
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