question
1. In the Cobb-Douglas production function ():
a.the marginal product of labor (L) is equal to b1
b.the average product of labor (L) is equal to b2
c.if the amount of labor input (L) is increased by 1 percent, the output will increase by b1 percent
d.a and b
e.a and c
a.the marginal product of labor (L) is equal to b1
b.the average product of labor (L) is equal to b2
c.if the amount of labor input (L) is increased by 1 percent, the output will increase by b1 percent
d.a and b
e.a and c
answer
C) if the amount of labor input (L) is increased by 1 percent, the output will increase by b1 percent
question
Consider a firm that produces its output using two inputs: K and L. The costs for these two inputs are, respectively, r and w. If the manager wishes to minimize the cost of producing a given level of output, the manager will use that combination of K and L for which:
a. MPK = MPL
b. MPK = r and MPL = w
c. r = w
d. MPK/r = MPL/w
a. MPK = MPL
b. MPK = r and MPL = w
c. r = w
d. MPK/r = MPL/w
answer
d) MPK/r=MPL/w
question
Consider the following Cobb-Douglas production function for bus transportation: Q = 2.3 L.45 F.20 B 30
Where L is labor, F is fuel, and B represents the number of buses:
a. the production function is constant returns to scale.
b. the production function is decreasing returns to scale.
c. the production function is increasing returns to scale.
d. the production is NOT homogeneous.
Where L is labor, F is fuel, and B represents the number of buses:
a. the production function is constant returns to scale.
b. the production function is decreasing returns to scale.
c. the production function is increasing returns to scale.
d. the production is NOT homogeneous.
answer
C) The production function is increasing returns to scale.
question
The output elasticity of labor is:
a. equal to one at the level of output where average product is at a maximum.
b. the percentage change in labor required to produce one more unit of output.
c. equal to the ratio of total product to the quantity of labor employed.
d. a measure of the percentage change in output that can result when the quantity of labor is held constant.
a. equal to one at the level of output where average product is at a maximum.
b. the percentage change in labor required to produce one more unit of output.
c. equal to the ratio of total product to the quantity of labor employed.
d. a measure of the percentage change in output that can result when the quantity of labor is held constant.
answer
a. equal to one at the level of output where average product is at a maximum.
question
The combination of inputs is optimal:
a. at points of tangency between isoquants and isocosts.
b. if the marginal revenue product is equal to the marginal resource cost for all inputs.
c. if the marginal rate of technical substitution between every pair of inputs is equal to the ratio of the prices of those inputs.
d. All of the above are correct.
a. at points of tangency between isoquants and isocosts.
b. if the marginal revenue product is equal to the marginal resource cost for all inputs.
c. if the marginal rate of technical substitution between every pair of inputs is equal to the ratio of the prices of those inputs.
d. All of the above are correct.
answer
D) All of the above are correct.
question
If the marginal product of labor is 2, the marginal product of capital is 4, the wage rate is $3, the rental price of capital is $6, and the price of output is $1.50, then the firm should:
a. Increase output by hiring more labor, more capital, or both.
b. Hold output constant, but hire more labor and less capital.
c. Decrease output by reducing the quantity of capital, reducing the number of units of labor, or both.
d. None of the above is correct.
Answer: D
a. Increase output by hiring more labor, more capital, or both.
b. Hold output constant, but hire more labor and less capital.
c. Decrease output by reducing the quantity of capital, reducing the number of units of labor, or both.
d. None of the above is correct.
Answer: D
answer
D) None of the above is correct.
question
Consider the following short-run production function for Superfast Hairdryers, Inc., where M is material inputs, and Q is output.
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
a. Determine the marginal revenue product of materials. (This is a function.)
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
a. Determine the marginal revenue product of materials. (This is a function.)
answer
Total revenue is:
TR = P·Q = 10·Q = 10·[10·M - .25·M2] = 100·M - 2.5·M2.The marginal revenue by using a little more materials, M, is the derivative of TR with respect to M.dTR/dM = 100 - 5·M.The same answer can be found by finding the marginal product of M, and multiplying by the price of the final product, in this case, $10.
TR = P·Q = 10·Q = 10·[10·M - .25·M2] = 100·M - 2.5·M2.The marginal revenue by using a little more materials, M, is the derivative of TR with respect to M.dTR/dM = 100 - 5·M.The same answer can be found by finding the marginal product of M, and multiplying by the price of the final product, in this case, $10.
question
Consider the following short-run production function for Superfast Hairdryers, Inc., where M is material inputs, and Q is output.
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
B) Determine the marginal factor cost function.
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
B) Determine the marginal factor cost function.
answer
Total factor cost, TFC = 20·M. Marginal factor cost is the derivative of cost, or $20.
question
Consider the following short-run production function for Superfast Hairdryers, Inc., where M is material inputs, and Q is output.
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
c)Determine the optimal value of M, given the objective is to maximize profits.
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
c)Determine the optimal value of M, given the objective is to maximize profits.
answer
The optimal amount of M occurs where the marginal revenue product equals the marginal factor cost. From parts (a) and (b) we have:
MRP = 100 - 5·M = 20 = MFC. Therefore, M = 16.
MRP = 100 - 5·M = 20 = MFC. Therefore, M = 16.
question
Consider the following short-run production function for Superfast Hairdryers, Inc., where M is material inputs, and Q is output.
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
d)If the price of hair dryers were to rise, what happens to the optimal value of M employed to produce them?
Q = 10·M - .25·M2
Suppose the hair dryers are sold for $10 per unit to K-Mart. Also assume that the firm can obtain as much of the variable materials, input (M), as it needs at $20 per unit.
d)If the price of hair dryers were to rise, what happens to the optimal value of M employed to produce them?
answer
Of course, the optimal use of M rises, if the price of hair dryers rises. The marginal revenue product curve shifts up. Given a constant MFC, then the optimal amount of M will be greater. The morale for workers in the hair dryer industry is this: whatever improves the desirability of Superfast Hairdryers, increases the need for more workers at the Superfast Hairdryer factories.
question
Suppose the Total Product function looks like: TP = 600L2 − 100L3 . The value of labor input that maximizes average production is
answer
C) 4 units.
question
If the labor elasticity of output is .65, then the anticipated increase in output for a 3% increase in labor would be approximately 1.95%.
answer
a) True
question
If a production function is homogeneous of degree 0.94, then doubling all inputs will result in an increase in output of 20.94, which is 1.9185. That means output rises only 91.85 percent even though inputs increased 100 percent.
answer
a) true
question
If a firm has increasing returns to scale, then increasing all inputs by 1% will increase output by more than 1%.
answer
a) True
question
The optimal input combination is where marginal products are equal.
answer
b) False
question
Suppose that a firm uses two inputs: capital and labor. It has selected the levels of usage of capital and labor at which MPK = 50 and MPL = 20. If the cost of labor is $5 per unit and the cost of capital is $10 per unit:
answer
The firm should increase its usage of capital relative to labor
question
The law of diminishing marginal returns states that increases in the variable input reduce the total product.
answer
False
question
The Cobb-Douglas production function is: Q = 1.4L0.6K0.5. What would be the percentage change in output (%∆Q) if labor grows by 3.0% and capital is cut by 5.0%?
[Hint: %∆Q = (EL %∆L) + (EK %∆K)]
[Hint: %∆Q = (EL %∆L) + (EK %∆K)]
answer
%∆Q = - 0.70%
question
The following is a Cobb-Douglas production function: Q = 1.75K0.5∙L0.5. What is correct here?
answer
This production function displays constant returns to scale
question
The primary purpose of the Cobb-Douglas power function is to:
answer
allow one to make predictions about a resulting increase in output for a given increase in the inputs
question
For a firm with a cost constraint, the maximization of output occurs where:
answer
Marginal cost is equal to the marginal revenue.
question
The marginal rate of technical substitution may be defined as all of the following except:
answer
C.
the rate at which all combinations of inputs have equal total costs
the rate at which all combinations of inputs have equal total costs
question
Natural resources come in two types
answer
-Renewable (such as timber, which can be harvested and replanted)
-Exhaustible (such as coal and oil which can run out)
-Exhaustible (such as coal and oil which can run out)
question
optimal harvesting
answer
The potential revenue from waiting to harvest and selling the extra resources later.
question
A positive discount rate
answer
implies that the optimal resource stock is smaller than it would be otherwise.
question
The optimal population size is always smaller than the
answer
maximum sustainable yield.
question
Solutions to excessive harvest include
answer
Limiting the catch sizes
Regulation catch method.
Regulation catch method.
question
•Price changes and price change expectations are key to exhaustible resource decisions.
answer
•High prices for exhaustible resources are inevitable.
question
A production function
answer
relates the most that can be produced from a given set of inputs.
--Allow measures of the marginal product of each input.
(Cost and production are symbiotic, like two sides of the same can)
--Allow measures of the marginal product of each input.
(Cost and production are symbiotic, like two sides of the same can)
question
A production function
answer
is the maximum feasible quantity from any amounts of inputs
question
Cobb-Douglas production function
answer
A production function that assumes some degree of substitutability among inputs.
Q = a • L b1• K b2
With K being capital and L being labor.
Q = a • L b1• K b2
With K being capital and L being labor.
question
Short run
answer
one or more inputs is fixed.
•only a subset of total possible input combinations is available to a firm.
•only a subset of total possible input combinations is available to a firm.
question
Long Run
answer
•all inputs are variable.
all possible combinations are available.
all possible combinations are available.
question
Average Product
answer
Q/L
Output per labor
Output per labor
question
Marginal Product
answer
•output attributable to last unit of labor applied
question
•Similar to profit functions, the Peak of MP occurs before the Peak of average product
answer
•When MP = AP, this is the peak of the AP curve
question
Law of Diminishing Marginal Returns
answer
Increases in one factor of production, holding one or other factors fixed, after some point, results in the decline of marginal product.
question
Bottlenecks in Production Plants
answer
•Boeing found diminishing returns in ramping up production.
•It sought ways to adopt lean production techniques, cut order sizes, and outsourced work at bottlenecked plants.
•It sought ways to adopt lean production techniques, cut order sizes, and outsourced work at bottlenecked plants.
question
Increasing Returns and Network Effects
answer
•There are exceptions to the law of diminishing returns.
When the installed base of a network product makes efforts to acquire new customers increasing more productive, we have network effects.
eg: facebook, microsoft, boeing)
When the installed base of a network product makes efforts to acquire new customers increasing more productive, we have network effects.
eg: facebook, microsoft, boeing)
question
When MP > AP
answer
then AP is RISING
•If your marginal grade in this class is higher than your grade point average, then your GPA is rising.
•If your marginal grade in this class is higher than your grade point average, then your GPA is rising.
question
When MP < AP
answer
then AP is FALLING
•If your marginal performance at batting is less than that your season average, then your seasonal average will decline.
•If your marginal performance at batting is less than that your season average, then your seasonal average will decline.
question
When MP = AP
answer
then AP is at its MAX
•If your marginal grade in this class is just as equal to your GPA, then it will have no impact on your GPA.
•If your marginal grade in this class is just as equal to your GPA, then it will have no impact on your GPA.
question
Three stages of production
answer
•Stage 1: average product is increasing
•Increasing returns (0 to L2)
•Stage 2: average product is declining (but marginal product positive)
•Decreasing returns (L2 to L3)
•Stage 3: marginal product is negative, or total product is declining
•Negative returns (area to the right of L3)
•Increasing returns (0 to L2)
•Stage 2: average product is declining (but marginal product positive)
•Decreasing returns (L2 to L3)
•Stage 3: marginal product is negative, or total product is declining
•Negative returns (area to the right of L3)
question
Employ as long as
answer
marginal benefits exceeds marginal costs
question
Employ as long as
answer
marginal revenue product > marginal factor cost: MRPL > MFCL
question
Optimum level
answer
MRPL = MFCL
question
Production Isoquants
answer
curve representing all input combinations which produces the same output
question
SLOPE of an ISOQUANT
answer
•is the ratio of marginal products, called the MRTS, the marginal rate of technical substitution.
question
Capital intensive technology
answer
this is when a production isoquant, you are using more capital than labour in that particular input combination.
question
Optimal Combination of Inputs
answer
•The objective is to minimize total cost for a given output
question
ISOCOST lines
answer
are the combination of inputs for a given cost, C
question
Equimarginal Criterion:
answer
Produce where MPL/CL = MPK/CK where marginal products of inputs per dollar are equal
question
Allocative Efficiency
answer
•asks if the firm is using the least-cost combination of inputs
question
Technical Efficiency
answer
asks if the firm is maximizing the potential output from a given set of inputs.
question
Overall Production Efficiency
answer
•scale efficiency)(technical efficiency)(allocative efficiency)
question
Returns to Scale
answer
•It is the proportionate increase in output that results from a given proportionate increase in all inputs.
question
Reasons for Increasing Returns to Scale
answer
•The advantage of specialization in capital and labor - become more adept at a task
question
Reasons for Decreasing Returns to Scale
answer
•Problems with coordination and control - as a organization gets larger, harder to get everyone to work together
question
Empirical Studies of the Cobb-Douglas production Function in Manufacturing
answer
Q = physical volume of manufacturing
L = index of the average number of employed wage earners
K = index of the value of plant, building, tools, and machinery reduced to dollars of constant purchasing power.
L = index of the average number of employed wage earners
K = index of the value of plant, building, tools, and machinery reduced to dollars of constant purchasing power.
question
The Importance of Cost Analysis
answer
»Managers seek to make the most efficient use of resources to maximize value, at the lowest possible cost.
»The advantages once assigned to being a large firm (economies of scale and scope) have not provided the advantages of flexibility and agility found in some smaller companies.
»Cost analysis is helpful in the task of finding the lowest cost methods to produce goods and services.
»The advantages once assigned to being a large firm (economies of scale and scope) have not provided the advantages of flexibility and agility found in some smaller companies.
»Cost analysis is helpful in the task of finding the lowest cost methods to produce goods and services.
question
Accounting costs
answer
•involve explicit historical costs.
question
Economic costs
answer
are based on making decisions. These costs can be both implicit and explicit (labor, rent, supplies etc.).
Example: economic costs include the opportunity costs (value of next best alternative use) of owner-supplied resources, such as time and money, which are implicit costs.
Example: economic costs include the opportunity costs (value of next best alternative use) of owner-supplied resources, such as time and money, which are implicit costs.
question
economic profit
answer
Total Revenues - Explicit Costs - Implicit Costs
•Implicit costs make economic profit lower than accounting profit.
•Implicit costs make economic profit lower than accounting profit.
question
Depreciation Cost Measurement:
answer
Accounting depreciation cost (e.g., straight-line depreciation) tends to be different from economic depreciation cost.
•Economic depreciation cost considers opportunity cost; accounting depreciation cost considers historical cost.
•Economic depreciation cost considers opportunity cost; accounting depreciation cost considers historical cost.
question
Inventory Valuation
answer
2.Accounting valuation depends on its acquisition cost.
Economists view the cost of inventory as the cost of replacement.
Economists view the cost of inventory as the cost of replacement.
question
Sunk Cost of Underutilized Facilities
answer
Empty space may appear to have "no cost"
•Economists view its alternative use (e.g., rental value) as its opportunity cost.
•Economists view its alternative use (e.g., rental value) as its opportunity cost.
question
Sunk Costs
answer
already paid for, or there already exists a contractual obligation to pay
question
When MC < AVC
answer
AVC declines
question
When MC > AVC
answer
AVC rises
question
Long-Run Cost Functions
answer
•All inputs are variable in the long run.
•LRAC is long-run average cost
Envelope of SRAC curves
•LRAC is long-run average cost
Envelope of SRAC curves
question
Product-level Internal Economies of Scale
answer
involves declining cost associated with a product, as a firm increases production or throughput per day due to volume discounts, specialization, mass customization , and learning curve effects.
question
Mass customization
answer
•is designed to standardize at least some of the production processes associated with fulfilling customer orders.
•Lee's customers can choose their own back-pocket stitching and the number of prior stone washings at a mall kiosk. Lee assembles the custom order from stockpiles of subassemblies.
• Economies offered in the mass production of items helps to offset the expense of individually designed products.
•Lee's customers can choose their own back-pocket stitching and the number of prior stone washings at a mall kiosk. Lee assembles the custom order from stockpiles of subassemblies.
• Economies offered in the mass production of items helps to offset the expense of individually designed products.
question
Learning Curve Relationship
answer
•Workers and management become more efficient with experience.
•The cost of production declines as the cumulative volume of output increases.
•The cost of production declines as the cumulative volume of output increases.
question
Percentage of Learning
answer
•The proportion by which costs are reduced through DOUBLING output is estimated as follows:
L = (C2/C1)·100%
L = (C2/C1)·100%
question
Plant-level Internal Economies of Scale
answer
involves producing several products at the same plant. These include economies in overhead, required reserves, investment, or interactions among products (economies of scope).
question
Firm level internal economies of scale
answer
occur in firms with several plants. These include economies in distribution and transportation of a geographically dispersed firm, or economies in marketing, sales promotion.
question
Diseconomies of Scale
answer
•Rising long-run average costs with an increase in output
•Sources include transportation costs, inflexible operations designed for long production runs, and problems of coordination and control by management.
•Sources include transportation costs, inflexible operations designed for long production runs, and problems of coordination and control by management.
question
Flat section of the LRAC
answer
•Displays constant returns to scale
•The minimum efficient scale (MES) is the smallest scale at which minimum long-run average total costs are attained.
•The maximum efficient scale (Max ES) is the largest scale before which unit costs begin to rise.
•The minimum efficient scale (MES) is the smallest scale at which minimum long-run average total costs are attained.
•The maximum efficient scale (Max ES) is the largest scale before which unit costs begin to rise.
question
Cost function
answer
shows the relationship between total, average, marginal cost.
question
Cost measurement issues involve
answer
•the type of cost (fixed, variable, direct accounting costs etc.) and issues of depreciation.
question
Estimating Cost Functions
answer
•Prices of inputs change with inflation, but capital asset values are stated in terms of historical costs.
question
Solutions for estimation cost functions
answer
•Deflating or detrending the cost data
•Using multiple regression analysis
•Economies of scope
•Using multiple regression analysis
•Economies of scope
question
Statistical Estimation of Short-Run Cost Functions
answer
•Studies have shown that short-run total costs tend to increase linearly over the range of output.
•Short-run average costs tend to decline and marginal costs tend to increase over the typical operating range of a firm.
•Short-run average costs tend to decline and marginal costs tend to increase over the typical operating range of a firm.
question
Statistical Estimation of Long-Run Cost Functions
answer
•Estimating costs in multiple plants usually uses a cross-sectional data assuming that each firm uses its inputs to accomplish minimum LRAC production.
•Estimating costs in a single plant usually uses a time-series data assuming that input prices, technology, and the products offered for sale remain unchanged.
•Estimating costs in a single plant usually uses a time-series data assuming that input prices, technology, and the products offered for sale remain unchanged.
question
Economies of scope
answer
•occur when producing two or more products jointly by one firm is less than the cost of producing them separately.
•For example banks that manages both unsecured consumer loans and property-secured mortgage loans, can provide both at lower cost.
•Specialized labor, computer and telecommunications technology, and business credit information are possible sources of production economies in financial institutions.
•Evidence indicates economies of scope between consumer installment credit lending and residential mortgage lending.
•For example banks that manages both unsecured consumer loans and property-secured mortgage loans, can provide both at lower cost.
•Specialized labor, computer and telecommunications technology, and business credit information are possible sources of production economies in financial institutions.
•Evidence indicates economies of scope between consumer installment credit lending and residential mortgage lending.
question
Engineering Cost Techniques
answer
•offer an alternative to estimate long-run costs without using accounting cost data.
•It uses knowledge about the efficiency of machinery, labor and raw materials.
•It is much easier with engineering approach to hold constant factors like input prices, product mix, and product efficiency.
•Use of engineering approach helps avoid cost-allocation and depreciation problems faced when using accounting data.
•It uses knowledge about the efficiency of machinery, labor and raw materials.
•It is much easier with engineering approach to hold constant factors like input prices, product mix, and product efficiency.
•Use of engineering approach helps avoid cost-allocation and depreciation problems faced when using accounting data.
question
The Survivor Technique
answer
•examines what size of firms are tending to succeed over time, and what sizes are declining.
•The rationale behind is that competition will eliminate firms with inefficient size, and only firms with lower average costs will survive.
•A study conducted by Haldi and Whitcomb reveals that in basic industries such as petroleum refining, primary metals, and electric power, economies of scale is prevalent in very large plant sizes.
•The rationale behind is that competition will eliminate firms with inefficient size, and only firms with lower average costs will survive.
•A study conducted by Haldi and Whitcomb reveals that in basic industries such as petroleum refining, primary metals, and electric power, economies of scale is prevalent in very large plant sizes.
question
contribution margin.
answer
Difference between selling price and variable cost per unit
question
Break-even Sales Volume
answer
•Break-even analysis can also be performed in terms of dollar sales.
•Amount of sales revenues that breaks even
•Sb = P•[TFC/(P-VC)]
=TFC/[ 1 - VC/P ]
•Amount of sales revenues that breaks even
•Sb = P•[TFC/(P-VC)]
=TFC/[ 1 - VC/P ]
question
Contribution Analysis
answer
Another variation is to find if added sales through an ad campaign or new product is justified. It looks at the incremental contributions and incremental additions to cost.
Do the project if:
Added Contribution > Added Cost
(P - VC) DQ > D Total Direct Fixed Cost
When this inequality holds, the project adds more to revenues than it adds to cost.
Do the project if:
Added Contribution > Added Cost
(P - VC) DQ > D Total Direct Fixed Cost
When this inequality holds, the project adds more to revenues than it adds to cost.
question
Limitations of Break even & Contribution Analysis
answer
Sometimes the assumptions do not hold
1.Costs may be semi-variable
2.Many times firms sell multiple products or small, medium, and large varieties
3.There is uncertainty as to the P, V, and F in the problem
4.Inconsistency in the planning horizon
1.Costs may be semi-variable
2.Many times firms sell multiple products or small, medium, and large varieties
3.There is uncertainty as to the P, V, and F in the problem
4.Inconsistency in the planning horizon
question
Degree of Operating Leverage
answer
DOL at Q = Percentage change in EBIT/ Percentage change in sales
-sensitivity of operating profit (EBIT) to changes in output
-sensitivity of operating profit (EBIT) to changes in output
question
Degree of Operating Leverage
answer
A measure of the importance of Fixed Cost
or Business Risk to fluctuations in output
or Business Risk to fluctuations in output
question
Inherent Business Risk
answer
•Inherent business risk is the inherent variability of a firm's EBIT.
•The higher a firm's DOL, the greater the inherent degree of business risk.
•Uncertainty of sales and uncertainty concerning selling prices and variable costs are other factors that can affect a firm's inherent business risk.
•The higher a firm's DOL, the greater the inherent degree of business risk.
•Uncertainty of sales and uncertainty concerning selling prices and variable costs are other factors that can affect a firm's inherent business risk.
question
Pure competition
answer
is a standard against which other market structures are compared; there are many firms and the product is perfectly undifferentiated.
-There are industries with many firm, but the products or service are heterogeneous or differentiated.
-There are industries with many firm, but the products or service are heterogeneous or differentiated.
question
Monopolistic competition
answer
is when there are many firms, but the product or service is differentiated.
-This brand competition may involve advertising campaigns and large promotional expenditures to stress often minor distinctions among products
-This brand competition may involve advertising campaigns and large promotional expenditures to stress often minor distinctions among products
question
Core Competencies
answer
•technology-based expertise or knowledge on which a firm can focus its strategy.
question
Value Proposition
answer
basis for customer willing to pay more than cost-covering prices
•Find value in the value chain
•Find value in network relationships
•Find value in the value chain
•Find value in network relationships
question
prerequesite Knowledge
answer
1. Customers
2. Competitors
3. Market Conditions
4. Capital Raising
5. Resource Availability
6. Socio-political Constraints
2. Competitors
3. Market Conditions
4. Capital Raising
5. Resource Availability
6. Socio-political Constraints
question
Components of the Business Model
answer
1. Target Market
2. Value Proposition
3. Role in Value Chain
4. Revenue Sources
5. Margins Defined
6. Network Value
7. Investment Required
8. Competitive Strategy
2. Value Proposition
3. Role in Value Chain
4. Revenue Sources
5. Margins Defined
6. Network Value
7. Investment Required
8. Competitive Strategy
question
Decisions (Managers will be more critical on this part of the strategy process)
answer
1. Products
2. Prices
3. Marketing Plans
4. Supply Chains
5. Distribution Channels
6. Projected Cash Flows to Lenders and Equity Owners
2. Prices
3. Marketing Plans
4. Supply Chains
5. Distribution Channels
6. Projected Cash Flows to Lenders and Equity Owners
question
product differentiation strategy
answer
•A strategy that relies upon differences in products or processes affecting perceived customer value.
•For example, Coca-Cola or Nestlé
•For example, Coca-Cola or Nestlé
question
cost-based strategy
answer
•A strategy that relies upon low-cost operations, marketing, or distribution. For example, Southwest Airlines & Dell Computers
question
•Information Technology Strategy
answer
•A strategy that relies on IT capabilities
•For example, Allstate Insurance & GPS tracking to offer lower insurance rates to those who don't drive their best cars to work
•For example, Allstate Insurance & GPS tracking to offer lower insurance rates to those who don't drive their best cars to work
question
The Relevant Market Concept
answer
•A market is a group of economic agents that interact in a buyer-seller relationship. The number and size of the buyers and sellers affect the nature of that relationship.
question
A popular measure of concentration is
answer
•the percentage of an industry comprised of the top 4 firms. Similarly, the market share held by the top 4 buyers is a popular measure of buyer concentration.
question
•The relationship among firms is affected by:
answer
a. the number of firms and their relative sizes
b. whether the product is differentiated or standardized
c. whether decisions by firms are independent or coordinated (collusion)
b. whether the product is differentiated or standardized
c. whether decisions by firms are independent or coordinated (collusion)
question
The Threat of Substitutes
answer
1.can be offset by brands, complementors, and special functions served by the product.
question
The Threat of Entry
answer
1.can be reduced by high fixed costs, scale economies, restriction of access to distribution channels, or product differentiation.
question
The Power of Buyers
answer
from the threat of concentration of buyers
question
The Power of Suppliers
answer
for the threat when concentrated suppliers of key inputs affect profitability
question
The Intensity of Rivalry
answer
impact profitability via market concentration, price competition tactics, exit barriers, ratio of FC to TC (cost fixity), and industry growth rates.
question
4 firm concentration ratio
answer
output of four largest firms / total output in the industry
question
The price-cost margin percentage (PCM) is defined as
answer
PCM = P - MC
question
The larger is the price-cost margin percentage
answer
the smaller will be the necessary quantity response to justify cutting price
PCM/(PCM - 0.1) < (1 + ∆Q/Q )
PCM/(PCM - 0.1) < (1 + ∆Q/Q )
question
Pure Competition assumes:
answer
a very large number of buyers and sellers
2. homogeneous product (standardized)
3. complete knowledge of all relevant market information
4. free entry and exit (no barriers)
These assumptions imply several things about competitive markets, including price equals average cost in the long run.
2. homogeneous product (standardized)
3. complete knowledge of all relevant market information
4. free entry and exit (no barriers)
These assumptions imply several things about competitive markets, including price equals average cost in the long run.
question
Monopoly assumes:
answer
Only one firm in the market area
2. Low cross-price elasticity with other products
3. No interdependence with other competitors
4. Substantial entry barriers
These assumptions imply that the monopoly price is well above marginal cost. Monopoly is discussed in full in Chapter 11.
2. Low cross-price elasticity with other products
3. No interdependence with other competitors
4. Substantial entry barriers
These assumptions imply that the monopoly price is well above marginal cost. Monopoly is discussed in full in Chapter 11.
question
Monopolistic competition assumes:
answer
A large number of firms, some of which may be dominant in size
2. Differentiated products
3. Independent decision making by individual firms
4. Easy entry and exit
These assumptions imply several things about monopolistic competition, including that the price in the long run is equal to average cost.
2. Differentiated products
3. Independent decision making by individual firms
4. Easy entry and exit
These assumptions imply several things about monopolistic competition, including that the price in the long run is equal to average cost.
question
Oligopoly assumes:
answer
Only a few firms in the market area
2. Products may be differentiated or undifferentiated
3. There is a large degree of interdependence with other competitors
2. Products may be differentiated or undifferentiated
3. There is a large degree of interdependence with other competitors
question
Price-Output Determination Under Pure Competition
answer
•Competitive firms attempt to maximize profits.
Competitive firms cannot charge more than the market price of others, since their product is identical to all others
Competitive firms cannot charge more than the market price of others, since their product is identical to all others
question
competitive firms are
answer
price takers.
question
Profit maximization implies that
answer
each firm produces an output where Price = Marginal Cost (P = MC).
•To produce more than this quantity implies that P < MC, which is not the most profitable decision.
•To produce less than where P=MC, implies that P > MC, and the firm could increase profits by expanding output.
•To produce more than this quantity implies that P < MC, which is not the most profitable decision.
•To produce less than where P=MC, implies that P > MC, and the firm could increase profits by expanding output.
question
A Competitive Market in the Short Run
answer
1.If P = MC for each firm, then each firm is doing what it thinks maximizes profits. Firms are in equilibrium.
2.Equilibrium for the industry if: Demand equals Supply at the given price
2.Equilibrium for the industry if: Demand equals Supply at the given price
question
A Competitive Market in the Long Run
answer
Industries which have economic profits draw entry and shift the SMC1 curve out to SMC2 where there is no reason for more firms to enter or firms to exit the industry
Price covers all cost, so in the LR, P=AC
Profit maximizing level of output is achieved where P=MR=MC=AC
Price covers all cost, so in the LR, P=AC
Profit maximizing level of output is achieved where P=MR=MC=AC
question
Long-Run Competitive Markets with external diseconomies of scale
answer
As demand rises for products, we find that inputs become more expensive.
The rising cost is not due necessarily to the productivity of the firms, but higher prices for what they purchase.
One example is the rising price for crude oil.
As demand in the world increases, the marginal seller of oil is ever pricier.
The rising cost is not due necessarily to the productivity of the firms, but higher prices for what they purchase.
One example is the rising price for crude oil.
As demand in the world increases, the marginal seller of oil is ever pricier.
question
•Monopolistic Competition:
MARKET STRUCTURE
MARKET STRUCTURE
answer
•Many Firms and Many Buyers
•Easy Entry & Exit
•PRODUCT DIFFERENTIATION
•Easy Entry & Exit
•PRODUCT DIFFERENTIATION
question
Differentiation
answer
•occurs when consumers perceive that a product differs from its competition on any physical or non-physical characteristic, including price.
•Examples: restaurants, dealer-owned gas stations, video rental stores, book & convenience stores, etc.
•Examples: restaurants, dealer-owned gas stations, video rental stores, book & convenience stores, etc.
question
•Assumptions of the Model: Product Differentiation
answer
•Large number of firms
•Differentiated Product
•Conditions of Cost and Demand are Similar
•Easy Entry & Exit
•Differentiated Product
•Conditions of Cost and Demand are Similar
•Easy Entry & Exit
question
•Optimal Advertising is when:
answer
Contribution Margin = Marginal Cost of Advertising
P - MC = k •(changeA/changeQ)
P - MC = k •(changeA/changeQ)
question
Asymmetric Information
answer
•unequal or dissimilar knowledge among market participants.
question
Incomplete Information
answer
- uncertain knowledge of payoffs, choices, or types of opponents a market player faces.
question
Search goods
answer
•are products or services whose quality is best detected through a market search.
question
Experience goods
answer
•are products and services whose quality is undetected when purchased.
question
•Suppose that a firm may decide to produce a High Quality or Low Quality product, and the buyer may decide to offer a High Price or a Low Price.
answer
•Since the firm fears that the buyers will only offer a Low Price, even if they offer High Quality product, they only produce Low Quality products and receive Low Prices.
•This is the problem of adverse selection
•This is the problem of adverse selection
question
Notorious Firm Analysis
answer
A risk averse decision by the firm is to make a Low Quality product
Best for the buyer is a low price, but a high quality good. Worst for the buyer is a high price but a low quality good.
Best for the buyer is a low price, but a high quality good. Worst for the buyer is a high price but a low quality good.
question
Solutions to the Problem of Adverse Selection
answer
•Regulation (Quotas, Restrictions, and Truth in Advertising Laws)
•Reliance Relationships are long term, mutually beneficial agreements, often informal.
•Brand names (a form of a "hostage" to quality)
•Non-Redeployable assets are assets that have little value in second-best use is low
•Reliance Relationships are long term, mutually beneficial agreements, often informal.
•Brand names (a form of a "hostage" to quality)
•Non-Redeployable assets are assets that have little value in second-best use is low
question
Mechanisms for commitments
answer
•Use of non-redeployable assets: such as reputation. Once lost, a good reputation is hard to rebuild.
•Entering into reliance relationships: which would fall apart if any party violated their commitments.
Examples are "escrow accounts," and "surety bond."
Using a "hostage mechanism": that is irreversible and irrevocable can deter breaking commitments
•Entering into reliance relationships: which would fall apart if any party violated their commitments.
Examples are "escrow accounts," and "surety bond."
Using a "hostage mechanism": that is irreversible and irrevocable can deter breaking commitments
question
Regulated monopolies are known as
answer
utilities.
question
Sources of Market Power for a Monopolist
answer
•Copyrights & patents
•Control of critical resources creates market power.
•Government-authorized franchises, such as provided to cable TV companies
•Economies of scale allow larger firms to produce at lower cost than smaller firms.
•Increasing returns from network effects - compatibilities increase market penetration. Once a critical level of adoption is achieved, the cost of marketing the next adoption decreases.
•Control of critical resources creates market power.
•Government-authorized franchises, such as provided to cable TV companies
•Economies of scale allow larger firms to produce at lower cost than smaller firms.
•Increasing returns from network effects - compatibilities increase market penetration. Once a critical level of adoption is achieved, the cost of marketing the next adoption decreases.
question
Price-Output Determination: Monopoly
answer
•At output where MR = MC, profit is maximized
Proof: Max P = TR - TC
dP/dQ = dTR/dQ - dTC/dQ = 0
MR - MC = 0
So: MR = MC
Proof: Max P = TR - TC
dP/dQ = dTR/dQ - dTC/dQ = 0
MR - MC = 0
So: MR = MC
question
Optimal Markups
answer
•The optimal markup can be found using this same formula. P = [ED /( ED+1)]•MC = (1 + %Mark-up)•MC
•For example, if ED = -3, the markup is 50%, since = [-3/( -3 +1)] = 1.5 multiplier.
•If ED = -4, the markup is 33.3%, since = [-4/( -4 +1)] = 1.33 multiplier.
•If the price elasticity is infinite, the markup is zero. This occurs in competition, where m = -1/(-¥ + 1) = 0.
•For example, if ED = -3, the markup is 50%, since = [-3/( -3 +1)] = 1.5 multiplier.
•If ED = -4, the markup is 33.3%, since = [-4/( -4 +1)] = 1.33 multiplier.
•If the price elasticity is infinite, the markup is zero. This occurs in competition, where m = -1/(-¥ + 1) = 0.
question
Components of Gross Profit Margin
answer
•Sometimes it is shortened to Profit Margin and is also called Direct Cost of Goods Sold (DCGS). It is defined as: Gross Profit Margin = Revenue - Variable Cost - Direct Fixed Cost
question
•Gross Profit Margin varies across industries:
answer
1.Because industries vary in capital intensity. Typically highly capital intensive industries have larger gross profit margins.
2.Because industries vary in selling costs, such as advertising and promotional expenses. Typically high selling costs lead to high gross profit margins.
3.Because industries vary in their overhead expense. Often, high overhead expense leads to high gross profit margins.
2.Because industries vary in selling costs, such as advertising and promotional expenses. Typically high selling costs lead to high gross profit margins.
3.Because industries vary in their overhead expense. Often, high overhead expense leads to high gross profit margins.
question
Limit Pricing
answer
•Firms charge lower price, to discourage entry of potential rivals.
•They forego short-run monopoly profit to maintain long-run monopoly position.
•Limit pricing strategy is beneficial if present value of profit after limit pricing is greater than present value of short-run monopoly profit.
•They forego short-run monopoly profit to maintain long-run monopoly position.
•Limit pricing strategy is beneficial if present value of profit after limit pricing is greater than present value of short-run monopoly profit.
question
Regulated Monopolies
answer
•Electric Power Companies
•Natural Gas Companies
•Communication Companies (telephone, cable, radio, TV, etc.)
•All are examples of regulated companies or Public Utilities.
•They are all "naturally monopolistic" as they all have significant declining cost curves.
•Natural Gas Companies
•Communication Companies (telephone, cable, radio, TV, etc.)
•All are examples of regulated companies or Public Utilities.
•They are all "naturally monopolistic" as they all have significant declining cost curves.
question
•Declining Cost Industries
answer
•economies in distribution
•economies of scale
•economies of scale
question
natural monopoly
answer
•Regulation is required to achieve a socially optimal combination of price and output.
question
A monopoly firm will produce at minimum ATC:
answer
if MR happens to equal MC where ATC is at a minimum.
question
In natural monopoly, AC continuously declines due to economies in distribution or in production, which tends to found in industries which face increasing returns to scale. If price were set equal to marginal cost, then:
answer
price would be below average cost.
question
The ultimate success of a monopoly in the long run depends on its ability:
answer
to prevent entry of rivals
question
Which of the following is NOT considered a consequence of monopoly?
:A.
high prices
B.
restriction of output
C.
huge profits
D.
least cost production
:A.
high prices
B.
restriction of output
C.
huge profits
D.
least cost production
answer
D. Least cost production
question
If the monopolist operated in the inelastic range of its demand curve:
answer
marginal revenue would be negative.
question
Monopolists always make economic profits.
answer
false
question
Which of the following is a barrier to entry that typically results in monopoly?
answer
Production of the industry's product requires a large initial capital investment.
question
Limit pricing occurs when firms with market power:
answer
choose to make less than the maximum possible profits in order to discourage new firms from entering the market.
question
If the monopoly firm wants to maximize its profit, it should operate at a level of output equal to
answer
Q3
question
In the case of pure monopoly:
A.
one firm is the sole producer of a good that has no close substitutes
B.
the firm's profit is maximized at the price and output combination where marginal cost equals marginal revenue.
C.
the demand curve is always in the elastic region at the optimal monopoly price
D.
All of the above are correct
A.
one firm is the sole producer of a good that has no close substitutes
B.
the firm's profit is maximized at the price and output combination where marginal cost equals marginal revenue.
C.
the demand curve is always in the elastic region at the optimal monopoly price
D.
All of the above are correct
answer
D. All the above are correct
question
If price is set equal to marginal cost in a naturally monopolistic industry, then there will be losses (negative profits), because P < AC.
answer
true
question
if the distribution of water is a natural monopoly, then
imultiple firms would likely each have to pay large fixed costs to develop their own network of pipes.
allowing for competition among different firms in the water-distribution industry is efficient.
a single firm can serve the market at the lowest possible average total cost.
imultiple firms would likely each have to pay large fixed costs to develop their own network of pipes.
allowing for competition among different firms in the water-distribution industry is efficient.
a single firm can serve the market at the lowest possible average total cost.
answer
i and iii only
question
The monopolist can increase output and price simultaneously
answer
false
question
The fraudulent delivery of low quality experience goods at high prices is more likely if:
A.
interest rates decline
B.
information about notorious firms is speedily disseminated
C.
price premiums for allegedly high quality increase
D.
none of the above
A.
interest rates decline
B.
information about notorious firms is speedily disseminated
C.
price premiums for allegedly high quality increase
D.
none of the above
answer
D. None of the above
question
A market that is monopolistically competitive will tend to have fewer firms than would be the case if the same market was perfectly competitive.
answer
false
question
In the purely competitive case, marginal revenue (MR) is equal to:
answer
price
question
The price for used cars is well below the price of new cars of the same general quality. This is an example of:
answer
A Lemon's Market
question
If a firm produces a unique product and inspires a brand loyalty, it will tend to have higher profits.
answer
true
question
If profit maximizing firms in a perfectly competitive industry will produce 14,000 units per day if the market price is $23 and consumers will purchase 14,000 units per day if the market price is $20, then the market equilibrium quantity must be greater than 14,000
answer
false
question
if a perfectly competitive firm is in long-run equilibrium, then market price is equal to short-run marginal cost, short-run average total cost, long-run marginal cost, and long-run average total cost.
answer
true
question
Buyers anticipate that the temporary warehouse seller of unbranded computer equipment will
answer
produce only one quality
question
The problems of asymmetric information exchange arise ultimately because
answer
one party cannot independently verify the information of another
question
Which of the following is a form of nonprice competition?
A.
Advertising
B.
Quality of service
C.
Product quality
D.
All of the above are forms of nonprice competition.
A.
Advertising
B.
Quality of service
C.
Product quality
D.
All of the above are forms of nonprice competition.
answer
D. All of the above
question
Experience goods are products or services
answer
whose quality is undetectable when purchased
question
Porter's strategic framework describes a structure based on five forces
answer
true
question
A linear total cost function implies that:
a. marginal costs are constant as output increases
b. average total costs are continually decreasing as output increases
c. a and b
d. none of the above
a. marginal costs are constant as output increases
b. average total costs are continually decreasing as output increases
c. a and b
d. none of the above
answer
C. a and b
question
What is another term meaning the degree of operating leverage?
A.
The measure of the importance of fixed cost.
B.
The operating profit elasticity.
C.
The measure of business risk.
D.
All of the above.
A.
The measure of the importance of fixed cost.
B.
The operating profit elasticity.
C.
The measure of business risk.
D.
All of the above.
answer
D all of the above
question
Economic theory suggests that a cubic function is an appropriate form for an empirical short-run total variable cost curve.
answer
true
question
Which of the following is not an assumption of the linear breakeven model:
answer
decreasing variable cost per unit
question
Operating profits have been highly volatile in the department store industry. As an intern for a department store management headquarters, what would you do to reduce the volatility of operating profits?
answer
Identify ways to change fixed costs into variable costs, through short term leases, so that costs can be reduced when store sales slack off.
question
For the cost-output relationship, describe the shape (U-shape, decreasing, increasing, constant) of the average total cost (AC) and marginal cost (MC) functions (C = total cost, Q = output):
C = 8.48 + 0.65Q + .00220Q2
C = 8.48 + 0.65Q + .00220Q2
answer
AC is U-shaped and MC is linear
question
For the following cost-output relationship, describe the shape (U-shape, decreasing, increasing, constant) of the average total cost (AC) and marginal
cost (MC) functions (C = total cost, Q = output):
C = 42,500,000 + 2550Q
cost (MC) functions (C = total cost, Q = output):
C = 42,500,000 + 2550Q
answer
AC is decreasing and MC is constant
question
In a study of banking by asset size over time, we can find which asset sizes are tending to become more prominent. The size that is becoming more predominant is presumed to be least cost. This is called:
answer
regression to the mean analysis.
question
Which of the following is an assumption of linear breakeven analysis?
answer
Average fixed cost is constant
question
Economies of scope exist between book publishing and magazine publishing if
answer
the cost of publishing a magazine is lower for book publishers than for other firms.
question
A ____ total cost function implies that marginal costs ____ as output is increased.
A. Linear; increase linearly
.
linear; increase linearly
B.
quadratic; are constant
C.
cubic; increase linearly
D.
none of the above
A. Linear; increase linearly
.
linear; increase linearly
B.
quadratic; are constant
C.
cubic; increase linearly
D.
none of the above
answer
none of the above
question
The survival technique
A.
can be used to estimate short-run total variable cost functions.
B.
is based on a technical knowledge of a firm's production function.
C.
uses regression analysis in combination with time-series or cross-sectional data.
D.
None of the above is correct.
A.
can be used to estimate short-run total variable cost functions.
B.
is based on a technical knowledge of a firm's production function.
C.
uses regression analysis in combination with time-series or cross-sectional data.
D.
None of the above is correct.
answer
None of the above is correct
question
In the linear breakeven model, a firm incurs operating losses whenever output is less than the breakeven level.
answer
true
question
Which one of the following distinguishes accounting costs from economic costs?
A.
Accounting depreciation often reflects historical cost rather than the replacement cost of capital assets
B.
Accounting depreciation often reflects arbitrary tax-based rules rather than time plus use depreciation.
C.
Accounting costs often transfer intermediate products within a company at their out-of-pocket expense rather than at their external market value (their opportunity cost).
D.
All of the above
A.
Accounting depreciation often reflects historical cost rather than the replacement cost of capital assets
B.
Accounting depreciation often reflects arbitrary tax-based rules rather than time plus use depreciation.
C.
Accounting costs often transfer intermediate products within a company at their out-of-pocket expense rather than at their external market value (their opportunity cost).
D.
All of the above
answer
All of the above
question
The cost function is:
answer
a schedule or mathematical relationship showing the total cost of producing various quantities of output
question
An unused storage building has an opportunity cost of its next best alternative use.
answer
true
question
What method of inventory valuation should be used for economic decision-making problems?
answer
C.
current replacement cost
current replacement cost
question
It is often believed that the minimum efficient scale for the automobile industry is very large. This tends to create an industry with few firms.
answer
true
question
The shortrun average cost curve is U-shaped because:
answer
as you produce more output, AFC continuously declines; however, as the plant capacity is reached, MC rises, driving average costs up again. This creates the U-shaped average cost curve.
question
For a short-run cost function which of the following statements is (are) not true?
answer
The marginal cost function intersects the average fixed cost function where the average variable cost function is a minimum.
question
The law of diminishing returns begins at the level of output where
answer
marginal cost is at a minimum.
question
Which of the following short-run cost curves declines continuously?
answer
Average fixed cost
question
The existence of diseconomies of scale (size) for the firm is hypothesized to result from:
answer
problems of coordination and control encountered by management
question
If a firm has a downward sloping long-run average cost curve, then
answer
it is a natural monopoly.
question
In cost theory, the "long run" is defined as when we are all dead.
answer
B.
False
False
question
When marginal product is at its maximum, average product is also at its maximum.
answer
false
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