question
Price elasticity of demand
answer
The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price
Horizontal demand curve
Horizontal demand curve
question
inelastic demand
answer
A condition in which the percentage change in quantity demanded is less than the percentage change in price
question
perfectly inelastic demand
answer
A condition in which the quantity demanded does not change as the price changes
Vertical demand curve
Vertical demand curve
question
price elasticity of supply
answer
The ratio of the percentage change in the quantity supplied of a product to the percentage change in its price
Es = percentage change in quantity supplied / percentage change in price
where...
Es = the price elasticity of supply coefficient
Es = percentage change in quantity supplied / percentage change in price
where...
Es = the price elasticity of supply coefficient
question
elastic demand
answer
A condition in which the percentage change in quantity demanded is greater than the percentage change in price
question
unitary elastic demand
answer
A condition in which the percentage change in quantity demanded is equal to the percentage change in price
question
income elasticity of demand
answer
a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income
Ei = percentage change in quantity demanded / percentage change in income
Ed = % change in Q / % change in Income
Ed = (Q2-Q1/Q1+Q2) / (I2-I1/L1+L2)
Ei = percentage change in quantity demanded / percentage change in income
Ed = % change in Q / % change in Income
Ed = (Q2-Q1/Q1+Q2) / (I2-I1/L1+L2)
question
total revenue
answer
The total number of dollars a firm earns from the sale of a good or service, which is equal to its price multiplied by the quantity demanded
Price x Quantity
Price x Quantity
question
perfectly elastic demand
answer
A condition in which a small percentage change in price brings about an infinite percentage change in quantity demanded
question
cross-elasticity of demand
answer
The ratio of the percentage change in the quantity demanded of a good or service to a given percentage change in the price of another good or service
Ec = percentage change in quantity demanded of one good / percentage change in price of another good
Ec = % change Qx / % change y
Ec = (Qx2-Qx1/Qx1+Qx2) / (Py2-Py1/Py1+Py2)
Ec = percentage change in quantity demanded of one good / percentage change in price of another good
Ec = % change Qx / % change y
Ec = (Qx2-Qx1/Qx1+Qx2) / (Py2-Py1/Py1+Py2)
question
tax incidence
answer
the manner in which the burden of a tax is shared among participants in a market
The share of a tax ultimately paid by consumers and sellers
The share of a tax ultimately paid by consumers and sellers
question
If good X has a price elasticity of demand equal to 2 and the price increases by 10 percent then by what percent will the quantity demanded change?
answer
The quantity demanded will decrease by 20 percent. Note: multiply the coefficient by the percentage change in the price to determine the percentage change in the quantity demanded.
question
If good X has a price elasticity of demand equal to 2 and good Y has a coefficient equal to 2.5 which has a more elastic demand?
answer
Good Y because the coefficient is greater than one by the greatest amount.
question
What is the advantage of using the midpoints formula as opposed to the total revenue test in determining the degree of price elasticity?
answer
You can only determine whether the product is elastic, unitary elastic, or inelastic when using the total revenue test. However, in addition to that, you can determine the degree of elasticity or inelasticity by observing the value of the coefficient if you use the midpoints formula.
question
Why are convenience stores able to charge higher prices than grocery stores for some items?
answer
Because of the time consideration for those shopping at convenience stores. Convenience store shoppers are usually in a hurry and are experiencing a more inelastic demand for goods like milk at the time.
question
If a firm wishes to increase its revenues and the product it is selling has an inelastic demand, then should the firm increase or decrease its price?
answer
Increase its price.
question
If a firm wants to maximize its revenues then what price should it charge?
answer
That price in which there is unitary elasticity. This is because if the price is above that level then there is an elastic demand which means a lower price will increase total revenue. At a price below that level there is an inelastic demand which means a higher price will increase total revenue.
question
What would an elastic income elasticity of demand for a product mean?
answer
That consumers are relatively responsive to the amount of this product that they buy as their income changes.
question
If the income elasticity of demand is greater than zero does this indicate the product is normal or inferior? Why?
answer
Normal, because as income increases (in the denominator) the quantity demanded increases (in the numerator). (A positive numerator divided by a positive denominator gives us a positive number, or quotient.)
question
In each of the following situations, indicate whether there is a case of two products being substitutes or a complements.
answer
a. Ec > 0.
Substitutes (because the coefficient is positive).
b. The price of one good increases by 12% and the quantity demanded for the other good decreases by 24%.
Complements (because the coefficient would be negative).
c. Ec = -.34. Complements (because the coefficient is negative).
Substitutes (because the coefficient is positive).
b. The price of one good increases by 12% and the quantity demanded for the other good decreases by 24%.
Complements (because the coefficient would be negative).
c. Ec = -.34. Complements (because the coefficient is negative).
question
If the price of a good increases by 10% and the quantity supplied increases by 30% what is the elasticity of supply? What does that mean---in other words, does this product have an elastic, unitary elastic or inelastic supply? What can we infer about the amount of time under consideration---is the time frame under consideration likely to relatively short or long? Why?
answer
Es = 3. Elastic supply. Sellers are relatively responsive to the price increase. There must be a rather long time period under consideration. (The greater the amount of time under consideration, the greater the opportunity for an output response.)
question
In each of the following situations, indicate who bears the biggest burden of a tax imposed on sellers, buyers or sellers?
answer
a. Given supply, demand is quite inelastic?
Consumers.
b. Given supply, demand is quite elastic?
Sellers.
c. Given demand, supply is quite inelastic?
Sellers.
d. Given demand, supply is quite elastic?
Consumers.
Consumers.
b. Given supply, demand is quite elastic?
Sellers.
c. Given demand, supply is quite inelastic?
Sellers.
d. Given demand, supply is quite elastic?
Consumers.
question
If a good has a price elasticity of demand coefficient less than one, then:
a. this good has an elastic demand.
b. this good has an inelastic demand.
c. a 10% increase in the price will result in a greater than 10% decrease in the quantity demanded.
d. the demand curve will be vertical.
a. this good has an elastic demand.
b. this good has an inelastic demand.
c. a 10% increase in the price will result in a greater than 10% decrease in the quantity demanded.
d. the demand curve will be vertical.
answer
B
question
2. If the price elasticity of demand is elastic, then:
a. Ed < 1.
b. consumers are relatively not very responsive to a price increase.
c. an increase in the price will increase total revenue.
d. there are likely a large number of substitute products available.
a. Ed < 1.
b. consumers are relatively not very responsive to a price increase.
c. an increase in the price will increase total revenue.
d. there are likely a large number of substitute products available.
answer
D
question
If the price elasticity of demand coefficient equals 2 then:
a. a 7% decrease in the price will result in a 14% decrease in the quantity demanded.
b. a price decrease will increase total revenue.
c. the good has an inelastic demand.
d. there is likely few substitutes, a short time period under consideration, or this good accounts for a relatively small percentage of consumers' budgets.
a. a 7% decrease in the price will result in a 14% decrease in the quantity demanded.
b. a price decrease will increase total revenue.
c. the good has an inelastic demand.
d. there is likely few substitutes, a short time period under consideration, or this good accounts for a relatively small percentage of consumers' budgets.
answer
B
question
Which of the following statements is true?
a. If the income elasticity of demand is less than zero, the good is an inferior good.
b. Only if the demand curve is vertical will sellers raise the price by the full amount of a tax.
c. Two goods are substitutes if the cross-elasticity of demand coefficient is positive.
d. A price elasticity of supply coefficient equal to 1.5 means the product exhibits an elastic supply and a 10% increase in the price will increase the quantity supplied by 15%.
e. All of the above.
a. If the income elasticity of demand is less than zero, the good is an inferior good.
b. Only if the demand curve is vertical will sellers raise the price by the full amount of a tax.
c. Two goods are substitutes if the cross-elasticity of demand coefficient is positive.
d. A price elasticity of supply coefficient equal to 1.5 means the product exhibits an elastic supply and a 10% increase in the price will increase the quantity supplied by 15%.
e. All of the above.
answer
E
question
Determinants of the price elasticity of demand:
answer
•The availability of substitutes
•The market used to measure demand
•The share of budget spent on the product
•The time horizon being considered
•The market used to measure demand
•The share of budget spent on the product
•The time horizon being considered
question
A good with many close substitutes is likely to have relatively ______ demand, because consumers can easily choose to purchase one of the close substitutes if the price of the good rises.
answer
Elastic
question
Organize the goods found in the following table by indicating which is likely to have the most elastic demand, which is likely to have the least elastic demand, and which will have a demand elasticity that falls in between.
answer
Pants = In between
Clothing = Least Elastic
Boot-cut jeans = Most Elastic
Clothing = Least Elastic
Boot-cut jeans = Most Elastic
question
Other things being equal, which of the following goods has the most elastic demand?
1. Lightbulbs
2. Toothbrush
3. TV and Internet service plan
1. Lightbulbs
2. Toothbrush
3. TV and Internet service plan
answer
3. TV and Internet service plan
question
The price elasticity of demand is also affected by the given time horizon.
Compared to the short-run demand for oil, the demand for oil in the long run will tend to be?
Compared to the short-run demand for oil, the demand for oil in the long run will tend to be?
answer
More elastic
question
Sam is a retired teacher who lives in Houston and provides math tutoring for extra cash. At a wage of $50 per hour, he is willing to tutor 7 hours per week. At $65 per hour, he is willing to tutor 10 hours per week.
Using the midpoints formula, the elasticity of Sam's labor supply between the wages of $50 and $65 per hour is approximately ______, which means that Sam's supply of labor within this wage range is ______.
Using the midpoints formula, the elasticity of Sam's labor supply between the wages of $50 and $65 per hour is approximately ______, which means that Sam's supply of labor within this wage range is ______.
answer
1.35, elastic
question
The tax incidence lies more heavily on the ______ elastic side of the market.
answer
Less
question
Suppose you are the manager of a local water company, and you are instructed to get consumers to reduce their water consumption by 10 percent. If the price elasticity of demand for water is 0.25, by how much would you have to raise the price of water?
answer
40 percent
question
An increase in total revenue results occurs from which of the following?
answer
Price decreases when demand is elastic.
question
Suppose that Starbucks reduces the price of its premium coffee from $2.20 to $1.80 per cup, and as a result, the quantity sold per day increased from 350 to 450. Over this price range, the price elasticity of demand for Starbucks coffee is:
answer
1.25
question
The president of Tucker Motors says, "Lowering the price won't sell a single additional Tucker car." The president believes that the price elasticity of demand is:
answer
perfectly inelastic.
question
If the price elasticity of demand is computed for two products, and product A measures .79, and product B measures 1.6, then:
answer
product B is more elastic than product A.
question
Suppose an increase in symphony tickets prices reduces the total revenue. This is evidence that demand is:
answer
price elastic.
question
The price elasticity of demand for a vertical demand curve is:
answer
perfectly inelastic.
question
A local doughnut shop reduced the price of its doughnuts from $4 per dozen to $3.50 per dozen, and as a result, the daily sales increased from 300 to 400 dozen. This indicates that the price elasticity of demand for the doughnuts was:
answer
Elastic
question
If a demand curve for a good were completely vertical, it would be considered:
answer
perfectly inelastic.
question
Suppose that a jewelry store found that when it increased prices by 10 percent, sales revenue increased by 3 percent. Which of the following is true about the price elasticity of demand for the store's goods?
answer
Demand is inelastic, but not perfectly.
question
elasticity formula
answer
Ed = percentage change in quantity demanded / percentage change in price
Ed = the elasticity coefficient
Ed = the elasticity coefficient
question
Suppose a university's enrollment drops by 20 percent because tuition rises by 10 percent. What is the price elasticity of demand?
answer
-20% / 10% = 2
The quantity demanded (enrollment) changes 2 percent for each 1 percent change in price (tuition).
Why is elasticity "2" in the previous example rather than "-2"? Because we know from the law of demand that quantity demanded and price are inversely related
The quantity demanded (enrollment) changes 2 percent for each 1 percent change in price (tuition).
Why is elasticity "2" in the previous example rather than "-2"? Because we know from the law of demand that quantity demanded and price are inversely related
question
What is the problem with using the elasticity formula?
answer
When we move along a demand curve between two base points, we get different answers to elasticity depending on whether we are moving up or down the demand curve.
question
How is this problem of different base points solved?
answer
By using the midpoints as the base points of changes in prices and quantities demanded
question
midpoints formula for price elasticity of demand
answer
Ed = (change in quantity / sum of quantities/2) / (change in price / sum of prices/2)
Also:
Ed = [% change Q / % change P]
Ed = (Q2-Q1/Q1+Q2) / (P2-P1/P1+P2)
Also:
Ed = [% change Q / % change P]
Ed = (Q2-Q1/Q1+Q2) / (P2-P1/P1+P2)
question
When is demand elastic?
answer
When the elasticity coefficient is greater than 1
question
What is the effect on total revenue when demand is elastic?
answer
When demand is elastic, the decrease in price causes an increase in total revenue.
question
When is demand inelastic?
answer
When the elasticity coefficient is less than 1
question
What is the effect on total revenue when demand is inelastic?
answer
When demand is inelastic, the decrease in price causes a decrease in total revenue.
question
What is the effect on total revenue when demand is unitary elastic?
answer
Because the percentage change in price equals the percentage change in quantity, total revenue does not change regardless of changes in price.
Ed = 1
Ed = 1
question
Does price elasticity of demand vary along a demand curve?
answer
Yes, the price elasticity coefficient of demand applies only to a specific range of prices.
question
What are determinants of price elasticity of demand?
answer
•The availability of substitutes
•The percentage of one's budget spent on the product
•The length of time allowed for adjustment to a price change
•The percentage of one's budget spent on the product
•The length of time allowed for adjustment to a price change
question
How does the availability of substitutes influence price elasticity of demand?
answer
Demand becomes more elastic for a good or service when the number of close substitutes increases. When consumers have limited alternatives, the demand for a good or service is more price inelastic.
question
What conclusion can we make regarding the availability of substitutes?
answer
The price elasticity coefficient of demand is directly related to the availability of suitable substitutes for a product
question
How does one's budget influence price elasticity of demand?
answer
Demand becomes more elastic when the purchase is a large percentage of one's budget because consumers are more sensitive to a price change
question
What conclusion can we make regarding share of budget spent on a product?
answer
The price elasticity coefficient of demand is directly related to the percentage of one's budget spent for a good or service
question
How do price changes over time influence price elasticity of demand?
answer
Demand becomes more elastic because as time passes, buyers can respond fully to a change in the price of a product by finding more substitutes
question
What conclusion can we make regarding adjustment to a price change over time?
answer
In general, the price elasticity coefficient of demand is higher the longer a price change persists.
question
What are some other elasticity measures?
answer
•Income elasticity of demand
•Cross-elasticity of demand
•Price elasticity of supply
•Cross-elasticity of demand
•Price elasticity of supply
question
What is income elasticity of demand?
answer
The ratio of the percentage change in the quantity demanded of a good or service to a given percentage change in income
question
What decides who pays what part of a tax increase?
answer
The more elastic the demand, the more the corporation pays. The less elastic demand, the more the consumer pays
question
CAUSATION CHAIN
answer
Increase in gasoline tax --> Decrease in supply --> Consumers and suppliers share burden of tax
question
Utility Definitions
answer
Nick is arguing with his girlfriend, Rosa. They have been going out for a little more than two years.
Rosa says to him: "I'm leaving you, Nick. Get over it."
Nick replies: "Are you saying that being single will make you happier than you've been with me? Speaking personally, I think the [TOTAL] utility we've had in this relationship was much more than you could have had if you'd been single this whole time!"
Nick's use of the word "utility" rang a bell for Rosa, who had taken an economics class. "It's not that at all. We've had a fine time. It's that the [MARGINAL] utility I would get by continuing our relationship isn't worth it anymore."
Nick replies: "I've never been dumped by someone citing the law of [DIMINISHING MARGINAL UTILITY] before. You're a piece of work, you know that?"
Rosa doesn't hear. She has already walked off, leaving Nick feeling like something of a sunk cost.
Rosa says to him: "I'm leaving you, Nick. Get over it."
Nick replies: "Are you saying that being single will make you happier than you've been with me? Speaking personally, I think the [TOTAL] utility we've had in this relationship was much more than you could have had if you'd been single this whole time!"
Nick's use of the word "utility" rang a bell for Rosa, who had taken an economics class. "It's not that at all. We've had a fine time. It's that the [MARGINAL] utility I would get by continuing our relationship isn't worth it anymore."
Nick replies: "I've never been dumped by someone citing the law of [DIMINISHING MARGINAL UTILITY] before. You're a piece of work, you know that?"
Rosa doesn't hear. She has already walked off, leaving Nick feeling like something of a sunk cost.
question
Balancing utility and price:
Suppose Latasha has to choose between purchasing plane tickets and water.
Which of the following is the utility-maximizing rule that Latasha should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.")
Suppose Latasha has to choose between purchasing plane tickets and water.
Which of the following is the utility-maximizing rule that Latasha should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.")
answer
MU of Water/Price of Water = MU of Plane Tickets/Price of Plane Tickets
question
Suppose Latasha has to choose between purchasing high-definition televisions and juice.
Which of the following is the utility-maximizing rule that Latasha should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.")
Which of the following is the utility-maximizing rule that Latasha should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.")
answer
MU of Juice/Price of Juice = MU of HDTVs/Price of HDTVs
question
Suppose Kenji has to choose between purchasing jewelry and milk.
Which of the following is the utility-maximizing rule that Kenji should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.") Which of the following is the utility-maximizing rule that Kenji should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.")
Which of the following is the utility-maximizing rule that Kenji should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.") Which of the following is the utility-maximizing rule that Kenji should follow while choosing the optimal quantities of these two goods? (Note: In the answer options that follow, MU stands for "marginal utility.")
answer
MU of Milk/Price of Milk = MU of Jewelry/Price of Jewelry
question
Since juice costs little and high-definition televisions are expensive, it must follow that when people choose their optimal quantities of juice and high-definition televisions to purchase, the marginal utility they receive from the last gallon of juice they buy is ______ than the marginal utility they receive from the last high-definition television they buy.
answer
Less
question
Since water costs little and plane tickets are expensive, it must follow that when people choose their optimal quantities of water and plane tickets to purchase, the marginal utility they receive from the last plane ticket they buy is ______ than the marginal utility they receive from the last gallon of water they buy.
answer
Greater
question
Kevin has a so-called fruit budget, which he uses to buy only pears and avocados. Assume the price of pears decreases. Which of the following is an example of the income effect?
answer
The decrease in the price of pears increases Kevin's real income, which enables Kevin to buy more fruits in general.
(The income effect refers to the change in the quantity demanded of a good or service caused by a change in real income (or purchasing power). That is, when the price of pears decreases, Kevin's real income (or purchasing power) increases. This enables Kevin to buy more total pears and avocados.
The income effect, together with the substitution effect, helps explain why individual demand curves slope downward.)
(The income effect refers to the change in the quantity demanded of a good or service caused by a change in real income (or purchasing power). That is, when the price of pears decreases, Kevin's real income (or purchasing power) increases. This enables Kevin to buy more total pears and avocados.
The income effect, together with the substitution effect, helps explain why individual demand curves slope downward.)
question
Amy has a so-called fruit budget, which she uses to buy only apricots and nectarines. Assume the price of apricots increases. Which of the following is an example of the substitution effect?
answer
The increase in the price of apricots makes apricots relatively more expensive than nectarines, so Amy will buy fewer apricots and more nectarines.
(The substitution effect refers to the change in the quantity demanded of a good or service caused by a change in its price relative to substitutes. That is, when the price of apricots increases, apricots become relatively more expensive than nectarines. Therefore, Amy will substitute away from the relatively more expensive apricots and toward the relatively less expensive nectarines. Amy will buy fewer apricots and more nectarines.
The substitution effect, together with the income effect, helps explain why individual demand curves slope downward.)
(The substitution effect refers to the change in the quantity demanded of a good or service caused by a change in its price relative to substitutes. That is, when the price of apricots increases, apricots become relatively more expensive than nectarines. Therefore, Amy will substitute away from the relatively more expensive apricots and toward the relatively less expensive nectarines. Amy will buy fewer apricots and more nectarines.
The substitution effect, together with the income effect, helps explain why individual demand curves slope downward.)
question
Frances has a so-called fruit budget, which she uses to buy only apples and oranges. Assume the price of apples increases. Which of the following is an example of the income effect?
answer
The increase in the price of apples decreases Frances's real income, which forces Frances to buy fewer fruits in general.
(The income effect refers to the change in the quantity demanded of a good or service caused by a change in real income (or purchasing power). That is, when the price of apples increases, Frances's real income (or purchasing power) decreases. This forces Frances to buy fewer total apples and oranges.
The income effect, together with the substitution effect, helps explain why individual demand curves slope downward.)
(The income effect refers to the change in the quantity demanded of a good or service caused by a change in real income (or purchasing power). That is, when the price of apples increases, Frances's real income (or purchasing power) decreases. This forces Frances to buy fewer total apples and oranges.
The income effect, together with the substitution effect, helps explain why individual demand curves slope downward.)
question
Suppose Charles has a monthly budget of $80 to spend on juice and cereal. Juice is priced at $4 per gallon, and cereal is priced at $2 per box.
1) If Charles spends his entire $80 on juice, he can buy ___ gallons of juice.
2) If he spends his entire $80 on cereal, he can buy ___ boxes of cereal.
3) What does the slope of Charles's budget line represent?
4) Suppose Charles receives an additional $20 from his grandmother on top of the $80 he already has and decides to dedicate this money to buy more juice and cereal.
True or False: Charles faces the same tradeoff between juice and cereal.
1) If Charles spends his entire $80 on juice, he can buy ___ gallons of juice.
2) If he spends his entire $80 on cereal, he can buy ___ boxes of cereal.
3) What does the slope of Charles's budget line represent?
4) Suppose Charles receives an additional $20 from his grandmother on top of the $80 he already has and decides to dedicate this money to buy more juice and cereal.
True or False: Charles faces the same tradeoff between juice and cereal.
answer
1) 20
2) 40
(Since cereal is priced at $2 per box, if Charles spends $80 on cereal, he can buy $80/$2 per box=40 boxes of cereal.)
3) The opportunity cost of an additional gallon of juice in terms of boxes of cereal
4) True
2) 40
(Since cereal is priced at $2 per box, if Charles spends $80 on cereal, he can buy $80/$2 per box=40 boxes of cereal.)
3) The opportunity cost of an additional gallon of juice in terms of boxes of cereal
4) True
question
If utility is not maximized, then:
answer
some change in consumption will increase satisfaction
question
A util represents a unit of measurement for the:
answer
happiness a person obtains from consuming a good
question
If total utility from consuming two cups of coffee is 20 utils, and if the total utility from consuming three cups of coffee is 25 utils, then which of the following is the marginal utility of the third cup of coffee?
answer
5
question
When total utility is at a maximum, marginal utility is:
answer
Zero
question
Which of the following best describes the economic concept of utility?
answer
Utility measures the satisfaction, or pleasure, that people receive from consuming a good or service.
The satisfaction, or pleasure, that people receive from consuming a good or service
The satisfaction, or pleasure, that people receive from consuming a good or service
question
The fact that a gallon of gasoline commands a higher market price than a gallon of water indicates that:
answer
the marginal utility of gasoline is greater than the marginal utility of a gallon of water.
question
The term utility refers to the:
answer
pleasure or satisfaction a consumer receives upon consuming a good.
question
Utility is defined as the:
answer
sense of pleasure or satisfaction derived from consuming goods and services.
question
If water is essential for life, while diamonds are not, then why is water cheaper than diamonds?
answer
Because water is abundant, the marginal utility of water is low, and price reflects marginal utility, not total utility.
question
The subjective measure of the physical and mental satisfaction that is anticipated from consumption is called
answer
Utility
question
Which of the following statements is true?
a. Total utility is the extra satisfaction from the consumption of a good or service.
b. Marginal utility is the amount of satisfaction received from all the units of a good or service consumed.
c. The law of diminishing marginal utility states that as more of a good or service is consumed total utility decreases.
d. Consumer equilibrium is a combination of goods and services consumed which maximizes total utility from a given budget.
a. Total utility is the extra satisfaction from the consumption of a good or service.
b. Marginal utility is the amount of satisfaction received from all the units of a good or service consumed.
c. The law of diminishing marginal utility states that as more of a good or service is consumed total utility decreases.
d. Consumer equilibrium is a combination of goods and services consumed which maximizes total utility from a given budget.
answer
D
question
If a consumer wishes to maximize satisfaction given limited income and MUx/Px < MUy/Py then the consumer should:
a. do nothing because she/he is in equilibrium.
b. buy more of X and less of Y.
c. buy more of Y and less of X.
d. buy more of both X and Y.
e. buy less of both X and Y.
a. do nothing because she/he is in equilibrium.
b. buy more of X and less of Y.
c. buy more of Y and less of X.
d. buy more of both X and Y.
e. buy less of both X and Y.
answer
C
question
Consumer equilibrium exists when:
a. the marginal utility of each good and service consumed is equal.
b. the total utility of each good and service consumed is equal.
c. the marginal utility of each good and service consumed equals its price.
d. ratio of marginal utility to price for all goods and services is equal.
a. the marginal utility of each good and service consumed is equal.
b. the total utility of each good and service consumed is equal.
c. the marginal utility of each good and service consumed equals its price.
d. ratio of marginal utility to price for all goods and services is equal.
answer
D
question
When the price of a normal good falls, then:
a. both the income and substitution effects combine to cause the quantity demanded to increase.
b. the substitution effect will cause people to buy more because the good is relatively less expensive.
c. the income effect will cause people to buy more because of the increased purchasing power associated with the lower price.
d. all of the above.
a. both the income and substitution effects combine to cause the quantity demanded to increase.
b. the substitution effect will cause people to buy more because the good is relatively less expensive.
c. the income effect will cause people to buy more because of the increased purchasing power associated with the lower price.
d. all of the above.
answer
D
question
If MUx/Px < MUy/Py, is the consumer in equilibrium, or should the consumer purchase more of X and less of Y, or vice versa?
answer
The consumer is not in equilibrium. To get there, the consumer should purchase more of X and less of Y.
question
Assume a two-good case, goods X and Y, and the consumer is initially in equilibrium. If the price of X declines then explain how a consumer will respond, and why, using the analysis introduced in this chapter. How is this related to the law of demand?
answer
The consumer will purchase more of good X because the marginal utility in relation to the price of good X will now exceed that for good Y. As the consumer purchases more of good X and less of good Y, the consumer will be moving toward an equality between the ratio of the marginal utility of good X in relation to the price paid for good X and that for good Y. Eventually an equality between the two will be observed which defines consumer equilibrium, When we compare the old equilibrium with the new one, we observe more of good X being purchased. That is, because the price of good X fell, the consumer has found that in acting out of her own self-interest that more of X will be purchased. This is exactly what the law of demand predicts---when the price of a good falls, consumers will purchase more of the good.
question
Assume the consumption of just two goods, X and Y. Also assume the consumer is in equilibrium. What do you think would happen to consumer equilibrium given each of the following changes?
answer
a. Income rises. (Because the consumer now has more to spend, the consumer will now purchase more of both X and Y. We are unable to determine exactly how much more of each good will be consumed. We would require more information to determine that (i.e. how much income rose, the marginal utility schedule and the price of goods X and Y)).
b. The price of both X and Y double. (The amount of X and Y would both be cut in half.)
c. The consumer now prefers X more and Y less. (This affects the marginal utility of both goods. The consumer will consume more of X and less of Y.)
b. The price of both X and Y double. (The amount of X and Y would both be cut in half.)
c. The consumer now prefers X more and Y less. (This affects the marginal utility of both goods. The consumer will consume more of X and less of Y.)
question
Suppose you are interested in purchasing just ice cream and cake for an upcoming birthday party. Assume you have only $45 to spend, the price per cake is $10 and the price per package of ice cream is $5. You have estimated the utility (or satisfaction) from the consumption of cake and ice cream according to the following tables.
ICE CREAM
Quantity - Total Utility:
0 - 0
1 - 100
2 - 175
3 - 225
4 - 250
5 - 260
CAKE
Quantity - Total Utility:
0 - 80
1 - 130
2 - 250
3 - 350
4 - 425
5 - 465
a. How many cakes and packages of ice cream should you purchase for the party? Why?
b. Now suppose the price of cake falls to $7.50. Now how many cakes and packages of ice cream should you buy for the party? Why?
c. How is the observed change in the quantity demanded of cake and the decrease in the price of cake related to the law of demand?
ICE CREAM
Quantity - Total Utility:
0 - 0
1 - 100
2 - 175
3 - 225
4 - 250
5 - 260
CAKE
Quantity - Total Utility:
0 - 80
1 - 130
2 - 250
3 - 350
4 - 425
5 - 465
a. How many cakes and packages of ice cream should you purchase for the party? Why?
b. Now suppose the price of cake falls to $7.50. Now how many cakes and packages of ice cream should you buy for the party? Why?
c. How is the observed change in the quantity demanded of cake and the decrease in the price of cake related to the law of demand?
answer
a. You should purchase 3 cakes and 3 packages of ice cream because this satisfies the algebraic formula for consumer equilibrium (i.e. this is the only quantity in which the marginal utility in relation to the price of both goods is equal).
b. Now you should purchase 3 packages of ice cream and 4 cakes.
c. The law of demand states there is an inverse relationship between the price and the quantity demanded. This was observed in this case. The law of demand exists because of the principle of rational choice.
b. Now you should purchase 3 packages of ice cream and 4 cakes.
c. The law of demand states there is an inverse relationship between the price and the quantity demanded. This was observed in this case. The law of demand exists because of the principle of rational choice.
question
Why does the law of demand exist?
answer
Ultimately because of the law of diminishing marginal utility.
substitution effect, income effect, law of diminishing marginal utility
substitution effect, income effect, law of diminishing marginal utility
question
How are the substitution and income effects related to the law of demand?
answer
Because of a lower price people will buy more not only because the product is relatively less expensive (substitution effect), but also because of the increased purchasing power due to the price decrease (income effect).
question
Utility
answer
Ability or capacity of a good or service to be useful and give satisfaction to someone.
question
marginal utility
answer
an additional amount of satisfaction
question
total utility
answer
the total amount of satisfaction obtained from consumption of a good or service
question
consumer equilibrium
answer
when the ratio of the prices of goods is equal to the ratio of the marginal utilities (point at which the consumer can get the most satisfaction)
question
income effect
answer
the change in the quantity demanded of a good that results from the effect of a change in the good's price on consumers' purchasing power
question
substitution effect
answer
The change in quantity demanded of a good or service caused by a change in its price relative to substitutes
Example:
Price of competing good Y rises --> Consumers switch from Y to good X --> Quantity of good X demanded increases.
Example:
Price of competing good Y rises --> Consumers switch from Y to good X --> Quantity of good X demanded increases.
question
law of diminishing marginal utility
answer
The principle that the extra satisfaction provided by a good or service declines as people consume more in a given period
question
marginal utility
answer
The change in total utility from one additional unit of a good or service
question
Why is water less expensive than diamonds?
answer
Even though water provides individuals with more total utility, marginal utility determines the price one is willing to pay. Water is plentiful in most of the world, so its marginal utility is low and therefore one's willingness to pay for water is low. This follows the law of diminishing marginal utility.
question
What is the marginal utility per dollar?
answer
The ratio of the marginal utility of each good to its price
question
What conclusion can we make regarding marginal utility per dollar?
answer
If the marginal utility per last dollar spent on each good is equal and the entire budget is spent, total utility is maximized
question
What is consumer equilibrium?
answer
A condition in which total utility cannot increase by spending more of a given budget on one good and spending less on another good
(MU of good A/Price of good A) = (MU of good B/Price of good B) = (MU of good Z/Price of good Z)
Example:
(MU of Big Mac/Price of Big Mac) = (MU of milkshake/Price of milkshake)
(4 utils/$2) = (4 utils/2)
(MU of good A/Price of good A) = (MU of good B/Price of good B) = (MU of good Z/Price of good Z)
Example:
(MU of Big Mac/Price of Big Mac) = (MU of milkshake/Price of milkshake)
(4 utils/$2) = (4 utils/2)
question
What happens when the price of a good or service falls?
answer
Consumer equilibrium no longer holds because the marginal utility per dollar for the good or service rises
question
How is equilibrium restored?
answer
To restore equilibrium, the consumer must increase consumption. As the quantity demanded increases, the marginal utility falls until equilibrium is again achieved.
question
How does consumer equilibrium relate to the law of demand?
answer
The price falls, and the quantity demanded rises, as predicted by the law of demand.
question
What are two alternative explanations of demand?
answer
•Income effect
•Substitution effect
•Substitution effect
question
What is the income effect?
answer
The change in quantity demanded of a good or service caused by a change in real income (purchasing power)
Example:
Price of good X falls --> Real purchasing power increases --> Quantity of good X demanded increases.
Example:
Price of good X falls --> Real purchasing power increases --> Quantity of good X demanded increases.
question
What conclusion can we make regarding the income effect and the substitution effect?
answer
When the price of a normal good falls, the income effect and the substitution effect combine to cause the quantity demanded to increase.
question
Shen lives in Detroit and runs a business that sells pianos. In an average year, he receives $709,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of $409,000; he also pays wages and utility bills totaling $281,000. He owns his showroom; if he chooses to rent it out, he will receive $1,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Shen does not operate this piano business, he can work as an accountant and receive an annual salary of $29,000 with no additional monetary costs. No other costs are incurred in running this piano business.
answer
Implicit Cost:
- The salary Shen could earn if he worked as an accountant
- The rental income Shen could receive if he chose to rent out his showroom
Explicit Cost:
- The wholesale cost for the pianos that Shen pays the manufacturer
- The wages and utility bills that Shen pays
Accounting Profit:
Accounting: 709,000−($409,000+$281,000) = $19,000
Economic Profit:
$709,000−($409,000+$281,000+$29,000+$1,000) = -$11,000
Alternatively, the economic profit he would earn as a financial advisor would be:
$29,000+$1,000−$19,000 = $11,000
If Shen's goal is to maximize his economic profit, he [SHOULD NOT] stay in the boat business.
Shen is not earning a normal profit because his profit is negative. True
- The salary Shen could earn if he worked as an accountant
- The rental income Shen could receive if he chose to rent out his showroom
Explicit Cost:
- The wholesale cost for the pianos that Shen pays the manufacturer
- The wages and utility bills that Shen pays
Accounting Profit:
Accounting: 709,000−($409,000+$281,000) = $19,000
Economic Profit:
$709,000−($409,000+$281,000+$29,000+$1,000) = -$11,000
Alternatively, the economic profit he would earn as a financial advisor would be:
$29,000+$1,000−$19,000 = $11,000
If Shen's goal is to maximize his economic profit, he [SHOULD NOT] stay in the boat business.
Shen is not earning a normal profit because his profit is negative. True
question
Lorenzo lives in San Diego and runs a business that sells boats. In an average year, he receives $723,000 from selling boats. Of this sales revenue, he must pay the manufacturer a wholesale cost of $423,000; he also pays wages and utility bills totaling $267,000. He owns his showroom; if he chooses to rent it out, he will receive $2,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Lorenzo does not operate this boat business, he can work as a financial advisor and receive an annual salary of $20,000 with no additional monetary costs. No other costs are incurred in running this boat business.
answer
Implicit Cost:
- The salary Lorenzo could earn if he worked as a financial advisor
- The rental income Lorenzo could receive if he chose to rent out his showroom
Explicit Cost:
- The wholesale cost for the boats that Lorenzo pays the manufacturer
- The wages and utility bills that Lorenzo pays
Accounting Profit:
Accounting: 723,000−($423,000+$267,000) = $33,000
Economic Profit:
$723,000−($423,000+$267,000+$20,000+$2,000) = $11,000
Alternatively, the economic profit he would earn as a financial advisor would be:
$20,000+$2,000−$33,000 = −$11,000
If Lorenzo's goal is to maximize his economic profit, he [SHOULD] stay in the boat business.
(because he would earn less economic profit (total revenue minus all explicit and implicit costs) if he were to rent out the space and work as a financial advisor.)
Lorenzo is earning a normal profit because his profit is positive. False
(A normal profit is zero economic profit. A firm earns zero economic profit when its revenue is just enough to pay the owners for all explicit and implicit costs. Because Lorenzo's economic profit is positive, he is not earning a normal profit. The same would be true if he earned a negative economic profit.)
- The salary Lorenzo could earn if he worked as a financial advisor
- The rental income Lorenzo could receive if he chose to rent out his showroom
Explicit Cost:
- The wholesale cost for the boats that Lorenzo pays the manufacturer
- The wages and utility bills that Lorenzo pays
Accounting Profit:
Accounting: 723,000−($423,000+$267,000) = $33,000
Economic Profit:
$723,000−($423,000+$267,000+$20,000+$2,000) = $11,000
Alternatively, the economic profit he would earn as a financial advisor would be:
$20,000+$2,000−$33,000 = −$11,000
If Lorenzo's goal is to maximize his economic profit, he [SHOULD] stay in the boat business.
(because he would earn less economic profit (total revenue minus all explicit and implicit costs) if he were to rent out the space and work as a financial advisor.)
Lorenzo is earning a normal profit because his profit is positive. False
(A normal profit is zero economic profit. A firm earns zero economic profit when its revenue is just enough to pay the owners for all explicit and implicit costs. Because Lorenzo's economic profit is positive, he is not earning a normal profit. The same would be true if he earned a negative economic profit.)
question
Explicit costs
answer
Payments to nonowners of a firm for their resources; these costs require an outlay of money by the firm.
question
Implicit costs
answer
The opportunity costs of using resources owned by a firm; these costs do not involve any monetary transactions.
question
Accounting profit
answer
equal to total revenue minus total explicit costs. In this case, total explicit costs are the sum of the wholesale cost and wages and utility bills.
Accounting Profit = Total Revenue−Total Explicit Costs
Accounting Profit = Total Revenue−Total Explicit Costs
question
Economic Profit
answer
equal to total revenue minus total opportunity costs (which is the sum of explicit costs and implicit costs). In this case, total opportunity costs equal the sum of the wholesale cost, wages and utility bills, forgone salary income, and forgone rental income.
= Total Revenue−Total Opportunity Costs
= Total Revenue−(Total Explicit Costs+Total Implicit Costs)
= Total Revenue−Total Opportunity Costs
= Total Revenue−(Total Explicit Costs+Total Implicit Costs)
question
Kenji's Performance Pizza is a small restaurant in San Diego that sells gluten-free pizzas. Kenji's very tiny kitchen has barely enough room for the two ovens in which his workers bake the pizzas. Kenji signed a lease obligating him to pay the rent for the two ovens for the next year. Because of this, and because Kenji's kitchen cannot fit more than two ovens, Kenji cannot change the number of ovens he uses in his production of pizzas in the short run.
answer
However, Kenji's decision regarding how many workers to use can vary from week to week because his workers tend to be students. Each Monday, Kenji lets them know how many workers he needs for each day of the week. In the short run, these workers are [VARIABLE] inputs, and the ovens are [FIXED] inputs.
The shape of the production function reflects the law of diminishing returns. TRUE
(The slope of the production function measures the change in output for each additional unit of labor input (the marginal product). From the graph, you can see that the production function becomes flatter as the number of workers increases. This represents the principle of diminishing returns.)
The shape of the production function reflects the law of diminishing returns. TRUE
(The slope of the production function measures the change in output for each additional unit of labor input (the marginal product). From the graph, you can see that the production function becomes flatter as the number of workers increases. This represents the principle of diminishing returns.)
question
When hiring the first and second workers, Kevin's Burrito Stand faces [increasing] marginal returns to labor.
answer
The first worker adds 50 burritos per day. Adding a second worker generates an additional 100 burritos per day. The firm therefore faces increasing marginal returns over this range of employment.
The third worker adds 50 burritos per day, less than the additional output from the second worker. The marginal product from the fourth worker (25 burritos per day) is less than that from the third. In hiring additional workers beyond the second employee, the firm faces diminishing marginal returns in accordance with the law of diminishing returns. In this case, the law of diminishing returns holds that the marginal product eventually begins to decline as more and more workers are added to a fixed number of grills.
The third worker adds 50 burritos per day, less than the additional output from the second worker. The marginal product from the fourth worker (25 burritos per day) is less than that from the third. In hiring additional workers beyond the second employee, the firm faces diminishing marginal returns in accordance with the law of diminishing returns. In this case, the law of diminishing returns holds that the marginal product eventually begins to decline as more and more workers are added to a fixed number of grills.
question
Over the range of workers for which the marginal product is decreasing, Kevin's Burrito Stand faces [increasing] marginal cost.
answer
The marginal product of the third worker (50 burritos per day) is lower than that of the second worker (100 burritos per day). Similarly, the marginal product of the fourth worker is lower than that of the third. The firm experiences diminishing marginal returns over the range of three to five workers. From the table, you can see that marginal cost increases over this range of workers. Recall that marginal cost is simply the ratio of the change in cost to the change in output. Since the cost of hiring all workers is the same ($100 per day), marginal cost will increase so long as the last worker hired has a lower marginal product than the previous worker.
question
When hiring its third worker, Neha's Big Burger faces diminishing marginal returns to labor.
answer
The first worker adds 20 burgers per day. Adding a second worker generates an additional 30 burgers per day. The firm therefore faces increasing marginal returns over this range of employment.
The third worker adds 20 burgers per day, less than the additional output from the second worker. The marginal product from the fourth worker (15 burgers per day) is less than that from the third. In hiring additional workers beyond the second employee, the firm faces diminishing marginal returns in accordance with the law of diminishing returns. In this case, the law of diminishing returns holds that the marginal product eventually begins to decline as more and more workers are added to a fixed number of grills.
The third worker adds 20 burgers per day, less than the additional output from the second worker. The marginal product from the fourth worker (15 burgers per day) is less than that from the third. In hiring additional workers beyond the second employee, the firm faces diminishing marginal returns in accordance with the law of diminishing returns. In this case, the law of diminishing returns holds that the marginal product eventually begins to decline as more and more workers are added to a fixed number of grills.
question
Over the range of workers for which the marginal product is increasing, Neha's Big Burger faces decreasing marginal cost.
answer
The marginal product of the second worker (30 burgers per day) is higher than that of the first worker (20 burgers per day), so the firm experiences increasing marginal product over this range of hires. From the table, you can see that marginal cost declines over this range of workers. Recall that marginal cost is simply the ratio of the change in cost to the change in output. Since the cost of hiring all workers is the same ($60 per day), marginal cost will decline so long as the last worker hired has a higher marginal product than the previous worker.
question
Sam quits his job as an airline pilot and opens his own pilot training school. He was earning $40,000 as a pilot. He withdraws $10,000 from his savings where he was earning 6 percent interest and uses the money in his new business. He uses a building he owns as a hanger and could rent it out for $5,000 per year. He rents a computer for $1,200, buys office supplies for $500, rents an airplane for $6,000, pays $1,300 for fuel and maintenance, and hires one worker for $30,000. Sam's total revenue from pilot training classes this year equaled $90,400. Sam's accounting profit this year equals:
answer
$51,400
question
A firm has $200 million in total revenue and explicit costs of $190 million. Suppose its owners have invested $100 million in the company at an opportunity cost of 10 percent interest rate per year. The firm's economic profit is:
answer
Zero
question
The difference between a firm's total revenues and total costs when all explicit and implicit costs are included is the firm's:
answer
economic profit.
question
Paul's Plumbing is a small business that employs 12 people. Which of the following is the best example of an implicit cost incurred by this firm?
answer
The accounting services provided free of charge to the firm by Paul's wife, who is an accountant.
question
A young chef is considering opening his own sushi bar. To do so, he would have to quit his current job, which pays $20,000 a year, and take over a store building that he owns and currently rents to his brother for $6,000 a year. His expenses at the sushi bar would be $50,000 for food and $2,000 for gas and electricity. What is the sum of his explicit costs?
answer
$52,000
question
Unlike implicit costs, explicit costs:
answer
are actual cash payments.
question
The opportunity costs associated with the use of resources owned by a firm are:
answer
implicit costs.
question
Cash payments to a steel mill for steel used in production would be an example of:
answer
explicit costs.
question
When total revenue minus total cost is equal to zero, the firm is:
answer
earning a normal profit.
question
Which of the following would be considered an implicit cost?
answer
Foregone rent on assets owned by the firm
question
Which of the following statements is true?
a. Economic profit equals accounting profit minus implicit costs.
b. The short run is any period of time in which there is at least one fixed input.
c. A fixed input is any resource for which the quantity cannot change during the period under consideration.
d. In the long run there are no fixed costs.
e. All of the above.
a. Economic profit equals accounting profit minus implicit costs.
b. The short run is any period of time in which there is at least one fixed input.
c. A fixed input is any resource for which the quantity cannot change during the period under consideration.
d. In the long run there are no fixed costs.
e. All of the above.
answer
e. All of the above.
question
Which of the following statements is true?
a. The law of diminishing returns states that beyond some point the marginal product of a variable resource continues to rise.
b. The marginal product is the change in total output by adding one additional unit of a fixed input.
c. Fixed costs are costs which vary with the output level.
d. When marginal productivity of a variable input is falling then marginal costs of production must be rising.
e. When marginal cost is below average cost, average cost rises; when marginal cost is above average cost, average cost falls.
a. The law of diminishing returns states that beyond some point the marginal product of a variable resource continues to rise.
b. The marginal product is the change in total output by adding one additional unit of a fixed input.
c. Fixed costs are costs which vary with the output level.
d. When marginal productivity of a variable input is falling then marginal costs of production must be rising.
e. When marginal cost is below average cost, average cost rises; when marginal cost is above average cost, average cost falls.
answer
d. When marginal productivity of a variable input is falling then marginal costs of production must be rising.
question
Which of the following statements is false?
a. TC = TFC + TVC.
b. AVC = ATC - AFC.
c. AFC = TFC/Q.
d. MC equals the change in ATC divided by the change in Q.
e. ATC = TC/Q.
a. TC = TFC + TVC.
b. AVC = ATC - AFC.
c. AFC = TFC/Q.
d. MC equals the change in ATC divided by the change in Q.
e. ATC = TC/Q.
answer
d. MC equals the change in ATC divided by the change in Q.
question
If a firm enlarges its factory size and realizes higher average (per unit) costs of production then:
a. it has experienced economies of scale.
b. it has experienced diseconomies of scale.
c. it has experienced constant returns to scale.
d. the long-run average cost curve slopes downward.
e. the long-run average cost curve shifts upward.
a. it has experienced economies of scale.
b. it has experienced diseconomies of scale.
c. it has experienced constant returns to scale.
d. the long-run average cost curve slopes downward.
e. the long-run average cost curve shifts upward.
answer
b. it has experienced diseconomies of scale.
question
Why does the marginal cost curve intersect the average variable and average total cost curves at their respective minimum points?
answer
Whenever the marginal lies below the average it pulls the average down. Whenever the marginal lies above the average it pulls the average up. Think of baseball. Whenever an extra player is added to the team whom has a batting average above the team's average then it pulls the team's average up; and vice versa.
question
If a firm wished to minimize its cost of production then what output level should it produce?
answer
Produce that output in which average total cost is at a minimum---the output where the ATC curve is lowest.
question
How can the extent to which economies or diseconomies of scale are experienced help us to predict the size and number of real-world firms in an industry?
answer
If economies of scale are quite extensive (the curve slopes downward over the relevant range of output) then we would expect to find a small number of very large scale firms (possibly only one firm in the case of a natural monopoly) operating in this market; and vice versa.
question
Some companies advertise: "We deal in high volume and pass our savings on to you in the form of lower prices." How could this be?
answer
They are experiencing economies of scale which result in lower per unit costs which can be passed on to consumers in the form of lower prices without sacrificing their per unit profits.
question
Many people search out and purchase "bargains" at garage and yard sales. What are some implicit costs associated with this type of shopping?
answer
Time and gas money spent. Plus, there is no guarantee how long these used items may last. These types of purchases may not be "bargains" after all.
question
Is the "best" quantity of workers to hire where the marginal productivity of the last worker employed is the greatest (which implies an output level in which the marginal cost of producing additional units is the cheapest)?
answer
No. The objective is to maximize profits, not to maximize marginal productivity (or to minimize the extra cost of producing the last unit of output).
question
Why do marginal costs of production rise?
answer
Because of the law of diminishing returns (diminishing marginal productivity)
question
If a firm has $20,000 in total fixed costs, is producing 100 units, has average total cost equal to $240, then what is its average variable cost of production?
answer
$40. Note: ATC - AFC = AVC. AFC = TFC/Q = $200. So, $240 - $200 = $40.
question
explicit costs
answer
costs that require a firm to spend money
Payments to nonowners of a firm for their resources
Payments to nonowners of a firm for their resources
question
production function
answer
The relationship between the maximum amounts of output a firm can produce and various quantities of inputs
question
average variable cost (AVC)
answer
Total variable cost divided by the quantity of output produced
AVC = TV
AVC = TV
question
implicit costs
answer
Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur
The opportunity costs of using resources owned by a firm
The opportunity costs of using resources owned by a firm
question
marginal product
answer
The change in total output produced by adding one unit of a variable input, with all other inputs used being held constant
question
average total cost (ATC)
answer
Total cost divided by the quantity of output produced
ATC = TC / Q
or
ATC = AFC + AVC
ATC = TC / Q
or
ATC = AFC + AVC
question
economic profit
answer
Total revenue minus explicit and implicit costs
Economic profit = total revenue - (explicit costs + implicit costs)
or
Economic profit = total revenue - total opportunity costs
Economic profit = total revenue - (explicit costs + implicit costs)
or
Economic profit = total revenue - total opportunity costs
question
law of diminishing returns
answer
The principle that beyond some point the marginal product decreases as additional units of a variable factor are added to a fixed factor
question
long-run average cost (LRAC)
answer
...
question
normal profit
answer
The minimum profit necessary to keep a firm in operation; a firm that earns normal profits earns total revenue equal to its total opportunity cost
question
total fixed cost (TFC)
answer
Costs that do not vary as output varies and that must be paid even if output is zero; these are payments that the firm must make in the short run, regardless of the level of output.
question
economies of scale
answer
A situation in which the long-run average cost curve declines as the firm increases output
question
fixed input
answer
Any resource for which the quantity cannot change during the period of time under consideration
question
total variable cost (TVC)
answer
Costs that are zero when output is zero and vary as output varies
question
constant returns to scale
answer
A situation in which the long-run average cost curve does not change as the firm increases output
question
variable input
answer
Any resource for which the quantity can change during the period of time under consideration
question
total cost (TC)
answer
The sum of total fixed cost and total variable cost at each level of output
TC = TFC + TVC
TC = TFC + TVC
question
diseconomies of scale
answer
A situation in which the long-run average cost curve rises as the firm increases output
question
short run
answer
A period of time so short that there is at least one fixed input
question
marginal cost (MC)
answer
The change in total cost when one additional unit of output is produced
MC = change in TC / change in Q
MC = change in TC / change in Q
question
marginal-average rule
answer
...
question
long run
answer
A period of time so long that all inputs are variable
question
average fixed cost (AFC)
answer
Total fixed cost divided by the quantity of output produced
AFC = TFC / Q
AFC = TFC / Q
question
Accounting profit
answer
Accounting profit = total revenue - total explicit cost
question
Why is economic profit important for decision-making purposes?
answer
Economic profit includes implicit costs and accounting profit does not.
question
What does normal profit signify?
answer
A normal profit is a zero economic profit, and it signifies there is just enough total revenue to pay the owners for all explicit and implicit costs.
question
What conclusion can we make regarding economic profit and accounting profit?
answer
Since business decision making is based on economic profit, rather than accounting profit, the word profit in this text always means economic profit.
question
What does the law of diminishing returns assume?
answer
The law of diminishing returns assumes at least one fixed input; thus, this principle is a short-run, rather than a long-run, concept.
question
What are the three total cost curves?
answer
1. Total fixed cost
2. Total variable cost
3. Total cost
2. Total variable cost
3. Total cost
question
What are examples of fixed costs?
answer
•Rent
•Interest on loans
•Property taxes
•Interest on loans
•Property taxes
question
What are examples of variable costs?
answer
•Wages for hourly workers
•Electricity
•Raw materials
•Electricity
•Raw materials
question
What are the three average cost curves?
answer
1.Average fixed cost
2.Average variable cost
3.Average total cost
2.Average variable cost
3.Average total cost
question
What is the marginal-average rule?
answer
The rule that states when marginal cost is below average cost, average cost falls; when average cost is above average cost, average cost rises; when marginal cost equals average cost, average cost is at its minimum point
question
What is the relationship between marginal cost and marginal product?
answer
Marginal cost and marginal product are mirror images of each other.
question
What conclusion can we make regarding marginal cost and marginal product?
answer
The marginal cost declines as the marginal product of a variable input rises. Beginning at the point of diminishing returns, the marginal cost rises as the marginal product of a variable input declines.
question
What conclusion can we make regarding firms operating in the short run and long run?
answer
A firm operates in the short run when there is insufficient time to alter some fixed input. The firm plans in the long run when all inputs are variable.
question
What is the long-run average cost curve (LRAC)?
answer
The curve that traces the lowest cost per unit at which a firm can produce any level of output when the firm can build any desired plant size
question
What conclusion can we make regarding the choice of plant size by a firm?
answer
The plant size selected by a firm in the long run depends on the expected level of production.
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