Self-Check Questions

long-run average cost curve determines how many firms will exist in a given industry. If the quantity demanded in the market of a certain product is much greater than the quantity found at the bottom of the long-run average cost curve, where the cost of production is lowest, the market will have many firms competing. If the quantity demanded in the market is less than the quantity at the bottom of the LRAC, there will likely be only one firm.

Self-Check Questions

1 . A firm had sales revenue of $1 million last year. It spent $600,000 on labor, $150,000 on capital and $200,000 on materials. What was the firm’s accounting profit? 2 . Continuing from Exercise 7.1, the firm’s factory sits on land owned by the firm that it could rent for $30,000 per year. What was the firm’s economic profit last year? 3 . The WipeOut Ski Company manufactures skis for beginners. Fixed costs are $30. Fill in Table 7.16 for total cost, average variable cost, average total cost, and marginal cost. Quantity Variable Fixed Total Average Variable Average Total Marginal Cost Cost Cost Cost Cost Cost 0 0 $30 1 $10 $30 2 $25 $30 3 $45 $30 4 $70 $30 5 $100 $30 6 $135 $30 TABLE 7.16 4 . Based on your answers to the WipeOut Ski Company in Exercise 7.3, now imagine a situation where the firm produces a quantity of 5 units that it sells for a price of $25 each. a. What will be the company’s profits or losses? b. How can you tell at a glance whether the company is making or losing money at this price by looking at average cost? c. At the given quantity and price, is the marginal unit produced adding to profits? 5 . If two painters can paint 200 square feet of wall in an hour, and three painters can paint 275 square feet, what is the marginal product of the third painter? 6 . Return to the problem explained in Table 7.13 and Table 7.14. If the cost of labor remains at $40, but the cost of a machine decreases to $50, what would be the total cost of each method of production? Which method should the firm use, and why? 7 . Suppose the cost of machines increases to $55, while the cost of labor stays at $40. How would that affect the total cost of the three methods? Which method should the firm choose now? 8 . Automobile manufacturing is an industry subject to significant economies of scale. Suppose there are four domestic auto manufacturers, but the demand for domestic autos is no more than 2.5 times the quantity produced at the bottom of the long-run average cost curve. What do you expect will happen to the domestic auto industry in the long run?

Review Questions

9 . What are explicit and implicit costs? 10 . Would you consider an interest payment on a loan to a firm an explicit or implicit cost? 11 . What is the difference between accounting and economic profit? 12 . What is a production function? 13 . What is the difference between a fixed input and a variable input? 14 . How do we calculate marginal product? 15 . What shapes would you generally expect a total product curve and a marginal product curve to have? 16 . What are the factor payments for land, labor, and capital? 17 . What is the difference between fixed costs and variable costs? 18 . How do we calculate each of the following: marginal cost, average total cost, and average variable cost? 19 . What shapes would you generally expect each of the following cost curves to have: fixed costs, variable costs, marginal costs, average total costs, and average variable costs? 20 . Are there fixed costs in the long-run? Explain briefly. 21 . Are fixed costs also sunk costs? Explain. 22 . What are diminishing marginal returns as they relate to costs? 23 . Which costs are measured on per-unit basis: fixed costs, average cost, average variable cost, variable costs, and marginal cost? 24 . What is a production technology? 25 . In choosing a production technology, how will firms react if one input becomes relatively more expensive? 26 . What is a long-run average cost curve? 27 . What is the difference between economies of scale, constant returns to scale, and diseconomies of scale? 28 . What shape of a long-run average cost curve illustrates economies of scale, constant returns to scale, and diseconomies of scale? 29 . Why will firms in most markets be located at or close to the bottom of the long-run average cost curve?

Critical Thinking Questions

30 . Small “Mom and Pop firms,” like inner city grocery stores, sometimes exist even though they do not earn economic profits. How can you explain this? 31 . A common name for fixed cost is “overhead.” If you divide fixed cost by the quantity of output produced, you get average fixed cost. Suppose fixed cost is $1,000. What does the average fixed cost curve look like? Use your response to explain what “spreading the overhead” means. 32 . How does fixed cost affect marginal cost? Why is this relationship important? 33 . Average cost curves (except for average fixed cost) tend to be U-shaped, decreasing and then increasing. Marginal cost curves have the same shape, though this may be harder to see since most of the marginal