Understanding Costs, Profits, and Production in Economics
Which of the following is true?
b. Economic profits are generally lower than accounting profits.
For most firms, the major difference between accounting profit and economic profit is that
c. accounting profit does not consider the opportunity cost of the firm’s equity capital.
Sunk or “historical” costs are costs
a. that have already been incurred as the result of past decisions.
The sum of the explicit and implicit costs incurred in the production process is called
a. total cost.
Mr. Capps recently built a dental floss factory in Montana. It cost $500,000 and is expected to last ten years. The plant can only be used to produce dental floss and will have no scrap value. When a recession occurs, the yearly revenue from the plant declines to $35,000, compared to costs of $25,000 just for the variable resources required to produce the current rate of output. Mr. Capps should
d. continue to operate since he is covering his variable costs and the cost of the plant is a sunk cost.
Which of the following explains why business owners have a strong incentive to strive for operational efficiency?
b. Since the owners are residual income claimants, increased efficiency will mean a higher income for the owners.
Which of the following is most likely to be an implicit cost of production?
d. The rental income foregone because the business owns its building.
In the short run, a firm will eventually experience rising per-unit costs because of
d. the law of diminishing returns.
Bart operates a lemonade stand in front of his house. His father works at the Springfield Nuclear Power Plant. Which of the following is most likely to be true?
e. The long run is longer for the power plant than it is for the lemonade stand.
If two workers can produce 22 units of output, and the addition of a third worker increases output to 30 units, the marginal product of the third worker is
a. 8 units.
Fixed costs are best defined as
d. costs that are at a minimum when output approaches the firm’s capacity.
The rate of return that owners of capital must receive in order to induce them to continue supplying the capital is often referred to as
c. the normal or market rate of return.
When total revenue minus total economic cost is greater than zero, the firm is
b. earning higher than normal profits.
The implicit rate of return that must be paid to induce investors to continue to supply the funds necessary to maintain a firm’s capital assets is called
a. the opportunity cost of capital.
Suppose a professor gives up her teaching job to devote her time to writing textbooks. If salaries of professors rise,
d. her economic profit from textbooks will fall.
The law of diminishing returns
a. explains why marginal cost eventually increases as output expands.
Which of the following explains most accurately why the firm’s short-run marginal cost curve will eventually rise?
d. When diminishing marginal returns set in, it will take ever-larger quantities of the variable resources to produce an additional unit of output.
Before entry into an industry, a profit-maximizing decision-maker will compare the expected market price with the expected
d. long-run average total cost.
An airline can increase its profit by offering standby customers an unsold seat at a substantial discount just before takeoff because
d. the marginal cost of additional passengers is very small.
Interest foregone on financial capital invested in a firm represents an economic cost
b. because funds invested in the firm could be earning interest elsewhere.
What is the difference between accounting profit and economic profit?
d. Accounting profit makes no allowance for several implicit costs, including equity capital, while economic profit takes these costs into account.
Sally leaves her $34,000 secretarial position and invests her savings of $15,000 (on which she was earning 6 percent interest) to start her own agency. After expenses, her net income was $38,900. Her economic profit was
d. $4,000.
Mr. Hudson notes that if he produces 10 pairs of shoes per day, his average fixed cost (AFC) is $14 and his marginal cost is $8; if he produces 20 pairs of shoes per day, his MC is $15. What is his AFC when output is 20 pairs of shoes per day?
d. $7
Suppose you value watching a movie at $5. You rent it from your local movie rental store for $3.50 for one night. You do not get a chance to watch it, so you decide to keep it an extra day and pay a late fee of $2. Your decision is
d. correct; the $3.50 paid for the first night is a sunk cost and is not relevant in your decision to keep it an additional night.
Which of the following provides the best explanation for diseconomies of scale?
c. Large management structures may be bureaucratic and inefficient.
When an economist says a firm is earning zero economic profit, this implies that the firm
c. is earning as high a rate of return now as could be earned in other industries.
The owners of a business
a. are residual income claimants.
If a firm increases its output and finds that its average total cost decreases as a result, this implies that
c. average total cost exceeds marginal cost.
In recent years, the number of farms has fallen while the average farm size has increased. What concept may explain this phenomenon?
b. economies of scale
A homeowner will be away from her house for six months. The monthly mortgage payment on the house is $1,000. The owner’s cost of utilities is $100 if the house is unoccupied but $300 if the owner
but $300 if the owner