MicroEconomics Chapter 8 Roger A. Arnold 10th edition self-test
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14 terms
Terms | Definitions |
|---|---|
 Will individuals form teams or firms in all settings? | No. Individuals will form teams or firms only when the sum of what they can produce as a team (or firm) is greater than the sum of what they can produce working alone. |
| Suppose everything about two people is the same except that currently one person earns a high salary and the other person earns a low salary. Which is more likely to start his or her own business and why? | The person earning the low salary has lower implicit costs and so is more likely to start a business. She gives up less to start a business. |
| Is accounting profit or economic profit larger? Why? | Accounting profit is larger. Only explicit costs are subtracted from total revenue in computing accounting profit, but both explicit and implicit costs are subtracted from total revenue in computing economic profit. If implicit costs are zero, then accounting profit and economic profit are the same. Economic profit is never greater than accounting profit. |
| When can a business owner be earning a profit but not covering costs? | A business owner can be earning a profit but not covering costs when he is earning (positive) accounting profit but his total revenue does not cover the sum of his explicit and implicit costs. For example, suppose Brad earns total revenue of $100,000 and has explicit costs of $40,000 and implicit costs of $70,000. His accounting profit is $60,000, but his total revenue of $100,000 is not large enough to cover the sum of his explicit and implicit costs ($110,000). Brad's economic profit is a negative $10,000. In other words, although Brad earns an accounting profit, he takes an economic loss. |
| If the short run is 6 months, does it follow that the long run is longer than 6 months? Explain your answer. | No. The short run and the long run are not lengths of time. The short run is that period of time when some inputs are fixed and therefore the firm has fixed costs. The long run is any period of time when no inputs are fixed (i.e., all inputs are variable) and thus all costs are variable costs. The short run can be, say, six months, and the long run can be a much shorter period of time. In other words, the time period when there are no fixed inputs can be shorter than the time period when there are fixed inputs. |
| "As we add more capital to more labor, eventually the law of diminishing marginal returns will set in." What is wrong with this statement? | The law of diminishing marginal returns holds only when we add more of one input to a given (fixed) quantity of another input. The statement does not identify one input as fixed (it says that both increase), and so the law of diminishing marginal returns is not relevant in this situation. |
| Suppose a marginal cost (MC) curve falls when output is in the range of 1 unit to 10 units. Then it flattens out and remains constant over an output range of 10 units to 20 units, and then rises over a range of 20 units to 30 units. What does this have to say about the marginal physical product (MPP) of the variable input? | When MC is declining, MPP is rising; when MC is constant, MPP is constant; and when MC is rising, MPP is falling. |
| Identify two ways to compute average total cost (ATC). | ATC = TC/Q and ATC = AFC + AVC. |
| Would a business ever sell its product for less than cost? Explain your answer. | Yes. Suppose a business incurs a cost of $10 to make a product. Before it can sell the product, though, the demand for it falls and moves the market price from $15 to $6. Does the owner of the business say, "I can't sell the product for $6 because I'd be taking a loss"? If she does, she chooses to let a sunk cost affect her current decision. Instead, she should ask herself, "Do I think the market price of the product will rise or fall?" If she thinks it will fall, she should sell the product today for $6. |
| What happens to unit costs as marginal costs rise? Explain your answer. |  Unit costs are another name for average total costs (ATC); so the question is what happens to ATC as MC rises? You might be inclined to say that as MC rises, so does ATC, but this is not necessarily so [see region 1 in Exhibit 6(b)]. What matters is whether MC is greater than ATC. If it is, then ATC will rise. If it is not, then ATC will decline. This is a trick question of sorts. There is a tendency to misinterpret the average-marginal rule and to believe that as marginal cost rises, average total cost rises and that as marginal cost falls, average total cost falls. But the average-marginal rule actually says that when MC is above ATC, ATC rises, and when MC is below ATC, ATC falls. |
| Do changes in marginal physical product influence unit costs? Explain your answer. | Yes. As marginal physical product (MPP) rises, marginal cost (MC) falls. If MC falls enough to move below unit cost (which the same is as average total cost), then unit cost declines. Similarly, as MPP falls, MC rises. If MC rises enough to move above unit cost, then unit cost rises. |
| Give an arithmetical example to illustrate economies of scale. | It currently takes 10 units of X and 10 units of Y to produce 50 units of good Z. Let both X and Y double to 20 units each. As a result, the output of Z more than doubles—say, to 150 units. When inputs are increased by some percentage and output increases by a greater percentage, then economies of scale are said to exist. When economies of scale exist, unit costs fall, and another name for unit costs is average total costs. |
| What would the LRATC curve look like if there were always constant returns to scale? Explain your answer. | The LRATC curve would be horizontal. When there are constant returns to scale, output doubles if inputs double. If this happens, unit costs stay constant. In other words, they don't rise and they don't fall; so the LRATC curve is horizontal. |
| Firm A charged $4 per unit when it produced 100 units of good X, and it charged $3 per unit when it produced 200 units. Furthermore, the firm earned the same profit per unit in both cases. How can this happen? | Unit costs must have been lower when it produced 200 units than when it produced 100 units. That is, there were economies of scale between 100 units and 200 units. To explain further, profit per unit is the difference between price per unit and cost per unit (or unit costs): Profit per unit = Price per unit − Cost per unit. Suppose the unit cost is $3 when the price is $4—giving a profit per unit of $1. Next, there are economies of scale as the firm raises output from 100 units to 200 units. Unit costs must fall—let's say to $2 per unit. If price is $3, then there is still a $1 per-unit profit. |
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