TRUE/FALSE
3. When economists speak of a firm’s costs, they are usually excluding the opportunity costs.
4. Accounting profit and economic profit are two ways to say the same thing.
5. Accountants keep track of the money that flows into and out of firms.
6. Implicit costs that do not require a money outlay are typically ignored by economists.
7. Costs that have already been incurred and are non-recoverable should be included in marginal cost
calculations.
8. The cost of capital includes both any interest payments in loans as well as any forgone interest on
savings used to finance the business.
9. The fact that many decisions are fixed in the short run but variable in the long run has an impact on
the firm’s cost curves.
10. The short run is defined as the period of time in which all factors of production are fixed.
ANS: F PTS: 1 DIF: Easy TOP: How long is the long
run?
11. When trying to understand the decision making process of different firms, economists assume that
people think at the margin.
12. The shape of the total cost curve is unrelated to the shape of the production function.
13. If the total cost curve becomes flatter as output increases, then this reveals diminishing marginal
product.
14. Diminishing marginal product exists when the production function becomes flatter as inputs
increase.
15. Several related measures of cost can be derived from a firm’s total cost.
16. Even if a firm was to produce nothing, it still incurs some variable costs in the short-run.
17. Variable costs usually change as the firm alters the quantity of output produced.
18. Average variable cost and marginal cost are two ways for economists to say the same thing.
19. The cost of producing an additional unit of a good is not the same as the average cost of the good.
20. Average variable cost is equal to the quantity of output divided by the total variable cost.
21. The average total cost curve is unaffected by diminishing marginal product.
ANS: F PTS: 1 DIF: Moderate TOP: Cost curves and their
shapes
22. The average total cost curve reflects the shape of both the average fixed cost and average variable
cost curves.
23. The marginal cost curve can rise even if the average total cost is falling.
24. The marginal cost curve bisects the average total cost curve at the minimum point of the average
total cost curve.
25. A second or third worker may have a higher marginal product than the first worker in certain
circumstances.
26. The marginal cost curve intersects the average variable cost curve at the minimum of the average
variable cost curve.
27. If a firm incurs fixed costs the average variable cost curve will always lie below the average total
cost curve.
28. Suppose that as a firm expands and notices that its long-run average total costs are declining. The
most likely explanation for this is economies of scale.
29. In some cases, specialisation allows larger factories to produce goods at a lower average cost than
smaller factories.
30. The use of specialisation to achieve economies of scale is one reason modern societies are as
prosperous as they are.
31. The firm’s total cost can be used to determine both the firm’s average total cost and its marginal
cost.
32. Average total cost reveals how much total cost will change as the firm alters its level of
production.
33. The marginal product of a firm’s workers is revealed by the shape of the marginal cost curve.
34. When average total cost rises if a producer either increases or decreases production, then the firm
is said to be operating at efficient scale.
35. As a firm moves along its long-run average cost curve, it is adjusting the size of its factory to the
quantity of production.
36. Because of the greater flexibility that firms have in the long run, all short-run cost curves lie on or
above the long-run curve.
37. The time it takes for a firm to reach the long run depends on the firm and the products it makes.
38. The adage ‘Jack of all trades, master of none’ helps explain why some firms experience economies
of scale.
39. Adam Smith’s example of the pin factory demonstrates that economies of scale result from
specialisation.
40. Implicit costs are costs that do not require an outlay of cash by the firm.
ANS: T PTS: 1 DIF: Easy TOP: Costs as opportunity
costs
42. The relationship between the quantity of inputs and quantity of output is called the production
function.
MULTIPLE CHOICE
4. The amount of money that a firm receives from the sale of its output is called:
A. total revenue
B. total gross profit
C. total net profit
D. net revenue
10. Those things that must be forgone to acquire a good are called:
A. competitors
B. substitutes
C. opportunity costs
D. explicit costs
18. To an economist, the field of industrial organisation answers which of the following questions?
A. How does the difference in the number of firms affect prices and efficiency of market
outcomes?
B. Why are consumers subject to the law of demand?
C. Why do firms experience falling marginal product of labour?
D. Why do firms consider production costs when determining product supply?
20. Mosti, a materials engineer, has discovered a groundbreaking new way to make recycled plastic
stronger. He is looking to exploit this discovery by starting up his own business at a cost of $500
000. Unfortunately Mosti has only $200 000 in savings and must borrow the other $300 000. If the
interest rate is 10%, then what, according to an economist, is the opportunity cost of starting up the
business?
A. $500,000 per annum
B. $50,000 per annum
C. $30,000 per annum
D. $20,000 per annum
21. Mike just finished designing a new coffee cup for his manufacturing business and is considering if
the new cup will be profitable to manufacture. When calculating total costs involved in
manufacturing this new coffee cup, which of the following should not be considered?
A. employee wages
B. foregone rental income on the manufacturing equipment used
C. the cost of designing the new coffee cup
D. the cost of cardboard used to make the cups
24. The amount of money that an orchardist could have earned if he had planted orange trees rather
than apple trees is termed:
A. explicit cost
B. accounting cost
C. implicit cost
D. total sales
30. During the summer Jeremy, a small business owner, can hire extra staff to help him repair boats.
On his own Jeremy can repair 10 boats a day, adding a second staff member sees 15 boats a day
repaired, and adding a third sees 18 boats a day repaired. The marginal product of the third worker
is:
A. 18 boats/day
B. 15 boats/day
C. 5 boats/day
D. 3 boats/day
NARRBEGIN: 13-1
Graph 13-1
This graph depicts a production function for a firm that produces cookies. Use the
graph to answer the following question(s).
NARREND
36. Refer to Graph 13-1. With regard to cookie production, the figure implies:
A. decreasing cost of cookie production
B. diminishing marginal product of workers
C. increasing marginal product of workers
D. diminishing marginal cost of cookie production
37. Refer to Graph 13-1. The slope of the total product curve reveals information about the:
A. average product of workers
B. fixed product of workers
C. total product of workers
D. marginal product of workers
38. Lettuce Eat, a vegetarian cafe, exhibits diminishing returns to labour. If the cost of each meal is
constant and labour is the only other input, then the total cost-curve will:
A. become flatter as meal production increases
B. become steeper as meal production increases
C. will stay constant as meal production increases
D. we cannot tell without more information
39. Jeremy, a small business owner, earns $50 an hour repairing boats. One afternoon he takes five
hours off work to build a gazebo in his garden, spending $200 on materials. If the addition of a
gazebo increases his home’s value by $400, then his accounting profit will be:
A. - $50
B. $0
C. $200
D. $400
40. Jeremy, a small business owner, earns can $50 an hour repairing boats. One afternoon he takes 5
hours off work to build a gazebo in his garden, spending $200 on materials. If the addition of a
gazebo increases his home’s value by $400, then his economic profit will be:
A. - $50
B. $0
C. $200
D. $400
NARRBEGIN: 13-2
Graph 13-2
This graph depicts a total cost function for a firm that produces cookies. Use the graph to answer
the following question(s).
NARREND
42. Refer to Graph 13-2. Which of the statements below is most consistent with the shape of the total
cost curve?
A. producing additional cookies is equally costly, regardless of how many cookies are
already being produced
B. producing additional cookies becomes increasingly costly only when the number of
cookies already being produced is large
C. producing an additional cookie is always more costly than producing the previous cookie
D. total production of cookies decreases with additional units of input
43. Refer to Graph 13-2. Identify the true statements from the list below.
(i) the marginal cost of cookie production is increasing
(ii) cookie production exhibits diminishing marginal product
(iii) the slope of the production function increases as quantity of inputs increase
A. (i) only
B. (ii) and (iii)
C. (i) and (iii)
D. (i), (ii) and (iii)
44. Refer to Graph 13-2. The changing slope of the total cost curve reflects:
A. decreasing average cost
B. increasing marginal product
C. decreasing marginal product
D. increasing fixed cost
45. Refer to Graph 13-2. Which of the statements below best captures information about the
underlying production function?
A. output increases at a decreasing rate with additional units of input
B. output increases at an increasing rate with additional units of input
C. output decreases at a decreasing rate with additional units of input
D. output decreases at an increasing rate with additional units of input
46. Which of the following costs do not vary with the amount of output a firm produces?
A. marginal costs and average fixed costs
B. total fixed costs
C. average fixed costs
D. total fixed costs and average fixed costs
47. A sawmill processes logs into timber. Identify the costs below that are an example of a fixed cost.
(i) rent paid on the factory
(ii) maintenance of the trucks used for transport of logs
(iii) wages of the workers
A. (i) only
B. (i) and (ii)
C. (ii) and (iii)
D. (i), (ii) and (iii)
ANS: A PTS: 1 DIF: Moderate TOP: Fixed and variable costs
50. If a firm mothballs a factory so that its output is zero, which of the following costs will also be
zero?
A. variable cost
B. total cost
C. average cost
D. all of the above
51. One assumption that distinguishes short-run cost analysis from long-run cost analysis for a
profit-maximising firm is that, in the short run:
A. output is not variable
B. the size of the factory is fixed
C. the number of workers used to produce the firm’s product is fixed
D. there are no fixed costs
55. Suppose a firm increases output by one unit. Which of the following statements is true?
A. total cost will increase by an amount equal to average variable cost
B. total cost will increase by an amount equal to the marginal cost
C. variable cost will increase by an amount equal to marginal cost
D. average fixed cost will stay constant
NARRBEGIN: 13-3
Graph 13-3
NARREND
64. Refer to Graph 13-3. Which of the marginal cost curves shown reflects the existence of
diminishing marginal product?
A. A
B. B
C. C
D. D
69. Diminishing marginal product causes the average variable cost curve to:
A. rise
B. fall
C. rise until it equals the total cost curve
D. level out
70. At low output levels a firm’s average total cost tends to be high because:
A. marginal costs are increasing
B. variable costs are spread over only a few units of output
C. average fixed cost is large
D. there is a shortage of experienced workers
71. Average total cost necessarily rises due to which of the following?
(i) rising marginal cost
(ii) increasing marginal product
(iii) decreasing marginal cost
A. (i) only
B. (i) and (ii)
C. (ii) only
D. none of the above
72. The efficient scale of the firm is the quantity of output that:
A. maximises marginal product
B. maximises average fixed cost
C. minimises average total cost
D. minimises average variable cost
74. Which of the following statements are true? When marginal cost exceeds average total cost:
(i) average total cost must be rising
(ii) average variable cost must be rising
(iii) average fixed cost must be rising
A. (i) only
B. (i) and (ii)
C. (ii) and (iii)
D. (i), (ii) and (iii)
75. The average total cost curve is increasing when marginal cost is:
A. increasing
B. decreasing
C. less than average total cost
D. greater than average total cost
77. The marginal cost curve crosses the average total cost curve at:
A. the efficient scale
B. economies of scale
C. diseconomies of scale
D. maximum ATC
79. At all levels of production beyond the point where the marginal cost curve crosses the average
variable cost curve, average variable cost:
A. falls
B. rises
C. remains unaffected
D. all of the above are possible; it depends on the shape of the marginal cost curve
NARRBEGIN: 13-4
Graph 13-4
NARREND
81. Refer to Graph 13-4. Which of the following can be inferred from the figure shown?
(i) marginal costs vary for different levels of output
(ii) diminishing marginal product does not occur directly after the first worker
(iii) marginal product of the second worker exceeds that of the first
A. (i) and (ii)
B. (ii) and (iii)
C. (i) and (iii)
D. (i), (ii) and (iii)
ANS: D PTS: 1 DIF: Difficult TOP: The various measures of
cost NAR: 13-4
NARRBEGIN: 13-5
Graph 13-5
The set of curves above reflect information about the cost structure of a firm. Use this graph to
answer the following question(s).
NARREND
82. Refer to Graph 13-5. Which of the curves is most likely to represent average fixed cost?
A. A
B. B
C. C
D. D
83. Refer to Graph 13-5. Which of the curves is most likely to represent average total cost?
A. A
B. B
C. C
D. D
84. Refer to Graph 13-5. Which of the curves is most likely to represent marginal cost?
A. A
B. B
C. C
D. D
ANS: A PTS: 1 DIF: Moderate TOP: Cost curves and their
shapes NAR: 13-5
85. Refer to Graph 13-5. Which of the curves is most likely to represent average variable cost?
A. A
B. B
C. C
D. D
86. Refer to Graph 13-5. This particular firm is necessarily experiencing increasing marginal product
when curve:
A. A is falling
B. B is falling
C. C is falling
D. D is falling
88. Refer to Graph 13-5. This particular firm is necessarily experiencing diminishing marginal product
when which of the following is occurring?
(i) line A is rising
(ii) line B is rising
(iii) line C is rising
A. (i) only
B. (iii) only
C. (i) and (ii)
D. (i), (ii) and (iii)
NARRBEGIN: 13-6
Graph 13-6
This graph depicts average total cost functions for a firm that produces automobiles. Use the graph
to answer the following question(s).
NARREND
91. Refer to Graph 13-6. Which of the curves is most likely to characterise the short-run average total
cost curve of the biggest factory?
A. ATCA
B. ATCB
C. ATCC
D. ATCD
92. Refer to Graph 13-6. Which curve represents the long-run average total cost?
A. ATCA
B. ATCB
C. ATCC
D. ATCD
94. Refer to Graph 13-6. If the firm is currently operating on ATCB, what options does it have if it
wants to change its level of automobile production over the next couple of weeks?
A. The firm has no options. It cannot change output level in the short run.
B. it can operate at any level of output between points M and N
C. it can operate at any level of output, as long as it stays on ATCD
D. it can operate at any level of output as long as it stays on ATCB
95. Refer to Graph 13-6. This firm experiences constant returns to scale at which output levels?
A. output levels above N
B. output levels between M and N
C. output levels below M
D. all of the above levels if the firm is operating in the long run
96. Refer to Graph 13-6. At levels of output below point M, the firm experiences:
A. economies of scale
B. accounting profit
C. economic profit
D. diseconomies of scale
103. A U-shaped long-run average total cost curve can be explained by firms increasing their size to do
which of the following?
(i) take advantage of greater specialisation
(ii) avoid coordination problems
(iii) avoid fixed costs
A. (i) and (ii)
B. (ii) and (iii)
C. (i) only
D. (i), (ii) and (iii)
Table 13-1
Measures of Cost for Splashy Cardboard Kayak Factory.
NARREND
107. Refer to Table 13-1. The average fixed cost of producing five kayaks is:
A. $15
B. $3
C. $5
D. none of the above
109. Refer to Table 13-1. The average total cost of producing four kayaks is:
A. $28
B. $3.25
C. $7
D. it can’t be determined from the above information
110. Refer to Table 13-1. What is the variable cost of producing zero kayaks?
A. $0
B. $2
C. $20
D. it can’t be determined from the information above
111. Refer to Table 13-1. The marginal cost of producing the sixth kayak is:
A. $15
B. $7
C. $25
D. it can’t be determined from the information given
112. Refer to Table 13-1. What is the variable cost of producing five kayaks?
A. $18
B. $17
C. $12
D. it can’t be determined from the information given
113. Refer to Table 13-1. What is the marginal cost of producing the first kayak?
A. it can’t be determined from the information given
B. $0
C. $15
D. $4
Table 13-2
Adrienne’s Premium Boxing Service subcontracts with a chocolate manufacturer to box premium
chocolates for their mail order catalogue business. Adrienne rents a small room for $150 a week in
the downtown business district that serves as her factory. She can hire workers for $275 a week.
Costs are in dollars per week.
NARREND
114. Refer to Table 13-2. What is the marginal product of the fourth worker?
A. 40
B. 110
C. 260
D. 275
115. Refer to Table 13-2. What is the total cost associated with making 890 boxes of premium
chocolates per week?
A. $975
B. $1100
C. $1250
D. $1375
116. Refer to Table 13-2. During the week of 25 April, Adrienne doesn’t box any chocolates. What are
her costs during the week?
A. $0
B. $75
C. $150
D. $425
118. Refer to Table 13-2. Adrienne has received an order for 3000 boxes of chocolates for next week. If
she expects that the trend in the marginal product of labour will continue in the same direction, it is
most likely that her best decision will be to:
A. hire about 12 new workers and hope she can satisfy the order
B. commit to meeting the order and then take three weeks to complete the job
C. not commit to meeting the order until she can move to a larger room and hire more
workers to box the chocolates
D. close her business until she is able to hire more productive workers
Table 13-3
Consider the following firm which makes high-performance racing bicycles. All costs are given in
dollars. Output is shown on a monthly basis. The firm’s fixed costs include a rent of $800 and a
lease cost of $400 per month.
NARREND
119. Refer to Table 13-3. What is the marginal cost of producing the tenth bicycle in a given month?
A. $300
B. $304
C. $321
D. $340
120. Refer to Table 13-3. What is the average variable cost for the month if six bicycles are produced?
A. $200
B. $265
C. $465
D. $1590
121. Refer to Table 13-3. What is the average fixed cost for the month if 10 bicycles are produced?
A. $120
B. $284.40
C. $404.40
D. $1200
122. Refer to Table 13-3. How many bicycles are produced when marginal cost is $321?
A. four
B. seven
C. nine
D. 10
123. Refer to Table 13-3. One month the firm worked overtime to produce 16 bicycles. What was the
average fixed cost for that month?
A. 340
B. 75
C. 120
D. it can’t be determined from the information given
124. Refer to Table 13-3. At what level of output will average variable cost equal average total cost?
A. when marginal cost equals average variable cost
B. when marginal cost equals average total cost
C. there is no level of output where this occurs, as long as fixed costs are positive
D. this holds true for all levels of output in which average variable cost is falling
Amy owns a photo developing shop. She also does contract photography. If she takes on a contract,
she cannot develop photos in that time and her customers use another firm. Suppose Amy rejects a
contract to photograph a wedding. This would have been a five hour job and Amy charges $500
per hour. She spent those five hours developing photos. Her chemicals and paper cost $1250. She
earned $3500 in sales.
125. According to the information provided, what is the total opportunity cost that Amy incurred to
spend her time developing photographs?
A. $1250
B. $2500
C. $3500
D. $3750
126. According to the information provided, Amy’s accountant would most likely figure the total cost
of her photograph developing to be:
A. $1250
B. $2500
C. $3500
D. $3750
Farmer Jack is a watermelon farmer. If Jack plants no seeds on his farm, he gets no harvest. If he
plants one bag of seeds, he gets 30 watermelons. If he plants two bags of seeds, he gets 50
watermelons. If he plants three bags of seeds he gets 60 watermelons. A bag of seeds costs $100
and seeds are his only costs.
129. According to the information provided, which of the following statements is(are) true?
(i) farmer Jack experiences decreasing marginal product
(ii) farmer Jack’s total cost curve is linear
(iii) farmer Jack’s production function is nonlinear
A. (i) only
B. (i) and (ii)
C. (ii) only
D. (i) and (iii)
132. Harry’s Hotdogs is a small street vendor business owned by Harry Huggins. Harry is trying to get a
better understanding of his costs by categorising them as fixed or variable. Which of the following
costs are most likely to be considered fixed costs?
A. hotdog buns
B. mustard
C. the cost of bookkeeping services
D. wages paid to workers that sell hotdogs
133. Harry Hoarder runs a small street vendor service which contracts to produce and sell moulded
plastic souvenirs (key chains, commemorative plastic coins, plastic animals, etc.) at small theatre
shows. As owner of the firm, Harry must decide how much of each product to produce. The key
element of this decision is:
A. the fixed cost of production
B. the cost of his selling booth
C. how costs will vary as he changes the level of production
D. the cost of book keeping services
134. Harry’s Hotdogs is a small street vendor business owned by Harry Huggins. If Harry makes 10
hotdogs in his first hour of business and incurs a total cost of $16.50, his average total cost per
hotdog is:
A. $1.65
B. $6.50
C. this is impossible to determine without specific information on fixed cost
D. this is impossible to determine without specific information on variable cost
136. Thirsty Thelma owns and operates a small lemonade stand. When Thelma is producing a small
quantity of lemonade, she has few workers and her equipment is not being fully utilised. Because
she can easily put her idle resources to use:
A. the marginal cost of an extra worker is large
B. the marginal product of an extra worker is small
C. the marginal cost of one more glass of lemonade is small
D. her lemonade stand is likely to be crowded with workers
SHORT ANSWER
1. What are opportunity costs? How do explicit and implicit costs relate to opportunity costs?
ANS:
The opportunity cost of an item refers to all those things that must be forgone to acquire that item.
Both explicit and implicit costs are included as opportunity costs.
2. A key difference between accountants and economists is their different treatment of the cost of
capital. Does this cause an accountant’s estimate of total costs to be higher or lower than an
economist’s estimate? Explain.
ANS:
An accountant would not include the forgone interest income that the money could have earned
elsewhere if it had not been invested in the business. Therefore an accountant’s estimate of total
cost will be less than an economist’s.
3. The production function depicts a relationship between which two variables? Draw a production
function that exhibits diminishing marginal product.
ANS:
The production function depicts a relationship between output and a given input. The graph should
show output increasing but at a decreasing rate as inputs increase.
4. How would a production function that exhibits decreasing marginal product affect the shape of the
total cost curve? Explain or draw a graph.
ANS:
The total cost curve will increase at an increasing rate. In other words, the total cost curve gets
steeper as the amount produced rises.
PTS: 1 DIF: Easy TOP: From the production function to the total-cost
curve
Identify the average fixed cost curve, the marginal cost curve, the average variable cost curve and
the average total cost curve.
ANS:
The average fixed cost curve is D
The marginal cost curve is A
The average variable cost curve is C
The average total cost curve is B.
6. Bob Edwards owns Bob’s Bagels. He hires an economist who assesses the shape of the bagel
shop’s average total cost (ATC) curve as a function of the number of bagels produced. The results
indicate a U-shaped average total cost curve. Bob’s economist explains that the ATC curve is
U-shaped for two reasons, the first being the existence of diminishing marginal product, which
causes it to rise. What would the second reason be? Assume that the marginal cost curve is linear.
(Hint: The second reason relates to average fixed cost.)
ANS:
Average fixed cost always declines as output rises because fixed cost is getting spread over a larger
number of units, thus causing the average total cost curve to fall.
7. If the average total cost curve is falling, what is necessarily true of the marginal cost curve? If the
average total cost curve is rising, what is necessarily true of the marginal cost curve?
ANS:
When the average total cost curve is falling, it is necessarily above the marginal cost curve. If the
average total cost curve is rising, it is necessarily below the marginal cost curve.
PTS: 1 DIF: Moderate TOP: The relationship between marginal cost and
average total cost
ANS:
Output Fixed Total Total Cost Average Average Average Marginal
Cost Variable Fixed Variable Total Cost Cost
Cost Cost Cost
0 14.00 14.00
1 14.00 2.00 16.00 14.00 2.00 16.00 2.00
2 14.00 5.00 19.00 7.00 2.50 9.50 3.00
3 14.00 9.00 23.00 4.66 3.00 7.66 4.00
4 14.00 14.00 28.00 3.50 3.50 7.00 5.00
5 14.00 20.00 34.00 2.80 4.00 6.80 6.00
6 14.00 27.00 41.00 2.33 4.50 6.83 7.00
PTS: 1 DIF: Moderate TOP: Average and marginal cost
9. If the long-run average total cost curve is flat, then what does this imply about specialisation?
What will be the firm’s efficient scale?
ANS:
If the long-run average total cost curve is flat then this implies that there are no returns to
specialisation. As a result, the firm can produce efficiently at any output level.
ANS:
As increasing quantities of a variable input are added to a fixed amount of another input, the
additions to output gained as a result will at some point start to decrease.
TVC = costs
TC = total
AVC = costs
AC = costs
TFC = costs
AFC = average
MC = costs
TC = TFC +
AC = + AVC
MC = ∆TC/ = /∆Q
AFC = TFC/
AVC = /Q
AC = TC/Q
ANS:
TC = TFC + TVC
AC = AFC + AVC
MC = ∆TC/Q = TVC/∆Q
AFC = TFC/Q
AVC = TVC/Q
AC = TC/Q
PTS: 1 DIF: Moderate TOP: Average and marginal cost