Microeconomics, 7e (Perloff)

Chapter 7 Costs

7.1 The Nature of Costs

1) Economic costs of an input include

A) only implicit costs.
B) only explicit costs.
C) both implicit and explicit costs.
D) whatever management wishes to report to the shareholders.
Answer: C
Section: Measuring Costs
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2) The cost of waiting two months for health care to address a debilitating problem in
Canada is most accurately described as
A) an explicit cost.
B) an accounting cost.
C) no real cost.
D) an opportunity cost.
Answer: D
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3) Sarah earns $40,000 per year working for a large corporation. She is thinking of quitting
this job to work full time in her own business. She will invest her savings of $50,000 (which
currently has an annual 10% rate of return) into the business. Her annual opportunity cost
of this new business is
A) $0.
B) $40,000.
C) $45,000.
D) $90,000.
Answer: C
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4) Johnny has worked as a CPA for five years and wants to open his own public accounting
practice. The cost of his college degree in accounting represents
A) the opportunity cost of this endeavor.
B) a sunk cost.
C) an expense.
D) a variable cost.
Answer: B
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5) Economists proclaim that competitive firms make zero economic profit in the long run.
This shows how
A) detached economists are from the real world.
B) unrealistic economic theory is.
C) firms cover all their cost, both monetary and non-monetary.
D) firms cover only monetary cost when economic profits are zero.
Answer: C
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6) If a firm buys a building so as to have office space for its workers, the monthly
opportunity cost of the building is best measured as
A) the monthly mortgage payment the firm must pay.
B) the price the firm paid divided by twelve.
C) zero.
D) the rent the firm could earn if it rented the building to another firm.
Answer: D
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7) Economic efficiency entails

A) producing a given amount of output with the most expensive mix of inputs.
B) producing a given amount of output with the least number of inputs.
C) producing a given amount of output with the most inputs.
D) producing a given amount of output with the cheapest mix of inputs.
Answer: D
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8) If Option A costs $40 and yields 20 units of output and Option B costs $50 and yields 20
units of output,
A) Option B and Option A are equally economically efficient.
B) Option B is economically efficient relative to Option A.
C) Option A is economically efficient relative to Option B.
D) It is not possible to determine which option is more economically efficient.
Answer: C
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9) If Option A costs $40 and yields 20 units of output and Option B costs $50 and yields 30
units of output,
A) Option B and Option A are equally economically efficient.
B) Option B is economically efficient relative to Option A.
C) Option A is economically efficient relative to Option B.
D) It is not possible to determine which option is more economically efficient.
Answer: D
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10) Why might a police officer not pull over someone speeding two miles over the speed
limit?
A) The explicit costs of stopping the driver over are too high.
B) The opportunity costs of stopping the driver are too high.
C) The opportunity costs of topping he driver are too low.
D) The explicit costs of stopping the driver are too low.
Answer: B
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11) The high cost of advertising during the Super Bowl will
A) not affect the efficient level of output because advertising is a sunk cost.
B) will affect the efficient level of output because profits will fall significantly.
C) not affect the efficient level of output because advertising is a fixed cost.
D) Not enough information given.
Answer: A
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For the following, please answer "True" or "False" and explain why.

12) When buying a piece of equipment, it is always best for the firm to pay cash instead of
borrowing the funds since this renders the equipment less costly.
Answer: False. It depends. The opportunity cost of the capital when paying cash is the
interest the firm receives on its cash reserves. This is an implicit cost. The opportunity cost
of the capital when the funds are borrowed is the interest the firm must pay to the lender.
This is an explicit cost. If the rate the firm receives on its cash reserves exceeds the rate at
which it borrows, the firm is better off borrowing the funds to buy the equipment.
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13) Four years after graduating from college you must decide if you want to go on as an
accountant (your college major) or if you want to make a career change and become a
singer. The cost of your education will matter for your decision.
Answer: False. At this point the cost of your education represents a sunk cost and
therefore should not figure into your decision. You incur it no matter what decision you
make.
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14) An accountant may amortize the expense of a durable good by dividing the total
amount spent on the good by the number of years the good is expected to last. An
economist may amortize the expense of a durable and never fully account for the total
expense.
Answer: True. The accountant uses a set of predetermined rules to amortize the total
expense of the good. The economist amortizes based on the opportunity cost of the good,
which may never sum to the total expense of the good.
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15) Your company makes copper pipes. Over the years, you have collected a large
inventory of raw copper. The production process involves melting the copper and shaping it
into pipes. You also have a large stockpile of pennies. Suppose the price of copper rises so
much that the copper in the penny becomes worth more than one cent. Should you melt
down your pennies?
Answer: This problem appeared as a puzzle in the Journal of Economic Perspectives
(Winter, 1988). It is true (in this problem) that the pennies when melted currently have a
value greater than one cent. Yet, the price of copper can fluctuate. If the price of copper
stays high, it does not matter if you melt pennies or not. However, if the price of copper
falls so that the value of the copper in the penny falls below one cent, your unmelted
pennies are still worth one cent. Your melted pennies would be worth less than one cent.
Thus, as long as you have some other source of copper, you are better off melting that
copper and not the pennies.
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16) You have two career options. You can work for someone else for $50,000 a year, or, you
can run your own business, with an annual revenue of $100,000, and explicit costs of
$40,000 annually. Explain which career option a profit-maximizer would select and why.

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Answer: In the absence of other implicit costs a profit-maximizer will run their own
business. The business owner will receive $100,000 - $40,000 = $60,000. The opportunity
cost is only $50,000.
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7.2 Short-Run Costs

1) A firm's marginal cost can always be thought of as the change in total cost if
A) the firm produces one more unit of output.
B) the firm buys one more unit of capital.
C) the firm's average cost increases by $1.
D) the firm moves to the next highest isoquant.
Answer: A
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2) Fixed costs are

A) a production expense that does not vary with output.
B) a production expense that changes with the quantity of output produced.
C) equal to total cost divided by the units of output produced.
D) the amount by which a firm's cost changes if the firm produces one more unit of output.
Answer: A
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3) Variable costs are

A) a production expense that does not vary with output.
B) a production expense that changes with the quantity of output produced.
C) equal to total cost divided by the units of output produced.
D) the amount by which a firm's cost changes if the firm produces one more unit of output.
Answer: B
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4) Which of the following statements is NOT true?
A) AC = AFC + AVC
B) C = F + VC
C) AVC = wage/MPL
D) AFC = AC - AVC
Answer: C
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5) Joey's Lawncutting Service rents office space from Joey's dad for $300 per month. Joey's
dad is thinking of increasing the rent to $400 per month. As a result Joey's marginal cost of
cutting grass will
A) increase by $100 divided by the amount of grass cut.
B) increase by $100.
C) decrease by $100.
D) not change.
Answer: D
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6) Suppose a firm can only vary the quantity of labor hired in the short run. An increase in
the cost of capital will
A) increase the firm's marginal cost.
B) decrease the firm's marginal cost.
C) have no effect on the firm's marginal cost.
D) More information is needed to answer the question.
Answer: C
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7) Suppose the total cost of producing T-shirts can be represented as TC = 50 + 2q. The
marginal cost of the 5th T-shirt is
A) 2.
B) 10.
C) 12.
D) 60.
Answer: A
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8) Suppose the total cost of producing T-shirts can be represented as TC = 50 + 2q. The
average cost of the 5th T-shirt is
A) 2.
B) 12.
C) 52.
D) 60.
Answer: B
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9) Suppose the total cost of producing T-shirts can be represented as TC = 50 + 2q. Which
of the following statements is TRUE at all levels of production?
A) MC = AVC
B) MC = AC
C) MC > AFC
D) All of the above.
Answer: A
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10) Suppose the short-run production function is q = 10 ∗ L. If the wage rate is $10 per
unit of labor, then AVC equals
A) q.
B) q/10.
C) 10/q.
D) 1.
Answer: D
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11) Suppose the short-run production function is q = 10 ∗ L. If the wage rate is $10 per
unit of labor, then MC equals
A) q.
B) q/10.
C) 10/q.
D) 1.
Answer: D
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12) If average cost is decreasing,
A) marginal cost equals average cost.
B) marginal cost exceeds average cost.
C) marginal cost is less than average cost.
D) Not enough information is given.
Answer: C
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13) If average cost is positive,

A) marginal cost equals average cost.
B) marginal cost exceeds average cost.
C) marginal cost is less average cost.
D) Not enough information is given.
Answer: D
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14) Suppose the short-run production function is q = L0.5. If the marginal cost of
producing the tenth unit is $5, what is the wage per unit of labor?
A) $1
B) $0.5
C) $0.25
D) It cannot be determined without more information.
Answer: C
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15) Suppose the short-run production function is q = 10 ∗ L. If the wage rate is $10 per
unit of labor, then AFC equals
A) 0.
B) 1.
C) 10/q.
D) It cannot be determined from the information provided.
Answer: D
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16) When a firm produces one unit, the variable cost is $3. When the firm produces two
units, the variable cost is $6. What is the marginal cost associated with two units of
production?
A) $2
B) $0.5
C) $6
D) $3
Answer: D
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17) If the marginal cost of producing a good is increasing as a firm produces more of the
good, then which of the following must be TRUE?
A) AFC is rising.
B) AVC is rising.
C) MC > AVC.
D) MPL is falling.
Answer: D
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18) If the average cost of producing a good is increasing as a firm produces more of the
good, then which of the following must be TRUE?
A) AFC is falling.
B) AVC is rising.
C) MC > AVC.
D) All of the above.
Answer: D
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19) Suppose each worker must use only one shovel to dig a trench, and shovels are useless
by themselves. In the short run, an increase in the price of shovels will result in
A) fewer shovels being purchased.
B) more workers being hired.
C) a decrease in the firm's output.
D) no change in the firm's output.
Answer: D
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20) Which of the following will cause the marginal cost curve of making cigarettes to shift?
A) a $5 million penalty charged to each cigarette maker
B) a $1 per pack tax on cigarettes
C) a $1 million advertising campaign by the American Cancer Society
D) All of the above.
Answer: B
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21) Which of the following will cause the average cost curve of making cigarettes to shift?
A) a $5 million penalty charged to each cigarette maker
B) a $1 per pack tax on cigarettes
C) a $1 an hour wage increase paid to all cigarette production workers
D) All of the above.
Answer: D
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22) Which of the following will cause the average fixed cost curve of making cigarettes to
shift?
A) a $5 million penalty charged to each cigarette maker
B) a $1 per pack tax on cigarettes
C) a $3 per hour wage increase
D) An increase in the demand for cigarettes.
Answer: A
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23) A specific tax of $1 per unit of output will affect a firm's

A) average total cost, average variable cost, average fixed cost, and marginal cost.
B) average total cost, average variable cost, and average fixed cost.
C) average total cost, average variable cost, and marginal cost.
D) marginal cost only.
Answer: C
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24) Assume baseball player salaries are fully determined before the season starts. From the
point of view of the baseball team owner, player salaries during the course of the season
are then
A) variable costs.
B) marginal costs.
C) fixed costs.
D) average costs.
Answer: C
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25) A firm's cost curve is determined by

A) congressional laws.
B) whether the firm hires engineers or not.
C) natural laws.
D) the firm's production function.
Answer: D
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26) A windfall profit tax imposed on oil companies would shift the firms'
A) marginal tax rate.
B) marginal cost curve.
C) average cost curve.
D) production function.
Answer: C
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27) Assume Congress decides that oil companies are making too much profit and decides to
tax oil companies for each gallon of gasoline produced. This would
A) shift the marginal cost curve up.
B) shift the marginal cost curve down.
C) shift the average fixed cost curve up.
D) shift the average fixed cost curve down.
Answer: A
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28) Assume Congress decides that Social Security taxes must increase in order to fund the
system. This would
A) shift up the marginal cost curve for any firms that hire labor.
B) guarantee a decrease in profits.
C) shift up the average fixed cost curve for any firms that hire labor.
D) guarantee an increase in tax revenues.
Answer: A
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29) In the short run, marginal cost is increasing when

A) MPL is decreasing.
B) MPL is increasing.
C) APL is increasing.
D) APL is decreasing.
Answer: A
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30) In the short run, marginal cost is minimized when

A) MPL is maximized.
B) MPL equals zero.
C) APL is maximized.
D) APL equals zero.
Answer: A
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31) In the short run, average variable costs are minimized when
A) MPL equals APL.
B) APL is maximized.
C) MPL is maximized and APL is increasing.
D) Both A and B.
Answer: D
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32) At what output level, q, is average cost minimized if the short-run costs for a company
are
C = 40 + 4q + q2?
A) q = 2 .
B) q = 0.
C) q = 40.
D) q = 2.
Answer: A
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For the following, please answer "True" or "False" and explain why.

33) The "Law of Diminishing Marginal Returns" could also be termed the "Law of
Increasing Marginal Costs."
Answer: True. Since MC = w/MPL in the short run, the fact that MPL eventually declines
means that MC must eventually increase.
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34) The marginal cost curve intersects the average fixed cost curve at its minimum.
Answer: False. Marginal cost intersects average variable cost (and average cost) at its
minimum.
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35) A consumer purchases a book by driving across town to a bookstore, standing in line
for five minutes to pay the cashier, and then pays $5. The same book is purchased by
another consumer who spends 2 minutes placing the order over the internet for $10. The
book necessarily cost the first consumer less.
Answer: False. The opportunity cost of driving across town and standing in line may have
raised the total cost of the book to the first consumer to more than $10.
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36) A firm's production function for pretzels is shown in the above figure. If the firm's fixed
cost equals $100 per time period and the wage rate equals $1 per unit of labor per time
period, calculate the firm's MC, AVC, and AC schedules. Do these cost functions follow the
general rules concerning the relationships between MC, AVC and AC?
Answer:

MC > AVC, AVC is rising.

MC < AC, AC is falling.
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37) Explain why the marginal cost curve intersects a U-shaped average cost curve at its
minimum point.
Answer: At low quantities, the average cost curve declines as the quantity increases. The
marginal cost is below the average cost. The marginal cost represents the cost of an
additional unit of production. Thus, as the marginal cost curve declines, this pulls the
average cost down from its previous level. Then, the marginal cost curve will begin to rise.
However, the marginal cost is still below the average cost, and will continue to lower the
average cost. When the two costs are equal the marginal cost will leave the average cost
unchanged. Then, the marginal cost will be above the average cost so it will start to pull up
the average cost. Thus, the marginal cost curve will intersect the average cost curve at its
minimum point.
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7.3 Long-Run Costs

1) In the long run, fixed costs are

A) sunk.
B) avoidable.
C) larger than in the short run.
D) not included in production decisions.
Answer: B
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2) The slope of the isocost line tells the firm how much
A) capital must be reduced to keep total cost constant when hiring one more unit of labor.
B) capital must be increased to keep total cost constant when hiring one more unit of labor.
C) more expensive a unit of capital costs relative a unit of labor.
D) the isocost curve will shift outward if the firm wishes to produce more.
Answer: A
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3) The slope of the isoquant tells the firm how much

A) output increases when labor increases by one unit.
B) output increases when capital and labor are doubled.
C) capital must decrease to keep output constant when labor increases by one unit.
D) a unit of capital costs relative to the cost of labor.
Answer: C
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4) If an isocost line crosses the isoquant twice, a cost minimizing firm will
A) use a different isocost line to select the bundle of inputs.
B) use the input bundle associated with the intersection on the higher point of the isoquant.
C) use the input bundle associated with the intersection on the lower point of the isoquant.
D) Both B and C.
Answer: A
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5) When the isocost line is tangent to the isoquant, then
A) MRTS = -w/r.
B) the firm is producing that level of output at minimum cost.
C) the last dollar spent on capital yields as much extra output as the last dollar spent on
labor.
D) All of the above.
Answer: D
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6) A firm can minimize cost by

A) picking the bundle of inputs where the lowest isocost line touches the isoquant.
B) picking the bundle of inputs where the isoquant is tangent to the isocost line.
C) picking the bundle of inputs where the last dollar spent on one input gives as much
extra output as the last dollar spent on any other input.
D) All of the above.
Answer: D
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7) When the isocost line is tangent to the isoquant, then

A) MPL = MPK.
B) the firm is producing that level of output at minimum cost.
C) the firm has achieved the right economies of scale.
D) All of the above.
Answer: B
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8) If the cost of labor increases, the isocost line will

A) stay the same.
B) shift outward in parallel fashion.
C) rotate inward around the point where only capital is employed in production.
D) shift inward in parallel fashion.
Answer: C
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9) If the isoquants are straight lines or L-shaped, then a cost-minimizing firm will
A) not be able to minimize costs.
B) find the lowest isocost line touching the relevant isoquant.
C) find the highest isocost line touching the relevant isoquant.
D) choose not to produce any output.
Answer: B
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10) If the marginal rate of technical substitution for a cost minimizing firm is 10, and the
wage rate for labor is $5, what is the rental rate for capital in dollars?
A) .5
B) 1
C) 2
D) 10
Answer: A
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11) Suppose MPL = 0.5 ∗ (q/L) and MPK = 0.5 ∗ (q/K). In the long run, the firm will hire
equal amounts of capital and labor
A) all of the time.

C) only when w = 0.5 ∗ r.

B) only when w = r.

D) at no point in time.
Answer: B
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12) Suppose that each worker must use only one shovel to dig a trench, and shovels are
useless by themselves. In the long run, an increase in the price of shovels will result in
A) fewer shovels being purchased to produce the same number of trenches.
B) more workers being hired to produce the same number of trenches.
C) the firm wishing to produce more trenches.
D) no change in the firm's input mix.
Answer: D
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13) Suppose that each worker must use only one shovel to dig a trench, and shovels are
useless by themselves. In the long run, the firm will experience
A) increasing returns to scale.
B) constant returns to scale.
C) decreasing returns to scale.
D) The returns to scale cannot be determined from the information provided.
Answer: B
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14) Suppose that each worker must use only one shovel to dig a trench, and shovels are

A) TC = (w/r) ∗ q.
useless by themselves. In the long run, the firm's cost function is

B) TC = (w + r)/q.

D) TC = (w + r) ∗ q.
C) TC = (w + r).

Answer: D
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15) At the XYZ Co., a unit of capital costs 3 times as much as a unit of labor. If the
isoquants are convex, and the firm does not change its input mix in the long run, we can

A) MPK = 3 ∗ MPL.
conclude that

B) the firm will not hire any capital.

C) the firm will hire 3 times as much labor as capital.
D) the firm will hire 3 times as much capital as labor.
Answer: A
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16) The production of cigarettes is highly automated; however, a worker is required to

monitor each machine. Machines and workers do not interact with one another. Given this
information, there are most likely
A) economies of scale.
B) economies of scope.
C) constant returns to scale.
D) increasing returns to scale.
Answer: C
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17) A change in relative factor prices will always result in
A) a change in the slope of the isoquants.
B) a tangency between the new isocost line and a new isoquant.
C) a rotation of the isocost lines.
D) All of the above.
Answer: C
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18) Assuming that w and r are both positive, if the long-run expansion path is horizontal,
then
A) MPK = 0.
B) MRTS is a function of capital only.
C) w = r.
D) All of the above.
Answer: B
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19) The above figure shows the long-run expansion path. The long-run average cost curve
will be
A) horizontal.
B) downward sloping.
C) upward sloping.
D) vertical.
Answer: B
Section: Long-Run Costs
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20) The long-run average cost curve may initially slope downward due to
A) decreasing average fixed costs.
B) increasing marginal returns.
C) economies of scale.
D) All of the above.
Answer: C
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

20
Copyright © 2015 Pearson Education, Inc.
21) If a production function is represented as q = LaKb, the long-run average cost curve
will be horizontal as long as
A) a + b = 0.
B) a + b = 1.
C) q > 0.
D) L = K.
Answer: B
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

22) If there are diseconomies of scale within a given range of output, which of following
is(are) TRUE?
A) The short-run average cost curve must be upward sloping within that range of output.
B) The long-run average cost curve must be upward sloping within that range of output.
C) Long-run average cost must equal short-run average cost.
D) All of the above.
Answer: B
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

23) The total cost of producing one unit is $50. The total cost of producing two units is $75.
At a production level of two units, the cost function exhibits
A) economies of scale.
B) rising average costs.
C) increasing marginal costs.
D) constant returns to scale.
Answer: A
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

24) Economies of scale in nuclear power plants exist because of

A) more efficient plant management.
B) a better understanding of the plant's idiosyncrasies, or learning-by-doing.
C) nuclear power technology changes.
D) both A and B.
Answer: D
Section: Long-Run Costs
Question Status: New
AACSB: Analytic thinking

21
Copyright © 2015 Pearson Education, Inc.
25) A U.S. firm currently produces 200 units of output according to the production function
q = L0.5K0.5 and faces input prices equal to wU.S. = rU.S = $11. Should the U.S. firm
move their company abroad where they will face input prices equal to wabroad = $6.50
and rabroad = $15.00?
A) Yes, because the total costs will fall from $3,859 to $2,810.
B) No, because the total costs will increase from $2,810 to $3,859.
C) No, because the firm has decreasing returns to scale.
D) Not enough information is given to answer this problem.
Answer: A
Section: Long-Run Costs
Question Status: New
AACSB: Analytic thinking

26) A firm produces output according to the production function, q = L4/3K1/2 and faces
input prices equal to w = $20 and r = $80. What is the minimum cost of producing 1140
units of output?
A) Cost = $780.
B) Cost = $694
C) Cost = $2,071.
D) Not enough information is given to answer this problem.
Answer: B
Section: Long-Run Costs
Question Status: New
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

27) If increasing returns to scale are present, the long-run average cost increases as more
output is produced.
Answer: False. Increasing returns to scale imply that with a doubling of inputs, output
more than doubles. Since average cost is the ratio of total cost divided by output, this
increase in inputs will cause the numerator to be just double the old value while the new
denominator is more than double the old value. As a result, long-run average cost falls as
more output is produced.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

28) Economies of scale and Increasing Returns to Scale are the same thing looked at from
either the production or cost perspective.
Answer: False. Increasing returns to scale imply economies of scale but the reverse is not
true. A firm can experience economies of scale for other reasons (without increasing
returns to scale)
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

22
Copyright © 2015 Pearson Education, Inc.
29) Explain the difference between fixed costs in the short run and fixed costs in the long
run.
Answer: In the short run fixed costs are sunk; in the long run, fixed costs are avoidable.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

30) What are the functions for MC and AC if TC = 100q + 100q2? Are the returns to scale
increasing, decreasing, or constant?
Answer: MC = 100 + 200q
AC = 100 + 100q
Since AC increases with an increase in output, there are decreasing returns to scale.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

31) Explain how a firm can have constant returns to scale in production and economies of
scale in cost.
Answer: A firm can have constant returns to scale in production at every output level. If
the firm doubled all inputs the output would double. However, the firm may also more than
double one input and double its output. Therefore in this way, as output doubles, the total
cost might be less than doubling, resulting in a decreasing average cost, which is known as
economies of scale.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

32) Explain why the long-run total cost curve, not the short-run total cost curve, shows the
lowest cost of producing any level of output. Is there an exception?
Answer: In the long run, all costs are variable so the firm can select the least-cost mix of
all inputs to produce any given quantity. The exception would be at minimum long-run cost
where min. LR and min. SR costs are equal.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

23
Copyright © 2015 Pearson Education, Inc.
33) A local non-profit group prints a weekly newsletter. Professional typists earn $10 per
hour and can type 2 pages per hour. Unpaid volunteers can type only 1 page per hour.
Measuring hours of professional typist services on the vertical axis and hours of unpaid
volunteer typist services on the horizontal axis, draw the relevant isoquant and isocost
curves if the newsletter is 10 pages long. What input mix is chosen by the non-profit group
if they wish to minimize the cost of the newsletter? If the group will reimburse volunteers
for expenses (lunch, driving), how much must the reimbursement be for your answer to
change?
Answer:

See the above figure. The isoquant is a straight line with a slope of 1/2. The group can use
either 5 pros, 10 volunteers, or some combination of the two. The isocost curves are
horizontal since volunteers are free. As a result, the lowest isocost curve is achieved by
hiring all volunteers. If the group reimbursed volunteers for expenses (lunch, driving, etc.)
then the group will still hire all volunteers as long as they do not cost more than $5 per
hour.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

24
Copyright © 2015 Pearson Education, Inc.
34) A firm pays $5 for each unit of capital. Labor costs $5 per hour for the first 10 hours
and $10 per hour for every hour thereafter. Draw the isocost curves for total costs of $50
and $100.
Answer:

See the above figure.

Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

25
Copyright © 2015 Pearson Education, Inc.
35) To dig a trench, each worker needs a shovel. Workers can use only one shovel at a
time. Workers without shovels do nothing, and shovels cannot operate on their own.
Graphically determine the number of shovels and workers used by a firm to dig 2 trenches
when:
(a) w = 10 and r = 10
(b) w = 10 and r = 5
Answer:

See the above figure. Because the production process requires fixed proportions of K and
L, the firm cannot change input mix when the relative factor costs change.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

36) Suppose the production function is q = 12 L0.25K0.75. Determine the long-run capital-
to-labor ratio (K/L) if the cost a unit of capital (r) is three times the cost of a unit of labor
(w).
Answer: The firm minimizes costs by setting MRTS = w/r. MRTS = MP L /MPLK = K/3L =
w/r = 1/3. This firm will set K/L equal to one.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

37) "If the wage rate paid to one form of labor is twice the cost of another form of labor,
the first type of labor must be twice as productive." Comment.
Answer: This is true. Firms minimize cost by setting the ratio of marginal productivity per
unit cost equally across all inputs. If one form of labor is twice as expensive as another, the
firm will want the MP of the first type of labor to be twice that of the second.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

38) Suppose capital and labor are perfect substitutes resulting in a production function of q

26
Copyright © 2015 Pearson Education, Inc.
= K + L. That is, the isoquants are straight lines with a slope of -1. Derive the long-run
total cost function TC = C(q) when the wage rate is w and the rental rate on capital is r.
Answer:
The firm will always hire the input that is cheapest. So, the function is

If w < r, TC = wq.
If w > r, TC = rq.
If w = r, either equation works.
Section: Long-Run Costs
Question Status: Old
AACSB: Analytic thinking

7.4 Lower Costs in the Long Run

1) Long-run average cost is never greater than short-run average cost because in the long
run,
A) capital costs equal zero.
B) the firm can move to the lowest possible isocost curve.
C) wages always increase over time.
D) wages always decrease over time.
Answer: B
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

2) Which of the following statements best explains why long-run average cost is never
greater than short-run average cost?
A) In the long run, tangency of the isocost and isoquant is attainable. This is not necessarily
true in the short run.
B) In the long run, diseconomies of scale might not occur, but in the short run diminishing
marginal returns do.
C) In the long run, the cost of capital declines because the firm is able to pay down some of
its debts.
D) In the long run, the average cost curve need not be U-shaped, but in the short run it is.
Answer: A
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

3) In the short run, the expansion path is

A) horizontal.
B) vertical.
C) diagonal.
D) indeterminate.
Answer: A
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

4) In the long run, the expansion path is

A) horizontal.
B) vertical.
C) diagonal.
D) Not enough information.
Answer: D
Section: Lower Costs in the Long Run
27
Copyright © 2015 Pearson Education, Inc.
Question Status: Old
AACSB: Analytic thinking

5) Learning by doing will result in

A) an upward sloping long-run average cost curve.
B) a larger long-run marginal cost than long-run average cost.
C) a rotation in the isocost curves.
D) lower long-run costs than short-run costs.
Answer: D
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

6) Learning by doing is represented by

A) a decrease in the average total cost curve.
B) an increase in the average total cost curve.
C) no change in the average total cost curve.
D) an increase in the average total cost curve and a decrease in the marginal cost curve.
Answer: A
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

7) Why do many people choose to not read the manuals included with their new computer?
A) They perceive that learning by doing decreases costs faster than learning by reading.
B) They perceive that learning by doing is more enjoyable than learning by reading.
C) They perceive that learning by reading is not sophisticated.
D) They perceive that learning by doing is better than learning by reading.
Answer: A
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

28
Copyright © 2015 Pearson Education, Inc.
8) A firm is currently producing1140 units of output according to the production function q
= L4/3K1/2 and faces input prices equal to w = $20 and r = $80. In the short run, capital is
fixed at 5 units. In the long run, the firm's costs are
A) lower because the firm substitutes towards more labor and away from capital.
B) lower because the firm substitutes towards more capital and away from labor.
C) higher because the firm substitutes towards more labor and away from capital.
D) higher because the firm substitutes towards more capital and away from labor.
Answer: B
Section: Lower Costs in the Long Run
Question Status: New
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

9) Short-run average cost exceeds long-run average cost only when there are economies of
scale.
Answer: False. Short-run average costs exceed long-run average costs because the firm is
locked into a certain input mix in the short run that may not be cost minimizing when all
inputs are variable. This condition holds regardless of the presence of economies of scale.
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

10) Short-run costs are never equal or lower than long-run cost.
Answer: False. Since the long-run curve "envelopes" all short-run curves there is always a
level of output where short-run cost are equal to long-run cost. However, short-run cost can
never be lower than long-run cost.
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

11) At Albert's Pretzel Company, MPL = 1/L, and MPK = 1/K. The isoquant for 100 pounds
29
Copyright © 2015 Pearson Education, Inc.
of pretzels daily is shown in the above figure. Albert minimizes the cost of producing 100
pounds of pretzels daily by hiring 5 units of labor and 10 units of capital when w = 50 and r
= 25. When r rises to 100, what is the minimum cost of producing 100 pounds of pretzels

Answer: In the short run, the input mix cannot change. The short-run cost is (5 ∗ 50) + (10
daily in the short run? in the long run?

∗ 100) = 1250. In the long run, Albert will change the input mix. From the graph, the new

MRTS = w/r which equals 1/2. As a result, the long-run cost of 100 pretzels is (10 ∗ 50) +
mix will be L = 10 and K = 5. To check, the MRTS = K/L and costs are minimized when

(5 ∗ 100) = 1000.
Section: Lower Costs in the Long Run
Question Status: Old
AACSB: Analytic thinking

7.5 Cost of Producing Multiple Goods

1) Many universities have either a top football program OR a top basketball program. Very
few have both. These results suggest the presence of
A) economies of scope.
B) diseconomies of scope.
C) returns to scale.
D) the law of diminishing marginal returns.
Answer: B
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

30
Copyright © 2015 Pearson Education, Inc.
2) Economies of scope exist between book publishing and magazine publishing if
A) the cost of publishing a magazine is lower for book publishers than for other firms.
B) the cost of publishing a magazine is lower for firms that publish many magazines than
for firms that publish only one magazine.
C) the cost of publishing a book falls over time as the publisher acquires more experience.
D) the cost of a publishing a book is not subject to diminishing marginal returns.
Answer: A
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

3) Suppose the cost of producing two goods, x and y, can be represented as C = ax + by +

cxy. If the measure of economies of scope, SC, is zero, then which of the following must be
true?
A) a = b
B) a + b = -c
C) c = 0
D) a = -b
Answer: C
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

4) Suppose the cost of producing two goods, x and y, can be represented as C = ax + by +

cxy. If there are economies of scope, then which of the following must be true?
A) c > 0
B) a + b = -c
C) c = 0
D) c < 0
Answer: D
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

5) Suppose the cost of producing two goods, x and y, can be represented as C = ax + by +

cxy. If there are diseconomies of scope, then which of the following must be true?
A) a = b
B) a + b = -c
C) c > 0
D) c < 0
Answer: C
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

31
Copyright © 2015 Pearson Education, Inc.
6) A production possibilities frontier that is a downward-sloping straight line implies
A) economies of scale.
B) diseconomies of scale.
C) economies of scope.
D) no economies of scope.
Answer: D
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

7) A production possibilities frontier that is bowed-inward implies

A) economies of scale.
B) diseconomies of scope.
C) economies of scope.
D) no economies of scope.
Answer: B
Section: Cost of Producing Multiple Goods
Question Status: Revised
AACSB: Analytic thinking

8) What is one possible reason a firm that produces balloons might outsource its
accounting department?
A) There is no longer economies of scale.
B) There are now economies of scope.
C) There is no longer economies of scope.
D) There are now economies of scale.
Answer: C
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

9) Travel websites such as Travelocity tend to offer reservation services for multiple travel
modes. This is because
A) the firms have contractual obligations to offer reservations for airlines and railroads, for
example.
B) the firms have statutory obligations to offer reservations for airlines and railroads, for
example.
C) once the firm has the reservation technology for airlines, there are economies of scale in
offering the same service for railroads.
D) once the firm has the reservation technology for airlines, there are economies of scope
in offering the same service for railroads.
Answer: D
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

32
Copyright © 2015 Pearson Education, Inc.
10) Wood Working Company (WWC) can produce tables for a cost equal to C = 30 + qt or
chairs for a cost equal to
C = 30 + qc. However, the firm can also produce tables and chairs simultaneously for a
cost equal to
C = 50 + qc + qt. Does WWC experience economies of scope?

A) Yes, with SC = .

B) Yes, with SC = .

C) No, with SC = - .

D) No, with SC = 0.
Answer: A
Section: Cost of Producing Multiple Goods
Question Status: New
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

11) If a pharmaceutical firm is researching ways to improve its heartburn medicine and
discovers a technique that will improve its allergy medicine, one could conclude that
economies of scope exist in that industry.
Answer: True. Economies of scope imply that the cost of producing two goods together is
less than the cost of producing them separately. In this case, the costs of producing
heartburn medicine and allergy medicine are lower for the firm that produces both.
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

12) Explain why in the case of economies of scope the production possibility frontier is
bowed outward.
Answer: With economies of scope a firm uses less resources if it produces 2 goods jointly
instead of producing the 2 goods in two firms separately. This means that the firm can
produce more of the 2 goods when the goods are produced jointly. Hence, the PPF is
bowed outward.
Section: Cost of Producing Multiple Goods
Question Status: Old
AACSB: Analytic thinking

33
Copyright © 2015 Pearson Education, Inc.