The Costs of Production

True/False

1. Accountants often ignore implicit costs.

ANS: T

2. A second or third worker may have a higher marginal product than the first worker in certain
circumstances.
ANS: T

3. The average fixed cost curve is constant.

ANS: F

4. If the marginal cost of producing the tenth unit of output is $3, and if the average total cost of
producing the tenth unit of output is $2, then at ten units of output, average total cost is rising.
ANS: T

5. Marginal costs are costs that do not vary with the quantity of output produced.
ANS: F

Multiple Choice

1. Profit is defined as

a. net revenue minus depreciation.

b. total revenue minus total cost.
c. average revenue minus average total cost.
d. marginal revenue minus marginal cost.

ANS: B

2. If Kelsey sells 300 glasses of lemonade at $0.50 each, her total revenues are
a. $150.
b. $299.50.
c. $300.
d. $600.

ANS: A

3. John has decided to start his own lawn-mowing business. To purchase the mowers and the trailer to
transport the mowers, John withdrew $1,000 from his savings account, which was earning 3% interest,
and borrowed an additional $2,000 from the bank at an interest rate of 7%. What is John's annual
opportunity cost of the financial capital that has been invested in the business?
a. $30
b. $140
c. $170
d. $300
ANS: C

Short questions

Joe wants to start his own business, which will require that he purchase a factory that costs $400,000. Joe
currently has $500,000 in the bank earning 3 percent interest per year.

If Joe purchases the factory with his own money, what is the annual implicit opportunity cost of purchasing
the factory?

ANS: $12,000

Suppose Joe purchases the factory using $200,000 of his own money and $200,000 borrowed from a bank at
an interest rate of 6 percent. What is Joe’s annual opportunity cost of purchasing the factory?

ANS: $18,000

Alyson’s Pet Sitting Service

Number of Output (number
Workers of pet visits)
0 0
1 20
2 45
3 60
4 70
1.

a. What is the marginal product of the second worker? Ans: 25

b. What is the marginal product of the third worker? Ans:15
c. When does Alyson’s pet sitting service experiences diminishing marginal productivity?
Ans: With the addition of the third worker.
d. Suppose that Alyson’s pet sitting service has a fixed cost of $50 per month for her cell phone. Each
worker costs Alyson $60 per day. What is the shape of Alyson’s total cost curve as output increases
from 0 and 45?
Ans: Total cost increases but gets flatter.

3.
Number of Output Fixed Variable Total
Workers Cost Cost Cost
0 0 $50 $0 $50
1 90 $50 $20 $70
2 170 $50 $40 $90
3 230 $50 $60 $110
4 240 $50 $80 $130
The marginal product of the second worker is
a. 90 units.
b. 85 units.
c. 80 units.
d. 20 units.

ANS: C
The marginal product of the third worker is
a. 230 units.
b. 100 units.
c. 77 units.
d. 60 units.

ANS: D

The marginal product of the fourth worker is

a. 10 units.
b. 60 units.
c. 230 units.
d. 240 units.

ANS: A

At which number of workers does diminishing marginal product begin?

a. 1
b. 2
c. 3
d. 4

ANS: B

If the firm can sell its output for $1 per unit, what is the profit-maximizing level of output?
a. 240 units
b. 230 units
c. 190 units
d. 170 units

ANS: B
Chapter 14
Firms in Competitive Markets

1. By comparing the marginal revenue and marginal cost from each unit produced, a firm in a competitive
market can determine the profit-maximizing level of production.
ANS: T

2. A firm is currently producing 100 units of output per day. The manager reports to the owner that
producing the 100th unit costs the firm $5. The firm can sell the 100th unit for $4.75. The firm should
continue to produce 100 units in order to maximize its profits (or minimize its losses).
ANS: F

Short Question
1. Describe the difference between average revenue and marginal revenue.

ANS:
Average revenue is total revenue divided by the quantity of output. Marginal revenue is the change in total
revenue from the sale of each additional unit of output. Marginal revenue is used to determine the profit-
maximizing level of production, and average revenue is used to help determine the level of profits. Note that
for all firms, price equals average revenue because AR=(PxQ)/Q=P. But only for a firm operating in a
perfectly competitive industry does price also equal marginal revenue.

2. Use a graph to demonstrate the circumstances that would prevail in a perfectly competitive market
where firms are experiencing economic losses. Identify costs, revenue, and the economic losses on your
graph. Using your graph, determine whether an individual firm will shut down in the short run, or
choose to remain in the market. Explain your answer.

ANS:
The losses and revenues are identified on the individual firm's graph. Total cost is equal to the sum of the
losses and revenue (because profit/loss=TR-TC, so TC=TR+profit/loss). The decision about whether this
firm shuts down or remains in the market depends upon the position of average variable cost. If average
variable cost is below P0 at output level Q0, the firm will remain in the market. If average variable cost is
above P0 at output level Q0 the firm will shut down in the short run.

3. At its current level of production a profit-maximizing firm in a competitive market receives $12.50 for
each unit it produces and faces an average total cost of $10. At the market price of $12.50 per unit, the
firm's marginal cost curve crosses the marginal revenue curve at an output level of 1,000 units. What is
the firm's current profit?
ANS:
$2,500

MULTIPLE CHOICE

1. Who is a price taker in a competitive market?

a. buyers only
b. sellers only
c. both buyers and sellers
d. neither buyers nor sellers

ANS: C

2. Suppose a firm in a competitive market reduces its output by 20 percent. As a result, the price of its
output is likely to
a. increase.
b. remain unchanged.
c. decrease by less than 20 percent.
d. decrease by more than 20 percent.

ANS: B

Quantity Total Revenue

0 $0
1 $7
2 $14
3 $21
4 $28

3. For a firm operating in a competitive market, the price is

a. $0.
b. $7.
c. $14.
d. $21.

ANS: B
4. For a firm operating in a competitive market, the marginal revenue is
a. $0.
b. $7.
c. $14.
d. $21.

5. For a firm operating in a competitive market, the average revenue is

a. $21.
b. $14.
c. $7.
d. $0.

ANS: C

Chapter 15
Monopoly

TRUE/FALSE

1. Monopolists can achieve any level of profit they desire because they have unlimited market power.
ANS: F

2. If the ABC company owns the exclusive rights to mine land in Afghanistan for Lapis Lazuli, a rare
stone used in jewelry which is found only in Afghanistan, the company benefits from a barrier to entry.
ANS: T

3. A monopoly creates a deadweight loss to society because it produces less output than the socially
efficient level.
ANS: T

4. Suppose a profit-maximizing monopolist faces a constant marginal cost of $10, produces an output
level of 100 units, and charges a price of $50. The socially efficient level of output is 200 units.
Assume that the demand curve and marginal revenue curve are the typical downward-sloping straight
lines. The monopoly deadweight loss equals $4,000.
ANS: F

Short Questions
1. Graphically depict the deadweight loss caused by a monopoly. How is this similar to the deadweight
loss from taxation?

ANS:
A profit-maximizing monopolist will choose to produce Q0 units of output and sell at price P0. However,
marginal cost is MC0. This is identical to the deadweight loss of taxation when the tax forces a wedge
between market price and marginal cost.
A monopoly firm maximizes its profit by producing Q = 500 units of output. At that level of output, its
marginal revenue is $30, its average revenue is $60, and its average total cost is $34.

The firm's profit-maximizing price is

a. $30.
b. between $30 and $34.
c. between $34 and $60.
d. $60.

ANS: D

At Q = 500, the firm's total revenue is

a. $13,000.
b. $15,000.
c. $17,000.
d. $30,000.

ANS: D

At Q = 500, the firm's profit is

a. $13,000.
b. $15,000.
c. $17,000.
d. $30,000.

ANS: A

At Q = 500, the firm's marginal cost is

 a. less than $30.

b. $30.
c. $34.
d. greater than $34.

ANS: B

MULTIPLE CHOICE
1. One difference between a perfectly competitive firm and a monopoly is that a perfectly competitive
firm produces where
a. marginal cost equals price, while a monopolist produces where price exceeds marginal
cost.
b. marginal cost equals price, while a monopolist produces where marginal cost exceeds
price.
c. price exceeds marginal cost, while a monopolist produces where marginal cost equals
price.
d. marginal cost exceeds price, while a monopolist produces where marginal cost equals
price.

ANS: A
2. When a monopolist decreases the price of its good, consumers
a. continue to buy the same amount.
b. buy more.
c. buy less.
d. may buy more or less, depending on the price elasticity of demand.

ANS: B
3. A monopolist maximizes profits by
a. producing an output level where marginal revenue equals marginal cost.
b. charging a price that is greater than marginal revenue.
c. earning a profit of (P - MC) x Q.
d. Both a and b are correct.

ANS: D