41) Assuming the existence of economies of scale, if a firm finds that it can reduce its unit cost
by decreasing its scale of production, it means that
A) it has too much production capacity relative to its demand.
B) it should try to produce less.
C) the law of diminishing returns has not taken effect.
D) it has too much fixed overhead relative to its variable cost.
42) As a firm attempts to increase its production, its long-run average costs eventually rise
because of
A) the law of diminishing returns.
B) diseconomies of scale.
C) fixed capital.
D) insufficient demand.
43) Economies of scale are created by greater efficiency of capital and by
A) longer chains of command in management.
B) better wages for labor.
C) smaller plant sizes.
D) increased specialization of labor.
44) Economies of scale are indicated by
A) declining long-run AVC.
B) declining long-run AFC.
C) declining long-run AC.
D) declining long-run TC.
45) Which of the following is a reason for economies of scale?
A) Fixed costs are spread out as volume increases.
B) The law of diminishing returns does not take effect.
C) Input productivity increases as a result of greater specialization.
D) There is greater savings in transportation costs.
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46) Diseconomies of scale can be caused by
A) the law of diminishing returns.
B) bureaucratic inefficiencies.
C) increasing advertising and promotional costs.
D) All of the above
47) Which of the following is the best example of economies of scope?
A) Coca-Cola expands its global operations to sub-Sahara Africa.
B) Alcohol for car fuel is produced from corn.
C) Amazon.com decides to rent out its Web site to independent e-commerce companies.
D) A company reduces its cost by getting bigger discounts for bulk purchases.
48) Short-run cost functions are estimated using
A) time-series regression analysis.
B) cross-sectional regression analysis.
C) nominal cost data.
D) present value cost data.
49) In estimating short-run cost functions, one must adjust for
A) price level changes.
B) accounting procedure changes.
C) product heterogeneity.
D) All of the above
50) Long-run cost functions are estimated using
A) time-series regression analysis.
B) cross-sectional regression analysis.
C) cost accounting data.
D) None of the above
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Analytical Questions
1) You have opened your own word-processing service. You bought a personal computer, and
paid $5,000 for it. However, due to the cost changes in the computer industry, the current price of
an equivalent machine is $2,500. You could sell any used machine for $1,000. If you were not
word processing, you could earn $20,000 per year at an alternative job. Assume that the interest
rate is 10%. You can also hire an assistant who can do everything that you can do for $20,000 per
year (you would still continue to do word processing).
One person using one computer can produce 11,000 typed pages per year, and the price per page
for your service is $2.
You are considering three options: (1) expand your business by hiring an assistant; (2) leave your
business the way it is; (3) shut down. Based on the costs and revenues above, which should you
do? Explain and show any relevant calculations.
2) Fred’s Widget Company has purchased $500,000 in equipment, which can be sold for a
salvage value of $300,000 at any time. The best interest rate on alternative investments is 5%.
What is the cost of using this machinery for one year? How would your answer be different if the
machinery had not yet been purchased?
3) The following table shows the relationship between output and number of workers in the short
run. If the wage is $50/day, find marginal cost of production.
Number of
Workers Output
0 0
1 50
2 110
3 300
4 450
5 590
6 665
7 700
8 725
9 740
10 735
4) Consider a firm that has just built a plant, which cost $1,000. Each worker costs $5.00 per
hour. Based on this information, fill in the table below.
Number of
Worker
Hours
Output Marginal
Product
Fixed
Cost
Variable
Cost
Total
Cost
Marginal
Cost
Average
Variable
Cost
Average
Total Cost
0 0 — — —
50 400
100 900
150 1300
200 1600
250 1800
300 1900
350 1950
5) How would each of the following affect the firm’s marginal, average, and average variable
cost curves?
a. An increase in wages
b. A decrease in material costs
c. The government imposes a fixed amount of tax.
d. The rent that the firm pays on the building that it leases decreases.
6) A firm experiences increasing returns to scale; that is, doubling all its inputs more than
doubles its output. What can be inferred about the firm’s short-run costs?
7) Carefully explain if the following statements are true, false, or uncertain.
a. If average cost is increasing, marginal cost must be increasing.
b. If there are diminishing returns, the marginal cost curve must be positively sloped.
c. Marginal costs decrease as output increases because the firm can spread fixed costs over
more units.
8) Carefully explain the difference between diseconomies of scale and diminishing returns.
9) For each of the following cost functions, find MC, AC, and AVC.
a. TC = 20,000 + 10 Q
b. TC = 18,000 + Q + 0.2 Q2
10) For each of the following cost functions, if possible, find minimum AC and minimum AVC.
a. TC = 20,000 + 10 Q
b. TC = 18,000 + Q + 0.2 Q2
11) Given the total cost function TC = 100 + 40Q – 15Q2 + 5Q3, calculate the
a. average fixed cost function (AFC)
b. average variable cost function (AVC)
c. marginal cost function (MC)
12) Given the production function Q = 21X + 9X2 – X3, where Q = Output, and X = Input
a. At what value of X does Stage II of the production function begin?
b. At what value of X does Stage III of the production function begin?
c. At what value of X does diminishing returns set in?