Chapter 7: Short run Costs and Output Decisions

MULTIPLE-CHOICE QUESTIONS

1. The short-run supply curve for a perfectly competitive firm is upward sloping because, as
production increases,

(a) the firm must pay higher hourly wages to its workers.
(b) total fixed costs increase.
(e) the firm is able to assign its workforce to specialized tasks.
(d) the marginal productivity of additional workers decreases.

2. In the short run, which of the following is possible?

3. The firm is at the output level where marginal cost intersects average variable cost.
We can infer that
(a) average variable cost is rising.
(b) average variable cost is falling.
(e) average total cost is falling.
(d) average total cost is rising.

4. In the short run, profits will be maximized at the output level where
(a) price is equal to marginal revenue.
(b) marginal cost is equal to average variable cost (which is when AVC is minimized).
(c) average total cost is minimized (and is equal to marginal cost).
(d) marginal cost is equal to price (which is equal to marginal revenue).

5.At the current production level, ATC is increasing. Of the following situations, we should
consider increasing production if
(a) price is less than average total cost.
(b) price is greater than average total cost.
(c) price exceeds average variable cost, but less than average total cost.
(d) price is equal to average total cost.

6. In the short run, profits will be maximized at that output level where
(a) total revenues are maximized.
(b) total costs are minimized.
(c) marginal costs and marginal revenues are equalized.
(d) variable costs are minimized .
7. HAL Corp., a perfectly competitive firm, is currently producing 20 units. The price is
$10 per unit, total fıxed eosts are $10, and average variable costs are $3. The firm
(a) is making a total profit of $130.
(b) is maximizing profit.
(c) is making a loss of $3 per unit.
(d) is making a profit of $7 per unit.

Use the following diagram, which refers to Jill and John's Jugs, to answer the next six
questions.

8. In the preceding diagram, the profit-maximizing output level is

9. In the preceding diagram, if the firm produces 600 jugs, its profit will be
(a) zero.
(b) $2400.
(c) $3600.
(d) $6300

10. In the preceding diagram, if the firm produces 400 jugs, its total cost will be
(a) $10
(b) $400
(c) $800
(d) $4000
11. In the preceding diagram, if the firm is producing 600 jugs it should _________ to
maximize profits.
(a) increase output to 900 jugs
(b) increase output to 1000 jugs
(c) maintain its current output level
(d) increase price to $20 and increase output to 1000 jugs

12. In the preceding diagram, if the firm produces 900 jugs, total revenue is
(a) $2700
(b) $5600
(c) $6300
(d) $9000

13. In the preceding diagram, if the firm expands production from 600 jugs to 900 jugs,
profit will
(a) increase from zero to $2700.
(b) decrease from $2400 to zero.
(c) decrease from $2400 to $1800.
(d) increase from $2400 to $2700.
APPLICATION QUESTIONS

1.Here is a production function for XYZ Incorporated.

Number Output TVC TFC TC AVC AFC ATC MC

The firm's overheads/day are:

Taxes $15
Rent $50
Machines $45
Total/day $110

The variable costs/day are the $30 wage for each worker hired.

(a) The firm is operating in the short run. How can you tell?

(b) What is happening to marginal product? Why? (Refer to Chapter 6 if you're

(c) Use the figures given to derive the cost information for the table.
 (d) Use the figures to sketch diagrams of the average cost curves and marginal cost
(Remember that the "average-marginal rule" guarantees that MC will intersect AVC
and ATC at their minimum points!)

(e) Compare the output level where MP peaks with the output level where MC bottoms
out. Why are they the same?

2. You are hired as a consultant by Ken's Cuddly Critters, a manufacturer of soft toy animals.
Ken has the most modem equipment and a well-motivated workforce, but he is not sure
whether he is maximizing his profits. You are given the following information about Ken's
costs and the market he faces. Ken informs you that production comes in "batches" of 100
animals.
Note: The "Other Costs" category includes items like rent, interest on bank loans
incurred by Ken, and an allowance for capital depredation.

(a) What is the price per stuffed animal?

(b) Calculate Ken's total fıxed cost.

(c) Calculate Ken's marginal cost per animal and complete the following table
(d) Having compiled your information, you ask Ken for his present output level and are told
that output is 200 animals per week. Ken asks if this the profit-maximizing output level and, if
not, how he should adjust his production. How should you respond?

(e) Before he makes his decision to accept your recommendation, Ken asks what the
maximum economic profit will be.

(f) Ken now tells you that his landlord is proposing a rent increase to $200 per week, effective
next week. How does this change in Ken's costs affect your recommendations?

3. Examine the following data:

The cost of producing the 51st unit is $25. Sketch the AFC, AVC, ATC, and MC curves as
they would be at an output level of 50 units.
4. Average total cost is $300, total fixed cost is $2,000, and total cost is $6,000. Calculate the
average variable cost.

5. Suppose that the total costs of a purely competitive firm are as follows:

(a) Complete the AVC and TC columns.

(b) The price of the product is $30. Fill in the TR column.

(c) Compare the TC and TR columns to fill in the profit column.

(d) To maximize profits, what output should the firm choose? _____

What will be the firm's total profit? _____

(e) Fill in the P(MR) column. Using the P = MC (profit maximization) rule, what output
should the firm choose? ______

(f) What do you predict will happen to the number of firm in this industry? In that case,
what will happen to supply and to the market price?

(g) Now work out the profit-maximizing output levels when price is

$20 ____ $40____ $50____ $60____

Solutions to Multiple-Choice Questions

1. (d) The shape of marginal cost curve is affected by marginal productivity. The upward
sloping section of the MC curve is related to diminishing returns as additional units of
variable inputs(workers) are added.

2. (c) When low levels of output are produced, few variable resources are hired and
fixed costs can exceed variable cost.

3. (c) AVC will be at its minimum value and neither rising nor falling. Because marginal
cost is lower than ATC, ATC will be increasing.

4. (d) In perfect competition, price and marginal revenue have the same value. To
maximize profits, the firm should produce at the level of output where MR=MC.

5. (b) If ATC is rising, MC must be above it. In perfect competition, price equals MR. The
profit maximizing firm should increase production only if MR exceeds MC. This may
be case only if price (MR) exceeds ATC. In all other cases, MR is less than MC and
output should be reduced.

6. (c) The profit maximizing condition is that MT should equal MC.

7. (a) TR=Pxq=$10x 20= $200. TVC=AVCxq=$3x 20=$60.

TC=TFC+TVC=$10+$60=$70.

Total economic profit=TR-TC=$200-$70=$130

8. (c) MR=MC when the output level is 900.

9. (b) TR=$10x600=$6000. TC=$6x6000=$3600

10. (d) TC=ATCxq=$10x400=$4000.

11. (a) MR=MC at 900 units of output. Note: The perfectly competitive firm is a price
taker and cannot increase its price.

12. (d) TR=Pxq=$10x900=$9000.

13. (d) At 600, TR-TC=$6000-$3600=$2400