Chapter 7 Costs

Multiple Choice
1) Economic costs of an input include (a) (b) (c) (d) only implicit costs. only explicit costs. both implicit and explicit costs. whatever management wishes to report to the shareholders.

Answer: C Difficulty: 0 Topic: Measuring Costs Question Status: Revised 2) The cost of waiting two months for health care to address a debilitating problem in Canada is most accurately described as (a) (b) (c) (d) an explicit cost. an accounting cost. no real cost. an opportunity cost.

Answer: D Difficulty: 1 Topic: Measuring Costs Question Status: New 3) Sarah earns $40,000 per year working for a large corporation. She is thinking of quitting this job to work fulltime 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) (b) (c) (d) $0. $40,000. $45,000. $90,000.

Answer: C Difficulty: 1 Topic: Measuring Costs Question Status: Revised

Chapter 7 Costs

135

4)

The Nifty Gum Co. has purchased a large parcel of land for $1 million. The company recently discovered that the land is contaminated and is worthless to all possible buyers. The opportunity cost of the land is (a) (b) (c) (d) $0. $1 million. some amount greater than $0 but less than $1 million. equal to the cost of the factory that was planned to be built there.

Answer: A Difficulty: 1 Topic: Measuring Costs Question Status: Revised 5) 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) (b) (c) (d) the opportunity cost of this endeavor. a sunk cost. an expense. a variable cost.

Answer: B Difficulty: 1 Topic: Measuring Costs Question Status: Revised 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) (b) (c) (d) the monthly mortgage payment the firm must pay. the price the firm paid divided by twelve. zero. the rent the firm could earn if it rented the building to another firm.

Answer: D Difficulty: 1 Topic: Measuring Costs Question Status: Revised 7) A firms marginal cost can always be thought of as the change in total cost if (a) (b) (c) (d) the firm produces one more unit of output. the firm buys one more unit of capital. the firms average cost increases by $1. the firm moves to the next highest isoquant.

Answer: A Difficulty: 0 Topic: Short-run Costs Question Status: New

136

Jeffrey Perloff Microeconomics, Third Edition

8)

Joeys Lawncutting Service rents office space from Joeys dad for $300 per month. Joeys dad is thinking of increasing the rent to $400 per month. As a result Joeys 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 Difficulty: 2 Topic: Short-run Costs Question Status: Revised

9)

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 firms marginal cost. (b) decrease the firms marginal cost. (c) have no effect on the firms marginal cost. (d) More information is needed to answer the question. Answer: C Difficulty: 2 Topic: Short-run Costs Question Status: Revised

10)

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 Difficulty: 2 Topic: Short-run Costs Question Status: Revised

11)

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 Difficulty: 2 Topic: Short-run Costs Question Status: Revised

Chapter 7 Costs

137

12)

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) (b) (c) (d) MC = AVC MC = AC MC > AFC All of the above.

Answer: A Difficulty: 2 Topic: Short-run Costs Question Status: Revised 13) Suppose the short-run production function is q = 10 * L. If the wage rate is $10 per unit of labor, then AVC = (a) q. (b) q/10. (c) 10/q. (d) 1. Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised 14) Suppose the short-run production function is q = 10 * L. If the wage rate is $10 per unit of labor, then MC = (a) (b) (c) (d) q. q/10. 10/q. 1.

Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised 15) 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) $10 (b) $5 (c) $2.5 (d) Cannot be determined without more information. Answer: C Difficulty: 2 Topic: Short-run Costs Question Status: Revised

138

Jeffrey Perloff Microeconomics, Third Edition

16)

Suppose the short-run production function is q = 10 * L. If the wage rate is $10 per unit of labor, then AFC = (a) (b) (c) (d) 0. 1. 10/q. Cannot be determined from the information provided.

Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised 17) 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) (b) (c) (d) $2 $0.5 $6 $3

Answer: D Difficulty: 1 Topic: Short-run Costs Question Status: Revised 18) In the short run, the point at which diminishing marginal returns to labor begin is the point at which the marginal cost curve (a) (b) (c) (d) peaks. bottoms out. is upward sloping. is downward sloping.

Answer: B Difficulty: 1 Topic: Short-run Costs Question Status: Revised 19) 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) (b) (c) (d) AFC is rising. AVC is rising. MC > AVC. MPL is falling.

Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised

Chapter 7 Costs

139

20)

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) (b) (c) (d) AFC is falling. AVC is rising. MC > AVC. All of the above.

Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised 21) If a particular production process is subject to diminishing marginal returns to labor at every level of output, then at every level of output (a) (b) (c) (d) AC is upward sloping. MC exceeds AVC. AFC is constant. All of the above.

Answer: B Difficulty: 2 Topic: Short-run Costs Question Status: Revised 22) 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) (b) (c) (d) fewer shovels being purchased. more workers being hired. a decrease in the firms output. no change in the firms output.

Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised 23) Which of the following will cause the marginal cost curve of making cigarettes to shift? (a) (b) (c) (d) A $5 million penalty charged to each cigarette maker. A $1 per pack tax on cigarettes. A $1 million advertising campaign by the American Cancer Society. All of the above.

Answer: B Difficulty: 2 Topic: Short-run Costs Question Status: Revised

140

Jeffrey Perloff Microeconomics, Third Edition

24)

Which of the following will cause the average cost curve of making cigarettes to shift? (a) (b) (c) (d) A $5 million penalty charged to each cigarette maker. A $1 per pack tax on cigarettes. A $1 an hour wage increase paid to all cigarette production workers. All of the above.

Answer: D Difficulty: 2 Topic: Short-run Costs Question Status: Revised 25) Which of the following will cause the average fixed cost curve of making cigarettes to shift? (a) (b) (c) (d) A $5 million penalty charged to each cigarette maker. A $1 per pack tax on cigarettes. A $3 per hour wage increase. An increase in the demand for cigarettes.

Answer: A Difficulty: 2 Topic: Short-run Costs Question Status: Revised 26) A specific tax of $1 per unit of output will affect a firms (a) (b) (c) (d) average total cost, average variable cost, average fixed cost, and average marginal cost. average total cost, average variable cost, and average fixed cost. average total cost, average variable cost, and average marginal cost. average marginal cost only.

Answer: C Difficulty: 1 Topic: Short-run Costs Question Status: New 27) In the long run, fixed costs are (a) (b) (c) (d) sunk. avoidable. larger than in the short run. not included in production decisions.

Answer: B Difficulty: 1 Topic: Long-run Costs Question Status: Revised

Chapter 7 Costs

141

28)

The slope of the isocost line tells the firm how much (a) (b) (c) (d) capital must be reduced to keep total cost constant when hiring one more unit of labor. capital must be increased to keep total cost constant when hiring one more unit of labor. more expensive a unit of capital costs relative a unit of labor. the isocost curve will shift outward if the firm wishes to produce more.

Answer: A Difficulty: 2 Topic: Long-run Costs Question Status: Revised 29) The slope of the isoquant tells the firm how much (a) (b) (c) (d) output increases when labor increases by one unit. output increases when capital and labor are doubled. capital must decrease to keep output constant when labor increases by one unit. a unit of capital costs relative to the cost of labor.

Answer: C Difficulty: 1 Topic: Long-run Costs Question Status: Revised 30) If an isocost line crosses the isoquant twice, a cost minimizing firm will (a) (b) (c) (d) use a different isocost line to select the bundle of inputs. use the input bundle associated with the intersection on the higher point of the isoquant. use the input bundle associated with the intersection on the lower point of the isoquant. both b and c.

Answer: A Difficulty: 1 Topic: Long-run Costs Question Status: New 31) When the isocost line is tangent to the isoquant, then (a) (b) (c) (d) MRTS = w/r. the firm is producing that level of output at minimum cost. the last dollar spent on capital yields as much extra output as the last dollar spent on labor. All of the above.

Answer: D Difficulty: 1 Topic: Long-run Costs Question Status: Revised

142

Jeffrey Perloff Microeconomics, Third Edition

32)

When the isocost line is tangent to the isoquant, then (a) (b) (c) (d) MPL = MPK. the firm is producing that level of output at minimum cost. the firm has achieved the right economies of scale. All of the above.

Answer: B Difficulty: 1 Topic: Long-run Costs Question Status: Revised 33) If the isoquants are straight lines or L-shaped, then a cost-minimizing firm will (a) (b) (c) (d) not be able to minimize costs. find the lowest isocost line touching the relevant isoquant. find the highest isocost line touching the relevant isoquant. choose not to produce any output.

Answer: B Difficulty: 1 Topic: Long-run Costs Question Status: Revised 34) 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 Difficulty: 1 Topic: Long-run Costs Question Status: New 35) 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) (b) (c) (d) all of the time. only when w = r. only when w = 0.5 * r. at no point in time.

Answer: B Difficulty: 1 Topic: Long-run Costs Question Status: Revised

Chapter 7 Costs

143

36)

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) (b) (c) (d) fewer shovels being purchased to produce the same number of trenches. more workers being hired to produce the same number of trenches. the firm wishing to produce more trenches. no change in the firms input mix.

Answer: D Difficulty: 1 Topic: Long-run Costs Question Status: Revised 37) 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) (b) (c) (d) increasing returns to scale. constant returns to scale. decreasing returns to scale. The returns to scale cannot be determined from the information provided.

Answer: D Difficulty: 2 Topic: Long-run Costs Question Status: Revised 38) Suppose that each worker must use only one shovel to dig a trench, and shovels are useless by themselves. In the long run, the firms cost function is (a) (b) (c) (d) TC = (w/r) * q. TC = (w + r)/q. TC = (w + r). TC = (w + r) * q.

Answer: D Difficulty: 1 Topic: Long-run Costs Question Status: Revised 39) 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 conclude that (a) (b) (c) (d) MPK = 3 * MPL. the firm will not hire any capital. the firm will hire 3 times as much labor as capital. the firm will hire 3 times as much capital as labor.

Answer: A Difficulty: 2 Topic: Long-run Costs Question Status: Revised

144

Jeffrey Perloff Microeconomics, Third Edition

40)

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) (b) (c) (d) economies of scale. economies of scope. constant returns to scale. increasing returns to scale.

Answer: C Difficulty: 1 Topic: Long-run Costs Question Status: Revised 41) Suppose that capital and labor must be kept in a fixed proportion to produce a particular good. For example, digging a trench requires one worker who has one shovel. What does this imply about returns to scale? (a) (b) (c) (d) There are constant returns to scale. There are increasing returns to scale. There are decreasing returns to scale. Nothing.

Answer: A Difficulty: 2 Topic: Long-run Costs Question Status: Revised 42) A change in relative factor prices will always result in (a) (b) (c) (d) a change in the slope of the isoquants. a tangency between the new isocost line and a new isoquant. a rotation of the isocost lines. all of the above.

Answer: C Difficulty: 0 Topic: Long-run Costs Question Status: New 43) Assuming that w and r are both positive, if the long-run expansion path is horizontal, then (a) (b) (c) (d) MPK = 0. MRTS is a function of capital only. w = r. All of the above.

Answer: B Difficulty: 2 Topic: Long-run Costs Question Status: Revised

Chapter 7 Costs

145

Figure 7.1 44) Figure 7.1 shows the long-run expansion path. The long-run average cost curve will be (a) (b) (c) (d) horizontal. downward sloping. upward sloping. vertical.

Answer: B Difficulty: 1 Topic: Long-run Costs Question Status: Revised 45) The long run average cost curve may initially slope downward due to (a) (b) (c) (d) decreasing average fixed costs. increasing marginal returns. economies of scale. all of the above.

Answer: C Difficulty: 0 Topic: Long-run Costs Question Status: New 46) If a production function is represented as q = LK, the long-run average cost curve will be horizontal as long as (a) (b) (c) (d) a + b = 0. a + b = 1. q > 0. L = K.

Answer: B Difficulty: 2 Topic: Long-run Costs Question Status: Revised

146

Jeffrey Perloff Microeconomics, Third Edition

47)

If there are diseconomies of scale within a given range of output, which of following is(are) TRUE? (a) (b) (c) (d) The short-run average cost curve must be upward sloping within that range of output. The long-run average cost curve must be upward sloping within that range of output. Long-run average cost must equal short-run average cost. All of the above.

Answer: B Difficulty: 2 Topic: Long-run Costs Question Status: Revised 48) 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) (b) (c) (d) economies of scale. rising average costs. increasing marginal costs. constant returns to scale.

Answer: A Difficulty: 1 Topic: Long-run Costs Question Status: Revised 49) Long-run average cost is never greater than short-run average cost because in the long run (a) (b) (c) (d) capital costs equal zero. the firm can move to the lowest possible isocost curve. wages always increase over time. wages always decrease over time.

Answer: B Difficulty: 1 Topic: Lower Costs in the Long Run Question Status: Revised 50) 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 Difficulty: 2 Topic: Lower Costs in the Long Run Question Status: Revised

Chapter 7 Costs

147

51)

In the short run, the expansion path is (a) (b) (c) (d) horizontal. vertical. diagonal. indeterminate.

Answer: A Difficulty: 1 Topic: Lower Costs in the Long Run Question Status: Revised 52) Learning by doing will result in (a) (b) (c) (d) an upward sloping long-run average cost curve. a larger long-run marginal cost than long-run average cost. a rotation in the isocost curves. lower long-run costs than short-run costs.

Answer: D Difficulty: 0 Topic: Lower Costs in the Long Run Question Status: New 53) Many universities have either a top football program OR a top basketball program. Very few have both. These results suggest the presence of (a) (b) (c) (d) economies of scope. diseconomies of scope. returns to scale. the law of diminishing marginal returns.

Answer: B Difficulty: 1 Topic: Cost of Producing Multiple Goods Question Status: Revised 54) 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 Difficulty: 1 Topic: Cost of Producing Multiple Goods Question Status: Revised

148

Jeffrey Perloff Microeconomics, Third Edition

55)

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) (b) (c) (d) a=b a + b = c c=0 a = b

Answer: C Difficulty: 2 Topic: Cost of Producing Multiple Goods Question Status: Revised 56) 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) (b) (c) (d) c>0 a + b = c c=0 c<0

Answer: D Difficulty: 2 Topic: Cost of Producing Multiple Goods Question Status: Revised 57) 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) (b) (c) (d) a=b a + b = c c>0 c<0

Answer: C Difficulty: 2 Topic: Cost of Producing Multiple Goods Question Status: Revised 58) A production possibilities frontier that is a downward-sloping straight line implies (a) (b) (c) (d) economies of scale. diseconomies of scale. economies of scope. no economies of scope.

Answer: D Difficulty: 1 Topic: Cost of Producing Multiple Goods Question Status: Revised

Chapter 7 Costs

149

True/False/Explain
1) 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. Difficulty: 1 Topic: Measuring Costs Question Status: Revised 2) 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 tot the total expense of the good. Difficulty: 1 Topic: Measuring Costs Question Status: New 3) 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. Difficulty: 1 Topic: Short-run Costs Question Status: Revised 4) 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. Difficulty: 1 Topic: Short-run Costs Question Status: New

150

Jeffrey Perloff Microeconomics, Third Edition

5)

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. Difficulty: 1 Topic: Long-run Costs Question Status: Revised

6)

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. Difficulty: 1 Topic: Costs Lower in the Long Run Question Status: Revised

7)

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. Difficulty: 1 Topic: Cost of Producing Multiple Goods Question Status: Revised

Problems
1) 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. Difficulty: 2 Topic: Measuring Costs Question Status: Revised

Chapter 7 Costs

151

2)

You have two career options. You can work for someone else for $50,000 a year. You can run your own business, your annual revenue is $100,000, and explicit costs are $40,000 annually. Explain which career option a profit-maximizer would select and why. Answer: 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. Difficulty: 0 Topic: Measuring Costs Question Status: New

Figure 7.2 3) A firms production function for pretzels is shown in Figure 7.2. If the firms fixed cost equals $100 per time period and the wage rate equals $1 per unit of labor per time period, calculate the firms MC, AVC, and AC schedules. Do these cost functions follow the general rules concerning the relationships between MC, AVC and AC? Answer: q AFC AVC AC 10 10.00 0.20 10.20 20 5.00 0.25 5.25 30 3.30 0.30 3.60 40 2.50 0.35 2.85 50 2.00 0.40 2.40 MC > AVC, AVC is rising. MC < AC, AC is falling. Difficulty: 1 Topic: Short-run Costs Question Status: Revised MC 0.30 0.40 0.50 0.60

152

Jeffrey Perloff Microeconomics, Third Edition

4)

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, which 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. Difficulty: 1 Topic: Short-run Costs Question Status: Revised

5)

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. Difficulty: 0 Topic: Long-run Costs Question Status: New

6)

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. Difficulty: 2 Topic: Long-run Costs Question Status: Revised

7)

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 have a decreasing average cost. As more inputs are used and output increases, the average cost declines, which is known as economies of scale. Difficulty: 2 Topic: Long-run Costs Question Status: Revised

8)

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. 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. Difficulty: 1 Topic: Long-run Costs Question Status: Revised

Chapter 7 Costs

153

Figure 7.3 9) 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 Figure 7.3. 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. Difficulty: 2 Topic: Long-run Costs Question Status: Revised

154

Jeffrey Perloff Microeconomics, Third Edition

Figure 7.4 10) 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 Figure 7.4. Difficulty: 1 Topic: Long-run Costs Question Status: Revised

Chapter 7 Costs

155

Figure 7.5 11) 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 Figure 7.5. Because the production process requires fixed proportions of K and L, the firm cannot change input mix when the relative factor costs change. Difficulty: 2 Topic: Long-run Costs Question Status: Revised 12) Suppose the production function is q = 12 L0.25 K0.75. 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 = MPL/MPK = K/3L = 1/3 = w/r. This firm will set K/L equal to one. Difficulty: 2 Topic: Long-run Costs Question Status: Previous edition 13) 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. Difficulty: 2 Topic: Long-run Costs Question Status: Revised

156

Jeffrey Perloff Microeconomics, Third Edition

Figure 7.6 14) At Alberts Pretzel Company, MPL = 1/L, and MPK = 1/K. The isoquant for 100 pounds of pretzels daily is shown in Figure 7.6. 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 daily in the short run? in the long run? Answer: In the short run, the input mix cannot change. The short-run cost is (5*50) + (10*100) = 1250. In the long run, Albert will change the input mix. From the graph, the new mix will be L = 10 and K = 5. To check, the MRTS = K/L and costs are minimized when MRTS = w/r which equals 1/2. As a result, the long-run cost of 100 pretzels is (10*50) + (5*100) = 1000. Difficulty: 2 Topic: Costs Lower in the Long Run Question Status: Revised 15) Suppose capital and labor are perfect substitutes resulting in a production function of q = 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. Difficulty: 2 Topic: Long-run Costs Question Status: Revised