TEST II.

EXPLANATION (5 points each)

Instruction: Answer all questions concisely, briefly, and legibly. You may use a diagram to explain your
answers.

1. If the owner of a business pays himself no salary, then accounting cost is zero, but economic
cost is positive. True or false? Explain.

2. True. Since there is no

monetary transaction, there is no
accounting, or explicit, cost.
However,
3. since the owner of the
business could be employed
elsewhere, there is an economic
cost. The
4. economic cost is positive,
reflecting the opportunity cost
of the owner’s time. The
economic cost
5. is the value of the owner’s
time in his next best alternative,
 or the amount that the owner
would
6. earn if he took the next best
job
7. True. Since there is no
monetary transaction, there is no
accounting, or explicit, cost.
However,
8. since the owner of the
business could be employed
elsewhere, there is an economic
cost. The
9. economic cost is positive,
reflecting the opportunity cost
of the owner’s time. The
economic cost
 10. is the value of the owner’s
time in his next best alternative,
or the amount that the owner
would
11. earn if he took the next best
job
True. Since there is no monetary transaction, there is no accounting, or explicit, cost. However, since the
owner of the business could be employed elsewhere, there is an economic cost. The economic cost is
positive, reflecting the opportunity cost of the owner’s time. The economic cost is the value of the
owner’s time in his next best alternative, or the amount that the owner would earn if he took the next
best job

2) Do fixed costs refer to the long run or short run? Why?

Fixed cost are only short term and do change over time. In long run, there are no fixed costs
because the long run enough for all short run fixed inputs to become variable.

3) Suppose that labor is the only variable input in the production process. If the marginal cost of
production is diminishing as more units of output are produced, what can you say about the marginal
product of labor?

The marginal product of labor must be increasing. The marginal cost of production measures the extra
cost of producing one more unit of output. If this cost is diminishing, then it must be taking fewer units
of labor to produce the extra unit of output. If fewer units of labor are required to produce a unit of
output, then the marginal product (extra output produced by an extra unit of labor) must be increasing.
Note also, that MC  w/MPL, so that if MC is diminishing then MPL must be increasing for any given w.

4) What are economies of scale? What are economies of scope? What is the difference between the
two?

Economies of scale occur when a company that mass produces products reaches a point where
production costs begin to decrease rather than increase. Creating an economy of scale essentially means
increasing output while decreasing per-unit costs. This allows businesses to expand production while
lowering costs, allowing them to lower product costs for their customers.

There are numerous advantages to creating economies of scale, including lower production costs,
gaining a competitive advantage, increasing business scale, and improving products.

Economies of scope occur when a company diversifies its products and begins to produce a wide range
of different products, thereby lowering production costs. In terms of scope economies, the cost of
producing at least two different goods concurrently is less than the cost of producing both goods
separately.. A restaurant that expands its menu to include new options while using the same resources
as before is an example of a scope economy.

There are numerous advantages to creating economies of scope, including lower production costs,
increased efficiency, increased product variety, improved customer satisfaction, and lower business
risks.

Both economies of scale and economies of scope are useful financial concepts that businesses can use
to cut costs. There are, however, significant differences between the two. Here are a few key
distinctions between economies of scale and economies of scope: 1. How costs are reduced.. Businesses
use economies of scale to increase production and standardize their products, allowing them to reduce
production costs. Businesses diversify their products in economies of scope, which leads to cost
reductions. 2. Limitations. There is a point in economies of scale where costs no longer decrease, which
means that businesses can stop creating economies of scale if their production becomes too large. One
limitation of economies of scope is that companies may not have enough knowledge to expand their
product offering. 3. the number of products. Economies of scale are used for a single product that a
company specializes in producing. Economies of scope involve multiple products that a company can
produce using the same set of resources, lowering production costs. 4. . Resources needed. The
resources required to create each are another distinction between economies of scale and economies of
scope. Creating economies of scale typically necessitates significantly more resources than creating
economies of scope. This is because economies of scope do not rely on mass production, but rather on
the production of a variety of products in a single operation.

5) A firm that has positive accounting profit does not necessarily have positive economic profit. True
or false? Explain.
True. Accounting profit considers
only the explicit, monetary costs.
Since there may be some
opportunity costs that were not
fully realized as explicit monetary
costs, it is possible that when
the opportunity costs are added in,
economic profit will become
negative. This indicates that the
firm’s resources are not being put
to their best use
True. Accounting profit considers only the explicit, monetary costs. Since there may be some
opportunity costs that were not fully realized as explicit monetary costs, it is possible that when the
opportunity costs are added in, economic profit will become negative. This indicates that the firm’s
resources are not being put to their best use.

6) Assume that marginal cost in production is greater than average variable costs. Can you determine
whether average variable cost is decreasing or increasing? Explain.

Yes, the average variable cost is increasing. If marginal cost is above average variable cost, each
additional unit costs more to produce than the average of the previous units, so the average variable
cost is pulled upward. This is shown in the diagram above for output levels greater than q2.