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Chapter 6 – The firm and the industry
2. When the production function gets flatter as the quantity of labour increases, we
know
a. that the marginal product of labour is rising.
b. that the marginal product of labour is falling.
c. nothing about the marginal product of labour.
d. that the marginal product of labour is zero.
e. that the marginal product of labour goes to infinity.
Exhibit 6-1
Quantity of Quantity
labour produced
1 10
2 18
3 23
4 26
5 28
4. Refer to Exhibit 6-1. The marginal product of the fifth unit of labour is
a. 8.
b. 28.
c. 5.
d. 2.
e. 3.
9. The change in variable costs that results from producing one more unit of output
is called
a. marginal variable cost.
b. average variable cost.
c. total variable cost.
d. marginal cost.
e. marginal product.
Exhibit 6-2
14. Refer to Exhibit 6-2. The marginal cost of the second kilogram of bananas is
a. $25.
b. $2.
c. $3.
d. $4.
e. $0.
17. To derive the supply curve of a firm, we assume that the firm chooses to produce
where
a. sales are at a maximum.
b. employment is at a maximum.
c. profits are at a maximum.
d. total revenue is at a maximum.
e. total cost is at a minimum.
ANS: C PTS: 1 DIF: Basic TOP: Profit maximisation and the firm’s
supply curve
Exhibit 6-3
18. Refer to Exhibit 6-3. Suppose the firm has fixed costs of $30. What is the total
cost if output is five units?
a. $80
b. $104
c. $30
d. $50
e. $62
19. Refer to Exhibit 6-3. If output price is $14, the profit-maximising output level is
____ units.
a. 2
b. 5
c. 3
d. 4
e. 6
Exhibit 6-4
21. Refer to Exhibit 6-4. Which of the following statements is not true?
a. Fixed costs equal total costs when output equals zero.
b. The output closest to the profit-maximising level is Q3.
c. Profit is the same at Q1 as it is at Q4.
d. Profit is equal to zero when output equals zero.
e. Marginal cost is less than marginal revenue at Q2.
25. If price is greater than marginal cost and output is infinitely divisible, then
a. decreasing output decreases revenue less than it decreases cost.
b. increasing output increases revenue more than it increases cost.
c. increasing output increases revenue less than it increases cost.
d. decreasing output increases revenue more than it increases cost.
e. increasing output has no effect on revenue and cost.
27. If the marginal cost curves of all the businesses in an industry are horizontally
summed, one obtains
a. market demand.
b. total industry cost.
c. nothing of value.
d. market supply.
e. total fixed costs.
29. If the market wage increases, marginal cost shifts ____ and market supply ____.
a. upward; decreases
b. downward; decreases
c. upward; increases
d. downward; increases
e. upward and then downward; remains unchanged
31. The difference between the market price of a good and a producer’s marginal
cost of every unit of the good is called
a. consumer surplus.
b. producer surplus.
c. marginal surplus.
d. excess supply.
e. market surplus.
32. Which of the following scenarios would not affect producer surplus in the short
run?
a. Supply curve shifts to the left.
b. A price ceiling below equilibrium is imposed by government.
c. Wages paid to labour increase.
d. Demand curve shifts to the right.
e. Fixed costs for the typical firm increase.
33. Refer to Exhibit 6-5. Producer surplus in the market is illustrated by area(s)
a. A + B.
b. B.
c. A.
d. A + B – C.
e. C.
35. Refer to Exhibit 6-5. Total revenue in the market is illustrated by area(s)
a. B.
b. B + C.
c. A.
d. A + B.
e. C.
38. Which of the following does not change with the level of output?
a. Variable costs
b. Total costs
c. Fixed costs
d. Average total costs
e. Marginal cost
40. If a firm is currently producing zero output in the short run, total cost equals
a. fixed cost.
b. zero.
c. variable cost.
d. average variable cost.
e. marginal cost.
41. If the total cost of producing six units is $228 and the total cost of producing
seven units is $245, what is the marginal cost of producing seven units?
a. $35
b. $38
c. $245
d. $3
e. $17
43. Refer to Exhibit 6-6. At an output quantity of five units, the fixed cost is
a. $20.
b. $100.
c. $120.
d. $185.
e. $326.
44. Refer to Exhibit 6-6. At an output quantity of three units, the variable cost is
a. $13.
b. $20.
c. $48.
d. $148.
e. $185.
Exhibit 6-7
47. Refer to Exhibit 6-7. At an output of five units, the average fixed cost is
a. $50.40.
b. $252.
c. $68.
d. $100.
e. $20.
48. Refer to Exhibit 6-7. At an output of five units, the average total cost is
a. $16.40.
b. $20.
c. $30.40.
d. $50.40.
e. $252.
49. Refer to Exhibit 6-7. The average variable cost at three units of output is
a. $49.33.
b. $16.
c. $13.33.
d. $29.33.
e. $25.
51. Assume that one labourer produces six units of output, two labourers produce 14
units, three labourers produce 20 units, and four labourers produce 24 units.
Diminishing returns to labour set in
a. when the business hires the first labourer.
b. when the business hires the second labourer.
c. when the business hires the third labourer.
d. when the business hires the fourth labourer.
e. Diminishing returns have not set in as total output is still increasing.
54. Which curve passes through the minimum point of the average total cost curve?
a. The fixed cost curve
b. The average variable cost curve
c. The long-run average total cost curve
d. The marginal cost curve
e. The demand curve
57. Consider the following string of numbers: 20, 18, 14, 8, 2. Given the average of
these numbers, what happens when the number 6 is included?
a. The average falls, because 6 is less than 20, the first number in the set.
b. The average does not change, because 6 is insignificant.
c. The average rises, because 6 is greater than the last number in the set, 2.
d. The average rises, because 6 is greater than the previous average.
e. The average falls, because 6 is less than the previous average.
Exhibit 6-9
63. Refer to Exhibit 6-9. If the market price is $10, total revenue for the profit-
maximising business is
a. $550.
b. $3000.
c. $1800.
d. $1350.
e. $1000.
64. Refer to Exhibit 6-9. At an output of 100 units, fixed costs equal
a. $550.
b. $200.
c. $450.
d. $1000.
e. $350.
65. Refer to Exhibit 6-9. If the market price is $10, the firm’s profits are
a. $450.
b. $1200.
c. $3000.
d. $1200.
e. –$450.
67. If a profit-maximising, competitive firm is producing at a loss in the short run, then
a. P < AVC.
b. P < MC.
c. P = AVC + AFC.
d. average revenue is less than price.
e. P < ATC, but P > AVC.
68. If total revenue is greater than variable cost but less than total costs, the firm
should
a. remain in operation, because revenue is sufficient to cover variable costs and
some fixed costs.
b. shut down, because revenue is insufficient to cover all costs.
c. not make any decisions until it hires an economist.
d. remain in operation, because revenue is sufficient to cover all fixed costs.
e. shut down, because P is less than ATC.
70. The long-run average total cost curve is often bumpy because
a. capital can be varied only in tiny increments.
b. capital can often be varied only in large increments.
c. short-run average variable cost curves are bumpy.
d. short-run average total cost curves are bumpy.
e. capital cannot be increased with labour at the same time.
75. True or False. In economics, the main objective of a firm is to maximise customer
satisfaction.
ANS: F PTS: 1 DIF: Basic TOP: Profit maximisation and the firm’s
supply curve
76. True or False. Revenue is the only factor that affects profits.
ANS: F PTS: 1 DIF: Basic TOP: Profit maximisation and the firm’s
supply curve
77. True or False. The slope of the production function turns from positive to negative
when the marginal product of labour turns from positive to negative.
78. True or False. When marginal cost is positive, total cost must be rising.
79. True or False. Marginal product decreases as labour increases because marginal
cost is rising.
ANS: T PTS: 1 DIF: Basic TOP: Profit maximisation and the firm’s
supply curve
81. True or False. The market supply curve tends to get steeper as output increases.
82. True or False. If a firm leaves an industry, all other things being equal, the market
supply curve shifts left.
83. True or False. In a market diagram, producer surplus is shaped like a triangle
bounded by the vertical axis, the demand curve and the supply curve.
84. True or False. All other things being equal, an increase in marginal cost reduces
producer surplus.
85. True or False. In the long run, only fixed costs can change; variable costs cannot.
86. True or False. In the short run, total cost is zero when the business produces
nothing.
87. True or False. Both fixed cost and average fixed cost do not decline as the
quantity of output increases.
89. True or False. The marginal product of labour is the change in output divided by a
change in labour input.
90. True or False. The marginal cost curve intersects the average total cost curve at
the lowest point of the average total cost curve.
92. True or False. A firm is at the break-even point if its economic profits are greater
than zero.
93. True or False. Some competitive firms are willing to operate at a loss in the short
run because their revenues are at least able to cover their fixed costs.
94. True or False. If total revenue is greater than variable costs but less than total
costs, a business should remain in operation, because its revenue is sufficient to
cover variable costs and some fixed costs.
95. True or False. An expansion of capital increases fixed costs but does not affect
variable costs.
96. True or False. Economies of scale exist when the long-run total cost curve is
increasing at an increasing rate.
97. True or False. Economies and diseconomies of scale are the reasons short-run
average total cost decreases and then increases.
98. True or False. Minimum efficient scale is the largest output size for which the
long-run average total cost is at a minimum.
ANS:
If a business was producing at a price higher than all the other businesses in the
market, then nobody would want to patronise the more expensive business. If a
business was charging a price lower than all the other businesses, then consumers
would patronise only this business. It would be in the self-interest of all the other
businesses to charge a lower price if they wished to remain in business.
100. Define diminishing returns in production and illustrate it with a graph of a
production function.
ANS:
Diminishing returns occur when an additional unit of input causes less output to be
added than the previous unit of input. This assumes that all other things are equal.
The graph illustrates output increasing at a decreasing rate as input is added. Note
that output increases less when input is changed from I1 to I2 than it does when input
changes from I0 to I1.
101. Explain the relationship between marginal product and marginal cost.
ANS:
Marginal product is the change in output that results when one unit of an input is
added. Marginal cost is the change in total cost that results when output is increased
by one unit. It is assumed that, in the short run, only one input can change in order to
change output. A decrease in marginal product implies that the amount of input
needed to produce one more unit of output is increasing, which in turn means that
each additional unit of output is becoming increasingly costly to produce.
102. Explain why a firm’s supply curve is its marginal cost curve.
ANS:
A supply curve indicates how much a firm is willing to produce at any given price. To
maximise profit, the firm must equate marginal cost and output price, and it does this
by adjusting output. Thus, for any given price, the firm sets output so that price
equals marginal cost, and for any given price, the firm is producing a quantity
consistent with the marginal cost curve.
PTS: 1 DIF: Challenging TOP: Profit maximisation and the firm’s supply
curve
103. What is the profit-maximisation rule? Explain why profit is maximised when
the rule is met.
ANS:
Setting output so that price equals marginal cost is the profit-maximisation rule. Price
is assumed to be constant, whereas marginal cost is always increasing. If output is
reduced from the level described by the rule, revenue falls more than total cost and
profit falls. If output is increased, revenue rises less than total cost and profit falls.
Therefore, profit is maximised.
PTS: 1 DIF: Challenging TOP: Profit maximisation and the firm’s supply
curve
Exhibit 6-10
104. Refer to Exhibit 6-10. Assume that the market price is $15 and fixed costs are
$5. Calculate the profit at the profit-maximising output level.
ANS:
$23
The profit-maximising output level is four units, because the price is greater than $13
and the fourth unit has a marginal cost nearest to $15.
Profit at 4 units:
(4 $15) – ($4 + $6 + $9 + $13 + $5) = $60 – $37
PTS: 1 DIF: Moderate TOP: Profit maximisation and the firm’s supply
curve
105. Why does it not make sense to sum individual firms’ supply prices at every
quantity, rather than summing individual firms’ supply quantities at every price?
ANS:
The individual supply curve tells how much each firm is willing to produce for any
given price. With market supply, we want to know how much will be produced in the
market at any given price. Therefore, we sum how much each of the firms in the
market will produce at a given price to get the market quantity supplied. Summing
price at each quantity makes no sense given the nature of the supply decision on the
part of the firm.
ANS:
In this example, profit is being maximised when three or four crates of grapes are
produced. Marginal revenue (price) is equal to marginal cost when grape production
equals four crates. Profits are being maximised at this level of output.
PTS: 1 DIF: Moderate TOP: Profit maximisation and the firm’s supply
curve
107. Explain why average cost is not necessarily rising when marginal cost is
rising.
ANS:
Marginal cost first falls, pulling down the average. However, the average does not fall
as quickly as marginal cost falls. Thus, when marginal cost begins to increase, it is
still less than the average, thus pulling the average down. Only when marginal cost
exceeds the average does the average begin to rise.
108. Explain what happens to variable costs when capital usage in a business
increases.
ANS:
At all levels of output, variable costs tend to decrease. Less labour is necessary
because more capital makes the same amount of production possible with less
labour.
109. Consider the relationship between the average test score of a class and one
student’s test score. Suppose there are 10 students with an average test score of
80. Suppose the marginal score is the test score of a new student, Kelly.
(A) If Kelly’s score is 90, what will happen to the new average test score of the
class?
(B) If Kelly’s score is 70, what will happen to the new average test score of the
class?
(C) What do your answers to parts (A) and (B) illustrate about the relationship
between marginal and average curves in general?
ANS:
(A) If Kelly’s score is 90, which is higher than the original average score, then the
new average test score will increase.
(B) If Kelly’s score is 70, which is lower than the original average score, then the
new average test score will decrease.
(C) If the marginal curve is higher than the average curve, then the average curve
will increase; if the marginal curve is lower than the average curve, then the
average curve will decrease.
110. Draw typical average total cost, average variable cost, and marginal cost
curves for a competitive firm with price at the shutdown point. Show that total
revenue equals variable costs at this quantity. Also show the firm’s losses at this
quantity.
ANS:
If total revenue is equal to total variable cost for a price-taking firm, then price is
equal to average variable cost, as shown in the diagram below. Economic profit is
equal to the difference between total revenue and total cost. This difference is
illustrated by the shaded rectangle in the diagram below. The firm is earning a
negative economic profit because price, which also equals average variable cost, is
less than average total cost. The difference between variable cost and total cost is
the fixed cost, so the area of the shaded rectangle also equals total fixed cost.
ANS:
In the diagram, area A exhibits economies of scale, area B exhibits constant returns
to scale and area C exhibits diseconomies of scale.