1 of 16 10/19/2013 12:21 PM All of the following are ways a business can earn economic profits except Discover new products. Maximize implicit costs but not explicit costs. Take above-average risks. Find new and better methods of production. To earn economic profits, a business must see opportunities that others have missed, discover new products, find new and better methods of production, or take above-average risks. A firm will want to minimize costs in order to maximize profit. Accounting costs and economic costs differ because Accounting costs exceed economic costs whenever any factor is not paid an explicit wage. Accounting costs include implicit costs, and economic costs do not. Economic costs include the opportunity costs of all resources used, while accounting costs include actual dollar outlays. Accounting costs include explicit costs, and economic costs do not. Accounting costs refer to the explicit dollar outlays made by a producer. Economic costs, in contrast, refer to the value of all costs, both explicit and implicit. Normal profit Covers the full opportunity cost of the resources used by the firm. Is an above-average rate of return. Is the accounting profit earned when economic profits are greater than zero. Is sufficient to induce entry into the industry. Normal profit is the profit made that covers all explicit costs and implicit costs but does not include any profit above and beyond what could have made with those resources used elsewhere. Difficulty: 1 Easy
2 of 16 10/19/2013 12:21 PM Which of the following should not be included when calculating accounting profit? The cost of taxes. The return on inventory investment. The cost of rent. The cost of utilities. The cost of taxes, rent, and utilities are all explicit costs. The return on inventory investment is an implicit cost and therefore is not included when calculating accounting profit. The $600 paid in property taxes counts as An implicit cost. A normal cost. A variable cost. An explicit cost. The costs of taxes, fertilizer, seeds, water, wages, and interest are all explicit costs. Suppose a firm has an annual budget of $200,000 in wages and salaries, $75,000 in materials, $30,000 in new equipment, $20,000 in rented property, and $35,000 in interest costs on capital. The owner/manager does not choose to pay himself, but he could receive income of $90,000 by working elsewhere. The firm earns revenues of $360,000 per year. What is the accounting profit for the firm described above? -$90,000. $0. $90,000. $200,000. Accounting profit is equal to revenue ($360,000) minus explicit costs ($360,000), which is $0.
3 of 16 10/19/2013 12:21 PM The perfectly competitive market structure includes all of the following except Many firms. Identical products. Large advertising budgets. Low entry barriers. A perfectly competitive industry has several distinguishing characteristics, including many firms, identical products, and low entry barriers. Because the products are nearly identical, it is not necessary or even beneficial to advertise. When a producer can control the market price for the good it sells, the producer Is an entrepreneur. Is certain to make a profit. Has market power. Is a perfectly competitive firm. A firm that has market power will have the ability to control the market price for the good it sells, unlike a perfectly competitive firm that risks losing all of its customers, who will shop elsewhere, if it increases the price of its product. Difficulty: 1 Easy A competitive firm Has the market power to compete effectively. Is large enough relative to the market to be taken into account by competitors. Confronts a downward-sloping firm demand curve. Is a price taker. A perfectly competitive firm risks losing all of its customers, who will shop elsewhere, if it increases the price of its product above the market-established price. Therefore, it is compelled to take the market price that is determined by the interaction of supply and demand.
4 of 16 10/19/2013 12:21 PM The demand curve confronting a competitive firm is Horizontal, as is market demand. Horizontal, while market demand is downward-sloping. Downward-sloping, while market demand is flat. Downward-sloping, as is market demand. The market demand curve for a product is always downward-sloping (law of demand). The demand curve confronting a perfectly competitive firm is horizontal (perfectly elastic demand). The fact that a perfectly competitive firm's total revenue curve is an upward-sloping straight line implies that The total profit curve is also an upward-sloping straight line. Product price is constant at all levels of output. Product price decreases as output increases, and demand is elastic. Product price increases at all output levels. Because a competitive firm can sell all its output at the prevailing price, its total revenue curve is linear. If a perfectly competitive firm wanted to maximize its total revenues, it would produce The output where MC equals price. As much as it is capable of producing. The output where the ATC curve is at a minimum. The output where the marginal cost curve is at a minimum. If a competitive firm wanted to maximize its total revenue, it would always produce at capacity because the individual firm is so small relative to the market that it will not impact market price.
5 of 16 10/19/2013 12:21 PM Which of the following is generally a fixed cost? Property taxes on land used in production. Wages. Profit taxes. Utilities. Fixed costs, such as the cost of the basic plants and equipment and property taxes, do not vary with the rate of output. When the short-run marginal cost curve is upward-sloping, The average total cost curve is upward-sloping. The average total cost curve is above the marginal cost curve. Diminishing returns occurs with greater output. There are diseconomies of scale. Whenever marginal physical product is increasing, the marginal cost of producing a good must be falling. At the point of diminishing marginal returns, the marginal physical product declines and the marginal cost increases.
6 of 16 10/19/2013 12:21 PM Refer to the data in Figure 22.1. The shape of the total revenue curve indicates that the price of this good Falls as output rises. Rises as output rises. Stays the same as output rises. Falls at first as output rises, but then rises as output rises. The straight-line total revenue curve has a constant slope of $10. That indicates that the price is always $10 even when output rises. Difficulty: 3 Hard Learning Objective: 22-03 How a competitive firm maximizes profit.
7 of 16 10/19/2013 12:21 PM Short-run profits are maximized at the rate of output where Average total costs are minimized. Total revenue is maximized. Marginal revenue is zero. Marginal revenue is equal to marginal cost. A competitive firm maximizes total profit at the output rate where MC is equal to MR. If MC is less than MR, the firm can increase profits by producing more. If MC exceeds MR, the firm should reduce output. Learning Objective: 22-02 The characteristics of perfectly competitive firms. If a perfectly competitive firm is producing a rate of output at which MC exceeds price, then the firm Must have an economic loss. Can increase its profit by increasing output. Can increase its profit by decreasing output. Is maximizing profit. If MC exceeds price, a firm is spending more to produce that extra unit than it is getting back, and total profits will decline. Hence a firm will want to decrease production whenever price is less than MC. Learning Objective: 22-02 The characteristics of perfectly competitive firms. If price is greater than marginal cost, a perfectly competitive firm should increase output because Marginal costs are increasing. Additional units of output will add to the firm's profits (or reduce losses). The price it receives for its product is increasing. Total revenues would increase. If an extra unit brings in more revenue than it costs to produce, it would add to total profit. Hence a competitive firm should expand the rate of production whenever price exceeds MC. Learning Objective: 22-02 The characteristics of perfectly competitive firms.
8 of 16 10/19/2013 12:21 PM Refer to Figure 22.3 for a perfectly competitive firm. If the market price is $15, The firm should produce 39 units. The firm should shut down. The firm will have above-normal profits. Economic profits will be zero. When the market price is $15, the profit-maximizing output is 31 units. At that point price is equal to ATC, and profits will be zero. Learning Objective: 22-03 How a competitive firm maximizes profit.
9 of 16 10/19/2013 12:21 PM Refer to Figure 22.3 for a perfectly competitive firm. If the market price is $23, The firm should produce 31 units. Economic profits are zero. The firm should produce 25 units. The firm will have above-normal profits. When the market price is $23, the profit-maximizing output is 39 units. At that point price is greater than ATC, and economic profits will be greater than zero (above normal). Learning Objective: 22-03 How a competitive firm maximizes profit.
10 of 16 10/19/2013 12:21 PM Refer to Figure 22.3 for a perfectly competitive firm. If the market price is $10, The firm should produce 31 units. The firm will shut down in the short run. An economic loss will occur. The firm will earn normal profits. When the market price is $10, the profit-maximizing output is 25 units. At that point price is less than ATC, and economic losses will be incurred. Learning Objective: 22-03 How a competitive firm maximizes profit.
11 of 16 10/19/2013 12:21 PM Refer to Figure 22.3 for a perfectly competitive firm. At a market price of $23, profit per unit is maximized at an output of 13 units. 25 units. 31 units. 39 units. The difference between price and average cost profit per unit is illustrated by the vertical distance between the price and ATC curves. At a price of $23, the profit per unit is maximized at the output that minimizes ATC, 31. Learning Objective: 22-03 How a competitive firm maximizes profit.
12 of 16 10/19/2013 12:21 PM Refer to Figure 22.3 for a perfectly competitive firm. Which of the following statements is true for this firm between the prices of $10 and $15? The firm is experiencing zero economic profits. The firm is experiencing economic profits because the market price is greater than or equal to the minimum AVC. The firm is experiencing economic losses and should shut down. The firm is experiencing economic losses but should continue to produce. A firm should shut down only if the losses from continuing production exceed fixed costs. This happens when price is less than average variable cost. When the price is between $10 and $15, price is less than ATC, so the firm is losing money, but it is losing less than it would if it shut down. Difficulty: 3 Hard Learning Objective: 22-03 How a competitive firm maximizes profit.
13 of 16 10/19/2013 12:21 PM A catfish farmer will shut down production when He is losing money. Price falls below AVC. Total revenue falls below total costs. The best he can do is break even. A firm should shut down only if the losses from continuing production exceed fixed costs. This happens when total revenue is less than total variable cost or price is less than average variable cost. Learning Objective: 22-04 When a firm will shut down. When a firm minimizes its losses in the short run, It continues to produce only if price exceeds average variable cost. The firm makes an investment decision. The firm enters or exits from the market. It continues to produce only if price exceeds marginal revenue. If the price (or MR) is less than ATC but greater than AVC, then a perfectly competitive firm is losing less than its fixed costs and should continue producing in the short run in order to minimize its losses. Learning Objective: 22-04 When a firm will shut down. The decision to start or expand a business is known as the Output decision. Investment decision. Production decision. Profit maximization decision. An investment decision is the decision to build, buy, or lease plants and equipment, or to enter or exit an industry. Difficulty: 1 Easy Learning Objective: 22-05 The difference between production and investment decisions.
14 of 16 10/19/2013 12:21 PM An investment decision involves choosing A rate of output and is a short-run decision. A rate of output and is a long-run decision. The amount of plants and equipment and is a short-run decision. The amount of plants and equipment and is a long-run decision. An investment decision is the long-run decision to build, buy, or lease plants and equipment, or to enter or exit an industry. Learning Objective: 22-05 The difference between production and investment decisions. In making an investment decision, an entrepreneur Treats all costs as variable. Makes a shutdown decision if price is below average variable cost. Must take account of diminishing returns to fixed factors. Decides the level of output to produce. An investment decision is the long-run decision to build, buy, or lease plants and equipment, or to enter or exit an industry. In the long run all costs are variable. Learning Objective: 22-05 The difference between production and investment decisions. If Microsoft is thinking about building a new factory, it is making a Long-run decision that will definitely enhance its profit. Long-run decision that may enhance its profit. Short-run decision that will definitely enhance its profit. Short-run decision that may enhance its profit. An investment decision is the long-run decision to build, buy, or lease plants and equipment, or to enter or exit an industry. Difficulty: 3 Hard Learning Objective: 22-05 The difference between production and investment decisions.
15 of 16 10/19/2013 12:21 PM A change in which of the following will change the optimal rate of output? Payroll taxes. Profit taxes. Property taxes. Inflation taxes. If any determinant of supply changes, the supply curve shifts. An increase in payroll taxes, for example, would raise the marginal cost. This would shift the supply curve to the left, therefore changing the optimal rate of output. Learning Objective: 22-06 What shapes or shifts a firm s supply curve. If a perfectly competitive firm is producing at its profit-maximizing output in the short run and fixed costs decline, the firm should Use less capital but increase output by hiring more labor. Not change output. Reduce output. Increase output. Since fixed costs do not affect marginal costs, a change in fixed costs leaves the optimal rate of output unchanged. Learning Objective: 22-06 What shapes or shifts a firm s supply curve. Which of the following affects both the marginal and average total cost curves of a firm in the short run? A change in profit taxes. A change in payroll taxes. A change in property taxes. A change in consumer income. Marginal cost is the change in total cost that occurs when more output is produced. However, fixed costs are constant, so the change in total cost will be the result of a change in variable costs only. A change in variable costs will impact both the marginal and the average total cost. Learning Objective: 22-06 What shapes or shifts a firm s supply curve.
16 of 16 10/19/2013 12:21 PM When technology improves, the firm's marginal cost curve shifts Upward, and supply increases. Downward, and supply increases. Upward, and supply decreases. Downward, and supply decreases. If any determinant of supply changes, the supply curve shifts. An increase in technology will lower the marginal cost of producing a good, and the supply curve will shift to the right. Learning Objective: 22-06 What shapes or shifts a firm s supply curve. Which of the following affects the ATC curve for a firm but not the MC curve? A change in property taxes. A change in payroll taxes. A change in profit taxes. A change in the price of the good. Fixed costs such as the cost of the basic plants and equipment and property taxes do not vary with the rate of output and therefore do not affect marginal costs but do affect the ATC. Learning Objective: 22-06 What shapes or shifts a firm s supply curve. Businesses that fail to account for implicit costs, like the strawberry farmer, Hiroshi Fujishige, who failed to consider the enormous opportunity of selling his property to Disneyland, will Go out of business immediately. Make higher-than-normal profits. Make more money when they shut down. Have to increase revenues in order to stay in business. Fujishige could have made even more money if he had stopped growing strawberries. Learning Objective: 22-03 How a competitive firm maximizes profit.