Economics for Business Decisions - Term Paper Example

?Chapter 05 Production and Cost     Essay Questions   Always Round Tire has a production function of Q = 300 L.75 K.5. In the short run, if L = 250 and K = 25, what happens to the output of tires if L jumps to 300 and then 350. What law does this illustrate?  When L=250 and K=25 then Q=94307. When L increases to 300, Q increases to 108,127. When L increases to 350, Q increases to 121,379. This shows the effects of diminishing marginal returns to labor as a factor of production. Always Round Tire has a production function of Q = 300 L.75 K.5 . If Always Round Tire doubles the size of its production facility – increasing L from 250 to 500 and K from 25 to 50 – what happens to the cost of production, even though we do not know the wages of labor or the price of capital?  This production exhibits increasing returns to scale. Doubling the scale of production will more than double the quantity of output. Costs per unit will decline because the firm takes advantage of the economies of scale. Why do economies of scale and learning curve effects look similar when they are graphed? What different concepts do they represent?  A graph of economies of scale shows that average costs per unit of output fall when the quantity of output increases. However, this decrease in the average cost per unit of output occurs at a decreasing rate. Economies of scale show the cost advantages larger firms have in some industries, like basic metals, where costs per unit fall with the cumulative volume of output. A graph of a learning curve shows that average costs per unit of output fall when the cumulative quantity of output produced since inception increases. This decrease in the average cost per unit of output occurs at a decreasing rate. Learning curves show the cost advantages firms that have cumulatively produced greater amounts of output have in some industries, like semiconductors. For many corporations, a major portion of the cost of production is fixed in the short run. Should these very large fixed costs be ignored when the executives are making output and pricing decisions? Why?  Yes, these fixed costs should be ignored when making short-run output and pricing decisions because they do not affect marginal costs or marginal benefits in the short-run. In the long-run all costs are variable costs and there are no long-run fixed costs.   Wanda Weeks is tired of running her small machine tool company. She wishes to sell it in order use her time and money elsewhere. She is currently earning a salary of $85,000 per year and a 10% return on her capital investment. She wants to take a job in a bank and invest her capital in a mutual fund. What issues should she look at before making the decision to change careers?  She should look at the opportunity cost of her time and capital. The total opportunity cost running her machine tool business is the value of both her time and her capital. She should compare how much she could earn from both labor income and selling her capital investment in the machine tool business to her current labor income and capital return as the owner of this business. The Springfield Bank received 1500 inquires following its latest advertisement describing its "establish a Certificate of Deposit (CD)-get a free CD (compact disk)" promotion in the Springfield Shopper, a local newspaper. The most recent similar ad in a similar advertising campaign in the Brockman Business Newsletter, a local business publication generated 500 inquires. Each ad in the Springfield Shopper costs $500. Each ad in the Brockman Business Newsletter costs $125. Inquires from both publications have the same success rate in turning inquires into sales. (a.) Assuming that additional ads will generate similar response rates, is Springfield Bank running an optimal mix of ads in the Springfield Shopper and the Brockman Business Newsletter? Why or why not? (b.) If you claim that the Springfield Bank is currently running an optimal mix of ads clearly explain why they are using an optimal mix of ads. If you claim that the Springfield Bank is currently not running an optimal mix of ads clearly explain how better manage the Springfield Bank.  Profit maximization requires cost minimization. So the key question is whether Springfield Bank is minimizing the cost of generating inquirers into its financial products through its choice of advertising. We should compare the bang-for-buck ratios of advertising in the Springfield Shopper and advertising in the Brockman Business Newsletter. The bang-for-buck ratio is the ratio of marginal product to unit cost for each form of advertising. Since the bang-for-buck ratio is higher for the Brockman Business Newsletter than the Springfield Shopper the bank should reduce advertising in the Springfield Shopper and increase advertising in the Brockman Business Newsletter. At the optimal amount of advertising in each publication the bang-for-buck ratios would be equal.  Can a production function with two factors, exhibit increasing returns to scale, while at the same time have diminishing returns to each factor?  The answer is YES. Look at the following production function: Q = S0.5 A0.6. Here, following the book, we have Q for the quantity of auto parts produced. S and A are the amounts of Steel and Aluminum used in production. For checking if the production function exhibits increasing returns to scale, first set S = A = 1 unit. Then total auto parts produced is Q = (1)0.5 (1)0.6 = 1 unit. Now, double the inputs and set S = A = 2 units. Now check for the new output: new Q = (2)0.5 (2)0.6 = (2)1.1 > 2 units. So here we see that doubling both inputs, more than doubles the output. This reflects increasing returns to scale. Now we want to see if each factor exhibits diminishing returns. To see if S exhibits diminishing returns, set A = 1 unit. Increase S from 1 to 2 units and check the output level: A = 1, S = 1 and so Q = (1)0.5 (1)0.6 = 1 unit. A = 1. S = 2 and so Q = (2)0.5 (1)0.6 = 1.41 units. As S increases by 1 unit, Q increases only by 0.41 units. So S exhibits decreasing returns. Do the same exercise for A and you will see a similar result: S = 1, A = 1 and so Q = (1)0.5 (1)0.6 = 1 unit. S = 1. A= 2 and so Q = (1)0.5 (2)0.6 = 1.51 units. As A increases by 1 unit, Q increases only by 0.51 units. So A exhibits decreasing returns as well.   Currently where "s" and "a" refer to steel and aluminum, and Ps and Pa refer to the prices of steel and aluminum, and MPs and MPa refer to their marginal products. Has the firm come up with the right amounts of steel and aluminum, or should it reallocate its resources to make the maximum profit?  No, currently the firm is not in equilibrium. Since the firm cannot touch prices, it can only manipulate the marginal products to set which is the necessary condition for maximum profits. From the given question, we note that MPs has to fall, and MPa has to rise. This can happen only if the firm hires more S and/or less A. So the current allocation of resources is not optimal. Currently the Marginal Cost equation is given by MC = 10 + 2 Q for a shoe manufacturing company. The market price per pair is $60. How many units should the company produce?  The company should produce 25 units. We get this by setting MC = P and solving for Q: 10 + 2 Q = 60 or 2 Q = 50 Q = 25 units   Multiple Choice Questions   Assume your company produces good X using only two inputs, capital (K) and labor (L). Also, assume L is measured on the vertical axis and K on the horizontal one. If the prices of inputs are PK=$30 and PL=15, and your company is behaving efficiently, what is the slope of the isoquant at the current input mix?  A. -2 B. -1/2 C. 2 D. 1/2 Assume SeatComfy Inc. produces table and chairs with the following total cost function, TC=10,000+10Q+0.1Q2, where Q=quantity of chairs produced. If SeatComfy can sell as many chairs it wishes at the current market price of $45, how many chairs should it produce to maximize its short-run profits?  A. 350 B. 700 C. 175 D. 45  Assume the generic production function Q=f(K,L) displays both decreasing returns to capital (K), and decreasing returns to labor (L). Then:  A. this production function will certainly display decreasing returns to scale. B. this production function will certainly display constant returns to scale. C. this production function will certainly display increasing returns to scale. D. this production function may display increasing returns to scale  In general, which of the following implies that a marginal cost curve will eventually increase as a firm produces more output?  A. Profit maximizing behavior by the firm. B. A production function displaying increasing returns to scale. C. The law of diminishing returns. D. The law of equi-marginal returns.       Refer to Figure 5.1. Observe the three isoquants depicted and determine which of the following statements is true.  A. K and L are substitutes in each of the three cases. B. K and L are substitutes in cases (1) and (2). C. K and L are substitutes in cases (2) and (3). D. K and L are substitutes in cases (1) and (3). The curve showing all the combinations of inputs that can be purchased with a given outlay of funds is called a(n):  A. total cost curve. B. isocost. C. isoquant. D. production function     Refer to Figure 5.2 and determine which of the following answers is correct.  A. The missing values are MPL(L=2)=45, MPL(L=3)=29, APL(L=2)=35, and APL(L=4)=28. B. The missing values are MPL(L=2)=35, MPL(L=3)=33, APL(L=2)=35, and APL(L=4)=28. C. The missing values are MPL(L=2)=45, MPL(L=3)=29, APL(L=2)=45, and APL(L=4)=13. D. The missing values are MPL(L=2)=45, MPL(L=3)=29, APL(L=2)=35, and APL(L=4)=13. The Marginal Product curve of input Y shows:  A. how the quantity of output produced changes for each amount of input Y, whether or not all other inputs are held constant. B. how the quantity of output produced changes for each amount of input Y, holding all other inputs constant. C. how the average quantity of output produced varies with input Y, whether or not all other inputs are held constant. D. how the average quantity of output produced varies with input Y, holding all other inputs constant.  If the generic production function Q=f(K,L) displays increasing returns to scale, the value of K is fixed in the short-run, and the prices of all inputs are held constant, then:  A. the Short-Run Average Cost curve must be strictly decreasing. B. the Long-Run Average Cost curve must be strictly decreasing . C. the Short-Run and the Long-Run Average Cost curves will coincide. D. the Long-Run Average Cost curve must be strictly increasing . If the price of a variable input increases, then:  A. the total cost curve will shift up. B. the average total cost curve will shift down. C. the marginal cost curve will shift down. D. the fixed cost curve will shit up.  A production with the form Q = 150L.75 K.50 will have __________ in the long run.  A. increasing returns to scale B. decreasing returns to scale C. constant returns to scale D. diminishing returns to the variable input   A production with the form Q = 40 L.75 K.20 will have __________ in the long run.  A. increasing returns to scale B. decreasing returns to scale C. constant returns to scale D. diminishing returns to the variable input  If a company has significant economies of scale in the long run – assuming a large market -- the company will tend to:  A. grow larger and have a declining average cost curve. B. become smaller and have a declining average cost curve. C. grow larger and have raising average cost curve. D. become smaller and have a rising average cost curve.    If a company has a cost curve of TC = 300 + 2Q + Q2 and it produces 300 units per day, then its marginal cost is:  A. $1.00. B. $600. C. $602. D. $2.02.   If a company has a cost curve of TC = 300 + 2Q + Q2 and it produces 300 units per day, then its average (total) cost is:  A. $1.00. B. $303. C. $300. D. $602. The general rule for profit maximization in a firm is to:  A. set average cost at its minimum. B. reduce fixed costs by expanding output. C. maximize sales revenue. D. set marginal revenue to marginal cost. The opportunity cost of any business decision is:  A. accounting cost divided by the level of output. B. cost per unit. C. the cost of the next best alternative. D. the cost of doing business in the future.     Over time, learning costs per unit tend to:  A. rise as volume accumulates. B. stay constant as volume accumulates. C. fall as volume accumulates. D. first falls and then rises as volume accumulates As output expands from 199 to 200 units and total costs rise from $2985 to $3000, the marginal cost and average cost of production are:  A. $1.00, and $200. B. $15 and $15. C. $29.85 and $15. D. $1.  An independent trucker has the following options. If he buys expensive machinery, then he can hire fewer drivers to deliver the same output. Over the course of this month, he has to deliver to 50 spots. To do this job, he has 3 possible combinations of output that he can use: Method 1: 20 drivers, 10 machines Method 2: 50 drivers, 2 machines Method 3: 100 drivers, 0 machines   The following table gives cost information for the production of widgets. Some values are missing, however. Which of the following statements is true? Method 4: 10 drivers, 12 machines Hiring a driver costs $10. Each machine costs $100. Which method should he use?  A. Method 1 B. Method 2 C. Method 3 D. Method 4     Refer to Figure 5.3, which gives cost information for the production of widgets. Some values are missing, however. Which of the following statements is true?  A. A=45, E=40 B. A=45, E=10 C. A=75, E=40 D. A=75, E=10 A firm that produces widgets must pay fixed costs of $150. It costs an additional $30 for every widget that they produce. If the market price is $40, how many widgets does the firm have to sell so that they do not make a loss?  A. 1 B. 5 C. 10 D. 15 A firm produces 10 widgets that they sell for $15 each. The average variable cost for the production of 10 widgets is $13/unit. The fixed costs for this firm equal $20. What is the value of this firm's profits?  A. -$20 B. -$2 C. 0 D. $20 A firm's average total cost is minimized when it produces 10 units. When it produces 10 units, the average total cost is $5/unit. What is the marginal cost when the firm produces 10 units?  A. less than $5/unit B. greater than $5/unit C. $5/unit D. $10/unit Which of the following statements about the average total cost curve is false?  A. it is initially downward sloping because increases in quantity make the average fixed cost smaller B. it eventually becomes upward sloping because the law of diminishing returns sets in C. it is always downward sloping because the average fixed costs will always decrease as quantity increases D. the marginal cost curve crosses the average total cost curve at the point at which average total cost is minimized   36.  Refer to Figure 5.4. On the graph that shows total costs, what is the level of variable costs when 6 units are produced?  A. $50 B. $100 C. $400 D. $500 Bob owns an auto parts firm. He uses a combination of steel and aluminum to produce his auto parts. All of the following combinations will finish the task on time. Steel costs $15 per unit and the aluminum costs $50 per unit. What combination of steel and aluminum should he use?  A. 10 units of steel and 10 units of aluminum B. 12 units of steel and 8 units of aluminum C. 15 units of steel and 7 units of aluminum D. 20 units of steel and 6 units of aluminum Diminishing marginal returns occur when  A. one input is increasing and the others are held constant B. all inputs increase C. one input is decreasing while the other increases D. output is decreasing    Economies of scale arise when  A. all inputs increase by the same amount B. one input increases and the others are held constant C. one input increases and the others decrease D. all inputs increase at the same rate   Read More