Chapter Six: The cost structure of firms

Table of Contents

1. Chapter Six: The cost structure of firms

Chapter Six: The cost structure of firms

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Question 1 Which one of the following is an accurate explanation of the relationship between marginal cost and average cost? a) If marginal cost is rising then average cost is rising. b) If marginal cost is constant then average cost is falling. c) If marginal cost is above average cost then average cost is rising. d) If marginal cost is above average cost then average cost is falling. e) If average cost is constant then marginal cost is zero. Correct.Incorrect. The answer is c) If marginal cost is above average cost then average cost is rising.Your answer has been saved.

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Question 2 Which one of the following is not an accurate explanation of the relationship between marginal cost (MC) and average variable cost (AVC)? a) If MC is rising then AVC is rising. b) If AVC is constant for all levels of output then MC is also constant. c) If AVC is rising then AVC must be below MC. d) If AVC is falling then MC must be below AVC. e) MC cuts AVC at its minimum point. Correct.Incorrect. The answer is a) If MC is rising then AVC is rising.Your answer has been saved.

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Question 3 Which of the following is a correct definition of a 'production function'? a) It shows how the value of output is determined by the costs of inputs. b) It shows how much production is needed in order to make a profit. c) It shows a firm how many workers it should hire. d) It shows how quantities of output per period are related to alternative possible quantities of inputs used per period. e) It shows how the average cost of production varies with output. Correct.Incorrect. The answer is d) It shows how quantities of output per period are related to alternative possible quantities of inputs used per period.Your answer has been saved.

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Question 4 The economists' definition of profit is the same as the accounting definition except that: a) It deducts fixed costs. b) It deducts taxes on profit. c) It deducts wages and salaries of workers. d) It deducts rental costs. e) It deducts the imputed costs of the owners' capital. Correct.Incorrect. The answer is e) It deducts the imputed costs of the owners' capital.Your answer has been saved.

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Question 5 The 'law of diminishing returns' states that: a) All firms will have economies of scale. b) All firms will have diminishing returns to scale. c) Holding one major input (such as the capital stock) constant, increasing quantities of the variable input will eventually lead to a diminishing marginal and average product. d) Long-run cost curves are always U-shaped. e) Labour productivity cannot always increase. Correct.Incorrect. The answer is c) Holding one major input (such as the capital stock) constant, increasing quantities of the variable input will eventually lead to a diminishing marginal and average product.Your answer has been saved.

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Question 6 Profit maximizing firms than can vary all of their inputs (and by small amounts where necessary) will higher all inputs so that: a) The marginal product of each input is zero. b) The marginal product of each input is the same. c) The average product of each input is at its maximum. d) The ratio of marginal products of each input is equal to their price ratio. e) The prices of each input are equal. Correct.Incorrect. The answer is d) The ratio of marginal products of each input is equal to their price ratio.Your answer has been saved.

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Question 7 The 'principle of substitution' implies that: a) Firms will try to replace workers with machines. b) Changing relative input prices will lead to changing combinations of inputs, such that relatively cheaper inputs will be substituted for relatively dearer inputs. c) Long-run cost curves are always falling. d) Firms will choose to produce goods that use more of the relatively cheaper inputs. e) Firms will only use the cheapest inputs. Correct.Incorrect. The answer is b) Changing relative input prices will lead to changing combinations of inputs, such that relatively cheaper inputs will be substituted for relatively dearer inputs.Your answer has been saved.

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Question 8 The presence of 'economies of scale' implies that: a) The short-run average cost curve is U-shaped. b) The short-run average cost curve is flat over a range and then positively sloped. c) The long-run average cost curve is positively sloped over some significant range. d) The long-run average cost curve is negatively sloped over some significant range. e) The law of diminishing returns does not hold. Correct.Incorrect. The answer is d) The long-run average cost curve is negatively sloped over some significant range.Your answer has been saved.

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Question 9 To what extent is the assumption that firms maximise profit consistent with the assumption that individuals seek to maximise utility? What factors might prevent a firm from maximising profit or an individual maximising utility? Hint: re-read 'Firms in theory' pp115-116. With respect to the second question, you might want to start off by thinking, at a personal level, things that prevent you from maximising your utility on a day to day basis and then applying these to the situation of the firm.

10	Question 10 Why do firms exist? Hint: An insight into answering this question can be derived from Box 6.3 (p116) which articulates some of the issues raised by Ronald Coase in his classic paper entitled 'The Nature of the Firm', published in 1937 in the Journal 'Economica'.

11	Question 11 Why might real-world firms not produce the output that can be derived theoretically from a given set of inputs (as defined within the production function)? Hint: re-read the section 'Production' on page 117 and ask yourself whether firms are truly 'efficient'.

12	Question 12 Why is a production function technology specific? Hint: re-read the section 'Production' on page 117.

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Question 13 Explain why a firm's marginal cost curve must pass through the firm's average variable cost curve and average total cost curves at their minimum points. Hint: re-read the section 'Short run variations in cost' pp123-124. For an alternative perspective to the question consider question 1, p135.

14	Question 14 If a firm has a range of outputs at which long run average cost is minimised (i.e. the long run average cost curve has a horizontal section), at what output is the minimum efficient scale? Hint: Re-read the section 'The shape of the long-run average cost curve' pp128-129.

15	Question 15 Why may firms experience a reduction in their long run average costs as output rises? What factors prevent firms from continuing to enjoy these reductions in average costs at ever increasing outputs? Hint: Re-read the section 'The shape of the long-run average cost curve' pp128-129.

16	Question 16 Why might a bakery be able to operate at its minimum efficient scale whereas a car manufacturer might not be able to? Hint: Re-read the section 'The shape of the long-run average cost curve' pp128-129 and think about the demand and supply characteristics of the two products.

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Question 17 Consider a firm contemplating an increase in output from Qo to Q1. Why might it find its average costs rising in the short-run but falling in the long-run? Hint: re-read the section 'The relationship between long-run and short-run costs' pp130-131. If you have a pencil and paper to hand, you might also wish to draw such a scenario.

18	Question 18 What factors will cause a firm's family of short-run and long-run average cost curves to shift (upwards or downwards)? Hint: re-read the section 'Shifts in cost curves' p131.