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1 Chapter 3 Multiple Choice Questions 1. A business owner makes 1000 items a day. Each day he or she contributes 8 hours to produce those items. If hired, elsewhere he/she could have earned $250 an hour. The item sells for $15 each. Production does not stop during weekends. If the explicit costs total $150,000 for 30 days, the firm s accounting profit for the month equals: a. $300,000 b. $60,000 c. $450,000 d. $240, A business owner makes 1000 items a day. Each day he/she contributes 8 hours to produce those items. If hired, elsewhere he/she could have earned $250 an hour. The item sells for $15 each. Production does not stop during weekends. If the explicit costs total $150,000 for 30 days, the economic profit for the month equals: a. $300,000 b. $60,000 c. $450,000 d. $240, If a firm is earning negative economic profits, it implies a. That the firm s accounting profits are zero b. That the firm s accounting profits are positive c. That the firm s accounting profits are negative d. More information is needed to conclude about accounting profits 4. Opportunity costs arise due to a. Resource scarcity b. Interest rates c. Limited wants d. Unlimited scarcity 5. After graduating from college, Jim had three choices, listed in order of preference: (1) Move to Florida from Philadelphia, (2) work in a car dealership in Philadelphia, or (3) play soccer for a minor league in Philadelphia. His opportunity cost of moving to Florida includes a. The benefits he could have received from playing soccer b. The income he could have earned at the car dealership c. Both a and b d. Cannot be determined from the given information 6. Economic Value Added helps firms to avoid the hidden-cost fallacy a. by ignoring the opportunity costs to using a capital b. by differentiating between sunk and fixed costs c. by taking all capital costs into account including the cost of equity d. none of the above 5

2 7. The fixed-cost fallacy occurs when a. A firm considers irrelevant costs b. A firm ignores relevant costs c. A firm considers overhead or depreciation costs to make short-run decisions d. Both a and c 8. Mr. D's Barbeque of Pickwick, TN produces 10,000 dry-rubbed rib slabs per year. Annually Mr. D's fixed costs are $50,000. The average variable cost per slab is a constant $2. The average total cost per slab then is a. $7. b. $2. c. $5. d. impossible to determine. 9. All the following are examples of variable costs, except a. Labor costs b. Cost of raw materials c. Accounting fees d. Electricity costs 10. The U.S. Government bought 112,000 acres of land in southeastern Colorado in 1968 for $17,500,000. The cost of using this land today exclusively for the reintroduction of the blacktailed prairie dog a. is zero, because they already own the land. b. is zero, because the land represents a sunk cost. c. is equal to the market value of the land. d. is equal to the total dollar value the land would yield if used for farming and ranching. e. depends on the value to society of black-tailed prairie dogs. Multiple Choice Key 1. A 2. D 3. D 4. A 5. B 6. C 7. D 8. A 9. C 10. C Short Answer Questions 3-1 Concert Opportunity Cost 6

3 You won a free ticket to see a Bruce Springsteen concert (assume the ticket has no resale value). U2 has a concert the same night, and this represents your next-best alternative activity. Tickets to the U2 concert cost $80, and on any particular day, you would be willing to pay up to $100 to see this band. Assume that there are no additional costs of seeing either show. Based on the information presented here, what is the opportunity cost of seeing Bruce Springsteen? 3-2 Concert Opportunity Cost 2 You were able to purchase two tickets to an upcoming concert for $100 apiece when the concert was first announced three months ago. Recently, you saw that StubHub was listing similar seats for $225 apiece. What does it cost you to attend the concert? 3-3 Housing Bubble Due to the housing bubble, many houses are now selling for much less than their selling price just two to three years ago. There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house. What fallacy are they making? 3-4 Opportunity Cost The expression 3/10, net 45 means that the customers receive a 3% discount if they pay within 10 days; otherwise, they must pay in full within 45 days. What would the seller s cost of capital have to be in order for the discount to be cost justified? (Hint: Opportunity Cost) 3-5 Starbucks Starbucks is hoping to make use of its excess restaurant capacity in the evenings by experimenting with selling beer and wine. It speculates that the only additional costs are hiring more of the same sort of workers to cover the additional hours and costs of the new line of beverages. What hidden costs might emerge? 3-6 Dropping University Courses Students doing poorly in courses often consider dropping the courses. Many universities will only offer a refund up to a certain date. Should this affect their drop decisions? Short Answer Key 3-1 Concert Opportunity Cost $20. Opportunity cost is the value of your next best alternative. In this case, your next best alternative is attending the U2 concert. Your value for this alternative is $100 with a corresponding cost of $80 leaving a net value of $20. Note: This question is adapted from Paul J. Ferraro and Laura O. Taylor (2005) "Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science", Contributions to Economic Analysis & Policy: Vol. 4: No. 1, Article Concert Opportunity Cost 2 What you paid three months ago is irrelevant to your costs now. The decision you are facing is to attend the concert or not. If you do not attend, you can sell the tickets for $225 (ignoring any brokering fees and hassle costs). Thus, you forego $450 to attend the concert. 3-3 Housing Bubble These two homeowners have virtually identical houses that should sell at virtually identical prices. The purchase price from years ago is a sunk cost and therefore irrelevant to the pricing decision. They are committing the sunk cost fallacy. 3-4 Opportunity Cost The "opportunity cost" of receiving a late payment is the foregone benefit of receiving the money early. This is determined by a firm s cost of capital. A 3% interest rate for 35 days corresponds to an annual rate of about 3%*(365/35)=31%. 7

4 3-5 Starbucks There could be many hidden costs. Here are a few examples: Some of Starbucks current baristas are underage and are not permitted to serve alcohol. Hiring new bartenders may raise the labor costs. The storage and preparation of cold drinks, like beer and wine, differs considerably from the storage and preparation of hot drinks, like coffee. This suggests two separate production lines at each store. The Starbucks brand is known for signaling a quiet, comfy place to linger in small groups or alone. Serving alcohol may change the atmosphere enough that traditional coffee drinkers in the afternoon and early evening will be turned off. The Starbucks brands is also known for high quality coffees that are high quality partly because of the care in choosing beans, roasting them and brewing on the premises. It is not clear that there is much scope for care in 'preparing' beer and wine beverages to add similar value. If not, this brand extension could dilute the signal of the brand. 3-6 Dropping University Courses Before this date, the tuition is avoidable. After this date, it is sunk. Before this date, students compare the expected benefits to the tuition cost. After this date, they compare the expected benefits only to avoiding the hassle costs of continuing to participate in the course. 8

5 Chapter 4 Multiple Choice Questions 1. When economists speak of marginal, they mean a. Opportunity b. Scarcity c. Incremental d. Unimportant 2. Managers undertake an investment only if a. Marginal benefits of the investment are greater than zero b. Marginal costs of the investment are greater than marginal benefits of the investment c. Marginal benefits are greater than marginal costs d. Investment decisions do not depend on marginal analysis 3. A firm produces 500 units per week. It hires 20 full-time workers (40 hours/week) at an hourly wage of $15. Raw materials are ordered weekly and they costs $10 for every unit produced. The weekly cost of the rent payment for the factory is $2,250. How do the overall costs breakdown? a. Total variable cost is $17,000; total fixed cost is $2,250; total cost is $19,250 b. Total variable cost is $12,000; total fixed cost is $7,250; total cost is $19,250 c. Total variable cost is $5,000; total fixed cost is $14,250; total cost is $ d. Total variable cost is $5,000; total fixed cost is $2,250; total cost is $7, Total costs increase from $1500 to $1800 when a firm increases output from 40 to 50 units. Which of the following are true? a. FC = $100 b. FC = $200 c. FC = $300 d. FC = $ A manager of a clothing firm is deciding whether to add another factory in addition to one already in production. The manager would compare a. The total benefits gained from the two factories to the total costs of running the two factories. b. The incremental benefit expected from the second factory to the total costs of running the two factories. c. The incremental benefit expected from the second factory to the cost of the second factory d. The total benefits gained from the two factories to the incremental costs of running the two factories. 6. A firm is thinking of hiring an additional worker to their organization who they believe can increase total productivity by 100 units a week. The cost of hiring him or her is $1500 per week. If the price of each unit is $12, a. The MR of hiring the worker is $1500 b. The MC of hiring the worker is $1200 9

6 c. The firm should not hire the worker since MB<MC d. All the above 7. A retailer has to pay $9 per hour to hire 13 workers. If the retailer only needs to hire twelve workers, a wage rate of $7 per hour is sufficient. What is the marginal cost of the 13th worker? a. $117. b. $9. c. $33. d. $ If a firm s average cost is rising then a. Marginal cost is less than average cost. b. Marginal cost is rising. c. Marginal cost is greater than average cost d. The firm is making an economic profit 9. After the first week of his MBA Managerial Economics class, one of your pharmaceutical sales representatives accuses you of committing the sunk cost fallacy by refusing to allow him to reduce price to make what he considers to be a really tough sale. Which of the following suggest the sales representative may be right? a. Most of the costs of drug development are sunk, not fixed. b. Sales representatives are paid a sales commission on revenue, so they want to price where MR>0 instead of where MR>MC. c. Sales representatives don t worry that a low price today may make it more difficult for the company s other sales representatives to charge higher prices to their customers. d. Sales representatives forget that P>MC does NOT imply that MR>MC. 10. A company is producing 15,000 units. At this output level, marginal revenue is $22 and the marginal cost is $18. The firm sells each unit for $48 and average total cost is $40. What can we conclude from this information? a. The company is making a loss b. The company needs to cut production c. The company needs to increase production d. Not enough information is provided Multiple Choice Key 1. C 2. C 3. A 4. C 5. C 6. C 7. C 8. C 9. A 10. C 10