MULTIPLE CHOICE
1. Evidence from empirical studies of short-run cost-output relationships lends support to the:
a. existence of a non-linear cubic total cost function
b. hypothesis that marginal costs first decrease, then gradually increase over the normal operating range of the firm
c. hypothesis that total costs increase quadratically over the ranges of output examined
d. hypothesis that total costs increase linearly over the range of output examined
e. none of the above
2. The short-run cost function is:
a. where all inputs to the production process are variable
b. relevant to decisions in which one or more inputs to the production process are fixed
c. not relevant to optimal pricing and production output decisions
d. crucial in making optimal investment decisions in new production facilities
e. none of the above
3. Theoretically, in a long-run cost function:
a. all inputs are fixed
b. all inputs are considered variable
c. some inputs are always fixed
d. capital and labor are always combined in fixed proportions
e. b and d
4. Break-even analysis usually assumes all of the following except:
a. in the short run, there is no distinction between variable and fixed costs.
b. revenue and cost curves are straight-lines throughout the analysis.
c. there appears to be perfect competition since the price is considered to remain the same regardless of quantity.
d. the straight-line cost curve implies that marginal cost is constant.
e. both c and d
5. What is another term meaning the degree of operating leverage?
a. The measure of the importance of fixed cost.
b. The operating profit elasticity.
c. The measure of business risk.
d. D.O.L.
e. All of the above.
6. In a study of banking by asset size over time, we can find which asset sizes are tending to become more prominent. The size that is becoming more predominant is presumed to be least cost. This is called:
a. regression to the mean analysis.
b. breakeven analysis.
c. survivorship analysis.
d. engineering cost analysis.
e. a Willie Sutton analysis.
7. George Webb Restaurant collects on the average $5 per customer at its breakfast & lunch diner. Its variable cost per customer averages $3, and its annual fixed cost is $40,000. If George Webb wants to make a profit of $20,000 per year at the diner, it will have to serve__________ customers per year.
a. 10,000 customers
b. 20,000 customers
c. 30,000 customers
d. 40,000 customers
e. 50,000 customers
8. In determining the shape of the cost-output relationship only ____ depreciation is relevant.
a. direct
b. indirect
c. usage
d. time
e. scheduled
9. Which of the following is not a limitation of the survivor technique for measuring the optimum size of firms within an industry?
a. since the technique does not employ actual cost data in the analysis, there is no way to assess the magnitude of the cost differentials between firms of varying size and efficiency.
b. the managerial and entrepreneurial aspects of the production process are not included in the analysis
c. because of legal factors, the long-run cost curve derived by this technique may be distorted and may not measure the cost curve postulated in economic theory
d. a and b
e. b and c
10. The primary disadvantage of engineering methods for measuring cost functions is that they deal with the managerial and entrepreneurial aspects of the production process or plant.
a. true
b. false
11. A linear total cost function implies that:
a. marginal costs are constant as output increases
b. average total costs are continually decreasing as output increases
c. a and b
d. none of the above
12. A ____ total cost function implies that marginal costs ____ as output is increased.
a. linear; increase linearly
b. quadratic; increase linearly
c. cubic; increase linearly
d. a and b
e. none of the above
13. A ____ total cost function implies that marginal costs ____ as output is increased.
a. linear; increase linearly
b. quadratic; are constant
c. cubic; increase linearly
d. linear; are constant
e. none of the above
14. A ____ total cost function yields a U-shaped average total cost function.
a. cubic
b. quadratic
c. linear
d. a and b only
e. a, b, and c
15. In the linear breakeven model, the difference between selling price per unit and variable cost per unit is referred to as:
a. variable margin per unit
b. variable cost ratio
c. contribution margin per unit
d. target margin per unit
e. none of the above
16. Which of the following is not an assumption of the linear breakeven model:
a. constant selling price per unit
b. decreasing variable cost per unit
c. fixed costs are independent of the output level
d. a single product (or a constant mix of products) is being produced and sold
e. all costs can be classified as fixed or variable
17. In the linear breakeven model, the breakeven sales volume (in dollars) is equal to fixed costs divided by:
a. unit selling price less unit variable cost
b. contribution margin per unit
c. one minus the variable cost ratio
d. a and b only
e. a, b, and c
18. The degree of operating leverage is equal to the ____ change in ____ divided by the ____ change in ____.
a. percentage; sales; percentage; EBIT
b. unit; sales; unit; EBIT
c. percentage; EBIT; percentage; sales
d. unit; EBIT; unit; sales
e. none of the above
19. The linear breakeven model excludes ____ from the analysis.
a. financing costs
b. taxes
c. contribution margin
d. a and b only
e. a, b, and c
20. In the linear breakeven model, the relevant range of output is that range where the linearity assumptions of the model are assumed to hold.
a. true
b. false
21. In the linear breakeven model, the breakeven sales volume (in dollars) can be found by multiplying the breakeven sales volume (in units) by:
a. one minus the variable cost ratio
b. contribution margin per unit
c. selling price per unit
d. standard deviation of unit sales
e. none of the above
22. In the linear breakeven model, a firm incurs operating losses whenever output is less than the breakeven level.
a. true
b. false
PROBLEMS
1. For each of the following cost-output relationships, describe the shape (U-shape, decreasing, increasing, constant) of the average total cost and marginal cost functions (C = total cost, Q = output):
(a) C = 42,500,000 + 2550Q
(b) C = 8.48 + 0.65Q + .00220Q2
2. Offshore Petroleum’s fixed costs are $2,500,000 and its debt repayment requirements are $1,000,000. Selling price per barrel of oil is $18 and variable costs per barrel are $10.
(a) Determine the breakeven output (in dollars).
(b) Determine the number of barrels of oil that offshore must produce and sell in order to earn a target (operating) profit of $1,500,000.
(c) Determine the degree of operating leverage at an output of 400,000 barrels.
(d) Assuming that sales of oil are normally distributed with a mean of 362,500 barrels and a standard deviation of 100,000 barrels, determine the probability that Offshore will incur an operating loss.
Chapter 10—Prices, Output, and Strategy: Pure and Monopolistic Competition
MULTIPLE CHOICE
1. The main difference between perfect competition and monopolistic competition is:
a. The number of sellers in the market
b. The ease of entry and exit in the industry
c. The degree of information about market price
d. The degree of product differentiation
e. Whether it is the short run or the long run
2. Long distance telephone service has become a competitive market. The average cost per call is $0.05 a minute, and it’s declining. The likely reason for the declining price for long distance service is:
a. Governmental pressure to lower the price
b. Reduced demand for long distance service
c. Entry into this industry pushes prices down
d. Lower price for a barrel of crude oil
e. Increased cost of providing long distance service
3. What is the profit maximization point for a firm in a purely competitive environment?
a. The output where P = MC
b. The output where P < MC
c. The output where P > MC
d. The output where MR = MC
e. The output where AVC < P
4. All of the following are true for both competition and monopolistic competition in the long run, except one of them. Which is it?
a. P = MC
b. P = AC
c. Economic profits become zero in the long-run
d. The barriers to entry and exit are relatively easy
e. None of the above is an exception
5. Which of the following statements is (are) true concerning a pure competition situation?
a. Its demand curve is represented by a vertical line.
b. Firms must sell at or below market price.
c. Marginal revenue is equal to price.
d. both b and c
e. both a and b
6. In pure competition:
a. the optimal price-output solution occurs at the point where marginal revenue is equal to price
b. a firm’s demand curve is represented by a horizontal line
c. a firm is a price-taker since the products of every producer are perfect substitutes for the products of every other producer
d. a and b only
e. a, b, and c
7. In the short-run for a purely competitive market, a manufacturer will stop production when:
a. the total revenue is less than total costs
b. the contribution to fixed costs is zero or less
c. the price is greater than AVC
d. operating at a loss
e. a and b
8. In the purely competitive case, marginal revenue (MR) is equal to:
a. cost
b. profit
c. price
d. total revenue
e. none of the above
9. In long-run equilibrium, all firms in a pure competition market situation operating under a condition of certainty will have identical costs even though they may use different production and operation techniques.
a. true
b. false
10. If price exceeds average costs under pure competition, ____ firms will enter the industry, supply will ____, and price will be driven ____.
a. more; decrease; down
b. more; decrease; up
c. more; increase; down
d. more; increase; up
e. none of the above
11. A firm in pure competition would shut down when:
a. price is less than average total cost
b. price is less than average fixed cost
c. price is less than marginal cost
d. price is less than average variable cost
12. In the long-run, firms in a monopolistically competitive industry will
a. earn substantial economic profits
b. tend to just cover costs, including normal profits
c. seek to increase the scale of operations
d. seek to reduce the scale of operations
13. Uncertainty includes all of the following except ____.
a. unknown effects of deliberate actions
b. incomplete information as to the type of competitor
c. random disturbances
d. unverifiable claims
e. accidents due to weather hazards
14. Experience goods are products or services
a. that the customer already knows
b. whose performance is highly unusual
c. whose quality is undetectable when purchased
d. not likely to cause repeat purchases
e. all of the above
15. Buyers anticipate that the temporary warehouse seller of unbranded computer equipment will
a. deliver high quality products consistent with expectations
b. not attempt to establish any warranty enforcement mechanisms
c. offer several prices and qualities
d. produce only one quality
e. none of the above
16. All of the following are mechanisms which reduce the adverse selection problem except ____.
a. warranties from established enterprises with non-redeployable assets
b. high interest rates
c. large collateral requirements
d. brand names and product-specific promotions and retail displays
e. higher prices in repeat customer transactions
17. Asset specificity is largest when
a. value in first best use is large
b. value in second best use is large
c. customers choose their supplier at random
d. very valuable assets are non-redeployable
e. customers are loyal to a particular seller
18. Under asymmetric information,
a. you never get what you pay for
b. you sometimes get cheated
c. you always get cheated
d. at best you get what you pay for
e. sellers make profits in excess of competitive returns
19. To escape adverse selection and elicit high quality experience goods buyers can
a. offer price premiums to new firms in the market
b. seek out unbranded goods
c. buy from generic storefronts that have leased temporary space
d. secure warranties from warehouse retailers
e. none of the above
20. The problems of asymmetric information exchange arise ultimately because
a. one party to the exchange possesses different information than another
b. one party has more information than another
c. one party knows nothing
d. one party cannot independently verify the information of another
e. information is scarce
21. The market for “lemons” is one in which
a. the rational buyer discounts
b. the seller’s product claims are unverifiable at the point of purchase
c. “the bad apples drive out the good”
d. the problem of adverse selection is rampant
e. all of the above
22. The fraudulent delivery of low quality experience goods at high prices is more likely if
a. interest rates decline
b. information about notorious firms is speedily disseminated
c. price premiums for allegedly high quality increase
d. sellers invest in non-transferable reputation
e. none of the above
23. An “experience good” is one that:
a. Only an expert can use
b. Has undetectable quality when purchased
c. Can be readily experienced simply by touching or tasting
d. Improves with age, like a fine wine
e. All of the above
24. A “search good” is:
a. One that depends on how the product behaves over time
b. A product whose quality is only found out over time by finding how durable it is
c. Like a peach that can be examined for flaws
d. Like a used car, since it is easy to determine its inherent quality
e. None of the above
25. The price for used cars is well below the price of new cars of the same general quality. This is an example of:
a. The Degree of Operating Leverage
b. A Lemon’s Market
c. Redeployment Assets
d. Cyclical Competition
e. The Unemployment Rate
PROBLEMS
1. Sunrise Juice Company sells its output in a perfectly competitive market. The firm’s total cost function is given in the following schedule:
Output Total Cost
(Units) ($)
0 50
10 120
20 170
30 210
40 260
50 330
60 430
Total costs include a “normal” return on the time (labor services) and capital that the owner has invested in the firm. The prevailing market price is $7 per unit.
(a) Prepare (i) marginal cost and (ii) average total cost schedules for the firm.
(b) What is the firm’s profit maximizing output level?
(c) Is the industry in long-run equilibrium? Justify your answer.
2. Superior Metals Company has seen its sales volume decline over the last few years as the result of rising foreign imports. In order to increase sales (and hopefully, profits), the firm is considering a price reduction on luranium–a metal that it produces and sells. The firm currently sells 60,000 pounds of luranium a year at an average price of $10 per pound. Fixed costs of producing luranium are $250,000. Current variable costs per pound are $5. The firm has determined that the variable cost per pound could be reduced by $.50 if production volume could be increased by 10 percent (fixed costs would remain constant). The firm’s marketing department has estimated the arc elasticity of demand for luranium to be -1.5.
(a) How much would Superior Metals have to reduce the price of luranium in order to achieve a 10 percent increase in the quantity sold?
(b) What would the firm’s (i) total revenue, (ii) total cost, and (iii) total profit be before and after the price cut?
Chapter 11—Price and Output Determination: Monopoly and Dominant Firms
MULTIPLE CHOICE
1. Unique Creations has a monopoly position in magnometers. If the marginal cost for a magnometer is $50 and the price elasticity for magnometers is -4, what is the optimal monopoly price?
Hint: P (1 +1/E) = MC.
a. $37.50
b. $41.25
c. $66.67
d. $75.00
e. $82.50
2. Land’s End estimates a demand curve for turtleneck sweaters to be:
Log Q = .41 + 2.3 Log Y – 3 Log P
where Q is quantity, P is price, and Y is a measure on national income. If the marginal cost of imported turtleneck sweaters is $9.00. (HINT: P (1 +1/E) = MC). The optimal monopoly price would be:
a. P = $13.50
b. P = $26.50
c. P = $27.50
d. P = $34.50
e. P = $56.22
3. Declining cost industries
a. have upward rising AC curves.
b. have upward rising demand curves.
c. have Ç-shaped total costs.
d. have diseconomies of scale.
e. have marginal cost curves below their average cost curve.
4. A monopolist seller of Irish ceramics faces the following demand function for its product: P = 62 – 3Q. The fixed cost is $10 and the variable cost per unit is $2. What is the maximizing QUANTITY for this monopoly? Hint: MR is twice as steep as the inverse demand curve: MR = 62 – 6 Q. (Pick closest answer)
a. Q = 10
b. Q = 15
c. Q = 22
d. Q = 37
e. Q = 41
5. Globo Public Supply has $1,000,000 in assets. Its demand curve is: P = 206 – .20•Q and its total cost function is: TC = 20,000 + 6•Q where TC excludes the cost of capital. If Globo Public Supply is UNREGULATED, find Globo’s optimal price.
a. $206
b. $106
c. $56
d. $6
e. $3
6. A monopolist faces the following demand curve: P = 12 – .3Q with marginal costs of $3. What is the monopolistic PRICE?
a. P = $5.50
b. P = $6.50
c. P = $7.50
d. P = $8.50
e. P = $9.50
7.
8.
9.
10.
11.
12.
7. In natural monopoly, AC continuously declines due to economies in distribution or in production, which tends to found in industries which face increasing returns to scale. If price were set equal to marginal cost, then:
a. price would equal average cost.
b. price would exceed average cost.
c. price would be below average cost.
d. price would be at the profit maximizing level for natural monopoly
e. all of the above
8. The profit maximizing monopolist, faced with a negative-sloping demand curve, will always produce:
a. at an output greater than the output where average costs are minimized
b. at an output short of that output where average costs are minimized
c. at an output equal to industry output under pure competition
d. a and c
e. none of the above
9. In the case of pure monopoly:
a. one firm is the sole producer of a good or service which has no close substitutes
b. the firm’s profit is maximized at the price and output combination where marginal cost equals marginal revenue
c. the demand curve is always elastic
d. a and b only
e. a, b, and c
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