Deck 9: Long-Run Costs and Output Decisions

Question 1

In economics, what differentiates the short run from the long run?

Answer 1

In the short run, the firm has a fixed factor that limits its level of production. In the long run, all factors are variable. In the short run firms cannot enter or exit the industry. In the long run, this is no longer true.

Question 2

Using Figure 9.1, explain what a firm would do in the short run if the market price of its product dropped below P₁.

Answer 2

The firm would shut down since it would be suffering an operating loss. For the firm to remain in business in the short run the price must be equal to or greater than the average variable cost.

Question 3

To the casual observer it is often difficult to understand how a company would spend several million dollars building a plant or other structure and then simply stop and abandon the project midway. How can this be justified on economic grounds?

Answer 3

The building or structure is viewed as a fixed cost. The firm may very well have determined that even if finished the project would not be profitable. Rather than incur additional expenses on a project that is likely not to be profitable it is better to cut losses and abandon production of the structure rather than complete it.

Question 4

Is it possible for the average fixed cost curve to have the shape depicted above? Explain.

Question 5

What does it mean for a firm to be breaking even?

Question 6

Maxine's Cookie Shop sells chocolate chip cookies in a perfectly competitive market for $2 per dozen. Maxine currently produces 200 dozen cookies per day and average total cost at this level of production is $1.75. What level of profit is this firm earning? Explain.

Question 7

Suppose in a purely competitive market that American firms consider labor costs to be mostly variable while Japanese firms consider labor costs to be mostly fixed. What implication would this have for the viability of firms in each country if they compete with one another in the short run? What about the long run?

Question 8

Evaluate the following statement. If a firm is suffering economic losses then the sensible thing to do is to shut down temporarily.

Question 9

Why is it not a contradiction to say that a firm is simultaneously earning an accounting profit but suffering an economic loss?

Question 10

The S.G. Allen Fabric Company sells cotton fabric in a perfectly competitive market at a price of $4 per yard. Its marginal cost, average variable cost, and average total cost curves can be seen below: Find the profit-maximizing level of output and mark it q*. Shade in the area of profit earned by the firm. Is it positive or negative? How do you know?

Question 11

If the fixed costs for a firm rise what will be the impact on the marginal cost, average variable cost and average total cost curves? Explain.

Question 12

Using Figure 9.1, explain what a firm would do in the short run if the market price of its product were at P₃ and it produced Q₃. Is the firm earning an economic profit? Explain.

Question 13

Assume an electric company has spent $3 billion on a nuclear power plant. It's producing at a price per kilowatt hour that is above its average variable cost. However, after 10 years the price remains below average total cost. If there is no expectation that price will equal or rise above the average total cost what would you expect this company to do with its nuclear power plant? Why is the $3 billion not part of the decision? Explain.

Question 14

What does it mean when a firm is earning positive economic profit?

Question 15

Using Figure 9.1, explain what a firm would do in the short run if the market price of its product were at P₂ and it produced Q₂. Is the firm earning an economic profit? An operating profit? Explain.

Question 16

The Lotsa Pasta Company sells pasta in a perfectly competitive market at a price of $2 per pound. Its marginal cost, average variable cost, and average total cost curves can be seen below: Find the profit-maximizing level of output and mark it q*. Shade in the area of profit earned by the firm. Is it positive or negative? How do you know?

Question 17

If a firm is earning just enough to cover all its economic profits does that mean it's not making a profit?

Question 18

Assume two firms have the same total costs of production. Firm A's average variable cost if $5 per unit and firm B's average variable cost is $7. Both firms have an average total cost of $8. If the current market price is $6 and remains unchanged what action will both firms take in the short run and the long run?

Question 19

What does it mean for a firm to be suffering an economic loss? Does this imply that the firm is earning negative profit in the accounting sense? Explain.

Question 20

Using Figure 9.1, explain what a firm would do in the short run if the market price of its product were at P₄ and it produced Q₄. Is the firm earning an economic profit? Explain.

Question 21

Comment on the following statement: "When firms are earning positive profits, the industry supply curve will shift to the right."

Question 22

A firm is currently selling its output for $10 per unit and is producing where marginal revenue equals marginal cost at an output level of 100 units. If the firm's total variable costs are $900 and its fixed costs are $300 should it produce in the short run or shut down?

Question 23

Why is the minimum of the average variable cost curve called the shutdown point?

Question 24

Lentz's Incorporated sells paper in a perfectly competitive market at a price of $2 per ream. At the profit-maximizing (cost-minimizing) level of output, average total cost is $2.50 per ream and average variable cost is $1.95 per ream. Should the firm continue to operate in the short run? Explain.

Question 25

Why cannot firms leave the industry in the short run?

Question 26

The ERT Company sells lead pencils in a perfectly competitive market for $5 per box of a dozen pencils. The firm currently produces 2,500 boxes of lead pencils each week and average total cost at this level of production is $5.15. What level of profit is this firm earning? Explain.

Question 27

The PPB Corporation sells ping pong balls in a perfectly competitive market at a price of $1 each. The firm's marginal cost, average total cost, and average variable cost curve can be represented by the following: Should the firm continue to operate in the short run? Explain.

Question 28

A purely competitive firm is faced with a marginal revenue curve that lies everywhere below the average variable cost curve. Would this firm be able to operate in the short run? Explain.

Question 29

The Binkle Binder Corporation sells 3-ring binders in a perfectly competitive market at a price of $3 each. The firm's marginal cost, average total cost, and average variable cost curves can be represented by the following: Should the firm continue to operate in the short run? Explain.

Question 30

Bubba's Burgers sells hamburgers in a perfectly competitive market at a price of $1.50 each. At the profit-maximizing (cost-minimizing) level of output, average total cost is $1.90 per hamburger and average variable cost is $1.75 per hamburger. Should the firm continue to operate in the short run? Explain.

Question 31

List two things that can cause the industry supply curve to shift.

Question 32

What is the shutdown point?

Question 33

Suppose that a firm is currently earning revenues that are smaller than its total costs. The firm's managers are trying to decide whether or not the firm should shut down in the short run. On what information should the manager's decision be based?

Question 34

What is meant by operating profit or net operating revenue?

Question 35

The table below represents cost data for Matters & Sons which sells paper plates in a perfectly competitive market for a price of $2 per package:
How many units of the output will this firm produce? How much profit will it earn? Will the firm choose to operate in the short run? Will the firm choose to operate in the long run? Explain.

Question 36

Comment on the following statement: "If a firm shuts down in the short run, it will earn zero economic profit."

Question 37

Why are losses acceptable in the short run but not the long run?

Question 38

The table below represents cost data for Vester, Incorporated, which sells tennis balls in a perfectly competitive market for a price of $4 per package:
How many units of the output will this firm produce? How much profit will it earn? Will the firm choose to operate in the short run? Will the firm choose to operate in the long run? Explain.

Question 39

What is the short-run industry supply curve in a perfectly competitive industry?

Question 40

The table below represents cost data for Amalgamated Plastics Inc., which sells bubble wrap for shipping in a perfectly competitive market for a price of $6 per package:
How many units of the output will this firm produce? How much profit will it earn? Will the firm choose to operate in the long run? Explain.

Question 41

Use the graph below to show the firm's short-run supply curve of a perfectly competitive firm.

Question 42

If marginal costs are constant what will the average variable cost curve look like? What about the average total cost curve?

Question 43

How is a long-run average cost curve different from a short-run average cost curve? How are they related?

Question 44

What is meant by decreasing returns to scale?

Question 45

The table below shows the monthly output and total monthly cost of widgets for three firms in the widget industry. Given the information in the table, can we draw any conclusions about the returns to scale in the widget industry? If so, what does the information suggest about the shape of the long-run average cost curve?

Question 46

Books.com is earning a total revenue of $200,000 per year. Its annual total fixed costs are $50,000 and its annual total variable costs are $75,000. What is the operating profit for Books.com? What is economic profit?

Question 47

Are the short-run and long-run average cost curves U-shaped for the same reason? Explain.

Question 48

A railroad company lays a line of track between Houston and Dallas. It provides daily service for industrial customers and ships 5,000 ton-miles per day with a single train and only one departure and arrival at each end. It has an opportunity to purchase a second train that would allow it to ship twice the amount of ton-miles per day. Does this firm face increasing, constant or decreasing returns to scale? Explain.

Question 49

Comdex Computer Company is producing at a price of $10 with an average total cost of $12 and a fixed cost of $300. The firm is currently producing 100 units. What are the operating profits of this firm? What are the economic profits of this firm?

Question 50

Using the two graphs below determine the number of firms that are operating in this industry.

Question 51

Assume there are three firms in an industry as depicted in the graphs below. Based on this information construct the industry supply curve.

Question 52

Flowers.com is earning a total revenue of $100,000 per year. Its annual total fixed costs are
$25,000 and its annual total variable costs are $75,000. What is the operating profit for Flowers.com? What is economic profit?

Question 53

What is meant by increasing returns to scale?

Question 54

Critically evaluate the following statement. "Short-run costs curves must be downward-sloping because after all labor is increasingly more productive."

Question 55

How do constant returns to scale affect the shape of the long-run average cost curve?

Question 56

How do increasing returns to scale affect the shape of the long-run average cost curve?

Question 57

What is meant by constant returns to scale?

Question 58

How do decreasing returns to scale affect the shape of the long-run average cost curve?

Question 59

Music.com is earning a total revenue of $100,000 per year. Its annual total fixed costs are $50,000 and its annual total variable costs are $175,000. What is the operating profit for Music.com? What is economic profit? Is this firm doing the right thing by continuing to produce in the short run? If conditions don't change what should this firm do in the long run?

Question 60

If revenue in the short run is less than variable costs, what should the firm do??

Question 61

What must be true for an industry to be in long-run equilibrium?

Question 62

Assume a firm is operating in a purely competitive market facing an upward-sloping long-run supply curve. If the industry is currently making pure economic profit what adjustment processes would take place in this market? What would happen to the industry supply curve, equilibrium quantity and equilibrium price?

Question 63

How does the idea of efficient markets influence the long-run market adjustment mechanism?

Question 64

If a firm's short-run average cost curves are u-shaped, does this imply that the long-run average cost curve must also be u-shaped?

Question 65

What is a long-run average cost curve?

Question 66

The figures below show the supply and demand for a perfectly competitive industry and the cost curves for a representative firm in the industry. Explain what will happen in the long run in this industry.

Question 67

List three reasons why a firm might experience economies of scale.

Question 68

Netflix introduced DVD rentals via US Mail whereby customers do not have to leave their home to rent movies. They also introduced the concept of no-late fees. Netflix has enjoyed strong profits over the last few years. However, what does economic theory tell us should happen to these profits in the long run and why?

Question 69

Marty's Seafood Company sells fish in a perfectly competitive market. The market price is currently $3 per pound. At its current level of production, long-run average cost at Marty's Seafood Company is $2.75 per pound. If Marty's Seafood Company is representative of firms in the industry, is this industry in equilibrium? Explain.

Question 70

The table below comes from cost data from the long run total cost function. It shows the monthly output and total monthly cost of USB drives for three firms in the industry. Given the information in the table, can we draw any conclusions about the returns to scale in the USB drive industry? If so, what does the information suggest about the shape of the long-run average cost curve?

Question 71

Toothpicks are sold in a perfectly competitive market. The market price is currently $3 per box of one hundred toothpicks. At its current level of production, a representative firm in the toothpick industry is producing at a level of output such that long-run average cost is $3.25 per box of one hundred toothpicks. Given this information, is the toothpick industry in equilibrium? Explain.

Question 72

What does it mean if an industry has external economies?

Question 73

The figures below show the supply and demand for a perfectly competitive industry and the cost curves for a representative firm in the industry. Explain what will happen in the long run in this industry.

Question 74

Assume that a manufacturer of new handheld computer makes a sales pitch to a retailer in which he is willing to sell 5,000 at $10, 7,000 for $8, 9,000 for $7. But any orders above that amount will start costing the retailer more money on a per-unit basis. The president of the retailer asks why he can't get a discount if he orders more. Can you provide an answer that would help this president understand this apparent paradox?

Question 75

Comment on the following statement: "The shape of the long-run average cost curve is determined by diminishing returns."

Question 76

If the long-run average cost curve for the industry is flat what implication does this have for the relationship between the average cost curves for small and large firms?

Question 77

List two reasons why a firm might experience diseconomies of scale.

Question 78

What is meant by long-run competitive equilibrium?

Question 79

What is the optimal scale of plant?

Question 80

Explain the relationship between price, short-run marginal cost, short-run average cost and long-run average cost in the final long-run competitive equilibrium condition. What are economic profits in this long-run equilibrium condition?