# Production and Cost Test Bank

Pages: 16 (3349 words) Published: September 9, 2012
Chapter 05
Production and Cost

Essay Questions

1. 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.

AASCB: Analytic
Bloom's: Application

2. 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.

AASCB: Communication
Bloom's: Comprehension

3. 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.

AASCB: Communication
Bloom's: Comprehension

4. 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.

AASCB: Communication
Bloom's: Comprehension

5. 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.

AASCB: Communication
Bloom's: Comprehension