Download chapter 4: answers to analysis and application

CHAPTER 4:Costs of Production
1a. The daily cost of Process A is $130 [= ($20 x 4 workers) + ($25 x 2
machines)] and the daily cost of Process B is $135 [= ($20 x 3 workers) + ($25
x 3 machines)]. Because wages are lower than in the text example, Process A is
cheaper than Process B, and therefore maximizes productive efficiency.
b. The daily cost of Process A is $700 [= ($100 x 4 workers) + ($150 x 2
machines)] and the daily cost of Process B is $750 [= ($100 x 3 workers) +
($150 x 3 machines)]. Because the daily cost of a sewing machine is higher
than in the text example, Process A is now cheaper than Process B, and
therefore maximizes productive efficiency.
2a. Rodriguez's total explicit costs, which include rent, taxes and inventory
costs, are $390 000 [= $25 000 + $15 000 + $350 000]. His total implicit
costs, which include normal profit and implicit wages, are 106 000 [= (.20 x
$80 000) + $90 000].
b. The store's accounting profit, which is found by subtracting explicit costs
from total revenue, is $90 000 (= $480 000 - $390 000).
c. The store's economic profit, which is found by subtracting both explicit
costs and implicit costs from total revenue, is -$16 000 (= $480 000 - $390
000 - $106 000).
d. Economic profit is a better indicator of the performance of Rodriguez's
business, since it takes into account all relevant opportunity costs. However,
because implicit costs are based on subjective estimates by the owner,
accountants prefer to use accounting profit rather than economic profit as a
measure of business performance.
e. Because the variety store is making an economic loss, Rodriguez should
consider closing down this business.
3a. a fixed cost, because depreciation is limited to the firm’s fixed inputs
such as machinery and buildings
b. a variable cost, since employee benefits vary with the number of workers
employed by the business
c. a variable cost, because lumber is a material input that varies with the
business’s output
d. a fixed cost, since property insurance is related to the restaurant’s fixed
inputs such as furniture and equipment
e. a variable cost, since gasoline is a material input that varies with the
business’s output
f. a fixed cost, because the firm’s research outlays do not vary with its
software output
g. a fixed cost, because the wireless spectrum, once purchased, does not vary
with the provider’s output of services
4a. Column 3 (marginal product): 100, 180, 230, 50, -20; Column 4 (average
product): 100, 140, 170, 140, 108.
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Chapter 4
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b.
FIGURE 4A–1
The behaviour of both total product and average product can be related to the
marginal product curve. Total product reaches a maximum at the same employment
level (4 workers) at which marginal product equals zero. At employment levels
below 4 workers, a positive marginal product means that total product is
rising. At employment levels above 4 workers, marginal product is negative and
therefore total product is falling. Average product reaches a maximum at 3
workers, which is the same employment level at which average product equals
marginal product. At employment levels below 3 workers, marginal product
exceeds average product, which causes average product to rise as employment
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Chapter 4
37
expands. Once marginal product falls below average product, at employment
levels above 3 workers, average product drops with expanding employment.
c. Marginal product rises when the first, second, and third workers are hired,
since the marginal product of the second worker (180) exceeds that of the
first worker (100), and the marginal product of the third worker (230) exceeds
that of the second worker. Marginal product falls and is positive when the
fourth worker is hired, since marginal product is declining (from 230 to 50).
Marginal product is negative (-20) when the fifth worker is hired.
5a. Column 3 (marginal product): 120, 160, 130, 110, 60; Column 6 (total
cost): 60, 240, 420, 600, 780, 960; Column 7 (marginal cost): 1.50, 1.13,
1.38, 1.64, 3.00; Column 8 (average fixed cost): .50, .21, .15, .12, .10;
Column 9 (average variable cost): 1.50, 1.29, 1.32, 1.38, 1.55; Column 10
(average cost): 2.00, 1.50, 1.46, 1.50, 1.66.
b. Marginal product begins to fall when the third worker is hired, since
marginal product decreases from 160 to 130 cars per day. This is related to
the point at which marginal cost begins to rise from its minimum of $1.13 to
$1.38. Once each new worker adds less to total product, the extra cost of this
new output begins to rise.
c.
FIGURE 4A–2
d. Average variable cost and marginal cost have the same value at an output of
280 cars (point a in the graph), while average cost and marginal cost have the
same value at an output of 410 cars (point b in the graph).
6a. Column 3 (marginal product): 20, 35, 25, 20, 5; Column 6 (total cost):
1200, 1400, 1600, 1800, 2000, 2200; Column 7 (marginal cost): 10.00, 5.71,
8.00, 10.00, 40.00; Column 8 (average fixed cost): 60.00, 21.82, 15.00, 12.00,
11.43; Column 9 (average variable cost): 10.00, 7.27, 7.50, 8.00, 9.52; Column
10 (average cost): 70.00, 29.09, 22.50, 20.00, 20.96.
b. Diminishing returns set it when the third worker is hired, since marginal
product decreases from 35 to 25 kites per day. This is related to the point at
which marginal cost begins to rise from its minimum of $5.71 to $8.00.
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Chapter 4
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c. FIGURE 4A–3
FIGURE 4A–4
d. Average variable cost and marginal cost have the same value at an output of
55 cars (point a in the graph), while average cost and marginal cost have the
same value at an output of 100 cars (point b in the graph).
7a. An extended range with a zero slope, reflecting constant returns to scale,
since an expansion of output requires an exact repetition of production
methods, so that inputs and output vary by the same percentage.
b. An extended range with a negative slope, reflecting economies of scale,
Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
Chapter 4
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since an expansion of output allows for added specialization of labour and
capital, so that output rises more quickly than inputs.
c. An extended range with a positive slope, reflecting diseconomies of scale,
since limited resource supplies mean that an increase in inputs does not lead
to as large a percentage increase in output.
d. An extended range with a negative slope, reflecting economies of scale,
since an expansion of output allows the same distribution and marketing
software to be used in selling more e-book titles.
8a. Column 3 (fixed costs): 500, 500, 500, 500, 500; Column 4 (variable
costs): 0, 120, 240, 360, 480; Column 5 (total cost): 500, 620, 740, 860, 980;
Column 6 (marginal cost): 1.20, 0.67, 0.52, 2.40.
b.
FIGURE 4A-5
c. As output increases, total cost and variable cost both rise in ways
identical to one another. In the first output range - to the left of points a
and b - total cost and variable cost both increase at a decreasing rate. This
reflects falling marginal cost, which means progressively smaller rates of
change in both total cost and variable cost. After point c, marginal cost
begins to rise, so that the rates of change in both total cost and variable
cost become progressively bigger.
d. The output range in which total cost and variable cost become progressively
Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
Chapter 4
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flatter (up to an output of 395, which is halfway between 280 and 510)
corresponds to the employment range where marginal product is rising (when the
first, second, and third workers are hired). This is because a greater extra
product for each new worker employed means a smaller rate of change for both
total cost and variable cost. In contrast, the output range in which total
cost and variable cost become progressively steeper (above an output of 395)
is the result of the law of diminishing marginal returns, which sets in when
the fourth worker is hired. Once a smaller marginal product is added by each
new worker, the rates of change of total cost and variable cost rise.
9. The first point has a horizontal coordinate of 40, which is the midpoint of
the two associated output levels, 0 and 80 T-shirts (40 = (80 + 0)/2). The
second point has a coordinate of 140 (= (200 + 80)/2), the third a coordinate
of 225 (= (250 + 200)/2), the fourth a coordinate of 260 (= (270 + 250)/2),
and the fifth a coordinate of 275 (= (280 + 270)/2).
10. Governments can help reduce the price of knowledge (for example, by
funding research and development, or by subsidizing knowledge-producing
industries). This helps reduce one of the main fixed costs of knowledge-based
industries, thereby raising profits and spurring expansion in these
industries.
Internet Application Questions
1. Answers are found in links to ‘Summary Tables’, ‘Tables by Subject’,
‘Labour’, ‘Employment and unemployment’, ‘Employment by industry’.
2. Answers are found in the same links as in part a.
ANSWERS TO QUESTIONS AT THE END OF ‘CRITIC OF THE MODERN
CORPORATION’
1a. For a corporation, stocks have two main advantages: (i) they provide the
firm with funds until the corporation chooses to repurchase them from
shareholders, and (ii) dividends paid on stocks can vary with the
corporation's earnings. An important disadvantage of stocks for a corporation
is that issuing more of them dilutes ownership among a wider pool of
shareholders. Any drop in the price of the stock caused by this dilution harms
current shareholders. For individual wealthholders, stocks provide the
advantage of a possible high rate of return. Their main disadvantage for
individual wealthholders is their fluctuating earnings because of changing
stock prices and dividend payments.
b. For a corporation, bonds have an advantage because of the possibility that
the company's profits will exceed bond interest payments. Bonds have two main
disadvantages for a corporation: (i) the value of the bond must be repaid at a
preset time and monetary amount, and (ii) their interest payments cannot be
adjusted to reflect changes in the company's profits. For individual
wealthholders, bonds have the advantage of dependable interest payments. As
long as a borrower has the funds to do so, it is legally required to pay
interest on its outstanding bonds. Bonds' main disadvantage to wealthholders
is the possibility of fluctuations in the bond's price if the bond is sold
before the time when its value is repaid by the borrower.
2. Hostile takeover bids are more likely if a corporation is in a growing
industry, since this provides the possibility of increasing profits for the
bidder. A corporation that is managed in a way that goes against shareholder
interest is also more likely to face a hostile bid, since the bidder can
expect to raise the stock price by appointing new managers who run the company
in a way that maximizes profit.
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Chapter 4
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3. The two main ways corporate management can mask financial troubles are
through inflating sales revenues (for example, by recording sales that have
not occurred) and neglecting to record costs (for example, by backdating
expenses so that they will be recorded in the next accounting period).
ANSWERS TO QUESTIONS AT THE END OF 'MARKETS IN MOTION' (at the
Online Learning Centre)
1. In sectors, such as high-tech, where P/E ratios are far above the average
value of P/E ratios in the economy, stockholders must be expecting companies’
earnings to rise rapidly, so that earnings today are not a good indication of
earnings in the future.
2. The trader is putting down $10 000 [= (10 percent x $100 000)] on this
futures contract.
a. If the contract’s price has risen to $120 000 by the time it is sold, the
rate of return is 200 percent [= (($120 000 - $100 000)/$10 000) x 100].
b. If the contract’s price has fallen to $70 000, the rate of return is -300
percent [= (($70 000 - $100 000)/$10 000) x 100].
3a. After the option holder purchases the 100 shares of ABC Corporation at $50
each, for $5000, they can then immediately sell the shares at $60 each, for a
total of $6000. Before commissions, this represents a gain of $1000 on the
$200 investment, which gives a rate of return of 500 percent [= ($1000/$200) x
100].
b. If the option holder does not exercise the option, the contract becomes
worthless on the expiration date. This represents a loss of the entire $200
investment, which gives a rate of return of -100 percent [= (-$200/200) x
100].
ANSWERS TO QUESTIONS AT THE END OF 'THE PROFIT GAME' (at the
Online Learning Centre)
1a. The company’s total sales are $135 400, from which are subtracted $24 800
in total expenses ($20 600 in wages, $2 300 in costs for business supplies, $1
100 in depreciation, and $800 for payments on the bank loan. Therefore total
accounting profit is $110 600.
b. The relatively low accounting profit suggests that the owner should
consider closing down Readyware Solutions. If she were to take account of
implicit costs such as normal profit and implicit wages for her work in the
business, she would be certain to find that the business is making a negative
economic profit.
2. The company’s total implicit costs are $68 000, which is the $65 000 in
implicit wages, plus the $3000 (= .15 x $20 000) a year she could earn from
investing her funds at a similar level of risk. Therefore the owner’s economic
profit is $42 600, which is the $110 600 in total accounting profit minus the
$68 000 in total implicit costs.
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Chapter 4
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