Lecture 6 Quiz

Model Answers Submitted By Students

  1. Accounting profit is ________ minus _________.

Accounting profit is equal to total revenue minus explicit costs. (Cara M.)

Accounting profit is total revenue minus explicit costs, which are the expenses of worker’s wages, building costs, and the cost of materials. (Kris T.)

  1. Suppose your company spends $10,000 on labor and $30,000 on equipment for an output of 5000 widgets. You increase your labor costs to $15,000 and your equipment costs to $45,000, and your output increases to 8000. Describe your return to scale.

Both the labor costs and equipment costs have been increased by 50%, but the widget output has increased by 60%. This means that I have an increasing return to scale. (Gregory J.)

  1. Presumably there is constant or increasing return to scale for the entire world itself. Suppose the population doubled and the other utilized economic inputs (air, water, capital, etc.) doubled as needed. What would happen to economic output, such as new inventions and food production?

If the population of the entire world were to increase by 100 percent, then I would expect the entire economic output of the world to increase by substantially more than 100 percent. I would expect the number of new inventions to increase by dramatically more than 100 percent. Very few, if any, inventions are entirely original. Instead, most new inventions are based upon old inventions. Consequently, as the number of old inventions increases, the rate at which new inventions are conceived and produced should accelerate. … While population control advocates may not realize the result of their efforts, they are actually decreasing the economic out put of the world by an even greater percentage than the percentage by which they are decreasing the population of the world. (Eric J.)

The economic output would be slightly greater because of the greater number of inventions created because of more minds thinking of what to make. (Scott J.)

  1. In comparing the short run to the long run, what might the insight of Coase yield? For example, suppose option A immediately gives your company an extra $10,000, but option B gives your company no money but a better long-term market position. Which option do you take?

The Coase Theorem [implies] that having more money ($10,000) doesn’t affect sales. Therefore, choice B is my choice. (Michael N.)

… In an average size business, I would stick to the long run choice unless the long run benefit is the same or smaller than the short run benefit. (Chris R.)

… Eternal benefits such as salvation are always the best to choose because it gives you a better long-term position rather than a short-term gain. (Kirstin L.)

  1. Suppose you hire an employee who just took this course, and he says you should invest everything you have in a new facility to reap long-run efficiencies. Why might you say no?

It seems too risky. It all depends on the demand. … You should research the market and see how your widgets are in demand. (Rebecca B.)

Investing all my money in a new facility might not be a smart idea because I also need to pay people to work in the new facility and I still need to pay the employee and his co-workers in the current facility. … I’m better off with one facility and the workers I have. (Alexandra S.)

First I would find out from him if he had analyzed if we have increasing, constant, or decreasing returns to scale. … I would question him as to if we were already maxing our demand for the widgets that the buyer would be purchasing. … (Charles A.)

… And what if Wal-Mart decided to produce the same widget as us for a much cheaper price. We would be ruined. (Zack S.)

  1. Suppose Alexandra is going to hire people to write a book about homeschooling. It will cover all aspects of the topic. What will the returns to scale be on that project? At what point and why might there be decreasing returns to scale?

By hiring multiple people to write this book, you are increasing the number of opinions. If you hire too many authors then you will have a decreasing return to scale; the saying “too many cooks ruin the soup” explains it rather well. (Daniel L.)

If it isn’t broke, don’t fix it. Profit can easily be lost when trying to fix things that don’t need fixing. There is most likely no need for a new facility. (Lisa H.)

There would be decreasing returns to scale after there were enough people to research all of the aspects of homeschooling. After that, your would be wasting money on research that has already been covered. (Sarah S.)

  1. When communists took over China, they destroyed their big steel mills and told every household to built its own little steel furnace to prove the superiority of communist will. What do you think happened to their economic output? Explain, using economic terms.

There must have been a lot of transaction costs involved. … (Jessica H.)

I would expect China’s economic out to decrease greatly…. [T]he idea of having every one build their own furnace instead of having furnaces built by factories flies in the face of at least three basic economic principles: economies of scale, transaction costs, and division of labor. Economies of scale: it is an established fact that, except under certain circumstances, large-scale firms have greater efficiency (production per expenses) than small scale operations. The levels of efficiency are almost incomparable when it comes to the difference between factory with an assembly line and trained workers, and a single man that has never built anything out of steel before in his life. Transaction costs: transaction costs in the production, purchasing, and use of steel might include shipping, the time it takes to learn how to build things out of steel, and the opportunity cost what else you might have been doing. In a steel mill these costs are cut to a minimum per widget: materials are ordered in large shipments, employees have only one job to learn, and opportunity cost is low because employees are earning wages all the while. When an individual does it all himself, however, transaction costs are high: he must order his materials in small shipments, he must learn to do this work in addition to a paying job, and opportunity cost is high because he could have been working at a job that actually pays. Division of labor: it is clearly more efficient to train different people too different, specialized jobs than to have everyone provide for their own needs. It is much more efficient to train employees to work in a steel factory for a living than to have everyone build their own steel furnaces, in addition to working another job for a living. Unless China’s steel mills were very poorly managed, I have no doubt that China’s economic out put would have decreased significantly. (Chris J.)

The economic output of China decreased after communism took over. The government forced people to build steel furnaces. This action rejected the principle of the “invisible hand” and put steel production into the hands of a centralized government. Since there is increased time and expense to build home steel furnaces and there was no division of labor in the homes, this system was nowhere near as efficient. Transaction costs are also increased in gathering steel from several small locations instead of a few large steel mills. (Katie G.)

  1. Suppose Joseph knows more than real doctors do, and in emergencies has actually saved several lives. He wants to see and treat patients no one else will treat, but lacks a license to practice. Is this a short-run or long-run issue for him? Should the State require licenses?

This would be a long run issue for Joseph. I do not think that the state should require a license. Instead people should be allowed to make their own decisions about who they think is qualified to treat them. (Tim S.)

In order for Joseph to gain a license he must to school and pass and this takes years so it would be a long run issue. I do believe that the state should require a license, because with the exception of Joseph other people will try and do the same leading to a whole lot of unlicensed doctors. (Anthony B.)

This is a long-run issue for him. The state should not require licenses because they create a shortage in doctors. They should let the patient watch out for bad doctors. (Ben S.)

I think poor little Joseph should get a license before practicing. What if he cuts out someone’s kidney instead of their kidney stone? What if he – or anybody – injects type A-blood into a type O-blood person? Or what if he forgets the anesthetic when amputating someone’s arm? Licenses should be required. (Phyllis S.)

… Maybe a good ideas would be if individual hospitals could certify the doctors they wish to hire. (Sarah B.)

  1. Tim’s company grew to 500,000 workers, but then faced bankruptcy and layoffs. Suppose he seeks legislation to grant him a special zero-interest government loan to make it through the tough times. Should he receive one?

No, he should not receive a loan because it will destroy any competition and free enterprise in this country. If Tim’s company were able to receive this loan it would absolutely destroy any competition in his market; he would take any risks necessary to expand his company because he knows that he can get bailed out if he fails. … (Chris B.)

No, although this could be argued either way, I think that [it] is a bad ideas. First of all, can the government bail the company out, and where does the government get the money? The people are already over-taxed and the government is in debt. (Abigail L.)

I don’t think that any companies should be bailed out by the government because it is no one’s problem except their own. Plus it would also be our tax dollars that are bailing them out. (Matt P.)

  1. Suppose (ph)armer Phyllis invented fertilizer that is costly to make but has an ever-increasing marginal product. Suppose she owns an acre of farmland in South Jersey, and now must decide between buying more acres or making more fertilizer. Which does she do? Explain.

She should make fertilizer, because the ever-increasing marginal output means that each new unit of input enables her to make fertilizer more than the unit before it did. It makes sense to put as much money into fertilizer production as possible, because the more she puts in, the higher efficiency becomes each unit of input creates more and more output. Phyllis has economics of scale and increasing returns to scale, as well. (Joseph S.)

She should make more fertilizer because the more of it that she puts in the more output she will get. So it does not matter how much land she owns because the marginal product is ever-increasing. (Kevin H.)

She should make more fertilizer because each unit of input she puts in increases her productivity by a higher margin each time. … (Brandon M.)

… If the fertilizer had a decreasing marginal product, then I would say she should buy more acres …. (Alyssa G.)

  1. A company’s stock price often rises when it announces taking a large one-time write-off (or loss) on its accounting books. Using one or more principles learned in this course, can you explain reasons for that effect on the stock price?

[T]his is because the company made some decision that caused a short-term loss, but is expected to increase long-term efficiency. Most investors realize that investing in the long run is more efficient than concentrating on the short-run. Stock prices seem to be based more on how a company is expected to perform in the future, rather than where the company is in the present. … (Eric J.)

  1. The tremendous economic growth of the 1980s and 1990s resulted from the supply side economic policies of President Ronald Reagan, which boosted production by cutting taxes and encouraging investment. Why might the supply side be more important than the demand side?

Demand didn’t change significantly, but supply increased in investment capital, resulting in supply expansion. Increased investment leads to increased productivity which leads to lower production costs which, in turn, leads to a higher marginal profit for the producer, resulting in economic growth. (Mary Rose B.)

The Law of Demand strikes again! … The quantity of the supply determines the price that the good is sold at, and the price the good is sold at determines the demand for that good. … (Sarah C.)