# Managerial Economics & Business Strategy 8th Edition by Michael Baye – Test Bank

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Managerial Economics & Business Strategy 8th Edition by Michael Baye – Test Bank

Sample  Questions

Chapter 05

The Production Process and Costs

Multiple Choice Questions

1. Suppose the marginal product of labor is 8 and the marginal product of capital is 2. If the wage rate is \$4 and the price of capital is \$2, then in order to minimize costs the firm should use:

 A. more capital and less labor.

 B. more labor and less capital.

 C. three times more capital than labor.

 D. none of the answers are correct.

2. Suppose the production function is Q = min{K, 2L}. How much output is produced when 4 units of labor and 9 units of capital are employed?

 A. 2

 B. 4

 C. 8

 D. 9

3. Suppose the production function is given by Q = 3K + 4L. What is the average product of capital when 10 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 7

 D. 45

4. Suppose the production function is given by Q = 3K + 4L. What is the marginal product of capital when 10 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

5. Suppose the production function is given by Q = min{K, L}. How much output is produced when 10 units of labor and 9 units of capital are employed?

 A. 0

 B. 4

 C. 9

 D. 13

6. Suppose the production function is given by Q = min{K, L}. How much output is produced when 4 units of labor and 9 units of capital are employed?

 A. 0

 B. 4

 C. 9

 D. 13

7. Suppose the production function is given by Q = 3K + 4L. What is the marginal product of capital when 5 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

8. Suppose the production function is given by Q = 3K + 4L. What is the average product of capital when 5 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

9. For the cost function C(Q) = 100 + 2Q + 3Q2, the marginal cost of producing 2 units of output is:

 A. 2

 B. 3

 C. 12

 D. 14

10. For the cost function C(Q) = 100 + 2Q + 3Q2, the average fixed cost of producing 2 units of output is:

 A. 100

 B. 50

 C. 3

 D. 2

11. For the cost function C(Q) = 100 + 2Q + 3Q2, the total variable cost of producing 2 units of output is:

 A. 16

 B. 12

 C. 4

 D. None of the answers are correct.

12. If a firm’s production function is Leontief and the wage rate goes up, the:

 A. firm must use more labor in order to minimize the cost of producing a given level of output.

 B. firm must use more capital in order to minimize the cost of producing a given level of output.

 C. firm must use less labor in order to minimize the cost of producing a given level of output.

 D. cost minimizing combination of capital and labor does not change.

13. Which of the following statements is incorrect?

 A. Fixed costs do not vary with output.

 B. Sunk costs are those costs that are forever lost after they have been paid.

 C. Fixed costs are always greater than sunk costs.

 D. Fixed costs could be positive when sunk costs are zero.

14. You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = \$40, r = \$100, MPL = 20, and MPK = 40 the firm:

 A. is cost minimizing.

 B. should use less L and more K to cost minimize.

 C. should use more L and less K to cost minimize.

 D. is profit maximizing but not cost minimizing.

15. The production function Q = L.5K.5 is called:

 A. Cobb Douglas.

 B. Leontief.

 C. linear.

 D. None of the answers are correct.

16. The production function for a competitive firm is Q = K.5L.5. The firm sells its output at a price of \$10, and can hire labor at a wage of \$5. Capital is fixed at 25 units. The profit-maximizing quantity of labor is:

 A. 1

 B. 2

 C. 10

 D. None of the answers are correct.

17. You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = \$40, r = \$100, MPL = 4, and MPK = 40 the firm:

 A. is cost minimizing.

 B. should use less L and more K to cost minimize.

 C. should use more K and less L to cost minimize.

 D. is profit maximizing but not cost minimizing.

18. If the production function is Q = K.5L.5 and capital is fixed at 1 unit, then the average product of labor when L = 25 is:

 A. 2/5.

 B. 1/5.

 C. 10

 D. None of the answers are correct.

19. For a cost function C = 100 + 10Q + Q2, the marginal cost of producing 10 units of output is:

 A. 10

 B. 200

 C. 210

 D. None of the answers are correct.

20. For a cost function C = 100 + 10Q + Q2, the average variable cost of producing 20 units of output is:

 A. 10

 B. 20

 C. 30

 D. None of the answers are correct.

21. For a cost function C = 100 + 10Q + Q2, the average fixed cost of producing 10 units of output is:

 A. 10

 B. 5

 C. 1

 D. None of the answers are correct.

22. Which of the following conditions is true when a producer minimizes the cost of producing a given level of output?

 A. The MRTS is equal to the ratio of input prices.

 B. The marginal product per dollar spent on all inputs is equal.

 C. The marginal products of all inputs are equal.

 D. The MRTS is equal to the ratio of input prices, and the marginal product per dollar spent on all inputs is equal.

23. If the production function is Q = KL and capital is fixed at 1 unit, then the marginal product of labor when L = 25 is:

 A. ¼.

 B. 1/10.

 C. 15

 D. None of the answers are correct.

24. The production function for a competitive firm is Q = K.5L.5. The firm sells its output at a price of \$10, and can hire labor at a wage of \$5. Capital is fixed at one unit. The profit-maximizing quantity of labor is:

 A. 2/5.

 B. 1

 C. 10

 D. None of the answers are correct.

25. The production function for a competitive firm is Q = K.5L.5. The firm sells its output at a price of \$10, and can hire labor at a wage of \$5. Capital is fixed at one unit and costs \$2. The maximum profits are:

 A. 3

 B. 10

 C. 15

 D. None of the answers are correct.

26. The feasible means of converting raw inputs such as steel, labor, and machinery into an output are summarized by:

 A. Land.

 B. Production.

 C. Capital.

 D. Technology.

27. The recipe that defines the maximum amount of output that can be produced with K units of capital and L units of labor is the:

 A. Production function.

 B. Technological constraint.

 C. Research and development schedule.

 D. Total product.

28. The creation of a new product is referred to as:

 A. Process innovation.

 B. Independent research and development.

 C. Product innovation.

 D. Patent disclosure.

29. Which of the following is NOT a means of acquiring product and process innovations?

 A. Independent research and development

 B. Mass production of the existing product

 C. Reverse engineering

 D. Hiring employees of innovating firms

30. Inputs a manager may adjust in order to alter production are:

 A. all factors.

 B. variable factors.

 C. long-run factors.

 D. fixed factors.

31. What is the average product of labor, given that the level of labor equals 10, total output equals 1200, and the marginal product of labor equals 200?

 A. 20

 B. 120

 C. 6

 D. 2,000

32. The change in total output attributable to the last unit of an input is the:

 A. total product.

 B. average product.

 C. marginal product.

 D. marginal return.

33. If the last unit of input increases total product, we know that the marginal product is:

 A. positive.

 B. negative.

 C. zero.

 D. indeterminate.

34. Total product begins to fall when:

 A. Marginal product is maximized.

 B. Average product is below zero.

 C. Average product is negative.

 D. Marginal product is zero.

35. What is the value marginal product of labor if: P = \$10, MPL = \$25, and APL = 40?

 A. \$10,000

 B. \$1,000

 C. \$400

 D. \$250

36. It is profitable to hire units of labor as long as the value of marginal product:

 A. is less than wage.

 B. exceeds average product.

 C. equals price.

 D. exceeds wage.

37. Given the following table, how many workers should be hired to maximize profits?

 A. 1

 B. 2

 C. 3

 D. 4

38. Firm managers should use inputs at levels where the:

 A. Marginal benefit equals marginal cost.

 B. Price equals marginal product.

 C. Value marginal product of labor equals wage.

 D. Marginal benefit equals marginal cost and value marginal product of labor equals wage.

39. Given the linear production function Q = 10K + 5L, if Q = 10,000 and K = 500, how much labor is utilized?

 A. 600 units

 B. 800 units

 C. 500 units

 D. 1,000 units

40. Given the Leontief production function Q = min{5.5K, 6.7L}, how much output is produced when K = 40 and L = 35?

 A. 220

 B. 234.5

 C. 192.5

 D. 268

41. Suppose the production function is given by Q = K1/2L1/2, and that Q = 30 and K = 25. How much labor is employed by the firm?

 A. 49

 B. 6

 C. 36

 D. 25

42. Given the production function Q = min{4K, 3L}, what is the average product of capital when 8 units of capital and 16 units of labor are used?

 A. 16

 B. 2

 C. 4

 D. 32

43. For the production function Q = 5.2K + 3.8L, if K = 16 and L = 12, we know that MPK is:

 A. 16

 B. 5.2.

 C. 3.8.

 D. 12

44. The combinations of inputs that produce a given level of output are depicted by:

 A. indifference curves.

 B. budget lines.

 C. isocost curves.

 D. isoquants.

45. Isoquants are normally drawn with a convex shape because:

 A. inputs are perfectly substitutable.

 B. inputs are perfectly complementary.

 C. inputs are not perfectly substitutable.

 D. inputs are not perfectly complementary.

46. The absolute value of the slope of the isoquant is the:

 A. marginal rate of technical substitution.

 B. marginal product of capital.

 C. marginal rate of substitution.

 D. value marginal product of labor.

47. The production function is Q = K.6 L.4. The marginal rate of technical substitution is:

 A. 2/3 K-1 L.

 B. K-1 L-1.

 C. 2/3 K L-1.

 D. K.4 L-.6.

48. The Leontief production function implies:

 A. straight-line isoquants.

 B. convex-shaped isoquants.

 C. A positive MRTS.

 D. L-shaped isoquants.

49. In order for isoquants to have a diminishing marginal rate of substitution, they must be:

 A. L-shaped.

 B. straight lines.

 C. vertical.

 D. None of the statements is correct.

50. Changes in the price of an input cause:

 A. isoquants to become steeper.

 B. slope changes in the isocost line.

 C. parallel shifts of the isocost lines.

 D. changes in both the isoquants and isocosts of equal magnitude.

51. Which of the following sets of economic data is minimizing the cost of producing a given level of output?

 A. MPL = 20, MPK = 40, w = \$16, r = \$32.

 B. MPL = 20, MPK = 40, w = \$32, r = \$16.

 C. MPL = 40, MPK = 20, w = \$16, r = \$32.

 D. MPL = 40, MPK = 40, w = \$16, r = \$32.

52. In order to minimize the cost of producing a given level of output, a firm manager should use more inputs when:

 A. that input’s price rises.

 B. that input’s price falls.

 C. that input’s price remains the same.

 D. the prices of other inputs fall.

53. Fixed costs exist only in:

 A. the long run.

 B. capital-intensive markets.

 C. the short run.

 D. labor-intensive markets.

54. Costs that change as output changes are:

 A. variable costs.

 B. fixed costs.

 C. sunk costs.

 D. None of the statements is correct.

55. Costs that are forever lost after they have been paid are:

 A. production costs.

 B. fixed costs.

 C. sunk costs.

 D. variable costs.

56. Suppose you are a manager of a factory. You purchase five (5) new machines at one million dollars each. If you can resell two of the machines for \$500,000 and three of the machines for \$200,000, what are the sunk costs of purchasing the machines?

 A. \$5 million

 B. \$500,000

 C. \$3.4 million

 D. \$1.6 million

57. According to the table below, what is the total cost of producing 125 units of output?

 A. 1,000

 B. 2,050

 C. 1,400

 D. 2,400

58. According to the table below, what is the average variable cost of producing 50 units of output?

 A. 21

 B. 34

 C. 14

 D. 20

59. According to the table below, what is the average total cost of producing 160 units of output?

 A. 12.98

 B. 16.31

 C. 22.04

 D. 19.38

60. According to the table below, what is the marginal cost of producing 90 units of output?

 A. 5.32

 B. 8.75

 C. 11.67

 D. 21

61. According to the table below, at what level of output is marginal cost minimized?

 A. 90

 B. 50

 C. 125

 D. 160

62. Which curve(s) does the marginal cost curve intersect at the (their) minimum point?

 A. Average total cost curve

 B. Average fixed cost curve

 C. Average variable cost curve

 D. Average total cost curve and average variable cost curve

63. Given a cost function C(Q) = 200 + 14Q + 8Q2, what is the marginal cost function?

 A. 14 + 16Q

 B. 14Q + 8Q2

 C. 200 + 8Q2

 D. 14 + 16Q2

64. What is implied when the total cost of producing Q1 and Q2 together is less than the total cost of producing Q1 and Q2 separately?

 A. Economies of scale

 B. Diminishing average fixed costs

 C. Cost complementarity

 D. Economies of scope

65. For the cost function C(Q) = 1000 + 14Q + 9Q2 + 3Q3, what is the marginal cost of producing the fourth unit of output?

 A. \$42

 B. \$295

 C. \$230

 D. \$116

66. For the cost function C(Q) = 200 + 3Q + 8Q2 + 4Q3, what is the average fixed cost of producing six units of output?

 A. 18.31

 B. 212.61

 C. 42.12

 D. 33.33

67. Which of the following cost functions exhibits cost complementarity?

 A. -4Q1Q2 + 8Q1.

 B. -4Q2 + 8Q1.

 C. 6Q1Q2 – Q1.

 D. 4Q2Q1 + 8Q1.

68. For the multiproduct cost function C(Q1, Q2) = 100 + 2Q1Q2 + 4Q12, what is the marginal cost function for good one?

 A. MC1 = 2Q2 + 4Q1 – Q22.

 B. MC1 = 2Q2 + 8Q1.

 C. MC1 = 100 + 2Q1Q2 + 4Q12.

 D. MC1 = 4Q12 – 2Q22.

69. Which of the following cost functions exhibits economies of scope when three (3) units of good one and two (2) units of good two are produced?

 A. C = 50 – 5Q1Q2 + 0.5Q12 + Q22.

 B. C = 10 + 4Q1Q2 + Q12 + Q22.

 C. C = 15 + 5Q1Q2 + 2Q1 + 4Q2.

 D. C = 5 + Q1Q2 + Q12Q22.

70. The minimum average cost of producing alternate levels of output, allowing for optimal selection of all variables of production is defined by the:

 A. long-run average total cost curve.

 B. short-run average fixed cost curve.

 C. short-run marginal cost curve.

 D. long-run marginal cost curve.

71. A production function:

 A. defines the minimum amount of output that can be produced with inputs such as capital and labor.

 B. defines the average amount of output that can be produced with inputs such as capital and labor.

 C. represents the technology available for turning inputs into output.

 D. is determined only by the expenditures on R&D.

72. Which of the following is the most common source of technology?

 A. independent R&D

 B. licensing technology

 C. publications or technical meetings

 D. reverse engineering

73. Variable factors of production are the inputs that a manager:

 A. may adjust in order to alter sales.

 B. may adjust in order to alter production.

 C. cannot adjust in the short run.

 D. cannot adjust in the long run.

74. The short run is defined as the time frame:

 A. in which there are no fixed factors of production.

 B. in which there are fixed factors of production.

 C. less than one year.

 D. less than three years.

75. The long run is defined as:

 A. the horizon in which the manager can adjust all factors of production.

 B. the horizon in which there are only fixed factors of production.

 C. the horizon in which there are both fixed and variable factors of production.

 D. greater than one year.

76. Which of the following is NOT a measure of productivity?

 A. Total product

 B. Marginal product

 D. Input-output ratio

77. The marginal product of an input is defined as the change in:

 A. average output attributable to the last unit of an input.

 B. total output attributable to the last unit of an input.

 C. total input attributable to the last unit of an output.

 D. average output attributable to the last unit of an output.

78. As long as marginal product is increasing, marginal product is:

 A. less than average product.

 B. greater than average product.

 C. equal to average output.

 D. equal to total product.

79. As the usage of an input increases, marginal product:

 A. initially increases then begins to decline.

 B. initially decreases then begins to increase.

 C. consistently decreases.

 D. consistently increases.

80. If a firm is operating on the production function, then workers:

 A. must be putting forth maximal effort.

 B. may not be putting forth maximal effort.

 C. are usually putting forth average effort.

 D. are usually putting forth minimal effort.

81. The manager institutes an incentive structure to ensure:

 A. workers are in fact working at the expected potential.

 B. workers are in fact working at their utility-maximizing effort level.

 C. the firm produces on the production function.

 D. the firm produces above the production function.

82. The value of marginal product of an input is the value of the:

 A. total output produced by total inputs.

 B. average output produced by inputs.

 C. output produced by the last unit of an input.

 D. output produced by the first unit of an input.

83. It is profitable to hire labor so long as the:

 A. MPL is greater than wage.

 B. MPL is less than wage.

 C. VMPL is less than wage.

 D. VMPL is greater than wage.

84. The demand for labor by a profit-maximizing firm is determined by:

 A. MPL = MC.

 B. VMPL = MC.

 C. MPL = W.

 D. VMPL = W.

85. The demand for an input is:

 A. sloping upward.

 B. the VMP of the input.

 C. determined by MPL = W.

 D. derived from input owner’s profit-maximizing condition.

86. The Leontief production function:

 A. implies inputs are used in variable proportions.

 B. implies inputs are used in fixed proportions.

 C. is Q = max{bK, cL}.

 D. is Q = aK + bL.

87. With a linear production function there is a:

 A. perfect complementary relationship between all inputs.

 B. perfect substitutable relationship between all inputs.

 C. fixed-proportion relationship between all inputs.

 D. variable-proportion relationship between all inputs.

88. The Cobb-Douglas production function is:

 A. Q = aK + bL.

 B. Q = min{bK, cL}.

 C. Q = max{bK, cL}.

 D. Q = KaLb.

89. The average product of labor depends on how many units of:

 A. labor are used.

 B. capital are used.

 C. labor and capital are used.

 D. None of the statements is correct.

90. The marginal product of capital for the Cobb-Douglas production function is given by:

 A. bKa Lb-1.

 B. aKa-1 Lb.

 C. aKa-1 Lb-1.

 D. bKa Lb.

91. An isoquant defines the combination of inputs that yield the producer:

 A. higher levels of output than the desired level of output.

 B. lower levels of output than the desired level of output.

 C. the same level of output.

 D. None of the statements is correct.

92. The isoquants are normally drawn with a convex shape because inputs are:

 A. not perfectly substitutable.

 B. perfectly substitutable.

 C. perfect complements.

 D. normal goods.

93. The marginal rate of technical substitution:

 A. determines the rate at which a producer can substitute between two inputs in order to increase one additional unit of output.

 B. is the absolute value of the slope of the isoquant.

 C. is the absolute value of marginal revenue.

 D. is constant along the isoquant curve.

94. Whenever an isoquant exhibits a diminishing marginal rate of technical substitution, the corresponding isoquants are:

 A. convex to the origin.

 B. concave to the origin.

 C. L-shaped.

 D. linear.

95. An isocost line:

 A. represents the combinations of w and K that cost the firm the same amount of money.

 B. represents the combinations of K and L that cost the firm the same amount of money.

 C. represents the combinations of r and w that cost the firm the same amount of money.

 D. has a convex shape.

96. For given input prices, isocosts farther from the origin are associated with:

 A. lower costs.

 B. the same costs.

 C. higher costs.

 D. initially lower, then higher costs.

97. If the marginal product per dollar spent on capital is less than the marginal product per dollar spent on labor, then in order to minimize costs the firm should use:

 A. less capital and more labor.

 B. less labor and more capital.

 C. less labor and less capital.

 D. more labor and more capital.

98. If the price of labor increases, in order to minimize the costs of producing a given level of output, the firm manager should use:

 A. less of labor and more of capital.

 B. less of labor and less of capital.

 C. more of labor and more of capital.

 D. more of labor and less of capital.

99. Sunk costs are those costs that:

 A. do not vary without output.

 B. are forever lost after they have been paid.

 C. can be collected even after they have been paid.

 D. do vary with output.

100. Average fixed cost:

 A. initially declines, reaches a minimum, and then begins to increase as output increases.

 B. increases continuously as output increases.

 C. declines continuously as output is expanded.

 D. keeps constant as output is expanded.

101. The marginal cost curve:

 A. lies always below the average total cost curve (ATC).

 B. lies always above the average variable cost curve (AVC).

 C. intersects the ATC and AVC at their maximum points.

 D. intersects the ATC and AVC at their minimum points.

102. When marginal cost curve is below an average cost curve, average cost is:

 A. increasing with output.

 B. declining with output.

 C. not varying with output.

 D. None of the statements is correct.

103. The difference between average total costs and average variable costs is:

 A. marginal cost.

 B. average fixed cost.

 C. fixed cost.

 D. None of the statements is correct.

104. Economies of scope exist when:

 A. C(Q1) + C(Q2) < C(Q1, Q2).

 B. C(Q1) – C(Q2) < C(Q1, Q2).

 C. C(Q1) + C(Q2) > C(Q1, Q2).

 D. C(Q1) – C(Q2) > C(Q1, Q2).

105. Cost complementarity exists in a multiproduct cost function when:

 A. the average cost of producing one output is reduced when the output of another product is increased.

 B. the average cost of producing one output is increased when the output of another product is increased.

 C. the marginal cost of producing one output is increased when the output of another product is decreased.

 D. the marginal cost of producing one output is reduced when the output of another product is increased.

106. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What are the fixed costs?

 A. \$50

 B. \$10

 C. \$1

 D. \$2

107. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What is the total cost of producing 10 units?

 A. \$2,060

 B. \$1,060

 C. \$560

 D. \$1,010

108. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What is the variable cost of producing 10 units?

 A. \$401

 B. \$1,060

 C. \$560

 D. \$1,010

109. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What is the marginal cost of producing 10 units?

 A. \$401

 B. \$1,060

 C. \$560

 D. \$1,010

110. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. At 10 units of output, the average cost curve is:

 A. in the increasing stage.

 B. in the declining stage.

 C. at the minimum level.

 D. at the maximum level.

111. When there are economies of scope between two products which are separately produced by two firms, merging into a single firm can:

 A. accomplish an increase in sales.

 B. accomplish a reduction in costs.

 C. lead to an increase in cost.

 D. lead to a reduction in sales.

112. When there are economies of scope between products, selling off an unprofitable subsidiary could lead to:

 A. a major reduction in costs.

 B. only a minor reduction in costs.

 C. only a minor reduction in sales.

 D. a major reduction in sales.

113. Economies of scale exist whenever long-run average costs:

 A. increase as output is increased.

 B. decrease as output is increased.

 C. remain constant as output is increased.

 D. None of the statements is correct.

114. The long-run average cost curve defines the minimum average cost of producing alternative levels of output, allowing for optimal selection of:

 A. fixed factors of production.

 B. variable factors of production.

 C. all factors of production.

 D. sunk cost factors of production.

115. The costs of production include:

 A. the costs that appear on the income statements.

 B. the opportunity costs foregone by producing a given product.

 C. accounting costs.

 D. accounting costs and opportunity costs.

116. Suppose the long-run average cost curve is U-shaped. When LRAC is in the increasing stage, there exist:

 A. economies of scope.

 B. diseconomies of scope.

 C. economies of scale.

 D. diseconomies of scale.

117. Constant returns to scale exist when long-run average costs:

 A. increase as output is increased.

 B. decrease as output is increased.

 C. remain constant as output is increased.

 D. None of the statements is correct.

118. Larger firms can produce a product at lower average cost than small firms when:

 A. economies of scope exist.

 B. diseconomies of scale exist.

 C. economies of scale exist.

 D. cost complementarities exist.

119. Two firms producing identical products may merge due to the existence of:

 A. economies of scope.

 B. economies of scale.

 C. cost complementarities.

 D. All of the statements are correct.

120. Suppose the marginal product of labor is 10 and the marginal product of capital is 8. If the wage rate is \$5 and the price of capital is \$2, then in order to minimize costs the firm should use:

 A. more capital and less labor.

 B. more labor and less capital.

 C. equal amounts of labor and capital.

 D. None of the statements is correct.

121. Suppose the production function is Q = min{3K, L}. How much output is produced when 6 units of labor and 3 units of capital are employed?

 A. 3

 B. 6

 C. 9

 D. None of the statements is correct.

122. Suppose the production function is given by Q = 2K + 5L. What is the marginal product of labor when 15 units of capital and 10 units of labor are employed?

 A. 2

 B. 5

 C. 25

 D. 50

123. Suppose the production function is given by Q = 4K + 6L. What is the average product of capital when 10 units of capital and 5 units of labor are employed?

 A. 14

 B. 10

 C. 7

 D. 5

124. For the cost function C(Q) = 75 + 4Q + 2Q2, the marginal cost of producing 5 units of output is:

 A. 4

 B. 54

 C. 20

 D. 24

125. For the cost function C(Q) = 50 + 4Q + 2Q2, the total variable cost of producing 7 units of output is:

 A. 32

 B. 102

 C. 126

 D. None of the answers are correct.

126. If a firm’s production function is Leontief and the price of capital goes down, the:

 A. firm must use less labor in order to minimize the cost of producing a given level of output.

 B. firm must use more capital in order to minimize the cost of producing a given level of output.

 C. firm must use less capital in order to minimize the cost of producing a given level of output.

 D. cost-minimizing combination of capital and labor does not change.

127. Which of the following “costs” could a firm that wants to remain in business avoid if it halted current production?

 A. Fixed costs

 B. Variable costs

 C. Sunk costs

 D. Opportunity costs

128. If the production function is Q = K.5L.5 and capital is fixed at 1 unit, then the average product of labor when L = 36 is:

 A. 1/3.

 B. 1/6.

 C. 2/3.

 D. None of the answers are correct.

129. Which of the following conditions is true when a producer minimizes the cost of producing a given level of output?

 A. The marginal product per dollar spent on all inputs is equal.

 B. The MRTS is equal to the ratio of the quantity of inputs.

 C. The marginal products of all inputs are equal.

 D. The marginal product per dollar spent on all inputs is equal and the MRTS is equal to the ratio of the quantity of inputs.

130. The inputs that a manager uses to alter production are referred to as:

 A. variable factors.

 B. long-run factors.

 C. fixed factors.

 D. All of the statements are correct.

131. The point where diminishing marginal returns has begun to affect production is best characterized by the point where the:

 A. total product curve flattens out.

 B. average product curve begins to be negatively sloped.

 C. marginal product curve begins to be negatively sloped.

 D. marginal product curve equals the average product curve.

132. Changes in the price of an input cause:

 A. isoquants to become steeper.

 B. slope changes in the isocost line.

 C. parallel shifts of the isocost lines.

 D. changes in both the isoquants and isocosts of equal magnitude.

133. In the short run, the marginal cost curve crosses the average total cost curve at:

 A. a point just below the average fixed cost curve.

 B. the minimum point of the average total cost curve.

 C. the maximum point of the average total cost curve.

 D. the point where the average total cost curve and average variable cost curve intersect.

134. Which of the following cost functions exhibits cost complementarity?

 A. -3Q2 + 4Q1

 B. 5Q1Q2 – Q1

 C. Q2Q1 + 2Q1

 D. -5Q1Q2 + 7Q1

135. Which of the following cost functions exhibits economies of scope over the specified output range?

 A. C(Q1, Q2) = 2 – 0.5Q1Q2 – (Q1)2 + (Q2)2, for all Q1 > 0 and Q2 > 0

 B. C(Q1, Q2) = 2 – 3Q1Q2 – (Q1)2 + (Q2)2, for all Q1 > 0 and Q2 > 0

 C. C(Q1, Q2) = 2 – 0.5Q1Q2 – (Q1)2 + (Q2)2, for all Q1 < 2 and Q2 < 2

 D. C(Q1, Q2) = 2 – 3Q1Q2 – (Q1)2 + (Q2)2, for all Q1 > 4 and Q2 > 4

136. The production function for good X exhibited in the table below is for the:

 A. long run, since K is the fixed input.

 B. short run, since L is the fixed input.

 C. long run, since K is the variable input.

 D. short run, since L is the variable input.

137. The marginal product of capital of producing 2,991 units of output (find point A) in the table below is:

 A. 26.7.

 B. 19.5.

 C. 5.7.

 D. 2.4.

138. The production function for good X in the table below exhibits increasing marginal returns to capital over what output range?

 A. Between 0 and 1,524

 B. Between 0 and 2,991

 C. Between 2,391 and 3,048

 D. Between 3,016 and 2,945

139. The production function in the table below exhibits negative marginal returns to capital over what output range?

 A. Between 0 and 1,524

 B. Between 0 and 2,991

 C. Between 2,391 and 3,048

 D. Between 3,016 and 2,945

140. The production function in the table below exhibits decreasing marginal returns to capital over what output range?

 A. Between 0 and 1,524

 B. Between 0 and 2,991

 C. Between 2,391 and 3,048

 D. Between 3,016 and 2,945

141. The average product of capital of producing 2,991 units of output (find point B) in the table below is:

 A. 11.1.

 B. 21.9.

 C. 37

 D. 73

142. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the fixed cost of using 81 units of capital and 9 units of labor is:

 A. \$2,160.

 B. \$2,025.

 C. \$135.

 D. There is insufficient information to determine the fixed costs.

143. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the variable cost of using 81 units of capital and 9 units of labor is:

 A. \$2,160.

 B. \$2,025.

 C. \$135.

 D. There is insufficient information to determine the variable costs.

144. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the average total cost of using 81 units of capital and 9 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average total costs.

145. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the average variable cost of using 81 units of capital and 9 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average variable costs.

146. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the average fixed cost of using 81 units of capital and 9 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average fixed costs.

147. The derivative, dAC(Q)/dQ = (1/Q2) {Q(dC/dQ) – C(Q)}, illustrates that when:

 A. MC(Q) < AC(Q), average costs increase as output increases.

 B. MC(Q) < AC(Q), average costs decrease as output increases.

 C. MC(Q) > AC(Q), average costs decrease as output increases.

 D. None of the answers are correct.

148. The first-order conditions for maximizing profits, π = P × F(K, L) – wL – rK, are:

 A.

 B. P × MPK – r = 0 and P × MPL – w = 0.

 C. VMPK = r and VMPL = w.

 D. All of the answers are correct.

149. Which of the following profit functions exhibits a Leontief production function?

 A. π = P × K0.75L0.50 – 20L – 35K

 B. π = P × min(2L, 5K) – 20L – 35K

 C. π = P × (3K + 4L) – 20L – 35K

 D. π = P × (3K0.5 + 4L0.5)1/0.2 – 20L – 35K

150. Which of the following profit functions exhibits a linear production function?

 A. π = P × K0.75L0.50 – 20L – 35K

 B. π = P × min(2L, 5K) – 20L – 35K

 C. π = P × (3K + 4L) – 20L – 35K

 D. π = P × (3K0.5 + 4L0.5)1/0.2 – 20L – 35K

151. Which of the following profit functions exhibits a Cobb-Douglas production function?

 A. π = P × K0.75L0.50 – 20L – 35K

 B. π = P × min(2L, 5K) – 20L – 35K

 C. π = P × (3K + 4L) – 20L – 35K

 D. π = P × (3K0.5 + 4L0.5) 1/0.2 – 20L – 35K

152. Which of the following relations is the slope along a given isoquant?

 A.

 B.

 C.

 D.

153. Suppose the w = \$20 and r = \$30. The isocost line for a firm in this industry is:

 A. C = 20K + 30L.

 B. K = 0.033C – 0.66L.

 C. 1.5L + K = 0.5C.

 D. Depends entirely on the functional form of the production function.

154. Suppose the production function is given by Q = 2K + L. If w = \$4 and r = \$4, how many units of K and L will be utilized in the production process?

 A. All K and no L.

 B. All L and no K.

 C. Equal amounts of K and L.

 D. A combination of K and L not represented above.

155. For given input prices, isocosts closer to the origin are associated with:

 A. lower costs.

 B. the same costs.

 C. higher costs.

 D. initially lower, then higher costs.

156. For the cost function C(Q) = 500 + 12Q + 4Q2 + Q3, what is the marginal cost of producing the eighth unit of output?

 A. \$184

 B. \$268

 C. \$524

 D. \$852

157. If the production function is Q = K.5L.5 and capital is fixed at 9 units, then the marginal product of labor when L = 49 is:

 A. 3

 B. 9/98.

 C. 3/14.

 D. None of the answers are correct.

158. Suppose the production function is given by Q = 4K + 3L. What is the average product of labor when 10 units of capital and 5 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

159. The production function is Q = K.4 L.6. The marginal rate of technical substitution is:

 A. 3/2 K-1 L.

 B. K-1 L-1.

 C. 3/2 K L-1.

 D. K.6 L-.4.

160. For the cost function C(Q) = 100 + 4Q + 19Q2 + 2Q3, what is the marginal cost of producing the fourth unit of output?

 A. \$42

 B. \$295

 C. \$252

 D. \$116

161. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. At 3 units of output, the marginal cost curve is:

 A. in the increasing stage.

 B. in the declining stage.

 C. at the minimum level.

 D. at the maximum level.

162. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$86.80 and the per-unit wage, w, is \$20, then the average total cost of using 25 units of capital and 49 units of labor is:

 A. \$5.

 B. \$75.

 C. \$90.

 D. There is insufficient information to determine the average total costs.

163. Suppose that production for good X is characterized by the following production function, Q = 4K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$86.80 and the per-unit wage, w, is \$20, then the average total cost of using 25 units of capital and 49 units of labor is:

 A. \$5.25.

 B. \$22.50.

 C. \$31.00.

 D. There is insufficient information to determine the average total costs.

164. Suppose that production for good X is characterized by the following production function, Q = 4K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$12 and the per-unit wage, w, is \$20, then the average total cost of using 25 units of capital and 49 units of labor is:

 A. \$6.25.

 B. \$9.14.

 C. \$10.07.

 D. There is insufficient information to determine the average total costs.

165. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$15 and the per-unit wage, w, is \$25, then the average fixed cost of using 9 units of capital and 81 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average fixed costs.

166. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$15 and the per-unit wage, w, is \$125, then the average fixed cost of using 16 units of capital and 25 units of labor is:

 A. \$9.

 B. \$12.

 C. \$56.

 D. There is insufficient information to determine the average fixed costs.

167. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$15 and the per-unit wage, w, is \$5, then the average fixed cost of using 16 units of capital and 25 units of labor is:

 A. \$9.

 B. \$12.

 C. \$56.

 D. There is insufficient information to determine the average fixed costs.

Essay Questions

 168 Congress is considering legislation that will provide additional investment tax credits to businesses. Effectively, an investment tax credit reduces the cost to firms of using capital in production. Would you expect labor unions to lobby for or against such a bill? (Hint: What impact would such a plan have on the capital-to-labor ratio at the typical firm?)

 169 You have been hired to replace the manager of a firm that used only two inputs, capital and labor, to produce output. The firm can hire as much labor as it wants at a wage of \$5 per hour and can rent as much capital as it wants at a price of \$50 per hour. After you look at the company books, you learn that the company has been using capital and labor in amounts that imply a marginal product of labor of 50 and a marginal product of capital of 100. Do you know why the firm hired you? Explain.

 170 The manager of a meat-packing plant can use either butchers (labor) or meat saws (capital) to prepare packages of sirloin steak. Based on estimates provided by an efficiency expert, the firm’s production function for sirloin steak is given by Q = K + L a. Graph the isoquant corresponding to 5 units of output. b. What is the marginal product of capital and labor? Does the answer depend on how much labor and capital are used? c. If the price of labor is \$2 per hour and the rental price of capital is \$3 per hour, how much capital and labor should be used to minimize the cost of producing 5 units of output?

 171 The manager of a national retailing outlet recently hired an economist to estimate the firm’s production function. Based on the economist’s report, the manager now knows that the firm’s production function is given by   and that capital is fixed at 1 unit. a. Calculate the average product of labor when 9 units of labor are utilized. b. Calculate the marginal product of labor when 9 units of labor are utilized. c. Suppose the firm can hire labor at a wage of \$10 per hour and output can be sold at a price of \$100 per unit. Determine the profit-maximizing levels of labor and output. d. What is the maximum price of capital at which the firm will still make nonnegative profits?

 172 An accountant for a car rental company was recently asked to report the firm’s costs of producing various levels of output. The accountant knows that the most recent estimate available of the firm’s cost function is   where costs are measured in thousands of dollars and output is measured in thousands of hours rented. a. What is the average fixed cost of producing 2 units of output? b. What is the average variable cost of producing 2 units of output? c. What is the average total cost of producing 2 units of output? d. What is the marginal cost of producing 2 units of output? e. What is the relation between the answers to (a), (b), and (c) above? Is this a general property of average cost curves?

 173 There are over 5,000 banks in the United States—more than 10 times more per person than in other industrialized countries. A recent study suggests that the long-run average cost curve for an individual bank is relatively flat. If Congress took steps to consolidate banks, thereby reducing the total number to 2,500, what would you expect to happen to costs within the banking industry? Explain.

 174 A production function exhibits constant returns to scale if a twofold (threefold, etc.) increase in all inputs leads to a twofold (threefold, etc.) increase in output. For example, by doubling the use of capital and labor, the firm would exactly double its output. a. What would the average and marginal cost curves look like under constant returns to scale? Explain. b. Give an example of a production function that exhibits constant returns to scale.

 175 A production function exhibits decreasing returns to scale if a twofold (threefold, etc.) increase in all inputs increases output by less than twofold (less than threefold, etc.). For example, by doubling the use of capital and labor, the firm would less than double its output. a. What would the average and marginal cost curves look like under decreasing returns to scale? Explain. b. Give an example of a production function that exhibits decreasing returns to scale.

 176 The total costs for Morris Industries are summarized in the following table. Based on this information, fill in the missing entries in the table for fixed cost, variable cost, average fixed cost, average variable cost, average total cost, and marginal cost.

 177 The following table summarizes the short-run production function for your firm. Your product sells for \$5 per unit, labor costs \$5 per unit, and the rental price of capital is \$20 per unit. Complete the following table, and then answer the accompanying questions. a. Which inputs are fixed inputs? Which are the variable inputs? b. How much are your fixed costs? c. What is the variable cost of producing 20 units of output? d. How many units of the variable input should be used to maximize profits? e. What are your maximum profits? f. Over what range of variable input usage do increasing marginal returns exist? g. Over what range of variable input usage do decreasing marginal returns exist? h. Over what range of variable input usage do negative marginal returns exist?

 178 Your firm produces two products, Q1 and Q2. An economic consulting firm has estimated your cost function to be a. Are there economies of scope? b. Are there cost complementarities? c. Your market for Q1 is not very good, and an overseas firm has offered to buy the division of your company that produces Q1. What will happen to your marginal cost of producing Q2 if you sell the division?

 179 In the text, we showed that the multiproduct cost function   exhibits cost complementarity whenever   and economies of scope whenever a. Can cost complementarity exist without economies of scope? b. Can there be economies of scope when cost complementarities exist?

 180 Standard Enterprises produces an output that it sells in a highly competitive market at a price of \$100 per unit. Its inputs include two machines (which cost the firm \$50 each) and workers, who can be hired on an as-needed basis in a labor market at a cost of \$2,800 per worker. Based on the following production data, how many workers should the firm employ to maximize its profits?

 181 You are the manager of Telecall Inc., a small telemarketing company. Your company pays \$10,000 per month for office space. A real estate agent has noticed that you are only using 75 percent of your available space and tells you that Telecall could add \$800 per month to its bottom line by renting out the space it does not use. Telecall has been asked to do a new telemarketing campaign for a large credit card company, but this would require it to use the remaining office space. What is the opportunity cost of using the extra office space to handle the credit card company’s promotion?

 182 Suppose the production function of automobiles is given by a. Show that the marginal product of any given quantity of labor increases as capital is increased. b. Suppose Japanese and U.S. automakers produce on identical isoquants with this Cobb-Douglas production function and that labor costs are higher in Japan than in the United States. Do autoworkers in Japan have a higher marginal product than American autoworkers? Explain carefully. c. Now suppose Japanese automakers produce on a different isoquant from U.S. firms, but the prices of Japanese and American cars are identical. Do Japanese or American autoworkers have a higher marginal product? Why?

 183 Show that the Cobb-Douglas production function   exhibits the law of diminishing marginal rate of technical substitution.

 184 You are the manager of a firm that sells output at a price of \$40 per unit. You are interested in hiring a new worker who will increase your firm’s output by 2,000 units per year. Several other firms also are interested in hiring this worker. a. What is the highest annual salary you should be willing to pay this worker to come to your firm? b. What will determine whether or not you actually have to offer this much to the worker to induce him to join your firm?

 185 To open a new business, a manager must obtain a license from the city for \$20,000. The license is transferable, but only \$3,000 is refundable in the event the firm does not use the license. a. What are the firm’s fixed costs? Sunk costs? b. Suppose the manager obtains a license but then decides against opening the business. If another firm offers the manager \$2,000 for the license, should the manager accept the offer?

 186 The maker of Turbotax produces software that prepares federal income tax returns. In addition, it produces software that prepares various state income tax returns. Why doesn’t it pay for the firm to specialize in federal software?

 187 The management of Morris Industries is considering a plan to terminate a new employee. The action stemmed from documented evidence supplied by the firm’s accounting department that this new employee did not add as much to the firm’s overall output as did a worker hired two weeks earlier. Based on this evidence, do you agree that the latest worker hired should be fired? Explain.

 188 In 1995 the U.S. Justice Department sued to block a merger between Microsoft and Intuit, the producer of the nation’s best-selling business software. The Justice Department argued that the merger would lessen competition and raise prices of business software. Is there an economic argument that the merger might actually result in lower prices? Explain.

Chapter 05 The Production Process and Costs Answer Key

Multiple Choice Questions

1. Suppose the marginal product of labor is 8 and the marginal product of capital is 2. If the wage rate is \$4 and the price of capital is \$2, then in order to minimize costs the firm should use:

 A. more capital and less labor.

 B. more labor and less capital.

 C. three times more capital than labor.

 D. none of the answers are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

2. Suppose the production function is Q = min{K, 2L}. How much output is produced when 4 units of labor and 9 units of capital are employed?

 A. 2

 B. 4

 C. 8

 D. 9

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

3. Suppose the production function is given by Q = 3K + 4L. What is the average product of capital when 10 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 7

 D. 45

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

4. Suppose the production function is given by Q = 3K + 4L. What is the marginal product of capital when 10 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

5. Suppose the production function is given by Q = min{K, L}. How much output is produced when 10 units of labor and 9 units of capital are employed?

 A. 0

 B. 4

 C. 9

 D. 13

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

6. Suppose the production function is given by Q = min{K, L}. How much output is produced when 4 units of labor and 9 units of capital are employed?

 A. 0

 B. 4

 C. 9

 D. 13

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

7. Suppose the production function is given by Q = 3K + 4L. What is the marginal product of capital when 5 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

 AACSB: Analytic Blooms: Analyze Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

8. Suppose the production function is given by Q = 3K + 4L. What is the average product of capital when 5 units of capital and 10 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

9. For the cost function C(Q) = 100 + 2Q + 3Q2, the marginal cost of producing 2 units of output is:

 A. 2

 B. 3

 C. 12

 D. 14

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

10. For the cost function C(Q) = 100 + 2Q + 3Q2, the average fixed cost of producing 2 units of output is:

 A. 100

 B. 50

 C. 3

 D. 2

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

11. For the cost function C(Q) = 100 + 2Q + 3Q2, the total variable cost of producing 2 units of output is:

 A. 16

 B. 12

 C. 4

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

12. If a firm’s production function is Leontief and the wage rate goes up, the:

 A. firm must use more labor in order to minimize the cost of producing a given level of output.

 B. firm must use more capital in order to minimize the cost of producing a given level of output.

 C. firm must use less labor in order to minimize the cost of producing a given level of output.

 D. cost minimizing combination of capital and labor does not change.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

13. Which of the following statements is incorrect?

 A. Fixed costs do not vary with output.

 B. Sunk costs are those costs that are forever lost after they have been paid.

 C. Fixed costs are always greater than sunk costs.

 D. Fixed costs could be positive when sunk costs are zero.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 3 Hard Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

14. You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = \$40, r = \$100, MPL = 20, and MPK = 40 the firm:

 A. is cost minimizing.

 B. should use less L and more K to cost minimize.

 C. should use more L and less K to cost minimize.

 D. is profit maximizing but not cost minimizing.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

15. The production function Q = L.5K.5 is called:

 A. Cobb Douglas.

 B. Leontief.

 C. linear.

 D. None of the answers are correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

16. The production function for a competitive firm is Q = K.5L.5. The firm sells its output at a price of \$10, and can hire labor at a wage of \$5. Capital is fixed at 25 units. The profit-maximizing quantity of labor is:

 A. 1

 B. 2

 C. 10

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

17. You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = \$40, r = \$100, MPL = 4, and MPK = 40 the firm:

 A. is cost minimizing.

 B. should use less L and more K to cost minimize.

 C. should use more K and less L to cost minimize.

 D. is profit maximizing but not cost minimizing.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

18. If the production function is Q = K.5L.5 and capital is fixed at 1 unit, then the average product of labor when L = 25 is:

 A. 2/5.

 B. 1/5.

 C. 10

 D. None of the answers are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

19. For a cost function C = 100 + 10Q + Q2, the marginal cost of producing 10 units of output is:

 A. 10

 B. 200

 C. 210

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

20. For a cost function C = 100 + 10Q + Q2, the average variable cost of producing 20 units of output is:

 A. 10

 B. 20

 C. 30

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

21. For a cost function C = 100 + 10Q + Q2, the average fixed cost of producing 10 units of output is:

 A. 10

 B. 5

 C. 1

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

22. Which of the following conditions is true when a producer minimizes the cost of producing a given level of output?

 A. The MRTS is equal to the ratio of input prices.

 B. The marginal product per dollar spent on all inputs is equal.

 C. The marginal products of all inputs are equal.

 D. The MRTS is equal to the ratio of input prices, and the marginal product per dollar spent on all inputs is equal.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

23. If the production function is Q = KL and capital is fixed at 1 unit, then the marginal product of labor when L = 25 is:

 A. ¼.

 B. 1/10.

 C. 15

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

24. The production function for a competitive firm is Q = K.5L.5. The firm sells its output at a price of \$10, and can hire labor at a wage of \$5. Capital is fixed at one unit. The profit-maximizing quantity of labor is:

 A. 2/5.

 B. 1

 C. 10

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

25. The production function for a competitive firm is Q = K.5L.5. The firm sells its output at a price of \$10, and can hire labor at a wage of \$5. Capital is fixed at one unit and costs \$2. The maximum profits are:

 A. 3

 B. 10

 C. 15

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

26. The feasible means of converting raw inputs such as steel, labor, and machinery into an output are summarized by:

 A. Land.

 B. Production.

 C. Capital.

 D. Technology.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

27. The recipe that defines the maximum amount of output that can be produced with K units of capital and L units of labor is the:

 A. Production function.

 B. Technological constraint.

 C. Research and development schedule.

 D. Total product.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

28. The creation of a new product is referred to as:

 A. Process innovation.

 B. Independent research and development.

 C. Product innovation.

 D. Patent disclosure.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

29. Which of the following is NOT a means of acquiring product and process innovations?

 A. Independent research and development

 B. Mass production of the existing product

 C. Reverse engineering

 D. Hiring employees of innovating firms

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

30. Inputs a manager may adjust in order to alter production are:

 A. all factors.

 B. variable factors.

 C. long-run factors.

 D. fixed factors.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

31. What is the average product of labor, given that the level of labor equals 10, total output equals 1200, and the marginal product of labor equals 200?

 A. 20

 B. 120

 C. 6

 D. 2,000

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

32. The change in total output attributable to the last unit of an input is the:

 A. total product.

 B. average product.

 C. marginal product.

 D. marginal return.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

33. If the last unit of input increases total product, we know that the marginal product is:

 A. positive.

 B. negative.

 C. zero.

 D. indeterminate.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

34. Total product begins to fall when:

 A. Marginal product is maximized.

 B. Average product is below zero.

 C. Average product is negative.

 D. Marginal product is zero.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

35. What is the value marginal product of labor if: P = \$10, MPL = \$25, and APL = 40?

 A. \$10,000

 B. \$1,000

 C. \$400

 D. \$250

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

36. It is profitable to hire units of labor as long as the value of marginal product:

 A. is less than wage.

 B. exceeds average product.

 C. equals price.

 D. exceeds wage.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

37. Given the following table, how many workers should be hired to maximize profits?

 A. 1

 B. 2

 C. 3

 D. 4

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

38. Firm managers should use inputs at levels where the:

 A. Marginal benefit equals marginal cost.

 B. Price equals marginal product.

 C. Value marginal product of labor equals wage.

 D. Marginal benefit equals marginal cost and value marginal product of labor equals wage.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

39. Given the linear production function Q = 10K + 5L, if Q = 10,000 and K = 500, how much labor is utilized?

 A. 600 units

 B. 800 units

 C. 500 units

 D. 1,000 units

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

40. Given the Leontief production function Q = min{5.5K, 6.7L}, how much output is produced when K = 40 and L = 35?

 A. 220

 B. 234.5

 C. 192.5

 D. 268

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

41. Suppose the production function is given by Q = K1/2L1/2, and that Q = 30 and K = 25. How much labor is employed by the firm?

 A. 49

 B. 6

 C. 36

 D. 25

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

42. Given the production function Q = min{4K, 3L}, what is the average product of capital when 8 units of capital and 16 units of labor are used?

 A. 16

 B. 2

 C. 4

 D. 32

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

43. For the production function Q = 5.2K + 3.8L, if K = 16 and L = 12, we know that MPK is:

 A. 16

 B. 5.2.

 C. 3.8.

 D. 12

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

44. The combinations of inputs that produce a given level of output are depicted by:

 A. indifference curves.

 B. budget lines.

 C. isocost curves.

 D. isoquants.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

45. Isoquants are normally drawn with a convex shape because:

 A. inputs are perfectly substitutable.

 B. inputs are perfectly complementary.

 C. inputs are not perfectly substitutable.

 D. inputs are not perfectly complementary.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

46. The absolute value of the slope of the isoquant is the:

 A. marginal rate of technical substitution.

 B. marginal product of capital.

 C. marginal rate of substitution.

 D. value marginal product of labor.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

47. The production function is Q = K.6 L.4. The marginal rate of technical substitution is:

 A. 2/3 K-1 L.

 B. K-1 L-1.

 C. 2/3 K L-1.

 D. K.4 L-.6.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

48. The Leontief production function implies:

 A. straight-line isoquants.

 B. convex-shaped isoquants.

 C. A positive MRTS.

 D. L-shaped isoquants.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

49. In order for isoquants to have a diminishing marginal rate of substitution, they must be:

 A. L-shaped.

 B. straight lines.

 C. vertical.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

50. Changes in the price of an input cause:

 A. isoquants to become steeper.

 B. slope changes in the isocost line.

 C. parallel shifts of the isocost lines.

 D. changes in both the isoquants and isocosts of equal magnitude.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

51. Which of the following sets of economic data is minimizing the cost of producing a given level of output?

 A. MPL = 20, MPK = 40, w = \$16, r = \$32.

 B. MPL = 20, MPK = 40, w = \$32, r = \$16.

 C. MPL = 40, MPK = 20, w = \$16, r = \$32.

 D. MPL = 40, MPK = 40, w = \$16, r = \$32.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

52. In order to minimize the cost of producing a given level of output, a firm manager should use more inputs when:

 A. that input’s price rises.

 B. that input’s price falls.

 C. that input’s price remains the same.

 D. the prices of other inputs fall.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

53. Fixed costs exist only in:

 A. the long run.

 B. capital-intensive markets.

 C. the short run.

 D. labor-intensive markets.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

54. Costs that change as output changes are:

 A. variable costs.

 B. fixed costs.

 C. sunk costs.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

55. Costs that are forever lost after they have been paid are:

 A. production costs.

 B. fixed costs.

 C. sunk costs.

 D. variable costs.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

56. Suppose you are a manager of a factory. You purchase five (5) new machines at one million dollars each. If you can resell two of the machines for \$500,000 and three of the machines for \$200,000, what are the sunk costs of purchasing the machines?

 A. \$5 million

 B. \$500,000

 C. \$3.4 million

 D. \$1.6 million

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

57. According to the table below, what is the total cost of producing 125 units of output?

 A. 1,000

 B. 2,050

 C. 1,400

 D. 2,400

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

58. According to the table below, what is the average variable cost of producing 50 units of output?

 A. 21

 B. 34

 C. 14

 D. 20

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

59. According to the table below, what is the average total cost of producing 160 units of output?

 A. 12.98

 B. 16.31

 C. 22.04

 D. 19.38

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

60. According to the table below, what is the marginal cost of producing 90 units of output?

 A. 5.32

 B. 8.75

 C. 11.67

 D. 21

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

61. According to the table below, at what level of output is marginal cost minimized?

 A. 90

 B. 50

 C. 125

 D. 160

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Cost Function

62. Which curve(s) does the marginal cost curve intersect at the (their) minimum point?

 A. Average total cost curve

 B. Average fixed cost curve

 C. Average variable cost curve

 D. Average total cost curve and average variable cost curve

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

63. Given a cost function C(Q) = 200 + 14Q + 8Q2, what is the marginal cost function?

 A. 14 + 16Q

 B. 14Q + 8Q2

 C. 200 + 8Q2

 D. 14 + 16Q2

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

64. What is implied when the total cost of producing Q1 and Q2 together is less than the total cost of producing Q1 and Q2 separately?

 A. Economies of scale

 B. Diminishing average fixed costs

 C. Cost complementarity

 D. Economies of scope

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

65. For the cost function C(Q) = 1000 + 14Q + 9Q2 + 3Q3, what is the marginal cost of producing the fourth unit of output?

 A. \$42

 B. \$295

 C. \$230

 D. \$116

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

66. For the cost function C(Q) = 200 + 3Q + 8Q2 + 4Q3, what is the average fixed cost of producing six units of output?

 A. 18.31

 B. 212.61

 C. 42.12

 D. 33.33

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

67. Which of the following cost functions exhibits cost complementarity?

 A. -4Q1Q2 + 8Q1.

 B. -4Q2 + 8Q1.

 C. 6Q1Q2 – Q1.

 D. 4Q2Q1 + 8Q1.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

68. For the multiproduct cost function C(Q1, Q2) = 100 + 2Q1Q2 + 4Q12, what is the marginal cost function for good one?

 A. MC1 = 2Q2 + 4Q1 – Q22.

 B. MC1 = 2Q2 + 8Q1.

 C. MC1 = 100 + 2Q1Q2 + 4Q12.

 D. MC1 = 4Q12 – 2Q22.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: Multiple-Output Cost Functions

69. Which of the following cost functions exhibits economies of scope when three (3) units of good one and two (2) units of good two are produced?

 A. C = 50 – 5Q1Q2 + 0.5Q12 + Q22.

 B. C = 10 + 4Q1Q2 + Q12 + Q22.

 C. C = 15 + 5Q1Q2 + 2Q1 + 4Q2.

 D. C = 5 + Q1Q2 + Q12Q22.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

70. The minimum average cost of producing alternate levels of output, allowing for optimal selection of all variables of production is defined by the:

 A. long-run average total cost curve.

 B. short-run average fixed cost curve.

 C. short-run marginal cost curve.

 D. long-run marginal cost curve.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

71. A production function:

 A. defines the minimum amount of output that can be produced with inputs such as capital and labor.

 B. defines the average amount of output that can be produced with inputs such as capital and labor.

 C. represents the technology available for turning inputs into output.

 D. is determined only by the expenditures on R&D.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

72. Which of the following is the most common source of technology?

 A. independent R&D

 B. licensing technology

 C. publications or technical meetings

 D. reverse engineering

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

73. Variable factors of production are the inputs that a manager:

 A. may adjust in order to alter sales.

 B. may adjust in order to alter production.

 C. cannot adjust in the short run.

 D. cannot adjust in the long run.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

74. The short run is defined as the time frame:

 A. in which there are no fixed factors of production.

 B. in which there are fixed factors of production.

 C. less than one year.

 D. less than three years.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

75. The long run is defined as:

 A. the horizon in which the manager can adjust all factors of production.

 B. the horizon in which there are only fixed factors of production.

 C. the horizon in which there are both fixed and variable factors of production.

 D. greater than one year.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

76. Which of the following is NOT a measure of productivity?

 A. Total product

 B. Marginal product

 D. Input-output ratio

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

77. The marginal product of an input is defined as the change in:

 A. average output attributable to the last unit of an input.

 B. total output attributable to the last unit of an input.

 C. total input attributable to the last unit of an output.

 D. average output attributable to the last unit of an output.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

78. As long as marginal product is increasing, marginal product is:

 A. less than average product.

 B. greater than average product.

 C. equal to average output.

 D. equal to total product.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

79. As the usage of an input increases, marginal product:

 A. initially increases then begins to decline.

 B. initially decreases then begins to increase.

 C. consistently decreases.

 D. consistently increases.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

80. If a firm is operating on the production function, then workers:

 A. must be putting forth maximal effort.

 B. may not be putting forth maximal effort.

 C. are usually putting forth average effort.

 D. are usually putting forth minimal effort.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

81. The manager institutes an incentive structure to ensure:

 A. workers are in fact working at the expected potential.

 B. workers are in fact working at their utility-maximizing effort level.

 C. the firm produces on the production function.

 D. the firm produces above the production function.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

82. The value of marginal product of an input is the value of the:

 A. total output produced by total inputs.

 B. average output produced by inputs.

 C. output produced by the last unit of an input.

 D. output produced by the first unit of an input.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

83. It is profitable to hire labor so long as the:

 A. MPL is greater than wage.

 B. MPL is less than wage.

 C. VMPL is less than wage.

 D. VMPL is greater than wage.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

84. The demand for labor by a profit-maximizing firm is determined by:

 A. MPL = MC.

 B. VMPL = MC.

 C. MPL = W.

 D. VMPL = W.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

85. The demand for an input is:

 A. sloping upward.

 B. the VMP of the input.

 C. determined by MPL = W.

 D. derived from input owner’s profit-maximizing condition.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

86. The Leontief production function:

 A. implies inputs are used in variable proportions.

 B. implies inputs are used in fixed proportions.

 C. is Q = max{bK, cL}.

 D. is Q = aK + bL.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

87. With a linear production function there is a:

 A. perfect complementary relationship between all inputs.

 B. perfect substitutable relationship between all inputs.

 C. fixed-proportion relationship between all inputs.

 D. variable-proportion relationship between all inputs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

88. The Cobb-Douglas production function is:

 A. Q = aK + bL.

 B. Q = min{bK, cL}.

 C. Q = max{bK, cL}.

 D. Q = KaLb.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

89. The average product of labor depends on how many units of:

 A. labor are used.

 B. capital are used.

 C. labor and capital are used.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

90. The marginal product of capital for the Cobb-Douglas production function is given by:

 A. bKa Lb-1.

 B. aKa-1 Lb.

 C. aKa-1 Lb-1.

 D. bKa Lb.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

91. An isoquant defines the combination of inputs that yield the producer:

 A. higher levels of output than the desired level of output.

 B. lower levels of output than the desired level of output.

 C. the same level of output.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

92. The isoquants are normally drawn with a convex shape because inputs are:

 A. not perfectly substitutable.

 B. perfectly substitutable.

 C. perfect complements.

 D. normal goods.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

93. The marginal rate of technical substitution:

 A. determines the rate at which a producer can substitute between two inputs in order to increase one additional unit of output.

 B. is the absolute value of the slope of the isoquant.

 C. is the absolute value of marginal revenue.

 D. is constant along the isoquant curve.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

94. Whenever an isoquant exhibits a diminishing marginal rate of technical substitution, the corresponding isoquants are:

 A. convex to the origin.

 B. concave to the origin.

 C. L-shaped.

 D. linear.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

95. An isocost line:

 A. represents the combinations of w and K that cost the firm the same amount of money.

 B. represents the combinations of K and L that cost the firm the same amount of money.

 C. represents the combinations of r and w that cost the firm the same amount of money.

 D. has a convex shape.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

96. For given input prices, isocosts farther from the origin are associated with:

 A. lower costs.

 B. the same costs.

 C. higher costs.

 D. initially lower, then higher costs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

97. If the marginal product per dollar spent on capital is less than the marginal product per dollar spent on labor, then in order to minimize costs the firm should use:

 A. less capital and more labor.

 B. less labor and more capital.

 C. less labor and less capital.

 D. more labor and more capital.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

98. If the price of labor increases, in order to minimize the costs of producing a given level of output, the firm manager should use:

 A. less of labor and more of capital.

 B. less of labor and less of capital.

 C. more of labor and more of capital.

 D. more of labor and less of capital.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

99. Sunk costs are those costs that:

 A. do not vary without output.

 B. are forever lost after they have been paid.

 C. can be collected even after they have been paid.

 D. do vary with output.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

100. Average fixed cost:

 A. initially declines, reaches a minimum, and then begins to increase as output increases.

 B. increases continuously as output increases.

 C. declines continuously as output is expanded.

 D. keeps constant as output is expanded.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

101. The marginal cost curve:

 A. lies always below the average total cost curve (ATC).

 B. lies always above the average variable cost curve (AVC).

 C. intersects the ATC and AVC at their maximum points.

 D. intersects the ATC and AVC at their minimum points.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

102. When marginal cost curve is below an average cost curve, average cost is:

 A. increasing with output.

 B. declining with output.

 C. not varying with output.

 D. None of the statements is correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

103. The difference between average total costs and average variable costs is:

 A. marginal cost.

 B. average fixed cost.

 C. fixed cost.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

104. Economies of scope exist when:

 A. C(Q1) + C(Q2) < C(Q1, Q2).

 B. C(Q1) – C(Q2) < C(Q1, Q2).

 C. C(Q1) + C(Q2) > C(Q1, Q2).

 D. C(Q1) – C(Q2) > C(Q1, Q2).

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

105. Cost complementarity exists in a multiproduct cost function when:

 A. the average cost of producing one output is reduced when the output of another product is increased.

 B. the average cost of producing one output is increased when the output of another product is increased.

 C. the marginal cost of producing one output is increased when the output of another product is decreased.

 D. the marginal cost of producing one output is reduced when the output of another product is increased.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

106. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What are the fixed costs?

 A. \$50

 B. \$10

 C. \$1

 D. \$2

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

107. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What is the total cost of producing 10 units?

 A. \$2,060

 B. \$1,060

 C. \$560

 D. \$1,010

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

108. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What is the variable cost of producing 10 units?

 A. \$401

 B. \$1,060

 C. \$560

 D. \$1,010

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

109. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. What is the marginal cost of producing 10 units?

 A. \$401

 B. \$1,060

 C. \$560

 D. \$1,010

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

110. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. At 10 units of output, the average cost curve is:

 A. in the increasing stage.

 B. in the declining stage.

 C. at the minimum level.

 D. at the maximum level.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

111. When there are economies of scope between two products which are separately produced by two firms, merging into a single firm can:

 A. accomplish an increase in sales.

 B. accomplish a reduction in costs.

 C. lead to an increase in cost.

 D. lead to a reduction in sales.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

112. When there are economies of scope between products, selling off an unprofitable subsidiary could lead to:

 A. a major reduction in costs.

 B. only a minor reduction in costs.

 C. only a minor reduction in sales.

 D. a major reduction in sales.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

113. Economies of scale exist whenever long-run average costs:

 A. increase as output is increased.

 B. decrease as output is increased.

 C. remain constant as output is increased.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

114. The long-run average cost curve defines the minimum average cost of producing alternative levels of output, allowing for optimal selection of:

 A. fixed factors of production.

 B. variable factors of production.

 C. all factors of production.

 D. sunk cost factors of production.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

115. The costs of production include:

 A. the costs that appear on the income statements.

 B. the opportunity costs foregone by producing a given product.

 C. accounting costs.

 D. accounting costs and opportunity costs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

116. Suppose the long-run average cost curve is U-shaped. When LRAC is in the increasing stage, there exist:

 A. economies of scope.

 B. diseconomies of scope.

 C. economies of scale.

 D. diseconomies of scale.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

117. Constant returns to scale exist when long-run average costs:

 A. increase as output is increased.

 B. decrease as output is increased.

 C. remain constant as output is increased.

 D. None of the statements is correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

118. Larger firms can produce a product at lower average cost than small firms when:

 A. economies of scope exist.

 B. diseconomies of scale exist.

 C. economies of scale exist.

 D. cost complementarities exist.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

119. Two firms producing identical products may merge due to the existence of:

 A. economies of scope.

 B. economies of scale.

 C. cost complementarities.

 D. All of the statements are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

120. Suppose the marginal product of labor is 10 and the marginal product of capital is 8. If the wage rate is \$5 and the price of capital is \$2, then in order to minimize costs the firm should use:

 A. more capital and less labor.

 B. more labor and less capital.

 C. equal amounts of labor and capital.

 D. None of the statements is correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

121. Suppose the production function is Q = min{3K, L}. How much output is produced when 6 units of labor and 3 units of capital are employed?

 A. 3

 B. 6

 C. 9

 D. None of the statements is correct.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

122. Suppose the production function is given by Q = 2K + 5L. What is the marginal product of labor when 15 units of capital and 10 units of labor are employed?

 A. 2

 B. 5

 C. 25

 D. 50

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

123. Suppose the production function is given by Q = 4K + 6L. What is the average product of capital when 10 units of capital and 5 units of labor are employed?

 A. 14

 B. 10

 C. 7

 D. 5

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

124. For the cost function C(Q) = 75 + 4Q + 2Q2, the marginal cost of producing 5 units of output is:

 A. 4

 B. 54

 C. 20

 D. 24

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

125. For the cost function C(Q) = 50 + 4Q + 2Q2, the total variable cost of producing 7 units of output is:

 A. 32

 B. 102

 C. 126

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

126. If a firm’s production function is Leontief and the price of capital goes down, the:

 A. firm must use less labor in order to minimize the cost of producing a given level of output.

 B. firm must use more capital in order to minimize the cost of producing a given level of output.

 C. firm must use less capital in order to minimize the cost of producing a given level of output.

 D. cost-minimizing combination of capital and labor does not change.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

127. Which of the following “costs” could a firm that wants to remain in business avoid if it halted current production?

 A. Fixed costs

 B. Variable costs

 C. Sunk costs

 D. Opportunity costs

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

128. If the production function is Q = K.5L.5 and capital is fixed at 1 unit, then the average product of labor when L = 36 is:

 A. 1/3.

 B. 1/6.

 C. 2/3.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

129. Which of the following conditions is true when a producer minimizes the cost of producing a given level of output?

 A. The marginal product per dollar spent on all inputs is equal.

 B. The MRTS is equal to the ratio of the quantity of inputs.

 C. The marginal products of all inputs are equal.

 D. The marginal product per dollar spent on all inputs is equal and the MRTS is equal to the ratio of the quantity of inputs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

130. The inputs that a manager uses to alter production are referred to as:

 A. variable factors.

 B. long-run factors.

 C. fixed factors.

 D. All of the statements are correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

131. The point where diminishing marginal returns has begun to affect production is best characterized by the point where the:

 A. total product curve flattens out.

 B. average product curve begins to be negatively sloped.

 C. marginal product curve begins to be negatively sloped.

 D. marginal product curve equals the average product curve.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

132. Changes in the price of an input cause:

 A. isoquants to become steeper.

 B. slope changes in the isocost line.

 C. parallel shifts of the isocost lines.

 D. changes in both the isoquants and isocosts of equal magnitude.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

133. In the short run, the marginal cost curve crosses the average total cost curve at:

 A. a point just below the average fixed cost curve.

 B. the minimum point of the average total cost curve.

 C. the maximum point of the average total cost curve.

 D. the point where the average total cost curve and average variable cost curve intersect.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

134. Which of the following cost functions exhibits cost complementarity?

 A. -3Q2 + 4Q1

 B. 5Q1Q2 – Q1

 C. Q2Q1 + 2Q1

 D. -5Q1Q2 + 7Q1

 AACSB: Analytic Blooms: Analyze Difficulty: 1 Easy Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

135. Which of the following cost functions exhibits economies of scope over the specified output range?

 A. C(Q1, Q2) = 2 – 0.5Q1Q2 – (Q1)2 + (Q2)2, for all Q1 > 0 and Q2 > 0

 B. C(Q1, Q2) = 2 – 3Q1Q2 – (Q1)2 + (Q2)2, for all Q1 > 0 and Q2 > 0

 C. C(Q1, Q2) = 2 – 0.5Q1Q2 – (Q1)2 + (Q2)2, for all Q1 < 2 and Q2 < 2

 D. C(Q1, Q2) = 2 – 3Q1Q2 – (Q1)2 + (Q2)2, for all Q1 > 4 and Q2 > 4

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

136. The production function for good X exhibited in the table below is for the:

 A. long run, since K is the fixed input.

 B. short run, since L is the fixed input.

 C. long run, since K is the variable input.

 D. short run, since L is the variable input.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Production Function

137. The marginal product of capital of producing 2,991 units of output (find point A) in the table below is:

 A. 26.7.

 B. 19.5.

 C. 5.7.

 D. 2.4.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

138. The production function for good X in the table below exhibits increasing marginal returns to capital over what output range?

 A. Between 0 and 1,524

 B. Between 0 and 2,991

 C. Between 2,391 and 3,048

 D. Between 3,016 and 2,945

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

139. The production function in the table below exhibits negative marginal returns to capital over what output range?

 A. Between 0 and 1,524

 B. Between 0 and 2,991

 C. Between 2,391 and 3,048

 D. Between 3,016 and 2,945

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

140. The production function in the table below exhibits decreasing marginal returns to capital over what output range?

 A. Between 0 and 1,524

 B. Between 0 and 2,991

 C. Between 2,391 and 3,048

 D. Between 3,016 and 2,945

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

141. The average product of capital of producing 2,991 units of output (find point B) in the table below is:

 A. 11.1.

 B. 21.9.

 C. 37

 D. 73

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

142. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the fixed cost of using 81 units of capital and 9 units of labor is:

 A. \$2,160.

 B. \$2,025.

 C. \$135.

 D. There is insufficient information to determine the fixed costs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

143. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the variable cost of using 81 units of capital and 9 units of labor is:

 A. \$2,160.

 B. \$2,025.

 C. \$135.

 D. There is insufficient information to determine the variable costs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

144. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the average total cost of using 81 units of capital and 9 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average total costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

145. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the average variable cost of using 81 units of capital and 9 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average variable costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

146. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$25 and the per-unit wage, w, is \$15, then the average fixed cost of using 81 units of capital and 9 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average fixed costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

147. The derivative, dAC(Q)/dQ = (1/Q2) {Q(dC/dQ) – C(Q)}, illustrates that when:

 A. MC(Q) < AC(Q), average costs increase as output increases.

 B. MC(Q) < AC(Q), average costs decrease as output increases.

 C. MC(Q) > AC(Q), average costs decrease as output increases.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

148. The first-order conditions for maximizing profits, π = P × F(K, L) – wL – rK, are:

 A.

 B. P × MPK – r = 0 and P × MPL – w = 0.

 C. VMPK = r and VMPL = w.

 D. All of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

149. Which of the following profit functions exhibits a Leontief production function?

 A. π = P × K0.75L0.50 – 20L – 35K

 B. π = P × min(2L, 5K) – 20L – 35K

 C. π = P × (3K + 4L) – 20L – 35K

 D. π = P × (3K0.5 + 4L0.5)1/0.2 – 20L – 35K

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

150. Which of the following profit functions exhibits a linear production function?

 A. π = P × K0.75L0.50 – 20L – 35K

 B. π = P × min(2L, 5K) – 20L – 35K

 C. π = P × (3K + 4L) – 20L – 35K

 D. π = P × (3K0.5 + 4L0.5)1/0.2 – 20L – 35K

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

151. Which of the following profit functions exhibits a Cobb-Douglas production function?

 A. π = P × K0.75L0.50 – 20L – 35K

 B. π = P × min(2L, 5K) – 20L – 35K

 C. π = P × (3K + 4L) – 20L – 35K

 D. π = P × (3K0.5 + 4L0.5) 1/0.2 – 20L – 35K

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

152. Which of the following relations is the slope along a given isoquant?

 A.

 B.

 C.

 D.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

153. Suppose the w = \$20 and r = \$30. The isocost line for a firm in this industry is:

 A. C = 20K + 30L.

 B. K = 0.033C – 0.66L.

 C. 1.5L + K = 0.5C.

 D. Depends entirely on the functional form of the production function.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

154. Suppose the production function is given by Q = 2K + L. If w = \$4 and r = \$4, how many units of K and L will be utilized in the production process?

 A. All K and no L.

 B. All L and no K.

 C. Equal amounts of K and L.

 D. A combination of K and L not represented above.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

155. For given input prices, isocosts closer to the origin are associated with:

 A. lower costs.

 B. the same costs.

 C. higher costs.

 D. initially lower, then higher costs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

156. For the cost function C(Q) = 500 + 12Q + 4Q2 + Q3, what is the marginal cost of producing the eighth unit of output?

 A. \$184

 B. \$268

 C. \$524

 D. \$852

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

157. If the production function is Q = K.5L.5 and capital is fixed at 9 units, then the marginal product of labor when L = 49 is:

 A. 3

 B. 9/98.

 C. 3/14.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

158. Suppose the production function is given by Q = 4K + 3L. What is the average product of labor when 10 units of capital and 5 units of labor are employed?

 A. 3

 B. 4

 C. 11

 D. 45

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

159. The production function is Q = K.4 L.6. The marginal rate of technical substitution is:

 A. 3/2 K-1 L.

 B. K-1 L-1.

 C. 3/2 K L-1.

 D. K.6 L-.4.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

160. For the cost function C(Q) = 100 + 4Q + 19Q2 + 2Q3, what is the marginal cost of producing the fourth unit of output?

 A. \$42

 B. \$295

 C. \$252

 D. \$116

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

161. Suppose the cost function is C(Q) = 50 + Q – 10Q2 + 2Q3. At 3 units of output, the marginal cost curve is:

 A. in the increasing stage.

 B. in the declining stage.

 C. at the minimum level.

 D. at the maximum level.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

162. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$86.80 and the per-unit wage, w, is \$20, then the average total cost of using 25 units of capital and 49 units of labor is:

 A. \$5.

 B. \$75.

 C. \$90.

 D. There is insufficient information to determine the average total costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

163. Suppose that production for good X is characterized by the following production function, Q = 4K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$86.80 and the per-unit wage, w, is \$20, then the average total cost of using 25 units of capital and 49 units of labor is:

 A. \$5.25.

 B. \$22.50.

 C. \$31.00.

 D. There is insufficient information to determine the average total costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

164. Suppose that production for good X is characterized by the following production function, Q = 4K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$12 and the per-unit wage, w, is \$20, then the average total cost of using 25 units of capital and 49 units of labor is:

 A. \$6.25.

 B. \$9.14.

 C. \$10.07.

 D. There is insufficient information to determine the average total costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

165. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$15 and the per-unit wage, w, is \$25, then the average fixed cost of using 9 units of capital and 81 units of labor is:

 A. \$5.

 B. \$75.

 C. \$80.

 D. There is insufficient information to determine the average fixed costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

166. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$15 and the per-unit wage, w, is \$125, then the average fixed cost of using 16 units of capital and 25 units of labor is:

 A. \$9.

 B. \$12.

 C. \$56.

 D. There is insufficient information to determine the average fixed costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

167. Suppose that production for good X is characterized by the following production function, Q = K0.5L0.5, where K is the fixed input in the short run. If the per-unit rental rate of capital, r, is \$15 and the per-unit wage, w, is \$5, then the average fixed cost of using 16 units of capital and 25 units of labor is:

 A. \$9.

 B. \$12.

 C. \$56.

 D. There is insufficient information to determine the average fixed costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

Essay Questions

 168 Congress is considering legislation that will provide additional investment tax credits to businesses. Effectively, an investment tax credit reduces the cost to firms of using capital in production. Would you expect labor unions to lobby for or against such a bill? (Hint: What impact would such a plan have on the capital-to-labor ratio at the typical firm?) An investment tax credit would reduce the price of capital relative to labor. Other things equal, this would increase w/r, thereby making the isocost line steeper. This means that the cost-minimizing input mix will now involve more capital and less labor, as firms substitute toward capital. If labor unions are concerned that this higher capital/labor ratio will translate into lost jobs, they will likely oppose the investment tax credit. On the other hand, the marginal product of labor will likely rise as a result of the greater use of capital, so those workers employed might receive higher wages. If the union values higher wages, they might favor the legislation.

 AACSB: Analytic Blooms: Evaluate Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 169 You have been hired to replace the manager of a firm that used only two inputs, capital and labor, to produce output. The firm can hire as much labor as it wants at a wage of \$5 per hour and can rent as much capital as it wants at a price of \$50 per hour. After you look at the company books, you learn that the company has been using capital and labor in amounts that imply a marginal product of labor of 50 and a marginal product of capital of 100. Do you know why the firm hired you? Explain. Before the manager is hired, the marginal rate of technical substitution is 1/2. However, the relative input price is 1/10. This means that either more workers or less physical capital should be used. Hence, you are hired to change this input ratio in order to minimize costs.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 170 The manager of a meat-packing plant can use either butchers (labor) or meat saws (capital) to prepare packages of sirloin steak. Based on estimates provided by an efficiency expert, the firm’s production function for sirloin steak is given by Q = K + L a. Graph the isoquant corresponding to 5 units of output. b. What is the marginal product of capital and labor? Does the answer depend on how much labor and capital are used? c. If the price of labor is \$2 per hour and the rental price of capital is \$3 per hour, how much capital and labor should be used to minimize the cost of producing 5 units of output? a. See Figure 5-1. b. MPK = 1; MPL = 1. These marginal products do not depend on how much labor and capital are used. c. Five hours of labor and zero hours of capital should be used to minimize the cost of producing five units of output.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 171 The manager of a national retailing outlet recently hired an economist to estimate the firm’s production function. Based on the economist’s report, the manager now knows that the firm’s production function is given by   and that capital is fixed at 1 unit. a. Calculate the average product of labor when 9 units of labor are utilized. b. Calculate the marginal product of labor when 9 units of labor are utilized. c. Suppose the firm can hire labor at a wage of \$10 per hour and output can be sold at a price of \$100 per unit. Determine the profit-maximizing levels of labor and output. d. What is the maximum price of capital at which the firm will still make nonnegative profits? a. Q = (1)1/2(9)1/2 = 3. The average product of labor is thus Q/L = 3/9. b. MPL = .5K1/2L-1/2 = .5(1)1/2 (9)-1/2 = 1/6 c. The profit-maximizing level of labor and output is achieved where VMPL = w, where VMPL = .5(\$100)(L-1/2) and w = \$10. Solving for L yields L = 25. The corresponding level of output is Q = (25)1/2 = 5. d. The firm’s variable costs are (25)(\$10) = \$250, while its total revenues are 5 × \$100 = \$500. The maximum price of capital, hence, cannot be greater than \$250 per unit.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 172 An accountant for a car rental company was recently asked to report the firm’s costs of producing various levels of output. The accountant knows that the most recent estimate available of the firm’s cost function is   where costs are measured in thousands of dollars and output is measured in thousands of hours rented. a. What is the average fixed cost of producing 2 units of output? b. What is the average variable cost of producing 2 units of output? c. What is the average total cost of producing 2 units of output? d. What is the marginal cost of producing 2 units of output? e. What is the relation between the answers to (a), (b), and (c) above? Is this a general property of average cost curves? a. AFC(2) = 100/2 = \$50 b. AVC(2) = [(10)(2) + (2)2]/2 = \$12 c. ATC(2) = AFC(2) + AVC(2) = \$62 d. MC(2) = 10 + 2(2) = \$14 e. AVC + AFC = ATC. This holds for all output levels, not just Q = 2.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

 173 There are over 5,000 banks in the United States—more than 10 times more per person than in other industrialized countries. A recent study suggests that the long-run average cost curve for an individual bank is relatively flat. If Congress took steps to consolidate banks, thereby reducing the total number to 2,500, what would you expect to happen to costs within the banking industry? Explain. With a flat long-run average cost curve, there are neither economies nor diseconomies of scale in banking services. Consolidation would mean that 2,500 banks would each have to double their output in order to service the consumers initially served by 5,000 banks. But the corresponding average cost per firm, as well as total costs for the industry, would be unchanged.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

 174 A production function exhibits constant returns to scale if a twofold (threefold, etc.) increase in all inputs leads to a twofold (threefold, etc.) increase in output. For example, by doubling the use of capital and labor, the firm would exactly double its output. a. What would the average and marginal cost curves look like under constant returns to scale? Explain. b. Give an example of a production function that exhibits constant returns to scale. a. Average and marginal cost curves coincide and are flat (constant). b. Q = K + L

 AACSB: Analytic Blooms: Create Difficulty: 3 Hard Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

 175 A production function exhibits decreasing returns to scale if a twofold (threefold, etc.) increase in all inputs increases output by less than twofold (less than threefold, etc.). For example, by doubling the use of capital and labor, the firm would less than double its output. a. What would the average and marginal cost curves look like under decreasing returns to scale? Explain. b. Give an example of a production function that exhibits decreasing returns to scale. a. Average and marginal cost curves are increasing, since doubling the inputs means doubling the total cost but less than doubling the output. Hence, average cost is increasing with output. A similar argument holds for marginal cost. b. Q = L1/2

 AACSB: Analytic Blooms: Create Difficulty: 3 Hard Learning Objective: 05-06 Distinguish between short-run and long-run production decisions and illustrate their impact on costs and economies of scale. Topic: The Cost Function

 176 The total costs for Morris Industries are summarized in the following table. Based on this information, fill in the missing entries in the table for fixed cost, variable cost, average fixed cost, average variable cost, average total cost, and marginal cost.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-05 Calculate average and marginal costs from algebraic or tabular cost data and illustrate the relationship between average and marginal costs. Topic: The Cost Function

 177 The following table summarizes the short-run production function for your firm. Your product sells for \$5 per unit, labor costs \$5 per unit, and the rental price of capital is \$20 per unit. Complete the following table, and then answer the accompanying questions. a. Which inputs are fixed inputs? Which are the variable inputs? b. How much are your fixed costs? c. What is the variable cost of producing 20 units of output? d. How many units of the variable input should be used to maximize profits? e. What are your maximum profits? f. Over what range of variable input usage do increasing marginal returns exist? g. Over what range of variable input usage do decreasing marginal returns exist? h. Over what range of variable input usage do negative marginal returns exist? a. Labor is the fixed input while capital is the variable input. b. Fixed costs are (5)(\$5) = \$25. c. Assume that capital is indivisible, (that is, it must be rented in an integer number of units). Then the required variable cost is (2)(\$20), which equals \$40. d. Using the VMPK = r rule, six units of capital should be used to maximize profits. e. The maximum profits are (\$5)(95) – (\$20)(6) – (\$5)(5) = \$330. f. There are increasing marginal returns when K is less than or equal to 3. g. There are decreasing marginal returns when K is greater than 3. h. There are negative marginal returns when K is greater than 7.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 178 Your firm produces two products, Q1 and Q2. An economic consulting firm has estimated your cost function to be a. Are there economies of scope? b. Are there cost complementarities? c. Your market for Q1 is not very good, and an overseas firm has offered to buy the division of your company that produces Q1. What will happen to your marginal cost of producing Q2 if you sell the division? a. For a quadratic multiproduct cost function, economies of scope exist if   Here, f = 100 and a = 1, so economies of scope exist whenever b. Since a = 1 > 0, there are no cost complementarities. c. Since a = 1 > 0, the marginal cost of producing product 2 will fall if the division producing product 1 is sold.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

 179 In the text, we showed that the multiproduct cost function   exhibits cost complementarity whenever   and economies of scope whenever a. Can cost complementarity exist without economies of scope? b. Can there be economies of scope when cost complementarities exist? a. Cost complementarities cannot exist without economies of scope. This is because when a is negative, f – aQ1Q2 is necessarily positive (remember, f is fixed cost, which is nonnegative). b. Suppose f is positive and a is negative. Then f – aQ1Q2 must be positive. Hence, there are both economies of scope and cost complementarities.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

 180 Standard Enterprises produces an output that it sells in a highly competitive market at a price of \$100 per unit. Its inputs include two machines (which cost the firm \$50 each) and workers, who can be hired on an as-needed basis in a labor market at a cost of \$2,800 per worker. Based on the following production data, how many workers should the firm employ to maximize its profits? The relevant production data is as follows: To maximize profits, the firm should continue adding workers so long as the value marginal product exceeds the wage. The value marginal product is defined as the marginal product times the price of output. Here, output sells for \$100 per unit, so the value marginal product of the third worker is \$100(29) = \$2,900. The table above summarizes the VMPL for each possibility. Since the wage is \$2,800, the profit-maximizing number of workers is 3.

 AACSB: Analytic Blooms: Evaluate Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 181 You are the manager of Telecall Inc., a small telemarketing company. Your company pays \$10,000 per month for office space. A real estate agent has noticed that you are only using 75 percent of your available space and tells you that Telecall could add \$800 per month to its bottom line by renting out the space it does not use. Telecall has been asked to do a new telemarketing campaign for a large credit card company, but this would require it to use the remaining office space. What is the opportunity cost of using the extra office space to handle the credit card company’s promotion? The \$800 per month that could be earned by renting out the excess office space.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-03 Calculate a cost function from a production function and explain how economic costs differ from accounting costs. Topic: The Cost Function

 182 Suppose the production function of automobiles is given by a. Show that the marginal product of any given quantity of labor increases as capital is increased. b. Suppose Japanese and U.S. automakers produce on identical isoquants with this Cobb-Douglas production function and that labor costs are higher in Japan than in the United States. Do autoworkers in Japan have a higher marginal product than American autoworkers? Explain carefully. c. Now suppose Japanese automakers produce on a different isoquant from U.S. firms, but the prices of Japanese and American cars are identical. Do Japanese or American autoworkers have a higher marginal product? Why? a. Notice that MPL can be written as.75(K/L)1/4, which increases as K increases. b. Since the higher labor costs in Japan induce a higher K/L ratio, the result in part (a) implies that the marginal product of Japanese workers is higher than that of American workers. c. Since the prices of American and Japanese cars are assumed to be identical, the ratio of the value marginal product of American workers to Japanese workers is simply the ratio of the marginal products. Since this ratio equals the ratio of the wages—which is higher in Japan—our conclusion in part (b) is obtained again. Japanese workers have higher marginal products than do American workers.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 183 Show that the Cobb-Douglas production function   exhibits the law of diminishing marginal rate of technical substitution. MPL/MPK = 3(K/L). This clearly decreases as L increases.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 184 You are the manager of a firm that sells output at a price of \$40 per unit. You are interested in hiring a new worker who will increase your firm’s output by 2,000 units per year. Several other firms also are interested in hiring this worker. a. What is the highest annual salary you should be willing to pay this worker to come to your firm? b. What will determine whether or not you actually have to offer this much to the worker to induce him to join your firm? a. The extra revenue you will earn by hiring the worker is 2,000 × \$40 = \$80,000 per year. The most you should pay the worker is an annual salary of \$80,000. b. It depends on how much the worker can get from other firms. For instance, if his opportunity cost is \$60,000, you will only have to pay \$60,000.01 to get him.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-01 Explain alternative ways of measuring the productivity of inputs and the role of the manager in the production process. Topic: The Production Function

 185 To open a new business, a manager must obtain a license from the city for \$20,000. The license is transferable, but only \$3,000 is refundable in the event the firm does not use the license. a. What are the firm’s fixed costs? Sunk costs? b. Suppose the manager obtains a license but then decides against opening the business. If another firm offers the manager \$2,000 for the license, should the manager accept the offer? a. Fixed costs are \$20,000. Sunk costs are \$17,000. b. No. The manager can get a refund of \$3,000 from the city, and this exceeds the \$2,000 that it would have earned by selling the license to another firm.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 05-04 Explain the difference between and the economic relevance of fixed costs; sunk costs; variable costs; and marginal costs. Topic: The Cost Function

 186 The maker of Turbotax produces software that prepares federal income tax returns. In addition, it produces software that prepares various state income tax returns. Why doesn’t it pay for the firm to specialize in federal software? There are cost complementarities and economies of scope in producing software for federal returns (QF) and state returns (QS). When the multiproduct cost function, C(QF, QS), for producing federal and state tax preparation software exhibits economies of scope, it will be cheaper to produce both types of software jointly than to produce them separately. When there are cost complementarities in production, the marginal cost of producing state software (QS) will be lower when federal software is produced (QF). The economies of scope and cost complementarities are due to similarities in the programs and user interfaces that comprise federal and state income tax preparation software. Once a basic program and interface is written to compute federal taxes, the marginal cost of producing software for state purposes is much lower (effectively, it is the cost of entering details about each particular state’s tax code). If the maker of Turbotax specialized, then another firm that produced both types of software could do so at lower cost and undermine Turbotax’s position in the market.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

 187 The management of Morris Industries is considering a plan to terminate a new employee. The action stemmed from documented evidence supplied by the firm’s accounting department that this new employee did not add as much to the firm’s overall output as did a worker hired two weeks earlier. Based on this evidence, do you agree that the latest worker hired should be fired? Explain. No. In order to maximize profits, firms should hire workers up to the point where the value marginal product equals the wage rate in the range of diminishing marginal returns. The data suggests that the last worker added less to total output than the previous worker, which means that the firm is indeed operating in the range of diminishing marginal returns, as it should. The worker should be fired if his or her value marginal product is less than the wage. Unfortunately, management is not considering this information.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-02 Calculate input demand and the cost-minimizing combination of inputs and use isoquant analysis to illustrate optimal input substitution. Topic: The Production Function

 188 In 1995 the U.S. Justice Department sued to block a merger between Microsoft and Intuit, the producer of the nation’s best-selling business software. The Justice Department argued that the merger would lessen competition and raise prices of business software. Is there an economic argument that the merger might actually result in lower prices? Explain. If there are economies of scope or cost complementarities in producing operating systems like DOS and Windows in conjunction with business software, then the merger might lower costs and therefore prices to consumers.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 05-07 Conclude whether a multiple-output production process exhibits economies of scope or cost complementarities and explain their significance for managerial decisions. Topic: Multiple-Output Cost Functions

Chapter 07

The Nature of Industry

Multiple Choice Questions

1. Which of the following are measures of industry concentration?

 A. Four-firm concentration ratio

 B. HHI index

 C. Consumer surplus

 D. Four-firm concentration ratio and HHI index

2. A firm has a marginal cost of \$20 and charges a price of \$40. The Lerner index for this firm is:

 A. 0.20.

 B. 0.50.

 C. 0.33.

 D. 0.75.

3. An industry is comprised of 20 firms, each with an equal market share. What is the four-firm concentration ratio of this industry?

 A. 0.2

 B. 0.4

 C. 0.6

 D. 0.8

4. A firm’s average cost is \$20, and it charges a price of \$20. The Lerner index for this firm is:

 A. 0.20.

 B. 0.50.

 C. 0.33.

 D. insufficient information.

5. An industry is comprised of 10 firms, each with an equal market share. What is the four-firm concentration ratio of this industry?

 A. 0.2

 B. 0.4

 C. 0.6

 D. 0.8

6. An unregulated industry has a Lerner index of zero. These numbers:

 A. reveal that social welfare would be improved by regulating the firms.

 B. are consistent with the industry being monopolistically competitive.

 C. are consistent with the industry being perfectly competitive.

 D. reveal that social welfare would be improved by regulating the firms and are consistent with the industry being monopolistically competitive.

7. The concentration and Herfindahl indices computed by the U.S. Bureau of Census must be interpreted with caution because:

 A. they overstate the actual level of concentration in markets served by foreign firms.

 B. they understate the degree of concentration in local markets, such the gasoline market.

 C. Both they overstate the actual level of concentration in markets served by foreign firms and they understate the degree of concentration in local markets, such the gasoline market are correct.

 D. None of the statements are correct.

8. The industry elasticity of demand for gadgets is -2, while the elasticity of demand for an individual gadget manufacturer’s product is -2. Based on the Rothschild approach to measuring market power, we conclude that:

 A. there is little monopoly power in this industry.

 B. there is significant monopoly power in this industry.

 C. the Herfindahl index for this industry is -2.

 D. the Herfindahl index for this industry is 2.

9. A Herfindahl index of 10,000 suggests:

 A. perfect competition.

 B. monopolistic competition.

 C. monopoly.

 D. oligopoly.

10. A Herfindahl index of 0 suggests:

 A. monopoly.

 B. monopolistic competition.

 C. perfect competition.

 D. oligopoly.

11. A Lerner index of 0 suggests:

 A. monopoly.

 B. monopolistic competition.

 C. oligopoly.

 D. perfect competition.

12. When economies of scale are large, firms can reduce their average total cost by:

 A. selling off their subsidiaries.

 B. merging into even larger firms.

 C. eliminating the bureaucratic costs.

 D. hiring professional managers.

13. Which of the following is NOT one class of a market structure?

 A. Perfect competition

 B. Dictatorship

 C. Monopoly

 D. Monopolistic competition

14. Which of the following kinds of market structure are NOT associated with market power?

 A. Oligopoly

 B. Perfect competition

 C. Monopolistic competition

 D. Perfect competition and monopolistic competition

15. Monopolistic competition is characterized by:

 A. heterogeneous products.

 B. employing labor from a perfectly competitive labor market.

 C. no free entry.

 D. large markets.

16. Oligopoly differs from monopoly as follows:

 A. Oligopoly involves a few firms; monopoly involves a single firm.

 C. Oligopoly involves free entry; monopoly involves no free entry.

 D. Oligopoly involves a few firms; monopoly involves a single firm and oligopoly involves free entry; monopoly involves no free entry.

17. In perfect competition, which is NOT true?

 A. Every firm has a small but perceivable market power.

 B. There are a large number of firms.

 C. Firms are price-takers.

 D. Firms produce homogenous goods.

18. Which of the following is used to measure market structure and performance?

 A. Four-firm concentration ratio

 B. HHI (Herfindahl-Hirschman index)

 C. Dansby-Willig Performance index

 D. All of the answers are correct.

19. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The four-firm concentration ratio for industry A is:

 A. 0.9.

 B. 1.0.

 C. 0.8.

 D. 0.7.

20. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The HHI for industry A is:

 A. 3,200.

 B. 2,800.

 C. 1,800.

 D. 2,500.

21. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The four-firm concentration ratio for industry B is:

 A. 0.9.

 B. 1.0.

 C. 0.8.

 D. 0.7.

22. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The HHI for industry B is:

 A. 2,500.

 B. 1,800.

 C. 3,200.

 D. 2,800.

23. A student in a managerial economics class calculated the four-firm concentration ratio and HHI for industries A and B. What is the proper conclusion she can draw from the following findings?

 A. Industry B is a monopoly.

 B. The market power of firms in industry A is greater than that in industry B.

 C. C4 is higher for industry A while the HHI is higher for industry B. This inconsistency must be due to a calculation error.

 D. Neither industry is perfectly competitive.

24. As a general rule of thumb, industries with a Herfindahl index below ______ are considered to be competitive, while those above ______ are considered noncompetitive.

 A. 1,000, 1,800

 B. 1,800, 1,000

 C. 1,000, 3,000

 D. 1,800, 3,000

25. The ranking of industries by the four-firm concentration ratio usually, but not always, reveals the same pattern as ranking by HHI. When a discrepancy is found it is usually due to the following:

 A. The four-firm concentration index contains data on only the largest four firms, while the HHI is based on data for all firms in the industry.

 B. The HHI is based on squared market shares, while the four-firm concentration ratio is not.

 C. The four-firm concentration index contains data on only the largest four firms, while the HHI is based on data for all firms in the industry and the HHI is based on squared market shares, while the four-firm concentration ratio is not.

 D. The two indices are designed to measure two different attributes of markets.

26. A student figured out that the HHI for an industry was 15,000. What is the proper conclusion?

 A. The market is monopolistic.

 B. The market is close to perfectly competitive or monopolistically competitive.

 C. The student made some computational errors.

 D. There is free entry in the market.

27. In the 1960s, each firm in the computer industry was able to make extremely large profit margins, some as high as 50 to 60 percent. The margin decreased to 20 to 40 percent in the 1970s and to 10 to 20 percent in the 1980s. We conclude that:

 A. market power increased in the two decades.

 B. the industry evolved from oligopolistic to a more competitive industry in the two decades.

 C. lower profit margins were due to the government’s regulation to protect consumers.

 D. lower profit margins were largely due to the mismanagement of computer firms.

28. The concentration and HHI reported in the U.S. Bureau of Census must be interpreted with caution since:

 A. they are calculated by excluding foreign imports, hence they bias upward the degree of concentration.

 B. they are based on figures for the entire national market.

 C. the definition of product classes used to define an industry affects the results.

 D. All of the answers are correct.

29. When the relevant markets are local, the concentration and HHI based on figures for the entire United States tend to:

 A. be biased downward.

 B. be biased upward.

 C. give a more precise description of the real situation.

 D. ignore the presence of import goods.

30. Suppose each of the 50 states had only one gasoline station, and all stations were the same size. The four-firm concentration ratio, based on national data, would be:

 A. 0.08.

 B. 0.16.

 C. 0.32.

 D. 1.0.

31. Suppose each of the 50 states had only one gasoline station, and all stations were the same size. The four-firm concentration ratio for the state of New York, based on the state data, is:

 A. 1.0.

 B. 0.08.

 C. 0.32.

 D. 0.16.

32. Suppose each of the 50 states had only one gasoline station, and all stations were the same size. The four-firm concentration ratio a consumer would experience is:

 A. 1.0.

 B. 0.08.

 C. 0.32.

 D. 0.16.

33. An industry consists of six firms with annual sales of \$300, \$500, \$400, \$700, \$600, and \$600. What is the industry’s C4?

 A. 0.58

 B. 0.62

 C. 0.74

 D. 0.77

34. An industry consists of six firms with annual sales of \$300, \$500, \$400, \$700, \$600, and \$600. What is the industry’s HHI?

 A. 1,659

 B. 1,779

 C. 1,839

 D. 1,909

35. An industry consists of six firms with annual sales of \$300, \$500, \$400, \$700, \$600, and \$600. According to the general rule of thumb, the HHI of this industry implies that the market structure is:

 A. competitive.

 B. noncompetitive.

 C. noninclusive.

 D. monopoly.

36. The causal view of an industry is that:

 A. market structure causes firms to behave in a certain way.

 B. market performance causes firms to have a certain structure.

 C. market performance causes firms to behave in a certain way.

 D. behavior causes firms to have a certain structure.

37. Pricing is an aspect of a firm’s:

 A. performance.

 B. structure.

 C. conduct.

 D. environment.

38. According to the “feedback critique”:

 A. the conduct of firms in an industry may affect the firm’s performance.

 B. the conduct of firms in an industry may affect the market structure.

 C. market structure may affect the firm’s conduct.

 D. All of the statements associated with this question are correct.

39. Which of the following measures market structure?

 A. Four-firm concentration ratio

 B. Lerner index

 C. Herfindahl-Hirschman index

 D. All of the choices may be used to make inferences about market structure.

40. Which of the following measures market power?

 A. Lerner index.

 B. Herfindahl-Hirschman index.

 C. Rothchild index.

 D. Lerner index and Rothchild index.

41. The industry elasticity of demand for telephone service is -2, while the elasticity of demand for a specific phone company is -5. What is the Rothchild index?

 A. 0.2

 B. 0.4

 C. 0.5

 D. 0.7

42. A local telephone company charges \$.10/min. based on a \$.08/min. marginal cost of operation. What is the Lerner index?

 A. 0.2

 B. 0.25

 C. 0.4

 D. 0.5

43. The Dansby-Willig index measures market:

 A. structure.

 B. performance.

 C. conduct.

 D. behavior.

44. The Dansby-Willig index measures the potential for a change in:

 A. production cost.

 B. firm’s revenue.

 C. firm’s profit.

 D. social welfare.

45. Which of the following is NOT a type of integration?

 A. Vertical mergers

 B. Horizontal mergers

 C. Mega mergers

 D. Conglomerate merger

46. Which of the following integration types exploits economies of scope?

 A. Vertical integration

 B. Horizontal integration

 C. Cointegration

 D. Conglomerate integration

47. An electronics company takes over one of its original suppliers in a merger. This is an example of:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

48. An electronics company purchases a food company. This is an example of:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

49. Which of the following integration types aims at reducing transaction costs?

 A. Vertical integration

 B. Horizontal integration

 C. Cointegration

 D. Conglomerate integration

50. A frozen food company buys a fresh food company. This takeover is an example of:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

51. The idea of improving cash flow by exploiting the cyclical nature of different product lines is represented in:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

52. Which of the following integration types has the potential problem of increasing the firm’s market power?

 A. Vertical integration

 B. Horizontal integration

 C. Cointegration

 D. Conglomerate integration

53. Which of the following may transform an industry from oligopoly to monopolistic competition?

 A. Entry

 B. Takeover

 C. Exit

 D. Acquisition

54. Which market structure has the most market power?

 A. Monopolistic competition

 B. Perfect competition

 C. Monopoly

 D. Oligopoly

55. Which of the following statements is true?

 A. The market structure of an industry frequently changes over time.

 B. Most horizontal mergers are blocked by the government.

 C. Most U.S. industries are perfectly competitive.

 D. Most U.S. industries are monopolies.

56. The products in a monopolistically competitive industry are:

 A. homogeneous.

 B. heterogeneous.

 C. competitive.

 D. uncompetitive.

57. The HHI of a local market is usually _____________ that of national markets.

 A. lower than

 B. the same as

 C. higher than

 D. twice

58. C4 and HHI tend to ____________ the concentration in a domestic industry.

 A. provide different rankings of

 B. understate

 C. overstate

 D. understate or overstate, depending on the true geographic market

59. A firm has a marginal cost of \$18 and charges a price of \$27. The Lerner index for this firm is:

 A. 0.33.

 B. 0.50.

 C. 0.67.

 D. 0.75.

60. There are five firms in an industry with sales at \$7 million, \$6 million, \$3 million, \$2 million, and \$2 million, respectively. The four-firm concentration ratio is:

 A. 0.8.

 B. 0.9.

 C. 1.0.

 D. 1.1.

61. The concentration and Herfindahl indices computed by the U.S. Bureau of Census must be interpreted with caution because:

 A. they may overstate the actual level of concentration in markets served by foreign firms.

 B. they may understate the degree of concentration in local markets.

 C. the definition of product classes used to define an industry affects the results.

 D. All of the statements associated with this question are correct.

62. The industry elasticity of demand for gadgets is -2, while the elasticity of demand for an individual gadget manufacturer’s product is -10. Based on the Rothschild approach to measuring market power, we conclude that:

 A. the Herfindahl index for this industry is 5.

 B. the Herfindahl index for this industry is 0.2.

 C. there is no monopoly power in this industry.

 D. there is significant monopoly power in this industry.

63. In perfect competition, which is NOT true?

 A. Both concentration ratios and Rothschild indexes tend to be close to zero.

 B. There are a large number of firms, and each is small relative to the entire market.

 C. At least one firm has a perceptible impact on the market price.

 D. Firms produce homogenous goods.

64. Which of the following may transform an industry from oligopoly to monopolistic competition?

 A. Entry of new firms

 B. Significant vertical integration

 C. Exit of firms

 D. A series of horizontal mergers

65. Conglomerate integration:

 A. reduces the transaction costs of acquiring inputs.

 B. improves cash flow by exploiting the cyclical nature of different product lines.

 C. exploits economies of scope by merging the production of similar products.

 D. All of the statements are correct.

66. An industry is comprised of 25 firms, each with an equal market share. What is the four-firm concentration ratio of this industry?

 A. 0.12

 B. 0.16

 C. 0.2

 D. 0.25

67. Monopolistic competition is characterized by:

 A. employing labor from a perfectly competitive labor market.

 B. Rothschild indices that are close to zero.

 C. concentration ratios that are well above zero.

 D. differentiated products.

68. As a general rule of thumb, the U.S. Department of Justice views industries to be highly concentrated if the Herfindahl index is:

 A. above 1,000.

 B. below 1,000.

 C. above 1,800.

 D. below 1,800.

69. A student figured out that the HHI for an industry was 13,000. What is the proper conclusion?

 A. The market is monopolistically competitive.

 B. The market is close to perfectly competitive.

 C. The market is served by a monopoly.

 D. The student made some computational errors.

70. Which of the following industry structures would you expect to have the lowest Lerner index score?

 A. Perfect competition

 B. Monopoly

 C. Monopolistic competition

 D. Oligopoly

71. The Dansby-Willig index measures the potential for a change in social welfare by examining the effect of changes in industry:

 A. production cost.

 B. output.

 C. revenue.

 D. profit.

72. The tobacco industry has a Lerner index of 0.76. Based on this information, compute the optimal markup factor.

 A. 4.17 times price

 B. 4.17 times marginal cost

 C. 0.24 times price

 D. There is not sufficient information to determine the optimal markup factor.

73. The chemical industry has a Lerner index of 0.67. Based on this information, a firm with marginal cost of \$10 should charge a price of:

 A. \$30.30.

 B. \$14.93.

 C. \$6.70.

 D. \$3.30.

74. The Lerner index in the paper industry is 0.58. Based on this information, a firm charging \$3.25 per ream of paper should have a marginal cost of:

 A. \$0.

 B. \$1.365.

 C. \$1.885.

 D. \$3.25.

75. Holding all else constant, higher prices will:

 A. increase the Lerner index.

 B. decrease the Lerner index.

 C. have no impact on the Lerner index.

 D. increase or decrease the Lerner index depending on the relative magnitude of the price increase.

76. Suppose you read in an industry publication that the Rothschild index for the petroleum industry is 0.88. Based on past experience, you know that the price elasticity of demand for the petroleum products sold by your firm is -1.5. Based on this information, you know that the elasticity of demand for a representative firm in the petroleum industry is:

 A. 1.32.

 B. 1.70.

 C. -0.587.

 D. -1.32.

77. Having worked for many of the firms in the petroleum industry, you know that the price elasticity of demand for a representative firm is about -1.25. An industry publication recently reported that the Rothschild index for the petroleum industry is estimated to be 0.88. Based on this information, you know that the price elasticity of demand for the firm you currently work for in the petroleum industry is:

 A. -1.42.

 B. -1.10.

 C. 0.704.

 D. 1.10.

78. Having worked for many of the firms in the petroleum industry, you know that the price elasticity of demand for a representative firm is about -1.25. Moreover, a recent report from an economist in your office revealed that the price elasticity of demand for the petroleum products sold by your firm is -1.5. Based on this information, you know that the Rothschild index is:

 A. 0.833.

 B. 1.20.

 C. -1.20.

 D. -0.833.

79. Suppose that the demand in a particular industry is given by Qd = 100 – 2P. When the market price in the industry is \$10 per unit, total demand in the industry is ___. Furthermore, assume that each of the four largest firms in the industry sell 15 units. Based on this information, the four-firm concentration ratio is ____.

 A. 80 units; 1.00

 B. 45 units; 0.75

 C. 80 units; 0.75

 D. 45 units; 0.25

80. Suppose the market for good X has a four-firm concentration ratio of 0.80. Having worked for the four largest firms in the industry, you know the sales for these four firms are given by \$100,000, \$125,000, \$150,000, and \$175,000. Based on this information, we know that sales for the remaining firms in the industry are:

 A. \$687,500.

 B. \$550,000.

 C. \$250,500.

 D. \$137,500.

81. Suppose the market for good X has a four-firm concentration ratio of 0.50. Furthermore, assume that total sales in the industry are \$1.2 million. Based on this information, we know that sales for the largest four firms in the industry equal (in aggregate):

 A. \$600,000.

 B. \$60,000.

 C. \$2,400,000.

 D. \$240,000.

82. Suppose that the demand in a particular industry is given by Qd = 500 – 2P. When the market price in the industry is \$50 per unit, total demand in the industry is _________. Furthermore, assume that the entire market consists of four firms that share the market equally. The HHI under these conditions is then _________.

 A. 225 units; 1,600

 B. 400 units; 2,500

 C. 225 units; 3,333.33

 D. 400 units; 10,000

83. Four firms control the market for a particular good, resulting in an HHI of 2,900. Total industry sales are \$500, and it is known that two firms each have sales of \$175. If each of the remaining two firms have the same sales, then we can conclude that the remaining two firms each have a market share of:

 A. \$125.

 B. \$75.

 C. 0.15.

 D. 0.50.

84. Consider a market characterized by two firms that set the same price in the market, P = \$10. Total market demand is QT = 100 – 2P, of which the two firms share equally. Based on this information, we can conclude:

 A. the HHI = 5,000 and the Rothschild index is 1.

 B. the HHI = 2,500 and the Rothschild index is 2.

 C. the HHI = 5,000 and the Rothschild index is 2.

 D. None of the answers are correct.

85. According to the U.S. Department of Justice Merger Guidelines, a Herfindahl-Hirschman index (HHI) above _________ is associated with a highly concentrated industry. Therefore, if the automobile industry had an HHI of 2,200, then a vertical merger between GM and one of its suppliers likely would be:

 A. 1,300 and rejected since the HHI is above the acceptable threshold

 B. 2,400 and approved since the HHI is below the acceptable threshold

 C. 1,800 and rejected since the HHI is above the acceptable threshold

 D. None of the answers are correct

86. Consider a market characterized by a Herfindahl-Hirschman index of 5,000. One of the firms in this market has a Lerner index of 0.89 and is considering a horizontal merger with a competing firm. Based on this information, it is likely that the U.S. Department of Justice will:

 A. approve the merger since the industry is not concentrated and the firm proposing to merge has little market power.

 B. reject the merger since the industry is highly concentrated, even though the firm proposing the merger has little market power.

 C. reject the merger since the industry is highly concentrated and the firm proposing the merger has significant market power.

 D. None of the answers are correct.

87. Some firms find conglomerate mergers advantageous since they permit firms to:

 A. take advantage of economies of scope.

 B. take advantage of economies of scale.

 C. pool cash flows resulting from products with low and high periods.

 D. reduce input costs.

88. Which of the following is NOT a measure of market structure?

 A. Entry conditions

 B. Four-firm concentration ratio

 C. Herfindahl-Hirschman index

 D. Pricing behavior

89. Which of the following is NOT considered a measure of firm conduct?

 A. Lerner index of pricing behavior

 B. Research and development measures

 D. Dansby-Willig index

90. In a perfectly competitive market that is operating at maximum efficiency, the Dansby-Willig index would be:

 A. zero.

 B. 0.25.

 C. 0.50.

 D. 1.00.

91. A firm has a marginal cost of \$200 and charges a price of \$500. The Lerner index for this firm is:

 A. 0.20.

 B. 0.50.

 C. 1.50.

 D. 0.60.

92. A firm has a Lerner index of 0.75 and charges a price of \$150. The firm’s marginal cost is:

 A. \$0.

 B. \$37.50.

 C. \$112.50.

 D. There is not sufficient information to determine the firm’s marginal cost.

93. An industry consists of eight firms with annual sales (in millions) of \$200, \$300, \$900, \$600, \$300, \$700, \$500, and \$600. What is the industry’s C4?

 A. 0.49

 B. 0.68

 C. 0.66

 D. 0.77

94. An industry consists of three firms with equal annual sales. What is the industry’s C4?

 A. 0.58

 B. 0.75

 C. 1

 D. There is not sufficient information to compute the industry C4.

95. An industry consists of four firms with annual sales of \$300, \$500, \$400, and \$600, respectively. What is the industry’s HHI?

 A. 1,659

 B. 2,654

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

96. An industry consists of five firms with equal annual sales. What is the industry’s HHI?

 A. 2,000

 B. 2,500

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

97. The industry elasticity of demand for good X is -1.5, while the elasticity of demand for an individual manufacturer of good X is -9. Based on this information, the Rothschild index of market power is:

 A. 1/6, indicating there is little monopoly power in this industry.

 B. 1/6, indicating there is significant monopoly power in this industry.

 C. 6, indicating there is little monopoly power in this industry.

 D. None of the answers are correct.

98. The industry elasticity of demand for good Y is -3, while the elasticity of demand for an individual manufacturer of good Y is -12. Based on the Rothschild approach to measuring market power, we conclude that:

 A. 1/4, indicating there is significant monopoly power in this industry.

 B. 1/4, indicating there is little monopoly power in this industry.

 C. 4, indicating there is little monopoly power in this industry.

 D. None of the answers are correct.

99. R&D is an aspect of a firm’s:

 A. performance.

 B. conduct.

 C. structure.

 D. environment.

100. Advertising is an aspect of a firm’s:

 A. performance.

 B. structure.

 C. environment.

 D. conduct.

101. Producer and consumer surpluses are measures of:

 A. industry performance.

 B. market structure.

 C. firm conduct.

 D. None of the answers are correct.

102. An industry consists of three firms with equal annual sales. What is the industry’s HHI?

 A. 2,000

 B. 3,300

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

103. Four firms control the market for a particular good, resulting in an HHI of 2,800. Total industry sales are \$750, and it is known that one firm has sales of \$300. If each of the remaining three firms has the same sales, then we can conclude that the remaining three firms each have a market share of:

 A. \$205.

 B. \$100.

 C. 0.20.

 D. 0.40.

104. Four firms control the market for a particular good, resulting in an HHI of 6,650. Total industry sales are \$1,750, and it is known that one firm has sales of \$1,400 and another sales of \$175. If each of the remaining two firms has the same sales, then we can conclude that the remaining two firms each have a market share of:

 A. 0.05.

 B. 0.20.

 C. \$90.

 D. \$200.

105. An industry consists of four firms with annual sales of \$3,000, \$5,000, \$4,000, and \$6,000. What is the industry’s HHI?

 A. 1,659.

 B. 2,654.

 C. 10,000.

 D. There is not sufficient information to compute the industry HHI.

106. An industry consists of five firms with annual sales of \$1,300, \$500, \$400, \$100, and \$600. What is the industry’s HHI?

 A. 2,937

 B. 5,654

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

107. An industry consists of five firms with annual sales of \$130, \$50, \$40, \$10 and \$60. What is the industry’s HHI?

 A. 2,937

 B. 5,654

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

108. Suppose the market for good X has a four-firm concentration ratio of 0.70. Having worked for the four largest firms in the industry, you know the sales for these four firms are given by \$200,000, \$225,000, \$250,000, and \$275,000. Based on this information, we know that sales for the remaining firms in the industry are:

 A. \$943,332.

 B. \$687,500.

 C. \$550,500.

 D. \$407,143.

109. Suppose the market for good X has a four-firm concentration ratio of 0.70. Having worked for the four largest firms in the industry, you know the sales for these four firms are given by \$2,000,000, \$2,250,000, \$2,500,000, and \$2,750,000. Based on this information, we know that sales for the remaining firms in the industry are:

 A. \$9,433,320.

 B. \$6,875,000.

 C. \$5,505,000.

 D. \$4,071,430.

110. There are five firms in an industry. You know sales of the four largest firms are \$1,000,000, \$500,000, \$400,000, and \$178,000. If the C4 ratio is 95 percent, then the HHI is:

 A. 1,810.

 B. 2,755.

 C. 3,038.

 D. 5,017.

111. There are five firms in an industry. You know sales of the four largest firms are \$800,000, \$700,000, \$440,000, and \$230,000. If the C4 ratio is 80 percent, then the HHI is:

 A. 1,810.

 B. 2,271.

 C. 4,338.

 D. 5,191.

Essay Questions

 112 Firms like McDonald’s and Wendy’s sell hamburgers, salads, and other products that are differentiated in nature. While numerous fast-food restaurants exist in most locations, the differentiated nature of the firms’ products permits them to charge prices that are in excess of marginal cost. Given these observations, is the fast-food industry most likely a perfectly competitive industry, a monopoly, monopolistically competitive, or an oligopoly? Use the causal view of structure, conduct, and performance to explain the roles of product differentiation in the industry, and explain how the feedback critique applies in this context.

 113 During a sales meeting, one of the regional managers of Toga Industries remarked that structural variables such as advertising and R&D activities by rival firms were likely to hamper the firm’s sales over the next year. The manager received numerous stares after making the remarks. Why?

 114 Alpha Industries operates in a highly competitive market. While there are few other firms in the industry due to the high fixed costs of building plants, rival firms are very aggressive in their pricing strategies. Of the products sold in the industry, over 80 percent have 10 years of patent protection remaining. Does this industry meet an economist’s definition of a perfectly competitive industry?

 115 It is sometimes said that a manager of a monopoly can charge any price and customers will still have to buy the product. Do you agree or disagree? Why?

 116 Omega Travel competes in the highly competitive market for travel. Consumers know that Omega has the best agents in the industry and offers superior service. Nonetheless, Omega earns zero economic profits because numerous competitors have entered the market over the last few years. Based on this information, does Omega operate in a perfectly competitive market? Why or why not?

 117 “The law of comparative advantage suggests that managers should specialize in learning the tools needed to manage either a monopoly, oligopoly, monopolistically competitive, or perfectly competitive firm.” Do you agree with this statement? Explain.

 118 In Tuna, Texas, the retail gasoline market consists of six firms. Firm 1 has 35 percent of the market, Firm 2 has 25 percent, and the remaining firms have 10 percent each. What is the four-firm concentration ratio for this industry?

 119 The widget industry is comprised of six firms of varying sizes. Firm 1 has 35 percent of the market. Firm 2 has 25 percent, and the remaining firms have 10 percent each. What is the Herfindahl-Hirschman index for the widget industry? Based on the U.S. Department of Justice merger guidelines described in the text, do you think the Justice Department would be likely to block a merger between firms 5 and 6?

 120 The Beta Corporation operates in an industry that has a Herfindahl-Hirschman index of 2,800. Beta wants to merge with Alpha Enterprises, but Alpha has argued that the merger will be blocked by the Justice Department. Are there conditions under which the Justice Department would allow the merger? Explain.

 121 Borris Industries operates in an industry that has a Rothschild index of 0.75. The firm gained access to a government report that revealed the own-price elasticity of market demand within the industry to be -3. Use this information to obtain an estimate of the own-price elasticity of demand for the product produced by Borris Industries.

 122 Zelda Manufacturing has a rather unique product that sells for \$15 per unit, and the marginal cost is \$7.50. Determine the Lerner index for Zelda Manufacturing. Does this index indicate market power?

 123 Determine whether integration between the following types of firms would constitute a horizontal, vertical, or conglomerate merger. a. A food company and a drug company. b. A milk producer and a cheese producer. c. A computer chip manufacturer and a silicon producer.

 124 Star Computer and a small telecommunications company are considering a merger. A socially minded member of Star Computer’s board of directors is against the merger, however, because she is concerned that the merger might not benefit society as a whole. Provide the board member with an argument for why it may be socially beneficial for the merger to take place.

 125 A host of best-selling books advance the thesis that increases in conglomerate mergers and concentration of U.S. industry are responsible for “obscene profits.” Do you agree? Explain, using the Lerner index.

Chapter 07 The Nature of Industry Answer Key

Multiple Choice Questions

1. Which of the following are measures of industry concentration?

 A. Four-firm concentration ratio

 B. HHI index

 C. Consumer surplus

 D. Four-firm concentration ratio and HHI index

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

2. A firm has a marginal cost of \$20 and charges a price of \$40. The Lerner index for this firm is:

 A. 0.20.

 B. 0.50.

 C. 0.33.

 D. 0.75.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

3. An industry is comprised of 20 firms, each with an equal market share. What is the four-firm concentration ratio of this industry?

 A. 0.2

 B. 0.4

 C. 0.6

 D. 0.8

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

4. A firm’s average cost is \$20, and it charges a price of \$20. The Lerner index for this firm is:

 A. 0.20.

 B. 0.50.

 C. 0.33.

 D. insufficient information.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

5. An industry is comprised of 10 firms, each with an equal market share. What is the four-firm concentration ratio of this industry?

 A. 0.2

 B. 0.4

 C. 0.6

 D. 0.8

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

6. An unregulated industry has a Lerner index of zero. These numbers:

 A. reveal that social welfare would be improved by regulating the firms.

 B. are consistent with the industry being monopolistically competitive.

 C. are consistent with the industry being perfectly competitive.

 D. reveal that social welfare would be improved by regulating the firms and are consistent with the industry being monopolistically competitive.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Conduct

7. The concentration and Herfindahl indices computed by the U.S. Bureau of Census must be interpreted with caution because:

 A. they overstate the actual level of concentration in markets served by foreign firms.

 B. they understate the degree of concentration in local markets, such the gasoline market.

 C. Both they overstate the actual level of concentration in markets served by foreign firms and they understate the degree of concentration in local markets, such the gasoline market are correct.

 D. None of the statements are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

8. The industry elasticity of demand for gadgets is -2, while the elasticity of demand for an individual gadget manufacturer’s product is -2. Based on the Rothschild approach to measuring market power, we conclude that:

 A. there is little monopoly power in this industry.

 B. there is significant monopoly power in this industry.

 C. the Herfindahl index for this industry is -2.

 D. the Herfindahl index for this industry is 2.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

9. A Herfindahl index of 10,000 suggests:

 A. perfect competition.

 B. monopolistic competition.

 C. monopoly.

 D. oligopoly.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

10. A Herfindahl index of 0 suggests:

 A. monopoly.

 B. monopolistic competition.

 C. perfect competition.

 D. oligopoly.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

11. A Lerner index of 0 suggests:

 A. monopoly.

 B. monopolistic competition.

 C. oligopoly.

 D. perfect competition.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

12. When economies of scale are large, firms can reduce their average total cost by:

 A. selling off their subsidiaries.

 B. merging into even larger firms.

 C. eliminating the bureaucratic costs.

 D. hiring professional managers.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

13. Which of the following is NOT one class of a market structure?

 A. Perfect competition

 B. Dictatorship

 C. Monopoly

 D. Monopolistic competition

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

14. Which of the following kinds of market structure are NOT associated with market power?

 A. Oligopoly

 B. Perfect competition

 C. Monopolistic competition

 D. Perfect competition and monopolistic competition

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

15. Monopolistic competition is characterized by:

 A. heterogeneous products.

 B. employing labor from a perfectly competitive labor market.

 C. no free entry.

 D. large markets.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

16. Oligopoly differs from monopoly as follows:

 A. Oligopoly involves a few firms; monopoly involves a single firm.

 C. Oligopoly involves free entry; monopoly involves no free entry.

 D. Oligopoly involves a few firms; monopoly involves a single firm and oligopoly involves free entry; monopoly involves no free entry.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

17. In perfect competition, which is NOT true?

 A. Every firm has a small but perceivable market power.

 B. There are a large number of firms.

 C. Firms are price-takers.

 D. Firms produce homogenous goods.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

18. Which of the following is used to measure market structure and performance?

 A. Four-firm concentration ratio

 B. HHI (Herfindahl-Hirschman index)

 C. Dansby-Willig Performance index

 D. All of the answers are correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure Topic: Performance

19. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The four-firm concentration ratio for industry A is:

 A. 0.9.

 B. 1.0.

 C. 0.8.

 D. 0.7.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

20. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The HHI for industry A is:

 A. 3,200.

 B. 2,800.

 C. 1,800.

 D. 2,500.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

21. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The four-firm concentration ratio for industry B is:

 A. 0.9.

 B. 1.0.

 C. 0.8.

 D. 0.7.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

22. Suppose that there are two industries, A and B. There are five firms in industry A with sales at \$5 million, \$2 million, \$1 million, \$1 million, and \$1 million, respectively. There are four firms in industry B with equal sales of \$2.5 million for each firm. The HHI for industry B is:

 A. 2,500.

 B. 1,800.

 C. 3,200.

 D. 2,800.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

23. A student in a managerial economics class calculated the four-firm concentration ratio and HHI for industries A and B. What is the proper conclusion she can draw from the following findings?

 A. Industry B is a monopoly.

 B. The market power of firms in industry A is greater than that in industry B.

 C. C4 is higher for industry A while the HHI is higher for industry B. This inconsistency must be due to a calculation error.

 D. Neither industry is perfectly competitive.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

24. As a general rule of thumb, industries with a Herfindahl index below ______ are considered to be competitive, while those above ______ are considered noncompetitive.

 A. 1,000, 1,800

 B. 1,800, 1,000

 C. 1,000, 3,000

 D. 1,800, 3,000

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

25. The ranking of industries by the four-firm concentration ratio usually, but not always, reveals the same pattern as ranking by HHI. When a discrepancy is found it is usually due to the following:

 A. The four-firm concentration index contains data on only the largest four firms, while the HHI is based on data for all firms in the industry.

 B. The HHI is based on squared market shares, while the four-firm concentration ratio is not.

 C. The four-firm concentration index contains data on only the largest four firms, while the HHI is based on data for all firms in the industry and the HHI is based on squared market shares, while the four-firm concentration ratio is not.

 D. The two indices are designed to measure two different attributes of markets.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

26. A student figured out that the HHI for an industry was 15,000. What is the proper conclusion?

 A. The market is monopolistic.

 B. The market is close to perfectly competitive or monopolistically competitive.

 C. The student made some computational errors.

 D. There is free entry in the market.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

27. In the 1960s, each firm in the computer industry was able to make extremely large profit margins, some as high as 50 to 60 percent. The margin decreased to 20 to 40 percent in the 1970s and to 10 to 20 percent in the 1980s. We conclude that:

 A. market power increased in the two decades.

 B. the industry evolved from oligopolistic to a more competitive industry in the two decades.

 C. lower profit margins were due to the government’s regulation to protect consumers.

 D. lower profit margins were largely due to the mismanagement of computer firms.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

28. The concentration and HHI reported in the U.S. Bureau of Census must be interpreted with caution since:

 A. they are calculated by excluding foreign imports, hence they bias upward the degree of concentration.

 B. they are based on figures for the entire national market.

 C. the definition of product classes used to define an industry affects the results.

 D. All of the answers are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

29. When the relevant markets are local, the concentration and HHI based on figures for the entire United States tend to:

 A. be biased downward.

 B. be biased upward.

 C. give a more precise description of the real situation.

 D. ignore the presence of import goods.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

30. Suppose each of the 50 states had only one gasoline station, and all stations were the same size. The four-firm concentration ratio, based on national data, would be:

 A. 0.08.

 B. 0.16.

 C. 0.32.

 D. 1.0.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

31. Suppose each of the 50 states had only one gasoline station, and all stations were the same size. The four-firm concentration ratio for the state of New York, based on the state data, is:

 A. 1.0.

 B. 0.08.

 C. 0.32.

 D. 0.16.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

32. Suppose each of the 50 states had only one gasoline station, and all stations were the same size. The four-firm concentration ratio a consumer would experience is:

 A. 1.0.

 B. 0.08.

 C. 0.32.

 D. 0.16.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

33. An industry consists of six firms with annual sales of \$300, \$500, \$400, \$700, \$600, and \$600. What is the industry’s C4?

 A. 0.58

 B. 0.62

 C. 0.74

 D. 0.77

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

34. An industry consists of six firms with annual sales of \$300, \$500, \$400, \$700, \$600, and \$600. What is the industry’s HHI?

 A. 1,659

 B. 1,779

 C. 1,839

 D. 1,909

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

35. An industry consists of six firms with annual sales of \$300, \$500, \$400, \$700, \$600, and \$600. According to the general rule of thumb, the HHI of this industry implies that the market structure is:

 A. competitive.

 B. noncompetitive.

 C. noninclusive.

 D. monopoly.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

36. The causal view of an industry is that:

 A. market structure causes firms to behave in a certain way.

 B. market performance causes firms to have a certain structure.

 C. market performance causes firms to behave in a certain way.

 D. behavior causes firms to have a certain structure.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-04 Describe the structure-conduct-performance paradigm; the feedback critique; and their relation to the five forces framework. Topic: The Structure-Conduct-Performance Paradigm

37. Pricing is an aspect of a firm’s:

 A. performance.

 B. structure.

 C. conduct.

 D. environment.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

38. According to the “feedback critique”:

 A. the conduct of firms in an industry may affect the firm’s performance.

 B. the conduct of firms in an industry may affect the market structure.

 C. market structure may affect the firm’s conduct.

 D. All of the statements associated with this question are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-04 Describe the structure-conduct-performance paradigm; the feedback critique; and their relation to the five forces framework. Topic: The Structure-Conduct-Performance Paradigm

39. Which of the following measures market structure?

 A. Four-firm concentration ratio

 B. Lerner index

 C. Herfindahl-Hirschman index

 D. All of the choices may be used to make inferences about market structure.

 AACSB: Analytic Blooms: Analyze Difficulty: 3 Hard Learning Objective: 07-04 Describe the structure-conduct-performance paradigm; the feedback critique; and their relation to the five forces framework. Topic: The Structure-Conduct-Performance Paradigm

40. Which of the following measures market power?

 A. Lerner index.

 B. Herfindahl-Hirschman index.

 C. Rothchild index.

 D. Lerner index and Rothchild index.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-04 Describe the structure-conduct-performance paradigm; the feedback critique; and their relation to the five forces framework. Topic: The Structure-Conduct-Performance Paradigm

41. The industry elasticity of demand for telephone service is -2, while the elasticity of demand for a specific phone company is -5. What is the Rothchild index?

 A. 0.2

 B. 0.4

 C. 0.5

 D. 0.7

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

42. A local telephone company charges \$.10/min. based on a \$.08/min. marginal cost of operation. What is the Lerner index?

 A. 0.2

 B. 0.25

 C. 0.4

 D. 0.5

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

43. The Dansby-Willig index measures market:

 A. structure.

 B. performance.

 C. conduct.

 D. behavior.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Performance

44. The Dansby-Willig index measures the potential for a change in:

 A. production cost.

 B. firm’s revenue.

 C. firm’s profit.

 D. social welfare.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Performance

45. Which of the following is NOT a type of integration?

 A. Vertical mergers

 B. Horizontal mergers

 C. Mega mergers

 D. Conglomerate merger

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

46. Which of the following integration types exploits economies of scope?

 A. Vertical integration

 B. Horizontal integration

 C. Cointegration

 D. Conglomerate integration

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

47. An electronics company takes over one of its original suppliers in a merger. This is an example of:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

48. An electronics company purchases a food company. This is an example of:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

49. Which of the following integration types aims at reducing transaction costs?

 A. Vertical integration

 B. Horizontal integration

 C. Cointegration

 D. Conglomerate integration

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

50. A frozen food company buys a fresh food company. This takeover is an example of:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

51. The idea of improving cash flow by exploiting the cyclical nature of different product lines is represented in:

 A. vertical integration.

 B. horizontal integration.

 C. cointegration.

 D. conglomerate integration.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

52. Which of the following integration types has the potential problem of increasing the firm’s market power?

 A. Vertical integration

 B. Horizontal integration

 C. Cointegration

 D. Conglomerate integration

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

53. Which of the following may transform an industry from oligopoly to monopolistic competition?

 A. Entry

 B. Takeover

 C. Exit

 D. Acquisition

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

54. Which market structure has the most market power?

 A. Monopolistic competition

 B. Perfect competition

 C. Monopoly

 D. Oligopoly

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

55. Which of the following statements is true?

 A. The market structure of an industry frequently changes over time.

 B. Most horizontal mergers are blocked by the government.

 C. Most U.S. industries are perfectly competitive.

 D. Most U.S. industries are monopolies.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

56. The products in a monopolistically competitive industry are:

 A. homogeneous.

 B. heterogeneous.

 C. competitive.

 D. uncompetitive.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

57. The HHI of a local market is usually _____________ that of national markets.

 A. lower than

 B. the same as

 C. higher than

 D. twice

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

58. C4 and HHI tend to ____________ the concentration in a domestic industry.

 A. provide different rankings of

 B. understate

 C. overstate

 D. understate or overstate, depending on the true geographic market

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

59. A firm has a marginal cost of \$18 and charges a price of \$27. The Lerner index for this firm is:

 A. 0.33.

 B. 0.50.

 C. 0.67.

 D. 0.75.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

60. There are five firms in an industry with sales at \$7 million, \$6 million, \$3 million, \$2 million, and \$2 million, respectively. The four-firm concentration ratio is:

 A. 0.8.

 B. 0.9.

 C. 1.0.

 D. 1.1.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

61. The concentration and Herfindahl indices computed by the U.S. Bureau of Census must be interpreted with caution because:

 A. they may overstate the actual level of concentration in markets served by foreign firms.

 B. they may understate the degree of concentration in local markets.

 C. the definition of product classes used to define an industry affects the results.

 D. All of the statements associated with this question are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

62. The industry elasticity of demand for gadgets is -2, while the elasticity of demand for an individual gadget manufacturer’s product is -10. Based on the Rothschild approach to measuring market power, we conclude that:

 A. the Herfindahl index for this industry is 5.

 B. the Herfindahl index for this industry is 0.2.

 C. there is no monopoly power in this industry.

 D. there is significant monopoly power in this industry.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

63. In perfect competition, which is NOT true?

 A. Both concentration ratios and Rothschild indexes tend to be close to zero.

 B. There are a large number of firms, and each is small relative to the entire market.

 C. At least one firm has a perceptible impact on the market price.

 D. Firms produce homogenous goods.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

64. Which of the following may transform an industry from oligopoly to monopolistic competition?

 A. Entry of new firms

 B. Significant vertical integration

 C. Exit of firms

 D. A series of horizontal mergers

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

65. Conglomerate integration:

 A. reduces the transaction costs of acquiring inputs.

 B. improves cash flow by exploiting the cyclical nature of different product lines.

 C. exploits economies of scope by merging the production of similar products.

 D. All of the statements are correct.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

66. An industry is comprised of 25 firms, each with an equal market share. What is the four-firm concentration ratio of this industry?

 A. 0.12

 B. 0.16

 C. 0.2

 D. 0.25

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

67. Monopolistic competition is characterized by:

 A. employing labor from a perfectly competitive labor market.

 B. Rothschild indices that are close to zero.

 C. concentration ratios that are well above zero.

 D. differentiated products.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

68. As a general rule of thumb, the U.S. Department of Justice views industries to be highly concentrated if the Herfindahl index is:

 A. above 1,000.

 B. below 1,000.

 C. above 1,800.

 D. below 1,800.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

69. A student figured out that the HHI for an industry was 13,000. What is the proper conclusion?

 A. The market is monopolistically competitive.

 B. The market is close to perfectly competitive.

 C. The market is served by a monopoly.

 D. The student made some computational errors.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

70. Which of the following industry structures would you expect to have the lowest Lerner index score?

 A. Perfect competition

 B. Monopoly

 C. Monopolistic competition

 D. Oligopoly

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

71. The Dansby-Willig index measures the potential for a change in social welfare by examining the effect of changes in industry:

 A. production cost.

 B. output.

 C. revenue.

 D. profit.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Performance

72. The tobacco industry has a Lerner index of 0.76. Based on this information, compute the optimal markup factor.

 A. 4.17 times price

 B. 4.17 times marginal cost

 C. 0.24 times price

 D. There is not sufficient information to determine the optimal markup factor.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

73. The chemical industry has a Lerner index of 0.67. Based on this information, a firm with marginal cost of \$10 should charge a price of:

 A. \$30.30.

 B. \$14.93.

 C. \$6.70.

 D. \$3.30.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

74. The Lerner index in the paper industry is 0.58. Based on this information, a firm charging \$3.25 per ream of paper should have a marginal cost of:

 A. \$0.

 B. \$1.365.

 C. \$1.885.

 D. \$3.25.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

75. Holding all else constant, higher prices will:

 A. increase the Lerner index.

 B. decrease the Lerner index.

 C. have no impact on the Lerner index.

 D. increase or decrease the Lerner index depending on the relative magnitude of the price increase.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

76. Suppose you read in an industry publication that the Rothschild index for the petroleum industry is 0.88. Based on past experience, you know that the price elasticity of demand for the petroleum products sold by your firm is -1.5. Based on this information, you know that the elasticity of demand for a representative firm in the petroleum industry is:

 A. 1.32.

 B. 1.70.

 C. -0.587.

 D. -1.32.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

77. Having worked for many of the firms in the petroleum industry, you know that the price elasticity of demand for a representative firm is about -1.25. An industry publication recently reported that the Rothschild index for the petroleum industry is estimated to be 0.88. Based on this information, you know that the price elasticity of demand for the firm you currently work for in the petroleum industry is:

 A. -1.42.

 B. -1.10.

 C. 0.704.

 D. 1.10.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

78. Having worked for many of the firms in the petroleum industry, you know that the price elasticity of demand for a representative firm is about -1.25. Moreover, a recent report from an economist in your office revealed that the price elasticity of demand for the petroleum products sold by your firm is -1.5. Based on this information, you know that the Rothschild index is:

 A. 0.833.

 B. 1.20.

 C. -1.20.

 D. -0.833.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

79. Suppose that the demand in a particular industry is given by Qd = 100 – 2P. When the market price in the industry is \$10 per unit, total demand in the industry is ___. Furthermore, assume that each of the four largest firms in the industry sell 15 units. Based on this information, the four-firm concentration ratio is ____.

 A. 80 units; 1.00

 B. 45 units; 0.75

 C. 80 units; 0.75

 D. 45 units; 0.25

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

80. Suppose the market for good X has a four-firm concentration ratio of 0.80. Having worked for the four largest firms in the industry, you know the sales for these four firms are given by \$100,000, \$125,000, \$150,000, and \$175,000. Based on this information, we know that sales for the remaining firms in the industry are:

 A. \$687,500.

 B. \$550,000.

 C. \$250,500.

 D. \$137,500.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

81. Suppose the market for good X has a four-firm concentration ratio of 0.50. Furthermore, assume that total sales in the industry are \$1.2 million. Based on this information, we know that sales for the largest four firms in the industry equal (in aggregate):

 A. \$600,000.

 B. \$60,000.

 C. \$2,400,000.

 D. \$240,000.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

82. Suppose that the demand in a particular industry is given by Qd = 500 – 2P. When the market price in the industry is \$50 per unit, total demand in the industry is _________. Furthermore, assume that the entire market consists of four firms that share the market equally. The HHI under these conditions is then _________.

 A. 225 units; 1,600

 B. 400 units; 2,500

 C. 225 units; 3,333.33

 D. 400 units; 10,000

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

83. Four firms control the market for a particular good, resulting in an HHI of 2,900. Total industry sales are \$500, and it is known that two firms each have sales of \$175. If each of the remaining two firms have the same sales, then we can conclude that the remaining two firms each have a market share of:

 A. \$125.

 B. \$75.

 C. 0.15.

 D. 0.50.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

84. Consider a market characterized by two firms that set the same price in the market, P = \$10. Total market demand is QT = 100 – 2P, of which the two firms share equally. Based on this information, we can conclude:

 A. the HHI = 5,000 and the Rothschild index is 1.

 B. the HHI = 2,500 and the Rothschild index is 2.

 C. the HHI = 5,000 and the Rothschild index is 2.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

85. According to the U.S. Department of Justice Merger Guidelines, a Herfindahl-Hirschman index (HHI) above _________ is associated with a highly concentrated industry. Therefore, if the automobile industry had an HHI of 2,200, then a vertical merger between GM and one of its suppliers likely would be:

 A. 1,300 and rejected since the HHI is above the acceptable threshold

 B. 2,400 and approved since the HHI is below the acceptable threshold

 C. 1,800 and rejected since the HHI is above the acceptable threshold

 D. None of the answers are correct

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 07-03 Explain the relevance of the Herfindahl-Hirschman index for antitrust policy under the horizontal merger guidelines. Topic: Market Structure

86. Consider a market characterized by a Herfindahl-Hirschman index of 5,000. One of the firms in this market has a Lerner index of 0.89 and is considering a horizontal merger with a competing firm. Based on this information, it is likely that the U.S. Department of Justice will:

 A. approve the merger since the industry is not concentrated and the firm proposing to merge has little market power.

 B. reject the merger since the industry is highly concentrated, even though the firm proposing the merger has little market power.

 C. reject the merger since the industry is highly concentrated and the firm proposing the merger has significant market power.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-03 Explain the relevance of the Herfindahl-Hirschman index for antitrust policy under the horizontal merger guidelines. Topic: Conduct

87. Some firms find conglomerate mergers advantageous since they permit firms to:

 A. take advantage of economies of scope.

 B. take advantage of economies of scale.

 C. pool cash flows resulting from products with low and high periods.

 D. reduce input costs.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

88. Which of the following is NOT a measure of market structure?

 A. Entry conditions

 B. Four-firm concentration ratio

 C. Herfindahl-Hirschman index

 D. Pricing behavior

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

89. Which of the following is NOT considered a measure of firm conduct?

 A. Lerner index of pricing behavior

 B. Research and development measures

 D. Dansby-Willig index

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

90. In a perfectly competitive market that is operating at maximum efficiency, the Dansby-Willig index would be:

 A. zero.

 B. 0.25.

 C. 0.50.

 D. 1.00.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Performance

91. A firm has a marginal cost of \$200 and charges a price of \$500. The Lerner index for this firm is:

 A. 0.20.

 B. 0.50.

 C. 1.50.

 D. 0.60.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

92. A firm has a Lerner index of 0.75 and charges a price of \$150. The firm’s marginal cost is:

 A. \$0.

 B. \$37.50.

 C. \$112.50.

 D. There is not sufficient information to determine the firm’s marginal cost.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

93. An industry consists of eight firms with annual sales (in millions) of \$200, \$300, \$900, \$600, \$300, \$700, \$500, and \$600. What is the industry’s C4?

 A. 0.49

 B. 0.68

 C. 0.66

 D. 0.77

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

94. An industry consists of three firms with equal annual sales. What is the industry’s C4?

 A. 0.58

 B. 0.75

 C. 1

 D. There is not sufficient information to compute the industry C4.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

95. An industry consists of four firms with annual sales of \$300, \$500, \$400, and \$600, respectively. What is the industry’s HHI?

 A. 1,659

 B. 2,654

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

96. An industry consists of five firms with equal annual sales. What is the industry’s HHI?

 A. 2,000

 B. 2,500

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

97. The industry elasticity of demand for good X is -1.5, while the elasticity of demand for an individual manufacturer of good X is -9. Based on this information, the Rothschild index of market power is:

 A. 1/6, indicating there is little monopoly power in this industry.

 B. 1/6, indicating there is significant monopoly power in this industry.

 C. 6, indicating there is little monopoly power in this industry.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

98. The industry elasticity of demand for good Y is -3, while the elasticity of demand for an individual manufacturer of good Y is -12. Based on the Rothschild approach to measuring market power, we conclude that:

 A. 1/4, indicating there is significant monopoly power in this industry.

 B. 1/4, indicating there is little monopoly power in this industry.

 C. 4, indicating there is little monopoly power in this industry.

 D. None of the answers are correct.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

99. R&D is an aspect of a firm’s:

 A. performance.

 B. conduct.

 C. structure.

 D. environment.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

100. Advertising is an aspect of a firm’s:

 A. performance.

 B. structure.

 C. environment.

 D. conduct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

101. Producer and consumer surpluses are measures of:

 A. industry performance.

 B. market structure.

 C. firm conduct.

 D. None of the answers are correct.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Performance

102. An industry consists of three firms with equal annual sales. What is the industry’s HHI?

 A. 2,000

 B. 3,300

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

103. Four firms control the market for a particular good, resulting in an HHI of 2,800. Total industry sales are \$750, and it is known that one firm has sales of \$300. If each of the remaining three firms has the same sales, then we can conclude that the remaining three firms each have a market share of:

 A. \$205.

 B. \$100.

 C. 0.20.

 D. 0.40.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

104. Four firms control the market for a particular good, resulting in an HHI of 6,650. Total industry sales are \$1,750, and it is known that one firm has sales of \$1,400 and another sales of \$175. If each of the remaining two firms has the same sales, then we can conclude that the remaining two firms each have a market share of:

 A. 0.05.

 B. 0.20.

 C. \$90.

 D. \$200.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

105. An industry consists of four firms with annual sales of \$3,000, \$5,000, \$4,000, and \$6,000. What is the industry’s HHI?

 A. 1,659.

 B. 2,654.

 C. 10,000.

 D. There is not sufficient information to compute the industry HHI.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

106. An industry consists of five firms with annual sales of \$1,300, \$500, \$400, \$100, and \$600. What is the industry’s HHI?

 A. 2,937

 B. 5,654

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

107. An industry consists of five firms with annual sales of \$130, \$50, \$40, \$10 and \$60. What is the industry’s HHI?

 A. 2,937

 B. 5,654

 C. 10,000

 D. There is not sufficient information to compute the industry HHI.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

108. Suppose the market for good X has a four-firm concentration ratio of 0.70. Having worked for the four largest firms in the industry, you know the sales for these four firms are given by \$200,000, \$225,000, \$250,000, and \$275,000. Based on this information, we know that sales for the remaining firms in the industry are:

 A. \$943,332.

 B. \$687,500.

 C. \$550,500.

 D. \$407,143.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

109. Suppose the market for good X has a four-firm concentration ratio of 0.70. Having worked for the four largest firms in the industry, you know the sales for these four firms are given by \$2,000,000, \$2,250,000, \$2,500,000, and \$2,750,000. Based on this information, we know that sales for the remaining firms in the industry are:

 A. \$9,433,320.

 B. \$6,875,000.

 C. \$5,505,000.

 D. \$4,071,430.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

110. There are five firms in an industry. You know sales of the four largest firms are \$1,000,000, \$500,000, \$400,000, and \$178,000. If the C4 ratio is 95 percent, then the HHI is:

 A. 1,810.

 B. 2,755.

 C. 3,038.

 D. 5,017.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

111. There are five firms in an industry. You know sales of the four largest firms are \$800,000, \$700,000, \$440,000, and \$230,000. If the C4 ratio is 80 percent, then the HHI is:

 A. 1,810.

 B. 2,271.

 C. 4,338.

 D. 5,191.

 AACSB: Analytic Blooms: Apply Difficulty: 3 Hard Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

Essay Questions

 112 Firms like McDonald’s and Wendy’s sell hamburgers, salads, and other products that are differentiated in nature. While numerous fast-food restaurants exist in most locations, the differentiated nature of the firms’ products permits them to charge prices that are in excess of marginal cost. Given these observations, is the fast-food industry most likely a perfectly competitive industry, a monopoly, monopolistically competitive, or an oligopoly? Use the causal view of structure, conduct, and performance to explain the roles of product differentiation in the industry, and explain how the feedback critique applies in this context. Monopolistically competitive. In a monopolistically competitive market, there are many firms, but each firm produces a differentiated product. According to the causal view, the structure of differentiated products causes firms to capitalize on the absence of close substitutes by charging higher prices. According to the feedback critique, the conduct of firms may determine the market structure. The products of firms may be differentiated because of the conduct of firms in the industry. Examples of such conduct include advertising and other behavioral tactics that feed back into demand, causing consumers to view products as differentiated. Thus, it is not at all clear that differentiated products are a structural variable.

 AACSB: Analytic Blooms: Evaluate Difficulty: 3 Hard Learning Objective: 07-04 Describe the structure-conduct-performance paradigm; the feedback critique; and their relation to the five forces framework. Topic: The Structure-Conduct-Performance Paradigm

 113 During a sales meeting, one of the regional managers of Toga Industries remarked that structural variables such as advertising and R&D activities by rival firms were likely to hamper the firm’s sales over the next year. The manager received numerous stares after making the remarks. Why? Structural variables include firm size, the number of firms, concentration, number of close substitutes, technology, and potential for entry—not advertising and R&D activities. These later variables reflect conduct or behavioral variables.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

 114 Alpha Industries operates in a highly competitive market. While there are few other firms in the industry due to the high fixed costs of building plants, rival firms are very aggressive in their pricing strategies. Of the products sold in the industry, over 80 percent have 10 years of patent protection remaining. Does this industry meet an economist’s definition of a perfectly competitive industry? No. The conditions for perfect competition include: a. There are many buyers and sellers of products. b. The products are homogenous. c. Consumers and producers have perfect information. d. There is free entry and exit. The market in which Alpha Industries operates contains only a few firms, and other firms cannot freely enter or exit. Therefore, the conditions for perfect competition are not satisfied.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

 115 It is sometimes said that a manager of a monopoly can charge any price and customers will still have to buy the product. Do you agree or disagree? Why? No. Once the monopoly has chosen the price, the customers will only buy a level of output stipulated by the demand curve. Consumers will not buy whatever the monopoly puts on the market once the price is fixed.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

 116 Omega Travel competes in the highly competitive market for travel. Consumers know that Omega has the best agents in the industry and offers superior service. Nonetheless, Omega earns zero economic profits because numerous competitors have entered the market over the last few years. Based on this information, does Omega operate in a perfectly competitive market? Why or why not? No, since products are differentiated. Omega Travel operates in a monopolistically competitive market. Products are homogenous in a perfectly competitive market.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-05 Identify whether an industry is best described as perfectly competitive; a monopoly; monopolistically competitive; or an oligopoly. Topic: Overview of the Remainder of the Book

 117 “The law of comparative advantage suggests that managers should specialize in learning the tools needed to manage either a monopoly, oligopoly, monopolistically competitive, or perfectly competitive firm.” Do you agree with this statement? Explain. No. As industries mature and demand conditions change, industry structures often change.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 2 Medium Learning Objective: 07-04 Describe the structure-conduct-performance paradigm; the feedback critique; and their relation to the five forces framework. Topic: The Structure-Conduct-Performance Paradigm

 118 In Tuna, Texas, the retail gasoline market consists of six firms. Firm 1 has 35 percent of the market, Firm 2 has 25 percent, and the remaining firms have 10 percent each. What is the four-firm concentration ratio for this industry? Four-firm concentration ratio, C4 = 0.8.

 AACSB: Analytic Blooms: Apply Difficulty: 1 Easy Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

 119 The widget industry is comprised of six firms of varying sizes. Firm 1 has 35 percent of the market. Firm 2 has 25 percent, and the remaining firms have 10 percent each. What is the Herfindahl-Hirschman index for the widget industry? Based on the U.S. Department of Justice merger guidelines described in the text, do you think the Justice Department would be likely to block a merger between firms 5 and 6? Before the merger, HHI = 10,000[(.35)2 + (.25)2 + (.1)2 + (.1)2 + (.1)2 + (.1)2] = 2,250. After the merger the HHI increases to 10,000[(.35)2 + (.25)2 + (.10)2 + (.10)2 + (.20)2] = 2,450. The merger is likely to be challenged because (a) the original HHI, 2,250, is greater than that in the Guidelines (1,800) and (b) the new HHI increases by 200, which is greater than that in the Guidelines (100).

 AACSB: Analytic Blooms: Evaluate Difficulty: 3 Hard Learning Objective: 07-03 Explain the relevance of the Herfindahl-Hirschman index for antitrust policy under the horizontal merger guidelines. Topic: Market Structure

 120 The Beta Corporation operates in an industry that has a Herfindahl-Hirschman index of 2,800. Beta wants to merge with Alpha Enterprises, but Alpha has argued that the merger will be blocked by the Justice Department. Are there conditions under which the Justice Department would allow the merger? Explain. The HHI ignores the geographical market and foreign competition. If these resulting biases are deemed significant, the merger might be allowed. It might also be allowed if one of the firms is in financial trouble, or if significant economies of scale exist in the industry.

 AACSB: Reflective Thinking Blooms: Remember Difficulty: 2 Medium Learning Objective: 07-03 Explain the relevance of the Herfindahl-Hirschman index for antitrust policy under the horizontal merger guidelines. Topic: Market Structure

 121 Borris Industries operates in an industry that has a Rothschild index of 0.75. The firm gained access to a government report that revealed the own-price elasticity of market demand within the industry to be -3. Use this information to obtain an estimate of the own-price elasticity of demand for the product produced by Borris Industries. Set .75 = -3/EF and solve to get EF = -4.

 AACSB: Analytic Blooms: Apply Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Market Structure

 122 Zelda Manufacturing has a rather unique product that sells for \$15 per unit, and the marginal cost is \$7.50. Determine the Lerner index for Zelda Manufacturing. Does this index indicate market power? The Lerner index is (P – MC)/P = (15 – 7.5)/15 = .50. Since the Lerner index is positive, there is evidence of market power.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-01 Calculate alternative measures of industry structure; conduct; and performance; and discuss their limitations. Topic: Conduct

 123 Determine whether integration between the following types of firms would constitute a horizontal, vertical, or conglomerate merger. a. A food company and a drug company. b. A milk producer and a cheese producer. c. A computer chip manufacturer and a silicon producer. a. Conglomerate merger. b. Under a broad definition of the market (dairy products), this is a horizontal merger. Under a narrower definition it might also be considered a vertical merger (milk is an input in making cheese). This is an example of a gray area of merger analysis. c. Vertical merger—silicon is an input used in making computer chips.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

 124 Star Computer and a small telecommunications company are considering a merger. A socially minded member of Star Computer’s board of directors is against the merger, however, because she is concerned that the merger might not benefit society as a whole. Provide the board member with an argument for why it may be socially beneficial for the merger to take place. The merger may generate economies of scope in making computers and providing telephone services, thus reducing costs and prices.

 AACSB: Reflective Thinking Blooms: Understand Difficulty: 1 Easy Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct

 125 A host of best-selling books advance the thesis that increases in conglomerate mergers and concentration of U.S. industry are responsible for “obscene profits.” Do you agree? Explain, using the Lerner index. One of the important lessons in this chapter is that “big” firms do not necessarily earn big profits.

 AACSB: Analytic Blooms: Analyze Difficulty: 2 Medium Learning Objective: 07-02 Describe examples of vertical; horizontal; and conglomerate mergers; and explain the economic basis for each type of merger. Topic: Conduct