Pepperdine University

FINC 655

Chapter 4

Multiple Choice Solutions:

1)When economists speak of “marginal”, they mean

1. 1. Opportunity [The opportunity cost of an alternative is the profit you give up to pursue it]
   2. Scarcity [Scarcity refers to the limited availability of resources]
   3. Incremental [marginal refers to additional cost or benefit created from producing each additional unit]
   4. Unimportant [In economic terms, marginal does not imply unimportant. On the contrary, marginal analysis is a critical component of a wide variety of economic decisions]

2. Managers undertake an investment only if
   1. Marginal benefits of the investment are greater than zero [when considering a decision, both the marginal benefits and marginal costs should be compared]
   2. Marginal costs of the investment are greater than marginal benefits of the investment [if the marginal costs are greater than the marginal benefits of a decision, management will not make the investment]
   3. Marginal benefits are greater than marginal costs [managers should undertake an investment when the marginal benefits are greater than the marginal costs]
   4. Investment decisions do not depend on marginal analysis [marginal analysis is critical in investment decisions]

3. A firm produces 500 units per week. It hires 20 full-time workers (40 hours/week) at an hourly wage of $15. Raw materials are ordered weekly and they costs $10 for every unit produced. The weekly cost of the rent payment for the factory is $2,250. How do the overall costs breakdown?

1. 1. Total variable cost is $17,000; total fixed cost is $2,250; total cost is $19,250 [both the $12,000 of labor costs (20 workers*40hrs/week*$15/hr) and the $5000 raw materials cost ($10/unit*500 units) are considered variable expenses. Factory rent is considered a fixed cost]
   2. Total variable cost is $12,000; total fixed cost is $7,250; total cost is $19,250 [Both labor and raw materials are considered variable costs as they both change as output levels change]
   3. Total variable cost is $5,000; total fixed cost is $14,250; total cost is $19.250 [Both labor and raw materials are considered variable costs as they change as output levels change]
   4. Total variable cost is $5,000; total fixed cost is $2,250; total cost is $7,250 [Both raw materials and labor should be considered as variable costs, which when added to the fixed rental cost will equal the total costs of production]

4. Total costs increase from $1500 to $1800 when a firm increases output from 40 to 50 units. Which of the following are true?
   1. FC = $100 [We know that Total cost = FC + VC(Quantity). This means 1500 = FC+VC(40) and 1800=FC+VC(50). Using this information, we can solve for FC]
   2. FC = $200 [We know that Total cost = FC + VC(Quantity). This means 1500 = FC+VC(40) and 1800=FC+VC(50). Using this information, we can solve for FC]
   3. FC = $300 [We know that Total cost = FC + VC(Quantity). This means 1500 = FC+VC(40) and 1800=FC+VC(50). Using this information, we can solve for FC. For example, using the first

equation we see VC(40)=1500-FC, hence VC=(1500-FC)/40. Plugging this value for VC into 1800=FC+VC(50) will give you 1800=FC+50((1500-FC)/40), which lets us find FC=300]

1. 4. FC = $400 [We know that Total cost = FC + VC(Quantity). This means 1500 = FC+VC(40) and 1800=FC+VC(50). Using this information, we can solve for FC]

5. A manager of a clothing firm is deciding whether to add another factory in addition to one already in production.

The manager would compare

1. 1. The total benefits gained from the two factories to the total costs of running the two factories. [By combining the total costs and benefits of the two factories, the manager would not be able to determine the contribution of the second factory on its own]
   2. The incremental benefit expected from the second factory to the total costs of running the two factories. [The additional benefit of the second factory should only be compared to the additional costs of that factory, as the costs from the first factory will be incurred regardless]
   3. The incremental benefit expected from the second factory to the cost of the second factory [the manager will decide to add another factory when the incremental benefits of that factory are greater than its incremental costs]
   4. The total benefits gained from the two factories to the incremental costs of running the two factories. [The incremental costs of having a second factory should be compared only to its incremental benefit, as the benefits of the first factory will be produced regardless]

6. A firm is thinking of hiring an additional worker to their organization who they believe can increase total productivity by 100 units a week. The cost of hiring him or her is $1500 per week. If the price of each unit is $12,
   1. The MR of hiring the worker is $1500 [The MR of hiring the worker is $1200 (100 additional units produced*$12/unit)]
   2. The MC of hiring the worker is $1200 [The MC of hiring the worker is his salary of $1500]
   3. The firm should not hire the worker since MR < MC [The MR of hiring the worker is $1200 (100 additional units*$12/unit), while his MC is his salary of $1500, indicating the company will lose $300/week by hiring the additional worker]
   4. All the above [Remember the marginal benefit is the additional revenue generated by the worker, while the marginal costs will be any additional costs that occur from hiring him]

7. A retailer has to pay $9 per hour to hire 13 workers. If the retailer only needs to hire twelve workers, a wage rate of $7 per hour is sufficient. What is the marginal cost of the 13th worker?
   1. $117. [This is the total cost of having 13 workers ($9*13)]
   2. $9. [This represents the wage of the additional worker, but does not take into consideration the additional costs of the wage increase for the rest of the employees associated with his hiring]
   3. $33. [The total cost of having twelve workers is $84 (12workers*$7hr) while the addition of the thirteenth worker brings the total cost up to $117 (13 workers*$9/hr). Therefore, the marginal cost of the 13th worker is $33 ($117-$84)]
   4. $84. [This is the total cost of having 12 workers (12*$7/hr)]

8. If a firm’s average cost is rising then
   1. Marginal cost is less than average cost. [If marginal cost is less that average cost, then its average cost will fall with each additional unit]