ch07_Solutions - Chapter 7 Costs and Cost Minimization...

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Chapter 7 Costs and Cost Minimization Solutions to Review Questions 1. Acquisition cost and opportunity cost are not necessarily the same. As the text points out, opportunity costs are forward looking. The opportunity cost is the payoff associated with the best of the alternatives that are not chosen. Once the test tubes are purchased, the decision is to use the tubes to clone snake cells or something else. It is possible that someone values the tubes for some purpose at higher (or lower) than $0.50 so that selling the tubes would earn the firm something more (or less) than $0.50 per tube. The opportunity cost then is different than the acquisition cost. 2. Since the business is computer consulting, an explicit cost, a cost involving a direct monetary outlay, might be the cost of paper and ink used to advertise your service. An implicit cost, a cost not involving a direct monetary outlay, might be the opportunity cost of your time, e.g. , to earn money working at the student fitness center or to study for your own classes. 3. Whether or not a particular cost is sunk or not depends on the decision being made. If the cost does not change as a result of the decision the cost is sunk, while if the cost does change the cost is not sunk. 4. A firm’s total costs are TC = rK + wL , so the equation for a typical isocost line is . TC w K L r r = - Since the slope of the isocost line is given by / w r - , if the price of labor increases the isocost line will become steeper and if the price of capital increases the isocost line will become flatter. 5. The solution to the firm’s cost minimization problem must lie on an isoquant. While the firm could produce a given output with a combination of inputs not on the isoquant, say by using more labor and more capital than necessary, a combination such as this would not be efficient and therefore not cost minimizing. 6. To understand why at an interior optimum the additional output the firm gets from a dollar spent on labor must equal the additional output the firm gets from a dollar spent on capital, assume these were not equal. For example, suppose the firm Page 7 - 1
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could get more output from a dollar spent on labor than on a dollar spent on capital. Then the firm could take one dollar away from capital and reallocate it to labor. Since the firm gets more output from a dollar of labor than from a dollar of capital, it will require the firm to spend less than one dollar on labor to offset the decline in output from taking one dollar away from capital. This implies the firm can keep output at the same level but do so at a lower cost. Therefore, if these amounts are not equal the firm is not minimizing cost. This requirement does not necessarily hold at a corner solution. While the firm could potentially reduce cost by reallocating spending to the more productive input, at a corner solution, by definition, the firm is not using one of the inputs. There is no further opportunity to reallocate spending if the firm is spending
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ch07_Solutions - Chapter 7 Costs and Cost Minimization...

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