Chapter 6 EKN ANSWERS.pdf

Chapter 6 EKN ANSWERS.pdf - The Costs of Production CHAPTER...

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The Costs of Production 78 CHAPTER SIX THE COSTS OF PRODUCTION ANSWERS TO END-OF-CHAPTER QUESTIONS 6-1 Distinguish between explicit and implicit costs, giving examples of each. What are the explicit and implicit costs of attending college? Why does the economist classify normal profit as a cost? Is economic profit a cost of production? Explicit costs are payments the firm must make for inputs to non owners of the firm to attract them away from other employment, for example, wages and salaries to its employees. Implicit costs are non expenditure costs that occur through the use of self-owned, self-employed resources, for example, the salary the owner of a firm forgoes by operating his or her own firm and not working for someone else. The explicit costs of going to college are the tuition costs, the cost of books, and the extra costs of living away from home (if applicable). The implicit costs are the income forgone and the hard grind of studying (if applicable). Economists classify normal profits as costs, since in the long run the owner of a firm would close it down if a normal profit were not being earned. Since a normal profit is required to keep the entrepreneur operating the firm, a normal profit is a cost. Economic profits are not costs of production since the entrepreneur does not require the gaining of an economic profit to keep the firm operating. In economics, costs are whatever is required to keep a firm operating. 6-2 ( Key Question ) Gomez runs a small pottery firm. He hires one helper at R12, 000 per year, pays annual rent of R5, 000 for his shop, and spends R20, 000 per year on materials. He has R40, 000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him R4, 000 per year if alternatively invested. He has been offered R15, 000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth R3, 000 per year. Total annual revenue from pottery sales is R72, 000. Calculate accounting profits and economic profits for Gomez’s pottery. Explicit costs: R37, 000 (= R12, 000 for the helper + R5, 000 of rent + R20, 000 of materials). Implicit costs: R22, 000 (= R4, 000 of forgone interest + R15, 000 of forgone salary + R3, 000 of entrepreneurship). Accounting profit = R35, 000 (= R72, 000 of revenue - R37, 000 of explicit costs); Economic profit = R13, 000 (= R72, 000 - R37, 000 of explicit costs - R22, 000 of implicit costs). 6-3 Which of the following are short-run and which are long-run adjustments? (a) Wendy’s builds a new restaurant; (b) Acme Steel Corporation hires 200 more production workers; (c) A farmer increases the amount of fertilizer used on his corn crop; and (d) An Alcoa plant adds a third shift of workers. (a) Long-run, (b) Short-run, (c) Short-run, (d) Short-run 6-4 ( Key Question ) Complete the following table by calculating marginal product and average product from the data given. Plot total, marginal, and average product and explain in detail the relationship between each pair of curves. Explain why marginal product first rises, then declines, and ultimately becomes negative. What bearing does the law of diminishing returns have on short-run costs?
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