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Unformatted text preview: Chapter 08 - Cost Chapter 8: Cost Main Concepts and Learning Objectives This chapter uses the production function analysis presented in the previous chapter to analyze cost. The chapter explains the concepts of fixed and variable costs, avoidable cost, sunk cost and economic cost. It explains the derivation of total short-run and total long-run cost from a production function. These total cost functions are used to derive average and marginal cost functions. Finally, the cost concepts are used to analyze the effects of input price changes, economies of scale and economies of scope. Students who master the material presented in this chapter will be able to: • Identify fixed, variable, sunk and avoidable costs • Use a production function to construct a cost function • Use isocost / isoquant diagrams to analyze input purchase decisions. • Compute short run and long run cost functions. • Use the equi-marginal principle to analyze efficiency • Compute the optimal allocation of production for a multi-plant firm Multiple Choice Quiz (10 questions) covering main points: 1. Section 8.1 presents a discussion of fixed and variable costs, sunk costs and avoidable costs. The take-home message of this section is: a. It is not possible to classify any cost (such as the purchase price of a license to operate a taxi cab) unless you know the context of the decision and the terms of the sale. If you buy a one-year license, the purchase price is fixed for one year after you buy the license. It is only a sunk cost if you cannot legally sell the license to another party (to recover your money). It was avoidable prior to moment at which you actually committed to purchase it. b. All fixed costs are sunk. c. Fixed costs cannot be avoidable. d. None of the above. 2. JetBlue has several different types of contracts for leasing gates at airports. At some airports, JetBlue must rent each gate for an entire day, regardless of the number of flights per day. At these airports, the gate rental expense is a: a. variable cost. b. fixed cost. c. avoidable cost. d. sunk cost. 8-1 Chapter 08 - Cost 3. Coors uses rice to brew beer, and it grows its own rice. Coors could have chosen to purchase this rice in the rice market at market prices, but – instead – Coors prefers to grow it’s own rice. Does this strategy reduce the cost of obtaining this input? a. yes, if the cost of growing the rice is lower than the cost to purchase the rice in the market b. no, because the opportunity cost of using the rice it grows is equal to the market price c. none of the above 4. If a long-lived asset is “expensed”, a. the asset is very costly. b. the firm records the full cost of the asset in the year the expenditure occurs....
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- Spring '11