# FINALW11AnswersExplained - Final Exam True-False Questions...

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Final Exam, March 17, 2011 True-False Questions: 1. If the average cost of a firm does not change as it produces more output, the firm's marginal cost equals its average cost. Answer: True If a firm’s marginal cost exceeds its average cost, its average cost is rising as it produces more. If a firm’s marginal cost is less than its average cost, its average cost is falling as it produces more. If average cost does not change, the firm’s marginal cost can’t be above its average cost (because average cost would then be rising), and the firm’s marginal cost can’t be below its average cost (because average cost would then be rising. If the firm’s marginal cost can’t be above its average cost and it can’t be below its marginal cost, that leaves just one option. Marginal cost must equal average cost. 2. For this question, assume that the only input a firm can vary is the number of workers it hires and that the wage it pays those workers does not depend on the number it hires. With those assumptions, if the average product of labor rises as the firm hires more workers, the average variable cost of the firm falls as it produces more output. Answer: True Let Q be the units of output for a firm, let L be the number of workers the firm hires to produce that output, and let W be the wage for each worker. The firm’s variable cost is therefore WL, and its average variable cost is AVC=WL/Q. The ratio Q/L is the average product of labor. It is the total product produced by the firm, Q, divided by the number of workers. Denote this ratio by APL. So, AVC = WL/Q = W/(Q/L)=W/APL By this formula, a rise in APL means a fall in AVC. In words, if workers become more productive on average, the average cost of production will fall.

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In the short run, a firm should produce the output that minimizes its average variable cost. Answer: False Remember this diagram? The diagram depicts the typical average cost and marginal cost of a firm. Average cost falls at first as the firm gains due to specialization and the division of labor. Average cost eventually rises, however, because of some fixed factor. When average cost is falling, marginal cost must be below it (to the left of q’). When average cost is rising, marginal cost must be above it (the the right of q’). Where marginal cost crosses average cost, q’, average cost must be at a minimum. Is this the profit maximizing point for the firm? No, because price, represented by the horizontal dashed line, exceeds marginal cost. Thus, by producing more, the firm will add more to its revenue than it adds to its costs. By producing more, it will increase its profits. Hence, q’ can’t be a profit maximizing output. The output than minimizes average cost does not maximize profits. The profit maximum is at point q*, where price equals marginal cost. \$/unit
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FINALW11AnswersExplained - Final Exam True-False Questions...

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