EASTERN MEDITERRANEAN UNIVERSITY FACULTY OF BUSINESS AND ECONOMICS DEPARTMENT OF BUSINESS ADMINISTRATION Discussion Questions and Pro !

e"s (Reference chapter 7; D. Salvatore; 2004) Discussion Questions #. (a) What is the distinction bet een econo!ic costs and accountin" costs# (b) Which are i!portant for calculatin" the econo!ic profits of the fir!# $. (a) What is the distinction bet een !ar"inal cost and incre!ental cost# (b) $o are sun% costs treated in !ana"erial decision !a%in"# Wh&# %. (a) What is !eant b& fir! architecture# (b) What is the architecture of the ideal fir!# &. What are the advanta"es and disadvanta"es of esti!atin" the lon"'run avera"e cost curve b& (a) the en"ineerin" techni(ue and (b) the survival techni(ue# (c) Do the lon"'run avera"e cost curves esti!ated b& the en"ineerin" or survival techni(ues support or contradict the shape of the lon"'run avera"e cost curves found b& cross'sectional re"ression anal&sis# )roble!s #. *evin +ou"hlin, a la &er or%in" for a lar"e la fir! and earnin" -.0,000 per &ear, is conte!platin" settin" up his o n la practice. $e esti!ates that rentin" an office ould cost -/0,000 per &ear, hirin" a le"al secretar& ould cost -20,000 per &ear, rentin" the re(uired office e(uip!ent ould cost -01,000 per &ear, and purchasin" the re(uired supplies, pa&in" for electricit&, telephone, and so forth ould cost another -1,000. 2he la &er esti!ated that his total revenues for the &ear ould be -/00,000, and he is indifferent bet een %eepin" his present occupation ith the lar"e la fir! and openin" his o n la office, (a) $o !uch ould be the e3plicit costs of the la &er for runnin" his o n la office for the &ear# (b) $o !uch ould the accountin" costs be# 2he i!plicit costs# 2he econo!ic costs# (c) Should the la &er "o ahead and start his o n practice# $. 4iven the follo in" total cost schedule of a fir!, (a) derive the total fi3ed cost and total variable cost schedules of the fir!, and fro! the! derive the avera"e fi3ed cost, avera"e variable cost, avera"e total cost, and !ar"inal cost schedules of the fir!, (b) )lot all the schedules of part (a) on a fi"ure si!ilar to 5i"ure 7' /. Q TC 0 -60 / 10 2 .0 6 7/ 4 //7 1 /70

%. 8ir a& 93press has an evenin" fli"ht fro! :os 8n"eles to ;e <or% ith an avera"e or 70 passen"ers and a return fli"ht the ne3t afternoon ith an avera"e of 10 passen"ers. 2he plane !a%es no other trip. 2he char"e for the plane re!ainin" in ;e <or% overni"ht is -/,200 and ould be =ero in :os 8n"eles. 2he air' line is conte!platin" eli!inatin" the ni"ht fli"ht out of :os 8n"eles and replacin" it ith a !ornin" fli"ht. 2he esti!ated nu!ber or passen"ers is 70 in the !ornin" fli"ht and 10 in the return afternoon fli"ht. 2he one' a& tic%et for an& fli"ht is -200. 2he operatin" cost of the plane for each fli"ht is -//,000. 2he fi3ed costs for the plane are -6,000 per da& hether it flies or not. (a) Should die airline replace its ni"ht fli"ht fro! :os 8n"eles ith a !ornin" fli"ht# (b) Should the airline re!ain in business# &.4iven that the a"e rate of labor (w) is -/0 per unit and the rental price of capital (r) is also -/0 per unit, and that the a!ount of labor (:) and capital (K) used to produce various levels of output are as "iven in the follo in" table, (a) dra a fi"ure si!ilar to 5i"ure 7'6, hich sho s the e3pansion path of the fir!, the lon"'run total cost curve, and the lon"'run avera"e and !ar"inal cost curves of the fir!. >n the panel

sho in" the lon"'run avera"e cost curve of die fir!, dra four short'run avera"e cost curves, (b) 0f the fir! could build onl& the four plants indicated b& the short'run avera"e cost curves sho n on &our fi"ure, hat ould be the lon"'run avera"e cost of the fir!# ?nder hat conditions ould the lon"'run avera"e cost curve of the fir! be a s!ooth curve# L K Q /0 0 0 2 2 / 6 6 2 6.41 6.41 6 4 4 4 . . 1 @ @ .

'( 2he 4oldber"'Schein!an )ublishin" +o!pan& is publishin" a ne !ana"erial econo!ics te3t for hich it has esti!ated the follo in" total fi3ed and avera"e variable costsA 2otal fi3ed costsA +op& editin" 2&pesettin" Sellin" and pro!otion 2otal fi3ed costs 8vera"e variable costsA )rintin" and bindin" 8d!inistrative costs Sales co!!issions Boo%store discounts 8uthorCs ro&alties - /0,000 70,000 20,000 -/00,000 -. 2 / 7 4 -20 -60

8vera"e variable costs )roDect sellin" price

(a) Deter!ine the brea%even output and total sales revenues and dra the cost'volu!e'profit chart, and (b) deter!ine the output that ould "enerate a total profit of -.0,000 and the total sales revenues at that output level; dra the cost'volu!e'profit chart, (c) Suppose that ith a technolo"ical brea%throu"h in printin", the publisher as able to lo er its TFC to -40,000. What ould be its brea%even output# the output that ould lead to a total profit of -.0,000# Dra a chart to sho &our ans er, (d) Suppose that total fi3ed costs re!ained at -/00,000 but avera"e variable costs declined to -/0. What ould be the publishers brea%even output# the output that ould lead to a total profit of -.0,000# Dra a chart to sho &our ans er, (e) 0f the publisherCs total fi3ed costs re!ained at -/00,000 and its avera"e variable costs at -20 but the publisher char"ed a price of -40, hat ould be the brea%even output# the output at hich the publisher earns a profit of -.0,000# Dra a chart sho in" &our ans er. )( 2 o fir!s in the sa!e industr& sell their product at -/0 per unit, but one fir! has 25+E-/00 and 8F+ E -. hile the other has 25+ E -600 and 8F+ E -6.66. (a) Deter!ine the brea%even output of each fir!. Wh& is the brea%even output of the second fir! lar"er than that of the first fir!# (b) 5ind the de"ree of operatin" levera"e for each fir! at Q E .0 and at QE70. Wh& is the de"ree of operatin" levera"e "reater for the second than for the first fir!# Wh& is the de"ree of operatin" levera"e "reater at Q E .0 than at Q E70# *. 2he Gicrosoft +o!puter +o!pan& ants to esti!ate the avera"e variable cost function of producin" co!puter dis%ettes. 2he fir! believes that 8F+ varies ith the level of output and a"es. 8lan 8nderson, the econo!ist in the research depart!ent of the fir!, collects !onthl& data on output (the nu!ber of dis%ettes produced), avera"e variable costs, and a"e rates paid b& the fir! over the past t o &ears. $e deflates costs and a"es b& their respective price inde3es in order to eli!inate inflationar& influences. $e then re"resses total variable costs (2F+) on output (Q) and a"es (W) and obtains the follo in" result ( here the nu!bers in parentheses are t values)A 2F+E 0./4 H 0.70Q H 0.06.W (2.7) (6.7) (6.6) R2 E0.@2 D E W E /.@

(a) 0f W E S/0, derive the 8F+ and G+ functions of the fir!. (b) What are the shapes of the 8F+ and G+

curves orC the fir!# (c) Wh& did 8nderson fit a linear rather than (uadratic or cubic 2+5 functionA (d) Was this the ri"ht choice# Wh&# +( Inte,ratin, Pro !e" 2he !ana"er of the 9lectronic +orporation has esti!ated the total variable costs and the total fi3ed cost functions for producin" a particular t&pe of ca!era to be 2F+ E .0Q I /2Q2 I Q6 25+ E -/00 2he corporation sells the ca!eras at the price of -.0 each. 8n en"ineerin" stud& Dust published esti!ated that if the corporation e!plo&s ne l& developed technolo"&, the lon"'run total cost function ould be 2+ E 10 H 20Q H 2 H 6r here w E a"e rate and r = rental price of capital. 2he !ana"er as%s &ou to find (a) the avera"e variable and !ar"inal cost functions of the fir!, the output level at hich the t o curves cross, and a plot of the! (Hint: See 9(uations 7'22 to 7'24); (b) the brea%even output of the fir! and the output at hich the fir! !a3i!i=es its total profits; and (c) the lon"'ter! avera"e cost and lon"'run !ar"inal cost functions ith the ne technolo"& if r E -20 and rE-/0, and plot the!. 8re these curves si!ilar to those found in other e!pirical studies of the lon"'run costs# (d) Should the corporation adopt the ne technolo"&C# 0f it did, hat ould be the profit'!a3i!i=in" level of output if the fir! can continue to sell its ca!eras at the price of -.0 per unit# 8ppendi3 Pro !e" # 4ivenA 2+ E /00 H .0Q ' /2Q2 H Q6 . 5ind (a) the e(uations of the 2F+, 85+, and G+ functions and (b) the level of output at hich 8F+ and G+ are !ini!u!, and prove that the 8F+ and G+ curves are ?'shaped. (c) 5ind the AVC and G+ for the level of output at hich the 8F+ curve is !ini!u!. Pro !e" $ 8ns er the sa!e (uestions as in )roble! / if 2+ E /20 H 10Q I 0>