Lecture 1 tasks & solutions (1)

Definitions
Accounting Costs: Costs located on accounting statements and generally historic.
Avoidable Costs: Costs that can be avoided if certain choices are made.
Economic Costs: Concept that cost of deploying resources in a particular activity is the value
of the best forgone alternative use of those resources.
Elasticity: The measurement of the sensitivity of quantity demanded to price.
Fixed Costs: In general, these are costs which remain constant as output increases.
Game Theory: The analysis of optimal decision making when all decision makers are
presumed to be rational and each is attempting to anticipate actions and reactions of
competitors.
Law of Demand: Concept relating lower price with greater quantity demand, and higher price
with smaller quantity demand.
Marginal Cost: Incremental cost of producing exactly one more unit of output.
Marginal Revenue Function: Rate of change in total revenue that results from the sale of Q
additional units of output.
Nash Equilibrium: The outcome in game theory where each player in the game is doing the
best it can, given the strategies of the other players.
Prisoners Dilemma: The conflict between the collective interest and self-interest.
Revenue Destruction: When revenue is destroyed as a result of a firm lowering its price in
order to sell a greater quantity that does not result in greater total revenues.
Sunk Costs: Costs that are incurred and therefore cannot be avoided and should not be used
when comparing financials to make business choices.
Total Costs: Represents the relationship between a firms total costs, denoted by TC, and the
total amount of output it produces in a given time period, denoted by Q.
Total Revenue Function: A function indicating how the firms sales revenues vary as a
function of how much product it sells.
Variable Costs: Costs that increase as output increases.
Discussion questions
1. Why is marginal revenue less than total revenue?
Marginal revenue is the amount at which each additional unit is sold. This will always be
less than the cumulative amount which is represented as total revenue.
2. Why does the elasticity of demand affect a firms optimal price?
The demand elasticity can be used to determine the extent to which the equilibrium price
will change when supply shifts exogenously. If demand is elastic, then a shift in supply
will have a smaller impact on the equilibrium price than when demand is inelastic.

Multiple choice questions

1. If a firm is producing as efficiently as it knows how, the how will the total cost function
slope?
a) Upward
b) Downward
c) No Slope
d) Downward until an output threshold value, then upward
e) Upward until an output threshold value, then downward
Ans: a
Heading: Costs - Cost Functions

2. Which of the following cost line items would be a fixed cost?

a) Commissions to Salespeople
b) Rent
c) Raw Materials
d) Packaging
e) Shipping/Delivery Charges
Ans: b
Heading: Costs Fixed and Variable Costs

3. If TC(Q)=1000Q2+100Q+10, what is the formula for AC(Q)?

a) 2000Q+100
b) 2000Q2+100Q
c) 1000Q2+100Q+10
d) 1000Q+100+10/Q
e) 100Q+10+1/Q
Ans: d
Heading: Costs Average and Marginal Cost Functions

4. Which of the following variables does not influence the quantity of product that a firm is
able to sell?
a) Price of the product
b) Price of related products
c) Plant production costs
d) Incomes and tastes of consumers
e) Advertising
Ans: c
Heading: Demand and Revenues Demand Curve

5. Which of the following best describes marginal revenue?

a) How sales revenue varies as a function of how much product is sold
b) The incremental sales from producing one more unit of output
c) Rate of change in total revenue that results from the sale of Q additional units of output
d) The total sales for a given product based on plant output
e) Percentage change in quantity divided by percentage change in price
Ans: c
Heading: Demand and Revenues Total Revenue and Marginal Revenue Functions