Economics Multiple Choice Questions: Sunk Costs, Opportunity Costs, and Cost Curves

1. Alice paid $20,000 for an option to purchase ten acres of land in 1985. This gave her the right to buy the land for $100,000 in 1992. The land was worth $120,000 in 1985 and $110,000 in 1992. Should Alice exercise the option and pay $100,000 for the land?

A) Yes B) No C) It depends on what the rate of inflation was between 1985 and 1992. D) It depends on what the rate of interest was.

Answer: A) Yes

2. Farmer Jones bought his farm for $75,000 in 1975. Today the farm is worth $500,000, and the interest rate is 10 percent. ABC Corporation has offered to buy the farm today for $500,000 and XYZ Corporation has offered to buy the farm for $530,000 one year from now. Farmer Jones could earn a net profit of $15,000 (over and above all of his expenses) if he farms the land this year. What should he do?

A) Sell to ABC Corporation. B) Farm the land for another year and sell to XYZ Corporation. C) Accept either offer as they are equivalent. D) Reject both offers.

Answer: B) Farm the land for another year and sell to XYZ Corporation.

3. Constantine purchased 100 shares of IBM stock several years ago for $150 per share. The price of these shares has fallen to $55 per share. Constantine's investment strategy is 'buy low, sell high.' Therefore, he will not sell his IBM stock until the price rises above $150 per share. If he sells at a price lower than $150 per share he will have 'bought high and sold low.' Constantine's decision:

A) is correct and shows a solid command of the nature of opportunity cost. B) is incorrect because the original price paid for the shares is a sunk cost and should have no bearing on whether the shares should be held or sold. C) is incorrect because when the price of a stock falls, the law of demand states that he should buy more shares. D) is incorrect because it treats the price of the shares as an explicit cost.

Answer: B) is incorrect because the original price paid for the shares is a sunk cost and should have no bearing on whether the shares should be held or sold.

4. Which of the following statements demonstrates an understanding of the importance of sunk costs for decision making?

I. 'Even though I hate my MBA classes, I can't quit because I've spent so much money on tuition.' II. 'To break into the market for soap our firm needs to spend $10M on creating an image that is unique to our new product. When deciding whether to develop the new soap, we need to take this marketing cost into account.'

A) I only B) II only C) Both I and II D) Neither I nor II

Answer: B) II only

5. Which of the following statements correctly uses the concept of opportunity cost in decision making?

I. 'Because my secretary's time has already been paid for, my cost of taking on an additional project is lower than it otherwise would be.' II. 'Since NASA is running under budget this year, the cost of another space shuttle launch is lower than it otherwise would be.'

A) I is true, and II is false. B) I is false, and II is true. C) I and II are both true. D) I and II are both false.

Answer: A) I is true, and II is false.

6. Carolyn knows average total cost and average variable cost for a given level of output. Which of the following costs can she not determine given this information?

A) Total cost B) Average fixed cost C) Fixed cost D) Variable cost E) Carolyn can determine all of the above costs given the information provided.

Answer: B) Average fixed cost

7. The average total cost to produce 100 cookies is $0.25 per cookie. The marginal cost is constant at $0.10 for all cookies produced. The total cost to produce 50 cookies is:

A) $20 B) $25 C) $50 D) $60 E) indeterminate

Answer: B) $25

8. The average total cost to produce 100 cookies is $0.25 per cookie. The marginal cost is constant at $0.10 for all cookies produced. For 100 cookies, the average total cost is:

A) falling. B) rising. C) neither rising nor falling. D) less than average fixed cost.

Answer: A) falling.

9. Jim left his previous job as a sales manager and started his own sales consulting business. He previously earned $70,000 per year, but he now pays himself $25,000 per year while he is building the new business. What is the economic cost of the time he contributes to the new business?

A) $25,000 per year B) Zero C) $70,000 per year D) $45,000 per year

Answer: D) $45,000 per year

10. We typically think of labor as a variable cost, even in the very short run. However, some labor costs may be fixed. Which of the following items represents an example of a fixed labor cost?

A) An hourly employee B) A temporary worker who is paid by the hour C) A salaried manager who has a three-year employment contract D) none of the above

Answer: C) A salaried manager who has a three-year employment contract

11. Use the following two statements to answer this question:

I. The average cost curve and the average variable cost curve reach their minima at the same level of output. II. The average cost curve and the marginal cost curve reach their minima at the same level of output.

A) Both I and II are true. B) I is true, and II is false. C) I is false, and II is true. D) Both I and II are false.

Answer: B) I is true, and II is false.

12. For any given level of output:

A) marginal cost must be greater than average cost. B) average variable cost must be greater than average fixed cost. C) average fixed cost must be greater than average variable cost. D) fixed cost must be greater than variable cost. E) None of the above is necessarily correct.

Answer: E) None of the above is necessarily correct.

13. Which of the following relationships is NOT valid?

A) Rising marginal cost implies that average total cost is also rising. B) When marginal cost is below average total cost, the latter is falling. C) When marginal cost is above average variable cost, AVC is rising. D) none of the above

Answer: D) none of the above

14. Consider the following statements when answering this question

I. If a firm employs only one variable factor of production, labor, and the marginal product of labor is constant, then the marginal costs of production are constant too. II. If a firm employs only one variable factor of production, labor, and the marginal product of labor is constant, then short-run average total costs cannot rise as output rises.

A) I is true, and II is false. B) I is false, and II is true. C) I and II are both true. D) I and II are both false.

Answer: C) I and II are both true.

15. With its current levels of input use, a firm's MRTS is 3 (when capital is on the vertical axis and labor is on the horizontal axis). This implies:

A) the firm could produce 3 more units of output if it increased its use of capital by one unit (holding labor constant). B) the firm could produce 3 more units of output if it increased its use of labor by one unit (holding capital constant). C) if the firm reduced its capital stock by one unit, it would have to hire 3 more workers to maintain its current level of output. D) if it used one more unit of both capital and labor, the firm could produce 3 more units of output. E) the marginal product of labor is 3 times the marginal product of capital.

Answer: B) the firm could produce 3 more units of output if it increased its use of labor by one unit (holding capital constant).

16. A firm employs 100 workers at a wage rate of $10 per hour, and 50 units of capital at a rate of $21 per hour. The marginal product of labor is 3, and the marginal product of capital is 5. The firm:

A) is producing its current output level at the minimum cost. B) could reduce the cost of producing its current output level by employing more capital and less labor. C) could reduce the cost of producing its current output level by employing more labor and less capital. D) could increase its output at no extra cost by employing more capital and less labor. E) Both B and D are true.

Answer: C) could reduce the cost of producing its current output level by employing more labor and less capital.

17. A firm wants to minimize the total cost of producing 100 tons of dynamite. The firm uses two factors of production, chemicals and labor. The combination of chemicals and labor that minimizes production costs will be found where:

A) the marginal products of chemicals and labor are equal. B) the ratio of the amount of chemicals used to the amount of labor used equals the ratio of the marginal product of chemicals to the marginal product of labor. C) the ratio of the amount of chemicals used to the amount of labor used equals the ratio of the price of chemicals to the wage rate. D) the production of an additional unit of dynamite costs the same regardless of whether chemicals or labor are used. E) none of the above

Answer: B) the ratio of the amount of chemicals used to the amount of labor used equals the ratio of the marginal product of chemicals to the marginal product of labor.

18. Suppose our firm produces chartered business flights with capital (planes) and labor (pilots) in fixed proportion (i.e., one pilot for each plane). The expansion path for this business will:

A) increase at a decreasing rate because we will substitute capital for labor as the business grow. B) follow the 45-degree line from the origin. C) not be defined. D) be a vertical line.

Answer: B) follow the 45-degree line from the origin.

19. The cost-output elasticity equals 1.4. This implies that:

A) there are neither economies nor diseconomies of scale. B) there are economies of scale. C) there are diseconomies of scale. D) marginal cost is less than average cost.

Answer: C) there are diseconomies of scale.

20. Use the following two statements to answer this question:

I. Increasing returns to scale cause economies of scale. II. Economies of scale cause increasing returns to scale.

A) Both I and II are true. B) I is true, and II is false. C) I is false, and II is true. D) Both I and II are false.

Answer: C) I is false, and II is true.