Economics Model Answers Six

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Introductory: 1. “Accounting profit” is ________ minus _________.

Revenue minus explicit costs.

2. Suppose your company spends $10,000 on labor and $30,000 on equipment for an output of 5000 widgets. You increase your labor costs to $15,000 and your equipment costs to $45,000, and your output increases to 8000. Describe your return to scale: increasing, constant, or decreasing?

This is increasing returns to scale, because your output increased by a larger percentage than your inputs did.

Intermediate: 3. Suppose the population doubled and the other utilized economic inputs (air, water, capital, etc.) doubled as needed. What would happen to economic output, such as new inventions and food production? In other words, what is the return to scale from increasing population (labor) and other inputs?

Should be increasing returns to scale due to the increased number of inventions and advances in technology by the larger population. Other views accepted, but it is incorrect that there is any shortage of land in the world.

4. Suppose you hire an employee who just took this course, and he says you should invest everything you have in a new facility to reap long-run efficiencies. Why might you say “no”?

This suggestion is risky. We need to know more about the market demand. We need to know whether we have increasing, constant, or decreasing returns to scale. We need to know if Wal-Mart is going to move into our market! As in real life, the best answer is this: we need more information before deciding.

5. In an online encyclopedia such as Wikipedia or Conservapedia, would you say that the marginal product of adding another contributor (editor) increases or decreases? What does that imply about the growth path of the project?

The instructor's view is that marginal product increases with each additional editor, because they can cross-link to each other's articles, discuss ideas with each other, and enjoy the cite more. On Wikipedia, about 410,000 articles were created in the first 5 years, but in the last two years 1.3 million articles have been created. We don't know how many editors they have had but I would guess that marginal product of an additional editor is greater the bigger the project is.

6. Is obtaining a medical, legal, accounting or other type of license to practice in a profession a short-run or long-run cost? Should the State require licenses for professions?

This is a long run cost. Most students said that state licensing is good. The instructor is skeptical: why not let the invisible hand handle this?

7. Suppose your classmate’s company grew and grew, until it had 1 million employees. But then the economy had a downturn, and you faced bankruptcy. You were in the legislature and your classmate begged you to sponsor legislation to give his company a special zero-interest government loan to make it through the tough times. Should you?

This was a debate topic in class, with one side arguing that if the business was valuable then private money would save it, and if not then it is a mistake to give it taxpayer's money. The other side argued that it was beneficial to the economy to save the jobs. The panel ruled against the government giving the company assistance.

Honors: 8. Suppose you invented fertilizer that is costly to make but has an ever-increasing marginal product. Suppose you own an acre of farmland in South Jersey, and now must decide between spending your money on buying more acres to use the fertilizer, or making more fertilizer. Which should you do? Explain.

9. A company’s stock price often rises when it announces taking a large one-time write-off (or loss) on its accounting books. Using one or more principles learned in this course, can you explain reasons for that effect on the stock price?

10. The tremendous economic growth of the 1980s and 1990s resulted from the “supply side” economic policies of President Ronald Reagan, which boosted production by cutting taxes and encouraging investment. Why might the supply side be more important than the demand side?

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