# Practice Test-2 on Costs of Production: Solutions

Question 1: Lisa used to work as a high school teacher for \$44,000 per year but quit in order to start her own catering business. To buy necessary equipment, she withdrew \$22,000 from her savings, (which paid 3% interest) and borrowed \$33,000 from her cousin, whom she pays 4% interest per year. Last year she paid \$28,000 for ingredients and had revenue of \$65,000. She asked Mike the accountant and Phil the economist to calculate her profits.
1. Lisa's accounting profits are \$35,660, and his economic profits are −\$5,000
2. Lisa's accounting profits are \$35,680, and his economic profits are −\$8,980
3. Lisa's accounting profits are \$35,680, and his economic profits are −\$9,000
4. Lisa's accounting profits are \$35,700, and his economic profits are −\$8,980
The accounting profit = Revenue − Explicit Costs.
Revenue = \$65,000, while Explicit Costs = \$28,000 + \$1320 (interests she has to pay to her cousin)
So, accounting profit = \$60,000 − \$29,320 = \$35,680.
The economic profit = Revenue − All Costs including implicit cost
But if she didn't start her business, she would have earned \$44,000, plus \$660 from interests from her savings (implicit costs)
Therefore, the economic profit = \$35,680 − \$44,000 − \$660 = −\$8,980
In this case, she lost \$8,980.

Question 2: A production function is a relationship between inputs and .......
1. profit
2. costs.
3. revenue.
4. quantity of output.

Question 3: Omar owns and manages a cleaning services company in Dubai. He can schedule 20 "housecleaning" per day. He is considering hiring additional cleaner Amy to work for him. Both he and Amy can visit 35 houses per day. What is Amy's marginal product?
1. \$15
2. \$35
3. \$20
4. \$25

Question 4: The marginal product of labor is equal to the .............
1. increase in labor necessary to generate a one unit increase in output. .
2. increase in output obtained from a one unit increase in labor
3. incremental cost associated with a one unit increase in labor.
4. incremental profit associated with a one unit increase in labor

Question 5: Suppose a manufacturing plan is able to produce 250 units of laptops per day when 25 workers are hired.
The plant is able to produce 260 laptops per day when 26 workers are hired (holding other inputs fixed). In this case,the marginal product of the 16th worker is ..................
1. 10.
2. 11.
3. 12
4. 13
5. 14

Explanation:
10 units. 25 workers produce 250 units per day. When 1 additional worker is hired 19 extra laptops are produced.
This change in output of 10 units is the marginal product of this extra worker.

Question 6: When adding another unit of labor leads to an increase in output that is smaller than the increases in
output that resulted from adding previous units of labor, the firm is experiencing ..................
1. diminishing output.
2. diminishing marginal product
3. negative marginal product. .
4. diminishing labor.

Question 7: Suppose Harry started up a diet coffee shop stand last month.
Variable costs for Harry's coffee shop stand now include the cost of ..........
1. hiring an artist to design a logo for his sign.
2. selling the coffee shop stand. .
3. coffee beans.
4. All of the above

Question 8: Which of the following is the best example of a variable cost?
1. annual property tax payments for a building.
2. monthly rent payments for a commercial apartment
3. annual insurance payments for a commercial apartment.
4. monthly salary payments for hired labor

Question 9: In a local handmade leather accessories shop, the total cost of producing 75 handmade wallets is \$500. The marginal cost of producing the 76th wallet is \$7.
We can conclude that the ...............................
1. average variable cost of 76 wallets is \$6.67
2. average variable cost of 76 wallets is \$7.67
3. average variable cost of 76 wallets is \$5.67
4. average variable cost of 76 wallets is \$8.67

Explanation:
\$500 + \$7 = \$507; average variable cost of 76 wallets is = \$507 / 76 = \$6.67

Question 10: Adam's Bike startup company has total fixed costs of \$200,000 per year. The company's average variable cost is \$50 for 15,000 bikes. At that level of output, the company's average total costs wouod be ..............
1. \$63.55
2. \$63.33
3. \$64.33
4. \$66.53