Practice problems

1. The sole proprietor of the "Books and More" bookstore receives all accounting profits earned by her firm and a $28,000-a-year salary she pays herself. She has a standing salary offer of $35,000 a year if she agrees to work for a large corporation. If she had invested her capital outside her own company, she estimates that would have returned $22,000 a year. Last year, her accounting profit was $50,000. What was her economic profit?

2. In his spare time, Shelby Williams makes chain mail using metal rings he buys from a hardware store, a C-clamp, and a pair of pliers. He sells the final product at local crafts fairs and at bikers' annual convention in Sturgis, SD. Being interviewed once by a local newspaper, he said literally the following: "The materials cost me $30, and the rest is just my labor, which is free. One vest sells for about $150, which gives me net profit of $120 for three nights of work."

a. Is he talking about economic profit or accounting profit? Explain the difference between the two.

b. Discuss Shelby's statement from an economic perspective (taking the opportunity cost into account, that is).

c. If Shelby talks his girlfriend into joining him in his hobby and buys another set of tools, would you consider it the short run or the long run decision? Explain the difference between the two.

3. Your firm has discovered a cheap and efficient technology of turning used plastic bottles and bags into various products. You limit your attention to the following two production opportunities: you can produce plastic utensils or helmets for Boilermakers' fans (sorry Ichabods - this problem was written back at Purdue). In the first case your estimated annual revenue is $25,000, while the production will cost you $8,000. However, in your second option, you expect to sell 2000 helmets every year at $10 each, and the average total cost of every helmet will be $2.

a. Which production opportunity will you choose and why?

b. If you do so, what will be your economic profit?

4. Kendra and Steve run their own business. Every Friday they take two gas grills and grill burgers in front of the Memorial Union. Working from noon till 6pm, they are able to serve 250 hungry customers. They are both equally good in what they are doing, so their wages are equal.
One day Steve was not feeling well, so Kendra had to go there alone. Of course, she has chosen to use only one grill. Within the same period of time she was able to serve 120 customers.

a. What has happened to the average cost of each burger? Show your work.

b. What can be said about the returns to scale for their business? Explain.

5. If a firm makes zero economic profit, then the firm
a) earns revenue that exceeds its economic costs.
b) must shut down.
c) can be earning positive accounting profit.
d) has no fixed costs.

6. True or False? The concept of economies of scale cannot be applied to the short run.

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