METU
Department of Economics
Econ 210: Principles of Economics
Section All
Spring 2025-2026
Problem Set 6 Solutions
Review
The Behavior of Profit Maximizing Firm
Profit (economic profit): The difference between total revenue and total
cost.
profit = total revenue − total cost
Total Revenue: The amount received from the sale of the product.
total revenue = quantity × price
Total (economic) cost: The total of out-of-pocket costs and opportunity cost
of all factors of production.
total cost = explicit cost + implicit cost
Short run versus Long Run
Short Run: The period of time for which two conditions hold: The firm is
operating under a fixed scale (fixed factor) of production, and firms can
neither enter nor exit an industry.
Long Run: That period of time for which there are no fixed factors of
production: Firms can increase or decrease the scale of operation, and new
firms can enter, and existing firms can exit the industry.
The Production
Marginal Product: The additional output that can be produced by adding
one more unit of a specific input, ceteris paribus.
Law of Diminishing Returns: When additional units of a variable input are
added to fixed inputs, after a certain point, the marginal product of the
variable input declines.
Average Product: The average amount produced by each unit of a variable
factor of production.
Costs
Fixed Cost: Any cost that does not depend on the firms’ level of output.
These costs are incurred even if the firm is producing nothing. There are no
fixed costs in the long run.
Variable Cost: A cost that depends on the level of production chosen.
Total Cost (TC): Total fixed costs plus total variable costs.
total cost = total fixed cost + total variable cost
Total Fixed Costs (TFC): The total of all costs that do not change with
output even if output is zero.
Average Fixed Cost (AFC) Total fixed cost divided by the number of units
of output; a per-unit measure of fixed costs.
Total Variable Cost (TVC): The total of all costs that vary with output in the
short run.
Average Variable Cost (AVC): Total variable cost divided by the number of
units of output
Average Total Cost (ATC): Total cost divided by the number of units of
output
average total cost = average fixed cost + average variable cost
Marginal Cost (MC): The increase in total cost that results from producing 1
more unit of output. Marginal
costs reflect changes in variable costs.
Economies of Scale: Economies of scale refers to the phenomenon
where the average costs per unit of output decrease with the increase in
the scale or magnitude of the output being produced by a firm
Diseconomies of Scale: Diseconomies of scale occur when a business
expands so much that the costs per unit increase. It takes place when
economies of scale no longer function.
Part A: Short Questions
Q1: Define the following terms:
a) Total Revenue, Explicit Cost, Implicit Cost, Total Cost
Total Revenue: The amount received from the sale of the product.
Total Revenue = Quantity x Price
Explicit costs require an outlay of money, e.g., paying wages to workers.
Implicit costs do not require a cash outlay, e.g., the opportunity cost of the
owner’s time.
Total (economic) cost: The total of out-of-pocket costs and opportunity cost
of all factors of production.
Total Cost = Explicit Cost + Implicit Cost
b) Accounting Profit, Economic Profit
Accounting profit = total revenue minus total explicit costs
Economic profit = total revenue minus total costs (including explicit and
implicit costs)
c) Marginal Product, Average Product, Law of Diminishing Return
Marginal Product: The additional output that can be produced by adding
one more unit of a specific input, ceteris paribus.
Law of Diminishing Returns: When additional units of a variable input are
added to fixed inputs, after a certain point, the marginal product of the
variable input declines.
Average Product: The average amount produced by each unit of a variable
factor of production.
d) Fixed Cost, Variable Cost, Total Cost, Total Fixed Cost, Average Fixed
Cost, Average Variable Cost, Average Total Cost, Marginal Cost
Fixed Cost: Any cost that does not depend on the firms’ level of output.
These costs are incurred even if the firm is producing nothing. There are no
fixed costs in the long run.
Variable Cost: A cost that depends on the level of production chosen.
Total Cost (TC): Total fixed costs plus total variable costs.
total cost = total fixed cost + total variable cost
Total Fixed Costs (TFC): The total of all costs that do not change with
output even if output is zero.
Average Fixed Cost (AFC): Total fixed cost divided by the number of units
of output; a per-unit measure of fixed costs.
Total Variable Cost (TVC): The total of all costs that vary with output in the
short run.
Average Variable Cost (AVC): Total variable cost divided by the number of
units of output
Average Total Cost (ATC): Total cost divided by the number of units of
output
Marginal Cost (MC): The increase in total cost that results from producing 1
more unit of output. Marginal costs reflect changes in variable costs.
Part B: Problems
Q1: Rosa Diaz is considering opening a beauty salon. She anticipates the
following annual costs:
Furniture: $ 20,000 Rent: $ 12,000
Equipment: $ 14,000 Coloring and styling products: $ 10,000
Additionally, Rosa is withdrawing $34,000 from her savings account that
pays 4% interest per year to purchase the furniture and equipment; she will
quit her current job that pays $25,000 per year. She expects total revenues
from the new business in the first year to be $70,000. Calculate the
following:
i. Explicit costs (list the items) and Implicit costs (list the items).
ii. Accounting profit and Economic profit.
iii. Given this first-year information only, should Rosa open a salon?
Solution:
i. Explicit costs: furniture, equipment, rent, coloring and styling products
20,000 + 14,000 + 12,000 + 10,000 = 56,000
Implicit costs are: lost income ($25,000) and lost interest (0.04 × $34,000)
25,000 + 1,360 = 26,360
ii. Accounting profit is: revenue minus explicit costs.
70,000 − 56,000 = 14,000
Economic profit is: revenue minus explicit and implicit costs.
70,000 − 56,000 − 26,360 = −12,600
iii. Economic profit is negative, so Rosa should not open the salon.
Part C: Multiple Choice Questions
Q1: Accounting profit is equal to:
a. implicit revenue minus implicit costs.
b. explicit revenue minus explicit measurable costs.
c. explicit revenue minus implicit and explicit costs.
d. implicit and explicit revenues minus implicit costs.
Q2: A business owner makes 50 items by hand in six hours. She could
have earned $10 an hour working for someone else. If each item sells for
$5 and the explicit costs total $14, economic profit equals:
a. $ 0. c. $ 176.
b. $ 74. d. $ 236.
Q3: Rachel left her job as a graphic artist, where she earned $42,000 per
year, to open her own graphic arts firm. Her explicit costs for her new
business include:
a. only the expenses incurred for office space, equipment, and supplies.
b. only her forgone salary of $42,000 per year.
c. both the expenses incurred for office space, equipment, and supplies
and her forgone salary of $42,000 per year.
d. neither the expenses incurred for office space, equipment, and supplies
nor her forgone salary of $42,000 per year
Q4: In the short run:
a. all inputs are variable.
b. firms can use any input combination they want.
c. firms can choose among all possible production techniques.
d. some inputs are fixed.
Q5: In the long run:
a. no inputs can be varied, and all inputs are fixed.
b. some inputs can be varied, and some inputs are fixed.
c. some inputs can be varied, and no inputs are fixed.
d. all inputs can be varied, and no inputs are fixed.
Q6: A regional airline owns 10 aircraft and employs 20 pilots. The airline
makes an average of three trips per day with each of its 10 aircraft. The
aircraft and their ground crews are idle part of the day. Minimum rest
requirements for its pilots mean that if the airline wants to increase its
flights, it must hire more pilots. The decision to hire more pilots is:
a. a short-run decision because the number of aircraft is held constant
while the labor input is changed.
b. a short-run decision because the number of pilots is being increased; if
the number of ground crew were decreased instead, it would be a long-run
decision.
c. a long-run decision because hiring pilots will increase revenues over a
long period of time for the airline.
d. a long-run decision because customers will become accustomed to the
new flight schedule
Q7: Refer to the graph shown. Marginal product is negative at point:
a. A. c. C.
b. B. d. D.
Answer the questions 9 – 11 according to the table.
Q9: Refer to the table. If the average product is 8, the number of workers
is:
a. 2. c. 6.
b. 4. d. 8.
Q10: Refer to the table. A firm would be most likely to hire between:
a. 1 and 3 workers.
b. 3 and 4 workers.
c. 5 and 8 workers.
d. 8 and 10 workers.
Q11: Refer to the table. When average product is 8, total output is:
a. 20. c. 40.
b. 32. d. 48.
Q12: Refer to the graph. Within which section(s) of the production function
is marginal product increasing?
a. A c. C
b. B d. B and C
Q14: Average fixed cost:
a. remains constant and doesn't vary with output.
b. increases as output increases.
c. decreases as output increases.
d. equals total cost divided by output.
Q15: The vertical distance between the average total cost curve and the
average variable cost curve is:
a. marginal cost.
b. average fixed cost.
c. total fixed cost.
d. total cos
Answer the questions 16 – 18 according to the graph.
The following graph shows average fixed costs, average variable costs,
average total costs, and marginal costs of production.
Q16: Marginal cost is minimized when output equals:
a. 6 units.
b. 12 units.
c. 21 units.
d. 25 units.
Q17: Average variable cost is minimized when output equals:
a. 12 units.
b. 6 units.
c. 21 units.
d. 25 units.
Q18: The distance EF represents:
a. average variable cost.
b. average total cost.
c. average fixed cost.
d. marginal cost.
Q19: The marginal cost curve:
a. first rises and then declines.
b. rises when the average total cost curve lies above the average variable
cost curve.
c. rises when the point of diminishing marginal productivity is reached.
d. declines until average total cost increases.
Q20: The minimum point of the average variable cost curve is reached at
the output level where:
a. marginal product is maximized.
b. neither marginal nor average product is maximized.
c. average product is maximized.
d. average and marginal products are maximized.
Q21: The marginal cost curve intersects the:
a. total cost curve at its minimum point.
b. variable cost curve at its minimum point.
c. average variable cost curve at its minimum point.
d. average fixed cost curve at its minimum point.
Q22: A firm can use 50 workers and 10 machines, 70 workers and 9
machines, or 75 workers and 9 machines to produce 40 chairs. If each
worker costs $20 and each machine is rented for $500, the economically
efficient input combination is:
a. 50 workers and 10 machines.
b. 70 workers and 9 machines.
c. 75 workers and 9 machines.
d. 120 workers and 19 machines.
Q23: Which of the following is most likely to be an example of economies of
scale?
a. The per-unit costs on Excel Publishing Company's manuals fall because
it adopted a new technology after receiving a large order from the
government.
b. Alpha-Beta Inc. raised its price by 10 percent after a 5 percent increase
in production costs.
c. Widget Manufacturing doubled its production by opening a new plant that
was identical to its old plant.
d. The XYZ Co. increased production 25 percent after a 30 percent
increase in all inputs
Q24: Economies of scale occur when a firm's long-run average total cost
curve is:
a. upward-sloping.
b. vertical.
c. downward-sloping.
d. horizontal.
Q25: If the demand for flat screen television sets is rising while at the same
time the price of a flat screen TV is falling, there is evidence of:
a. economies of scale.
b. diseconomies of scale.
c. constant returns to scale.
d. diminishing marginal product.