Applications of Cost Theory
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1. The greater the output sold, the greater the DOL.
2. A cubic function, a polynomial of degree 3, is U-shaped.
3. If the total cost function is cubic, the marginal cost function is quadratic.
4. The "Survivorship Technique" for finding the least cost size is to examine machinery closely.
5. After estimating a TC regression, with independent variables of
, we discover that the quadratic and cubic terms were statistically insignificant, whereas the coefficient on
was positive and significant. We conclude, therefore,
a. that average cost is constant.
b. that TC is linear.
c. that there are no noticeable increasing returns to scale.
d. all of the above.
6. Total cost is estimated using a quadratic form: TC =
The regression results were presented as follows:
R-square = 0.96
Adj R-square = 0.95
According to the results,
a. total cost is linear.
b. at an output of 10, total cost is 400.
c. at an output of 10, average total cost is 47.
d. at an output of 10, fixed cost (500) is not statistically significant.
7. Your firm manufactures air compressors. You must predict operating profits for the next year, but you anticipate a modest recession. In the past, mild recessions have led to a 10% reduction in quantity of compressors sold. You predict that operating profits will
a. fall by 10%, regardless of the degree of operating leverage.
b. fall by less than 10%, because your firm uses some fixed costs.
c. fall by 13.5% if the degree of operating leverage is 1.35.
d. fall by 21.3% if the degree of operating leverage is 0.213.
8. Operating profits have been highly volatile in the department store industry. As an intern for a department store management headquarters, what would you do to
the volatility of operating profits?
a. Increase the proportion of costs called fixed costs
b. Identify ways to change fixed costs into variable costs, through short term leases, so that costs can be reduced when store sales slack off
c. Reduce the quantity of products sold, as
appears in the degree of operating profit formula (
d. All of the above.
9. WhizKids offers computer classes to children between the ages of 6 through 14. Analysis of the cost structure shows that the fixed costs are $1300 per month, the variable cost per child is $9 per hour, and the price per hour is set at $15. What is the break-even number of hours of instruction sold per month?
a. 216.66 hours per month
b. 86.67 hours per month
c. 144.44 hours per month
d. 206.66 hours per month
10. Harris Corporation has annual fixed costs of $12 million. Its variable cost ratio is 0.60. Determine the company's break-even dollar sales volume.
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