These are original Marlbridge practice questions, not past exam questions. The mark points are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. All firms and data are fictional. A four-function calculator is enough. Unless a question says otherwise, each firm sells at a market price it cannot change, and it has already chosen its output where MR = MC.
Question 1 (multiple choice · foundation)
A firm sells its product at a market price of $9. At the output where MR = MC, its average variable cost is $11 and its average total cost is $15. Which statement correctly describes the firm’s best short-run decision and the reason for it?
- (A) Keep producing, because any revenue helps cover the fixed cost.
- (B) Shut down, because the price is below average variable cost.
- (C) Shut down, because the price is below average total cost.
- (D) Keep producing, because the firm must pay its fixed cost in the short run anyway.
Answer and explanation
Answer: (B). The price ($9) does not cover the variable cost of each unit ($11). Each unit adds $2 to the loss, so shutting down (loss = TFC) is better.
- (A) ignores variable cost. Revenue only helps with fixed cost after it has covered variable cost, and here it does not.
- (C) has the right action but the wrong test. A price below ATC means a loss, but a firm with P between AVC and ATC should keep producing.
- (D) is true about fixed cost but draws the wrong conclusion: because it is paid either way, only P versus AVC matters.
Question 2 (multiple choice · core)
At its best output, a firm has total revenue of $5,000, total variable cost of $3,800 and total fixed cost of $2,000 per week. What should it do in the short run, and what is its weekly result?
- (A) Produce; a loss of $800
- (B) Shut down; a loss of $2,000
- (C) Produce; a profit of $1,200
- (D) Shut down; a loss of $800
Answer and explanation
Answer: (A). TR ($5,000) > TVC ($3,800), so the firm should produce. Result = $5,000 − $3,800 − $2,000 = −$800. Shutting down would give −$2,000, so producing saves $1,200.
- (B) shuts down because there is a loss, but this loss is smaller than the fixed cost.
- (C) forgets the fixed cost: $1,200 is TR − TVC, the amount that goes towards fixed cost, not the profit.
- (D) pairs the wrong action with the result of producing. A firm that shuts down loses its whole fixed cost, $2,000.
Question 3 (multiple choice · core)
In a market with no barriers to entry or exit, the typical firm earns a positive accounting profit but expects an economic loss to continue. What is most likely to happen in the long run?
- (A) Some firms leave the market.
- (B) New firms enter, because accounting profit is positive.
- (C) Firms stay forever, because their fixed costs are already paid.
- (D) Nothing changes, because firms only respond to losses in the short run.
Answer and explanation
Answer: (A). An economic loss means the owners could earn more by using their resources elsewhere. In the long run all costs can be avoided, so some firms exit.
- (B) uses accounting profit. Firms respond to economic profit, which includes the implicit cost of the owners’ time and money.
- (C) confuses the short run with the long run. In the long run leases end and equipment can be sold.
- (D) has it backwards: the long run is when firms can leave.
Question 4 (calculation · core)
Selby Brickworks, a fictional firm, sells pallets of bricks at the market price. Its fixed cost is $120 per day, and its kilns can make at most 7 pallets per day.
| Pallets per day (Q) | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
|---|---|---|---|---|---|---|---|---|
| TVC ($) | 0 | 50 | 90 | 120 | 160 | 210 | 270 | 340 |
(a) Calculate MC, AVC and ATC for each output. Give ATC to 2 decimal places where needed. (b) State the shutdown price and the break-even price. (c) The price is $55. Find the best output, the result, and whether Selby should produce or shut down. (d) The price falls to $35. What should Selby do, and what is its result? (e) The price rises to $75. Find the best output and the result.
Worked solution
(a)
| Q | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
|---|---|---|---|---|---|---|---|
| MC ($) | 50 | 40 | 30 | 40 | 50 | 60 | 70 |
| AVC ($) | 50 | 45 | 40 | 40 | 42 | 45 | 48.57 |
| ATC ($) | 170 | 105 | 80 | 70 | 66 | 65 | 65.71 |
(b) Shutdown price = minimum AVC = $40. Break-even price = minimum ATC = $65.
(c) MC is at or below $55 up to the 5th pallet ($50); the 6th has MC = $60 (MC is rising). Best output = 5 pallets. TR = $275; TVC = $210; TC = $330. Result = −$55. TR > TVC (P = $55 > AVC = $42), so produce: −$55 is better than −$120.
(d) $35 is below the minimum AVC ($40), so TR < TVC at every output (for example, 3 pallets: TR = $105, TVC = $120). Shut down; result = −$120.
(e) MC is at or below $75 up to the 7th pallet ($70), the most Selby can make. Best output = 7 pallets. TR = $525; TC = $460. Profit = $65.
Suggested mark points (5): 1 for the MC, AVC and ATC rows; 1 for both prices; 1 for 5 pallets and −$55 with the decision to produce; 1 for shutting down at $35 with a loss of $120; 1 for 7 pallets and a profit of $65.
Question 5 (graph · core)
A price-taking firm faces a market price that is above its minimum average variable cost but below its minimum average total cost.
(a) Draw a correctly labelled graph showing the firm’s MC, ATC and AVC curves and the price line (MR = P). Label the firm’s best output Qf. (b) Shade the area that shows the firm’s economic loss. (c) Explain whether the firm should produce or shut down in the short run. (d) Explain what you expect the firm to do in the long run if the price does not change.
Model answer and suggested Marlbridge rubric
(a) Vertical axis: “Price and cost ($ per unit)”. Horizontal axis: “Quantity”. Draw U-shaped ATC and AVC curves, AVC below ATC, with MC rising through the minimum of each. Draw a horizontal line labelled MR = P between the two minimums. Mark Qf where MC crosses MR = P on the rising part of MC.
(b) Shade the rectangle with width Qf and height from P up to ATC at Qf. Its area = (ATC − P) × Qf, the economic loss.
(c) Produce. At Qf the price is above AVC, so TR > TVC. Revenue covers all variable costs and part of the fixed cost, so the loss is smaller than TFC, the loss from shutting down.
(d) In the long run all costs are avoidable. The price is below ATC, so the firm makes an economic loss, and its owners can earn more elsewhere. If the price is expected to stay there, the firm will exit the market.
| Point | What earns it |
|---|---|
| 1 | Axes labelled; MC passes through the minimums of AVC and ATC |
| 1 | MR = P drawn between minimum AVC and minimum ATC, with Qf where rising MC = MR |
| 1 | Loss rectangle shaded between P and ATC at Qf |
| 1 | Produce in the short run, because P > AVC (TR > TVC) |
| 1 | Exit in the long run, because P < ATC (expected economic loss) |
Do not award the second point if Qf is placed where MR = P crosses ATC or AVC.
Question 6 (constructed response · core)
Brightwater Laundrette, a fictional business, has one year left on the lease for its premises. Its yearly figures are:
- Total revenue: $210,000
- Explicit variable costs (staff, water, electricity, detergent): $150,000
- Explicit fixed costs (lease and machine loan repayments, which must be paid this year whatever happens): $36,000
- The owner does not work in the business, but has $400,000 of her own money tied up in machines. It could earn 8% a year in her next-best use, and the machines cannot be sold this year.
(a) Calculate the implicit cost, the accounting profit and the economic profit. (b) Should the laundrette operate or shut down this year? Support your answer with the result of each choice. (c) Explain what the owner should do when the lease ends, if these figures are expected to continue. (d) In another town, laundrettes earn economic profits and there are no barriers to entry. Explain what you expect to happen there.
Model answer and suggested Marlbridge rubric
(a) Implicit cost = 8% × $400,000 = $32,000. Accounting profit = $210,000 − $150,000 − $36,000 = $24,000. Economic profit = $24,000 − $32,000 = −$8,000 (an economic loss).
(b) Operate. TR ($210,000) > TVC ($150,000). Operating gives a result of −$8,000. Shutting down would still leave the lease, loan repayments and tied-up money, a result of −($36,000 + $32,000) = −$68,000. Operating is $60,000 better, which equals TR − TVC.
(c) When the lease ends, all costs become avoidable. TR ($210,000) is below total economic cost ($218,000), so the owner does better by selling the machines and investing elsewhere. She should exit, even though the accounting profit is positive.
(d) Economic profit means resources earn more in laundrettes than in their next-best use. With no barriers, new laundrettes enter that town.
| Point | What earns it |
|---|---|
| 1 | Implicit cost $32,000 and accounting profit $24,000 |
| 1 | Economic profit −$8,000 |
| 1 | Operate, because TR > TVC, with both results (−$8,000 and −$68,000) |
| 1 | Exit in the long run, because of the expected economic loss despite the accounting profit |
| 1 | Entry in the other town, linked to economic profit and the absence of barriers |
Question 7 (explanation · stretch)
Use Selby Brickworks from Question 4.
(a) Explain why fixed cost is left out when a firm decides whether to shut down in the short run. (b) Selby’s landlord doubles the rent, so the fixed cost rises from $120 to $240 per day. Does the shutdown price change? Does the break-even price change? Explain, with a calculation of ATC at 6 pallets. (c) After the rent rise, the price is $55. Find Selby’s best output and result, and state its short-run decision. (d) Explain the difference between Selby shutting down and Selby exiting the market.
Model answer and suggested Marlbridge rubric
(a) In the short run the fixed cost must be paid whether the firm produces or not. It is the same under both choices, so it cancels out of the comparison. Only revenue and variable cost differ between the choices.
(b) The shutdown price does not change. AVC depends only on variable cost, so minimum AVC is still $40. The break-even price rises. ATC rises at every output; at 6 pallets ATC = ($240 + $270) ÷ 6 = $85, up from $65. The firm now needs a higher price to cover all its costs. (Minimum ATC is now at 7 pallets, $580 ÷ 7 ≈ $82.86, so that is the new break-even price, not $85.)
(c) MC is unchanged, so the best output at $55 is still 5 pallets. TR = $275; TC = $240 + $210 = $450. Result = −$175. TR ($275) > TVC ($210), so produce: −$175 is better than shutting down, which loses $240.
(d) Shutting down is a short-run choice to produce zero while still paying $240 a day in rent. Exiting is a long-run choice, made when the lease ends, to leave the market and stop paying all costs. At $55, Selby expects an economic loss, so it should plan to exit if the price does not rise.
| Point | What earns it |
|---|---|
| 1 | (a) fixed cost is paid under both choices, so it does not affect the decision |
| 1 | (b) shutdown price unchanged at $40, because AVC is unchanged |
| 1 | (b) break-even price rises, with ATC at 6 pallets = $85 |
| 1 | (c) 5 pallets, −$175, produce |
| 1 | (d) shutdown is short run with fixed cost still paid; exit is long run with no costs |
How did you do?
- Q1, Q2 or Q4 wrong: re-read “The short-run decision: produce or shut down” and Worked example 1 in the study guide. Compare TR with TVC, not TC.
- Q3 or Q6 wrong: re-read “The long-run decision: enter or exit” and Worked example 2. Use economic profit.
- Q5 marked down: check Figure 1: MC must pass through the minimums of AVC and ATC.
- Q7 incomplete: re-read the table of shutdown versus exit at the top of the guide.
Then tick off the topic checklist.