Economics: Marginal Cost and Relevant Costs

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Questions and Answers

What is the primary purpose of calculating marginal cost for a business?

To reduce variable costs by cutting back on production.

To determine the total cost of production.

To account for fixed costs more accurately.

To maximize profit by optimizing pricing and production volumes. (correct)

If a company increases production by one unit, which cost is directly impacted according to the definition of marginal cost?

Opportunity cost.

Total fixed cost.

Average total cost.

Total production cost. (correct)

A construction firm has already invested $1 million in an office building and now needs an additional $0.5 million to complete. The firm is now evaluating if the sale price is worth the additional cost. What type of cost is relevant in this scenario?

Relevant cost. (correct)

Fixed cost.

Sunk cost.

Variable cost.

A clothing store is deciding whether to close some stores and rebrand. What should be considered as part of the 'relevant costs' for this decision?

Potential lost revenue from closed stores and costs of keeping them open. (B) Signup and view all the answers

What is the primary characteristic of differential cost?

It's the difference in cost between two alternative decisions. (D) Signup and view all the answers

A company has a choice between buying one of two new machines. One machine costs $10,000 and the other $12,000. What do we call the cost difference of $2000 in this scenario?

Differential cost. (C) Signup and view all the answers

In a production setting, when a manager is making decisions about product mix and pricing, which cost would be most helpful?

Marginal cost (D) Signup and view all the answers

A company is trying to decide whether to accept a special order, what would be 'relevant costs' in this situation?

Costs that are relevant to the decision such as: the production costs or opportunity costs for accepting or not. (C) Signup and view all the answers

When is the concept of differential cost most applicable?

When there are multiple options to choose from. (C) Signup and view all the answers

In the context of a hotel renovation, what does the differential cost represent?

The difference in costs between different renovation options. (B) Signup and view all the answers

According to the content, how would you describe the nature of variable costs?

Costs that fluctuate in proportion to the activity. (D) Signup and view all the answers

What defines a fixed cost within the context of business operations?

A cost that remains constant regardless of the business's activity level. (B) Signup and view all the answers

In the example given, what would be a typical variable cost?

Commissions paid to salespeople. (B) Signup and view all the answers

What is the defining characteristic of a mixed cost?

It has both fixed and variable components. (B) Signup and view all the answers

What could be an example of a differential cost when deciding between newspaper ads and social media marketing?

The difference in costs between using newspaper ads and social media marketing. (D) Signup and view all the answers

When considering driving versus taking the bus, what does differential cost entail?

The difference in variable expenses between driving and taking the bus. (B) Signup and view all the answers

Which of the following best describes a sunk cost?

A cost that has already been incurred and cannot be recovered (A) Signup and view all the answers

According to the provided information, which of the following is an example of a sunk cost?

The amount you spent to purchase a plane ticket that is non-refundable (D) Signup and view all the answers

Which statement is true regarding sunk and fixed costs?

Sunk costs are a type of fixed cost, but not all fixed costs are sunk costs. (B) Signup and view all the answers

What is the primary reason sunk costs are not considered when making future business decisions?

They are not relevant to the current or future outcomes. (B) Signup and view all the answers

What is opportunity cost?

The value of the best alternative that is not chosen when making a decision. (D) Signup and view all the answers

Using the equation provided, calculate the opportunity cost if Option A provides $10,000 return, and Option B (the one chosen) provides a return of $7,000?

$3,000 (D) Signup and view all the answers

Based on the cost information for part manufacturing, what is the total variable cost per unit?

34.00 (B) Signup and view all the answers

In the provided example of the manufacturing costs, if the company is operating at 80% capacity with no future use of the remaining 20%, which cost is considered irrelevant for deciding whether to produce additional units?

Fixed overheads (B) Signup and view all the answers

A company is deciding whether to manufacture a part or buy it. The cost to manufacture includes direct materials (Rs. 4), direct wages (Rs. 7), variable overhead (Rs. 3), and allocated fixed costs (Rs. 8). What is the total cost to manufacture one unit of the part?

Rs. 22 (D) Signup and view all the answers

Virat Mfg. Ltd. is currently operating at 80% capacity. They can purchase a part for Rs. 9.25 per unit. If they manufacture the part, their per-unit costs are: Material Rs. 4, Wages Rs. 3, and Factory Overhead Rs. 2. The company can manufacture 80,000 of these parts if operating at full capacity. If the company can only consider variable costs, what amount should be used for the 'make' cost per unit?

Rs. 9.00 (D) Signup and view all the answers

A company is considering purchasing a machine for Rs. 100,000 with an 8-year useful life and a salvage value of Rs. 12,000, or leasing it for Rs. 2,000 per month. The company can also earn 14% on investments if they don't purchase the machine. If the company does purchase, they would borrow at 10%. What is the opportunity cost using the companies usual business investment rate of purchasing the machine?

Rs. 14,000 (C) Signup and view all the answers

Ashi Ltd. is evaluating different sales mixes. To make the best decision, what type of cost information should be presented to the board?

Marginal cost of each product (B) Signup and view all the answers

Virat Mfg. Ltd., when calculating the cost of the part it produces, includes fixed costs as 20% of its total costs per unit. What is the danger of including fixed costs in a 'make or buy' calculation?

It overestimates the cost of producing the part (D) Signup and view all the answers

A company is considering leasing vs buying a machine. The company will borrow at 10% to purchase, but could otherwise invest at 14%. Which is the correct approach?

The opportunity cost should be considered. (C) Signup and view all the answers

Ashi Ltd. is deciding between multiple sales mixes for their two products. How should the company decide which is the most profitable mix?

The mix with the highest total marginal contribution should be chosen (A) Signup and view all the answers

If a company is operating at less than full capacity, and considering manufacturing a part rather than buying it, which of these factors is most important?

Relevant costs per unit (A) Signup and view all the answers

What is the marginal cost per unit for Product A?

Rs. 30 (D) Signup and view all the answers

Which of the following production plans yields the highest contribution, given the described costs and prices for products A and B?

800 units of B only (B) Signup and view all the answers

What is the total marginal cost for producing one unit of Product B?

Rs. 55 (C) Signup and view all the answers

Regarding the new machine proposal, what is the annual labor cost associated with the existing machine?

Rs. 6000 (A) Signup and view all the answers

If the existing machine produces 24 units per hour, what will be the total units produced annually if the machine works for 2000 hours?

48000 units (A) Signup and view all the answers

What is the total annual cost for consumables for the new machine?

Rs. 7500 (B) Signup and view all the answers

What is the total variable cost per unit for Product A in the second scenario?

Rs. 40 (A) Signup and view all the answers

What is the total annual power cost for the existing machine?

Rs. 2000 (D) Signup and view all the answers

Study Notes

Marginal Cost

Marginal cost is the change in total production cost resulting from one additional unit.
Calculated by dividing the change in costs by the change in quantity.
Used to find ideal production volume and pricing.
Includes the additional cost of producing a product or service.
Formula: Change in total costs / Change in quantity.
Purpose: Helps businesses optimize production, set prices, and maximize revenue.

Relevant Costs

Relevant costs are costs applicable to a specific business decision.
They are avoidable costs used in decision-making.
Eliminate unnecessary data, making the process more efficient.
Example: Construction firms deciding if completing a building is worth it based on current market values.
Example: Clothing stores considering closing stores and rebranding.
Example: Businesses deciding if a special order is worthwhile based on capacity, profitability, and long-term implications.

Differential Cost

Differential cost represents the difference between the costs of two alternative decisions.
Occurs when a business faces several similar options and must choose one.
Used to compare multiple options and select the best one.
Useful for step costing situations (add'l cost of producing one extra unit).
Two examples include whether a business should choose newspaper ads or social media ads; and if a hotel room should be renovated into a guest bedroom or gift shop

Sunk Cost

Sunk costs are past costs that cannot be recovered.
Not included in future decision-making.
Fixed costs are not always sunk costs, but sunk costs are always fixed costs.
Example: Driving 100 miles to a concert and realizing the artist isn't performing. The drive is a sunk cost.

Opportunity Cost

Opportunity cost is the value of the next best alternative not chosen.
Critical to business decision-making (part of CBA).
Formula: Return from option not chosen - return from option chosen.
Example: Choosing to invest in new equipment versus investing in stock market.

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Description

This quiz explores critical concepts in economics, focusing on marginal cost, relevant costs, and differential cost. You'll learn how these concepts aid businesses in decision-making, production optimization, and pricing strategies. Test your knowledge on how these costs influence economic decisions!