Question

One common, though tragic, phenomenon that occurred during the Great Recession of the late 2000s was homes that were “underwater,” where people took out mortgage loans to buy a house at a particular price before the recession, but later the home’s value dropped below the amount still owed. People might argue that a home’s value should never go “under water,” that the value of a home should never dip below its original purchase price as long as the home has not deteriorated sufficiently. Why, however, is it illogical to dismiss the possibility of a home’s current value dropping below its original purchase price? Select one:

a. The current market value of the home is considered a sunk cost and should be ignored (even if its price fluctuates); the original purchase price represents the true value of the home throughout its expected lifetime, even if it undergoes multiple resellings.

b. As time goes on, inflation causes future prices to drop, so current value can be less than the purchase price if the value of the dollar drops. The current price, though, does not accurately reflect the home's true market value.

c. The original purchase price of a home is a sunk cost and does not have any bearing on the home's current market value or price.

d. Future property taxes always put downward pressure on the value of homes, so the current value is usually below the original purchase price because of these expected future tax payments.

You have collected the following data on output and total variable costs:

Q TVC

1 533

2 1024

3 1491

4 1952

5 2425

6 2928

7 3479

8 4096

9 4797

10 5600

Over what range of output does this firm exhibit increasing returns (increasing MPMP), and diminishing returns (decreasing MPMP)? Select one: a. Increasing returns for output levels at 2 and higher, and decreasing returns for output levels at 3 and lower. b. Increasing returns for output levels at 4 and lower, and decreasing returns for output levels at 5 and higher. c. Increasing returns for output levels at 6 and lower, and decreasing returns for output levels at 7 and higher. d. Marginal costs are always less than fixed costs, so increasing returns is experienced over the whole range of output.

a. Increasing returns for output levels at 2 and higher, and decreasing returns for output levels at 3 and lower.

b. Increasing returns for output levels at 4 and lower, and decreasing returns for output levels at 5 and higher.

c. Marginal costs are always less than fixed costs, so increasing returns is experienced over the whole range of output.

d. Increasing returns for output levels at 6 and lower, and decreasing returns for output levels at 7 and higher.

Answer 1

(Question 1) Option (3)

Original purchase price of a house cannot be changed irrespective of future courses of actions/events, so this is a sunk cost. Therefore current market value, as long as it is above zero, is always a gain.

(Question 2) Option (d)

AVC = TVC/Q, computed as follows.

Q	TVC	AVC
1	533	533
2	1024	512
3	1491	497
4	1952	488
5	2425	485
6	2928	488
7	3479	497
8	4096	512
9	4797	533
10	5600	560

AVC is minimum (= 485) when Q = 5. Since minimum point of ATC is to the right of the minimum point of ATC, the ATC must be minimum when Q = 6 (output level from which AVC starts rising). Since a decreasing ATC signifies economies of scale and increasing returns, there are increasing returns when 1 < Q <= 6, and since increasing ATC signifies diseconomies of scale and decreasing returns, there are decreasing returns when Q > 7.