Problem Set 3 Answers
1. We did this one in class as a clicker question.
2. The relevant hiring criterion should be a comparison of the marginal revenue of adding a worker versus the marginal costs of adding a worker. If the MR > MC, then it makes sense to hire the worker. Diminishing returns has nothing to do with this. Diminishing returns simply means that the additional worker is not generating as much marginal revenue as the previous worker.
3. The profit-maximizing rule is not to minimize the average fixed cost of producing output. What is the profit-maximizing rule?
4. Be sure President Bruno is aware of the opportunity costs of using the land for an athletic field. What else could the college build on the land that might generate a larger payoff to the college?
5. Sunk costs should be ignored. As long as the MB > MC, the project should continue. In this case, the MB of completing the project are the (still) unrealized gains of $15 billion. The MC of completing the project are X and unknown. Thus, as long as the X < $15 billion, the project should continue.
6. We did this one in class.
7. It's all about diminishing marginal returns.
9. Graph and calculations are below.
c) profits are - $50,000.
d) since P > AVC, the firm should continue producing Q = 250 since shutting down would mean losing even more money (that is, FC = $75,000).
10. As long as P > AVC, the firm should stay open and produce where P = MR = MC. Since P = $8 and MC = $10, we know that the firm is not maximizing their profits by producing 200 units of output. Since P < MC, the firm should cut back on it production until P = MC. The new output will be between 150 and 200. The firm will not shut down.
11. Competitive Firm:
d) If price fell to $3, the firm would (temporarily) shut down and not produce any output since P = $3 is below the minimum AVC (note from the AVC column above that the minimum price the firm would need to stay open is at least $3.30--the minimum AVC).
12. Short run curves get their shapes from the productivity curves (which are governed by the concept of diminishing returns in the short run--the time period during which at least one input is fixed). The long run average cost curve gets its shape from the concept of economies of scale (which involves a proportionate change in all resources).
13. Think about the following string of equalities: P = MR = MC = ATC. What does each equality represent?
14. This is similar to #16 below except that it refers to a decreasing cost industry.
15. Think about the difference between accountants and economists in terms of defining profits.
16. We did something very similar to this one in class (it's in the powerpoint under Long Run Adjustment Process),
17. If, by monopoly, we are talking about a single-price monopolist (as opposed to one that practices price discrimination), then there is reason to believe that the monopolist is bad for the economy. Such a monopoly will cause dead-weight loss: the gain in producer surplus is less than the loss in consumer surplus.
18. Two words: entry barriers.
19. Since MC > MR, the monopolist should cut output (and thereby raise its price).
20. TR = $2000; TC = $1200; Profit = $800; The monopolist should not change its price and output because of the imposition of the lump sum tax--it's a fixed cost. Profits are simply reduced to $500.
21. Never in the elastic region of the demand curve. They will produce at the unit elastic range only if MC = 0. Otherwise, with MC > 0, a monopolist will always produce where MR = MC > 0 (and this occurs in the elastic region of the demand curve).
22. Price discrimination could be beneficial to the economy in the sense that it encourages the monopolist to eliminate dead weight loss by selling to more customers. The three conditions are in your notes.
23. Use a diagram to illustrate what's going on here. What does the MC curve look like? Where is the profit-maximizing output and price?
26. Price discrimination:
a) those who do not own a boat
c) business travelers
b) A single-price monopolist maximizes profit by selling Q = 2 (since MR < MC
for the 3rd car) at a P = $70,000. Profits are $50,000.
c) A price discriminating monopolist has an incentive to sell to all those who are willing to pay above the MC. Thus, the firm will sell to the first 4 buyers at the maximum price each is willing to pay. Thus TR=$240,000 and profits will be $110,000.
a) P2, Q2
b) P1, Q1