Problem Set 3 Answers
1. We did this one in class.
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 Scott 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. Here's the table:
7. We did this one in class.
8. It's all about diminishing marginal returns.
9. Remember to label all parts of your diagram.
10. This is an application of the shut down rule. What are the only costs that should be of concern? (We did this one in class.)
11. 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)..
12. Your coffee mug company should reduce its output below 200 units per month (since at 200 units we know that your P < MC)--but don't shut down. Even though you will still be losing money, it is better than temporarily shutting down.
13. 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).
14. 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).
15. Think about the following string of equalities: P = MR = MC = ATC. What does each equality represent?
16. This is similar to #18 below except that it refers to a decreasing cost industry.
17. Think about the difference between accountants and economists in terms of defining profits.
18. We did something very similar to this one in class (it's in the powerpoint under Long Run Adjustment Process),
19. Competitive industry:
a) P = $8.40 (Market price is the price at which quantity demanded equals quantity supplied. The firm's supply curve is the same as the MC curve above the shut-down point. When price is $8.40, each firm produces 350 units and the quantity supplied by the 1000 firms is 350,000, which matches the quantity demanded at that price.)
b) Q = 350,000
c) q = 350
d) profit = -$581
f) 750 (In the long run, price is driven to the minimum ATC, which is $10. At $10 each firm will produce 400 units. The quantity demanded is 300,000 which means there must be 750 firms.)
20. Competitive industry:
a) P = $8.40 (Fixed costs have no effect on marginal costs. Each firm's MC stays the same, thus the industry supply remains the same and the price remains at $8.40.)
b) Q = 350,000
c) q = 350
d) profit = -$1,561
f) 500 (The new long-run equilibrium price must equal the (new) minimum ATC. The rise in fixed costs changes the firm's ATC such that the minimum of the average total costs is now $12.40. At the equilibrium price of $12.40, the total quantity demanded is 225,000, and each firm produces 450. There will be 500 firms in the industry.)
21. Competitive firm
c) Output will be zero (shutdown) since P < AVC.
22. Some version of this question will probably appear on the exam. KNOW HOW TO SOLVE THIS QUESTION.
23. 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.
24. I'll let you ponder this one.
25. Two words: entry barriers.
26. 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.
27. Since MC > MR, the monopolist should cut output (and thereby raise its price).
28. 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).
29. This is for you to fill out.
30. 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.
31. 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?
32. Price discrimination:
a) those who do not own a boat
c) business travelers
b) A single-price monopolist maximizes profit by selling Q = 3
(where MR = MC) at a P = $30,000. Profits are $10,000.
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 all 5 buyers (that last buyer will be indifferent) at the maximum price each is willing to pay. Thus TR=$150,000 and profits will be $50,000.
a) P2, Q2
b) P1, Q1
35. Black Box Cable
a) P = $150 and Profit = $450,000 [ = (150)(4000) - 150,000].
b) Profit = $850,000 [ = (150)(4000) + (20)(20,000) - 150,000].
c) $400,000 (the loss in profit)
36. This same question appears on the sample exam.
37. Check your buddy's answer on this one.