1. Suppose that a young chef opened his own restaurant. To do so, he quit his job, which was paying $36,000 per year; cashed in a $6,000 certificate of deposit that was yielding 5% (to purchase equipment); and took over a building owned by his wife which had been rented out for $3,000 per month. His expenses for the first year amounted to $60,000 for food, $40,000 for extra help, and $7,000 for utilities. The chef is trying to figure out whether he would have been better off not being in business last year. He knows how to calculate his revenues, but he needs help with the cost side of the picture. What were the chef's total economic costs?
2. A business executive claims a company should never hire another worker if the new person causes diminishing returns. Explain why this person is wrong.
3. "My overhead (fixed cost) at this car dealership is $4,000 per day. So I figure that the best way to make the most money is to sell as many cars as possible, thereby spreading out the overhead so it is only a small part of the cost on each car sold." What is wrong with the reasoning of this person?
4. You are the adviser to President Scott of Marietta College. A wealthy alumnus buys, then gives a plot of land to the college for use as an athletic field. The president says that, as far as the land is concerned, it does not cost the college anything to use the land as an athletic field. What do you say?
5. Several years ago, Congress authorized development of the Z-13 bomber, based on a cost estimate of $10 billion and a benefit estimate of $15 billion. The benefit estimate appears to be correct, but costs to date total $20 billion, and the plane still is not ready. The cost of completing the project, X, is uncertain. Congressman Jones wants to stop now: "Whatever the value of X, it is clear that the Z-13 will yield negative net benefits." Congresswoman Smith wants to continue: "If we stop now, we will have wasted $20 billion." Comment. How should the decision depend on the value of X?
6. The following table shows some of the long-run costs for the American Production Company. Fill in the missing values.
| Output | Total Cost | Average Cost | Marginal Cost |
| 50 | $1000 | --- | |
| 51 | $52,000 | ||
| 52 | $1038 | ||
| 53 | $5000 |
7. What determines the shape of the short run MC curve? Explain.
8. The Preservation Embalming Company's cost data have been partially entered in the table below. Following the sudden and unexpected death of the company's accountant, you are called on to fill in the missing entries.
| Bodies Embalmed | TC | FC | VC | ATC | AVC | AFC | MC |
| 0 | 24 | ||||||
| 1 | 16 | ||||||
| 2 | 50 | ||||||
| 3 | 108 | ||||||
| 4 | 52 | ||||||
| 5 | 39.2 | ||||||
| 6 | 47 |
9. Draw a diagram showing a competitive firm operating at a loss in the short run. Identify the loss. Identify the loss the firm would incur if it shut down and explain why the firm continues to operate.
10. Suppose that you own a house that you are planning to be away from for one year. In a typical month when the house is occupied, you pay $175 in utility bills and $125 in taxes. If the house is vacant, the utility bills fall to $100, but the tax bill remains the same. Somebody wants to rent your house from you while you are away. What is the minimum monthly rent she would have to pay before you would agree?
11. A competitive firm is maximizing profits by
producing 250 units of output at the current market price of
$1000 per unit. The firm has AFC of $300 and total costs of
$300,000 at this output level.
a) Draw a graph showing all the relevant cost and demand curves.
That is, include the MR, MC, AVC, and ATC curves.
b) Calculate FC, VC, ATC, AVC, MC, TR, and MR.
c) Calculate and indicate the area of profits on your graph.
d) In light of your answer above, does it make sense that this
firm is "maximizing profits"? Explain precisely.
12. Your coffee mug company is currently producing at an output level of 200 units per month. Fixed costs are $500 per month. At the current output level, you know that marginal cost is $10 and equal to average total cost. At an output level of 150, you have determined that marginal cost would be $6 and equal to average variable cost. The market price for your coffee mugs is $8. If your goal is profit maximization, should you continue at q = 200, increase q above 200, or reduce q below 200? Would you do better to shut down? (Hint: It might be useful to sketch the cost curves and demand curve for this firm.)
13. Perfectly Competitive Firm:
| q | P | TR | MR | TC | FC | VC | MC | ATC | AVC | p |
| 0 | 8 | 8 | 300 | |||||||
| 100 | 8 | 900 | ||||||||
| 200 | 8 | 1300 | ||||||||
| 300 | 8 | 1500 | ||||||||
| 400 | 8 | 1600 | ||||||||
| 500 | 8 | 2000 | ||||||||
| 600 | 8 | 2600 | ||||||||
| 700 | 8 | 3300 | ||||||||
| 800 | 8 | 4400 |
a) Using Excel, create a spreadsheet to
complete the above table.
b) What is the p -maximizing price and output level? How does MR compare
with MC at this output level?
c) Using Excel, plot the following graphs (choose an X-Y chart):
Graph 1: TR, TC, VC, FC on the Y-axis and q on the X-axis.
Graph 2: MR, MC, ATC, AVC on the Y-axis and q on the X-axis.
Graph 3: p on the Y-axis and q on the X-axis.
d) Suppose the market price fell to $3.00 per unit. What would
the new p -maximizing output level be? Why?
14. Differentiate between the factors that give the short-run average cost curve and the long-run average cost curves their shapes.
15. What three conditions must be satisfied for a competitive industry to be in long-run equilibrium? Why is each condition necessary?
16. In the 1960s, hula-hoops were a popular toy, but in a short while, their novelty wore off and prices fell. However, after a few months, they were higher than ever. Given this description, trace out on a graph the fluctuations in supply and demand. What kind of long-run cost industry is this?
17. "Economists are silly to say that profits are competed away in the long run. No firm would operate unless it made profits." Explain.
18. Assume that the domestic beer industry is a constant cost industry. Let society's demand for beer increase. Explain precisely (using graphs and words) the chain of events that must happen for society to have more beer at the same price. (Hint: That is, derive the long run supply curve for a constant cost industry while discussing the market supply and demand curves and the individual firm's decision process assuming we start from a point of zero economic profit.)
| 19. The market demand schedule for cassettes is given below. | The market is perfectly competitive, and each firm has the following cost structure: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
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There are 1000 firms in the industry.
a) What is the market price?
b) What is the industry output?
c) What is the output produced by each firm?
d) What is the economic profit made by each firm?
e) Do firms enter or exit the industry?
f) What is the number of firms in the long run?
20. The same demand conditions as those in problem 19 prevail, and there are 1000 firms in the industry, but total fixed costs increase by $980. What now are your answers to the questions in #19?
21. The graph below describes a perfectly competitive industry.
a) If the market price is $1000, what is the
profit-maximizing output level?
b) What are profits equal to at the profit-maximizing output level?
c) If the market price equals $900, how much output should the firm
produce? Why?