Department of Economics University of PacificSpring Semester 2010 ECONOMICS 53 Problem Set 4 Due before lecture on March 4 Part 1: Multiple Choice (30 Questions, 1.5 Points Each) 1. Total cost is calculated as A) the sum of total fixed cost and total variable cost. B) the product of average total cost and price. C) the sum of all the firmʹs explicit costs. D) the sum of average fixed cost and average variable cost. 2. The Farley Farm, a dairy company, has total costs of $15,000 and total variable costs of $2,000. The Farley Farmʹs total fixed costs are A) $0. B) $13,000. C) $17,000. D) indeterminate because the firmʹs output level is not known. 3. Both Kate and John own saltwater taffy factories. Kateʹs factory has low fixed costs and high variable costs. Johnʹs factory has high fixed costs and low variable costs. Currently, each factory is producing 1,000 boxes of taffy at the same total cost. Complete the following statement with the correct answer. If each produces A) less, their costs will be equal. B) more, their costs will be equal. C) more, the costs of Kateʹs factory will exceed those of Johnʹs factory. D) less, the costs of Kateʹs factory will exceed those of Johnʹs factory. 4. Which statement is NOT true regarding the total variable cost curve? A) increases as output increases. B) shows the variable cost of production given current factor prices. C) starts at the origin. D) is a horizontal line. 5. Marginal cost is ________ average variable cost when ________. A) equal to; average total cost is minimized B) less than; total cost is maximized C) greater than; average fixed cost is minimized D) equal to; average variable cost is minimized 1 level of output to produce C) level of output to produce. the marginal revenue from selling the fifth unit is A) $25. C) horizontal. C) $125. Market demand for wheat increases. B) incurring a loss. D) All of the above are correct. B) $5. D) Unable to determine. If the market price is $25 in a perfectly competitive market. D) vertical. The main decision for a profit maximizing perfectly competitive firm is not what ________ but what ________. A) equal to. The marginal revenue curve for a perfectly competitive firm is A) downward sloping. B) upward sloping. More information needed. A) the difference between average total cost and average variable cost decreases. 10. increase B) increase. total revenue to achieve D) price to charge. C) maximizing profits. In the short run. Joeʹs Butcher Shop is producing where MR = MC.6. average total cost is minimized B) less than. average fixed cost is minimized D) equal to. 11. 12. as output increases. Joeʹs Butcher Shop must be A) earning a zero economic profit. average variable cost is minimized (Disregard this question…It’s repeated) 7. 8. B) the difference between total cost and average variable cost decreases. Wheat is produced in a perfectly competitive market. Marginal cost is ________ average variable cost when ________. A) level of output to produce. price to charge B) price to charge. D) maximizing revenue but not maximizing profits. decrease 2 . total cost to achieve 9. total cost is maximized C) greater than. C) marginal cost eventually decreases. This will cause the individual wheat farmerʹs marginal revenue to ________ and their profit maximizing level of output to ________. decrease C) decrease. increase D) decrease. A) increase. C) $45. C) $108. Refer to Figure 9. Refer to Figure 9. his profit will be C) $48. B) $9. B) $24. This farmer would earn a zero economic profit if price was A) $7. D) $11.1. D) indeterminate unless we know the level of output the firm is producing.1. This farmerʹs fixed costs are A) $0. A) $11 B) $66. A) -$24. 3 .1. B) $45. 18. If this farmer is maximizing profits. his TVC is A) $24.1. Refer to Figure 9. B) $135. his total costs will be D) $132. 19. C) $10. Refer to Figure 9.1. Refer to Figure 9.1. 20. A) 6 B)9 C) 12 D) 16 14. B) $4. D) $72.1. 17. D) $240. C) $90. D) $255. D) $10. A) $0. For this farmer to maximize profits he should produce ________ bushels of wheat. 16. B) $42. 13. 15. If this farmer is maximizing his profits. If this farmer is maximizing profits.In this industry the market equilibrium price is P = $15. This farmerʹs shutdown point is at a price of C) $7. C) $180.1. If this farmer is maximizing profits. Refer to Figure 9. Refer to Figure 9. his total revenue will be A) $90. Refer to Figure 9. 000 which is less than his loss if he shuts down. 23. Firms that are ʺbreaking evenʺ are A) earning zero economic profits. D) All of the above are correct. C) he has to pay his fixed costs of $2.he should shut down since he has a loss. B) his loss from operating is only $2. a firm would ________ in the short run and ________ in the long run. contract 22. A) operate. If TR > TC. D) In fact you do not tell him to operate -. C) shutting down in the short run. II.000 if he shuts down which is greater than his loss when he operates. A) I and II only B) I and III only C) III only D) All of the above are correct. contract C) shut down. firms have the flexibility to price their own product.21. a perfectly competitive firm. The owner of Tie-Dyed T-shirts. each firm sells slightly different products III.000. You tell him he should continue to operate in the short run because A) he is earning positive economic profits of $4. 4 . each firm is small compared to the entire industry. expand B) operate. A market is competitive if I. expand D) shut down. has hired you to give him some economic advice. He has told you that the market price for his shirts is $20 and that he is currently producing 200 shirts at an AVC of $15 and an ATC of $25. 24. B) earning less than a normal rate of return. If consumers switch to beef from chicken. A) increase. a(n) ________ in a firmʹs scale of production leads to ________ average total cost. 5 . shut down C) continue to produce where MC = MR. A) total cost to decrease B) average total costs to increase C) average total costs to decrease D) average fixed costs to increase 27. it is experiencing A) economies of scale B) constant returns to scale C) diseconomies of scale D) diminishing marginal returns 29. Some producers will enter the industry until all firms in the industry are earning a zero economic profit. Assume the market for beef is perfectly competitive. Some producers will enter the industry as long as all firms in the industry are earning an economic profit. you correctly deduce that such a change will cause ________ as output increases. A) economies of scale. In the short run this firm should ________ and in the long run this firm should ________. C) Beef producers will incur economic profits in the short run. which of the following is most likely to occur? A) Beef producers will now incur economic profits in both the short run and the long run. Engineers for the Off Road Skateboard Company have determined that a 10% increase in all inputs will cause output to increase by 5%. Beef producers are currently earning a zero economic profit. B) Beef producers will incur economic profits in the short run. D) Beef producers will now earn economic losses in the short run and there will be no additional adjustments in the long run. In the long run firms will expand as long as there are more ________ and new firms will enter the industry as long as they earn ________.3. positive economic profits C) diseconomies of scale. On the upward sloping portion of a firmʹs long run average cost curve. zero profits B) economies of scale. Refer to Figure 9. zero profits D) diseconomies of scale.25. A) shut down. no change in 28. For economies of scale. Assuming that input prices remain constant. lower B) increase. shut down 26. higher C) decrease. positive economic profits 30. lower D) decrease. if economic conditions do not change. exit the industry B) exit the industry. expand D) continue to produce where MC = MR. 33 10 11 12. Complete the table above.) AFC 6 5 4 AFC 3 2 1 0 0 1 2 3 4 5 6 7 AFC Quantity 6 . MC.67 1. Your firm faces the following cost and revenue schedule: Quantity of TShirts 0 1 2 3 4 5 6 Total Costs (TC) 5 12 22 33 45 60 78 Total Fixed Costs (TFC) 5 5 5 5 5 5 5 Total Variable Costs (TVC) 0 7 17 28 40 55 73 Average Fixed Costs (AFC) N/A 5 2.50 1.25 1 0.83 Average Variable Costs (AVC) N/A 7 8. (b) Sketch the following curves: AFC. ATC.25 12 13 Marginal Cost (MC) N/A 7 10 11 12 15 18 Total Revenue (TR) 0 12 24 36 48 60 72 Profit -5 0 2 3 3 0 -5 (a) Assume that the price of t-shirts is $12. (You may use EXCEL or another software program to draw the graphs or you can do it by hand.Part II: Short Answers Question 1: Total Costs and Profit Maximization You run a firm that produces T-shirts that are sold in a perfectly competitive market.17 Average Total Costs (ATC) N/A 12 11 11 11.5 9. ATC 13. Thus the optimal production is 4 t-shirts.5 12 11. 7 .5 0 1 2 3 4 5 6 7 ATC Quantity MC 20 18 16 14 12 10 8 6 4 2 0 0 1 2 3 4 5 6 7 MC (c) What is the optimal level of production for your t-shit firm? Optimal production is where MR=MC Since P = $12 therefore MR = $12 Looking at the table we see that MR = MC = 12 at Q = 4.5 13 12.5 11 10. We see that at 100 benches MR =$200 while MC = $300.500 8 . MC = 2Q + 100=MR=200 2Q+100 = 200 Q =50 At Q = 50 TR = P x Q = 200 x 50 = 10. TR = $200 x 100 = $20. Calculate the following (a) Total Variable Costs (TVC) The variable cost is the component of the cost function that depends on output TVC = Q2 – 100Q thus TVC = 1002 + 100(100) = 20. No.000/100 = 200 (e) Average Fixed Costs (AFC) AFC = TFC/Q = 500/100 = 5 (f) Average Total Costs (ATC) ATC = TC/Q =20. As we saw in Part (c) TC = $20. thus total fixed costs are 500. At Q = 100.500 therefore profit is equal to -$500 (j) Calculate the profit maximizing level of output for Noah’s bench factory.000 + 500 = 20.000.000 TC = 502 + 100(50) = 7500 Profit = 10000-7500 = 2. is he producing the optimal profit maximizing level of benches? Explain your answer. (c) Total Costs (TC) Total costs are TVC + TFC = 20. The total production costs are captured by the following production cost functions: TC = Q2 + 100Q + 500 (total cost function) MC = 2Q + 100 (marginal cost function) Where Q = number of benches produced If Noah produces 100 benches.Question2: Total Costs using Algebra Noah runs a garden bench production plant.500 /100 = 205 (g) Marginal Cost (MC) MC = 2(100) + 100 = 300 Suppose the industry for garden benches is perfectly competitive and the market equilibrium price is $200 (i) If Noah produces 100 benches. We can see that if Q = 0. In this case since MR is not equal to MC Noah is not producing at the optimal profit maximizing level.000 (b) Total Fixed Costs (TFC) Total fixed costs are costs that doesn’t depend on the level of output.500 (d) Average Variable Costs (AVC) AVC = TVC/Q = 20. Calculate the profit for Noah at Q = 100. total costs are 500. What is the profit at this level of production? MR=MC is where the firm will produce. But we know that at shutdown Q = 0. etc. Thus total variable costs = $1600 (c) Calculate total costs per week for the restaurant Total costs = Total Fixed costs per week + Total Variable costs per week = $3600 (d) Calculate total revenue per week for the restaurant P = $5 average. Paid in weekly installments = $1000 per week paid to investors. Q = 900 meals per week. The fixed costs are spread over the 52 weeks.000 to construct a building and purchase all equipment for a new Thai restaurant called Thai Me Up. Question 3 Investors put up $520. (b) Calculate total variable costs per week for the restaurant Variable costs include the $1000 in weekly wages and the $600 per week for materials. If the price of benches fall below 100. The investors expect to earn a minimum return of 10% on their investment. TR = P x Q = $5 x 900 = $4500 (e) Calculate the economic profit per week for the restaurant Profit = TR – TC = $4500 .000 per year. Included in the fixed costs is the 10% return to the investors (the interest paid to the investors are paid out in equal weekly installments) and $1000 per week in other fixed costs. Therefore P = 100.$3600 = $900 (f) If Thai Me Up were to shut down. Variable costs include $1000 in weekly wages and $600 per week for materials. The restaurant is open 52 weeks per year and serves 900 meals per week. Additional fixed costs amounts to $1000 per week. electricity. what would the economic profit be? Profit = -TFC = -$2000 9 . We get this from dividing the TVC function by Q. Total fixed costs = $2000. electricity.(j) Noah would shut down his business if benches fall below what price? Shut down rule is P = AVC The equation for AVC is Q + 100. (a) Calculate total fixed costs per week for the restaurant Fixed costs include the return to the investors: 10% x $520. Noah would shut down his business.000 = $52. etc. The restaurant charges $5 on average per meal. A perfectly competitive firm will produce where MR = MC. A perfectly competitive firm will produce where MR = MC. Thus TC will also equal $91. But notice that at Q = 13. (In your answer assume that the ATC is the same as the ATC you found in Part b) Would you expect entry or exit of firms from the industry in the long-run? Explain. Thus the firm is earning an economic profit of $30.Question #4: Perfect Compettition: Graphcial Analysis Figure 1: Wheat Market For the following questions refer to the figure above. Total revenue will be TR= P x Q = $7 x 13 = $91 Total cost will be TC = ATC x Q. ATC equals $7. The presence of economic profits will encourage firms to enter the industry in the long-run. 10 . the market equilbrium price would be at $9 which would also be the MR. Many. Economic Profit = $91 . small firms which cannot influence the market price 2. In the right hand panel that would be where Q = 15. Firms sell homogeneous (similar) products 3.$91 = $0 (c) If the demand for wheat increases to D3 what is the profit-maximizing level of output for a representative firm? Calculate the amount of economic loss or profit. Easy entry and exit from industry (b) If the demand for wheat is at D2 what is the profit-maximizing level of output for a representative firm? At that level of output what is the total revenue. At that price the firm is clearly earning an economic profit. At D3. the market equilbrium price would be at $7 which would also be the MR. TR = $9 x 15 = $135 while TC = ATC x Q = $7 x 15 = $105. Recall for the representative firm the MR curve is also the demand curve it faces. In the right hand panel that would be where Q = 13. total cost and economic profit? At D2. Assume that the wheat industry is perfectly competitive. (a) What are the three conditions needed for the wheat industry to be perfectly competitive? 1. It is clear from the diagram that at that point where MR=MC. Next to it draw a graph of a perfectly competitive firm that is incurring a short-run loss at this price. Use the diagram to show the long-term adjustment of the industry and the firm if demand remains constant. Thus the shut down rule says the firm will stop production immediately. Explain the adjustment mechanism. Question #5 From Short-Run to Long-Run Draw a supply and demand diagram showing equilibrium at a price of $10. P < AVC. but is still producing.(d) If the demand for wheat increases to D1 what is the profit-maximizing level of output for a representative firm? If the demand curve shifts to the left to D1 the equilibrium price will be at P = $5. which will cause the market supply curve will shift to the left. The adjustment will be that firms will leave the industry. The price will gradually rise until MR=MC=P=ATC 11 . The profit-maximizing level of output is 0.