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60 Cards in this Set
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Jen values her time at $60 an hour. She spends 2 hours giving Colleen a massage. Colleen was willing to pay as much at $300 for the massage, but they negotiate a price of $200. In this transaction, |
A. consumer surplus is $20 larger than producer surplus |
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The demand curve for cookies is downward sloping. When the price of cookies is $2, the quantity demanded is 100. If the price rises to $3, what happens to consumer surplus? |
A. It falls by less than 100. |
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John has been working as a tutor for $300 a semester. When the university raises the price it pays tutors to $400, Emily enters the market and begins tutoring as well. How much does producer surplus rise as a result of this price increase? |
B. between $100 and $200 |
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An efficient allocation of resources maximizes |
C. consumer surplus plus producer surplus. |
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When a market is in equilibrium, the buyers are those with the willingness to pay and the sellers are those with the costs. |
B. highest, lowest |
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Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer’s willingness to pay is |
C. positive but less than the marginal seller’s cost. |
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Melissa buys an iPhone for $120 and gets consumer surplus of $80. 1.What is her willingness to pay? 2. If she had bought the iPhone on sale for $90, what would her consumer surplus have been? 3. If the price of an iPhone were $250, what would her consumer surplus have been? |
a. Consumer surplus isequal to willingness to pay minus the price paid. Therefore, Melissa’s willingness to pay mustbe $200 ($120 + $80).
b. Her consumer surplus at a price of $90 would be $200 − $90 = $110.
c. If the price of an iPhone was $250, Melissa would not havepurchased one because the price is greater than her willingness to pay.Therefore, she would receive no consumer surplus.
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Ernie owns a water pump. Because pumping large amounts of water is harder than pumping small amounts, the cost of producing a bottle of water rises as he pumps more. Here is the cost he incurs to produce each bottle of water: Cost of first bottle $1Cost of second bottle $3Cost of third bottle $5Cost of fourth bottle $71. From this information, derive Ernie’s supply schedule. Graph his supply curve for bottled water. 2. If the price of a bottle of water is $4, how many bottles does Ernie produce and sell? How much producer surplus does Ernie get from these sales? Show Ernie’s producer surplus in your graph. 3. If the price rises to $6, how does quantity supplied change? How does Ernie’s producer surplus change? Show these changes in your graph. |
Ernie’s supply schedule forwater is:
Price
Quantity Supplied
More than $7 4 $5 to $7 3 $3 to $5 2 $1 to $3 1 Less than $1 0
Ernie’s supply curve is shown in Figure10.
Figure 10
b. When the price of each bottle of water is $4, Ernie sells twobottles of water. His producer surplus is shown as area A in the figure. Hereceives $4 for his first bottle of water, but it costs only $1 to produce, soErnie has producer surplus of $3. He also receives $4 for his second bottle ofwater, which costs $3 to produce, so he has producer surplus of $1. ThusErnie’s total producer surplus is $3 + $1 = $4, which is the area of A in thefigure.
c. When the price of each bottle of water rises from $4 to $6, Erniesells three bottles of water, an increase of one. His producer surplus consistsof both areas A and B in the figure, an increase by the amount of area B. Hegets producer surplus of $5 from the first bottle ($6 price minus $1 cost), $3from the second bottle ($6 price minus $3 cost), and $1 from the third bottle($6 price minus $5 price), for a total producer surplus of $9. Thus producersurplus rises by $5 (which is the size of area B) when the price of each bottleof water rises from $4 to $6. |
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Consider a market in which Bert from problem 4 is the buyer and Ernie from problem 5 is the seller. 1.Use Ernie’s supply schedule and Bert’s demand schedule to find the quantity supplied and quantity demanded at prices of $2, $4, and $6. Which of these prices brings supply and demand into equilibrium? 2. What are consumer surplus, producer surplus, and total surplus in this equilibrium? 3. If Ernie produced and Bert consumed one fewer bottle of water, what would happen to total surplus? 4. If Ernie produced and Bert consumed one additional bottle of water, what would happen to total surplus? |
a. From Ernie’s supplyschedule and Bert’s demand schedule, the quantity demanded and supplied are:
Price
Quantity Supplied
Quantity Demanded
$2 1 3 $4 2 2 $6 3 1
Only a price of $4 brings supply and demand intoequilibrium, with an equilibrium quantity of two.
b. At a price of $4, consumer surplus is $4 and producer surplus is$4, as shown in Problems 3 and 4 above. Total surplus is $4 + $4 = $8.
c. If Ernie produced one less bottle, his producer surplus woulddecline to $3, as shown in Problem 4 above. If Bert consumed one less bottle,his consumer surplus would decline to $3, as shown in Problem 3 above. So totalsurplus would decline to $3 + $3 = $6.
d. If Ernie produced one additional bottle of water, his cost wouldbe $5, but the price is only $4, so his producer surplus would decline by $1.If Bert consumed one additional bottle of water, his value would be $3, but theprice is $4, so his consumer surplus would decline by $1. So total surplusdeclines by $1 + $1 = $2. |
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1.
There are four consumers willing to pay the following amounts for haircuts: Gloria: $7Jay: $2Claire: $8Phil: $5 There are four haircutting businesses with the following costs: Firm A: $3Firm B: $6Firm C: $4Firm D: $2 Each firm has the capacity to produce only one haircut. For efficiency, how many haircuts should be given? Which businesses should cut hair and which consumers should have their hair cut? How large is the maximum possible total surplus? |
Figure 13 shows supply anddemand curves for haircuts. Supply equals demand at a quantity of threehaircuts and a price between $4 and $5. Firms A, C, and D should cut the hairof Claire, Gloria, and Phil. Jay’s willingness to pay is too low and firm B’scosts are too high, so they do not participate. The maximum total surplus isthe area between the demand and supply curves, which totals $11 ($8 value minus$2 cost for the first haircut, plus $7 value minus $3 cost for the second, plus$5 value minus $4 cost for the third).
Price of Haircuts
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One of the largest changes in the economy over the past several decades is that technological advances have reduced the cost of making computers. 1.Draw a supply-and-demand diagram to show what happened to price, quantity, consumer surplus, and producer surplus in the market for computers. 2. Forty years ago, students used typewriters to prepare papers for their classes; today they use computers. Does that make computers and typewriters complements or substitutes? Use a supply-and-demand diagram to show what happened to price, quantity, consumer surplus, and producer surplus in the market for typewriters. Should typewriter producers have been happy or sad about the technological advance in computers? 3. Are computers and software complements or substitutes? Draw a supply-and-demand diagram to show what happened to price, quantity, consumer surplus, and producer surplus in the market for software. Should software producers have been happy or sad about the technological advance in computers? 4. Does this analysis help explain why software producer Bill Gates is one of the world’s richest men? |
a. The effect offalling production costs in the market for computers resulted in a shift to theright in the supply curve, as shown in Figure 14. As a result, the equilibriumprice of computers declined and the equilibrium quantity increased. The declinein the price of computers increased consumer surplus from area A to A + B + C +D, an increase in the amount B + C + D.
Figure14 Figure15
Prior to the shift insupply, producer surplus was areas B + E (the area above the supply curve andbelow the price). After the shift in supply, producer surplus is areas E + F +G. So producer surplus changes by the amount F + G – B, which may be positiveor negative. The increase in quantity increases producer surplus, while thedecline in the price reduces producer surplus. Because consumer surplus risesby B + C + D and producer surplus rises by F + G – B, total surplus rises by C+ D + F + G.
b. Typewriters and computers are substitutes. The decline in theprice of computers means that people substituted computers for typewriters,shifting the demand for typewriters to the left, as shown in Figure 15. Theresult is a decline in both the equilibrium price and equilibrium quantity oftypewriters. Consumer surplus in the typewriter market changes from area A + Bto A + C, a net change of C – B. Producer surplus changes from area C + D + Eto area E, a net loss of C + D. Typewriter producers are sad abouttechnological advances in computers because their producer surplus declines.
c. Software and computers are complements. When the price of computers decreases, thedemand for software increases. The demand for software shifts to the right, asshown in Figure 16. The result is an increase in both the price and quantity ofsoftware. Consumer surplus in the software market changes from B + C to A + B,a net change of A – C. Producer surplus changes from E to C + D + E, anincrease of C + D, so software producers should be happy about thetechnological progress in computers.
Figure16
d. Yes, this analysis helps explain why Bill Gates is one the world’srichest people. His company produces a lot of software and the producer surplusin the software market increased with the technological advance in computers. |
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A friend of yours is considering two cell phone service providers. Provider A charges $120 per month for the service regardless of the number of phone calls made. Provider B does not have a fixed service fee but instead charges $1 per minute for calls. Your friend’s monthly demand for minutes of calling is given by the equation Q^D=150-50P , where P is the price of a minute. 1.With each provider, what is the cost to your friend of an extra minute on the phone? 2. In light of your answer to (a), how many minutes with each provider would your friend talk on the phone? 3. How much would she end up paying each provider every month? 4. How much consumer surplus would she obtain with each provider? (Hint: Graph the demand curve and recall the formula for the area of a triangle.) |
a. With Provider A, the cost of an extra minuteis $0. With Provider B, the cost of an extra minute is $1.
b. With Provider A, my friend will purchase 150 minutes [= 150 – (50)(0)].With Provider B, my friend would purchase 100 minutes [= 150 – (50)(1)].
c. With Provider A, she would pay $120. With Provider B, he wouldpay $100. |
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A tax on a good has a deadweight loss if
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A. the reduction in consumer and producer surplus |
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Jane pays Chuck $50 to mow her lawn every week. When the government levies a mowing tax of $10 on Chuck, he raises his price to $60. Jane continues to hire him at the higher price. What is the change in producer surplus, change in consumer surplus, and deadweight loss? |
B. $0, -$10, $0 |
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Eggs have a supply curve that is linear and upward-sloping and a demand curve that is linear and downward sloping. If a 2 cent per egg tax is increased to 3 cent, the deadweight loss of the tax |
C. increases by more than 50% |
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Peanut butter has an upward-sloping supply curve and a downward-sloping demand curve. If a 10 cent per pound tax is increased to 15 cent, the government’s tax revenue |
A. increases by less than 50% and may even decline. |
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The Laffer curve illustrates that, in some circumstances, the government can reduce a tax on a good and increase the |
B. government’s tax revenue. |
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If a policymaker wants to raise revenue by taxing goods while minimizing the deadweight losses, he should look for goods with elasticities of demand and elasticities of supply. |
A. small, small |
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Evaluate the following two statements. Do you agree? Why or why not? 1.“A tax that has no deadweight loss cannot raise any revenue for the government.” 2. “A tax that raises no revenue for the government cannot have any deadweight loss.” |
a. The statement,"A tax that has no deadweight loss cannot raise any revenue for thegovernment," is incorrect. An example is the case of a tax when eithersupply or demand is perfectly inelastic. The tax has neither an effect onquantity nor any deadweight loss, but it does raise revenue.
b. The statement, "A tax that raises no revenue for thegovernment cannot have any deadweight loss," is incorrect. An example isthe case of a 100% tax imposed on sellers. With a 100% tax on their sales ofthe good, sellers will not supply any of the good, so the tax will raise norevenue. Yet the tax has a large deadweight loss, because it reduces thequantity sold to zero.
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Suppose that the government imposes a tax on heating oil. 1.Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain. 2. Would the revenue collected from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain |
a. The deadweight lossfrom a tax on heating oil is likely to be greater in the fifth year after it isimposed rather than the first year. In the first year, the demand for heating oilis relatively inelastic, as people who own oil heaters are not likely to getrid of them right away. But over time they may switch to other energy sourcesand people buying new heaters for their homes will more likely choose gas orelectric, so the tax will have a greater impact on quantity. Thus, thedeadweight loss of the tax will get larger over time.
b. The tax revenue is likely to be higher in the first year after itis imposed than in the fifth year. In the first year, demand is more inelastic,so the quantity does not decline as much and tax revenue is relatively high. Astime passes and more people substitute away from oil, the quantity solddeclines, as does tax revenue. |
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After economics class one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. In what sense is taxing food a “good” way to raise revenue? In what sense is it not a “good” way to raise revenue?
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Because the demand for food isinelastic, a tax on food is a good way to raise revenue because it leads to asmall deadweight loss; thus taxing food is less inefficient than taxing otherthings. But it is not a good way to raise revenue from an equity point of view,because poorer people spend a higher proportion of their income on food. Thetax would affect them more than it would affect wealthier people. |
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Daniel Patrick Moynihan, the late senator from New York, once introduced a bill that would levy a 10,000 percent tax on certain hollow-tipped bullets. 1.Do you expect that this tax would raise much revenue? Why or why not? 2. Even if the tax would raise no revenue, why might Senator Moynihan have proposed it? |
a. This tax has such ahigh rate that it is not likely to raise much revenue. Because of the high taxrate, the equilibrium quantity in the market is likely to be at or near zero.
b. Senator Moynihan's goal was probably to ban the use ofhollow-tipped bullets. In this case, the tax could be as effective as anoutright ban. |
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The government places a tax on the purchase of socks. 1.Illustrate the effect of this tax on equilibrium price and quantity in the socks market. Identify the following areas both before and after the imposition of the tax: total spending by consumers, total revenue for producers, and government tax revenue. 2. Does the price received by producers rise or fall? Can you tell whether total receipts for producers rise or fall? Explain. 3. Does the price paid by consumers rise or fall? Can you tell whether total spending by consumers rises or falls? Explain carefully. (Hint: Think about elasticity.) If total consumer spending falls, does consumer surplus rise? Explain. |
a. Figure 6illustrates the market for socks and the effects of the tax. Without a tax, theequilibrium quantity would be Q1,the equilibrium price would be P1,total spending by consumers equals total revenue for producers, which is P1 x Q1, which equals area B + C + D + E + F, and governmentrevenue is zero. The imposition of a tax places a wedge between the pricebuyers pay, PB, and theprice sellers receive, PS,where PB = PS + tax. The quantity solddeclines to Q2. Now totalspending by consumers is PBx Q2, which equals area A+ B + C + D, total revenue for producers isPS x Q2,which is area C + D, and government tax revenue is Q2 x tax, which is area A + B.
b. Unless supply is perfectly elastic or demand is perfectlyinelastic, the price received by producers falls because of the tax. Totalreceipts for producers fall, because producers lose revenue equal to area B + E+ F.
Figure 6
c. The price paid by consumers rises, unless demand is perfectlyelastic or supply is perfectly inelastic. Whether total spending by consumersrises or falls depends on the price elasticity of demand. If demand is elastic,the percentage decline in quantity exceeds the percentage increase in price, sototal spending declines. If demand is inelastic, the percentage decline inquantity is less than the percentage increase in price, so total spendingrises. Whether total consumer spending falls or rises, consumer surplusdeclines because of the increase in price and reduction in quantity. |
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This chapter analyzed the welfare effects of a tax on a good. Consider now the opposite policy. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain.
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Figure 7 illustrates theeffects of the $2 subsidy on a good. Without the subsidy, the equilibrium priceis P1 and the equilibriumquantity is Q1. With thesubsidy, buyers pay price PB,producers receive price PS(where PS = PB + $2), and the quantitysold is Q2. The followingtable illustrates the effect of the subsidy on consumer surplus, producersurplus, government revenue, and total surplus. Because total surplus declinesby area D + H, the subsidy leads to a deadweight loss in that amount.
Before Subsidy
After Subsidy
Change
Consumer Surplus
A + B A + B + E + F + G +(E + F + G) Producer Surplus
E + I B + C + E + I +(B + C) Government Revenue
0 –(B + C + D + E + F + G + H) –(B + C + D + E + F + G + H) Total Surplus
A + B + E + I A + B – D + E – H + I –(D + H)
Figure 7
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uppose that a market is described by the following supply and demand equations: 1. Solve for the equilibrium price and the equilibrium quantity. Q^S=2P Q^D=300-P 2. Suppose that a tax of T is placed on buyers, so the new demand equation is q^d=300-(p+t) Solve for the new equilibrium. What happens to the price received by sellers, the price paid by buyers, and the quantity sold? 3. Tax revenue is TxQ. Use your answer to part (b) to solve for tax revenue as a function of T. Graph this relationship for T between 0 and 300. 4. The deadweight loss of a tax is the area of the triangle between the supply and demand curves. Recalling that the area of a triangle is ½, solve for deadweight loss as a function of . Graph this relationship for between and .(Hint: Looking sideways, the base of the deadweight loss triangle is , and the height is the difference between the quantity sold with the tax and the quantity sold without the tax.) 5. The government now levies a tax on this good of $200 per unit. Is this a good policy? Why or why not? Can you propose a better policy? |
. a. Setting quantity supplied equal to quantity demanded gives 2P = 300 – P. Adding P to both sides of the equation gives 3P = 300. Dividing both sides by 3 gives P = 100. Substituting P = 100 back into either equation for quantity demanded or supplied gives Q = 200. b. Now P is the price received by sellers and P +T is the price paid by buyers. Equating quantity demanded to quantity supplied gives 2P = 300 − (P+T). Adding P to both sides of the equation gives 3P = 300 – T. Dividing both sides by 3 gives P = 100 –T/3. This is the price received by sellers. The buyers pay a price equal to the price received by sellers plus the tax (P +T = 100 + 2T/3). The quantity sold is now Q = 2P = 200 – 2T/3.
c. Because tax revenue is equal to T x Q and Q = 200 – 2T/3, tax revenue equals 200T − 2T2/3. Figure 10 (on the next page) shows a graph of this relationship. Tax revenue is zero at T = 0 and at T = 300.
Figure 10 Figure 11
d. As Figure 11 shows, the area of the triangle (laid on its side) that represents the deadweight loss is 1/2 × base × height, where the base is the change in the price, which is the size of the tax (T) and the height is the amount of the decline in quantity (2T/3). So the deadweight loss equals 1/2 × T × 2T/3 = T2/3. This rises exponentially from 0 (when T = 0) to 30,000 when T = 300, as shown in Figure 12.
Figure 12 e. A tax of $200 per unit is a bad policy, because tax revenue is declining at that tax level. The government could reduce the tax to $150 per unit, get more tax revenue ($15,000 when the tax is $150 versus $13,333 when the tax is $200), and reduce the deadweight loss (7,500 when the tax is $150 compared to 13,333 when the tax is $200). |
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Raj opens up a lemonade stand for two hours. He spends $10 for ingredients and sells $60 worth of lemonade. In the same two hours, he could have mowed his neighbor’s lawn for $40. Raj has an accounting profit of and an economic profit of . |
A. $50, $10 |
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Diminishing marginal product explains why, as a firm’s output increases, |
D. the production function gets flatter, while the total-cost curve gets steeper. |
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A firm is producing 1,000 units at a total cost of $5,000. If it were to increase production to $1001 its total cost would rise to $5,008. What does this information tell you about the firm? |
D. Marginal cost is $8, and average total cost is $5 |
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A firm is producing 20 units with an average total cost of $25 and marginal cost of $15. If it were to increase production to 21 units, which of the following must occur? |
C. Average total cost would decrease. |
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The government imposes a $1,000 per year license fee on all pizza restaurants. Which cost curves shift as a result? |
B. average total cost and average fixed cost |
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If a higher level of production allows workers to specialize in particular tasks, a firm will likely exhibit of scale and average total cost. |
A. economies, falling |
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This chapter discusses many types of costs: opportunity cost, total cost, fixed cost, variable cost, average total cost, and marginal cost. Fill in the type of cost that best completes each sentence: 1.What you give up for taking some action is called the . 2. is falling when marginal cost is below it and rising when marginal cost is above it. 3. A cost that does not depend on the quantity produced is a(n) . 4. In the ice-cream industry in the short run, includes the cost of cream and sugar but not the cost of the factory. 5. Profits equal total revenue minus . 6. The cost of producing an extra unit of output is the . |
a. opportunity cost; b. average total cost; c.fixed cost; d. variable cost; e. total cost; f. marginal cost. |
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Your aunt is thinking about opening a hardware store. She estimates that it would cost $500,000 per year to rent the location and buy the stock. In addition, she would have to quit her $50,000 per year job as an accountant. 1.Define opportunity cost. 2. What is your aunt’s opportunity cost of running a hardware store for a year? If your aunt thinks she can sell $510,000 worth of merchandise in a year, should she open the store? Explain. |
a. The opportunity cost of something is whatmust be given up to acquire it.
b. The opportunity cost of running the hardware store is $550,000,consisting of $500,000 to rent the store and buy the stock and a $50,000implicit cost, because your aunt would quit her job as an accountant to run thestore. Because the total opportunity cost of $550,000 exceeds the projectedrevenue of $510,000, your aunt should not open the store, as her economicprofit would be negative. |
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Nimbus, Inc., makes brooms and then sells them door-to-door. Here is the relationship between the number of workers and Nimbus’s output in a given day: 1. Fill in the column of marginal products. What pattern do you see? How might you explain it? 2. A worker costs a day, and the firm has fixed costs of . Use this information to fill in the column for total cost. 3. Fill in the column for average total cost. (Recall that .) What pattern do you see? 4. Now fill in the column for marginal cost. (Recall that .) What pattern do you see? 5. Compare the column for marginal product and the column for marginal cost. Explain the relationship. 6. Compare the column for average total cost and the column for marginal cost. Explain the relationship. |
Here is the completed table:
Workers
Output
Marginal Product
Total Cost
Average Total Cost
Marginal Cost
0 0 --- $200 --- --- 1 20 20 300 $15.00 $5.00 2 50 30 400 8.00 3.33 3 90 40 500 5.56 2.50 4 120 30 600 5.00 3.33 5 140 20 700 5.00 5.00 6 150 10 800 5.33 10.00 7 155 5 900 5.81 20.00
a. See the table for marginal product. Marginal product rises atfirst, then declines because of diminishing marginal product.
b. See the table for total cost.
c. See the table for average total cost. Average total cost isU-shaped. When quantity is low, average total cost declines as quantity rises;when quantity is high, average total cost rises as quantity rises.
d. See the table for marginal cost. Marginal cost is also U-shaped,but rises steeply as output increases. This is due to diminishing marginalproduct.
e. When marginal product is rising, marginal cost is falling, andvice versa.
f. When marginal cost is less than average total cost, average totalcost is falling; the cost of the last unit produced pulls the average down.When marginal cost is greater than average total cost, average total cost isrising; the cost of the last unit produced pushes the average up. |
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You are the chief financial officer for a firm that sells digital music players. Your firm has the following average-total-cost schedule: QuantityAverage Total Cost 600 players $300 601 players $301 Your current level of production is 600 devices, all of which have been sold. Someone calls, desperate to buy one of your music players. The caller offers you $550 for it. Should you accept the offer? Why or why not? |
At an output level of 600players, total cost is $180,000 (600 × $300). The total cost of producing 601 players is $180,901. Therefore, you should not accept the offer of$550, because the marginal cost of the 601st player is $901. |
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onsider the following cost information for a pizzeria: QuantityTotal CostVariable Cost pizzas1. What is the pizzeria’s fixed cost? 2. Construct a table in which you calculate the marginal cost per dozen pizzas using the information on total cost. Also, calculate the marginal cost per dozen pizzas using the information on variable cost. What is the relationship between these sets of numbers? Comment. |
a. The fixed cost is$300, because fixed cost equals total cost minus variable cost. At an output ofzero, the only costs are fixed cost.
b. Quantity
Total Cost
Variable Cost
Marginal Cost (using total cost)
Marginal Cost
(using variable cost)
0 $300 $0 --- --- 1 350 50 $50 $50 2 390 90 40 40 3 420 120 30 30 4 450 150 30 30 5 490 190 40 40 6 540 240 50 50
Marginal cost equals the change in total cost foreach additional unit of output. It is also equal to the change in variable costfor each additional unit of output. This relationship occurs because total costequals the sum of variable cost and fixed cost and fixed cost does not changeas the quantity changes. Thus, as quantity increases, the increase in totalcost equals the increase in variable cost. |
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Consider the following table of long-run total costs for three different firms: QuantityFirm AFirm BFirm C Does each of these firms experience economies of scale or diseconomies of s cale or diseconomies of scale? |
10. The following table shows quantity (Q), total cost (TC), andaverage total cost (ATC) for thethree firms:
Firm A
Firm B
Firm C
Quantity
TC
ATC
TC
ATC
TC
ATC
1 $60.00 $60.00 $11.00 $11.00 $21.00 $21.00 2 70.00 35.00 24.00 12.00 34.00 17.00 3 80.00 26.67 39.00 13.00 49.00 16.33 4 90.00 22.50 56.00 14.00 66.00 16.50 5 100.00 20.00 75.00 15.00 85.00 17.00 6 110.00 18.33 96.00 16.00 106.00 17.67 7 120.00 17.14 119.00 17.00 129.00 18.43
Firm Ahas economies of scale because average total cost declines as output increases.Firm B has diseconomies of scale because average total cost rises as outputrises. Firm C has economies of scale from one to three units of output anddiseconomies of scale for levels of output beyond three units. |
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A perfectly competitive firm
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C. takes its price as given by market conditions. |
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A competitive firm maximizes profit by choosing the quantity at which |
B. marginal cost equals the price |
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A competitive firm’s short-run supply curve is its cost curve above its cost curve. |
D. marginal, average variable |
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If a profit-maximizing, competitive firm is producing a quantity at which marginal cost is between average variable cost and average total cost, it will |
A. keep producing in the short run but exit the market in the long run. |
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In the long-run equilibrium of a competitive market with identical firms, what is the relationship between price P, marginal cost MC, and average total cost ATC? |
D. P=MC and P=ATC |
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Pretzel stands in New York City are a perfectly competitive industry in long-run equilibrium. One day, the city starts imposing a $10 per month tax on each stand. How does this policy affect the number of pretzels consumed in the short run and in the long run? |
C. no change in the short run, down in the long run |
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Yougo out to the best restaurant in town and order a lobster dinner for $40. After eating half of the lobster, you realize that you are quite full. Your date wants you to finish your dinner because you can’t take it home and because “you’ve already paid for it.” What should you do? Relate your answer to the material in this chapter.
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Once you have ordered thedinner, its cost is sunk, so it does not represent an opportunity cost. As aresult, the cost of the dinner should not influence your decision about whetherto finish it.
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Bob’s lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for$27 each. His total cost each day is$280 , of which $30 is a fixed cost. He mows 10 lawns a day. What can you say about Bob’s short-run decision regarding shutdown and his long-run decision regarding exit?
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Bob' total variable cost is his totalcost each day less his fixed cost ($280 - $30 = $250). His average variable cost is his totalvariable cost each day divided by the number of lawns he mows each day ($250/10= $25). Because his average variablecost is less than his price, he will not shut down in the short run. Bob's average total cost is his total costeach day divided by the number of lawns he mows each day ($280/10 = $28). Because his average total cost is greaterthan his price, he will exit the industry in the long run.
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Ball Bearings, Inc. faces costs of production as follows: QuantityTotal Fixed CostsTotal Variable Costs1. Calculate the company’s average fixed costs, average variable costs, average total costs, and marginal costs at each level of production. 2. The price of a case of ball bearings is$50 . Seeing that he can’t make a profit, the chief executive officer (CEO) decides to shut down operations. What is the firm’s profit/loss? Was this a wise decision? Explain. 3. Vaguely remembering his introductory economics course, the chief financial officer tells the CEO it is better to produce 1 case of ball bearings, because marginal revenue equals marginal cost at that quantity. What is the firm’s profit/loss at that level of production? Was this the best decision? Explain. |
a. Costs are shown inthe following table:
Q
TFC
TVC
AFC
AVC
ATC
MC
0 $100 $0 ---- ---- ---- ---- 1 100 50 $100 $50 150 50 2 100 70 50 35 85 20 3 100 90 33.3 30 63.3 20 4 100 140 25 35 60 50 5 100 200 20 40 60 60 6 100 360 16.7 60 76.7 160
b. If the price is $50, the firm will minimize its loss by producing4 units, where price is equal to marginal cost. When the firm produces 4 units,its total revenue is $200 ($50 x 4 = $200) and its total cost is $240 ($100 +$140). This would give the firm a lossof $40. If the firm shuts down, it willearn a loss equal to its fixed cost ($100). The CEO did not make a wisedecision.
c. If the firm produces 1 unit, its total revenue is $50 and itstotal cost is $150 ($100 + $50), so its loss will still be $100. This was alsonot the best decision. The firm couldhave reduced its loss by producing more units because the marginal costs of thesecond and third unit are lower than the price.
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A firm in a competitive market receives $500 in total revenue and has marginal revenue of 10. What is the average revenue, and how many units were sold?
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Since the firm operates in aperfectly competitive market, its price is equal to its marginal revenue of$10. This means that average revenue isalso $10 and 50 units were sold.
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A profit-maximizing firm in a competitive market is currently producing 100 units of output. It has average revenue of $10, average total cost of $8, and fixed costs of $200. 1.What is its profit? 2. What is its marginal cost? 3. What is its average variable cost? 4. Is the efficient scale of the firm more than, less than, or exactly ? |
a. Profit is equal to(P – ATC) × Q. Price is equal to AR. Therefore, profit is ($10 – $8) × 100 = $200.
b. For firms in perfect competition, marginal revenue and averagerevenue are equal. Since profitmaximization also implies that marginal revenue is equal to marginal cost,marginal cost must be $10.
c. Average fixed cost is equal to AFC /Q which is $200/100= $2. Since average variable cost isequal to average total cost minus average fixed cost, AVC = $8 − $2 = $6.
d. Since average total cost is less than marginal cost, average totalcost must be rising. Therefore, theefficient scale must occur at an output level less than 100.
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The market for apple pies in the city of Ectenia is competitive and has the following demand schedule: PriceQuantity Demanded Each producer in the market has fixed costs of and the following marginal cost: QuantityMarginal Cost1. Compute each producer’s total cost and average total cost for to . 2. The price of a pie is now . How many pies are sold? How many pies does each producer make? How many producers are there? How much profit does each producer earn? 3. Is the situation described in part (b) a long-run equilibrium? Why or why not? 4. Suppose that in the long run there is free entry and exit. How much profit does each producer earn in the long-run equilibrium? What is the market price and number of pies each producer makes? How many pies are sold? How many pie producers are operating? |
a. The table below showsTC and ATC for a typical firm:
Q TC ATC 1 11 11 2 15 7.5 3 21 7 4 29 7.25 5 39 7.8 6 51 8.5
b. At a price of $11,quantity demanded is 200. With marginal revenue of $11, each firm will chooseto produce 5 pies where their marginal cost is closest to the marginal revenuewithout exceeding marginal revenue. Therefore, there will be 40 firms (= 200/5).Each producer will earn total revenue of $55 ($11 ´ 5), total cost is $39, so profitis $16.
c. The market is not inlong-run equilibrium because firms are earning positive economic profit. Firmswill want to enter the market.
d. With free entry and exit,each producer will earn zero profit in the long run. Long-run equilibrium will occur when price isequal to minimum average total cost ($7). At that price, 600 pies are demanded.Each firm will only produce 3 pies (the quantity at which, MC is closest to MRwithout exceeding MR) meaning that there will be 200 pie producers in themarket. |
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An industry currently has 100 firms, each of which has fixed costs of $16 and average variable costs as follows: QuantityAverage Variable Cost1. Compute a firm’s marginal cost and average total cost for each quantity from 1 to 6. 2. The equilibrium price is currently $10. How much does each firm produce? What is the total quantity supplied in the market? 3. In the long run, firms can enter and exit the market, and all entrants have the same costs as above. As this market makes the transition to its long-run equilibrium, will the price rise or fall? Will the quantity demanded rise or fall? Will the quantity supplied by each firm rise or fall? Explain your answers. 4. Graph the long-run supply curve for this market, with specific numbers on the axes as relevant. |
a. The firms' variablecost (VC), total cost (TC), marginal cost (MC), and average total cost (ATC)are shown in the table below:
Quantity VC TC MC ATC 1 1 17 1 17 2 4 20 3 10 3 9 25 5 8.33 4 16 32 7 8 5 25 41 9 8.20 6 36 52 11 8.67
b. If the price is $10, each firm will produce 5 units. There are 100firms in the industry, so there will be 5 ´ 100 = 500 units supplied in the market.
c. At a price of $10 and a quantity supplied of5, each firm is earning a positive profit because price is greater than averagetotal cost. Thus, entry will occur and the price will fall. As price falls, quantity demanded will risein accordance with the law of demand. This entry will continue until price isequal to minimum average total cost, $8, and each firm is producing thequantity at which marginal revenue ($8) is equal to marginal cost (4 units ifwe assume units are not divisible). Therefore, the quantity supplied by each firm decreases.
d. Figure 8 shows the long-run market supply curve, which will behorizontal at minimum average total cost, $8. Each firm produces 4 units.
Figure8
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A firm is a natural monopoly if it exhibits the following as its output increases:
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D. decreasing average total cost |
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For a profit-maximizing monopoly that charges the same price to all consumers, what is the relationship between price P, marginal revenue MR, and marginal cost MC? |
B. P>MR and MR=MC |
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If a monopoly’s fixed costs increase, its price will and its profit will .
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D. stay the same, decrease |
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Compared to the social optimum, a monopoly firm chooses |
A. a quantity that is too low and a price that is too high. |
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The deadweight loss from monopoly arises because |
B. some potential consumers who forgo buying the good value it more than its marginal cost. |
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When a monopolist switches from charging a single price to perfect price discrimination, it reduces |
C. consumer surplus. |
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Johnny Rockabilly has just finished recording his latest CD. His record company’s marketing department determines that the demand for the CD is as follows: PriceNumber of CDs The company can produce the CD with no fixed cost and a variable cost of $5 per CD. 1.Find total revenue for quantity equal to 10,000 ,20,000 , and so on. What is the marginal revenue for each 10,000 increase in the quantity sold? 2. What quantity of CDs would maximize profit? What would the price be? What would the profit be? 3. If you were Johnny’s agent, what recording fee would you advise Johnny to demand from the record company? Why? |
a. The following tableshows total revenue and marginal revenue for each price and quantity sold:
Price
Quantity
Total Revenue
Marginal Revenue
Total Cost
Profit
24 10,000 $240,000 ---- $50,000 $190,000 22 20,000 440,000 $20 100,000 340,000 20 30,000 600,000 16 150,000 450,000 18 40,000 720,000 12 200,000 520,000 16 50,000 800,000 8 250,000 550,000 14 60,000 840,000 4 300,000 540,000
b. Profits are maximized at a quantity where MR=MC. The quantity at which MC is closest to MRwithout exceeding it is 50,000 CDs at a price of $16. At that point, profit is$550,000.
c. As Johnny's agent, you should recommend that he demand $550,000from them, so he receives all of the profit (rather than the recordcompany). The firm would still choose toproduce 50,000 CDs because their marginal cost would not change.
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A company is considering building a bridge across a river. The bridge would cost$2 million to build and nothing to maintain. The following table shows the company’s anticipated demand over the lifetime of the bridge: Price per CrossingNumber of Crossings, in Thousands1. If the company were to build the bridge, what would be its profit-maximizing price? Would that be the efficient level of output? Why or why not? 2. If the company is interested in maximizing profit, should it build the bridge? What would be its profit or loss? 3. If the government were to build the bridge, what price should it charge? 4. Should the government build the bridge? Explain. |
a. The table belowshows total revenue and marginal revenue for the bridge. The profit-maximizingprice will occur at the quantity at which marginal revenue equals marginalcost. In this case marginal cost equalszero, so the profit-maximizing quantity occurs where marginal revenue equals 0.This occurs at a price of $4 and quantity of 400,000 crossings. The efficientlevel of output is 800,000 crossings, because that is where price is equal tomarginal cost. The profit-maximizing quantity is lower than the efficientquantity because the firm is a monopolist.
Price
Quantity
(in Thousands)
Total Revenue
(in Thousands)
Marginal Revenue
$8 0 $0 ---- 7 100 700 $7 6 200 1,200 5 5 300 1,500 3 4 400 1,600 1 3 500 1,500 -1 2 600 1,200 -3 1 700 700 -5 0 800 0 -7
b. The company should not build the bridge because its profits arenegative. The most revenue it can earn is $1,600,000 and the cost is$2,000,000, so it would lose $400,000.
c. If the government were to build the bridge, it should set priceequal to marginal cost to be efficient. Since marginal cost is zero, thegovernment should not charge people to use the bridge.
Price
Figure 5
d. Yes, the government should build the bridge, because it wouldincrease society's total surplus. As shown in Figure 5, total surplus has area½ × 8 × 800,000 = $3,200,000, which exceeds the cost ofbuilding the bridge.
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You live in a town with 300 adults and 200 children, and you are thinking about putting on a play to entertain your neighbors and make some money. A play has a fixed cost of $2,000 ,but selling an extra ticket has zero marginal cost. Here are the demand schedules for your two types of customers: PriceAdultsChildren1. To maximize profit, what price would you charge for an adult ticket? For a child’s ticket? How much profit do you make? 2. The city council passes a law prohibiting you from charging different prices to different customers. What price do you set for a ticket now? How much profit do you make? 3. Who is worse off because of the law prohibiting price discrimination? Who is better off? (If you can, quantify the changes in welfare.) 4. If the fixed cost of the play were $2,500 rather than $2,000, how would your answers to parts (a), (b), and (c) change? |
a. Theprofit-maximizing outcome is the same as maximizing total revenue in this casebecause there are no variable costs. Thetotal revenue from selling to each type of consumer is shown in the followingtables:
Price
Quantity of Adult Tickets
Total Revenue from Sale of Adult Tickets
10 0 0 9 100 900 8 200 1,600 7 300 2,100 6 300 1,800 5 300 1,500 4 300 1,200 3 300 900 2 300 600 1 300 300 0 300 0
Price
Quantity of Child Tickets
Total Revenue from Sale of Child Tickets
10 0 0 9 0 0 8 0 0 7 0 0 6 0 0 5 100 500 4 200 800 3 200 600 2 200 400 1 200 200 0 200 0
To maximize profit, you should charge adults $7and sell 300 tickets. You should charge children $4 and sell 200 tickets. Totalrevenue will be $2,100 + $800 = $2,900. Because total cost is $2,000, profitwill be $900.
b. If price discrimination were not allowed, you would want to set aprice of $7 for the tickets. You would sell 300 tickets and profit would be$100.
c. The children who were willing to pay $4 but will not see the shownow that the price is $7 will be worse off. The producer is worse off becauseprofit is lower. Total surplus is lower. There is no one that is better off.
d. In (a) total profit would be $400. In (b),there would be a $400 loss. There would be no change in (c). |
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Only one firm produces and sells soccer balls in the country of Wiknam, and as the story begins, international trade in soccer balls is prohibited. The following equations describe the monopolist’s demand, marginal revenue, total cost, and marginal cost: where is quantity and is the price measured in Wiknamian dollars. 1.How many soccer balls does the monopolist produce? At what price are they sold? What is the monopolist’s profit? 2. One day, the King of Wiknam decrees that henceforth there will be free trade—either imports or exports—of soccer balls at the world price of . The firm is now a price taker in a competitive market. What happens to domestic production of soccer balls? To domestic consumption? Does Wiknam export or import soccer balls? 3. In our analysis of international trade in Chapter 9, a country becomes an exporter when the price without trade is below the world price and an importer when the price without trade is above the world price. Does that conclusion hold in your answers to parts (a) and (b)? Explain. 4. Suppose that the world price was not but, instead, happened to be exactly the same as the domestic price without trade as determined in part (a). Would allowing trade have changed anything in the Wiknamian economy? Explain. How does the result here compare with the analysis in Chapter 9? |
a. The monopolist would set marginal revenueequal to marginal cost and then substitute the profit-maximizing quantity intothe demand curve:
10– 2Q = 1 + Q 9= 3Q Q = 3 P = 10 – Q = $7
Totalrevenue = P ´ Q =($7)(3) = $21 Totalcost = 3 + 3 + 0.5(9) = $10.5 Profit= $21 – $10.5 = $10.5
b. The firm becomes a price taker at a price of$6 and no longer has monopoly power. In a competitive equilibrium, the priceequals marginal cost so,
10 - Q = 1 + Q 10 = 1 +2Q 9 = 2Q Q= 4.5 P = 5.5
The firmwill export soccer balls because the world price is greater than the domesticprice (in the absence of monopoly power). As Figure 11 shows, domesticproduction will rise to 5 soccer balls, domestic consumption will rise to 4,and exports will be 1.
Figure11
c. The price actually falls even though Wiknamwill now export soccer balls. Once trade begins, the firm no longer hasmonopoly power and must become a price taker. However, the world price of $6 isgreater than the competitive equilibrium price ($5.50) so the country exportssoccer balls. d. Yes. The country would still exportballs at a world price of $7. The firm is a price taker and no longer is facinga downward-sloping demand curve. Thus, it is now possible to sell more withoutreducing price |
