ConsumerSurplus,ProducerSurplusWhatiswillingnesstopay?Howdoesitrelatetothedemandcurve?Thewillingnesstopayisthemaximumamountthatabuyeriswillingtopayforagood.Inotherwordsitishowmuchabuyervaluesagood.Pointsalongthedemandcurverepresentbuyer’swillingnesstopayorthemaximumamountbuyeriswillingtopay.Whatisconsumersurplus?Whatdoesitmeasure?Consumersurplusisthebuyer’swillingnesstopayminustheprice,inotherwordsitisthedifferencebetweenthemaximumamounttheconsumerwaswillingtopayandtheamountaconsumerhastopay.Itmeasuresthebenefitoftheconsumersbeingabletobuygoodsatthemarketpriceofferedratherthanthemaximumamounttheywerewillingtopay.Writetheformulaforconsumersurplus.CS=themaximumamounttheconsumer’swillingtopay–theactualamountconsumerpaysSupposetheconsumeriswillingtopay$20.00foraparticulargoodbutonlyhadtopay$14.00forit.Whatistheconsumersurplus?CS=$6.00Ifaconsumeriswillingtopay$15.00foraparticulargoodbutthepriceofthegoodis$17.00,thenwhatwouldbetheconsumersurplus?Consumerwouldnotpurchasethegoodandwouldnothaveanyconsumersurplus.Belvaiswillingtopay$65.00forapairofshoesforaformaldance.Shefindsapairatherfavoriteoutletshoestorefor$48.00.CalculateBelva’sconsumersurplus.CS=65–48=$17 Janinewouldbewillingtopay$50toseeLesMisérables,butbuysaticketforonly$30.HowmuchdoesJaninevaluestheperformance?Shevaluesit$50Denisevaluesastainlesssteeldishwasherforhernewhouseat$500,butbuysitfor$350.WhatisDenise’swillingnesstopay? $500Nathanbuysanewsoundsystemforhisdormroomfor$500.Hereceivesconsumersurplusof$400fromthepurchase.HowmuchdoesNathanvaluehissoundsystem?$900

BUYER

WILLINGNESSTOPAY

MIKE

$50.00

SANDY

$30.00

JONATHAN

$20.00

HALEY

$10.00

Ifthetablerepresentsthewillingnesstopayof4buyersandthepriceoftheproductis$15,thenwhowouldbewillingtopurchasetheproduct?Mike,Sandy,andJonathanOnagraph,describehowtofindtheconsumersurplusarea.CSisthearea belowthedemandcurveandabovepriceuptoquantitypurchased.Accordingtothegraphshown,whenthepriceisP1consumersurplusisgivenbywhicharea? CS=A+B+CAccordingtothegraphshown,atthepriceofP2,consumersurplusisgivenbywhicharea?CS=AWhatdopointsalongthesupplycurverepresent?Pointsalongthesupplycurverepresentsseller’sopportunitycostofproduction.Whatistheformulaforproducersurplus? PS=Amountreceivedbysellers–Costsofsellers.Onagraph,describehowtofindtheproducersurplusarea.PSistheareaunderpriceandabovesupplyuptoquantitysold.Rogerproducescomputerboards.Hisproductioncostis$10perboard.Hesellstheboardsfor$25each.Whatishisproducersurplus?PS=25-10=$15perboard

Accordingtothegraphshown,attheequilibriumprice,whatistheconsumersurplus? CS=$480Accordingtothegraphshown,attheequilibriumprice,whatistheproducersurplus?PS=$640Accordingtothegraphshown,attheequilibriumprice,whatisthetotalsurplus?TS=CS+PS=$1,120.ThereareonlyfiveconsumersinterestedinHangover3Blueraydiscs.ThemaximumwillingnesstopayoftheseconsumersforHangover3Blueraydiscaregivenbelow:

Emily $10Carter $14Angela $16Greyson $19Jack $20

a) DrawthemarketdemandcurveforHangover3blueraydisc.

PQ201192182172163153144134124114105

b)SupposethepriceofHangover3blueraydiscis$15.Howmanyunitswouldbesold?Howmuchwouldbetheconsumersurplus?CS=$5+$4+$1=$10c)SupposethepriceofHangover3blueraydiscis$14.Howmanyunitswouldbesold?Howmuchwouldbetheconsumersurplus?CS=$6+$5+$2=$13

3)Supposethedemandandsupplycurvesfortomatoesaregivenbelow.

Calculatetheconsumersurplus,producersurplusandtotalsurplusunderfreemarketequilibrium.CS=6x600x0.5=$1,800 PS=2x600x0.5=$600PriceControlsGovernmentssometimesinterveneinmarketsusingpricecontrolsiftheequilibriumpriceistoohighforconsumersortoolowforproducers.Whatisapriceceiling?Priceceilingisalegalmaximumpriceatwhichagoodcanbesold.Apriceceilingkeepsapricefromrisingaboveacertainlevel.Assumethegraphontherightrepresentthemarketforburritos.Supposethegovernmentimposesapriceceilinginthismarketatapriceof$5.00,whatwouldbetheresult?Quantitydemanded=60Quantitysupplied=40Quantitytraded=40Therewouldbeashortageof20burritos.Whatkindofpricecontrolisrentcontrolanexampleof?Rentcontrolisanexampleofamaximumpricecontrol(priceceiling).Listtheconsequencesofrentcontrols.

• Rentcontrolscreateashortageofapartmentsavailableforrentalpurposes.Theshortagegetsworseinthelongrunaslandlordsmayconverttheirapartmentstoco-opsandcondos,reducingthequantityofapartmentsavailableforrentalpurposes.

• Thequalityofapartmentsdecreasessincelandlordstendtospendlessonmaintenance.

0 100 200 300 400 500 600 700 800 900 10000

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5

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7

8

9

10

S

D

Supposethefollowingtablerepresentsthedemandandthesupplyofbicycles.Whathappensifgovernmentimposesapriceceilingof$100perbicycle?Price Quantitydemanded Quantitysupplied$160 20 80$120 40 40$100 50 20$80 60 0Apriceceilingof$100wouldcreateashortageof30bicycles.Supposethefiguresshownbelowrepresentthemarketfor3Dprinters.Ononeofthemarketsaneffectivepriceceilingisimposed.Theothermarkethasanineffectivepriceceiling.Identifywhichoneiswhich.(Note:effectivepriceceilingisabindingpriceceilingthatwouldaltertheinitialmarketequilibrium.Ineffectivepriceceilingisnotabindingonewhichwouldnothaveanyeffectontheinitialmarketequilibrium)

IneffectivePriceCeiling EffectivePriceCeilingInwhichpanel(s)inthefigureshownabove,wouldtherebeashortagefor3Dprintersattheceilingprice?Panel(b).Thisisaneffectivepriceceilingasitisintroducedbelowthemarketequilibriumpriceandhencecreatesshortage.Whatisapricefloor?Apricefloorisalegalminimumpriceatwhichagoodcanbesoldisaprice.Apricefloorkeepspricesfromfallingbelowagivenlevel.Whatkindofpricecontrolisminimumwageanexampleof?Minimumwageisanexampleofapricefloor.Supposethegraphshowsthemarketforunskilledlabor.Ifthegovernmentimposesaminimumwageof$14.00inthismarket,whatwouldbetheresult?Atthisminimumwageweseethatthequantitydemandedoflaborwillbelessthanthequantitysupplied.Quantitydemandedoflabor=30Quantitysuppliedoflabor=70 Therewouldbeexcesssupplyof40.(Unemploymentof40)

ExplicitandImplicitCosts,AccountingandEconomicProfitWhatdoweassumeineconomicsthattheaimofthefirmsis?Theaimofthefirmsistomaximizeprofit.Howisprofitcalculated?Profit=TotalRevenue–TotalCostHowistotalrevenuecalculated?TotalRevenue=PricexQuantityWhatisthedifferencebetweenaccountingprofitandeconomicprofit?EconomicProfit=TotalRevenue–(ExplicitCosts+ImplicitCosts)AccountingProfit=TotalRevenue–ExplicitCostsWhatisexplicitcost?Giveexamplesofexplicitcosts.ThecostswhichinvolveoutflowofcashduetopaymentstowardstheinputsusedinproductionisknownasExplicitCost.Theseareout-of-pocketcostsforafirm—forexample,paymentsforwagesandsalaries,rent,ormaterials.Whatisimplicitcost?Giveexamplesofimplicitcosts.Thecostsinwhichthereisnocashoutlay,buttherearetheopportunitycostofresourcesalreadyownedbythefirmandusedinbusiness—forexample,forgonesalaryinnextbestjobopportunityfortheowner,interestincomeforgoneonfundsusedforthebusiness,movingintoastorespacethatthebusinessalreadyownsinvolvesforgonerent,etc.Wolfgangcurrentlyworksforalawfirmforayearlysalaryof$125,000.Heisconsideringquittinghisjobandopeninghisownlawpractice,whereheexpectstobring$200,000revenueperyear.Tostarthisownfirm,hewouldneedanofficespaceandalawclerk.Theofficespacehefoundrentsfor$50,000peryear.Alawclerkcouldbehiredfor$35,000peryear.ListWolfgang’sexplicitcosts.Howmuchishisexplicitcosts?Explicitcosts:Officerental,Lawclerk’ssalaryExplicitcosts=Officerental+Lawclerk’ssalary=$50,000+$35,000=$85,000CalculateWolfgang’saccountingprofit.Accountingprofit=Revenues−Explicitcosts=$200,000−$85,000=$115,000ListWolfgang’simplicitcosts.Howmuchishisimplicitcosts?Implicitcosts:ThesalaryhewouldhavetogiveuponcehequitshiscurrentjobImplicitcosts:Forgonesalary=$125,000

ShouldWolfgangopenhisownlawpractice?Toanswerthisquestion,whatelsewouldyouwanttoknow?Inordertomakethisdecision,weneedtocalculateWolfgang’seconomicprofit.EconomicProfit=TotalRevenue–(ExplicitCosts+ImplicitCosts)EconomicProfit=200,000–($85,000+$125,000)=-$10,000ThenegativeeconomicprofitwouldmeanthatWolfgangwouldbeearning$10,000lessthanifheworkedforthecorporatefirm.Sohewouldbebetteroffstayingatthiscurrentjob.Supposeyouhavesecuredyourselfasummerjob,cuttinggrass.Youcharge$40perlawnandyoumow400lawnsoverthesummerbreak.Youspend$1,000onequipmentand$2,000ongasoline.YoucouldhaveworkedatMcDonaldsandearned$8,000overthesummer.Calculateyouraccountingprofitandeconomicprofit.WhichoptionisbetterforyoutoworkatMcDonaldsortocutgrass?Accountingprofit=Revenues−ExplicitcostsEconomicProfit=TotalRevenue–(ExplicitCosts+ImplicitCosts)Totalrevenue=$40x400=$16,000Explicitcosts=$1,000+$2,000=$3,000Implicitcosts=$8,000AccountingProfit=$16,000-$3,000=$13,000EconomicProfit=$16,000–($3,000+$8,000)=$5,000Sinceeconomicprofitispositive,youarebetterofcuttinggrass.Nexttoeachstatement,writeTfortrueorFforfalse.T 1.TotalRevenue=PricexQuantityT 2.Thedifferencebetweenaccountingprofitandeconomicprofitisimplicitcosts.F 3.Economicprofitisusuallybiggerthanaccountingprofit.KeyTermsMatcheachtermwithitsdefinition.

A.AccountingProfitFIncomefromsellingafirm’sproduct;definedaspricetimesquantitysoldB.EconomicProfitATotalrevenueminusexplicitcostsC.ExplicitCostsBTotalrevenueminus(explicitplusimplicitcosts)D.ImplicitCostsETheprocessofcombininginputstoproduceoutputE.ProductionHAnorganizationthatcombinesinputs(labor,capital,land,rawmaterials)toproduceoutputF.RevenueDOpportunitycostofresourcesalreadyownedbythefirmandusedinbusinessG.ProfitCOutofpocketcostsforafirm;suchaspaymentsforwages,rent,etc.H.FirmGThedifferencebetweenrevenueandcost,calculatedasRevenueminuscost

ProductionintheShortRunWhatarefixedinputs?Theseareinputsthatcannotbeeasilychangedintheimmediaterun.Capitalistypicallythefixed

inputintheshortrun.Whatarevariableinputs?Theseareinputsthatcanbeeasilyincreasedordecreasedintheshortrun.Laborisavariableinput.Howdowedefineshortrunineconomics?Thisistheperiodoftimeduringwhichatleastoneormoreofthefirm’sinputsisfixed.(i.e.firm

cannotchangethequantityoftheseinputsduringthattimeperiod).Howdowedefinelongrunineconomics?Thisistheperiodoftimeduringwhichallofthefirm’sinputsarevariable.(i.e.firmcanchangethe

quantityofalloftheinputsduringthattimeperiod.)Supposeyouhaveapizzarestaurant.Yourrestaurantisbecomingpopularandyouneedto

increaseyourproduction.Intheshortrunwhichofyourinputswouldbefixedandwhichwouldbevariable?Fixedinputs:Thespaceoftherestaurant,thenumberofpizzaovensinstalled,thetablesandchairs.Variableinputs:Workers,pizzaingredientsDefinemarginalproduct.Marginalproduct(MP)istheadditionaloutputofonemoreworker.Itiscalculatedasthechangein

totalproductdividedbychangeinlabor.Givendataintableformiflaborischangingby1fromrowtorowthentheformulaboilsdowntofindingthechangeinoutputfromonerowtothenext.Definethelawofdiminishingmarginalproduct.Asworkersareaddedintheshortrunwithcapitalbeingfixed.Marginalproductwillriseatfirst

butwilleventuallydeclineasworkersgetintoeachother’swayhavingtoworkwiththefixedinput.Youhaveasmallbusinesswherelumberjackscuttreeswithatwoperson-saw.Yourproduction

dataisgiveninthetablebelow.Fillinthemarginalproductcolumn.

No.oflumberjacks

No.oftreescut MarginalproductMP

0 0 1 4 42 10 63 12 24 13 15 13 0

Atwhichworkerdiminishingmarginalproductivitysetin?Withthe3rdworker

Supposeyouhaveasmallstandwhereyousellsnowcones.Thefollowingtableshowsthenumberofworkersandtheresultingsnowconeoutputthattheyproduce.Numberofworkers(L)

Totaloutput(Q)

MarginalProduct

AverageProduct

0 0 20 201 20 30 252 50 25 253 75 15 22.54 90 10 205 100 5 17.56 105 -5 14.287 100 -10 11.258 90 20 20

a) CalculateMPandAPoflaborandfillinthetable.b)Whendoesdiminishingmarginalproductivitybegin?

Diminishingmarginalproductivitybeginwiththe3rdworker.Yournewaccountantaccidentlylostsomeofyourdata.Luckilyusingtherelationshipbetweentotalproduct,averageproductandmarginalproductyouareabletofillinthebelowtable.Labor(L) TotalProduct

(Q)AverageProduct(APL)

MarginalProduct(MPL)

0 0 0 -1 19 19 192 72 36 533 153 51 814 256 64 1035 375 75 1196 504 84 1297 637 91 1338 768 96 131Nexttoeachstatement,writeTfortrueorFforfalse.T 1.Marginalproductistheadditionaloutputofonemoreworker.F 2.Laboristypicallyafixedinput.F 3.Marginalproductcanneverbenegative.KeyTermsMatcheachtermwithitsdefinition.

A.DiminishingFFactorsofproductionthatafirmcaneasilyincreaseordecreaseinmarginalproductivityashortperiodoftimeB.FixedinputsAAsfirmemploysmorelabor,capitalbeingfixed,additionaloutputproducedeventuallydeclinesC.MarginalproductESynonymforfirm’soutputD.ShortrunGResourcesfirmsusetoproducetheirproductsE.TotalproductDPeriodoftimeduringwhichatleastoneormoreofthefirm’sinputsisfixedF.VariableinputsCChangeinfirm’soutputwhenitemploysonemoreworkerG.FactorsofproductionHPeriodoftimeduringwhichallofthefirm’sinputsarevariableH.LongrunBFactorsofproductionthatcan’teasilybeincreasedordecreasedinashortperiodoftime

CostsintheShortRunDefinefixedcosts.Fixedcostsareexpendituresthatdonotchangeregardlessofthelevelofproduction.Thesecostsare

thecostoffixedinputs.Definevariablecosts.Variablecostsarethecostsofvariableinputs.Definetotalcosts.Totalcostsarethesumoffixedplusvariablecosts.TC=FC+VCSupposeyouownalawncarebusinesswhereyouprovidemowingservices.Yourfixedinputis

twolawnmowersthatyourented.Therentforeachlawnmoweris$80permonth.Yourvariableinputisworkersyouhire.Yourtotalcostisprovidedinthetablebelow.Fillinthemissingentries.WeknowthattheFC=$160sowefillintheFCcolumn.WealsoknowthatTC=FC+VCSowecanfindVCbysubtractingFCfromTC.

Quantity FixedCost(FC) VariableCost(VC) TotalCost(TC)0 $160 0 10 $160 $40 $20018 $160 $90 $25023 $160 $160 $32029 $160 $240 $40035 $160 $330 $49040 $160 $340 $500Writetheformulasforaveragetotalcost(ATC),averagevariablecost(AVC),averagefixedcost(AFC)andmarginalcost(MC).ATC=TC/Q AVC=VC/Q AFC=FC/Q MC=ChangeinTC/changeinQPleaserefertothelawncarebusinessproblemgivenabove.Usingthetableyoufilledpleaseanswerthefollowingquestions:Whatistheaveragevariablecostofproducing18lawnservices?AVC=VC/Q=90/18=$5Whatistheaveragefixedcostofproducing35lawnservices?AFC=FC/Q=160/35=$4.57Whatistheaveragetotalcostofproducing40lawnservices?ATC=VC/Q=500/40=$12.5DescribetherelationshipbetweenMCandATC.(thesamerelationshipappliestoMCandAVC)WhenMCishigherthanATC,ATCrises.WhenMCislowerthanATC,ATCdecreases.

SupposeyouareoperatingabicyclemessengerservicefordowntownColumbus.Thenumberofemployeesandthecorrespondingnumberofparcelsthattheycandeliverinamonthisgivenbythefirsttwocolumnsofthebelowtable.Youleased5bicycleswitha$500leaseoneachthatincludestheliabilityinsurance.Youarealsopaying$3,000permonthtorenttheofficespaceand$500forwebsitehostingandphoneservice.Youpay$800monthlysalarytoeveryworkeryouemploy.Giventhisinformation,fillinthetablebelow.Numberofworkers(L)

Totaloutput(Q)

FixedCosts VariableCosts TotalCost

0 0 6000 0 60001 30 6000 800 68002 65 6000 1600 76003 100 6000 2400 84004 130 6000 3200 92005 150 6000 4000 100006 160 6000 4800 108007 165 6000 5600 11600SupposeJanisstartingupasmallcoffeecartbusinessinfrontofCornsbuilding.VariablecostsforJan’scoffeecartbusinesswouldincludethecostofwhichofthefollowing: a. costofbuildingthecartFC b. costofhiringagraphicdesignertodesignherbannerforherbusinessFC c. costofgroundcoffee d. costoftheespressomachinesheleasedforonesemesterFCe. AlloftheaboveIfafirmproducesnothing,whichofthefollowingcostswillbezero? a. totalcost b. fixedcost c. opportunitycost d. variablecostAveragetotalcostisequalto a. output/totalcost. b. totalcost–totalquantityofoutput. c. averagevariablecost+totalfixedcost. d. totalcost/output.Thecostofproducinganadditionalunitofoutputisthefirm’s a. marginalcost. b. productivityoffset. c. variablecost. d. averagevariablecost.Marginalcosttellsusthe a. valueofallresourcesusedinaproductionprocess. b. marginalincrementtoprofitabilitywhenpriceisconstant. c. amountbywhichtotalcostriseswhenoutputisincreasedbyoneunit. d. amountbywhichoutputriseswhenlaborisincreasedbyoneunit.

Diminishingmarginalproductsuggeststhatthemarginal a. costofanextraworkerisunchanged. b. costofanextraworkerislessthanthepreviousworker’smarginalcost. c. productofanextraworkerislessthanthepreviousworker’smarginalproduct. d. productofanextraworkerisgreaterthanthepreviousworker’smarginalproduct.Theaveragefixedcostcurve a. alwaysdeclineswithincreasedlevelsofoutput. b. alwaysriseswithincreasedlevelsofoutput. c. declinesaslongasitisabovemarginalcost. d. declinesaslongasitisbelowmarginalcost.Whenmarginalcostislessthanaveragetotalcost, a. marginalcostmustbefalling. b. averagevariablecostmustbefalling. c. averagetotalcostisfalling. d. averagetotalcostisrising.Whenmarginalcostexceedsaveragetotalcost, a. averagefixedcostmustberising. b. averagetotalcostmustberising. c. averagetotalcostmustbefalling. d. marginalcostmustbefalling.Thecurvesbelowreflectinformationaboutthecoststructureofafirmwhichproducescellphones.Usethefiguretoanswerquestionsbelow.

Writetheletterofthecurvethatismostlikelytorepresentaveragetotalcost:B Writetheletterofthecurvethatismostlikelytorepresentaveragefixedcost:D Writetheletterofthecurvethatismostlikelytorepresentaveragevariablecost:CWritetheletterofthecurvethatismostlikelytorepresentmarginalcost:A

Foralargefirmthatproducesandsellsautomobiles,whichofthefollowingcostswouldbeavariablecost? a. the$20millionpaymentthatthefirmpayseachyearforaccountingservices b. thecostofthesteelthatisusedinproducingautomobiles c. therentthatthefirmpaysforofficespaceinasuburbofSt.Louis d. Alloftheabovearecorrect.Staplers–R-Usproducesandsellsstaplers.Lastyear,itproduced5,000staplersandsoldeachstaplerfor$8.Inproducingthe5,000staplers,itincurredvariablecostsof$30,000andatotalcostof$45,000.Howmuchisthefirm’sfixedcosts? FC=$15,000. Inproducingthe5,000staplers,whatwasthefirm’saveragefixedcost?AFC=FC/Q=15,000/5,000=$3Inproducingthe5,000staplers,whatwasthefirm’saveragevariablecost?AVC=VC/Q=30,000/5,000=$6 Inproducingthe5,000staplers,whatwasthefirm’saveragetotalcost?ATC=TC/Q=45,000/5,000=$9OrATC=AFC+AVC=$3+$6=$9 Whatwashefirm’seconomicprofitfortheyear?TR=PxQ=8x5,000=$40,000Profit=TR–TC=$40,000-$45,000=-$5,000 Harry'sHotdogsisasmallstreetvendorbusinessownedbyHarryHuggins.IfHarrymakes15hotdogsinhisfirsthourofbusinessandincursatotalcostof$16.50,whatishisaveragetotalcostperhotdog?ATC=TC/Q=16.50/15=$1.10Yoursmallpizzashop,BishopsPizzahasthefollowingcosts.Totaloutput

TC FC VC AFC AVC ATC MC

0 $100 100 0 10 $120 100 20 10 2 12 220 $140 100 40 5 2 7 230 $170 100 70 3.3 2.3 5.6 340 $200 100 100 2.5 2.5 5 350 $260 100 160 2 3.2 5.2 660 $360 100 260 1.6 4.3 6 10Fillinthebelowtablebycalculatingfixedcosts,variablecosts.averagefixedcosts,averagevariablecosts,averagetotalcostsandmarginalcosts.

Fillintheblanks.Totalcostdividedbythequantityofoutputistheaveragetotalcost.TheaveragetotalcostisusuallyaUshapedcurvethatstartsrelativelyhighduetohighfixedcostsatlowlevelsofoutput,fallstoaminimumasoutputincreases,andthenrisesagainduetodiminishingreturns.DrawyourownsketchoftheATC,AVCandMCcurves.PayattentiontotheshapesofthecurvesandthepointofintersectionbetweentheMC,AVCandATC.Alsodon’tforgettofactorinaveragefixedcostforthedistancebetweenyourAVCandATCasoutputrises.KeyTermsMatcheachtermwithitsdefinition.

A.AveragetotalcostFCostofproductionthatincreaseswiththequantityproduced;thecostofvariableinputsB.AveragevariablecostATotalcostdividedbythequantityofoutputC.FixedcostEThesumoffixedandvariablecostsofproductionD.MarginalcostBVariablecostdividedbythequantityofoutputE.TotalcostCCostofthefixedinputs;expenditurethatafirmmustmakebeforeproductionstartsanddoesnotchangeregardlessoftheproductionlevelF.VariablecostDTheadditionalcostofproducingonemoreunitG.AveragefixedcostGFixedcostdividedbythequantityofoutput

Nexttoeachstatement,writeTfortrueorFforfalse.F 1.Marginalcostwillalwaysbegreaterthanaveragevariablecost.F 2.Sunkcostsshouldbeconsideredwhenmakingeconomicdecisionsaboutfuture

production.T 3.WhenMCishigherthanATC,ATCrises.

CostsintheLongRunWhatiseconomiesofscale?Economiesofscaleoccurwhenincreasingoutputleadstolowerlong-runaveragecosts.Whatarediseconomiesofscale?Diseconomiesofscaleoccurwhenincreasingoutputleadstohigherlong-runaveragecosts.Howdoweobtainthelongrunaveragecostcurvefromtheshortrunaveragecostcurves?Thelongrunaveragecostcurve(LRAC)isacollectionofshortrunaveragecostcurves(SRAC)(itisthelowerenvelopeoftheSRACcurves).Thelongrunaveragecostcurve(LRAC)istheleastexpensiveaveragecostcurveforanylevelofoutput.Sketchagraphofafirm’slongrunaveragecostcurveshowingeconomiesofscale,constantreturnstoscaleanddiseconomiesofscale.Labelyouraxesandthethreescaleareasonyourgraph.

Thefigurebelowdepictsaveragetotalcostfunctionsforafirmthatproducesautomobiles.

Whichofthecurvesismostlikelytocharacterizetheshort-runaveragetotalcostcurveofthesmallestfactory?ATCAWhichcurverepresentsthelong-runaveragetotalcost?ATCDWritethenameoftheaveragetotalcostcurvesthatthefirmcanoperateoninthelongrunThefirmcanoperateonanyoftheaveragecostcurvesinthelongrun.Namely,ATCAorATCBor

ATCCWhatoutputlevelsdoesthisfirmexperiencediseconomiesofscale?OutputlevelsaboveN AtlevelsofoutputbelowMwhattypeofreturnstoscaledoesthefirmexperience?Economiesofscale. KeyTermsMatcheachtermwithitsdefinition.

A.ConstantreturnsBThelongrunaveragecostofproducingoutputdecreasesastotaloutputtoscaleincreasesB.EconomiesofScaleETheaveragetotalcostcurveintheshortterm;showsthetotaloftheaveragefixedcostsandaveragevariablecostsC.DiseconomiesofScaleDShowsthelowestpossibleaveragecostofproduction,allowingalltheinputstoproductiontovarysothatthefirmischoosingallinputsoptimallyD.LongrunaverageCThelongrunaveragecostofproducingoutputincreasesastotaloutputcostcurve(LRAC)increasesE.ShortrunaverageAExpandingoutputdoesnotchangethelongrunaveragecostofproductioncostcurve

ExercisesonPerfectCompetitionWhenafirmhasnoabilitytoinfluencemarketpricesitissaidtobeinwhatkindofamarket? acompetitivemarket

Inacompetitivemarket,howwilltheactionsofanysinglebuyerorsellerimpactthemarketprice?ItwillhavenoimpactonthemarketpriceListanddescribethecharacteristicsofaperfectlycompetitivemarket.

• Therearemanybuyersandsellersinthemarket.• Thegoodsofferedbythevarioussellersarethesame.• Firmscanfreelyenterorexitthemarketastherearenosignificantentrybarriers.

Whywouldafirminaperfectlycompetitivemarketalwayschoosetosetitspriceequaltothecurrentmarketprice?Ifafirmsetitspricebelowthecurrentmarketprice,whateffectwouldthishaveonthemarket?

Thefirmcouldnotsellanymoreofitsproductatalowerpricethanitcouldsellatthemarketprice.Asaresult,itwouldneedlesslyforgorevenueifitsetsapricebelowthemarketprice.Ifthefirmsetsahigherprice,itwouldnotsellanythingatallbecauseacompetitivemarkethasmanysellerswhowouldsupplytheproductatthemarketprice.

MangeroffirmX,reportsthathefacesthefollowingpriceandquantityrelationshipforhisproduct:Quantity(q)Price(P) 1 13 2 13 3 13 4 13 5 13 6 13 7 13 8 13 9 13

Thepriceandquantityrelationshipinthetableaboveismostlikelythatfacedbyafirminwhattypeofmarketstructure?CompetitivemarketOverwhichrangeofoutputismarginalrevenueequaltoprice?Marginalrevenueisequaltopriceoverthewholerangeofoutput(MR=P)Overwhatrangeofoutputismarginalrevenuedeclining? None;marginalrevenueisconstantoverthewholerangeofoutputandisequaltoprice.

Forafirm,likefirmXinaperfectlycompetitivemarket,whattypeofrelationshipistherebetweenthepriceofthegoodandmarginalrevenue?Priceisequaltomarginalrevenue.(P=MR)ManageroffirmXisdebatingwhetherheshoulddecreasehispricebelow$13tosellmoreunits.

Pleaseadvise.BecausethefirmXisoperatinginacompetitivemarket,thegoodofferedforsaleisahomogenousgood,andfirmXwon’tbenefitfromloweringitspriceasthefirmcansellallitwantsat$13andhencehasnoreasontochargelessthantheprevailingmarketprice.InclasswesaidthatthefirmslikefirmXinperfectcompetitionarepricetakers,itimpliesthatif

firmXraisesitsprice,whatwillhappen?FirmXwon’tsellanyunits,asthebuyerswillgoelsewhere.IffirmXinacompetitivemarketreportstohavezeroeconomicprofit,whatcanyouinferabout

itsaccountingprofit?Itsaccountingprofitispositive.

Whenafirminacompetitivemarketproduces10unitsofoutput,ithasamarginalrevenueof$8.Whatwouldbethefirm’sprice?Inperfectcompetition:price=marginalrevenue(P=MR)andthereforeprice=$8Choosethecorrectanswerforthefollowingmultiple-choicequestions:Inacompetitivemarket, a. eachsellercansellallhewantstosellatthegoingprice. b. buyersandsellersarepricetakers. c. thegoodsofferedbythedifferentsellersarelargelythesame. d. Alloftheabovearecorrect.Forafirminaperfectlycompetitivemarket,thepriceofthegoodisalways a. equaltomarginalrevenue. b. equaltototalrevenue. c. greaterthanaveragerevenue. d. Alloftheabovearecorrect.WhichofthefollowingisNOTacharacteristicofaperfectlycompetitivemarket? a. Firmsarepricetakers. b. Firmshavedifficultyenteringthemarket. c. Therearemanysellersinthemarket. d. Goodsofferedforsalearelargelythesame.Whichofthefollowingstatementsbestreflectsaprice-takingfirm? a. Ifthefirmweretochargemorethanthegoingprice,itwouldsellnoneofitsgoods. b. Thefirmhasnoincentivetochargelessthanthegoingprice. c. Thefirmcansellasmuchasitwantstosellatthegoingprice. d. Alloftheabovearecorrect.

Youaregiventhefollowingdataforafirmoperatinginacompetitivemarket.FillintheremainingcolumnsforMRandMC. QuantityTotalRevenueTotalCostMarginalRevenueMarginalCost 0 $0 $109 1 9 149 4 2 18 199 5 3 27 259 6 4 36 329 7 5 45 409 8 6 54 499 9 7 63 599 10 8 72 709 11Ataproductionlevelof4unitswhatistherelationshipbetweenTRandVC?Totalrevenueisgreaterthanvariablecost.Atwhichquantityofoutputismarginalrevenueequaltomarginalcost? Atq=6Whatistheformulatocalculatetotalprofitforafirm?Profit=Totalrevenue-TotalcostCanyouexpressthetotalprofitformulaintermsofperunitprofit?

Profit=(Price–Averagetotalcost)xOutputWhatistheruleforprofitmaximization?ChoosetheoutputwhereMR=MCTheWheelerWheatFarm,whichoperatesinacompetitivemarket,sellswheattoagrainbroker

inSeattle,Washington.TheWheelerWheatFarmreportsthefollowingdata: Quantity(q)TotalRevenue TotalCost 0 $0 $10 1 9 14 2 18 19 3 27 25 4 36 32 5 45 40 6 54 49 7 63 59 8 72 70 9 81 82 a)Atwhichquantityofoutputismarginalrevenueequaltomarginalcost?SinceTR=Pxq,weknowthatthepriceis$9.SinceP=MR,weknowthatMR=9CalculatingMCforeachoutputlevelweseethatatq=6,MR=MC.b)Supposeinthewheatindustry,achangeindemandresultsthewheatpricestoriseto$11.

Whatshouldthewheatfarmdotomaximizeitsprofit?Increaseitsoutputto8.

c)Supposeadecreaseindemandcausedwheatpricestodropto$5intheindustry.Whatshouldthewheatfarmdotomaximizeitsprofit?Increaseproductionto2.d)Wheelerfarm’smanagertellsyouthatthetotalrevenueislessthanvariablecostsattheir

profitmaximizingoutput.Whatwouldyouadvise?Shutdown.e)TheRoadrunnerfarm,Wheeler’soneofcompetitors,reportsthatattheirprofitmaximizing

output,thepriceisbelowaveragevariablecost.Whatwouldyouadvise? Shutdownandincurfixedcosts.f)Whenwouldaprofit-maximizingfirmshutdownintheshortrun?(Writeyourexpressionintermsofoneunitofoutput)Price<AverageVariableCost(P<AVC)g)Whenwouldaprofit-maximizingfirmshutdownintheshortrun?(Writeyourexpressionintermsofqunitsofoutput)Totalrevenue<Variablecost(TR<VC)

Inthelongrunallofafirm’scostsarevariable.Inthiscase,whatistheexitcriterionforaprofit-maximizingfirm?Price<averagetotalcost(P<LRAC)

Whenprofit-maximizingfirmsincompetitivemarketsareearningprofits,inthelongrunwhatwouldhappen?Newfirmswillenterthemarket,increasingthemarketsupply,decreasingtheequilibriumprice,decreasingtheindividualfirmprofitsuntileconomicprofitsdisappear.

Youwitnessednewfirmsenteringacompetitivemarket.Whatcanyouinferfortheexistingfirmsinthatmarket?Existingfirmsmusthavebeenenjoyingpositiveeconomicprofitorthatpriceexceedsaveragetotalcostfortheexistingfirms.

Indoorknobmanufacturingindustry,youobservedthatthefirmsaremakinglosses.Inthelongrunwhatwouldhappen?Someoftheexistingfirmswouldleavethemarket.Themarketsupplywoulddecreasewhichinturnwouldincreasethemarketpricefordoorknobs.Individualfirmlosseswoulddecreaseandexitoffirmswouldstopwhenindividualfirmprofitsreachtozero.

Youobservedthatinthelongrun,aprofit-maximizingfirmchosetoexitamarket.Whatcanyouinferabouttheprofitsofthisfirm?Profitsarenegative(totalrevenueislessthantotalcost)

Whatsignalsthefirmstoenterorexitamarketinacompetitiveindustry?Existenceofprofitsandlosses.

Youobservedthatfirmsareneitherenteringnorexitingthecompetitiveindustrywheresoybeansareproduced.Listallthatyoucaninferaboutexistingfirmsdatafromthisobservation.

• TotalcostmustequalTotalrevenue.• Economicprofitsmustbezero.• Pricemustequaltomarginalcostandaveragetotalcost(P=MC=LRAC)

Afirminacompetitivemarkethasthefollowingcoststructure: Output TotalCost 0 $5 1 $10 2 $12 3 $15 4 $24 5 $40 a)Ifthemarketpriceis$3,whatwillthisfirmdointheshortrun?P=MR=3WeneedtocalculateMC. Output TotalCost MC 0 $5 1 $10 5 2 $12 2 3 $15 3 4 $24 9 5 $40 16Tomaximizeprofit,thefirmwillchooseanoutputwhereMR=MCsoq*=3Sinceprofitisnegativeatthisoutput,weneedtocheckforshutdownandcompareTRtoVC.Atq=3,TR=3x3=$9andVC=$10sofirmwouldshutdownandproducenothing.b)Ifthemarketpriceis$3,whatwillthisfirmdointhelongrun?Sinceprofitisnegativeattheprofitmaximizingoutputlevel,thefirmwouldexitinthelongrun.c)Ifthemarketpriceis$9,whatwillthisfirmdointheshortrun?P=MR=$9Tomaximizeprofit,thefirmwillchooseanoutputwhereMR=MCsoq*=4Sinceprofitispositiveatthisoutput,wedonotneedtocheckforshutdown.Sothefirmwouldenjoyaprofitof$12intheshortrun.

Ineachofthediagramsbelowthefigureontherightrepresentstheperfectlycompetitivemilkindustry.Theoneontheleftrepresentsanindividualmilkproducerinthismarket.Inalldiagramstheverticalaxisismeasuredindollars,andthehorizontalaxisrepresentsoutput.ThediagramsarelabeledA,BandC.Matchtheletterofthegraphtothecorrectscenariogivenbelow.

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‘Squeaky-Clean’isacarwashcompanyoperatinginaperfectlycompetitivemarketintheshortrun.Thetotalcostofprovidingcarwashserviceforvariousoutputlevelsisgivenbelow.Moreover,theSqueaky-Clean’sfixedcosts(FC)aregivenas$30.Output(Q) TotalCost(TC)

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‘Squeaky-Clean’intheshortrun?Whatisthetotalprofitofthisfirm?P=MR=$8.CalculateMC.Tomaximizeprofit,choosetheoutputwhereMR=MCsoq*=5Output(Q) TotalCost(TC) MC

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Profit=TR–TC=8x5–63=-23NeedtocheckforshutdownsocompareTRtoVC.TR=$40andVC=$33soproduceq*=5andincuralossof$23.

TheshortRunCostCurvesforafirmoperatinginaperfectlycompetitivemarketaregivenbelow.

Ifthemarketpriceis$7intheperfectlycompetitiveindustry,intheshortrunhowmanyunits

willthisfirmproduce?Howmuchprofitwillitmake?P=MR=$7TomaximizeprofitthefirmwillchoosetheoutputwhereMR=MCandthusq*=80Sinceatq*=80P>AVC,thefirmwouldnotshutdown.Profit=(P–ATC)xq=(7–8)x80=-$80Giveanexampleofapricewherethisfirmmakespositiveeconomicprofit?P=$10Infactforallpricesthataregreaterthan$8(whereMC=ATC)thefirmwouldmakepositiveeconomicprofit.Giveanexampleofapricewherethisfirmmakesnegativeeconomicprofit?P=$7.50Infactforallpricesthatarelessthan$5.90(whereMC=AVC)thefirmwouldmakenegativeeconomicprofit.CanyoucalculatetheFCoftheabovefirmfromthecostcurvesdrawnabove?ATC=AFC+AVC.Thisrelationshipholdsatanyoutputlevel.Considerq=80whereATC=$8andAVC=$6soAFC=$2.NowFC=AFCxq=2x80=$160Describethechangesthatwouldtakeplaceinthelongruninacompetitivemarketwherefirmsareearningeconomicprofitsintheshortrun.Inacompetitivemarketwherefirmsareearningeconomicprofits,newfirmswillhaveanincentivetoenterthemarket.Thisentrywillincreasethenumberoffirms,increasethesupply,anddrivedownpricesandprofits.

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Describethechangesthatwouldtakeplaceinthelongruninacompetitivemarketwherefirmsaremakingnegativeprofitsintheshortrun.Inacompetitivemarketwherefirmsareearningnegativeprofits,somefirmswillleavethemarket.Thisexitoffirmswilldecreasethenumberoffirms,decreasethesupply,andincreasepricesandreduceindividualfirmlosses.

TheresidentialguttercleaningindustrycomprisesofmanyidenticalfirmsofferingthesameserviceinColumbus.Thediagramontherightrepresentstheperfectlycompetitiveguttercleaningindustry.Thelongruncostsof“WeGutGutters”,arepresentativefirmintheindustry,areshownintheleft-handpanel.

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Giventhedataabove,whatisthecurrentmarketpriceforguttercleaning?$60Giventhecurrentmarketprice,determinehowmanyguttercleaningserviceswill“WeGut

Gutters”provideintheshortrunifitwantstomaximizeprofit?q=15Atthecurrentmarketpricewhatisthetotalindustryoutput?Q=2000

Istheguttercleaningindustrycurrentlyinlongrunequilibrium?Ifnot,willthefirmsenterorexittheindustry?ItisnotinLRequilibrium.Morefirmswillentertheindustry.Whatwillbetheequilibriumpriceofaguttercleaningserviceinthelongrun?P=$40Inthelongrun,howmanyguttercleaningserviceswill“WeGutGutters”provide?q=10