Department of Economics Spring Semester 2010 University of Pacific ECONOMICS 53 Problem Set 4 Due before lecture on March 4 Part 1: Multiple Choice (30 Questions, 1 Point Each) 1. 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
6. 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 7. In the short run, as output increases, A) the difference between average total cost and average variable cost decreases. B) the difference between total cost and average variable cost decreases. C) marginal cost eventually decreases. D) All of the above are correct. 8. The main decision for a profit maximizing perfectly competitive firm is not what but what. A) level of output to produce; price to charge B) price to charge; level of output to produce C) level of output to produce; total revenue to achieve D) price to charge; total cost to achieve 9. If the market price is $25 in a perfectly competitive market, the marginal revenue from selling the fifth unit is A) $25. B) $5. C) $125. D) Unable to determine. More information needed. 10. The marginal revenue curve for a perfectly competitive firm is A) downward sloping. B) upward sloping. C) horizontal. D) vertical. 11. Joeʹs Butcher Shop is producing where MR = MC, Joeʹs Butcher Shop must be A) earning a zero economic profit. B) incurring a loss. C) maximizing profits. D) maximizing revenue but not maximizing profits. 12. Wheat is produced in a perfectly competitive market. Market demand for wheat increases. This will cause the individual wheat farmerʹs marginal revenue to and their profit maximizing level of output to. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease 2
In this industry the market equilibrium price is P = $15. 13. Refer to Figure 9.1. For this farmer to maximize profits he should produce bushels of wheat. A) 6 B)9 C) 12 D) 16 14. Refer to Figure 9.1. If this farmer is maximizing profits, his total costs will be A) $11 B) $66. C) $90. D) $132. 15. Refer to Figure 9.1. If this farmer is maximizing his profits, his TVC is A) $24. B) $42. C) $108. D) $255. 16. Refer to Figure 9.1. This farmerʹs fixed costs are A) $0. B) $24. C) $45. D) indeterminate unless we know the level of output the firm is producing. 17. Refer to Figure 9.1. If this farmer is maximizing profits, his total revenue will be A) $90. B) $135. C) $180. D) $240. 18. Refer to Figure 9.1. If this farmer is maximizing profits, his profit will be A) -$24. B) $45. C) $48. D) $72. 19. Refer to Figure 9.1. This farmer would earn a zero economic profit if price was A) $7. B) $9. C) $10. D) $11. 20. Refer to Figure 9.1. This farmerʹs shutdown point is at a price of A) $0. B) $4. C) $7. D) $10. 3
21. If TR > TC, a firm would in the short run and in the long run. A) operate; expand B) operate; contract C) shut down; expand D) shut down; contract 22. A market is competitive if I. firms have the flexibility to price their own product. II. each firm sells slightly different products III. each firm is small compared to the entire industry. A) I and II only B) I and III only C) III only D) All of the above are correct. 23. Firms that are ʺbreaking evenʺ are A) earning zero economic profits. B) earning less than a normal rate of return. C) shutting down in the short run. D) All of the above are correct. 24. The owner of Tie-Dyed T-shirts, a perfectly competitive firm, 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. You tell him he should continue to operate in the short run because A) he is earning positive economic profits of $4,000. B) his loss from operating is only $2,000 which is less than his loss if he shuts down. C) he has to pay his fixed costs of $2,000 if he shuts down which is greater than his loss when he operates. D) In fact you do not tell him to operate -- he should shut down since he has a loss. 4
25. Refer to Figure 9.3. In the short run this firm should and in the long run this firm should, if economic conditions do not change. A) shut down; exit the industry B) exit the industry; shut down C) continue to produce where MC = MR; expand D) continue to produce where MC = MR; shut down 26. Engineers for the Off Road Skateboard Company have determined that a 10% increase in all inputs will cause output to increase by 5%. Assuming that input prices remain constant, you correctly deduce that such a change will cause as output increases. A) total cost to decrease B) average total costs to increase C) average total costs to decrease D) average fixed costs to increase 27. For economies of scale, a(n) in a firmʹs scale of production leads to average total cost. A) increase; lower B) increase; higher C) decrease; lower D) decrease; no change in 28. On the upward sloping portion of a firmʹs long run average cost curve, it is experiencing A) economies of scale B) constant returns to scale C) diseconomies of scale D) diminishing marginal returns 29. 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. A) economies of scale; zero profits B) economies of scale; positive economic profits C) diseconomies of scale; zero profits D) diseconomies of scale; positive economic profits 30. Assume the market for beef is perfectly competitive. Beef producers are currently earning a zero economic profit. If consumers switch to beef from chicken, 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. B) Beef producers will incur economic profits in the short run. Some producers will enter the industry until all firms in the industry are earning a zero economic profit. C) Beef producers will incur economic profits in the short run. Some producers will enter the industry as long as all firms in the industry are earning an economic profit. D) Beef producers will now earn economic losses in the short run and there will be no additional adjustments in the long run. 5
Part II: Short Answers Question 1: and Profit Maximization (14 Points) You run a firm that produces T-shirts that are sold in a perfectly competitive market. Your firm faces the following cost and revenue schedule: Quantity of T- Shirts (TC) 0 5 1 12 2 22 3 33 4 45 5 60 6 78 Fixed (TFC) Variable (TVC) Average Fixed (AFC) Average Variable (AVC) Average (ATC) Marginal Cost (MC) Revenue (TR) Profit (a) Assume that the price of t-shirts is $12. Complete the table above. (5 Points) (b) Sketch the following curves: AFC, ATC, MC. (You may use EXCEL or another software program to draw the graphs or you can do it by hand.) (6 Points) (c) What is the optimal level of production for your t-shit firm? (3 Points) Question2: using Algebra (16 Points) Noah runs a garden bench production plant. The total production costs are captured by the following production cost functions: TC = Q 2 + 100Q + 500 (total cost function) MC = 2Q + 100 (marginal cost function) Where Q = number of benches produced If Noah produces 100 benches. Calculate the following (1 Point each) (a) Variable (TVC) (b) Fixed (TFC) (c) (TC) (d) Average Variable (AVC) (e) Average Fixed (AFC) (f) Average (ATC) (g) Marginal Cost (MC) 6
Suppose the industry for garden benches is perfectly competitive and the market equilibrium price is $200 (i) If Noah produces 100 benches, is he producing the optimal profit maximizing level of benches? Explain your answer. Calculate the profit for Noah at Q = 100. (3 Points) (j) Calculate the profit maximizing level of output for Noah s bench factory. What is the profit at this level of production? (3 Points) (k) Noah would shut down his business if benches fall below what price? (3 Points) Question 3 (6 Points; 1 Point each) Investors put up $520,000 to construct a building and purchase all equipment for a new Thai restaurant called Thai Me Up. The investors expect to earn a minimum return of 10% on their investment. The restaurant is open 52 weeks per year and serves 900 meals per week. The fixed costs are spread over the 52 weeks. 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. Variable costs include $1000 in weekly wages and $600 per week for materials, electricity, etc. The restaurant charges $5 on average per meal. (a) Calculate total fixed costs per week for the restaurant (b) Calculate total variable costs per week for the restuarant (c) Calculate total costs per week for the restaurant (d) Calculate total revenue per week for the restaurant (e) Calculate the economic profit per week for the restaurant (f) If Thai Me Up were to shut down, what would the economic profit be? 7
Question#4: Perfect Compettition: Graphcial Analysis (14 Points) Figure 1: Wheat Market For the following questions refer to the figure above. Assume that the wheat industry is perfectly competitive. (a) What are the three conditions needed for the wheat industry to be perfectly competitive? (3 Points) (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, total cost and economic profit? (4 Points) (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. (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. (4 Points) (d) If the demand for wheat increases to D1 what is the profit-maximizing level of output for a representative firm? (3 Points) Question #5 From Short-Run to Long-Run (20 Points) Draw a supply and demand diagram showing equilibrium at a price of $10. Next to it draw a graph of a perfectly competitive firm that is incurring a short-run loss at this price, but is still producing. Use the diagram to show the long-term adjustment of the industry and the firm if demand remains constant. Explain the adjustment mechanism. 8