Answers to End-of-Chapter Questions in Chapter 5
1.
The following table shows the average cost and average revenue (price) for a firm at each level of output.
Output
1
AC (£)
7.00
5.00
4.00
3.30
3.00
3.10
3.50
4.20
5.00
6.00
AR (£)
10.00
9.50
9.00
8.50
8.00
7.50
7.00
6.50
6.00
5.50
2
3
4
5
6
7
8
9
10
(a) Construct a table to show TC, MC, TR and MR at each level of output (put the figures for MC and MR
mid-way between the output figures).
(b) Using MC and MR figures, find the profit-maximising output.
(c) Using TC and TR figures, check your answer to (b).
(d) Plot the AC, MC, AR and MR figures on a graph.
(e) Mark the profit-maximising output and the AR and AC at this output.
(f) Shade in an area to represent the level of profits at this output.
*2
Draw the isoquant corresponding to the following table, which shows the alternative combinations of labour
and capital required to produce 100 units of output per day of good X.
K
L
16 K 20
200
160
2
26 /3
40
120
60
1
80
53 /3
80
100
40
32
(a) Assuming that capital costs are £20 per day and the wage rate is £10 per day, what is the least-cost
method of producing 100 units? What will the daily total cost be? (Draw in a series of isocosts.)
(b) Now assume that the wage rate rises to £20 per day. Draw a new set of isocosts. What will be the leastcost method of producing 100 units now? How much labour and capital will be used?
3.
Choose a particular industry. Identify factors used in that industry that in the short run are (i) fixed; (ii)
variable.
4.
Taking the same industry, identify as many economies of scale as you can.
6.
Why do marginal cost curves intersect both the average variable cost curve and the average cost curve at their
lowest point?
When marginal cost is below either average or average variable cost, each additional unit produced will cost
less than the respective average and therefore, when averaged in with the rest, will pull the average down: the
average curve will be downward sloping. When marginal cost is above either average or average variable cost,
each additional unit produced will cost more than the respective average and therefore, when averaged in with
the rest, will pull the average up: the average curve will be upward sloping. The marginal cost curve, therefore,
must cut both the average and average variable cost curves at their lowest point.
8.
Why might it make sense for a firm which cannot sell its output at a profit to continue in production for the
time being?
Because that way it might minimise its loss. If a loss-making firm can more than cover its variable costs, then
by continuing in production it will go some way to paying its fixed costs. If it ceased production, since it will
have already incurred these fixed costs, its loss would be higher.
Answers to End-of-Chapter Questions in Chapter 6
1.
A perfectly competitive firm faces a price of £14 per unit. It has the following short-run cost schedule:
Output
0
1
2
3
4
5
6
7
8
TC (£)
10
18
24
30
38
50
66
91
120
(a) Copy the table and put in additional rows for average cost and marginal cost at each level of output.
Chapter 6
(Enter the figures for marginal cost in the space between each column.)
(b) Plot AC, MC and MR on a diagram.
(c) Mark the profit-maximising output.
(d) How much (supernormal) profit is made at this output?
(e) What would happen to the price in the long run if this firm were typical of others in the industry? Why
would we need to know information about long-run average cost in order to give a precise answer to this
question?
2.
If the industry under perfect competition faces a downward-sloping demand curve, why does an individual
firm face a horizontal demand curve?
3.
If supernormal profits are competed away under perfect competition, why will firms have an incentive to
become more efficient?
4.
Is it a valid criticism of perfect competition to argue that it is incompatible with economies of scale?
6.
Why is the profit-maximising price under monopoly greater than marginal cost? In what way can this be seen
as inefficient?
Because profit is maximised where MR = MC. Under monopoly, AR is downward sloping and MR is therefore
less than AR (price). Thus price is greater than MC.
This is seen as inefficient, since, other things being equal, if more units were produced, the value of them
to consumers (i.e. the price people are prepared to pay) would exceed the marginal cost of producing them:
therefore ‘society’ is losing out by increased production not taking place. These arguments are explored in
section 11.1.
8.
Think of three examples of monopolies (local or national) and consider how contestable their markets are.
Answers to End-of-Chapter Questions in Chapter 7
1.
Assume that firm X is considering four possible strategies: 1, 2, 3, and 4. Assume that firm X estimates that
there are five possible responses (a, b, c, d and e) that its rivals might make to its actions. It estimates the
effects on its profits in the case of each of these five responses to each of its four strategies. Its estimates are
given in the following table.
Rivals’ responses
a
b
C
d
e
Alternative
1
30
20
80
–10
100
Strategies
2
–5
105
40
100
30
for
3
90
0
50
45
60
Firm X
4
30
15
10
20
25
(a) Which of the strategies (1, 2, 3 or 4) should it adopt if it was hoping to make the maximum possible
profit (maximax)?
(b) Which of the strategies should it adopt if it was very cautious and decided to assume that the worst
would happen (maximin)?
(c) Which of the strategies might be the best compromise between these two extreme positions? Explain.
3.
In what ways is a monopolistically competitive firm likely to be less efficient than one under perfect
competition?
2