Price Ceilings and Floors
How much rent do you pay per
month during the academic year?
(Enter DK if you don’t know.)
The price elasticity of demand for rental
housing is –1, and the price elasticity of
supply is +1/4. A rent ceiling is set at 20%
below equilibrium price. The number of
units rented
A)
B)
C)
D)
E)
Increases by 20%.
Decreases by 20%.
Decreases by 5%.
Increases by 25%.
Decreases by 10%.
What percentage of new
restaurants fail during the first
three years of operation?
A) 10-20%
B) 20-30%
C) 30-40%
D) 40-50%
E) 50-60%
What’s the answer?
About 59% of new restaurants fail in first 3
years of operation according to a 2005
study. See the link to the article “Why
restaurants fail” on the class web page.
A profit maximizing firm has fixed
costs of $100, variable costs of $20 per
unit and capacity of 10. The price of
output is $15. In the short run, how
many units should it sell?
A)
B)
C)
D)
E)
0
6 and 2/3
10
4
20
A profit maximizing firm has fixed
costs of $100, variable costs of $20
per unit and capacity of 10. The
price of output is $25. In the short
run, how many units should it sell?
A)
B)
C)
D)
E)
0
8
10
5
20
And on to our lecture…
But don’t shut off your clicker.
A profit maximizing firm has fixed costs of
$100, variable costs of $20 per unit and
capacity of 10. In the long run, the firm can
escape its fixed costs by shutting down. What
is the lowest price at which it would stay in
business in the long run?
A)
B)
C)
D)
E)
$20
$25
$30
$100
$120
Why is this?
• If the firm operates at full capacity, its total
costs will be $300=$100+$20x10.
• Its average costs will be $30=$300/10.
• It will want to shut down if price is less than
average cost.
• It will be better off staying in business than
shutting down if price is greater than
average cost.
A restaurant has fixed costs of $100
and variable costs of $10 per meal.
How does a sales tax of $5 per meal
sold affect a restaurant’s costs?
A) Increases marginal cost by $5.
B) Increases average cost by $5.
C) Both A and B.
Whoops!
• In class, I said the correct answer was A.
– I goofed!
• It is true that marginal cost rises by $5, but as
Andy Shu pointed out to me right after class, so
does average cost, so the correct answer is C.
• Here is Andy’s argument.
– With no tax, when n meals are sold, total cost is
100+10n and average cost is
(100+10n)/n=(100/n)+10.
– With a tax of $5 per meal, total cost is 100+15n and
average cost is (100+15n)/n=(100/n)+15.
– Therefore average cost rises by $5.