# ae ```ECON 200. Introduction to Microeconomics
Homework 5 Part I
Name:________________________________________
[Multiple Choice]
1. Diminishing marginal product explains why, as a firm’s output increases, (d)
a. the production function and total-cost curve both get steeper.
b. the production function and total-cost curve both get flatter
c. the production function gets steeper, while the total-cost curve gets flatter.
d. the production function gets flatter, while the total-cost curve gets steeper.
2. A firm is producing 1,000 units at a total cost of \$5,000. If it were to increase production to 1,001
units, its total cost would rise to \$5,008. What does this information tell you about the firm? (d)
a. Marginal cost is \$5, and average variable cost is \$8.
b. Marginal cost is \$8, and average variable cost is \$5.
c. Marginal cost is \$5, and average total cost is \$8.
d. Marginal cost is \$8, and average total cost is \$5.
3. 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)
a. Marginal cost would decrease.
b. Marginal cost would increase.
c. Average total cost would decrease.
d. Average total cost would increase
4. The government imposes a \$1,000 per year license fee on all pizza restaurants. Which cost curves
shift as a result? (b)
a. average total cost and marginal cost
b. average total cost and average fixed cost
c. average variable cost and marginal cost
d. average variable cost and average fixed cost
5. 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)
a. economies, falling
b. economies, rising
c. diseconomies, falling
d. diseconomies, rising
6. A perfectly competitive firm (c)
a. chooses its price to maximize profits.
b. sets its price to undercut other firms selling similar products.
c. takes its price as given by market conditions.
d. picks the price that yields the largest market share.
7. A competitive firm maximizes profit by choosing the quantity at which (b)
a. average total cost is at its minimum.
b. marginal cost equals the price.
c. average total cost equals the price.
d. marginal cost equals average total cost.
8. If profit-maximizing, competitive firm is producing a quantity at which marginal cost is between
average variable cost and average total cost, it will (a)
a. keep producing in the short run but exit the market in the long run.
b. shut down in the short run but return to production in the long run.
c. shut down in the short run and exit the market in the long run.
d. keep producing both in the short run and in the long run.
9. 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)
a. P &gt; MC and P &gt; ATC.
b. P &gt; MC and P = ATC.
c. P = MC and P &gt; ATC.
d. P = MC and P = ATC.
1. Draw the marginal-cost and average-total-cost curves for a typical firm. Explain why the curves have
the shapes that they do and why they cross where they do.
The figure shows the marginal-cost curve and the average-total-cost curve for a typical firm.
There are three main features of these curves: (1) marginal cost is U-shaped but rises sharply as output
increases; (2) average total cost is U-shaped; and (3) whenever marginal cost is less than average total
cost, average total cost is declining; whenever marginal cost is greater than average total cost, average
total cost is rising. Marginal cost is increasing for output greater than a certain quantity because of
diminishing returns. The average-total-cost curve is downward-sloping initially because the firm is able
to spread out fixed costs over additional units. The average-total-cost curve is increasing beyond some
output level because as quantity increases, the demand for important variable inputs increases;
therefore, the cost of these inputs increases. The marginal-cost and average-total-cost curves intersect
at the minimum of average total cost; that quantity is the efficient scale.
2. Define economies of scale and explain why they might arise. Define diseconomies of scale and explain
why they might arise.
Economies of scale exist when long-run average total cost decreases as the quantity of output
increases, which occurs because of specialization among workers. Diseconomies of scale exist when
long-run average total cost rises as the quantity of output increases, which occurs because of the
coordination problems inherent in a large organization
3. There are 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:
a. What you give up for taking some action is called the ______. opportunity cost
b. _____ is falling when marginal cost is below it and rising when marginal cost is above it.
average total cost
c. A cost that does not depend on the quantity produced is a(n) ______. fixed cost
d. In the ice-cream industry in the short run, ______ includes the cost of cream and sugar but not the
cost of the factory. variable cost
e. Profits equal total revenue minus ______. total cost
f. The cost of producing an extra unit of output is the ______. marginal cost
4. 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:
Workers
0
1
2
3
4
5
6
7
Output
0
20
50
90
120
140
150
155
Marginal
Product
Total
cost
20
30
40
30
20
10
5
\$200
300
400
500
600
700
800
900
Average
Total
cost
Marginal
cost
\$15.00
8.00
5.56
5.00
5.00
5.33
5.81
\$5.00
3.33
2.50
3.33
5.00
10.00
20.00
a. Fill in the column of marginal products. What pattern do you see? How might you explain it?
Marginal product rises at first, then declines because of diminishing marginal product.
b. A worker costs \$100 a day, and the firm has fixed costs of \$200. Use this information to fill in the
column for total cost.
c. Fill in the column for average total cost. (Recall that ATC=TC/Q.) What pattern do you see?
Average total cost is U-shaped. When quantity is low, average total cost declines as quantity
rises; when quantity is high, average total cost rises as quantity rises
d. Now fill in the column for marginal cost. (Recall that MC=dTC/dQ.) What pattern do you see?
Marginal cost is also U-shaped, but rises steeply as output increases. This is due to diminishing
marginal product
e. Compare the column for marginal product and the column for marginal cost. Explain the relationship.
When marginal product is rising, marginal cost is falling, and vice versa
f. Compare the column for average total cost and the column for marginal cost. Explain the relationship.
When marginal cost is less than average total cost, average total cost 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 is rising; the cost of the last unit produced pushes the average up
5. You are the chief financial officer for a firm that sells digital music players. Your firm has the following
average-total-cost schedule:
Quantity
600 players
601
Average Total Cost
\$300
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 600 players, total cost is \$180,000 (600 &times; \$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
6. Consider the following cost information for a pizzeria:
Quantity
0 dozen pizzas
1
2
3
4
5
6
TotalCost
\$300
350
390
420
450
490
540
Variable Cost
\$0
50
90
120
150
190
240
a. What is the pizzeria’s fixed cost?
The fixed cost is \$300, because fixed cost equals total cost minus variable cost. At an output of
zero, the only costs are fixed cost
b. 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
Quantity
0
1
2
3
4
5
6
Total
Cost
\$300
350
390
420
450
490
540
Variable
Cost
\$0
50
90
120
150
190
240
Marginal Cost
(using total cost)
--\$50
40
30
30
40
50
Marginal Cost
(using variable cost)
--\$50
40
30
30
40
50
Marginal cost equals the change in total cost for each additional unit of output. It is also equal to
the change in variable cost for each additional unit of output. This relationship occurs because total cost
equals the sum of variable cost and fixed cost and fixed cost does not change as the quantity changes.
Thus, as quantity increases, the increase in total cost equals the increase in variable cost
7. Your cousin Vinnie owns a painting company with fixed costs of \$200 and the following schedule for
variable costs:
Quantity of Houses
painted per month
Variable costs
1
2
3
4
5
6
7
\$10
\$20
\$40
\$80
\$160
\$320
\$640
Calculate average fixed cost, average variable cost, and average total cost for each quantity. What is the
efficient scale of the painting company?
The following table illustrates average fixed cost (AFC), average variable cost (AVC), and average
total cost (ATC) for each quantity. The efficient scale is 4 houses per month, because that minimizes
average total cost
Quantity
Variable
Cost
\$0.00
10.00
20.00
40.00
80.00
160.00
320.00
640.00
0
1
2
3
4
5
6
7
Fixed
Cost
\$200.00
200.00
200.00
200.00
200.00
200.00
200.00
200.00
Total
Cost
\$200.00
210.00
220.00
240.00
280.00
360.00
520.00
840.00
Average
Fixed Cost
--\$200.00
100.00
66.67
50.00
40.00
33.33
28.57
Average
Variable Cost
--\$10.00
10.00
13.33
20.00
32.00
53.33
91.43
Average
Total Cost
--\$210.00
110.00
80.00
70.00
72.00
86.67
120.00
8. Jane’s Juice Bar has the following cost schedules:
Quantity
0 vats of juice
1
2
3
4
5
6
Variable cost
\$0
10
25
45
70
100
135
Total cost
\$30
40
55
75
100
130
165
a. Calculate average variable cost, average total cost, and marginal cost for each quantity.
The following table shows average variable cost (AVC), average total cost (ATC), and marginal
cost (MC) for each quantity
Quantity
0
1
2
3
4
5
6
Variable
Cost
\$0.00
10.00
25.00
45.00
70.00
100.00
135.00
Total
Cost
\$30.00
40.00
55.00
75.00
100.00
130.00
165.00
Average
Variable Cost
--\$10.00
12.50
15.00
17.50
20.00
22.50
Average
Total Cost
--\$40.00
27.50
25.00
25.00
26.00
27.50
Marginal
Cost
--\$10.00
15.00
20.00
25.00
30.00
35.00
b. Graph all three curves. What is the relationship between the marginal-cost curve and the averagetotal-cost curve? Between the marginal-cost curve and the average-variable-cost curve? Explain
The figure shows the three curves. The marginal-cost curve is below the average-total-cost curve
when output is less than four and average total cost is declining. The marginal-cost curve is above the
average-total-cost curve when output is above four and average total cost is rising. The marginal-cost
curve lies above the average-variable-cost curve.
9. Consider the following table of long-run total costs for three different firms:
Quantity
Firm A
Firm B
Firm C
1
\$60
11
21
2
\$70
24
34
3
\$80
39
49
4
\$90
56
66
5
\$100
75
85
6
\$110
96
106
7
\$120
119
129
Does each of these firms experience economies of scale or diseconomies of scale?
The following table shows quantity (Q), total cost (TC), and average total cost (ATC) for the three
firms:
Firm A
Quantity
1
2
3
4
5
6
7
Firm B
Firm C
TC
ATC
TC
ATC
TC
ATC
\$60.00
70.00
80.00
90.00
100.00
110.00
120.00
\$60.00
35.00
26.67
22.50
20.00
18.33
17.14
\$11.00
24.00
39.00
56.00
75.00
96.00
119.00
\$11.00
12.00
13.00
14.00
15.00
16.00
17.00
\$21.00
34.00
49.00
66.00
85.00
106.00
129.00
\$21.00
17.00
16.33
16.50
17.00
17.67
18.43
Firm A has economies of scale because average total cost declines as output increases. Firm B
has diseconomies of scale because average total cost rises as output rises. Firm C has economies of scale
from one to three units of output and diseconomies of scale for levels of output beyond three units.
10. Under what conditions will a firm shut down temporarily? Explain.
A firm will shut down temporarily if the revenue it would get from producing is lower than the
variable costs of production. This occurs if price is less than average variable cost
11. Under what conditions will a firm exit a market? Explain.
A firm will exit a market if the revenue it would get from remaining in business is less than its
total cost. This occurs if price is less than average total cost
12. Does a competitive firm’s price equal the minimum of its average total cost in the short run, in the
long run, or both? Explain.
The competitive firm's price must equal the minimum of its average total cost only in the long
run. In the short run, price may be greater than average total cost (in which case the firm is earning a
profit), price may be less than average total cost (in which case the firm is incurring a loss), or price may
be equal to average total cost (in which case the firm is breaking even). In the long run, if firms are
earning profits, other firms will enter the industry, which will lower the price of the good. In the long run,
if firms are incurring losses, they will exit the industry, which will raise the price of the good. Entry or
exit continues until firms are making neither profits nor losses. At that point, price equals average total
cost
13. 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?
Bob' total variable cost is his total cost each day less his fixed cost (\$280 - \$30 = \$250). His
average variable cost is his total variable cost each day divided by the number of lawns he mows each
day (\$250/10 = \$25). Because his average variable cost is less than his price, he will not shut down in
the short run. Bob's average total cost is his total cost each day divided by the number of lawns he
mows each day (\$280/10 = \$28). Because his average total cost is greater than his price, he will exit the
industry in the long run
14. Ball Bearings, Inc. faces costs of production as follows:
Quantity
0
1
2
3
4
5
6
Total Fixed
Costs
\$100
100
100
100
100
100
100
Total Variable
Costs
\$0
50
70
90
140
200
360
a. Calculate the company’s average fixed costs, average variable costs, average total costs, and marginal
costs at each level of production.
Costs are shown in the following table:
Q
TFC
TVC
AFC
AVC
ATC
MC
0
1
2
3
4
5
6
\$100
100
100
100
100
100
100
\$0
50
70
90
140
200
360
---\$100
50
33.3
25
20
16.7
---\$50
35
30
35
40
60
---150
85
63.3
60
60
76.7
---50
20
20
50
60
160
b. 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.
If the price is \$50, the firm will minimize its loss by producing 4 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 loss of \$40. If the firm shuts down, it will earn a
loss equal to its fixed cost (\$100). The CEO did not make a wise decision
c. 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
If the firm produces 1 unit, its total revenue is \$50 and its total cost is \$150 (\$100 + \$50), so its
loss will still be \$100. This was also not the best decision. The firm could have reduced its loss by
producing more units because the marginal costs of the second and third unit are lower than the price
15. Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. Draw a diagram showing the average total cost, marginal cost, marginal revenue, and supply curve of
the typical firm in the industry.
The figure shows the curves of a typical firm in the industry, with average total cost ATC1,
marginal cost MC1, and marginal revenue equal to price P1. The long-run-supply curve is the marginal
cost curve above the minimum point of ATC1
b. Hi-Tech Printing Company invents a new process that sharply reduces the cost of printing books.
What happens to Hi-Tech’s profits and the price of books in the short run when Hi-Tech’s patent
prevents other firms from using the new technology?
The new process reduces Hi-Tech’s marginal cost to MC2 and its average total cost to ATC2, but
the price remains at P1 because other firms cannot use the new process. Thus Hi-Tech produces Q2 units
and earns positive profits
c. What happens in the long run when the patent expires and other firms are free to use the technology?
When the patent expires and other firms are free to use the technology, all firms’ average-totalcost curves decline to ATC2, so the market price falls to P3 and firms earn zero profit
16. 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.
a. What is its profit?
Profit is equal to (P – ATC) &times; Q. Price is equal to AR. Therefore, profit is (\$10 – \$8) &times; 100 = \$200
b. What is its marginal cost?
For firms in perfect competition, marginal revenue and average revenue are equal. Since profit
maximization also implies that marginal revenue is equal to marginal cost, marginal cost must be \$10
c. What is its average variable cost?
Average fixed cost is equal to AFC /Q which is \$200/100 = \$2. Since average variable cost is
equal to average total cost minus average fixed cost, AVC = \$8 − \$2 = \$6.
d. Is the efficient scale of the firm more than, less than, or exactly 100 units?
Since average total cost is less than marginal cost, average total cost must be rising. Therefore,
the efficient scale must occur at an output level less than 100
17. The market for fertilizer is perfectly competitive. Firms in the market are producing output but are
currently incurring economic losses.
a. How does the price of fertilizer compare to the average total cost, the average variable cost, and the
marginal cost of producing fertilizer?
If firms are currently incurring losses, price must be less than average total cost. However,
because firms in the industry are currently producing output, price must be greater than average
variable cost. If firms are maximizing profits, price must be equal to marginal cost
b. Draw two graphs, side by side, illustrating the present situation for the typical firm and for the market.
The present situation is depicted in the figure. The firm is currently producing q1 units of output
at a price of P1
c. Assuming there is no change in either demand or the firms’ cost curves, explain what will happen in
the long run to the price of fertilizer, marginal cost, average total cost, the quantity supplied by each
firm, and the total quantity supplied to the market.
The figure also shows how the market will adjust in the long run. Because firms are incurring
losses, there will be exit in this industry. This means that the market supply curve will shift to the left,
increasing the price of the product. As the price rises, the remaining firms will increase quantity supplied;
marginal cost will increase. Exit will continue until price is equal to minimum average total cost. Average
total cost will be lower in the long run than in the short run. The total quantity supplied in the market
will fall
18. The market for apple pies in the city of Ectenia is competitive and has the following demand
schedule:
Price
1
2
3
4
5
6
7
8
9
10
11
12
13
Quantity
Demanded
1200 pies
1100
1000
900
800
700
600
500
400
300
200
100
0
Each producer in the market has fixed costs of \$9 and the following marginal cost:
Quantity
1 pie
2
3
4
5
6
Marginal Cost
\$2
4
6
8
10
12
a. Compute each producer’s total cost and average total cost for 1 to 6 pies.
Q
TC
ATC
1
2
3
4
5
6
11
15
21
29
39
51
11
7.5
7
7.25
7.8
8.5
b. The price of a pie is now \$11. How many pies are sold? How many pies does each producer make?
How many producers are there? How much profit does each producer earn?
At a price of \$11, quantity demanded is 200. With marginal revenue of \$11, each firm will
choose to produce 5 pies where their marginal cost is closest to the marginal revenue without 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 profit is \$16
c. Is the situation described in part (b) a long-run equilibrium? Why or why not?
The market is not in long-run equilibrium because firms are earning positive economic profit.
Firms will want to enter the market
d. 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?
With free entry and exit, each producer will earn zero profit in the long run. Long-run
equilibrium will occur when price is equal 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 MR without
exceeding MR) meaning that there will be 200 pie producers in the market
```