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ECON 247: Assignment 2B
Due Date: After you have completed Unit 10
Credit Weight: 10% of your final grade
1. a. Explain why the demand-for-labour curve is downward sloping. (4 marks)
Ans: The term "derived demand" also refers to the labour demand curve. This is because as
output rises, firms expect more labour, which drives up labour costs. The law of diminishing
returns causes the desire for labour to decline over time. This implies that as employment
increases, the marginal output of labour declines. The marginal product of labor is the addition in
the output due to hiring extra labour.
VMPL is the demand for labour curve. VMPL equals (MPL)(price). In a
perfectly competitive industry price is constant and MPL declines due to
diminishing returns which causes VMPL to decline. Please refer to page
401/402.
b. A textile firm has decided to lay off 2000 workers. How would this decision impact the
marginal product of workers and the wage rate? Why did the textile firm not lay off more than
2000 workers? (4 marks)
Ans: In this scenario, marginal product is less than the wage and laying off 2000 workers will
increase the overall profits of the firm. With the higher number of employees, the
marginal product is declining as well as the marginal revenue. The firm did not
lay off more than 2000 workers because at that point, wage and the quantity of
labour is in equilibrium.
Before the layoff, the wage would have been greater than the marginal
revenue product. The decision to lay off 2000 workers will increase the
marginal product of labour and the marginal revenue product of labour. The
textile firm did not lay off more than 2000 workers because at that point, the
wage equals the marginal revenue product of labour, and the wage and
quantity of labour would be at equilibrium.
At equilibrium, VMPL = the wage rate. Please refer to page 401/402.
6 marks
2. Units of labour and units of output are given in the following table.
a. Complete the MPL marginal product of labour (MPL) and the value of the marginal product of
labour (VMPL1) and complete the columns for each. Assume that the firm sells its products in a
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competitive market for $20 per unit. If the wage rate is $200, how many workers will this firm
hire to maximize its profit? Explain your answer. (5 marks)
Units of Labour Units of Output MPL VMPL1 VMPL2
1
10
10
200
250
2
19
9
180
225
3
27
8
160
200
4
34
7
140
175
5
39
5
100
125
6
42
3
60
75
Ans: The firm maximizes profit by hiring the number of workers where VMPL=Wage rate.
From the table, VMPL1=wage rate=200 when the firm hires 1 worker so the firm will hire 1
worker.
correct
b. Calculate the VMPL for a unit price of $25 per unit and complete the VMPL2 column with
this data. If the wage rate is still $200, how many additional workers will this firm hire to
maximize its profit? Explain your answer. (4 marks)
Ans: The firm maximizes profit by hiring the number of workers where VMPL=Wage rate,
From the table, VMPL2=wage rate=200 when the firm hires 3 workers, Additional workers=31=2. The firm will hire 2 additional workers. correct
c. What will happen to the demand curve for labour if the price increases from $20 to $25 per
unit? Explain your answer. (3 marks)
Ans: The labor demand curve will shift to the right.
We have seen from part (b) that the firm will demand 2 more workers when price increases from
$20 to $25. The increase in demand will shift the labor demand curve to the right. The increase
in product price its revenue and profit. The firm therefore produces more units which requires
more workers. Correct all correct 12 marks.
3. 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)? (4 marks)
Ans: Price (P) will be equal to the marginal cost (MC) and the average total cost (ATC)@ ATC
minimum of each business in the long-run equilibrium of a competitive market with identical
firms. This will occur when prices in the market are identical. This is since companies in a
market that is totally competitive are price takers and have no ability to influence market price.
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If businesses can generate positive economic profits over the long term, then additional
businesses will enter the market. This will lead to an increase in the supply of the product and a
decrease in price until the price is equivalent to the marginal cost. On the other hand, if
businesses are experiencing losses, some of them will leave the market, which will lead to a
lower supply of the product and an increase in price until the price reaches the same level as the
marginal cost.
As a result, in the long-run equilibrium of a competitive market, the price will be equal to both
the marginal cost and the average total cost of each firm. This will ensure that enterprises do not
gain any economic profits. Because companies are producing at the lowest possible cost, and
customers are paying the lowest possible price, this is referred to as the efficient allocation of
resources. Correct
3 marks
4. A competitive firm is selling its product. The price for its product is $8.
a. Complete the TC, AFC, AVC, ATC, MC, TR, MR, and profit columns. Round off your
answers to two decimal places. (8 marks)
Total
TFC TVC
TC
AFC AVC ATC MC
TR
MR
product
0
$8
$0
8.00
0
0
0
0
0
0
1
$8
$15
23.00
8.00
15.00 23.00 15.00
8.00
8.00
2
$8
$20
28.00
4.00
10.00 14.00 5.00
16.00 8.00
3
$8
$29
37.00
2.66
9.66 12.33 9.00
24.00 8.00
4
$8
$48
56.00
2.00
12.00 14.00 19.00
32.00 8.00
5
$8
$83
91.00
1.60
16.60 18.20 35.00
40.00 8.00
6
$8
$140
148.00 1.33
23.33 24.66 57.00
48.00 8.00
7
$8
$225
233.00 1.14
32.14 33.28 85.00
56.00 8.00
8
$8
$344
352.00 1.00
43.00 44.00 119.00 64.00 8.00
9
$8
$503
511.00 0.88
55.88 56.77 159.00 72.00 8.00
10
$8
$708
716.00 0.80
70.80 71.60 205.00 80.00 8.00
Profit
-8.00
-15.00
-12.00
-13.00
-24.00
-51.00
-100.00
-177.00
-288.00
-439.00
-636.00
b. At what price and output level will the above firm maximize its profit or minimize its loss?
Should this firm continue to sell in the short run? Should it continue to sell in the long run?
Explain your answer. (2 marks)
Ans: At P= $8 and TP= 2, the firm will maximise their profit or minimize the loss as loss is
minimum in this case. The firm should shut down in both the short-run and long run. After
producing more than 3 units, marginal cost is greater than average variable cost (AVC) and
average total cost (ATC). Hence, the firm must shut down in both the short-run and long run.
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The loss is minimized at two units. MR = 8; MC = 5; Loss = $12. This firm
should not continue to sell in the short run as P ($8) is less than AVC ($10).
In the long run, this firm should exit the market because of losses.
c. Based on the table, what is the important relationship between ATC and MC? Also, explain
why AVC and ATC are U-shaped. (4 marks)
Ans: Relationship between ATC and MC: If MC is lesser than ATC, ATC falls. If MC is greater
than ATC, ATC rises. At a minimum, ATC=MC. AVC is U-shaped as there are diminishing
Marginal Returns. ATC curve is U-shaped this is because it is the sum of fixed costs and variable
costs and costs reduced with an increase in output.
ATC is comprised of AFC and AVC and AFC declines continually as Q
increases and AVC eventually increases due to diminishing returns causing
the U shape of the ATC curve. Please refer to page 291.
11 marks
5. What long-run effect will an increase in market demand have on a constant-cost industry (a
horizontal supply curve)? (6 marks)
Ans: In the long run, when market demand increases, then supply curve shifts to the right and
stops at the point where new long run equilibrium intersects at the same market price as before.
In this type of market, supply curve is very elastic. Business can easily increase their supply
based on their customer’s demand. For example, in recent years there is an increase in demand
for ethanol, this has caused the increased in demand for corn to increase. Many farmers
consequently switch from wheat to corn. Generally, agricultural industry is one of the good
examples of constant cost markets.
An increase in market demand will increase the market price which will lead new firms
to enter the industry increase supply and lower price. Price and ATC will decrease. In
the long run price and ATC will not change and there will be more firms in the industry
and an increase in quantity. Please refer to page 316.
3 marks
6. Explain why cartels are often ineffective in keeping the price of their products high. Use an
example of an actual cartel arrangement to support your answer. (6 marks)
Ans: Cartels are association of independent firms. Their purpose is to exert a monopolistic
influence in the production or sale of a commodity. In a cartel, they aimed at regulating prices,
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output, and dividing markets among themselves. Cartels sustain inefficient firms and prevent
cost-saving technological advances which leads to lower prices. Stability of their price are
determined on whether their members follow to their fixed price agreement or other members do
not. It would be coherent for members to lower their price than of the agreed price as this would
give their business the edge. Another reason for cartels to prove ineffective in maintaining their
prices high, there will always be new entrant and will not always be part of the cartel, this new
entrant will have the chance to undermine their agreement. One cartel example is the OPEC or
the Organization of Petroleum Exporting Countries. They have been standing long since 1960s.
The agreement between its members have been broken from time to time, OPEC still proves to
be an effective cartel as it controls the supply and charges of oil. Correct 6 marks
7. Why do firms advertise? What are some advantages and disadvantages of advertising?
(6 marks)
Ans: It has been long proven that a well-advertised product is to be sold in the market. A product
that is known, consumers tend to act favorably towards that product. It provides support to sales
professionals that sells the product. There are advantages and disadvantages of advertising.
Advantages
Increase in sales
Steady demand
Lower costs
Supplementing salesmanship
Greater dealer interest
Quick turnover and smaller inventories
Disadvantages
Deferred revenue expenditure
Misrepresentation of facts
Consumer's deficit
Barriers to entry
Increased costs
Multiplication of needs
Correct 6 marks.
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8. A local public transit (monopoly) sells monthly bus passes to adults and students. The
demand elasticity for bus passes by adults is –0.25, whereas demand elasticity by students is –
0.50. Their demand schedules are given in the following table:
Adults
Students
P
Q
TR
P
Q
TR
35
245
8575
35
268
9380
45
230
10350
45
238
10710
55
215
11825
55
208
11440
65
200
13000
65
178
11570
75
185
13875
75
148
11100
85
170
14450
85
118
10030
95
155
14725
95
88
8360
105
140
14700
105
58
6090
a. Currently, the transit is charging $85 for bus passes. What is the current total revenue? (2
marks)
Ans: When price is 85.
Adult demand= 170 tickets.
Total revenue from adults=14,450
When price is 85.
Student demand=118 tickets.
Total revenue from Students=10,030
Total revenue = revenue from adults + revenue from Students
Total revenue = 14,450 + 10,030
Total revenue = 24,480 correct
The current total revenue is $24,480.
b. Should the transit increase or decrease the price for adults? Should the transit increase or
decrease the price for students?
(2 marks)
Ans: The current total revenue is $24,480 for adults.
Now as given in the table if transit increases the price for adults from $85 to $95 then TR would
increase to $14725, so definitely price for adults needs to increase.
Again, as given in the table if transit decreases the price for students from $85 to $65 then TR
would increase to $11570, so definitely price for students needs to decrease. correct
c. What price will maximize the total revenue from adult customers? (2 marks)
Ans: At price equal to $ 95 TR is maximum i.e., equals to $14725 for adults.
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d. What price will maximize the total revenue from student customers? (2 marks)
Ans: At price equal to $ 65 TR is maximum i.e., equals to $11570 for students. correct
e. What would be the total revenue from both groups? (2 marks)
Ans: At the profit-maximizing point the cumulative TR would be $ 14725 + $11570 = 26295
correct
f. List and explain two conditions necessary for public transit to be able to successfully practice
price discrimination. (4 marks)
Ans: First, bus need to have sufficient market power and as given in the question it is monopoly,
so it has market power.
Second, it must identify differences in demand based on different conditions or customer
segments and again as given in the question, both the markets have different demand elasticity
so, it can charge two different prices in two different markets. students have higher elastic
demand so here lower price strategy would be beneficial and adult market is less elastic so here
higher price would be more beneficial. Correct all correct 14 marks.
9. Differentiate between the monopolistic competitive and oligopoly market structures.
(8 marks)
Ans: Monopolistic competition and oligopoly are two types of imperfectly competitive market
structures. There are a few key differences between them:
Number of firms: In a monopolistically competitive market, there are many small firms that sell
differentiated products, while in an oligopoly, there are few large firms that dominate the market.
Product differentiation: In monopolistic competition, firms sell products that are differentiated
from each other in terms of quality, design, packaging, etc. In contrast, oligopolistic firms can
produce homogeneous or differentiated products, but they usually try to differentiate their
products in some way to create a competitive advantage.
Entry barriers: Monopolistic competition has low barriers to entry, which means that new firms
can easily enter the market and compete with existing firms. In contrast, oligopolistic markets
have high barriers to entry due to the dominance of a few large firms, which makes it difficult for
new firms to enter the market.
Pricing power: In monopolistic competition, each firm has some degree of pricing power, which
means they can influence the price of their product in the market. In contrast, oligopolistic firms
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have significant pricing power due to their market dominance, which can lead to price collusion
and anti-competitive behavior.
Advertising and marketing: In monopolistic competition, firms use advertising and marketing to
differentiate their products and attract customers. In contrast, oligopolistic firms use advertising
and marketing to build brand image and create barriers to entry.
Monopolistic competition has many small firms selling differentiated products with low barriers
to entry, while oligopoly has few large firms dominating the market with high barriers to entry.
Monopolistically competitive firms: 0 profits in the long run and firms are not
interdependent.
Oligopolies: firms are interdependent
6 marks
10.
The data for a monopolistically competitive firm is given below:
Quantity P
TR
MR TC
MC
ATC Profit
1
72
72
92
92
-20
2
68
136
54
142
50
71
-6
3
64
192
56
186
44
62
6
4
60
240
48
234
48
58.5
6
5
56
280
40
284
50
56.8
-4
6
52
312
32
336
52
56
-24
7
48
336
24
392
56
56
-56
8
44
352
16
450
58
56.25 -98
a. Complete the above table. (6 marks)
b. What output will this monopolistically competitive firm produce?
(2 marks)
Ans: Output = 4 units, MR = MC = 48, at an output level of 4. correct
c. Is this firm experiencing excess capacity? If yes, calculate how much.
(6 marks)
Ans: Yes, the firm is facing excess capacity. The firm is producing 2 units less.
Yes. The profit maximizing level of output is four. The output where ATC is
minimum is seven, and at this level of output, ATC = MC. The excess
capacity would be 7 – 4 = 3.
Please refer to page 361.
11 marks
11. An owner of a local convenience store has put $300,000 into his business. Before starting his
business, he was working in a restaurant. His annual salary was $25,000 per year. Savings
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accounts are currently paying 5% annual interest. The owner’s total annual sales from the
business are $60,000. His annual expenses are merchandise ($3000), rent ($1000), insurance
($500), and advertising ($200).
a. What is his annual accounting profit?
(2 marks)
Ans: Annual accounting profit=$55,300 correct
b. What is his annual economic profit?
(2 marks)
Ans: Annual economic profit=$15,300 correct
c. Should this owner continue with his convenience store business? (2 marks)
Ans: Yes, the owner should continue. Because he is earning positive economic profits.
d. Is it possible for a firm to incur an economic loss and earn an accounting profit at the same
time? Explain. (2 marks)
Ans: Yes, it is possible to earn a positive accounting and a negative economic profit. This
happens when the opportunity costs of the business are too high that they exceed the accounting
profits. The higher opportunity costs mean higher implicit costs and higher economic costs.
Correct
All correct 8 marks
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