Practice Problem-1
Costs
If the total fixed cost is Rs. 60, complete the following table.
Average Total
Total
Variable Variable Fixed
Total
Marginal
Output(units) Cost (Rs.) Cost (Rs.) Cost (Rs.) Cost(Rs.) Cost(Rs.)
1
20
2
15
3
20
Solution:
Average Total
Total
Variable Variable Fixed
Total
Marginal
Output(units) Cost (Rs.) Cost (Rs.) Cost (Rs.) Cost(Rs.) Cost(Rs.)
0 NA
0
60
60 NA
1
20
20
60
80
20
2
15
30
60
90
10
3
20
60
60
120
30
Note
Total Variable Cost (TVC) = Output*Average Variable Cost(AVC)
Total Fixed Cost(TFC) remains constant at Rs. 60 as specified in question.
Total Cost (TC) = Total Variable Cost (TVC)+Total Fixed Cost (TFC)
Marginal Cost (MC1) = TC1 –TC0 = 80-60 = 20
MCn = TCn – TCn-1
Practice Problem-2
Costs
Assume that the fixed cost of the firm is Rs. 24. Complete the following table.
Average Total
Total
Total Cost Variable Fixed
Total
Marginal
Output(units) (Rs.)
Cost (Rs.) Cost (Rs.) Cost(Rs.) Cost(Rs.)
1
50
2
40
3
45
Solution
Average Total
Total
Total Cost Variable Fixed
Total
Marginal
Output(units) (Rs.)
Cost (Rs.) Cost (Rs.) Cost(Rs.) Cost(Rs.)
0 NA
0
24
24 NA
1
50
26
24
50
26
2
40
56
24
80
30
3
45
111
24
135
55
Note: Total Cost (TC) = Output*ATC
TVC = TC – TFC
MCn = TCn – TCn-1 (For example, MC1= TC1 – TC0 = 50-24=26)
Practice Problem-3
Costs
The following table shows the total cost of production of a firm at different levels of output. Find out the average variable cost
and the marginal cost at each level of output.
The demand equation for this firm is P=60-7.5Q
Output (units)
0
1
2
3
Find the output for profit maximization and the corresponding
Total Cost(Rs.)
60
100
130
150
Revenue and profit/loss.
Marginal Revenue (MR) = 60-2*7.5Q = 60-15Q
Profit maximization condition, MR = MC
Solution
Q=1, MR = 60-15*1 = 45, MC=40
Output (units) TC
TFC
TVC
AVC
MC
Q=2, MR=60-15*2 = 30, MC=30
0
60
60
0 NA
NA
1
100
60
40
40
40
Profit Maximization occurs at Q=2.
2
130
60
70
35
30
Q=2, Price = 60-7.5*2= 60-15=45
3
150
60
90
30
20
Revenue = 45*2=90
TC = 130
Note: Total Fixed Cost (TFC) = Total Cost (TC) at 0 (zero) output.Profit = 90-130 = -40
Practice Problem-4
Costs
The following table shows the cost function of a firm. Calculate the average variable cost and marginal cost at each level
of output.
Output (units)
Total Cost(Rs.)
0
30
1
45
2
56
3
69
Solution:
Output (units) TC
0
1
2
3
TFC
30
45
56
69
TVC
30
30
30
30
AVC
0 NA
15
26
39
MC
NA
15
13
13
15
11
13
Practice Problem-5
Costs
• The following information is given about a firm.
Output (units)
Total Cost (Rs.)
0
400
1
550
2
660
3
790
4
940
5
1150
6
1460
Find the following
(i) Average Fixed Cost of producing 4 units (Rs. 100)
(ii) Average Variable cost of producing 5 units (Rs. 150)
(iii) Least Average cost level of output (Rs. 230, at output =5)
(iv) Marginal Cost of producing the 3rd unit (Rs. 130)
(v) Total Variable cost of producing 6 units (Rs. 1060)
The answers have been given within brackets.
Demand and Supply
Curve Shifts
1. Discuss the effect of drought on the supply of coffee? How does it affect equilibrium, if the demand curve is unchanged?
Graphically explain using the demand supply curve.
Answer:
The drought would lower coffee production. The suppliers
would be able to provide less coffee at the same price. As the
quantity supplied at the original equilibrium point shrinks, price
would rise to P2 dampening demand from Q1 to Q2..
The equilibrium demand would decrease, price would go up.
S2
P2
P1
S1
E2
E1
D Demand Curve
Q2 Q1
Demand
Curve Shifts
2. Restaurants in a city serve biryani ( a rice item) and naan (a wheat based item). Analyze the impact of a hurricane which
severely affected the rice crops in a particular season on this market.
S2
Answer
The scarcity of rice would raise the input costs of Biriyani. As a
result, less biriyani would be available in the market shifting its supply
curve to the left. The equilibrium quantity of biriyani would decline while
the equilibrium price would rise.
E2
Price
D
S1
Biriyani
E1
Quantity
The demand for naan, assuming it to be a substitute good would rise which
Would move the demand curve rom D 1 to D2.. The equilibrium
Quantity would rise, while the price would also rise.
S
Price
E2’
E1’
D2
D1
Quantity
Naan
Curve Shifts
3. What would be the impact for a rise in the demand for cheese on the butter market?
D2
Answer
The cheese demand curve would shift to the right resulting
In a rise in equilibrium quantity coupled with an increase in
Equilibrium price.
As milk is the raw material for both, the amount of milk available
For butter production would reduce. This would push the supply
Curve to the left as shown in the diagram causing a shrink in
Equilibrium demand and rise in equilibrium price.
D1
S
Cheese
E2
E1
Quantity
S2
S1
E’2
Butter
E’1
Quantity
D
Demand and Supply Equation
price
The demand equation for a product is P=80-Q, the supply equation is P=20+2Q. Compute the demand and supply quantities
when the prices are U$ 50,55,60.65 and 70. Calculate the corresponding supply surpluses or deficits. Find the equilibrium
quantity and price. If the Government announces a tax of U$ 6 on every unit of the item which the suppliers have to pay
From the existing price, find the new supply equation, equilibrium price, quantity and tax collected by the government.
Present this data in a graphical manner.
S2 P = 26+2Q
Answer:
P=80
We need to find two points each on the demand as well as the
S1 P = 20+2Q
supply lines to be able to be able to graphically represent them.
E2
Demand Line
60
P=80 – Q, P=0, Q=80 and Q=0, P=80
E1
Supply Line
P=20+2Q, Q=0, P=20 and P=80, Q=30
Equilibrium Point
D
40
20
At Equilibrium point both demand and supply lines would meet.
80-Q = 20+2Q, 3Q = 60, Q=20, P=80-20=60
q=80
The demand-supply quantities are shown in the next slide in a tabular
20
40
80
quantity60
manner.
Demand and Supply Equation
Price
Demand
Supply
Supply Surplus/Deficit
50
30
15
-15
55
25
17.5
-7.5
60
20
20
0
65
15
22.5
7.5
70
10
25
15
P=50
50 = 80-Q (Demand Equation), Q=30
50 = 20+2Q (Supply Equation), Q=15
Supply Surplus/Deficit = Supply – Demand = 15-30 = -15 (Deficit)
P = 20+2Q
Net Price retained by supplier P-6 = 20+2Q
P = 26+2Q
Tax scenario
While the price paid by the customer would stay unchanged, the retention with the supplier would be lower by U% 6.
The demand equation is unchanged. The supply equation would be P -6= 20+2Q, P=26+2Q
The supply line would shift upwards as shown in the figure in the previous slide, The new equilibrium price and quantity
are given below. 26+2Q = 80-Q, 3Q=54. Q=18
Tax collected = U$ 6* 18 = U$ 108.
Practice Problem-1
Consumer Choice
A consumer’s income (budget) is Rs. 200. He spends it on the purchase of good x and good y whose prices are Rs. 20 and
Rs. 10 per unit respectively. Write the equation of the budget line and represent graphically showing the points where the
Line intersects the x and the y axes respectively.
Solution:
The equation of budget line is Px *X + Py *Y = I
Substituting the numbers from the question, the equation is 20X+10Y = 200 where X and Y represent the amounts of good x
and good y consumed.
good y
Note: To find the points where the budget line intercepts the x-axis, put
Y=0 in the budget line equation. Thus we get, 20X = 200, X=10. This is the
Point (at a distance of 10 from the origin along the x-axis) where the budget
Line would meet the x-axis. To find its counterpart on the y-axis, put x=0
Y = 20
good x
Practice Problem-2
Consumer Choice
A consumer consumes only two goods x and y whose prices are Rs. 20 and Rs. 30 respectively. If the consumer chooses a
combination of the goods with marginal utility (MU) of x as 10 and that of y equal to 12, would she be in equilibrium? What
Would a rational customer do in such a situation?
Solution
For consumer equilibrium MUx /Px = MUy/Py
MUx / Px = 10/20 = ½
MUy / Py = 12/30 = 2/5 , MUx / Px > MUy /Py
Hence the consumer will not be in equilibrium.
The rational consumer would consume more of X at the expense of Y till the marginal utility of X declines and that of Y rises
and equality is established.
Practice Problem-3
Consumer Choice
Explain the law of demand using utility analysis.
The law of demand states demand decreases with increased price and vice versa.
Consider a consumer with two options to choose from, X and Y. At equilibrium, MUx /Px = MUy / Py
If Px increases, the LHS decreases and the equation changes to MUx / Px < MUy / Py . This changes
the customer’s demand pattern in favor of product Y leading to a fall in demand.