CARLETON UNIVERSITY
Department of Economics
Introduction to Economics: Microeconomics
Assignment 3
Professor: Amir Kia
________________________________________________________________________
Note: Students are not required to hand in this assignment. However, this
assignment will help in the preparation of all examinations, including the final
examination.
1.
Define consumer surplus and producer surplus. Use graphs to explain very
carefully.
2.
Suppose you are willing to pay $65,000 for your favorite car, but being one of the
best economists in the world, you could get a good deal at $50,000. Do you think
you gain an extra benefit in the transaction? If your answer is yes, how much is
your surplus?
Answer: $15,000
3.
Your hourly fee as a consultant is $500. Yo ur production cost is $200 per hour.
You work 8 hours a day. Calculate your daily producer surplus.
Answer: Revenue = $4,000; Cost = $1,600; Producer surplus = $2,400
4.
Suppose the equilibrium price for a commodity is $10. What is the marginal
benefit to consumers if the equilibrium quantity is $10,000?
Answer: $10
5.
Providing a brief explanation, indicate if the following is true or false:
(i)
(ii)
(iii)
(iv)
(v)
When market price increases, producer surplus increases because (1)
producer surplus received by existing seller increases, and (2) new sellers
enter the market because they can receive producer surplus at the higher
price.
Total surplus in a market is consumer surplus minus producer surplus.
Total surplus in a market is the value to buyers of the goods minus the
costs to sellers of providing those goods.
Free markets allocate the supply of goods to the buyers who value them
most highly, and free markets allocate the demand for goods to the sellers
who can produce them at least cost.
Willingness to pay measures how much a buyer values a good.
2
6.
If a consumer is willing and able to pay $200 for a certain quantity of a particular
good but only has to pay $140. Calculate the consumer surplus.
Answer: $60
7.
Suppose you are willing to pay $1000 for a man’s suit, but are able to buy the suit
for $600. (a) How much do you value the suit? (b) What is your consumer
surplus?
Answer: (a) $1000, and (b) $400
8.
Suppose there are only 5 individuals in the market for a car. Their willingness to
pay for a car is respectively $8,500; $7,000; $5,500; $4,000 and $3,500.
(i)
(ii)
(iii)
(iv)
In a graph, show the demand in the market for cars.
Suppose the market price is $5,500. Calculate the consumer surplus if
there are only 3 cars available for sale. Answer = $4,500
At price = $3,500, which individual is the marginal buyer? First, second,
third, fourth or the last one?
At price = $3,500, do you expect each individual to have a consumer
surplus?
9.
Start from the equilibrium point. Now assume the supply curve shifts to the left.
Do you expect the consumer surplus to increase, decrease or remain the same.
10.
Define cost and producer surplus and using graphs explain both very carefully.
Show when demand for a commodity goes up the producer surplus will increase.
11.
The cost of production for a commodity is the following:
Seller
1
$100
2
80
3
70
4
50
5
30
(i)
Suppose the market price is $70. Calculate the producer surplus.
Answer: $60
(ii)
What is the total cost of the product at price $70.
Answer: $150
3
12.
We know that the marginal seller is the seller who would leave the market first if
the price were any lower, then explain what the height of the surplus curve at a
particular output rate represents.
13.
Define total surplus to society in a market. Explain how the allocation of
resources is efficient.
14.
The following table shows market supply and demand for good X.
Price
$12
10
8
6
4
2
0
(i)
(ii)
Quantity Demanded
0
4
8
12
16
20
24
Quantity Supplied
24
20
16
12
8
4
0
What price would result from market-clearing? Answer: $6
At the equilibrium price, what is the total surplus? Answer: $36
15.
Define deadweight of tax. In a graph show the deadweight loss of a tax and
carefully demonstrate that both buyers and sellers are worse off after the tax.
Explain how the losses of consumer surplus and producer surplus as a result of a
tax exceed the revenue raised by the government.
16.
Demonstrate and explain how the deadweight loss from a given tax, ceteris
paribus, will be larger the more elastic is the supply or demand. Use graphs in
your explanation.
17.
By using graphs, demonstrate and explain on whom falls the burden of the tax on
land.
18.
Start from equilibrium and show on your graph the total welfare gain at the
equilibrium. Explain carefully. Now show the quantity and price effect of a tax.
Show on your graph the welfare loss of the tax.
19.
Draw a supply-demand diagram for chocolate. On the diagram, show the
equilibrium before and after the imposition of a tax. Now identify areas
corresponding to each of the following.
a. consumer surplus before the tax
b. producer surplus before the tax
c. total surplus before the tax
d. consumer surplus after the tax
e. producer surplus after the tax
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f. total surplus after the tax
g. tax revenue
h. deadweight loss
20.
Craig has been in the habit of mowing Alice's lawn each week for $20. Craig's
opportunity cost is $15, and Alice would be willing to pay $25 to have her lawn
mowed. What is the maximum tax the government can impose on lawn mowing
without discouraging Craig and Alice from continuing their mutually beneficia l
arrangement?
Answer: If the tax is less than $10, there will exist a price at which both Craig and
Alice will benefit from the lawn- mowing arrangement. If the tax is $10, a price
can be set that will leave Craig and Alice neither better off nor worse off from the
lawn- mowing arrangement. If the tax is greater than $10, all possible prices will
leave at least one of the parties worse off from the lawn- mowing arrangement.
21.
Suppose that a tax is imposed on the coal market, and is left in place for several
years. What would you predict about (a) the size of the deadweight loss of the tax
in the short run relative to the long run, and (b) the amount of revenue collected
from the tax in the short run relative to the long run? Assume that the economy
doesn't grow during the period in question.
Answer: Because both demand and supply tend to be more elastic in the long run
than in the short run, we would predict that (a) the deadweight loss of the tax
would be larger in the long run than in the short run, and (b) the tax revenue
would be smaller in the long run than in the short run.
22.
Define budget constraint and show: (i) The slope of a budget constraint reflects
the rate of exchange between commodities. (ii) An increase in income does not
change the slope of the budget constraint.
23.
(i) In a graph explain how indifference curves can be used to rank all possible
bundles of two commodities. (ii) Do you expect bundles of goods on higher
indifference curves always contain more of two goods than bundles on lower
indifference curves? Explain your answer very carefully. (iii) Explain what does
the slope of an indifference curve reflect? Do you expect indifference curves to
cross? Explain your answer. In a graph show indifference curves, which are
consistent with perfect substitutes and perfect complements in consumption.
24.
Assume an individual has a budget of $100 for groceries and she is interested to
spend all her money on good x and good y. The price of good x is $2 and the price
of good y is $4. (i) Show the individual’s budget line. (ii) Now suppose the
individual receives a phone call indicating that some friends want to visit her. She
adds another $100 to her grocery budget. Show the new budget line. (iii) When
she goes to the grocery store she will notice that the price of good x has gone up
5
to $4. Show her new budget line in a graph. Calculate the slope of the budget line
after the change in the price of x.
25.
Define utility and explain the Law of Diminishing Returns. Explain how a family
of indifference curves can be derived from an individual utility function.
26.
In a figure show how an optimizing consumer selects a consumption bundle.
Explain your answer very carefully. Keep one price constant and derive the
demand curve for the other commodity for which the price changes.
27.
Assume that a consumer has an income of $100, and faces prices Px= $10, and
Py= $20. If this consumer chooses a consumption bundle which maximizes his
utility function what is the marginal rate of substitution at the optimized point.
Show your answer in a graph.
28.
Explain carefully substitution and income effects. Use graphs in your explanation.
29.
Define the following:
(i)
Implicit and explicit costs of production
(ii)
Economic and accounting profits
(iii)
Firm
(iv)
Production function, marginal product of labor
(v)
Fixed cost, variable cost, sunk cost, total cost, average cost and marginal
cost
30.
Assume labor is the only factor of production. Use graphs to explain the
following :
(i)
Total product of labor
(ii)
Average product of labor
(iii)
Marginal product of labor
31.
Explain carefully short run and long run in economics.
32.
Explain constant, increasing and decreasing returns to scale.
33.
Define economies of scale and compare it with increasing returns to scale.
34.
Define profit. Is profit the same as producer surplus? Explain your answer.
35.
Use graphs and carefully explain total, average and marginal products of a factor
of production. Be sure you relate the total product with the average and the
marginal products of the factor of production. You also need to describe clearly
the area of the production function that is subject to the Law of Diminishing
returns.
6
36.
What is the difference between fixed costs and variable costs? Can fixed costs
ever be considered variable? Exp lain.
37.
Explain the relationship between a firm's production function and its total cost.
Answer: The production function defines the input combinations that can be used
to produce output. As such, it defines technical possibilities, and when input
prices are attached to various input combinations it helps determine the firm's cost
structure.
38.
Graphically depict a typical U-shaped long-run average cost curve. On your
graph, identify the regions associated with economies of scale, diseconomies of
scale, and constant returns to scale. Describe the circumstances that are related to
each of these regions on the long-run average cost curve.
39.
Complete the following table.
Measures of Cost for Fred's Fritter Factory
Quantity
Fixed
Cost
4
5
6
7
8
9
10
$100
40.
Variable
Cost
Total
Cost
Average
Fixed
Cost
Average
Variable
Cost
Average
Total
Cost
$110.50
Marginal
Cost
$2.00
$15
$18.10
$3.80
$126.40
$2.93
$13.19
Describe the difference between marginal cost and average total cost. Why are
both of these costs important to a profit- maximizing firm?
Answer: Marginal cost is the amount that total cost rises when the firm increases
production by one unit of output. Average total cost is the total cost divided by the
quantity of output. Marginal cost is used to determine the optimal production level
and average total cost is used to determine the level of profits.
41.
The table below reflects the production function of a firm that uses both capital
and labour in its production process. The numbers on the interior of the table are
levels of output associated with the usage of capital and labour in the respective
margins. For example, when the firm employs 3 units of labour and 4 units of
capital, output is 48 units.
7
1
2
Labour 3
4
5
a.
b.
c.
d.
e.
1
1
2
3
4
5
Capital
2
3
4
9
8
18
12
27
16
36
20
45
4
16
32
48
64
80
5
25
50
75
100
125
If two units of capital are used in production, what is the marginal product
of the third unit of labour?
If 4 units of labour are used in production, what is the marginal product of
the second unit of capital?
Does marginal product of labour ever decrease for this firm? Explain your
answer.
Does marginal product of capital ever decrease for this firm? Explain your
answer.
Assume that this firm is using 3 units of capital. If each unit of labour costs
the firm $5, what is the marginal cost of output associated with increasing
employment from 3 to 4 workers?
Answer:
a. 4
b. 12
c. No, marginal product of labour is constant for each level of capital.
d. No
e. 5/9 = 0.5555
42.
Describe the difference between average revenue and marginal revenue. Why are
both of these revenue measures important to a profit- maximizing firm
Answer: Average revenue is total revenue divided by the amount of output.
Marginal revenue is the change in total revenue from the sale of each additional
unit of output. Marginal revenue is used to determine the profit- maximizing level
of production and average total revenue is used to determine the level of profits.
43.
Use a graph to demonstrate the circumstances that would prevail in a perfectly
competitive market where firms are earning economic profits. Identify costs,
revenue, and the economic profit earned on your graph.
8
Answer:
44.
How do you find the profit- maximizing level of production for a competitive
firm?
45.
Firms in perfectly competitive markets are said to be price takers. Explain what is
meant by this term and what it implies about the relationship between average
revenue and marginal revenue.
46.
Why would a firm in a perfectly competitive market choose not to set its price
below the going price? If a firm did set its price below the going price, what effect
would this have on the market?
Answer: It could not sell any more of its product at the lower price than it could
sell at the higher price. As a result, it would needlessly forgo revenue if it set a
price below the going price.
47.
Use a graph to demonstrate the circumstances that would prevail in a perfectly
competitive market where firms are incurring economic losses. Identify costs,
revenue, and the economic losses on your graph. On the basis of your graph,
determine whether this firm will shut down in the short run, or choose to remain
in the market. Explain your answer.
9
Answer:
48.
Under what conditions would a firm choose to shut down and record its fixed
costs as losses? When would it decide to exit the market?
Answer: When price is below average variable cost. The exit decision is a longrun decision in which the firm has no prospect for being able to cover its cost of
production.
49.
In a perfectly competitive market with free entry and exit, discuss the process that
induces firms to operate at efficient scale in the long run.
Answer: If all firms in a competitive industry face the exact same cost structure,
the exit and entry of firms will force every firm in the market to operate at the
efficient scale of production. If it does not operate at efficient scale, it will be
incurring economic losses.
50.
If firms that remain in a perfectly competitive market over the long-term must
make zero profit, why do firms choose to remain in the market?
Answer: Because a normal rate of return on their investment is included as part of
the opportunity cost of production.
51.
Suppose at price $15 a firm’s range of production is from 1 to 19 units of output.
(i)
Over which range of output is average revenue equal to price?
Answer: Over the whole range of output
10
(ii)
Over what range of output is marginal revenue declining?
Answer: None
(iii)
What is elasticity of demand when the firm sells 10 units?
Answer: Perfectly elastic
52.
Explain the condition at which a profit- maximizing producer always chooses to
produce.
53.
The Wheeler Wheat Farm has a long-term lease on 5000 hectares of land in
Saskatchewan. The annual lease payment is $250,000. Prior to planting in the
spring of 1996, the Wheeler Farm accountant predicted that the Farm would have
$135,000 left after paying all of it s 1996 fixed and variable costs except the
annual lease payment.
(i)
Calculate the farm accounting loss.
Answer: $115,000
(ii)
Should the Wheeler Wheat Farm continue to produce even at above cost?
Explain your answer.
54.
What is a firm’s short-run shutdown condition? Explain your answer.
55.
In the long run all of a firm's costs are variable. What is a firm’s long-run
shutdown condition? Explain your answer.
56.
If a monopolist maximizes profit, society as a whole must benefit. Explain the
validity of this statement.
57.
Is it true that the fundamental cause of monopoly is barriers to entry? Explain
your answer.
58.
Explain the profit maximization of a monopoly. Do you think a monopoly has a
supply curve?
59.
Explain how a natural monopoly occurs.
60.
Explain the key difference between a competitive firm and a monopoly firm.
61.
What is typically the market demand curve for a monopolist.
11
62.
What is typically the market demand curve for a firm operating in a competitive
market.
63.
What is the monopolist's profit under the following conditions:
The price charged for goods produced is $16. The intersection of the marginal
revenue and marginal cost curves occurs where output is 10 units and price is $8.
Average cost for 10 units of output is $6.
Answer: $100
64.
The economic inefficiency of a monopolist can be measured by the deadweight
loss. Explain very carefully this statement. Use graphs in your explanation.
65.
Suppose in Manitoba, Black Box Cable has a monopoly in the provision of cable
TV services in the town of Brandon. The diagram above represents the linear
market demand curve that it faces for cable TV in Brandon.
a.
b.
c.
d.
If Black Box has a constant marginal cost curve at $5, what is its profitmaximizing level of output?
How much revenue will Black Box make from selling the profit- maximizing
quantity of output?
How much profit will Black Box make when it produces at the profitmaximizing level of output?
Is there some scenario under which Black Box will have economic losses
rather than economic profits?
12
Answer:
a.
Q = 192. (MR = 125 - .625 Q)
b.
TR = P * Q
P = 125 - .3125 Q => P = 125 - .3125(192) = 65
TR = 65 * 192 = $12 480
c.
We can't tell without more information about the cost structure of the firm.
d.
Yes, if the total cost of producing 192 units exceeds the revenue of
$12,480, Black Box will have economic losses. This would be the case for
capital intensive firms that sell in small markets.
66.
Graphically depict the deadweight loss caused by a monopoly. How is this similar
to the deadweight loss from taxation?
67.
A profit- maximizing monopolist is often a target for some kind of government
intervention. Describe why governments may choose to intervene in monopoly
markets. List and describe the possible ways in which governments may choose to
enhance the social efficiency of monopoly markets.
Answer: Governments typically intervene in monopoly markets to either capture
some monopoly profits for themselves or to move the market outcome to a more
socially optimal level of output and price. Possible ways the government
intervenes include legislation and enforcement of laws, regulation and public
ownership.
68.
Explain characteristics of both a duopoly and an oligopoly market.
69.
Explain two possible outcomes of both a duopoly and an oligopoly market.