Eco 301
Test 2
Name_______________________________
4 November 2005
100 points. Please write answers in ink, but do graphs and figures in pencil.
1. Assume that a competitive firm has the short-run costs given in the table below. What is the
firm's most profitable output, and how large is profit if the price per unit of output is (a) $15?
(b) $26? And (c) $35?
Output
0
1
2
3
4
5
6
7
8
9
10
Total
Total Cost
Total
Fixed Cost Variable Cost
Marginal
Cost
0.00
—
30.00
19.00
16.00
15.00
20.00
24.00
26.00
30.00
35.00
40.00
60.00
60.00
60.00
60.00
60.00
60.00
60.00
60.00
60.00
60.00
60.00
30.00
49.00
65.00
80.00
100.00
124.00
150.00
180.00
215.00
255.00
60.00
90.00
109.00
125.00
140.00
160.00
184.00
210.00
240.00
275.00
315.00
Average
Average
Average
Fixed Cost Variable Cost Total Cost
—
60.00
30.00
20.00
15.00
12.00
10.00
8.57
7.50
6.67
6.00
—
—
30.00
24.50
21.67
20.00
20.00
20.67
21.43
22.50
23.89
25.50
90.00
54.50
41.67
35.00
32.00
30.67
30.00
30.00
30.56
31.50
(a) Firm shuts down because producing four units would result in a loss of $80,
which exceeds its fixed cost of $60.
(b) Firm produces 7 units for total revenue of $182 and an economic loss of $28,
which is less than its fixed cost.
(c) Firm produces 9 units for total revenue of $315 and an economic profit of $40.
2. Suppose that the gasoline retailing industry is perfectly competitive, constant-cost, and
in long-run equilibrium. If the government unexpectedly levies a five-cent tax on every
gallon sold by gasoline retailers, depict what will happen to the representative firm's cost
curves. What will the effects of the tax be in the short run on industry output and price? Will
the price rise by the full five cents in the short run? In the long run?
The tax will cause the firm’s marginal cost, average variable cost, and average total
cost curves to shift up by five cents per gallon. In the short run, the firms will
reduce output and make losses. Price will rise, but by less than five cents. In the
long run, some firms will exit the industry and the long-run equilibrium price will be
five cents more than originally.
3. Is it possible that diminishing marginal returns will set in after the very first unit of labor is
employed? What do the total, average, and marginal product curves look like in this case?
The total product curve has a slope that becomes flatter right from the start,
as shown below left. The marginal and average product curves are depicted below
right. Note that AP = MP for the first unit.
4. For a given increase in demand, will output increase by more if the MBA education
industry is constant-cost or increasing-cost? For a given decrease in demand, will output fall
by more if the industry is constant-cost or increasing-cost?
In both cases the change in output is greatest in the constant-cost industry. This
is because there are no adjustments in the input markets that attenuate the
effects of the changes in demand.
Eco 301
Test 2
Name_______________________________
4 November 2005
100 points. Please write answers in ink, but do graphs and figures in pencil.
1. The table below shows how costs vary with output for a price-taking firm.
Output
Total
Cost
0
1
2
3
4
5
6
7
8
9
$ 1.50
$ 2.00
$ 3.00
$ 4.50
$ 6.50
$ 9.00
$ 12.00
$ 15.50
$ 19.50
$ 24.00
Marginal Profit
Cost
P = $4
$
$
$
$
$
$
$
$
$
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
Profit
P = $1
($1.50) ($1.50)
$2.00 ($1.00)
$5.00 ($1.00)
$7.50 ($1.50)
$9.50 ($2.50)
$11.00 ($4.00)
$12.00 ($6.00)
$12.50 ($8.50)
$12.50 ($11.50)
$12.00 ($15.00)
a. If the product price is $4.00, what is the profit-maximizing output? 8 units
b. At this level of output, what is the total profit or loss for this firm? $12.50
c. If the price falls to $1.00, will this firm shut down or produce in the short run? If it produces,
how many units will it sell? What is the loss for this firm? Suppose there is a decrease in
demand for widgets that are provided by a competitive, constant-cost industry.
At a price of $1 the firm will produce 2 units to minimize its loss at $1. If the
firm does not produce it loses $1.50.
2. Suppose there is a decrease in demand for widgets that are provided by a competitive,
constant-cost industry.
a. Does the industry-wide quantity change by more in the short run or in the long run?
Illustrate your answer.
b. Does the quantity provided by each individual widget producer change by more in the short
run or in the long run? Illustrate your answer.
a. The change in output is greater in the long run than in the short run. In the
long run firms exit the industry thereby causing the industry supply curve to
shift inward.
b. As firms exit the industry, price begins to rise toward the original price. Firms
remaining in the industry increase output by moving up their marginal cost
curves. Once price has returned to the original price, the remaining firms
produce as much as they did prior to the decline in demand. So in the long run,
individual firms—the ones that did not exit—produce what they did before the
change in demand.
3. Suppose that the gasoline retailing industry is perfectly competitive, constant-cost, and
in long-run equilibrium. If the government unexpectedly levies a five-cent tax on every
gallon sold by gasoline retailers, depict what will happen to the representative firm's cost
curves. What will the effects of the tax be in the short run on industry output and price? Will
the price rise by the full five cents in the short run? In the long run?
The tax will cause the firm’s marginal cost, average variable cost, and average total
cost curves to shift up by five cents per gallon. In the short run, the firms will
reduce output and make losses. Price will rise, but by less than five cents. In the
long run, some firms will exit the industry and the long-run equilibrium price will be
five cents more than originally.
4. Is it possible that diminishing marginal returns will set in after the very first unit of labor is
employed? What do the total, average, and marginal product curves look like in this case?
The total product curve has a slope that becomes flatter right from the start,
as shown below left. The marginal and average product curves are depicted below
right. Note that AP = MP for the first unit.