Chapter 8
Review
Supplemental Instruction
Iowa State University
Leader:
Course:
Instructor:
Date:
Veronica
Econ 101
Kreider
11-4-14
Review Notes:
Term
Accounting Profit
Economic Profit
Formula
= Total Revenue –
Accounting Costs
= Total Revenue – All costs
of production
Types of Costs included
Explicit
Explicit & Implicit
1.
Facts on MR and MC:
a. An increase in output will always raise profit as long as marginal revenue is
greater than marginal cost.
b. An increase in output will always lower profit whenever marginal revenue is
less than marginal cost
c. To find the profit-maximizing output level, the firm should increase output
whenever MR>MC, but not increase output when MR<MC.
d. Optimal decision-making requires us to examine marginal benefits and costs
not average
2. Let Q* be the output level at which MR = MC. Then, in the short run:
a. If TR > TVC at Q*, the firm should Continue to Produce
b. If TR < TVC at Q*, the firm should They should Shutdown
c. If TR = TVC at Q*, the firm Indifferent.
d. Draw a graph of each
3. A firm should exit the industry in the long run when—at its best possible output
level—it would suffer a loss. Which means:
a. If TR > TC at Q*, the firm should Continue to Produce
b. If TR < TC at Q*, the firm should They should Shutdown
c. If TR = TC at Q*, the firm Indifferent
d. Draw a graph of each
Review Problems:
1. Suppose you own a restaurant that serves only dinner. Your restaurant currently has
the following monthly costs:
Rent on building:
Electricity:
Wages and salaries:
Advertising:
Purchases of food and supplies:
Your forgone labor income:
Your forgone interest:
$ 2,000
$ 1,000
$15,000
$ 2,000
$ 8,000
$ 4,000
$ 1,000
a. Which of your current costs are implicit, and which are explicit?
Implicit: forgone income, forgone interest.
Explicit: Rent, Electricity, Wages, Supplies, Advertising
b. If you are currently making $18,000 per month what is your accounting profit
and Economic Profit?
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Accounting profit = Revenue – Explicit costs
=18,000 – (2000 + 1000 + 15000 + 2000 + 8000) = -$10,000
Economic Profit = Revenue – explicit costs – implicit costs
= -10,000 – (4000 + 1000) = -$15,000
2. A bakery currently charges $1.50, the profit-maximizing price, for each gourmet
cookie, and it sells 5,000 cookies per month. The bakery’s rent and utility costs are a
flat fee of $4,000 per month, and it has just signed a lease obligating it to make the
payments for one year. To make each cookie costs $1 in labor and raw materials,
regardless of how many cookies are made. The bakery has no costs other than those
listed
a. What is the monthly economic profit earned by the bakery?
Economic profit =Revenue – Explicit costs – Implicit costs
= (1.5 * 5000) – (4000) – (1 * 5000) = -$1,500
b. Over the short run (for the next few months), should the bakery keep operating
or shut down? Why?
TR = 1.5*5000= $ 7,500
TVC= 1* 5000 = $5,000
Since TR > TVC in the short run the company should keep producing
c. Assuming that the bakery’s current “plant” is also its least-cost plant, should the
bakery plan to exit or stay in business a year from now?
If The bakery is planning to stay at its current location It should shut down
because TR= $7,500 < TC = $9,000.
However if the bakery can find a cheaper place to rent out (costs< $2,500) they
should continue to produce.
3.
The adjacent tables give
Firm A
information about demand and total
Quantity
Price Total Cost
TR
Profit
TVC
0
above $125
$250
$0
-$250
$0
cost for two firms. In the short run,
1
$125
$400
$125 -$275
$150
how much should each produce?
2
$100
$500
$200 -$300
$250
Firm 1 should shut down because
3
$ 75
$550
$225 -$325
$300
they cannot even make a positive
4
$ 50
$600
$200 -$400
profit / their TVC > TR at all
5
$ 25
$700
$125 -$575
output.
Firm B
Quantity
0
1
2
3
4
5
Price
above $500
$500
$400
$300
$200
$100
Total Cost
$ 500
$ 700
$ 900
$1,100
$1,300
$1,500
TR
$0
$500
$800
$900
$800
$500
Profit
-$500
-$200
$100
-$200
-$500
-$1000
TVC
$0
$200
$400
$600
$800
$1000
Firm 2 should produce at 2 units
because at that point they are
making a positive profit.
4. At its best possible output level, a firm has total revenue of $3,500 per day and total
cost of $7,000 per day. What should this firm do in the short run if: the firm has total
fixed costs of $3,000 per day? Shut down b/c TVC > TR
a. the firm has total variable costs of $3,000 per day?
Produce b/c TR > TVC
b. What if they had a variable cost of $4,000 per day?
Shutdown b/c TVC > TR
c. What about a fixed cost of $3,500 per day?
Produce or Shutdown B/C TR = TVC