1. _____/20 4._____/30 2. _____/20 5._____/10 3. _____/20

Total: _____/100

Name: _________________________ Period/Team: _________________________

Graded by: _________________________

Unit III: Costs of Production and Perfect Competition Problem Set #3

1. Explain an example that demonstrates the “real world” application of each of the following. Define the

terms in your own words and use examples that clearly demonstrate your understanding of each concept. a. Explicit and Implicit Costs (____/5) b. The Law of Diminishing Marginal Returns (____/5) c. Fixed Costs, Variable Costs, and Total Cost (____/5) d. Economies of Scale and Diseconomies of Scale (____/5)

2. Productivity and Costs

a. Complete the attached worksheet “Production Function for Tony’s Hat Store” (____/5) b. Complete the attached worksheet titled “Cost and Competitive Market Supply” (____/10) c. Explain the relationship between the marginal product curve and the marginal cost curve. In your

response, explain why the marginal cost curve is “U” shaped using numerical examples. (____/5)

3. Below is information regarding Cory’s Surfboard Inc. Complete the table and do the following (____/5): a. On a large graph, plot the MC, AFC, AVC, and ATC curves from this data (____/5) b. EXPLAIN what would happen to each of Cory’s per unit cost curves if the price of Styrofoam

surfboard blanks (a variable input) increases. How would the cost curves change if there was an increase in his rent (a fixed input)? Explain why the results are different. (____/5)

c. If the market for surfboards was perfectly competitive and the market price was $150, how many surfboards should Cory make and how much profit will he make for EACH surfboard? Draw the firm’s demand on your graph in a. Explain how you got your answer. (____/5)

Total

Product Variable

Costs (TVC) Total Cost

(TC) Average Fixed

Cost (AFC) Average Variable

Cost (AVC) Average Total

Cost (ATC) Marginal

Cost (MC) 0 $0 $100 1 60 2 90 3 130 4 180 5 250 6 340 7 490 8 680

4. Complete the attached practice FRQs (one or more will be done in class):

a. No. 1 (____/10) b. No. 2 (____/10) c. No. 3 (____/10)

5. Assume that apples are an inferior good. Draw a perfectly competitive market for apples and a firm selling apples in long-run equilibrium where price is $10 and the firm’s equilibrium quantity is 50. Explain the following situations graphically and in words (Draw and label side-by-side graphs for each).

a. EXPLAIN what happens in the short-run if incomes increase by 15%? ( ____/5) b. EXPLAIN the process by which this market returns to long-run equilibrium ( ____/5)

Short-Run Production Function for Tony’s Hat Store

Quantity of Input (workers hired)

Total Product (Total hats produced)

Marginal Product (additional hats

from each worker)

Average Product (hats per worker)

0 0 1 10 2 25 3 45 4 60 5 70 6 75 7 70

Graph TP, MP*, AP, and identify regions of increasing, decreasing, and marginal returns 75 70 65 60 55 50 45 40 35 30 25 20 15 10

Num

ber o

f Hat

s

5

0 1 2 3 4 5 6 7

Number of Workers *Graph MP between workers

Definitions: Total Product (TP)= Marginal Product (MP)= Average Product (AP)= The Law of Diminishing Marginal Returns-

Stage I: Increasing marginal returns Stage II: Decreasing marginal returns Stage III: Negative marginal returns

Questions: 1. How many hats can three workers make? 2. How many additional hats are made as a result of hiring the 5th worker? 3. On average, how many hats can 2 workers make? 4. At what point does marginal product diminish? 5. Does total product decrease when marginal product falls? 6. When marginal product is zero, what happens to total product? 7. The hiring of which worker leads to 20 additional hats being produced? 8. How many workers does it take to make 60 hats? 9. What is the result of hiring the 7th worker? Why? 10. What causes increasing marginal returns? 11. How does MP affect AP? How is this demonstrated by the curve?

Problem Set FRQ No. 1 Analyzing Costs Complete the following chart for a perfectly competitive firm sellings product at a price of $30, and then answer the questions.

Total Product

Total Revenue

Marginal Revenue

Variable Cost Fixed Cost Total Cost Marginal Cost (MC)

0 0 - $0 $10 - 1 30 2 50 3 60 4 70 5 85 6 105 7 130 8 170

a. What is the AVC when producing five units of output? b. B. To maximize profits/minimize losses, what output should this firm produce? Explain

how you got your answer. c. Using your answer from (b), what is the profit or loss per unit at the profit-maximizing

output?

Problem Set FRQ No. 2 Perfect Competition

Tim is a producer of Christmas trees in a perfectly competitive market that is currently in long-

run equilibrium at the price of $50. At equilibrium quantity of 100 trees, Tim’s average variable cost per tree is $35.

a. Draw a graph for both the industry and Tim’s firm (include MR, MC, ATC, and AVC). i. Label the area of Tim’s Total Revenue

ii. Label the area of Total Cost iii. Label the shut down point

b. Describe Tim’s firm in terms of the following: i. Productive efficiency

ii. Allocative efficiency c. With new graphs, show the results of an increase in demand for Christmas trees on the

following: i. Price and quantity of Tim’s firm in the short-run

ii. Price and quantity of Tim’s firm in the long-run

Practice FRQ No. 3 Perfect Competition Market and Firm 1. Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry

that is in long-run equilibrium.

(a) Draw correctly labeled side-by-side graphs for the dairy market and for Bestmilk and show each of the following.

(i) Price and output for the industry (ii) Price and output for Bestmilk

(b) Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs in part (a), show the effect of the decrease in income on each of the following in the short run.

(i) Price and output for the industry (ii) Price and output for Bestmilk

(iii) Area of loss or profit for Bestmilk

(c) Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run?

(d) Assume that the industry adjusts to a new long-run equilibrium. Compare the following between the initial and the new long-run equilibrium. (i) Price in the industry

(ii) Output of a typical firm (iii) The number of firms in the dairy industry

Costs and Competitivc Market Supply (I>crfect Oornl>ctition)

Part A

@ f'ft. Fia,scei OonrPany is a grcrfl'ctly corrrP(tiliv(' tirrrr rvh,rse drrily costs ol'prodrrcliorr ( inulrrtling l"nonnal" ratc ()[ prof'it ) in the shorl run .lrc irs lirllows:

H u'*ure 2tt.I

Output(per day)

The Fiasco Company's Cost'l'able

TotalVariable

Cost

Average AverageTotal Marginal Total VariableCost Cost Cost Cost

i$ $0 $12.00 \1 4.00 16.00 { =$a.oo $16.00 $4.00

2 7.00 19.00 q \ s.oo 9.50 3.50

3 9.00 21,00; \ 7.00 3.00

4 12.00 24.00 r \

5 18.00 \,6 27.O4 \,7 37.00 \I 49.00 \I 63.00 \

10 79.00 \

(A) I;ill in thc [rlarrks irr l;igurc Jtt.l.

'(tl)()nl"igrrre 2tt.),plot ;ttttl lirlrcl lllt'itt,et';rBt'i'rrri.rhl.'r()st{.,\\1(.},itvrrir1i('l(}l.ll ((}rli;\'l t.}.rrrrfnrarllitritl cost (fr'l(l)tttt-vt's. I'lnt ttt.tt'girr.tl ru\t;rt llrt'rrtitlpoirrl. r\ssirrrrr'tlris linu (.ut l)t(lclUce *ny Jilr-:liort o1'ottllrtrl llr't' (llty so llt.tl v(lll r'{)t}ttr:cl tltc llsittts I1 llt'ltr tgl}lit}g9trs ( 1f \'(,ir

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$18

16

14

12

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The Fiasco Company's Cost Curves

i) Wfrat happens to AVC as output rises?

t.\$ l What happens to ATC as output rises?

6

4

2

0

':

':

t-1 r)OUTPUT

910

il)'Wnut happens to MC as output rises?

(C) How would you interpret the vc'rtieal clistance lretween the average total cost and average vari-able cost curves?

(D) \{hy does average total cost decline at first, then start rising as output is increased?

{E) The marginal cost curve intersects both average cost curves (ATC and AVC) at their mininrumpoints. Why?

(F) If fixed costs were $20 instcad of $ 12, how woulcl the change affect average variable costs andmarginal costs?

@/ Given the cost curves ftrr Fiasco Oonrpany on liigure 2t].2 antl the fact that the competitive marketprice at which the company must sell its outpul is $ I I a Lrnit, fill in the blank below and aeld toyour graph in Figure 28.2. (Remenrber, fractions of units are allowecl. )

(A) Draw and label the average antl margin*l revenue L-urves on your graph.

(B) tn order to maximize profits, Fiasco would sell

-

units, at a price of

-.

Its averagetotal cost would be

-.

Its average revenue would be

-.

It would earn a per-unit profit of _ and total profit of per day.

(C) If the firm produced instead at the quantity that minimized its average total cost, it could sellunits, at a price of . Its average total cost would be

Ifthemarketpricewere$11,itsaveragerevenuewouldbe-.Itwouldearnaper-unit profit of and total profit of-- per day.

(D) If the cornpetitive market price fell to $5 a unit, Fiasco would setl

-

units. Average totalcostwouldbe-.Itwouldearnaper-unit(profit/loss)ofand a total (profit / loss) of per day.

6 tnl Why will a firm maximize its profits or minimize its losses at the ourput where MR (price) eq*als\.l MC?

16)Wtry are price and MR the same for a perfect competitor?

CC) why is a perfect comperitor called a price takerz.

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