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## Problem set 3: Organizing Production, Production costs, Perfect Competition

HOME ASSINGMENT # 3
Textbook chapters: MP: Ch.10, Ch.11, and Ch.12;
CFO: Ch.7, Ch.8, Ch.9 and Ch. 12
1. Suppose XYZ Corporation has a technology that uses only labor (L) and the
production function is the following: one unit of labor will produce one unit of output (x),
i.e., x=L. Also suppose that the firm can buy as much labor as it would ever want to at a
price of \$10 per unit of labor.
a) Graph the: i) Total product of labor function; ii) Average product of labor function; iii)
Marginal product of labor function.
HINT: total product = x; average product = x/L; marginal product = (change in x)/
(change in L)
b) Graph the: i) Total cost function; ii) Average cost function; iii) Marginal cost function.
(Notice I have not differentiated between long-run and short-run, because with only one
input it doesn't make any sense to.)
2. The Manager for the ABC-Company is worried that the firm is not a cost-minimizer.
The company uses capital and labor in their production process. Both capital and labor
are purchased in competitive markets and are variable inputs. Given the current allocation
of labor and capital, the marginal product of labor is 49 and the marginal product of
capital is 45. The price of capital is 10 and the price of labor (wages) is 7. Analyze the
ABC-Company's situation. Is the firm cost-minimizing? If not, in what direction should
they move vis a vis capital and labor usage?
3. The following schedule represents the production function of a "Gift industry"
producing hand-carved National Souvenirs. Labor is the only variable input. Capital is
fixed at one unit.
Labor

total product
of labor

average product
of labor

marginal product
of labor

14.5

22

29

35

39

Problem set 3: Organizing Production, Production costs, Perfect Competition
7

39

34

## a) Draw the total product curve.

b) Determine the average and marginal products and plot the curves.
c) Where is the intersection point of AP and MP? (In terms of average product curve.)
d) At what output level does the law of diminishing marginal returns set in?
4. The table below lists cost data (in dollars) for Knife Plant near Kapchagai City, a firm
producing concrete blocks for construction (output (X) in thousands per day).
X FC SRVC SRTC AFC SRAVC SRATC

SMC

(In \$)
0

50

10

68

34

28

92

14

12

24

169

168

21

## a) Complete all the blanks in the table.

b) On graph paper, nearly plot AFC, AVC, ATC and MC(all in \$) vs. output. Plot MC
points between the integers, i.e. at X = 0.5, 1.5, 2.5, etc.
5. A firm can build plants of three types, A, B, and C. The short-run average total cost
curve for each type of plant is given below:
TYPE A
x

SRATC
(in \$)

TYPE B
x

SRATC
(in \$)

TYPE C
x

SRATC
(in \$)

Problem set 3: Organizing Production, Production costs, Perfect Competition
20

10

60

120 6

40

80

140 5.50

60

100 6

160 5

80

120 5

180 4.50

100 6

140 6

200 5

120 7

160 7

220 6

## a) Graph the firm's long-run average total cost curve.

b) If the firm concludes from marketing data that it will sell 120 units, which type plant
will it choose to select and build.
c) Subsequently the firm only sells 80 units. What are its costs now? How does the
manager feel about his plant decision?
6. Listed below are essential pieces of production information for Ibragims Apple Farm
near Almaty city. Find the following:
1. The average product of labor in the production of apples.
2. The marginal product of labor in the production of apples.
Ibragims Apple Farm Production Function
Apples
(tons/year)
0
50
100
150
200
250
300
350

Land
(acres)
100
100
100
100
100
100
100
100

Labor
(hired)
0
2,500
3,700
5,000
6,800
10,000
15,000
27,000

Proprietor's
time
(hours)
1,100
1,100
1,100
1,100
1,100
1,100
1,100
1,100

average
product
of labor
x

marginal
product
of labor
x

Now use the cost information below, along with the product information above to get the
following short run costs:
3. fixed costs of apple production
4. variable costs of apples production
5. short run total costs of apple production
6. average fixed costs of apple production
7. average variable costs of apple production
8. short run average total costs of apple production
9. short run marginal costs of apple production
Prices
Labors' wage

\$8.00

per
hour

Problem set 3: Organizing Production, Production costs, Perfect Competition
per
\$12.00 hour
\$124.00 per acre
Ibragims Apple Farm Cost Functions

Owner's wage
Rent

Apples
(tons/year)
0
50
100
150
200
250
300
350

fixed
costs

variable
costs

average
fixed
costs

sr total
costs

average
variable
costs
x

sr
average
total
costs

sr
marginal
costs
x

7. The table below lists cost data (in dollars) for Knife Plant near Kapchagai City, a firm
producing concrete blocks for construction (output (x) in thousands per day). ( Continue
the problem #4)
X

units

( in \$)

50

10

68

34

28

92

14

12

24

169

168

21

## a) Complete all the blanks in the table.

b) On graph paper, nearly plot AFC, AVC, ATC and MC(all in \$) vs. output. Plot MC
points between the integers, i.e. at X = 0.5, 1.5, 2.5, etc.
c) On your graph, indicate Knife Plant's short-run supply curve.

Problem set 3: Organizing Production, Production costs, Perfect Competition
d) If the price set in a competitive market is \$30 per thousand, how much should this firm
produce? How much profit will the firm receive?
e) At what price would the firm make zero profit?
f) If price is \$16 per thousand, how much should the firm produce in the short-run? How
much profit will the firm receive? How much should they produce in the long-run?
8. Answer the question or critically evaluate the statement and explain why or in what
way the statement is true, false, or uncertain.
a) Knowing the firm's cost functions is all the information one needs to know to
determine the profit maximizing level of output which the firm should produce.
b) Profit is always maximized at the quantity of output where marginal revenue equals
marginal cost.
c) Since firms must always pay their fixed costs in the short-run, they should always
produce a positive amount of output in the short-run.
d) If a producer is minimizing the costs to produce a given level of output, then he/she is
maximizing profits by producing that level of output.
9. Fly-By-Night Airlines has regular flights to Iran. The airline is asked to add a
Nicaraguan flight to its route for which it will receive an additional \$700,000 in revenue.
Cost information is as follows:
Fixed Costs = \$1,000,000
Average Total Costs (with 1 flight to Iran) = \$1,500,000
Average Total Costs (with 1 flight to Iran and 1 flight to Nicaragua) = \$1,050,000
An unnamed source at Fly-By-Night claims the Nicaraguan route would be unprofitable
since the additional revenue would not cover costs. Do you agree or disagree. Explain.
10. As chief economist of BIN Publishing Co., (a firm in a perfectly competitive
industry) you have been asked to present the company's profit/loss situation at the Annual
General Meeting of stock holders. Show, using graphs, three alternative short-run
scenarios: (i) the firm making profits (ii) the firm making losses but continuing to
produce (iii) the firm making zero economic profit. Clearly label the areas denoting
profit/loss. When should the firm shut-down in the short-run?
11. Consider the following industries in the U.S. Would you characterize each as a
perfectly competitive industry? If not, explain why.
a) The market for IBM-compatible PCS, which are practically "identical" but come with
different servicing and warranty contracts.

Problem set 3: Organizing Production, Production costs, Perfect Competition
b) The market for mainframe computers.
c) The pizza delivery market in Indiana.
d) The market for cable TV in Indiana.
e) The market for second-hand cars.
f) The labor market for college jobs in Indiana.
12. The data below pertain to the first year of operation of a Brown caf at KIMEP
University.
Total revenue - \$350,000
Labor expenses - \$125,000
Maintenance - \$50,000
Electricity - \$5,000
Capital invested - \$100,000
Market interest rate 10%
a) What is the cafe's accounting profit?
b) The cafe's owner could have earned \$60,000 as a professor in the hotel school if he had
not opened the cafe. The \$100,000 of capital invested in the cafe came from his savings.
The capital invested was used to buy machinery that does not depreciate at all. What is
the cafe's economic profit?
c) Did the cafe owner make the right decision to open the cafe? Explain.
d) At what salary as a hotel school professor would the cafe owner have been indifferent
between opening the cafe and being a professor? Explain.
13. Suppose that the market demand curve and market supply curve for CDs (compact
disks) are as given in the following graph:
\$

5
D
5000

Quantity

One typical firm in this industry, Acme CDs, has the following cost structure. Using all
this information, answer the following questions:

SRMC

SRATC

5
4.5
6

Problem set 3: Organizing Production, Production costs, Perfect Competition
3
2

50

90

100

## a. Given the current market price, what is Acme's marginal revenue?

b. Do we know the lowest price such that Acme will operate in the short run? If so, what
is this lowest price? If not, what additional information do we need?
c. Complete the remaining entries in the following table:
Output (x)

Acme's
Marginal
Revenue

Acme's
Marginal
Cost

Acme's Total
Revenue

Acme's Total
Cost

Acme's
economic
Profit

50
90
100

d. What is Acme's profit maximizing level of output at the current market price? At this
quantity, what is the relationship between Acme's price and its marginal cost?
e. Suppose that Acme's fixed costs increase. What impact will this have on Acme's profit
maximizing level of output in the short run (relative to that found in part d.)? Why? What
impact will this increase in fixed costs have on Acme's profit in the short run?
f. Suppose that the price of CD players (a complementary good) decreases. How, if at all,
does this change influence Acme's profit maximizing quantity in the short run (relative to
that found in part d.)?
14. Answer the question or critically evaluate the statement and explain why or in what

way the statement is true, false, or uncertain. Economists are silly to say that profits are
competed away in the long-run in perfectly competitive firms because no one would
bother to stay in the industry if it is not profitable for them to do so.
15. Assume: that the U.S. auto industry: 1) is perfectly competitive, 2) is presently in
long-run equilibrium, 3) is a constant-cost industry, that is to say, the cost of inputs and/or
the technology do not change when firms enter and exit the industry, 4) is such that each
plant has a set of "typically" shaped cost curves (in particular this means that short-run
supply is typically shaped), 5) is such that all car plants are the same, 6) is such that
demand is typically shaped.
a) Graph the present long-run equilibrium situation for both a typical plant and the entire
industry.
7

Problem set 3: Organizing Production, Production costs, Perfect Competition
b) Let the demand for domestically built cars decrease because of attractive imports.
Explain and indicate on the graphs for the previous part, what happens in the short-run
and what must happen for the industry to be in long-run equilibrium once again.
c) Suppose now that the government becomes alarmed at the first sign of layoffs in the
industry and imposes a price support at the ORIGINAL price level. Using your graphs in
part (a), explain what will happen consequently, that is, explain what will happen in the
U.S. car industry in the short-run and in the long-run if the support is imposed.
d) How would your analysis be affected if the government decides to place import tariffs
on foreign made cars rather than use price supports to protect the domestic auto industry?
16. Assume that the gasoline industry is perfectly competitive, is a constant cost industry,
and is currently in long-run equilibrium, Graphically explain the short-run and long-run
effects on this market when a tax of \$t per unit is imposed. Assume that the demanders
are responsible for paying the tax. In your analysis, indicate the changes in the buyer's
price, seller's price, profits, and number of firms, industry output and firm's output going
from the initial before-tax equilibrium to the short-run equilibrium to the final long-run
equilibrium. Show clearly on your graph the long-run supply curve for the industry. How
does the economic incidence of the tax change from the short-run to the long-run?
17. The Modulator's [MODS] are Cincinnati's Premier Party Band [with whom former
T.A. Annika S. regularly joins on stage singing backup] and are being run as a corporate
entity. Aside from playing great shows, the MOD's sell their albums [\$5 profit per
album], MOD buttons [\$2 profit per button] and MOD Tour travel packages [a travel
package to Captiva Island with the band and make \$200 profit per MOD Tour sold]. All
net profits from albums, buttons, and MOD Tours go into the band's corporate account.
Unfortunately, the MODS do not have a sound system and must pay \$650 to rent this
system per day [24 hours].
Each member of the band demands \$40 per performance hour to play a show. Any money
left over after paying for the sound system and each of the eight band members is put into
the band's corporate account, i.e. if the band gets \$1,800 for a 3-hour show: \$650 goes to
rent the sound system, \$40x8 [the # of members] x 3 [the # of performance hours] = \$960
goes to the band members, and \$190 goes into the corporate account.
The band has already been booked for a 3-hour wedding show paying \$1900. To book the
sound system for the day of this show the MODS have paid the non-refundable sound
system fee of \$650. Assume that as a result of playing the wedding, No MOD albums,
buttons, or MOD Tours will be sold.
Recently, the Mayor of Cincinnati called the MODS and asked them to play at the
Entertainment Stage at the "Taste of Cincinnati" for 3-hours. Unfortunately though, at the
same time as the wedding show is planned. The City of Cincinnati will provide the sound
system [at no cost] but the MODS must play for free. The Mayor argues that the MODS
should think of doing this show in terms of potential profit. He confidently asserts that by

Problem set 3: Organizing Production, Production costs, Perfect Competition
playing such a popular and upscale event, the MODS will sell 14 MOD Tours, 160 MOD
albums, and 90 MOD buttons. [The Mayor asserts that the profits from selling MOD
items will easily pay the band members' and have money left over to put in the corporate
account.] Michael B. [the MOD's business strategist] realizes that the Mayor has a point,
but being the skeptic that he is, discounts the Mayors figures by 50% [i.e. MODS will sell
7 MOD Tours, 80 MOD albums, and 45 MOD buttons].
Suppose Michael B. wants to maximize net funds in the band's corporate account and you
have been hired to advise him. Please give a detailed analysis to the proceeding
questions.
a) Assuming that the MODS can cancel the wedding show without penalty [but will not
be able to recover their non-refundable fee to book the sound system for the day] should
the MODS cancel their wedding show to play the Taste of Cincinnati?
b) Now, suppose a shrewd tavern owner located near the "Taste" offers the MODS \$660
to play for 2-hours immediately after their "Taste" show [the MODS must bring a sound
system]. The only condition which the tavern owner insists upon is that the MODS must
announce at least 5 times during their "Taste" show that they will be appearing at his
tavern later that evening. The tavern owner realizes that by imposing this condition, he
will get valuable advertising which will draw people into his tavern. At first, Michael B.
is insulted that the tavern owner offered such a low fee since the minimum fee the MODS
would normally charge is \$1290 [\$640 for band members' fees, and \$650 for the sound
system rental]. But then, Michael B. remembers sitting through some introductory micro
lectures, and realizes that there are special circumstances involved in making this specific
decision. He realizes that perhaps in this case, the MODS would be willing to accept less
than \$1290 to play at the tavern. Why should the MODS consider accepting less than
\$1290 to play at the tavern?
c) Should the MODS cancel their wedding show [once again assuming that there is no
penalty for canceling, but that their day rental fee for the sound system is non-refundable]
and play the Taste/Tavern shows?
18. One year ago, Max and Aliya set up a vinegar-bottling firm (called MAVB). Use

## the following information to calculate MAVBs opportunity cost of production

during its first year of operation:
Max and Aliya put \$50,000 of their own money into the firm.
They bought equipment for \$30,000.
They hired one employee to help them for an annual wage of \$20,000.
Max gave up his previous job, at which he earned \$30,000, and spent all his time
working for MAVB.

Problem set 3: Organizing Production, Production costs, Perfect Competition
Aliya kept her old job, which paid \$30 an hour, but gave up 10 hours of leisure
each week (for 50 weeks) to work for MAVB.
MAVB bought \$10,000 of goods and services from other firms.
The market value of the equipment at the end of the year was \$28,000.
Max and Aliya have a \$100,000 home loan on which they pay an interest rate of 6
percent a year.
19. Aidan runs a shoeshine stand at the airport. With no skills and no job experience,
Aidan has no alternative employment. Other shoeshine stand operators that Aidan
knows earn \$10,000 a year. Aidan pays the airport \$2,000 a year for the space he
uses, and his total revenue from shining shoes is \$15,000 a year. He spent \$1,000
on a chair, polish, and brushes and paid for these items using his credit card. The
interest on his credit card balance is 20 percent a year. At the end of the year,
Aidan was offered \$500 for his business and all its equipment. Calculate Aidans
opportunity cost of production and his economic profit.
20. Alternative ways of laundering 100 shirts are shown in table below
Labor
Capital
Method (hours) (machines)
a. Which methods are technologically efficient?
A
1
10
b. Which method is economically efficient if the
B
5
8
hourly wage rate and implicit rental rate of
C
20
4
capital are
D
50
1
(i) Wage rate \$1, rental rate \$100?
(ii) Wage rate \$5, rental rate \$50?
(iii)
Wage rate \$50, rental rate \$5?
21. Sales of the firms in the tattoo industry are shown

## in table in the right.

a. Calculate the four-firm concentration ratio.
b. What is the structure of the tattoo industry?

Sales
(dollars
per year)
450
325
250
200
800

Firm
Bright Spots
Freckles
Love Galore
Native Birds
Other 15 firms
22. Vladimir is a computer programmer who earned
\$35,000 in 2012. But on January 1, 2013 Vladimir opened a body board
manufacturing business. At the end of the first year of operation, he submitted the
following information to his accountant:
He stopped renting out his cottage for \$3,500 a year and used it as his factory. The
market value of the cottage increased from \$70,000 to \$71,000.
He spent \$50,000 on materials, phone, utilities, etc.
He leased machines for \$10,000 a year.
He paid \$15,000 in wages.
He used \$10,000 from his savings account, which earns 5 percent a year interest.
He borrowed \$40,000 at 10 percent a year from the bank.
He sold \$160,000 worth of body boards.

10

Problem set 3: Organizing Production, Production costs, Perfect Competition
Normal profit is \$25,000 a year.
a. Calculate Vladimirs opportunity cost of production and economic profit.
b. Vladimirs accountant recorded the depreciation on his cottage during 2007 as
\$7,000. According to the accountant, what profit did Vladimir make?
23. In 2012, Balnur taught music and earned \$20,000. She also earned \$4,000 by
renting out her basement. On January 1, 2013, she quit teaching, stopped renting
out her basement, and began to use it as the office for her new Web site design
business. She took \$2,000 from her savings account to buy a computer. During
2013, she paid \$1,500 for the lease of a Web server and \$1,750 for high-speed
Internet service. She received total revenue from Web site designing of \$45,000 and
earned interest at 5 percent a year on her savings account balance. Normal profit is
\$55,000 a year. At the end of 2013, Balnur could have sold her computer for \$500.
Calculate Balnurs opportunity cost of production and economic profit in 2013.
24. Four methods of completing a tax return and the time taken by each method are:
with a PC, one hour; with a pocket calculator, 12 hours; with a pocket calculator
and paper and pencil, 12 hours; and with a pencil and paper, 16 hours. The PC and
its software cost \$1,000, the pocket calculator costs \$10, and the pencil and paper
cost \$1.
a. Which, if any, of the methods is technologically efficient?
b. Which method is economically efficient if the wage rate is
(i) \$5 an hour?
(ii) \$50 an hour?
(iii)
\$500 an hour?

## loses some of his cost data. The bits of

paper that he recovers after the fire
provide the information in the table (all
the cost numbers are dollars). Azhat asks
you to come to his rescue and provide
the missing data in the five spaces
identified as A, B, C, D, and E.

TP
10

AFC
120

AVC
100

ATC
220

MC
80

20

150

30

40

90

130

40

30

90
130
E
50

24

108

132

26. The table shows the production function of Medeus Balloon Rides. Medeus pays

\$500 a day for each balloon it rents and \$25 a day for each balloon operator it hires.
a. Graph the ATC curve for Plant 1 and Plant 2.
Labor
(workers
per day)
10
20
30
40
50
Balloons

Plant 1
4
10
13
15
16
1

Output
(rides per day)
Plant 2
Plant 3
10
13
15
18
18
22
20
24
21
25
2
3

11

Plant 4
15
20
24
26
27
4

Problem set 3: Organizing Production, Production costs, Perfect Competition
b. On your graph in a, plot the ATC curve for Plant 3 and Plant 4.
c. Medeus LRAC curve, what is the average cost of producing 18 rides and 15 rides
a day?
d. Explain how Medeus uses its long-run average cost curve to decide how many
balloons to rent.
27. The market is perfectly competitive and there are 1,000 firms that produce paper.
As the quality of computer monitors improves, more people are reading documents
online rather than printing them out. The demand for paper permanently decreases
and the demand schedule becomes the schedule shown in the first table. If each
firm producing paper has the costs set out in second table
Price
(dollars per
box)
2.95
4.13
5.30
6.48
7.65
8.83
10.00
11.18

Quantity demanded
(thousands of boxes
per week)
500
450
400
350
300
250
200
150

Output
(boxes
per
week)
200
250
300
350
400
450
500

Marginal cost
(dollars per
box)
6.40
7.00
7.65
8.40
10.00
12.40
20.70

Average
Average
variable
total
cost
cost
(dollars per box)
7.80
12.80
7.00
11.00
7.10
10.43
7.20
10.06
7.50
10.00
8.00
10.22
9.00
11.00

a. What is the market price, market output, and economic profit or loss of each firm?
b. What is the long-run equilibrium price, market output, and economic profit or loss
of each firm?
c. Does this market experience external economics, external diseconomies, or
constant cost? Illustrate by drawing the long-run supply
curve.
28. Batyr is one of many burger stands near City Sport complex.
The figure shows Batyrs cost curves.
a. If the market price of a burger is \$4, what is Batyrs profitmaximizing output?
b. Calculate the economic profit that Batyr makes.
c. With no change in demand or technology, how will the
price change in the long run?
29. Leilas Lasagna is a price taker that has the costs shown in the
table.

12

Problem set 3: Organizing Production, Production costs, Perfect Competition
a. If lasagna sells for \$7.50 a plate, what is
Leilas profit-maximizing output?
b. What is Lucys shutdown point?
c. Over what price range will Leila leave the
lasagna industry?
d. Over what price range will other firms with
costs identical to Leilas enter the industry?
e. What is the price of lasagna in the long run?
30.

Output
(plates per hour)
0
1
2
3
4
5

Total cost
(dollars per hour)
5
20
26
35
46
59

## Cell Phone Sales Hit 1 Billion Mark

More than 1.15 billion mobile phones were sold worldwide in 2007, a 16 percent
increase from the 990.9 million phones sold in 2006. Emerging markets,
especially China and India, provided much of the growth as many people bought
their first phone, Carolina Milanesi, research director for mobile devices at
Gartner, said in a statement. In mature markets, such as Japan and Western
Europe, consumers appetite for feature-laden phones was met with new models
packed with TV tuners, global positioning satellite (GPS) functions, touch screens
and high-resolution cameras.
CNET News, February 27, 2008
a. Explain the effects of the global increase in demand for cell phones on the market
for cell phones and individual cell-phone producers in the short run.
b. Draw a graph to illustrate your explanation in a.
c. Explain the effects of the global increase in demand for cell phones on the market
for cell phones in the long run.
d. What factors will determine whether the price of cell phones will rise, fall, or stay
the same in the new long-run equilibrium?

13