Quantitative Intermediate Economics II Winter 2019

Problem set 1 Solutions

1. For this problem, c0 (q) = 20 + 10q, cv (q)/q = 20 + 5q and F = $500.

(a) We multiply cv (q)/q by q to find cv (q) = 20q + 5q 2 . Then c(q) =

cv (q) + F = 20q + 5q 2 + 500. Note that this cost function implies
c0 (q) = dc(q)/dq = 20 + 10q.
(b) The firm’s profit-maximizing level of output is the value of q
which equates MR = p = $100 to MC = c0 (q): 100 = 20 + 10q →
q ∗ = 8.
(c) A tax imposed on profits should have no effect on q ∗ . That is,
a choice of q that maximizes profits, π, should also maximize
(1−.4)×π. The tax could force a firm to shut down its operations
though.
(d) Profit is total revenue, 8 × 100 = 800, minus total costs, 500 +
160 + 320 = 980, or −$180. Despite the negative profit, the firm
should remain in business in the short-run since p > cv (q)/q =
20 + 5(8) = 60.

2. You are given c(q) = aq + 16q − 8q 2 + q 3 for each firm and you know
that market demand for the good is Q = 120 − 4p or equivalently
p = 30 − Q/4.

(a) AC = c(q)/q = a + 16 − 8q + q 2 and MC = dc(q)/dq = a + 16 −

16q + 3q 2 .
(b) In the condition which tells us where these two curves meet, AC =
MC, a + 16 drops out. Hence, the term a is irrelevant in the
determination of the minimum value of AC. MC = AC → 3q 2 −
16q = q 2 − 8q. This condition is met at q = 0 and q = 4.
(c) The short-run supply curve is based on the condition that MC =
p or c0 (q) = a + 16 − 16q + 3q 2 = p. This condition holds only for
p ≥ min{cv (q)/q}. But note that there are no fixed costs for this
industry. Thus, we need only to find min{c(q)/q}. We already
know that this minimum occurs at q = 4, so that c(q)/q = a +
16 − 64 + 48 = a. So the short-run supply function is determined
by MC = p for p ≥ a; for p < a, q = 0.
(d) In the long run, a competitive firm produces at the minimum
point of AC = c(q)/q, which is where q = 4 and, thus, c(q)/q = a.
Quantitative Intermediate Economics II, Problem set 1 (Producer theory) 2

Since a = 10 by assumption, p = AC implies p = 10. At that

market price, Q = 120 − 4(10) = 80. Since each firm produces
4 units in this equilibrium, 20 firms will exist in the long run.
The adjustment will involve 10 new firms entering the industry.
[Without any fixed costs, this adjustment should take place rather
quickly.]
(e) If a now equals the number of firms, the hypothesis that the
number of firms in the long-run equilibrium equals 15 implies
that a = 15, so that the long-run price p = 15. In this case,
market demand is Q = 120 − 4(15) = 60. To supply a total of
60 units, with each firm supplying 4 units, 15 firms must exist in
this industry in the long-run.
3. Market demand for some good Q is given by p = 50−2Q. And, market
supply is given by p = 5 + Q.
(a) First calculate the equilibrium price by equating supply to de-
mand: 50 − 2Q = 5 + Q → Q∗ = 15 → p∗ = 20.
Consumer surplus = 12 Q∗ [50−p∗ ], the area of the triangle between
the demand curve as Q goes from 0 to Q∗ = 15, and the line
p = p∗ = 20 or 225.
Producer surplus = 21 Q∗ [p∗ − 5], the area of the triangle between
the supply curve as Q goes from 0 to Q∗ = 15 and the line p∗ = 20,
or 112.5. [Note that the y-intercept of the supply curve is 5.]
(b) To calculate the effects of a tax of $3.00 per unit first deter-
mine the new equilibrium gross price and quantity demanded,
by equating market demand to market supply adding in the per
unit tax of $3: 50 − 2Q = 8 + Q → Q∗ = 14 and p∗ = 22.
Hence, the price received by suppliers (netting out the sales tax)
is p∗ − 3 = 19.
Consumer surplus is the area of the triangle between the demand
curve and the line p = p∗ = 22: 12 14[50 − 22] or 196.
Producer surplus is the area of the triangle between the supply
curve and the line p = 19, the price per unit received by the firm:
1
2 14[19 − 5] or 98.
(c) The size of the efficiency loss resulting from the tax is equal to
the area of the triangle bounded by Q = 15 (the old equilibrium),
Q = 14 (the new equilibrium), p = p∗ = 22 (the price paid by
consumers per unit) and p∗ − 3 (the price received by the firm
after taxes): 12 (15 − 14)[22 − 19] or 1.5.