Niharika Mehrotra - 1

Niharika Mehrotra

Prof. Bipasha Maity

Introduction to Economics

Assignment 1

Question 1.

(a) Jack’s Total Cost of fixing 2 houses = $ 50000 (given)

Total Cost of fixing 1 house = 50000/2

=$25,000

Jack’s Average Total Cost of 2 houses = (25000+25000)/ 2

= $25,000

(b) George’s Total Cost for 5 houses = $50000 (given)

Harriet’s Total Cost for 5 houses = $50000(given)

George and Harriet’s Total Cost for 5 houses = 50000 + 50000

George and Harriet’s Average Cost = (50000 + 50000)/5

= $20,000

(c) Thus, we see that George and Harriet because of their superiority in plumbing and carpentry

are better off than Jack. This is because, while Jack is the jack of all trades, he isn’t

specialised in any one. So, being decent at both jobs might help with producing 1 or 2 houses.

However, when the number of houses to be produced increases, he will be increasing his costs

due to a lack in specialisation. But, for George and Harriet as the production increases, their

total costs will actually fall because each is proficient in one skill. This is known as

economies of scale. When the average total cost falls as the output increases then economies

of scale are experienced. In this case, due to specialisation, Harriet and George experience

economies of scale.
 Niharika Mehrotra - 2

Question 2.

(a) Marginal Product is defined as the change in the total output when an additional unit of input

is acquired. Initially the marginal product will increase for each additional hire. This is

primarily because of specialisation. Specialisation means that these hires will now focus on

individual tasks which they will progressively get better at as times goes on. This will

increase overall productivity and as a result marginal product will increase. However, as

labour input is added continuously then it results in marginal product decreasing. Because

each additional hire will contribute less and less to production. This might be due to a variety

of reasons such as overcrowding, poor managerial skills, etc. So, their marginal product will

go on decreasing. Thus, the marginal product initially increases, but at a certain point with

successive additions, marginal product decreases. This is called the Law of Diminishing

Returns.

(b) Yes. The outcome will be different in the long run because Toland Fisheries now has the

flexibility to vary all the inputs of production such as equipment. Thus, they can reach an

optimum level of resource allocation. As a result of this, his total cost will also reduce since

he will be utilising all the inputs efficiently and varying them to reduce costs and gain profits.

The Law of Diminishing Returns will also not hold true in the long run since it only operates

when a factor is fixed. The diagram below illustrates the same:

Niharika Mehrotra - 3
 Niharika Mehrotra - 4

Question 3.

(a) Mac is producing ice cream in the short run. This is because in the short run, the inputs

required in the cost of production are both fixed and varied. Fixed cost are the costs incurred

by the fixed factors of production such as machines, etc. These costs remain even when the

firm is not operating i.e. when Mac is not selling any ice creams. In this case, at 0 quantity,

the firm is incurring a cost of $50. Thus, $50 is the fixed cost of the firm and hence, it is

operating in the short run.

(b) Figure 1

Quantity of Ice Total Cost Average Total Change in Total Marginal Cost

Cream (Litre) Cost Cost

0 $50

10 $90 $9 $40 $4

20 $110 $5.5 $20 $2

30 $140 $4.6 $30 $3

40 $190 $4.75 $50 $5

50 $260 $5.2 $70 $7

60 $350 $5.83 $90 $9

Average Total Cost is computed by Total Cost/Quantity.

(c) Marginal Cost is computed by Change in Total Cost/ Change in Quantity. Here, change in

quantity for all levels of output remains 10 Litres. Marginal Cost is depicted in Figure 1

(d) At 40 Litres output the average total cost starts increasing. As the average total cost rises, the

marginal cost also rises and is greater than average total cost. As demonstrated by the

marginal cost increasing from the same output level as average total cost increases. It’s value

while rising is also greater than that of ATC (5,7,9 > 4.75,5.2,5.83). This is the reason why

the marginal cost cuts the average total cost from below. Conversely, as average total cost

falls, the marginal cost also falls.

 Niharika Mehrotra - 5

Question 4.

(a) Given total cost function TC (q) = 500 + 0.1q2

Now, the fixed cost remains constant – no matter the quantity. This is because fixed costs are

the costs accured due to a fixed factor of production that the firm always pays even with zero

output. In the equation above, the only constant is 500. Thus, fixed cost for the producer is

$500.

(b) Total Cost = Fixed Cost + Variable Cost

Since we have solved in (a) that Fixed Cost is $500. Thus, variable cost = 0.1q2

Average Variable Cost = Variable Cost/q

= 0.1q2/q

AVC (q) = 0.1q

(c) Profit will be maximised when MR/Price = MC

Given, Price = $20 and MC(q) = 0.2q

Equating the two, we get:

20=0.2q

q= 100 T-Shirts

Thus, the firm will produce 100 T-Shirts to maximise profit

(d) Total Cost = Fixed Cost + Variable Cost

Dividing the total and variable cost by quantity, we get:

Average Total Cost = Total Cost/ Quantity

Average Total Cost = 500 + 0.1q2/ Quantity

ATC for q = 100 will be,

= (500 + 0.1*100*100)/100

= 1500/100
 Niharika Mehrotra - 6

The average total cost of producing the profit-maximizing quantity of T-shirts is $15

(e) As found in part d,

AVC = 0.1*100 = $10

At this point, the firm will be covering its average variable cost and a part of its fixed cost

through its revenue. This means that the firm should continue production. This is because,

even though the firm doesn’t acquire a profit as such, it is covering its average variable cost

and even a portion of its fixed costs. Fixed costs are assumed to be “sunk costs” i.e they are

costs that once committed, can never be recovered. Due to this, they should not affect present

and future production decisions since they are essentially lost no matter what decision is

taken. Thus, the firm should continue production since marginal revenue = $20 > average

variable cost = $10.

(f) No, the firm is not technically making any profits. However, if the sunk costs are not taken

into account (since they are lost costs irrespective of current or future decisions) then since

the marginal revenue > the average variable cost, the firm does make a profit. Moreover, the

revenue is also covering part of the fixed costs.

 Niharika Mehrotra - 7

Question 5.

(a)

(i) Total Revenue = Quantity * Price

= 100 * 30 (given)

= $3000

(ii) Accounting Profit = Total Revenue - Total Costs1

= 3000 - (500 + 80 + 120)

= 3000 - 700

= $2300

(iii) Economic Profit = Total Revenue - (Implicit Cost 2+ Explicit Cost)

= 3000 - (700 + 1500)

= 3000 – 2200

= $800

(b) His new salary would have been increased by 30% i.e 1500 + 450 = $1950

(i) There will not be a change in the monthly explicit cost, but the implicit cost will

now change to $1950.

(ii) No. Since the accounting profit doesn’t take into account the implicit cost, the

accounting profit will not change

(iii) Yes, Economic Profit = Total Revenue - (Implicit Cost + Explicit Cost)

= 3000 – (700 + 1950)

= 3000 – 2650

= $350

1
Total Costs are the money spent on rent, utilities and labour
2
Implicit Cost is the opportunity city of Jeremy not being employed at the bank. Since Jeremy chooses to work
at the bookstore, he’s foregoing the salary of the bank. That is his opportunity cost i.e implicit cost
 Niharika Mehrotra - 8

Question 6.

(a) When the market price is $6 per unit, the approximate quantity of output the firm will produce

will be 600. This is because the firm will attain equilibrium when MC= Price. Thus, the point

on the x axis where Price cuts MC will be the output produced by the firm. In this case, 600.

(b) The firm’s economic profit will be positive. This is because the marginal revenue line, a

horizontal line starting at $6 on the y axis, will cut the marginal cost curve at a point (say D).

As mentioned in (a) the point where price and marginal cost intersect will be the equilibrium

point on which the firm will produce a certain level of output. Point D, in this case, is far

above the average total and average variable cost curve. This implies that the marginal

revenue, which is equal to price in a perfectly competitive market, is more than the average

total cost. Since MR > ATC, the firm earns a profit.

(c) Economic Profit will be 0 at point B. This is because, the marginal revenue at this point only

covers the average variable cost. Thus, the firm is not earning any profit since marginal

revenue = average variable cost. Here, we have not included fixed cost in our calculation of

profit. This is because fixed costs are assumed to be sunk casts which means that they are lost

regardless of the decisions taken by the firm. Hence, they are not included in calculating the

profit.

(d) At this point, the firm should shut down. This is because the marginal revenue < average

variable cost. Thus, with the supply of each additional unit, the firm is losing an amount equal

to average variable cost – marginal revenue. By shutting down, the firm will only incur their

fixed costs instead of the fixed costs as well as the uncovered costs of AVC – MR. This is

because when it shuts down it will not have any variable cost. Thus, the firm would shut

down at point A or a point below A.

(e) Average Variable Cost curve will not change because it does not have any relation with the

fixed cost. Average Total Cost is calculated as Total Cost/ Total Output. Since Total Cost =

Fixed Cost + Variable Cost, the Total Cost will increase. Since the Output remains the same,
 Niharika Mehrotra - 9

the ATC will increase as Fixed Cost increases. The curve itself will move upwards in such a

way that it still intersects MC curve at its minimum.

Now, the Marginal Cost = (Total Costn – Total Costn-1)/ Change in Output

= FC*VCn – FC*VCn-1/ Change in Output

= FC (VCn – VCn-1)/ Change in Output

Here, we see that Fixed Cost (FC) and Change in Output do not change and are thus, constant.

As a result, the Marginal Cost only depends on a change in Variable Cost (VC). Thus, the MC

curve will not change.

 Niharika Mehrotra - 10

Question 7.

Elasticity of Supply (εs) = Percentage change in quantity supplied/ Percentage change in price

(a) Increase in price = 1.25- 1.00

= $ 0.25

Average Price = (1.25+1.00)/2

= $1.125

% change = 22.2%

Increase in supply = 300 – 200

= 100 pens

Average Supply = (300+200)/2

=250 pens

% change = 40%

Elasticity = 40/22.2 = 1.8

Thus, elasticity of pens is 1.8 which is > 1. This means that the change in price < change in

quantity supplies. As such, the pens are relatively elastic.

(b) Decrease in price = 1.25-1.20

= $0.05

Average Price = (1.25+1.20)/2

= $1.225

% change = - 4%

Decrease in supply = 1000 – 980

= 200 bottles

Average Supply = (1000 + 980)/2

= 990

% change = -2%
 Niharika Mehrotra - 11

Elasticity = 2/4 = 0.5

Thus, elasticity of water is 0.5 which is < 1. This means that the change in price > change in

quantity supplies. As such, elasticity of bottled water is perfectly inelastic.

(c) Since there is no change in quantity supplied, the elasticity becomes 0. This means the

elasticity of land is perfectly inelastic.

Question 8.

Assume an individual has bought a ticket for the Olympic Games in the primary market and the cost

of this ticket is say $100. Now, even after the tickets have been sold off in the primary market the

demand for these tickets is still present since demand > supply (given in question). Thus, there exists

a secondary market where the original buyers of the tickets will sell them to the people who still

demand it. In this case, for the individual $100 is the cost of his ticket and thus he would want to

acquire a profit by selling the ticket at a price $ (100 + x). This x is the profit the individual will

acquire by purchasing in the primary market and selling in the secondary market. Hence, he will only

sell when he is able to at a price > his cost price i.e he will sell when selling price > $100. Thus, the

tickets sold through secondary sources are usually much more expensive than their face value.
 Niharika Mehrotra - 12

Question 9.

Daniel’s total revenue = Quantity * Price

= 500 * 2

= $1000

Daniel’s total cost = Fixed cost + Variable cost

= 1000 + 500

= $1500

Since Daniel’s Total Cost > Total Revenue, it appears that he is making a loss. However, he should

continue to operate his shop. This is because the revenue earned by him is able to cover his variable

cost which is $500. Here, fixed cost is not counted since they are termed as “sink costs” that are lost

irrespective of the production decisions taken by Daniel. Thus, the shop should remain open since he

is not losing money (except the money already lost which is the fixed cost).
Niharika Mehrotra - 13
Niharika Mehrotra - 14
Niharika Mehrotra - 15
Niharika Mehrotra - 16
 Niharika Mehrotra - 17

Question 11.

(a) Producer Surplus is defined as the difference between the minimum price the producer would

be willing to accept for a good and how much they could potentially receive by selling it at

the market price. In this case, Mr. Krovitz eventually sells the car to Mr. Kumar for 12,000

while he would have sold it for a minimum of 11,000. Thus, Mr. Krovitz’s producer surplus is

the difference between how much he sold it for minus the bare minimum he would have

accepted for a car. This means his producer’s surplus is 12,000- 11,000 = $1000. So, Larry

Krovitz’s producer surplus is $1000.

(b) Larry’s Profit = Revenue from selling the car – Cost of buying the car

= 12,000- 8,000

= $4,000

Thus, if Larry bought the car for $8,000, his profit is $4,000

(c) Producer Surplus in different from profit. This is because producer surplus is calculated with

respect to the marginal cost (It is the difference between the market price and the marginal

cost curve). However, profit takes into account total cost. Hence, we can say that profit

depends on the fixed cost as well whereas producer surplus does not (since marginal cost

curve does not rely on fixed cost)3

3
As seen in Question 6 (e)
 Niharika Mehrotra - 18

Question 12.

Output Firm I ATC Firm II ATC Firm III ATC

1 $8 - $5 - $7 -

2 $14 14-8 $12 12-5 $12 12-7

= $6 = $7 = $5

3 $18 18-14 $21 21-12 $15 15-12

= $4 = $9 = $3

4 $20 20-18 $32 32-21 $24 24-15

= $2 = $11 = $9

(a) Economies of Scale are experienced when the average total cost (ATC) falls as output

increases.

In Firm I as the output increases, the ATC falls from 6 to 4 to 2. This means that it

experiences economies of scale.

Diseconomies of Scale are experienced when the average total cost (ATC) rises as output

rises.

In Firm II as the output increases, the ATC rises from 7 to 9 to 11. This means that it

experiences diseconomies of scale.

(b) Minimum efficient scale is the lowest level of output where long-run average cost is

minimized. Firm III’s minimum efficient scale is output at 3. The corresponding average cost

at this level is the minimum, $3.