1 BM/DEC 2016/ECO555/556

ECO555/556
TEST 2 (Set 1)
Answer Scheme

QUESTION 1
a) Syarikat Segar has the following total product function, where Q is output per time period
and L is the number of units of labour hired:
Q = 1,200L + 3L2 – 0.02L3

i) Determine APL and MPL functions. (2 marks)

APL = Q/L = 1200 + 3L – 0.02L2 (1m)
MPL = Q’ = 1200 + 6L – 0.06L2 (1m)

ii) At what number of labour will the marginal product of labour (MPL) for this firm be
maximum? How much output can it produce at this level of labour? (3 marks)
Max MPL = MPL’ = 6 – 0.12L = 0 (1m)
L = 6/0.12 = 50 (1m)
Q = 1,200L + 3L2 – 0.02L3
Q = 1,200(50) + 3(50)2 – 0.02(50)3 = 65000 (1m)

iii) Find the number of labour that maximizes average product of labour (APL). (2 marks)
L? at max APL
APL’ = 3 – 0.04L = 0 (1m)
L = 3/0.04 = 75 (1m)

b) The estimated production function for a firm is given as follows Q = 100K 0.5 L0.5
The price of each unit of capital (K) and labour (L) are RM20 and RM40 respectively.
Currently, the firm is using 100 units of capital and 25 units of labour.

i) Find the value of output (Q) (1 mark)

Q = 100K0.5 L0.5
Q = 100(100)0.5 (25)0.5 = 5000 (1m)

ii) Derive the equation of expansion path. (4 marks)

MPL = 50 K0.5L-0.5 (1m)
MPK = 50 K-0.5L0.5 (1m)
MPL/MPK = w/r
50K/50L = 40/20 (1m)
K = 2L (1m) L = 0.5K

iii) Find the efficient input if the firm wishes to produce the initial level of output. (3 marks)
5000 = 100(2L)0.5L0.5 (1m)
5000 = 100(2)0.5.L
L = 5000/(100(2)0.5)
L = 35.355 (1m)
K = 2L
= 2(35.355) = 70.71 (1m)

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 2 BM/DEC 2016/ECO555/556

QUESTION 2
a) Explain the difference between economic profit and accounting profit. Why the concept of
economic profit is important in making managerial decisions? (3 marks)
Econ π = TR – explicit – implicit cost (1m)
Acc π = TR – explicit cost (1m)
Involve opportunity cost (1m)

b) Hanidah managed a bakery shop for someone else earned RM45,000 per year and decided
to open her own bakery. Revenue during the first year of operation is RM150,000 and the
expenses are RM40,000 for salaries, RM15,000 for supplies, RM12,000 for rent, RM2000 for
utilities and RM5,000 for interest on bank loan. Calculate explicit costs and economic costs.
Help her in making her decision. (5 marks)
Accounting (Explicit) Marks Implicit Marks
Salaries: RM40,000 Forgone salary: RM45000 1m
Supplies: RM15,000
Rent: RM12,000
Utilities: RM2000
r on bank loan: RM5,000
TOTAL = 74,000 1m
Economic Costs = Explicit + Implicit = 74,000 + 45,000 = 119,000 (1m)
Econ Profit = 150000 – 119000 = 31,000 (1m)
Should start her own bakery (1m)

c) A perfectly competitive firm has a total cost function given as

TC = 4000 + 204Q – 3Q2 + 0.02Q3

If the price in the market is fixed at RM60,

i) Calculate the profit (or loss) in the short run at equilibrium. (4 marks)
equilibrium : MR = P = MC
60 = 204 – 6Q + 0.06Q2 (1m)
144 – 6Q + 0.06Q2 = 0
Q = 60, 40
Choose Q max so Q = 60 (1m)
π = TR – TC
TR = PQ = 60 x 60 = 3600 (0.5m)
TC = 4000 + 204(60) – 3(60)2 + 0.02(60)3 = 9760 (0.5m)
π = - 6160 (1m)

ii) Should the firm continue operating or shut down in the short run? (3 marks)
Shut down or not will depends on variable cost
AVC = VC/Q = 204 – 3Q + 0.02Q2; (1m)
Subt Q = 60 in AVC function
AVC = 204 – 3(60) + 0.02(60)2 = 96 (1m)
Since P = 60 is less than 96 (P < AVC) so better shut down (1m)

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 3 BM/DEC 2016/ECO555/556

QUESTION 3
a) The demand functions for price increase and price cuts for an oligopolist are, respectively,
Q1 = 200 – 2P1
Q2 = 60 – 0.4P2
Where P and Q represents price and quantity respectively.

i) Find optimal price and quantity at kink. (2 marks)

Optimal at kink, Q1 = Q2
200 – 2P1 = 60 – 0.4P2 (0.5m)
140 = 2P – 0.4P
1.6P = 140
P = 140/1.6 = 87.5 (0.5m)
Q1 = 200 – 2P1 = 200 – 2(87.5) = 25 (1m)

ii) If the firm's marginal cost is RM50, what would be the profit maximizing price and output?
(3
marks)
MR1 Mark MR2 Mark
P1 = 100 – 0.5Q1 P2 = 150 – 2.5Q2
MR1 = 100 – Q1 0.5m MR2 = 150 – 5Q2 0.5m
subt Q = 25 in MR1 & MR2
MR1 = 100 – 25 = 75 0.5m MR2 = 150 – 5(25) = 25 0.5m

25 < MC < 75, MC is within the range of both MR (0.5m)

P & Q at kink (P = 87.5 & Q = 25) (0.5m)

b) Saga Food Company produces one type of frozen dinner sold directly to consumers and
restaurants. The demand function for Saga's frozen dinner by consumers and restaurants
are respectively
Consumers: P1 = 16 – 0.1Q1
Restaurants: P2 = 10 – 0.05Q2
Saga's total cost function is TC = 120 + 4Q where Q = Q 1 + Q2.

i) Find the profit maximizing price for both markets if the company practiced price
discrimination. (5 marks)
Consumers Marks Restaurants Marks
P1 = 16 – 0.1Q1 P2 = 10 – 0.05Q2
MR1 = 16 – 0.2Q1 0.5m MR2 = 10 – 0.1Q2 0.5m
MR = MC MR = MC
16 – 0.2Q1 = 4 10 – 0.1Q2 = 4
Q1 = 16 – 4/0.2 = 60 1m Q2 = 10 – 4/0.1 = 60 1m
P1 = 16 – 0.1(60) = 10 1m P1 = 10 – 0.05(60)Q2 = 7 1m

ii) Compare the price if the company decides to charge a uniform price. (5 marks)
Q1 = 16/0.1 – 1/0.1P1 = 160 – 10P1 (0.5m)
Q2 = 10/0.05 – 1/0.05P2 = 200 – 20P2 (0.5m)
Q = Q1 + Q2 = 360 – 30P (0.5m)
P = 360/30 – 1/30Q = 12 – 0.033Q
MR = 12 – 0.066Q (0.5m)
MR = MC : 12 – 0.066Q = 4 (1m)
Q = (12 – 4)/0.066 = 121.212 (1m)
P = 12 – 0.033(121.212) = 8 (1m)
Your answer depends on your decimal points
@
If use fraction form
P = 360/30 – 1/30Q = 12 – 1/30Q
MR = 12 – 2/30Q (0.5m)
MR = MC : 12 – 2/30Q = 4 (1m)
Q = (12 – 4) x 30/2 = 120 (1m)
P = 12 – 1/30(120) = 8 (1m)

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 4 BM/DEC 2016/ECO555/556

ECO555/556
TEST 2 (Set 2)
Answer Scheme

QUESTION 1
a) Consider the following short-run production function
Q = 1,000L + 6L2 – 0.04L3
where L is the variable labour input and Q is output

i) Find the number of labour that maximizes output. (2 marks)

L? at Q max
Q’ = MPL= 1000 + 12L – 0.12L2 = 0 (1m)
L = -54.083, 154.0833
so choose the higher value, L = 154.0833 (1m)

ii) Determine the average product of labour function (APL). Find the number of labour that
maximizes the average product of labour (APL) function. (3 marks)
APL = Q/L = 1000 + 6L – 0.04L2 (1m)
Max APL = APL’ = 6 – 0.08L = 0 (1m)
L = 6/0.08 = 75 (1m)

iii) State the range of labour for every stage of production. (2 marks)
Stage I : 0 < L < 75 (0.5m)
Stage II : 75 < L < 154.0833 (1m)
Stage III : L > 154.0833 (0.5m)

b) Given production function for a firm is Q = 10K0.6 L0.5

Currently, the firm is using 4 units of capital (K) and 2 units of labour (L), price of capital is
RM25 per unit and price of labour is RM30 per unit

i) Determine the current output level. (1 mark)

Q = 10K0.6 L0.5
Q = 10(4)0.6 (2)0.5 = 32.49 (1m)

ii) Derive the marginal product of capital and marginal product of labour function. (2 marks)
MPK = 6 K-0.6L0.5 (1m)
MPL = 5 K0.6L-0.5 (1m)

iii) What would be the input combination to produce the current output so that the firm can
produce efficiently? (5 marks)
MPL/MPK = w/r
5K/6L = 30/25 (1m)
K = 1.44L (1m)
32.49 = 10(1.44L)0.6L0.5 (1m)
32.49 = 10(1.44)0.6.L1.1
L1.1 = 32.49/(10(1.44)0.6)
L = 2.3925 (1m)
K = 1.44L = 1.44(2.3925) = 3.4452 (1m)

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 5 BM/DEC 2016/ECO555/556

QUESTION 2
a) What is the difference between zero accounting profit and zero economic profit? Which one
is preferable and why? (3 marks)
Zero acc π : TR = explicit cost (1m)
Zero econ π ; TR = explicit + implicit cost (1m)
Econ π is preferable (0.5m)
Help in decision making since involve both cost (0.5m)

b) Encik Zainal is considering bidding for a tender for a computer lab at a technical college. He
estimated that his monthly costs are as follows:
Utilities RM1,000
Supplies RM12,000
Staff RM2,000
Miscellaneous RM2,000
Encik Zainal expects to charge each student RM1.00 per hour for 25 hours a month. The
college has 1,500 students. He will be withdrawing RM25,000 from his savings for the
business. The interest rate for saving is 5 percent per annum. He would have to give up his
present employment for which he earns a monthly salary of RM4,000. Calculate his explicit
and economic cost. (5 marks)

Accounting (Explicit) Marks Implicit Marks

Utilities: RM1,000 Forgone div: 5% x 25000 = RM1250 1m
Supplies: RM12,000 Forgone salary: 4000 x 12 = 1m
Staff: RM2,000 RM48000
Misc: RM2,000
TOTAL = 17,000 x 12 = RM204,000 2m TOTAL = RM49,250
Economic Costs = Explicit + Implicit = RM204,000 + RM49,250 = RM253,250 (1m)

c) Sykt Alpha, a perfectly competitive firm supplies table to offices. The total cost function given
as TC = 35Q – 12Q2 + 4Q3

i) Calculate its profit maximizing output in long run. (3 marks)

In LR, normal π only ie P = AR = AC = MR = MC
AC = MC OR P at min AC
35 – 12Q + 4Q2 = 35 – 24Q + 12Q2 (2m) AC = 35 – 12Q + 4Q2 (1m)
12Q – 8Q2 = 0 AC’ = -12 + 8Q =0 (1m)
Q(12 – 8Q) = 0 Q = 12/8 = 1.5 (1m)
Q = 0, 1.5
Q = 1.5 (1m)

ii) Should the firm continue operating or shut down in the short run if the price of table is
RM60? Show your calculation. (4 marks)
AVC = VC/Q = 35 – 12Q + 4Q2 (0.5m)
AVC’ = -12 + 8Q = 0 (0.5m)
Q = 12/8 = 1.5 (1m)
AVC = VC/Q = 35 – 12(1.5) + 4(1.5)2 = 26 (1m)
Since P > AVC, firm can continue the operations (1m)

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QUESTION 3
a) A firm in an oligoplistic industry has identified 2 sets of demand curves. If the firm is the only
one that changes price, its demand curve takes the form Q 1 = 9 – P1
If however, it is expected that competitors will follow the price actions of the firm, then the
demand curve is of the form Q2 = 24 – 4P2

i) Derive the marginal revenue function for each set of demand curves. (1 mark)
MR1 Mark MR2 Mark
P1 = 9 – Q1 P2 = 6 – 0.25Q2
MR1 = 9 – 2Q1 0.5m MR2 = 6 – 0.5Q2 0.5m

ii) Given MC = 3, prove that the profit maximizing price and quantity will be at kink.
Calculate the optimal price and quantity at kink. (4 marks)
Optimal at kink, Q1 = Q2
9 – P1 = 24 – 4P2 (0.5m)
3P = 15
P = 15/3 = 5 (1m)
Q1 = 9 – P = 9 – 5 = 4 (1m)
If Q = 4
MR1 = 9 –2(4) = 1 (0.5m)
MR2 = 6 – 0.5(4) = 4 (0.5m)
1 < MC < 4 (0.5m)

b) A producer has the possibility of discriminating between domestic and foreign market for a
product, where the demand equations are:
P1 = 210 – 10Q1
P2 = 125 – 2.5Q2
Total cost = 2,000 + 10Q where Q = Q1 + Q2.

i) Using third degree price discrimination, determine the profit maximizing price and
quantity in each market. (5 marks)
Market 1 Marks Market 2 Marks
P1 = 210 – 10Q1 P2 = 125 – 2.5Q2
MR1 = 210 – 20Q1 0.5m MR2 = 125 – 5Q2 0.5m
MR = MC MR = MC
210 – 20Q1 = 10 125 – 5Q2 = 10
Q1 = 210 – 10/20 = 10 1m Q2 = 125 – 10/5 = 23 1m
P1 = 210 – 10(10) = 110 1m P1 = 125 – 2.5(23) = 67.5 1m

ii) Calculate the price charged if the firm did not practice price discrimination. (5 marks)
Q1 = 210/10 – 1/10P1 = 21 – 0.1P1 (0.5m)
Q2 = 125/2.5 – 1/2.5P2 = 50 – 0.4P2 (0.5m)
Q = Q1 + Q2 = 71 – 0.5P (0.5m)
P = 71/0.5 – 1/0.5Q = 142 – 2Q
MR = 142 – 4Q (0.5m)
MR = MC : 142 – 4Q = 10 (1m)
Q = (142 – 10)/4 = 33 (1m)
P = 142 – 2(33) = 76 (1m)

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 7 BM/DEC 2016/ECO555/556

ECO555/556
TEST 2 (Set 3)
Answer Scheme

QUESTION 1
a) Suppose a firm has the following production function:
Q = 50L + 6L2 – 0.5L3
where Q is output and L is labour

i) Determine APL and MPL functions. (2 marks)

APL = Q/L = 50 + 6L – 0.5L2 (1m)
MPL = Q’ = 50 + 12L – 1.5L2 (1m)

ii) How many labors should be employed to get maximum production? With that amount of
labour, how many outputs can the firm produce? (3 marks)
Max prodn = MPL = Q’ = 50 + 12L – 1.5L2 = 0 (1m)
L = -3.024, 11.024 (1m)
Q = 50L + 6L2 – 0.5L3
Q = 50(11.024) + 6(11.024)2 – 0.5(11.024)3 = 610.506 (1m)

iii) Find the number of labour that maximizes average product of labour (APL). (2 marks)
Max APL = APL’ = 6 – L = 0 (1m)
L=6 (1m)

b) Adventure Marina Bhd has the following production function:

Q = 20K0.8 L0.5
The current wage rate for a labor (L) is RM20 and the cost per unit of capital (K) is RM64.

i) Derive expressions for MPL and MPK. (2 marks)

MPL = 10 K0.8L-0.5 (1m)
MPK = 16 K-0.2L0.5 (1m)

ii) Determine the expansion path for this production function. (2 marks)
MPL/MPK = w/r
10K/16L = 20/64 (1m)
K = 20/64 x 16L/10 = 0.5L (1m) L = 2K

iii) Suppose the firm wants to produce 3,600 units of sail boats, calculate the number of
labour and capital should it use to produce efficiently. (4 marks)
3600 = 20(0.5L)0.8L0.5 (1m)
3600 = 20(0.5)0.8L1.3
L1.3 = 3600/(20(0.5)0.8) (1m)
L = 83.19 (1m)
K = 0.5L = 0.5(83.19) = 41.5953 (1m)

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QUESTION 2
a) Explain the differences between explicit costs, implicit costs and economic costs. (3 marks)
Explicit = acc cost : not belong to the owner (1m)
Implicit = opportunity cost, belong to the owner & need to let go (1m)
Econ cost = explicit + implicit (1m)

b) A recent graduate student, Mr. Kamal turns down a job offer of RM25,000 per year to start
his own advertisement company. He will invest RM70,000 of his own money that has been in
the bank account earning 9 percent in interest per annum. He also intends to use a building
he owns that has been rented to another business for RM1,850 per month. Revenue during
first year of his advertisement company is estimated to be RM105,000 while expenses are :
Advertising RM5,000
Taxes RM4,500
Employee's Salary RM50,500
Supplies RM5,500

Calculate her accounting and economic costs. (5 marks)

Accounting (Explicit) Marks Implicit Marks
Adv: RM5,000 Forgone salary: RM25,000 1m
Tax: RM4,500 Div on saving; 9% x 70000 = RM6300 1m
Salary: RM50,500 Rental: 1850 x 12 = RM22200 1m
Supplies: RM5,500
TOTAL = RM65,500 1m TOTAL = RM53,500
Economic Costs = Explicit + Implicit = 65500 + 53500 = RM119,000 (1m)

c) Superhealth Exercise Company manufactures clay pot and faces a horizontal demand
curve. The firm's total cost function is given by the equation:
TC = 1000 + 300Q – 40Q2 + 2Q3
where Q is the quantity of clay pot produced.

i) Derive AVC function and find Q if the company try to minimize its AVC. (2 marks)
AVC = 300 – 40Q + 2Q2 (0.5m)
AVC’ = -40 +4Q (0.5m)
Q = 40/4 = 10 (1m)

ii) If the price is fixed at RM12, should the company continue or shut down in the short run?
Why? (2 marks)
AVC = 300 – 40(10) + 2(10)2 = 100 (1m)
P < AVC so better shut down (1m)

iii) Calculate its profit maximizing output if the price is RM15. (3 marks)
Profit max when MR = MC
Know that MR = 15 & MC = TC’ = 300 – 80Q + 6Q2 (1m)
15 = 300 – 80Q + 6Q2 (1m)
Q = 6.67 (1m)

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QUESTION 3
a) The demand function for price increases and for price cuts for an oligopolist are,
respectively,
Q1 = 280 – 40P1
Q2 = 100 – 10P2
The oligopolist's total cost function: TC = 2Q + 0.025Q2

i) Derive the marginal revenue (MR1 and MR2). (1 marks)

MR1 Mark MR2 Mark
P1 = 7 – 0.025Q1 P2 = 10 – 0.1Q2
MR1 = 7 – 0.05Q1 0.5m MR2 = 10 – 0.2Q2 0.5m

ii) Determine the profit maximizing price and quantity. Show your calculation. (4 marks)
Optimal at kink, Q1 = Q2
280 – 40P1 = 100 – 10P2 (0.5m)
40P – 10P = 280 – 100
30P = 180
P = 180/30 = 6 (0.5m)
Q2 = 100 – 10P2 = 100 – 10(6) = 40 (0.5m)
If Q = 40
MR1 = 7 – 0.05(40) = 5 (0.5m)
MR2 = 10 – 0.2(40) = 2 (0.5m)
MC = 2 + 0.05Q = 2 + 0.05(40) = 4 (0.5m)
2 < MC < 5 (0.5m)
P & Q at kink (0.5m)

b) A firm sells in two market and has total cost equals to TC = 15 + 4Q. The demand equations
for the two markets are as follows:
Market 1 : P1 = 15 – 0.4Q1
Market 2 : P2 = 20 – 0.1Q2
and Q = Q1 + Q2

i) Calculate the profit maximizing price and quantity and profit if the company standardized
the price. (5 marks)
Q1 = 15/0.4 – 1/0.4P1 = 37.5 – 2.5P1 (0.5m)
Q2 = 20/0.1 – 1/0.1P2 = 200 – 10P2 (0.5m)
Q = Q1 + Q2 = 237.5 – 12.5P (0.5m)
P = 237.5/12.5 – 1/12.5Q = 19 – 0.08Q
MR = 19 – 0.16Q (0.5m)
MR = MC : 19 – 0.16Q = 4 (1m)
Q = (19 – 4)/0.16 = 93.75 (1m)
P = 19 – 0.08(93.75) = 11.5 (1m)

ii) Calculate the profit maximizing price and quantity demanded for each group if the
company decides to discriminate the price. (5 marks)
Market 1 Marks Market 2 Marks
P1 = 15 – 0.4Q1 P2 = 20 – 0.1Q2
MR1 = 15 – 0.8Q1 0.5m MR2 = 20 – 0.2Q2 0.5m
MR = MC MR = MC
15 – 0.8Q1 = 4 20 – 0.2Q2 = 4
Q1 = 15 – 4/0.8 = 13.75 1m Q2 = 20 – 4/0.2 = 80 1m
P1 = 15 – 0.4(13.75) = 9.5 1m P1 = 20 – 0.1(80) = 12 1m

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