CESEM 2021

Problem Set 3

Q1. Otto Carr is in the auto repair business, which is a competitive market. His total cost of repairing 𝑞
cars is 𝐶(𝑞) = 𝑞 2 + 16.
(1)
(a) What’s the total fixed cost? 16
(b) The total variable cost? 𝑞2
(c) Average fixed cost? 16/𝑞
(d) Average variable cost? 𝑞
(e) Average total cost? 𝑞 + 16/𝑞
(f) Marginal cost? 2𝑞
(g) Make a graph, draw the average total cost curve, average variable cost curve, and marginal cost
curve.

(2) At what output level is average total cost minimized?

At 𝑞 = 4

(3) What is Otto’s long-run supply curve? Short-run supply curve?

The long-run supply curve is the part of the MC curve that is above the ATC curve.
The short-run supply curve is the part of the MC curve that is above the AVC curve.

(4) Suppose market price is at 10. What is the optimal output, 𝑞 ∗? What is Otto’s revenue? His total
cost? His profit?
 At the optimal point, MR=MC=price. Since 𝑀𝐶 = 2𝑞, which is also the supply curve, optimal
quantity 𝑞 ∗ = 5.
𝑇𝑅 = 𝑝 ∗ 𝑞 ∗ = 50, 𝑇𝐶 = 𝑞 ∗ 2 + 16 = 41, 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑇𝑅 − 𝑇𝐶 = 9.

Q2. In the market of widgets (graph below), the price and quantity used to be at the equilibrium levels: $6
and 20 units. However, the government has newly imposed a per-unit tax. The vertical dashed line
represents the size of the tax. Answer the following questions.

(1) How much is the tax per unit? $5

(2) After the tax is imposed, what is the effective price per unit that buyers have to pay? $8

(3) After the tax is imposed, what is the effective price per unit that sellers get to keep? $3

(4) How much tax burden falls on the buyers?

Since buyers used to pay $6 for each unit, and now they have to pay $8, the tax burden is $2 per unit, that
is, 40% of the $5 tax burden falls on the buyers.

(5) How much tax burden falls on the sellers?

$3 per unit ($6-$3=$3), that is 60% of the $5 tax burden falls on the sellers.

(6) With the tax, how much quantity is exchanged in this market now? 10 units.

(7) How much is the tax revenue received by the government?

$5 * 10 units =$50, which is the grey area.
(8) How much is the consumer surplus in this market with taxes?
The CS is the area below the demand curve and above the price buyers pay, so it is the area of the pink
triangle. 2*10*1/2=10

(9) How much is the producer surplus in this market with taxes?
The PS is the area below the price sellers receive and above the supply curve, so it is the area of the blue
triangle. 3*10*1/2=15

(10) How much is the deadweight loss caused by this tax?

The deadweight loss is the triangle in green. (8-3)*(20-10)*(1/2)=25