November 2016

MN1017 Foundations of Economics

Seminar 4 Answer Key

The following is the answer key to the questions for Seminar 4.

Discuss 7.2: The Cost Function for Apple-Cinnamon Cheerios

1. The cost function is a linear function of the quantity produced (𝐶 = 2𝑄) as follows:
C

2 Slope: 2

O Q
1
2. The marginal and average cost functions are both independent of the quantity produced,
and is constant at $2, i.e. MC = AC = 2, which can be described graphically as follows:

O Q

3. If there were some fixed production costs, then the total cost curve looks as follows:
C

Slope: 2

F
O Q

The marginal cost function remains the same as above, but the average cost curve now looks
as follows:

AC
2
MC

O Q

1
Discuss 7.3: Cost Functions for University Education

1. For both undergraduates and (post)graduates, the average cost is decreasing in the number
of students.

2. UG: 58,063,500, PG: 14,308,800. Total cost is average cost times student number.

3. See below:

UG: Marginal and Average Costs

9000
8000
7000
6000
5000
4000 MC
3000
2000
AC
1000
0
0 5000 10000 15000 20000
Students

PG: Marginal and Average Costs

14000

12000

10000

8000

6000 MC
4000 AC
2000

0
0 500 1000 1500 2000 2500 3000 3500
Students

2
4. Since the marginal cost is decreasing in the number of students for undergraduates and is
increasing for graduates, the former is a concave function and the latter is a convex function
as follows:

UG: Total Costs PG: Total Costs

120000000 30000000

100000000 25000000

80000000 20000000

60000000 15000000

40000000 10000000

20000000 5000000

0 0
0 5000 10000 15000 20000 0 1000 2000 3000 4000
Students Students

5. Difference in the shape of the marginal cost curve is a reflection of the difference in the
variable cost structure. An increasing marginal cost means that the variable cost increases
more than proportionately than the increase in the number of students for graduates, while the
variable cost increases less than proportionately for undergraduates. Also, from the total cost
curves, there is an increasing returns to scale for the undergraduates, while there is a
decreasing returns to scale for the graduates.

6. One possible reason is that graduate education requires more equipment and/or facility or
other expenses that can be used only for a small number of people, mainly because of
research activities.

Discuss 7.4: Looking at Isoprofit Curves

1. The difference comes from the fact that the technology of Cheerios exhibits constant
returns to scale (so marginal and average costs are identical), while that of Beautiful Cars
shows an increasing returns to scale for lower quantity and a decreasing returns to scale for
larger quantity---the effects of the fixed cost dominate the increasing marginal cost for lower
quantities and the opposite holds for larger quantities.

2. By definition, profit equals (price – average cost) x quantity. Thus, for larger quantities, the
price – average cost must becomes smaller as long as the profit level remains the same (and is
the case on the same isoprofit line by definition).

3
Discuss 7.6: Elasticity and Expenditure

1. By 17.93 percent, since its price elasticity of demand is 1.793.

!.!"
2. Before: 2,577.77 grams per week (= !.!" × 100). After: 2,115.582 grams per week
!.!"
(= !.!" ×100 × 1 − 0.1793 ).

3. Before: $2.32 per week. After: $2.09 per week (= 2115.582 × 0.09 × 1.1 ÷ 100).

4. Pick up any of categories 2, 15, 17, 28, 29, and then follow the procedure above.