COST CURVES

1. Which of the following are true? (1) Average fixed (co dinh) costs never increase with output
(AFC/Q); (2)average total costs are always greater than or equal to average variable (bien
doi) costs (ATC/AVC); (3) average cost can never rise while marginal (can bien) costs are
declining.
T,T,F Giai thich: fc khong bao h tang 1T, atc=afc+avc ve dai han thi afc khong co nen atc luon
>= avc 2T, atc chi tang khi mc tang 3T
Bieu do

2. A firm produces identical outputs at two different plants. If the marginal cost at the firstplant
exceeds (vuot qua) the marginal cost at the second plant, how can the firm reduce costs and
maintain the same level of output?
By simultaneously producing more output at the second plant and reducing production at
the first plant, the firm can reduce costs.
3. True or false? In the long run a firm always operates at the minimum level of average costs
for the optimally sized plant to produce a given amount of output. F

FIRM SUPPLY

1. A firm has a cost function (ham chi phi) given by c(y) = 10y^2 + 1000. What is its supply
(duong cung) curve?
The inverse (nguoc dao) supply curve is p = 20y, so the supply curve is y = p/20
TC = 10y^2 + 1000
→ MC = TC’(y) = 20y
So the inverse supply curve will be:
p = MC
<-> p = 20y
→ Supply curve: y = p/20
2. A firm has a cost function given by c(y) = 10y^2 + 1000. At what output is average
costminimized?
Set AC = MC to find 10y + 1000/y = 20y. Solve to get y∗= 10.
AC = TC/y = (10y^2 + 1000)/y = 10y +1000/y
MC intersects the minimized AC → ACmin = MC
<-> 10y +1000/y = 20y
→ y = 10
At y = 10, the average cost is minimized.
AC: chi phi binh quan =TC/Q=AVC=AFC
MC: chi phi bien = del TC/del Q= (TC)’q= del VC/ del Q=(VC)’q
3. If the supply curve is given by S(p) = 100 + 20p, what is the formula for the inverse supply
curve?
Solve for p to get Ps(y) = (y - 100)/20
4. A firm has a supply function given by S(p) = 4p. Its fixed costs are 100. If the price changes
from 10 to 20, what is the change in its profits?
At 10 the supply is 40 and at 20 the supply is 80. The producer’s surplus is composed ofa
rectangle of area 10 × 40 plus a triangle of area 1/2 × 10 × 40, which gives a total change
inproducer’s surplus of 600. This is the same as the change in profits, since the fixed costs
don’t change.
5. If the long-run cost function is c(y) = y^2 +1, what is the long-run supply curve of the firm?
 The supply curve is given by y = p/2 for all p ≥ 2, and y = 0 for all p ≤ 2. At p = 2 the firm is
indifferent between supplying 1 unit of output or not supplying it
6. Classify each of the following as either technological or market constraints: the price of
inputs, the number of other firms in the market, the quantity of output produced, and
theability to produce more given the current input levels.
Mostly technical (in more advanced models this could be market), market, could be either
market or technical, technical
7. What is the major assumption that characterizes a purely competitive market?
That all firms in the industry take the market price as given.
8. In a purely competitive market a firm’s marginal revenue is always equal to what? Aprofit-
maximizing firm in such a market will operate at what level of output?
The market price. A profit-maximizing firm will set its output such that the marginal cost of
producing the last unit of output is equal to its marginal revenue, which in the case of pure
competition is equal to the market price.
9. If average variable costs exceed the market price, what level of output should the firm
produce? What if there are no fixed costs?
The firm should produce zero output (with or without fixed costs).
10. Is it ever better for a perfectly competitive firm to produce output even though it is losing
money? If so, when?
In the short run, if the market price is greater than the average variable cost, a firmshould
produce some output even though it is losing money. This is true because the firm would
have lost more had it not produced since it must still pay fixed costs. However, in the long
run there are no fixed costs, and therefore any firm that is losing money can produce zero
output and lose a maximum of zero dollars
11. In a perfectly competitive market what is the relationship between the market price and the
cost of production for all firms in the industry?
The market price must be equal to the marginal cost of production for all firms in the
industry

MONOPOLY

1. The market demand curve for heroin is said to be highly inelastic (do co dan). Heroin supply
is also said to be monopolized by the Mafia, which we assume to be interested in maximizing
profits. Are these two statements consist
No. A profit-maximizing monopolist would never operate where the demand for its product
was inelastic?
2. The monopolist faces a demand curve given by D(p) = 100-2p. Its cost function is c(y) =2y.
What is its optimal level of output and price?
First solve for the inverse demand curve to get p(y) = 50 - y/2. Thus the marginal revenue is
given by MR(y) = 50 - y. Set this equal to marginal cost of 2, and solve to get y =48. To
determine the price, substitute into the inverse demand function, p(48) = 50 - 48/2 =26
3. The monopolist faces a demand curve given by D(p) = 10p^-3. Its cost function is c(y) =2y.
What is its optimal level of output and price?
The demand curve has a constant elasticity of -3. Using the formula p[1 + 1/ǫ] = MC,we
substitute to get p[1 - 1/3] = 2. Solving, we get p = 3. Substitute back into the demand
function to get the quantity produced: D(3) = 10 × 3-3
4. If D(p) = 100/p and c(y) = y^2, what is the optimal level of output of the monopolist?
The demand curve has a constant elasticity of -1. Thus marginal revenue is zero for all levels
of output. Hence it can never be equal to marginal cost
 A monopolist maximizes the profit at the point where the marginal cost is equal to the
marginal revenue (MC = MR)
TR = P.Q = P.100/P = 100
The marginal revenue: MR = TR’(y) = 0
The marginal cost: MC = TC’(y) = (y^2)’= 2y
→ MC = MR
<-> 2y = 0
<-> y = 0
So, y=0 is the optimum level of production of the monopolist.evels of output. Hence it can
never be equal to marginal cost

PARETO

1. Is it possible to have a Pareto efficient allocation where someone is worse off than he is
at an allocation that is not Pareto efficient?
Yes. For example, consider the allocation where one person has everything. Then the
other person is worse off at this allocation than he would be at an allocation where he
had something.
2. Is it possible to have a Pareto efficient allocation where everyone is worse off than they
are at an allocation that is not Pareto efficient?
No. For this would mean that at the allegedly Pareto efficient allocation there is
someway to make everyone better off, contradicting the assumption of Pareto efficiency
3. True or false? If we know the contract curve, then we know the outcome of any trading.
F. If we know the contract curve, then any trading should end up somewhere on the
curve;however, we don’t know where
3. Can some individual be made better off if we are at a Pareto efficient allocation?
T, but not without making someone else worse off
Pareto efficiency implies that resources are allocated in the most economically efficient
manner, but does not imply equality or fairness. An economy is said to be in a Pareto
optimum state when no economic changes can make one individual better off without
making at least one other individual worse off.
4. If the value of excess demand in 8 out of 10 markets is equal to zero, what must be true
about the remaining two markets
The value of excess demand in the remaining two markets must sum to zero

PRODUCTION

1. The competitive price of coconuts is $6 per pound and the price of fish is $3 per pound.
Ifsociety were to give up 1 pound of coconuts, how many more pounds of fish could be
produced?
Giving up 1 coconut frees up $6 worth of resources that could be used to produce 2pounds
(equals $6 worth) of fish.
2. In what sense is a competitive equilibrium a good or bad thing for a given economy?
Given a few assumptions, an economy that is in competitive equilibrium is Pareto efficient. It
is generally recognized that this is a good thing for a society since it implies that there are no
opportunities to make any individual in the economy better off without hurting someone
else. However, it may be that the society would prefer a different distribution of welfare;
 that is, it may be that society prefers making one group better off at the expense of another
group
3. If Robinson’s marginal rate of substitution between coconuts and fish is -2 and the marginal
rate of transformation between the two goods is -1, what should he do if he wants to
increase his utility?
He should produce more fish. His marginal rate of substitution indicates that he is willing to
give up two coconuts for an additional fish. The marginal rate of transformation implies that
he only has to give up one coconut to get an additional fish. Therefore, by givingup a single
coconut (even though he would have been willing to give up two) he can have an additional
fish

5. Suppose that Robinson and Friday both want 60 pounds of fish and 60 pounds of coconuts per
day. Using the production rates given in the chapter, how many hours must Robinson and Friday
work per day if they don’t help each other? Suppose they decide to work together inthe most
efficient manner possible. Now how many hours each day do they have to work?What is the
economic explanation for the reduction in hours

Both would have to work 9 hours per day. If they both work for 6 hours per day(Robinson producing
coconuts, and Friday catching fish) and give half of their total production to the other, they can
produce the same output. The reduction in the hours of work from 9 to 6 hours per day is due to
rearranging production based on each individual’s comparative advantage

CHOICE

1. If two goods are perfect substitutes, what is the demand function for good 2?

2. Suppose that indifference curves are described by straight lines with a slope of −b. Given

arbitrary prices and money income p1, p2, and m, what will the consumer’s optimal choices

look like?

3. Suppose that a consumer always consumes 2 spoons of sugar with each cup of coffee. If

the price of sugar is p1 per spoonful and the price of coffee is p2 per cup and the consumer

has m dollars to spend on coffee and sugar, how much will he or she want to purchase?

4. Suppose that you have highly non convex preferences for ice cream and olives, like those

given in the text, and that you face prices p1, p2 and have m dollars to spend. List the choices

for the optimal consumption bundles.

5. If a consumer has a utility function u(x1,x2)= x1(x2)^4 , what fraction of her income will she spend
on good 2?

6. For what kind of preferences will the consumer be just as well-off facing a quantity tax as

an income tax?

ANSWER:

5.1. x2 = 0 when p2 > p1, x2 = m/p2 when p2 < p1, and anything between 0 and m/p2 when

p1 = p2.
5.2. The optimal choices will be x1 = m/p1 and x2 = 0 if p1/p2 < b, x1 = 0 and x2 = m/p2 if

p1/p2 > b, and any amount on the budget line if p1/p2 = b.

5.3. Let z be the number of cups of coffee the consumer buys. Then we know that 2z is the

number of teaspoons of sugar he or she buys. We must satisfy the budget constraint

2p1z + p2z = m.

Solving for z we have z=m/2p1+p2

5.4. We know that you’ll either consume all ice cream or all olives. Thus the two choices for

the optimal consumption bundles will be x1 = m/p1, x2 = 0, or x1 = 0, x2 = m/p2.

5.5. This is a Cobb-Douglas utility function, so she will spend 4/(1 + 4) = 4/5 of her income

on good 2.

5.6. For kinked preferences, such as perfect complements, where the change in price doesn’t induce
any change in demand.

MARKET DEMAND

1. If the market demand curve is D(p) = 100 - 0.5p, what is the inverse demand curve?

2. An addict’s demand function for a drug may be very inelastic, but the market demand

function might be quite elastic. How can this be?

3. If D(p) = 12 - 2p, what price will maximize revenue?

4. Suppose that the demand curve for a good is given by D(p) = 100/p. What price will

maximize revenue?

5. True or false? In a two good model if one good is an inferior good the other good must be a luxury
good.

ANSWER:

15.1. The inverse demand curve is P(q) = 200 - 2q.

15.2. The decision about whether to consume the drug at all could well be price sensitive, so

the adjustment of market demand on the extensive margin would contribute to the elasticity

of the market demand.

15.3. Revenue is R(p) = 12p - 2p^2, which is maximized at p = 3.

15.4. Revenue is pD(p) = 100, regardless of the price, so all prices maximize revenue.

15.5. True. The weighted average of the income elasticities must be 1, so if one good has a

negative income elasticity, the other good must have an elasticity greater than 1 to get the

average to be 1.
6. Yes. the marginal product of an input refers to the change in production that occurs when

all other inputs are held constant

PROFIT MAXIMIZATION

1. In the short run, if the price of the fixed factor is increased, what will happen to profits?

2. If a firm had everywhere increasing returns to scale, what would happen to its profits if

prices remained fixed and if it doubled its scale of operation?

3. If a firm had decreasing returns to scale at all levels of output and it divided up into two

equal-size smaller firms, what would happen to its overall profits?

6. If p/MP1 > w1, then should the firm increase or decrease the amount of factor 1 in order to

increase profits?

7. Suppose a firm is maximizing profits in the short run with variable factor x1 and fixed

factor x2. If the price of x2 goes down, what happens to the firm’s use of x1? What happens

to the firm’s level of profits?

8. A profit-maximizing competitive firm that is making positive profits in long-run

equilibrium (may/may not) have a technology with constant returns to scale.

ANSWER:

20.1. Profits will decrease.

20.2. Profit would increase, since output would go up more than the cost of the inputs.

20.3. If the firm really had decreasing returns to scale, dividing the scale of all inputs by 2

would produce more than half as much output. Thus the subdivided firm would make more

profits than the big firm. This is one argument why having everywhere decreasing returns to

scale is implausible.

20.6. Increase.

20.7. The use of x1 does not change, and profits will increase.

20.8. May not.

COST MINIMIZATION

1. Prove that a profit-maximizing firm will always minimize costs.

2. If a firm is producing where MP1/w1 > MP2/w2, what can it do to reduce costs but

maintain the same output?

3. Suppose that a cost-minimizing firm uses two inputs that are perfect substitutes. If the two

inputs are priced the same, what do the conditional factor demands look like for the inputs?

ANSWER:

21.1. Since profit is equal to total revenue minus total costs, if a firm is not minimizing costs

then there exists a way for the firm to increase profits; however, this contradicts the fact that

the firm is a profit maximizer.

21.2. Increase the use of factor 1 and decrease the use of factor 2.

21.3. Since the inputs are identically priced perfect substitutes, the firm will be indifferent

between which of the inputs it uses. Thus the firm will use any amount of the two inputs such
that x1 + x2 = y

FACTOR MARKETS

1. We saw that a monopolist never produced where the demand for output was inelastic. Will

a monopsonist produce where a factor is inelastically supplied?

2. In our example of the minimum wage, what would happen if the labor market was

dominated by a monopsonist and the government set a wage that was above the competitive

wage?

ANSWER

27.1. Sure. A monopsonist can produce at any level of supply elasticity.

27.2. Since the supply of labor would exceed the demand for labor at such a wage, we would
presumably see unemploymen

OLIGOPOLY

1. Suppose that we have two firms that face a linear demand curve p(Y ) = a - bY and have

constant marginal costs, c, for each firm. Solve for the Cournot equilibrium output.

2. Consider a cartel in which each firm has identical and constant marginal costs. If the cartel

maximizes total industry profits, what does this imply about the division of output between

the firms?

5. Draw a set of reaction curves that result in an unstable equilibrium.

6. Do oligopolies produce an efficient level of output?

ANSWER:

28.1. In equilibrium each firm will produce (a-c)/3b, so the total industry output is 2(a - c)/3b.

28.2. Nothing. Since all firms have the same marginal cost, it doesn’t matter which of them

produces the output.

28.5. Make f2(y1) steeper than f1(y2).

28.6. In general, no. Only in the case of the Bertrand solution does price equal the marginal

cost