Economics 2010
Problem Set #4
TA: Zoe Freedman
Due: Sunday November 3rd at 11:59pm
**** I will only be grading the first 3 questions – the rest is extra practice for exam 2!
1. Below are the costs of a firm that makes pretzels. It is one of many such firms in a
perfectly competitive industry. (.25 points each)
a. At a market price of $13.95, How much does the firm produce?
b. At a market price of $13.95, what will be the economic profit of this firm? You may give
$ value or formula with numbers correctly plugged in)
c. What will happen to the profits of this firm in the long run?
d. What price is this firm’s shut down point?
2. The same data applies but assume the firm is a monopoly. Below is the marginal
Revenue for the firm (.33 pts each)
a. At what output with this firm maximize its profits?
b. What will be the total cost of producing at the profit maximizing output?
c. What is the firm’s fixed cost at the profit maximizing output? (you may give the
dollar value or give the formula with numbers correctly plugged in)
3. Freedman, Inc. is a firm whose costs are shown below. This firm is one of many
operating in a perfectly competitive market. Its costs are the same as the other firms in
the market and the market itself is currently in long-run equilibrium. (.1 points) each
a. On the diagram above, show the market price and the output produced by Freedman,
Inc.
b. What else would you need to know to provide the total output in this market under the
current economic conditions?
c. Circle on the graph and describe the short run supply curve of this firm
d. Label the price in which the firm will shut down in the short-run
e. What are Freedman Inc.’s economic profits or losses in the short-run?
f. Assume that Freedman, Inc., but not its competitors, is able to produce the same
product as before but at lower marginal (and therefore average) costs for each level of
output. In the short-run, what effect will this cost reduction have on the output level of
Freedman, Inc.?
g. What effect will the reduction in costs have upon the price Freedman, Inc. charges their
customers?
h. Assume that in the long-run other firms in this market can adopt the same cost cutting
methods as Freedman, Inc. As this happens, what will be the effect on market price?
i. As other firms adopt the same cost cutting methods as Freedman, Inc., what will be the
effect on market output?
j. As other firms adopt the same cost cutting methods as Freedman, Inc., what will be the
effect on the long-run economic profits of Freedman, Inc.?
EXTRA PRACTICE!!!!!!!!!
1. There are five characteristics of a perfectly competitive market. Which of these
characteristics explains the demand curve faced by a single firm?
2. Fill in the values for the following table
Output (Q) TC TFC TVC MC
0 100 -
1 150
2 180
3 240
4 320
5 430
3. Suppose Firm A is in the short-run and it produces loaves of bread. The market price of a
loaf of bread is $10 (these are very expensive loaves of bread). If the minimum of the
average total cost curve is $15, and the minimum of the average variable cost curve is
$8, is the firm making a profit or a loss? Furthermore, will Firm A produce 0 loaves of
bread (shutdown) or produce a nonzero number of loaves? Why?
4. Draw a long-run average cost curve (LRAC) that reflects “economies of scale,”
“diseconomies of scale,” and “constant returns to scale.” Label the portions that reflect
the three different scale conditions.
5. What would cause the entire LRAC curve to “shift down”? What would cause the LRAC
to shift up?
6. You own a firm that dominates the market and there are significant barriers to entry.
Your firm makes substantial economic profits.
a. In the space below, draw a diagram of your firm, showing demand, marginal
revenue, marginal cost, average cost, and your firm’s economic profits. Be sure to
label each curve as well as the equilibrium price and quantity
b. Do you charge a price for your product that is in the inelastic or the elastic
portion of the demand curve for your firm’s product? Why?
c. Assume the entry barriers start to break down and new firms enter your market.
Will this cause your firm’s demand to become more or less elastic? Why?
7. Describe the difference between economic and accounting cost and give an example
8. Ben has $80 dollars to spend between goods A B and C
a. According to economic theory, what is the utility maximizing equilibrium that
Ben will try to attain as she considers these consumption choices?
b. Based on the economic rationale of Ben’s consumption behavior, explain why
one could conclude that the law of demand “holds” or applies in Ben’s situation?
c. Under what conditions, if any, could the Law of Diminishing Marginal Utility
result in Ben buying only good A and not purchasing any B or C?
9. Economic v accounting profit
a. Describe the difference between economic profit and accounting profit:
b. When we say: perfectly competitive firms make zero profit in the long run (or
normal profit) what type of profit (accounting or economic) are we referring to?
Explain.
c. Jack has a shirt business he owns. He has been offered a job by Big Tshirt Inc with
a salary of $130k per year. The company he currently owns has a total revenue of
$260k. He earns $40k in salary, pays $15k in facility rent, 35k in fabric, and $5k in
utilities. He has also invested $100k of his own money into his company.
Calculate his accounting costs and economic costs
Describe the key take aways from the econ minutes:
Miscellaneous Economic Vocabulary Questions
a. Consumer surplus
b. Law of demand
c. Income elasticity of demand
d. Principal-Agent Problem
e. LDMU
f. Economies of scope