Problem Set 9
Introduction to Economics I
Gunawan, Ph.D.
1. Many small boats are made of fiberglass and a resin derived from crude oil. Suppose that
the price of oil rises.
a. Using diagrams, show what happens to the cost curves of an individual boat-making
firm and to the market supply curve.
b. What happens to the profits of boat makers in the short run? What happens to the
number of boat makers in the long run?
2. Bob’s lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for
$27 each. His total cost each day is $280, of which $30 is a fixed cost. He mows 10 lawns
a day. What can you say about Bob’s short-run decision regarding shutdown and his long-
run decision regarding exit?
3. Consider total cost and total revenue given in the following table.
Quantity 0 1 2 3 4 5 6 7
Total cost $8 $9 $10 $11 $13 $19 $27 $37
Total revenue $0 $8 $16 $24 $32 $40 $48 $56
a. Calculate profit for each quantity. How much should the firm produce to maximize
profit?
b. Calculate marginal revenue and marginal cost for each quantity. Graph them. (Hint:
Put the points between whole numbers. For example, the marginal cost between 2 and
3 should be graphed at 2½.) At what quantity do these curves cross? How does this
relate to your answer to part (a)?
c. Can you tell whether this firm is in a competitive industry? If so, can you tell whether
the industry is in a long-run equilibrium?
4. Ball Bearings, Inc., faces costs of production as follows.
Quantity (cases) Total Fixed Cost Total Variable Cost
0 $100 $0
1 $100 $50
2 $100 $70
3 $100 $90
4 $100 $140
5 $100 $200
6 $100 $360
a. Calculate the company’s average fixed cost, average variable cost, average total cost,
and marginal cost at each level of production.
b. The price of a case of ball bearings is $50. Seeing that he can’t make a profit, the chief
executive officer (CEO) decides to shut down operations. What is the firm’s profit/loss?
Is shutting down a wise decision? Explain.
c. Vaguely remembering his introductory economics course, the chief financial officer
tells the CEO it is better to produce 1 case of ball bearings because marginal revenue
equals marginal cost at that quantity. What is the firm’s profit/loss at that level of
production? Is producing 1 case the best decision? Explain.
5. Suppose the book-printing industry is competitive and begins in a long-run equilibrium.
a. Draw a diagram showing the average total cost, marginal cost, marginal revenue, and
supply curve of the typical firm in the industry.
b. Hi-Tech Printing Company invents a new process that sharply reduces the cost of
printing books. What happens to Hi-Tech’s profits and to the price of books in the short
run when Hi-Tech’s patent prevents other firms from using the new technology?
c. What happens in the long run when the patent expires and other firms are free to use
the technology?
6. A firm in a competitive market receives $500 in total revenue and has marginal revenue of
$10. What is the average revenue, and how many units were sold?
7. A profit-maximizing firm in a competitive market is currently producing 100 units of
output. It has average revenue of $10, average total cost of $8, and fixed cost of $200.
a. What is its profit?
b. What is its marginal cost?
c. What is its average variable cost?
d. Is the efficient scale of the firm more than, less than, or exactly 100 units?
8. The market for fertilizer is perfectly competitive. Firms in the market are producing output
but are currently incurring economic losses.
a. How does the price of fertilizer compare to the average total cost, the average variable
cost, and the marginal cost of producing fertilizer?
b. Draw two graphs, side by side, illustrating the present situation for the typical firm and
for the market.
c. Assuming there is no change in either demand or the firms’ cost curves, explain what
will happen in the long run to the price of fertilizer, marginal cost, average total cost,
the quantity supplied by each firm, and the total quantity supplied to the market.
9. The market for apple pies in the city of Ectenia is competitive and has the following
demand schedule.
Price Quantity demanded
$1 1,200 pies
$2 1,100
$3 1,000
$4 900
$5 800
$6 700
$7 600
$8 500
$9 400
$10 300
$11 200
$12 100
$13 0
Each producer in the market has fixed costs of $9 and the following marginal cost schedule.
Quantity Marginal cost
1 pie $2
2 $4
3 $6
4 $8
5 $10
6 $12
a. Compute each producer’s total cost and average total cost for each quantity from 1 to
6 pies.
b. The price of a pie is now $11. How many pies are sold? How many pies does each
producer make? How many producers are there? How much profit does each producer
earn?
c. Is the situation described in part (b) a long-run equilibrium? Why or why not?
d. Suppose that in the long run there is free entry and exit. How much profit does each
producer earn in the long-run equilibrium? What is the market price? How many pies
does each producer make? How many pies are sold in the market? How many pie
producers are operating?
10. An industry currently has 100 firms, each of which has fixed cost of $16 and average
variable cost as follows.
Quantity Average Variable Cost
1 $1
2 $2
3 $3
4 $4
5 $5
6 $6
a. Compute a firm’s marginal cost and average total cost for each quantity from 1 to 6.
b. The equilibrium price is currently $10. How much does each firm produce? What is
the total quantity supplied in the market?
c. In the long run, firms can enter and exit the market, and all entrants have the same costs
as above. As this market makes the transition to its long-run equilibrium, will the price
rise or fall? Will the quantity demanded rise or fall? Will the quantity supplied by each
firm rise or fall? Explain your answers.
d. Graph the long-run supply curve for this market, with specific numbers on the axes as
relevant.
11. Suppose that each firm in a competitive industry has the following costs:
Total cost = 50 + ½ q2
Marginal cost = MC = q
Where q is an individual firm’s quantity produced. The market demand curve for this
product is as follows.
Demand = QD = 120 – P
Where P is the price and Q is the total quantity of the good. Currently there are 9 firms in
the market.
a. What is each firm’s fixed cost? What is its variable cost? Give the equation for average
total cost.
b. Graph the average-total-cost curve and the marginal-cost curve for q from 5 to 15. At
what quantity is the average-total-cost curve at its minimum? What is marginal cost
and average total cost at that quantity?
c. Give the equation for each firm’s supply curve.
d. Give the equation for the market supply curve for the short run in which the number of
firms is fixed.