CHAPTER 13

Problem 4: Nimbus, Inc., makes brooms and then sells them door to-door.
Here is the relationship between the number of workers and Nimbus’s output
during a given day:

a. Fill in the column of marginal products. What pattern do you see? How
might you explain it?
●​ Marginal Product (MP) = the change in output when an additional worker is
added → calculated as ΔQ when L increases by 1 unit.
●​ Pattern: Marginal Product initially rises (20 → 30 → 40), peaks at L = 3, then
begins to decline.
●​ Explanation: This illustrates the concept of diminishing marginal returns:
initially, adding workers allows better utilization of fixed machines and
space increasing efficiency. But when the number of workers exceeds the
fixed capital, adding new workers increases output by smaller amounts
because they must “share” equipment and workspace.

b. A worker costs $100 a day, and the firm has fixed costs of $200. Use this
information to fill in the column for total cost.

●​ Fixed cost (FC) = $200 (regardless of output). Each additional worker costs
$100.
●​ So:TC=FC+(Number of workers×100)
●​ From the table: when L = 0 → TC = 200; L = 1 → 200 + 100 = 300; …; L = 7 →
200 + 7×100 = 900.

c. Fill in the column for average total cost. (Recall that ATC 5 TC/Q.) What
pattern do you see?
●​ ATC = TC/Q. The values are: 15.00, 8.00, 5.56, 5.00, 5.00, 5.33, 5.81.
●​ Pattern: ATC decreases sharply at first, reaches its minimum around
 Q = 120–140, then slightly increases as output rises further — forming a
“U-shape.”
●​ Explanation: As output increases, fixed costs are spread over more units →
ATC decreases. But when too many workers are added relative to fixed
capital, marginal productivity declines → the marginal cost of each broom
increases → pushing ATC up.
d. Now fill in the column for marginal cost. (Recall that MC 5 ΔTC/ΔQ.) What
pattern do you see?

●​ MC = ΔTC ÷ ΔQ. When an additional worker is added, TC increases by $100;

Q increases depending on MPL → MC changes accordingly. Calculated MC
values: 5.00, 3.33, 2.50, 3.33, 5.00, 10.00, 20.00.
●​ Pattern: MC initially decreases (5 → 3.33 → 2.50), then starts rising
(“inverted U-shape” going down then up).

e. Compare the column for marginal product with the column for marginal
cost. Explain the relationship.

●​ When Marginal Product increases, Marginal Cost decreases. Conversely,

when Marginal Product decreases, Marginal Cost increases.
●​ Explanation: Higher Marginal Product → each additional worker produces
more output → the cost of producing an extra unit is lower (MC is lower).
When MPL declines (due to diminishing marginal returns), each additional
unit requires more labor → MC increases. This shows the inverse
relationship between MPL and MC.

f. Compare the column for average total cost with the column for marginal
cost. Explain the relationship.

●​ When MC < ATC → ATC decreases (the new unit has a lower marginal cost
than the current average, pulling the average down).
●​ When MC > ATC → ATC increases (the new unit has a higher marginal cost
than the current average, pulling the average up).
●​ In the table, when MC = 2.50 (less than ATC) → ATC falls; when MC rises
above ATC (e.g., MC = 10, 20) → ATC rises again.
Problem 8:The city government is considering two tax proposals:
• A lump-sum tax of $300 on each producer of hamburgers.
• A tax of $1 per burger, paid by producers of hamburgers.
a. Which of the following curves—average fixed cost, average variable cost,
average total cost, and marginal cost—would shift as a result of the lump-sum
tax? Why? Show this in a graph. Label the graph as precisely as possible.

(a) Lump-sum tax of $300 per producer

Curves that shift

●​ AFC (average fixed cost) → shifts upward (because fixed cost increases
by $300; AFC = (FC + 300)/Q).​

●​ ATC (average total cost) → shifts upward (ATC = AFC + AVC; an increase
in fixed cost raises ATC).

Curves that do not shift

●​ AVC → unchanged (tax does not affect variable cost).​

●​ MC → unchanged (marginal cost depends on variable cost; fixed cost

changes do not affect MC).
➔​ Because MC does not change, the firm’s optimal output in the short run
is [Link] tax reduces profit, but does not change the condition
MC = MR.
b. Which of these same four curves would shift as a result of the per-burger
tax? Why? Show this in a new graph. Label the graph as precisely as possible

(b)Per-unit tax of $1 per burger

Curves that shift

●​ AVC → shifts upward by exactly $1 at all output levels.​

●​ ATC → shifts upward by $1 (because ATC = AFC + AVC).​

●​ MC → shifts upward by $1 (each additional burger costs $1 more to

produce).

Curves that do not shift

●​ AFC → unchanged (fixed cost unaffected).

➔​ Because MC rises, the firm’s supply curve (MC above AVC) shifts
upward/[Link] firm produces less at every price, causing a smaller
quantity and a higher buyer price in the market.
CHAPTER 14
Problem 11: Suppose that each firm in a competitive industry has the following
costs: Total cost:

a. What is each firm’s fixed cost? What is its variable cost? Give the equation
for average total cost.
TC=50 + 1/2q^2
FC= 50
VC= 1/2q^2
=> ATC=AFC + AVC=50/q+ 1/2q
b. Graph 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
the marginal cost and average total cost at that quantity?

ATC min=MC
50/q+ 1/21=q
50/q-1/2q=0
50/q=1/2q
=>q=10
MC=10=> ATC=10
c. Give the equation for each firm’s supply curve.

For a competitive firm, supply = MC above ATC(min). Here, MC = q, ATC(min) =

10.

Supply curve: P=MC=q for P≥10, or equivalently q=P for P≥10P

d. Give the equation for the market supply curve for the short run in which the
number of firms is fixed.

Qs=nxq ( there are 9 firms in the market)

=>Qs=9q

e. What is the equilibrium price and quantity for this market in the short run?
Qd=Qs
120-P=9P
120= 9P+P
=>P=12
=>Q=120-12=108

f. In this equilibrium, how much does each firm produce? Calculate each firm’s
profit or loss. Is there incentive for firms to enter or exit?

q=Q/n=108/9=12

profit=TR-TC=Pxq- 50 - 1/2x 12^2 = 22( because profit>0, new firms wil have
incentive to enter market)

g. In the long run with free entry and exit, what is the equilibrium price and
quantity in this market?

●​ In long run: π=0 ⟹ P=ATC(min)=10

 ●​ MC=ATC⇔ 50/q + 1/2q=q ⇔ 50/q - 1/2q=0 => q =10

h. In this long-run equilibrium, how much does each firm produce? How many
firms are in the market?

●​ Each firm produces at minimum ATC: q=10​

●​ Number of firms:N=Qd/q=110/10=11

=>Each firm produces 10 units, 11 firms in the market, price = 10.

CHAPTER 15
Problem 6: You live in a town with 300 adults and 200 children, and you are
thinking about putting on a play to entertain your neighbors and make some
money. A play has a fixed cost of $2,000, but selling an extra ticket has zero
marginal cost. Here are the demand schedules for your two types of customer

a. To maximize profit, what price would you charge for an adult ticket? For a
child’s ticket? How much profit do you make?
❖​ Revenue = Price × Quantity
●​ To maximize revenue from adults:

$7 × 300 = $2,100 (max)

$8 × 200 = $1,600

$9 × 100 = $900​
→ So charge $7 for adults.

●​ Revenue for children:

$5 × 100 = $500

$4 × 200 = $800 (max)

$3 × 200 = $600​
→ So charge $4 for children.
 ❖​ Profit = Total Revenue − Fixed Cost
●​ Revenue adults = 300 × $7 = $2,100​

●​ Revenue children = 200 × $4 = $800​

●​ Total Revenue = $2,100 + $800 = $2,900​

●​ Profit = $2,900 − $2,000 = $900

b. The city council passes a law prohibiting you from charging different prices
to different customers. What price do you set for a ticket now? How much
profit do you make?

We now have to choose one price for everyone.

●​ Combine demand: 300 adults + 200 children = 500 potential customers​

●​ Maximum revenue = $2,100 at $7 (adults only)

=>Profit= $2,100-$2,000=$100

●​ But if we want everyone included, at $4 revenue = $2,000

=>Profit=$2,000-$2,000​

●​ Profit = Revenue − FC = $2,000 − $2,000 = $0

=> Price at $7 seems better for profit .(But including children ($4) gives the
same revenue as adults alone. Usually, price $7 maximizes profit ($100).)

c. Who is worse off because of the law prohibiting price discrimination? Who
is better off? (If you can, quantify the changes in welfare.)

●​ Adults: Could be neutral or better off depending on the uniform price.​

●​ Children: Could be better off (if price = $4) or worse off (if price = $7).​

●​ Producer: Always worse off (profit decreases from $900->$0).​

●​ Consumer surplus: Some consumers (like children at a lower price) may

benefit, but not all.​
=>Key point: Producer loses, some consumers may gain, outcome
depends on the single price.
d. If the fixed cost of the play were $2,500 rather than $2,000, how would your
answers to parts (a), (b), and (c) change?

FC = $2,500

●​ Profit falls by $500 everywhere (subtract extra $500 fixed cost)​

●​ (a) Profit = $900 − $500 = $400​

●​ (b) Profit = $0 − $500 = −$500 (loss)​

●​ (c) Welfare effects: same pattern; producer worse off, children

potentially better off​

CHAPTER 16
Problem 6:Sparkle is one of the many firms in the market for toothpaste, which
is in long-run equilibrium.
a. Draw a diagram showing Sparkle’s demand curve, marginal-revenue curve,
average-total-cost curve, and marginal-cost curve. Label Sparkle’s
profit-maximizing output and price.
 ●​ In perfect competition, a firm is a price taker, so its demand curve is
horizontal at the market price PPP.
●​ Profit-maximizing output occurs where MR = MC.
b. What is Sparkle’s profit? Explain.

●​ Economic profit formula: π=(P−ATC)⋅q

●​ In the long run for a perfectly competitive firm:

-Market price = Marginal Cost MC= Minimum Average Total Cost ATC.

-Profit-maximizing output q occurs where MC intersects ATC at its

minimum.

●​ Result:

-P=ATC⇒π=0

-Sparkle earns zero economic profit; the firm just covers all costs,
including opportunity costs.

●​ Explanation:​
-With free entry and exit in the market, if there were positive profits, new
firms would enter → supply increases → price falls.​
-If there were losses, firms would exit → supply decreases → price rises.​
-Thus, in the long run, the firm always earns zero economic profit

c. On your diagram, show the consumer surplus derived from the purchase of
Sparkle toothpaste. Also show the deadweight loss relative to the efficient
level of output.
●​ Consumer surplus (CS): triangle area between price P and demand
curve D, from 0 to q*.
●​ Deadweight loss (DWL): 0 in the long run, since q* is efficient output
(MC = P).
d. If the government forced Sparkle to produce an efficient level of output,
what would happen to the firm? What would happen to Sparkle’s customers?
●​ In reality, in long-run perfect competition: the efficient output already
equals the long-run equilibrium output (P = MC).
●​ Hypothetical case if output is forced beyond equilibrium:​
-ATC at that output could be higher than P → economic losses.​
-The firm may lose money, eventually reducing output or exiting the
market if not compensated.
●​ Effect on customers:​
-If output is set equal to equilibrium/efficient level → no change;
consumers already maximize surplus.​
-If output is forced beyond equilibrium → price may fall, consumers gain
short-term benefit, but the firm may face long-term losses.

Problem 7:Consider a monopolistically competitive market with N firms. Each

firm’s business opportunities are described by the following equations:

a. How does N, the number of firms in the market, affect each firm’s demand
curve? Why?

As N increases, 100/N decreases, so each firm’s demand curve:

●​ Shifts downward and becomes smaller​

●​ The maximum price consumers are willing to pay for a firm’s product
falls

Intuition:More firms in the market → more product varieties → each firm gets a
smaller share of the market, so demand for each individual firm declines.

b. How many units does each firm produce? (The answers to this and the next
two questions depend on N.)
MR = MC
100/N − 2Q = 2Q
Q = 25/N
c. What price does each firm charge?

P = 100/N − Q

P = 75/N
d. How much profit does each firm make?

TR = P × Q = 1875/N²

TC = 50 + 625/N²

Profit = 1250/N² − 50

e. In the long run, how many firms will exist in this market?

TR = P × Q = 1875/N²

TC = 50 + 625/N²

Profit = 1250/N² − 50

CHAPTER 17
Problem 4:Consider trade relations between the United States and Mexico.
Assume that the leaders of the two countries believe the payoffs to alternative
trade policies are as follows:

a. What is the dominant strategy for the United States? For Mexico? Explain

A dominant strategy is a strategy that gives a higher payoff regardless of what

the other player does.

United States:

-If Mexico chooses low tariffs, the U.S. gains more from high tariffs ($30 billion
> $25 billion).​
-If Mexico chooses high tariffs, the U.S. still gains more from high tariffs ($20
billion > $10 billion).

➔​ The dominant strategy for the United States is to impose high tariffs.
Mexico:

-If the U.S. chooses low tariffs, Mexico gains more from high tariffs ($30 billion
> $25 billion).

-If the U.S. chooses high tariffs, Mexico gains more from high tariffs ($20
billion > $10 billion).

➔​ The dominant strategy for Mexico is also to impose high tariffs.

b. Define Nash equilibrium. What is the Nash equilibrium for trade policy?

Nash equilibrium is a situation in which no player can improve their payoff by

unilaterally changing their strategy, given the strategy chosen by the other
player.

Because both countries have high tariffs as their dominant strategy, the Nash
equilibrium is: High Tariffs

At this equilibrium:

●​ U.S. payoff = $20 billion​

●​ Mexico’s payoff = $20 billion

Neither country has an incentive to change its policy on its own.

c. In 1993, the U.S. Congress ratified the North American Free Trade
Agreement, in which the United States and Mexico agreed to reduce trade
barriers simultaneously. Do the perceived payoffs shown here justify this
approach to trade policy? Explain.

Yes, the payoffs clearly justify the approach taken by NAFTA.

●​ If both countries choose low tariffs, each gains $25 billion, which is
higher than the Nash equilibrium payoff.​

●​ However, without an agreement, each country has an incentive to raise

tariffs unilaterally.

NAFTA serves as a binding commitment that allows both countries to reduce

trade barriers simultaneously, helping them avoid the inefficient Nash
equilibrium. Therefore, the perceived payoffs support the use of trade
agreements to promote cooperation.
d. Based on your understanding of the gains from trade (discussed in
Chapters 3 and 9), do you think that these payoffs actually reflect a nation’s
welfare under the four possible outcomes?

Probably not.

According to the theory of gains from trade (Chapters 3 and 9):

●​ Free trade increases consumer surplus and overall economic efficiency.​

●​ Tariffs create deadweight losses and reduce total welfare.​

The payoffs in the matrix likely reflect political or short-run interests, rather
than total national welfare. In reality, mutual low tariffs would generate larger
long-term gains than those suggested by the table.

Problem 9: Little Kona is a small coffee company that is consid ering entering
a market dominated by Big Brew. Each company’s profit depends on whether
Little Kona enters and whether Big Brew sets a high price or a low price

a. Does either player in this game have a dominant strategy?

Big Brew:

-If Little Kona enters:

●​ High price → Big Brew earns $3 million

●​ Low price → Big Brew earns $1 million

→ High price is better

-If Little Kona does not enter:

●​ High price → Big Brew earns $7 million​

 ●​ Low price → Big Brew earns $2 million

→ High price is better​

=>Big Brew has a dominant strategy: set a high price.

Little Kona:

-If Big Brew sets a high price:

●​ Enter → Little Kona earns $2 million​

●​ Don’t enter → earns $0

→ Enter

-If Big Brew sets a low price:​

●​ Enter → Little Kona loses $1 million​

●​ Don’t enter → earns $0

→ Don’t enter

=> Little Kona does not have a dominant strategy

b. Does your answer to part (a) help you figure out what the other player
should do?

[Link] Big Brew has a dominant strategy (high price), Little Kona can
predict Big Brew’s action. Knowing this, Little Kona should choose the best
response to high prices, which is to enter the market.

c. What is the Nash equilibrium? Is there only one?

A Nash equilibrium is a situation in which no player can improve their payoff

by unilaterally changing their action.

●​ Big Brew chooses high price (dominant strategy)​

●​ Little Kona chooses enter (best response to high price)

=> Nash equilibrium: (Enter, High Price)

●​ Big Brew profit: $3 million​

●​ Little Kona profit: $2 million

d. Big Brew threatens Little Kona by saying, “If you enter, we’re going to set a
low price, so you had better stay out.” Do you think Little Kona should believe
the threat? Why or why not?

No, the threat is not [Link] Brew threatens to set a low price if Little
Kona enters. However:

●​ When entry occurs, Big Brew earns more by setting a high price ($3
million) than a low price ($1 million).

Because Big Brew would not actually carry out the threat when the time
comes, the threat is not credible, and Little Kona should ignore it and enter the
market.

e. If the two firms could collude and agree on how to split the total profits,
what outcome would they pick?

The firms would choose the outcome that maximizes total [Link] profits
under each outcome:

●​ Enter, High price: $3m + $2m = $5m​

●​ Enter, Low price: $1m − $1m = $0​

●​ Don’t enter, High price: $7m + $0 = $7m​

●​ Don’t enter, Low price: $2m + $0 = $2m

=>Collusive outcome: Little Kona does not enter, and Big Brew sets a high
price, yielding $7 million total profit, which they could then share.

CHAPTER 21
Problem 5: Jacob buys only milk and cookies.
a. In year 1, Jacob earns $100, milk costs $2 per quart, and cookies cost $4 per
dozen. Draw Jacob’s budget constraint.
Income = $100
Milk= $2
Cookie= $4
a) Qm = 100/2 = 50
Qc = 100/4 = 25
Budget constraint:
b. Now suppose that all prices increase by 10 percent in year 2 and that
Jacob’s salary increases by 10 percent as well. Draw Jacob’s new budget
constraint. How would Jacob’s optimal combination of milk and cookies in
year 2 compare to his optimal combination in year 1?
10% of $100 = $10
→ New Jacob’s salary: $110
→ New price: milk: $2,2 , cookie: $4,4
New Qm= 110/2,2 = 50
New Qc= 110/4,4 = 25
New budget constraint:

Problem 7: A college student has two options for meals: eating at the dining
hall for $6 per meal, or eating a Cup O’ Soup for $1.50 per meal. Her weekly
food budget is $60.
a. Draw the budget constraint showing the trade-off between dining hall meals
and Cups O’ Soup. Assuming that she spends equal amounts on both goods,
draw an indifference curve showing the optimum choice. Label the optimum as
point A.
Pdh = $6
Pcs = $1,5
I = $60
All consumption in Cup O’ Soup:
Qcs = 60/1,5 = 40
All consumption in dining hall:
Qdh = 60/6 = 10 Budget constraint:

I = [Link] + [Link]
60 = [Link] + 1,[Link]
60 = 6.Q + 1,5.Q 60= 7,5Q
=>Q1= 8

b. Suppose the price of a Cup O’ Soup now rises to $2. Using your diagram
from part (a), show the consequences of this change in price. Assume that our
student now spends only 30 percent of her income on dining hall meals. Label
thenew optimum as point B.
Pdh . Qdh = I.30%
[Link] = 60.30%
6Qdh= 18
Qdh = 3
I = [Link] + [Link]
60= 6.3 + 2Qcs
=>Qcs = 21

c. What happened to the quantity of Cups O’ Soup consumed as a result of

this price change? What does this result say about the income and
substitution effects? Explain.
CS effect:
Due to increase Pcs
Income effect: Negative.
Substitute effect: Positive.
TE > 0
SE > IE
DH effect:
Due to increase Pcs
Income effect: Positive.
Substitute effect: Negative.
TE < 0
SE > IE
d. Use points A and B to draw a demand curve for Cup O’ Soup. What is this
type of good called?
Point A:
Price P=1.50
Quantity Q=8
Point B:
Price P=2.0
Quantity Q=21