SECTION V ANSWERS TO QUESTIONS

Warni-up questions: A (e). (a). (a). D (e). E (e). F (b). G (e). H (d). I (a). J (c). (e). L (e). M (e). N(e).0(e). P(a). Q(e). R (c). S (b). T (e). U (e). V(a). W(c). X (e). Y(b). Z (e).

General questions: 1 (a). This is simply another way of expressing total revenue minus total cost. 2 (a). If the firm is producing beyond the point at which is at its lowest, is rising and MC is above it. In equilibrium for a price-taking firm MC = MR = AR. Hence AR is greater than and the firm must be making a profit. By the way, it will help you master the new terminology of this section, if you develop the habit of mentally reading terms such as as "average total cost" instead of the three letters. 3 (b). Remember reflects opportunity cost, which now changes as a result of the change in the price of permanent waves. 4 (e). If he is producing where is a minimum, this is long-run equilibrium so (e) is the answer 5(a). None of the above. This is the definidon of marginal cost. 6 (a). If it takes three months to declare bankruptcy, then this is the shortest period in which all costs can be shed and therefore become variable. 7 (d). The only inference one can draw. 8 (b). Average fixed costs decline continuously with output. 9 (e). Whether marginal costs are rising or falling tells us nothing about whether the average total or variable cost curves are rising or falling. 10 (e). If total cost is increasing, marginal cost by definidon must be positive; we can say nothing about whether marginal or average total cost is rising or falling. 11 (d). MC will rise when you have new and better opportunities elsewhere. ITiis will make you better off. MC can also rise due to increases in the cost of inputs. This would make you worse off. 12 (c). A simple matter of drvid-ing total fixed cost by output. 13 (d). At 5000 units Brown is doing better than ifhe closed down, and he is minimizing his losses since MC=MR. 14 (a). If is falling because of scale economies, MC must be less than . 15 (d). is $75/15 = $5 per unit so MC is below it. 16 (d). Simply divide TC by output at each level of output to fmd the level of output minimizing . 17 (b). The fixed cost is. $4,000 and TVC = TC -TFC. Average variable cost can then be calculated for each level of output. 18 (a). For profit maximization, marginal cost = marginal revenue = $6. 19 (d). = (AR - ATOq = [AR -(AVC + AFC)]q. 20 (d). 7i = TC -TR = $5000 - $2500; so profit per unit = $2500/50 = $50 per unit. 21 (a). If is constant, then MC must

be equal to it. 22 (b). The firm will choose the level of which minimizes total cost for each level of output. 23 (d). MR = P = MC = $90 at 6 units. is covered. 24 (e). = (TR - TC) = ($90) (6) - $450= $90. 25 (e). Modify the total profit formula to derive profit per unit. 26(b). One of our favorites. Nodce that maximizing profit per unit and maximizing total profits are different. After all, how could maximizing something which is not profit be the same as maximizing profit? As you can see, maximizing profit per unit gives smaller total profits. 27 (c). minimum . 28 (d). S50. Entry and expansion will stop when the price falls to $50, the minimum of the curve. 29 (a). Long run industry equilibrium is 12,000 units at $50 each. Each firm will supply 100 units, so there will be 12,000/100 firms. 30 (c). See text. 31. (b). The definition. 32 (d). Remember, at prices below minimum AVC, a firm will produce no output. 33 (e). They amount to the same thing. In both situations producing means losses in excess of TFC, so it pa\s to shut down experiencing the loss of TFC alone. 34 (d). First get total cost by midtiphing by q. 35 (a). AVC is at a minimum at $2.50. 36 (c). Use average/marginal rules. 37 (d). Demand is perfecdy elasdc. 38 (e). Refer to definitions. 39 (d). TFC = (AFC)q. 40 (b). Remember cost in economics includes the value of foregone profitable opportunities, Avhich- dont figure as out-of-pocket cash payments. 41 (c). If firms are earning profits, entry would be attractive. 42 (a). Option (b) may or may not be true. The others are always false. 43 (b). Calculate and find its minimum. 44. First recognize that "cost per can" is etc. You should go back if you missed this. (b). MC = MR at 2 cans. P =70< < AVC = $1.10. so the firm will shut down. TC = $2.50 at 1 can and TVC = 51.50 at 1 can. so TFC = $1. The firm will lose all its TFC by shutting down. 45. (b). MC = MR at 3 cans. P = $1.45 > AVC = $1.21, so the firm will operate, = (P-ATC]q [SI.45 - $1.55]3 = -$0.30. Negative is a loss. 46. (d). MC = MR at 5 cans, per can (P - ] - 40C -($0.40)5 = $2.00. 47 ( ). Diminishing returns cause the TC and TVC curves to stop becoming flatter and start becoming steeper, i.e., MC stops falling and starts rising. and AVC will be falling or rising depending upon whedier MC is above or below. 48 (c). The horizontal summation of the individual supply curves above the price at which it pav-s to operate. .WC. 49 (c). By definition. 50 (d). MR = MC at 7 cars. = (65 - 59) 7 = $42. 51 (b). Labor co.st is a variable cost. 52 (b). See the graphs in text. 53 (b). Same method as questions 28 and 29. 54 (e). Again, whether MC is

increasing tells us nothing about whether the average cost curves are increasing. It only means that the TC and TVC curves are getting steeper 55 (c). Marginal / average rules. 56 (b). If marginal cost is falling where the firm is operadng, it couldnt be maximizing profit. 57 (c). See text. 58 (b). Consequently it cant react as much. 59 (e). You figure it out. 60 (d). The condition for profit maximizadon. 61 (b). P < means a loss. 62 (a). See text. 63 (c). The demand curve faced by the compedtive firm is always flat, i.e., perfecdy elasdc. 64 (d). See text. 65 (b). This is the standard situadon as explained in the text. 66 (c). The difference between these two quanddes is profit. 67 (c). Fixed costs do not affect the TVC curve, so AVC is unchanged. An increase in total fixed cost would shift the TC curve upward by a uniform amount. As such, die slope of the TC curve, i.e., the MC would be unchanged. AFC would, however, rise so that would also rise. It follows that an increase in total fixed cost would not affect either the price or output of a price-taking firm. Intuitively, how covdd a cost that you must pay no matter how you behave ever affect your behavior? 68 (c). In the long rtm the firm operates where is at a minimum and profit is zero. 69 (d). A perfecdy inelasdc demand curve would be verdcal. By the law of demand, this cant ever happen in the market demand, much less in the demand curve faced by a firm. 70 (b). When AVC is at a minimum, is sdll falling. 71 (a). In this case, price is less than minimum , so that is sdll falling. As the previous two quesdons illustrate, you need to be able to correcdy draw these curves. 72 (c). TFC must be $10

since the firm has to pay this amount even if it doesnt produce. Therefore, subtract SIO from each of the total costs depicted and divide bv output to determine where AVC is the smallest. 73 (b). Calculate TR and TC, then subtract TC from TR. 74 (c). See text. 75 (b). 11 + 91. 76 (a). They will equate price with MC. This means 10,000 barrels from Ty-pe I and 89,000 from Type 11. 77 (c). Type I wells will cut back by one barrel to 9 barrels, so there will be a loss of 1 barrels. Each Type II will expand by 1 barrel. Hence no change. 78 (e). The output reducdon in Type I wells will reduce cost by $10 per well for a total cost decrease of $10,000. The increase in total cost in each Type II well is $8 for a total of $8,000. The net saving is $10,000 - $8,000 = $2,000. 79 (e). We could have the same producdon at $2,000 less in total cost. Speaking as economists the strongest statement we could make is the technical one that this is inefficient. Whether there is a real difference between this policy and simply destroying $2,000 worth of property, we leave to your judgment. 80 (e). Were sad to report that the cost of being right is often a certain amount of loneliness. By the way, in case you might think the others favored the two der system out of blind ignorance, you should know that some of the best energy economists in the profession developed powerful jaw muscles tes-dfying before Congress on this subject. Unfortunately, they accomplished litde else. The two der poliq lasted as long as it did because of perverse polidcal incen-dves, not Congressional ignorance. We scratch the surface of polidcal incentives in Section IX

SECTION VI: MONOPOLY AND ITS SOURCES

Our analysis so far has focused exclusively upon compeutive industries, characterized by many firms. We now turn to the polar opposite market structure, monopoly. In Secdon VII, we will consider some intermediate structures.

MONOPOLY DEMAND CURVE

In Section V, we disdnguished between the perfecdy elastic demand - of the price-taking firm and die downward sloping industry demand curve. However, under monopoly a single firm consdtutes the entire industry because entry is blocked. Therefore, die monopolist faces the downwrard sloping industry demand curve.

PRICE SEARCHERS MARGINAL REVENUE

As \se saw in Section III. price-searchers or price-makers are firms facing downward sloping demand curves. An important consequence is that marginal revenue (MR) will turn out to be less than price for all such firms. We illustrate the general relationship in Figure I, where we consider a monopolists demand curve.

For example, at the output of Q price is given by P and MR by the lower amount MR. Hence, in selling another unit near Q. the firms added revenue is not die price P, but the lower amount MR. At Q",

price is given by P"* and marginal revenue is the negative number MR"*. Thus, when the firm sells anodier unit in the vicinity of Q"*, it "gains" the negative added revenue, MR""; which is to say, its total revenue now falls by the amount MR*.

Why should MR be less than price when a firms demand curve slopes down? The topic is so important that we approach it three ways: through average revenue, graphically, and numerically.