Hwk 2 key

Hwk 4 key

I. TRUE Average costs do not include fixed costs, so they are always smaller than average total costs. (Should draw curve showing AVC, ATC and MC).

II. E

III. B The difference between the long and the short run is

b. that in the long run, all inputs can be varied.

IV. This is a badly worded question (from the Multiple choice testbank put together by the textbook). What you need to know is that if p> AVC then the firm will produce Q>0, since the variable costs, and some of the fixed costs can be covered as soon as p rises above AVC. At AVC, the firm is indifferent between exiting or staying in the market.

2. Given the following data:

Q	TC	VC	TR
0	50,000	0	0
1000	250,000	200,000	300,000
2000	500,000	450,000	600,000
3000	A is 800,000	750,000	900,000
4000	1,200,000	1,150,000	1200,000
5000	1,800,000	B is 1,750,000	1500,000

a. What are this firm’s fixed costs? 50,000 b. Solve for a and b. (see table)

c. Graph ATC, AVC and MC.

d. Identify the minimum ATC. Q = 2000 (where ATC crosses MC)

e. Calculate and graph the firm’s total revenue, given a price of $ 300. (See table above.)

f. Graph the TC curve on the graph you drew for part e.

g. How much will the firm produce at this price? Q=3000 (profit max is where p=MC)

Identify in the graph you drew for c.

h. Calculate the firm’s profit at this point. Indicate on the graphs you drew for c and e. TR= 900,000, TC = 800,000, profit = 100,000. Can also calculate by taking (p-ATC)* Q = ($300-266 2/3)*3000 = 100,000

i. Is the profit you calculated economic or accounting profit? Explain. I didn't really give you enough information to answer this, since I didn't provide information about opportunity cost, but in general economists take into account OC and so the profit must be economic profit. (If this were an accounting class, we would look at accounting profit...)

j. If the price drops to $200, how much what will the firm produce? What will the firm’s profits be.

Firm is indifferent between operating and shutting down, since either way, firm’s profits will be negative.
profit = -50,000, Q =1000 or 0.

3. a. See old key.

b. Calculate the producer and consumer surplus in the case of a perfectly competitive market.

CS = ½ (160-60)(100) = 5000, PS = ½ (60-10)(100) = 2500, TS= 7500

c. The new diet will increase wool production, leading to a rightward shift of the Supply curve, driving down p and increasing Q.

d. Consumer surplus will increase, as will producer surplus.

4. a. This article challenges the argument being made by drug companies, which is that they need to keep prices high in order to cover their research and development costs. Instead, high prices are linked to high marketing expenses and salaries and large profits.

b. Whereas economists talk about fixed and variable costs, it is more common in examining an industry, to talk about the costs of inputs (labor, raw materials, etc.) as well as the costs of marketing and reseach and development (R&D). This article emphasizes the costs of the executive labor, and the cost of marketing and R&D.

c. Marketing and R&D costs are all generally fixed costs, since they do not vary with Q. Labor costs are generally variable costs, although in the case of executive pay this is less the case, since exec pay is generally not linked to Q either, which makes it a fixed cost as well!

d. There are a number of ads on TV that talk about a drug, and then say "Ask your doctor." Why do you think this is?

e. Advertising is used to 1. make the demand for a product more inelastic, 2. shift the demand curve to the right. If advertising is successful, firms can charge a higher price, and make more profits.

5.
4. a. Show the impact of a tax on beer on both the beer and wine markets.
See graph outside my office.

Suppose you have estimated an elasticity of demand for beer of -0.9 and an elasticity of demand for wine of -0.3.
What will you say if you are asked to advise the government on whether taxing beer or wine is the best strategy to
b . reduce alcohol consumption. Explain. Taxing beer makes more sense because demand for beer is more elastic. But one must also take into account the fact that some beer drinkers will simply switch to drinking wine (or hard liquor), so a tax on beer might have a negligable effect.
c . raise tax revenues. Explain. Taxing wine makes more sense, since demand is more inelastic, so an increase in price will not reduce Q much, and so tax revenues will be higher.
d. Do the elasticities estimated for beer and wine demand seem realistic? It would seem that the demand for alcohol might be inelastic, since alcohol is somewhat addictive and has few substitutes. It could also be that wine is more inelastic than beer, because wine drinkers are richer, and thus less sensitive to price changes.