Spring 2008                                                                                                                                           Dr. Olmsted

Microeconomics Homework # 4

Due: March 27, 2008

Homework instructions: Staple together, and if you work in a group, be sure to include all group members' names in alphabetical order. SHOW YOUR WORK and if possible, use graph paper. NOTE that for many of these graphs it is not necessary to use the same scale on the X and Y axes (since often the numbers on one axis will be much larger than the numbers on the other).  Instead you should draw proportional graphs. If the numbers on the X axis are in general 10 times larger than the numbers on the Y axis, one unit on X should 10 times larger than the equivalent units on Y

1. Be sure to draw any relevant graphs or formulas in answering the multiple choice and true/false questions:

I. True/False Explain - The average variable cost curve lies below the average total cost curve.

II. Profits equal

a. fixed costs minus average costs.
b. revenues minus fixed costs.
c. revenues minus variable costs.
d. price minus average cost.
e. revenues minus total cost.

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

a. that in the short run, there are constant returns but in the long run there are not.
b. that in the long run, all inputs can be varied.
c. three months.
d. that in the short run, the average cost is decreasing but,  in the long run, it is increasing.
e. a and b.

IV. When the price is greater than the minimum of the average variable cost curve, the firm

a. enters the market.
b. exits the market.
c. may continue or exit, depending on long term projections.
d. shuts down production but does not exit.

2. Given the following data for the widget industry:

Q

TC

VC

0

50,000

0

1000

250,000

200,000

2000

500,000

450,000

3000

a

750,000

4000

1,200,000

1,150,000

5000

1,800,000

b


a. What are this firm’s fixed costs?
b. Solve for a and b.
c. Graph ATC, AVC and MC.
d. Identify the minimum ATC.
e. Calculate and graph the firm’s total revenue, given a price of $ 300.
f. Graph the TC curve on the graph you drew for part e.
g. How much will the firm produce at this price?  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.
i. Is the profit you calculated economic or accounting profit? Explain.
j. If the price drops to $200, how much what will the firm produce? What will the firm’s profits be?
h. Suppose the the US government comes out with a report stating that widgets are bad for your health. Would this help explain the drop in price that this firm is experiencing? Illustrate graphically and explain.
i. What impact will the drop in the output price from $300 to $200 have on the widget worker market?

3. Using the data for the market for wool sweaters (from homework #3 - available on-line at my web page):

a. Graph the market for wool.
b. Calculate producer and consumer surplus in the case of a perfectly competitive market.
c .What impact would the discovery of a new diet, that stimulates sheep to produce more wool, have on the wool sweater market? Graph and explain.
d. How could consumer and producer surplus be affected? (No need for numbers, just provide a general discussion.)

4. Read the article at the following web page: http://www.twnside.org.sg/title/twr131n.htm
a. What is the main point of this article?
b. What are the different types of costs that most pharmaceutical companies incur?
c . Which of these costs would you consider fixed and which ones are variable?
d. Are you familiar with the ads puts out by pharmaceutical companies. If so, provide an example.
e. Why do you think pharmaceutical companies can and do spend so much money on advertising? (Try to think about this in terms of economic terminology!)

5. a. Show the impact of a tax on beer on both the beer and wine markets.
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.
c . raise tax revenues. Explain.
d. Do the elasticities estimated for beer and wine demand seem realistic?