Chapter 7 answers PDF

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This contains the answers of Chapter 7 Microeconomics. ...

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Answers to Practice Question Question 1 a) production function b) economic profits c) short run; long run Question 2 a) law of diminishing returns b) marginal product c) above; below Question 3 a) minimum b) increase c) capacity Question 4 a) Hourly wages are an explicit cost. These are subtracted from revenues for computing both accounting and economic profits. b) Depreciation of physical capital is an explicit cost. It is subtracted from revenues for computing both accounting and economic profits. c) The risk-free 2% return is part of the alternative return that investors could have earned if they did not invest in this firm. This is an implicit (opportunity) cost, and is subtracted from revenues to compute economic profit. It is ignored in the computation of accounting profit. d) Rental payments for a production facility are an explicit cost. It is subtracted from revenues for computing both accounting and economic profits. e) The additional wages the owner could have received in alternative employment is an implicit (opportunity) cost. It is subtracted from revenues to compute economic profit, but ignored in the computation of accounting profit. f) The risk premium of 3% is part of what owners could have earned if they invested elsewhere rather than in this firm. It is an implicit (opportunity) cost and is subtracted from revenues to get economic profit, but ignored in the computation of accounting profit.

Question 5 a) As shown in Table 7-1 in the chapter, accounting profits are equal to revenues minus explicit costs, and do not include the opportunity cost of the owner’s financial capital. The total revenues shown are $657 000. The total explicit costs equal $542 000. Thus the accounting profit is the difference between the two, $115 000. b) The 16 percent rate of return on capital is an annual rate. If equally risky ventures in other industries can generate a 16 percent annual return, then the opportunity cost on Mr. Buford’s capital for one year is 0.16  ($400 000) = $64 000. c) Economic profits are equal to accounting profits minus the opportunity cost of the owner’s financial capital. Thus economic profits for Spruce Décor in 2013 are $115 000 – $64 000 = $51 000. d) If Spruce Décor is a typical firm in the industry then the typical firm is making positive economic profits. Thus profits in this industry are higher than what is available in equally risky ventures in other industries. Such positive economic profits will lead other firms to enter this industry. Question 6 Note that the opportunity cost of remaining in business is not only the $70 000 in explicit expenses the carpenter incurs, but also the income from the furniture factory that the carpenter cannot receive because he has made the decision to operate his own shop. If this forgone salary is any larger than $30 000, then the carpenter should go back to the factory. Another way to say this is that his (accounting) profits are $30 000 per year when he runs his own business. So if his salary at his first job is higher than $30 000, he should go back to the factory. Question 7 a) The table is completed below. Note that for marginal product ( MP), the computation is done for the change in output and labour input between rows. Thus, the first value in the table for MP reflects the change in output from 0 to 2 and the change in labour from 0 to 1; the marginal product is therefore equal to ∆TP/∆L = 2/1 = 2.

Units of Labour (per week) 0 1 2 3 4 5 6 7 8

Number of Snowboards (per week) 0 2 5 9 14 18 21 23 24

AP

MP

--2 2.5 3 3.5 3.6 3.5 3.3 3

2 3 4 5 4 3 2 1

b) The MP and AP curves are shown in the figure below.

Question 9 a) The average product of labour is equal to total output divided by the number of units of labour input. The values are shown in the table below and the AP curve is plotted in the figure below. b) The marginal product of labour is equal to the change in total output divided by the change in labour input that brought it about. In the table above, we compute the marginal product according to the change in values from one row to the next, so the first row is left empty. The MP curve is plotted in the figure above. Note that the values are plotted at the midpoints of the units of labour. Average Product AP = 200/100 = 2.0 AP = 260/120 = 2.17 AP = 350/140 = 2.5 AP = 580/160 = 3.63 AP = 720/180 = 4.0 AP = 780/200 = 3.9 AP = 800/220 = 3.64 AP = 810/240 = 3.38

Marginal Product MP = 60/20 = 3.0 MP = 90/20 = 4.5 MP = 230/20 = 11.5 MP = 140/20 = 7.0 MP = 60/20 = 3.0 MP = 20/20 = 1.0 MP = 10/20 = 0.5

c) The law of diminishing marginal returns is satisfied for labour because (eventually) the marginal product of labour falls as more and more labour is used.

d) As we explained in the text, the average product of labour can only rise if the marginal product exceeds the average product. This relationship is seen clearly in the figure for levels of labour input below 180. Similarly, the average product of labour only falls when the marginal product is less than the average product, as seen in the figure for values of labour above 180. It follows that the MP curve must intersect the AP curve at its maximum, as shown in the figure. Question 12 a) Average fixed cost (AFC) is equal to total fixed cost ( TFC) divided by the level of output. The values for AFC are shown in the table below. b) Average variable cost (AVC) is equal to total variable cost (TVC) divided by the level of output. The values for AVC are shown in the table below. c) Average total cost (ATC) is equal to total cost (TVC + TFC) divided by the level of output. Alternatively, ATC is equal to the sum of AFC and AVC. The values for ATC are shown in the table below. The firm’s “capacity” is the level of output at which ATC is minimized, which in this case is 8 (thousand) bicycles per year. Output (000s per year) 1 2 3 4 5 6 7

AFC Average Fixed Cost ($)

AVC ATC Average Variable Average Cost ($) Total Cost ($)

200/1 = 200 200/2 = 100 200/3 = 66.7 200/4 = 50 200/5 = 40 200/6 = 33.3 200/7 = 28.6

40/1 = 40 70/2 = 35 105/3 = 35 120/4 = 30 135/5 = 27 155/6 = 25.8 185/7 = 26.4

240 135 101.7 80 67 59.1 55.0

8 9 10 11

200/8 = 25 200/9 = 22.2 200/10 = 20 200/11 = 18.2

230/8 = 28.8 290/9 = 32.2 350/10 = 35 425/11= 38.6

53.8 54.4 55 56.8

d) The scale diagram is shown below. Note that the upper-most section of the AFC curve is not shown.

Question 14 a) At this level of output, note that MC is above ATC, which means that ATC must be rising as output increases. This further implies that we are at a level of output beyond which ATC and AVC reach their minimum points. So we are on the upward-sloping portion of the MC curve and thus are already encountering diminishing marginal returns, and also on the upward-sloping portion of the AVC curve and so are encountering diminishing average returns. b) Since the firm is on the upward-sloping portion of the ATC curve, it is operating beyond its level of capacity....