Econowk 5 - assignment PDF

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1. Economies of Scale

Consider the following table of long-run total costs for three different firms:

Quantit y

1

2

3

4

5

6

7

Firm A

25

30

40

60

90

120

15 0

70

Firm B

75

80

85

90

95

10 0

15

Firm C

40

65

90

115

140

17 0

Indicate whether each firm experiences economies of scale or diseconomies of scale. ( Note: If a firm experiences economies of scale in one region and diseconomies of scale in another, make sure to select both columns.)

Firm

Economies of Scale

Diseconomies of Scale

A

B

C Points: 0.33 / 1 Close Explanation Explanation: The following table shows quantity, total cost (TCTC), and average total cost (ATCATC) for the three firms:

Quantit y

Firm A TC ATC

Firm B TC ATC

Firm C TC ATC

1

25

25.00

70

70.00

15

15.00

2

30

15.00

75

37.50

40

20.00

3

40

13.33

80

26.67

65

21.67

4

60

15.00

85

21.25

90

22.50

5

90

18.00

90

18.00

115

23.00

6

120

20.00

95

15.83

140

23.33

7

150

21.43

10 0

14.29

170

24.29

Firm A has economies of scale from one to three units of output and diseconomies of scale for levels of output beyond three units. Firm B has economies of scale because average total cost declines as output increases. Firm C has diseconomies of scale because average total cost rises as output rises. See Section: Economies and Diseconomies of Scale.

3. Costs in the short run versus in the long run

Ike’s Bikes is a major manufacturer of bicycles. Currently, the company produces bikes using only one factory. However, it is considering expanding production to two or even three factories. The following table shows the company’s short-run average total cost (SRATC) each month for various levels of production if it uses one, two, or three factories. (Note: Q equals the total quantity of bikes produced by all factories.)

Average Total Cost (Dollars per bike) Q= 600

Number of Factories

Q = 100

Q = 200

Q = 300

Q = 400

Q = 500

1

440

280

240

320

480

800

2

620

380

240

240

380

620

3

800

480

320

240

280

440

Suppose Ike’s Bikes is currently producing 600 bikes per month in its only factory. Its short-run average total cost is

$280

per bike. Points: 0/1 Close Explanation Explanation: If Ike’s Bikes has one factory, the average total cost of producing bikes can be read from the first row of the table. You can see from the table that the average cost of producing 600 bikes per month is $800 per bike. Suppose Ike’s Bikes is expecting to produce 600 bikes per month for several years. In this case, in the long run, it would choose to produce bikes using two factories .

Points: 0/1 Close Explanation Explanation: In the long run, Ike’s Bikes can vary all factors of production, including the number of factories. Because Ike’s Bikes can achieve the lowest average total cost of producing 600 bikes ($440 per bike) by having three factories, in the long run, it will choose to operate three factories to achieve that longrun level of output. On the following graph, plot the three SRATC curves for Ike’s Bikes from the previous table. Specifically, use the green points (triangle symbol) to plot its SRATC curve if it operates one factory (SRATC1SRATC1); use the purple points (diamond symbol) to plot its SRATC curve if it operates two factories (SRATC2SRATC2); and use the orange points (square symbol) to plot its SRATC curve if it operates three factories (SRATC3SRATC3). Finally, plot the long-run average total cost (LRATC) curve for Ike’s Bikes using the blue points (circle symbol). Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically. Your AnswerSRATC1SRATC2SRATC3LRATC010020030040050060070080072064056048040032024016080 0AVERAGE TOTAL COST (Dollars per bike)QUANTITY (Bikes) Correct Answer

Points: 0/1 Close Explanation Explanation: For each of the three short-run average total cost curves, you should have simply plotted the data from the table: 0100200300400500600700800720640560480400320240160800AVERAGE TOTAL COST (Dollars per bike)QUANTITY (Bikes)SRATC1SRATC2SRATC3 For the long-run average total cost curve, you should have selected the point for each output level that corresponds to the lowest possible average total cost. For output levels of 100 and 200 bikes per month, for example, Ike’s Bikes can achieve its lowest average total cost by using one factory; for 300 bikes per month, its lowest cost can be achieved using one or two factories; for 400 bikes per month, its lowest cost can be achieved using two or three factories; and for more than 400 bikes per month, it minimizes its average total cost by using three factories. In the following table, indicate whether the long-run average cost curve exhibits economies of scale, constant returns to scale, or diseconomies of scale for each range of bike production.

Range

Economies of Scale

Constant Returns to Scale

Diseconomies of Scale

More than 400 bikes per month

Fewer than 300 bikes per month

Between 300 and 400 bikes per month Points: 0/1 Close Explanation

Explanation: A firm experiences economies of scale when long-run average total cost falls as it increases production. In the long run, Ike’s Bikes can produce 100 bikes per month for an average total cost of $440 per bike, 200 bikes per month for an average total cost of $280 per bike, and 300 bikes per month for an average total cost of $240 per bike. The average total cost stays constant at $240 within the range of 300 to 400 bikes per month and increases when Ike’s Bikes produces more than 400 bikes per month. Therefore, it experiences economics of scale when it produces fewer than 300 bikes per month. Graphically, this is seen as the downward-sloping portion of Ike’s Bikes’s LRATC curve. A firm experiences constant returns to scale when it can increase production without changing long-run average total cost. In the long run, Ike’s Bikes can produce 300 or 400 bikes per month for an average total cost of $240 per bike. Therefore, it experiences constant returns to scale within this range. Graphically, this is seen as the horizontal portion of Ike’s LRATC curve. A firm experiences diseconomies of scale when long-run average total cost increases as it increases production. In the long run, Ike’s Bikes can produce 400 bikes per month for an average total cost of $240. As Ike’s Bikes increases production further, however, the average total cost rises. Therefore, it experiences diseconomies of scale when it produces more than 400 bikes per month. Graphically, this is seen as the upward-sloping portion of Ike’s LRATC curve.

Attempts:

At t empt1scor ei s : 0. 5At t empt 2scor ei s: 1 Keep the Highest:

0. 5outof11/1 5. Competition

Bob's lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for $27 each. His total cost each day is $280, of which $30 is a fixed cost. He mows 10 lawns a day. In the short run, Bob should

not shut down

. In the long run, Bob should

exit

the

industry. Points: 1/1 Close Explanation

Explanation: Because Bob's average total cost is $280/10=$28$280/10=$28, which is greater than the price, he will exit the industry in the long run. Because fixed cost is $30, average variable cost is $280− $3010=$25$280−$3010=$25, which is less than the price, so Bob will not shut down in the short

run. See Sections: The Firm's Short-Run Decision to Shut Down; and The Firm's Long-Run Decision to Exit or Enter a Market.

Attempts:

Attempt 1 score is:1.1Attempt2 score is:3 Keep the Highest: 1.1 out of 33 / 3 6. Firm’s Costs 2 Consider the following cost information for a pizzeria: Quantity

Total Cost

Variable Cost

(Dozens of pizzas)

(Dollars)

(Dollars)

0

320

0

1

380

60

2

430

110

3

460

140

4

500

180

5

550

230

6

620

300

The pizzeria's fixed cost is $320

.

Points: 1/1 Close Explanation Explanation: Fixed costs are costs that do not vary with the quantity of output produced. The easiest way to determine fixed costs is to examine total cost at an output of zero. In this case, the fixed cost is $320. (Note: This is also the difference between total cost and variable cost.) See Section: Fixed and Variable Costs. Complete the third column of the following table by calculating the marginal cost per dozen pizzas using the information on total cost. Then complete the final column by calculating the marginal cost per dozen pizzas using the information on variable cost. Quantity

Total Cost

Marginal Cost

Variable Cost

Using Total Cost (Dozens of pizzas)

0

(Dollars)

(Dollars)

320

Using Variable Cost (Dollars)

380

60

60

50

2

430

(Dollars)

0 60

1

Marginal Cost

50

110

Quantity

Total Cost

Marginal Cost

Variable Cost

Using Total Cost (Dozens of pizzas)

(Dollars)

(Dollars)

Using Variable Cost (Dollars)

30

3

460

140

500

40

180

50

5

550

50

230

70

6

Points: 1/1 Close Explanation Explanation:

620

(Dollars) 30

40

4

Marginal Cost

70

300

Marginal cost is the amount that total cost (TCTC) rises when the firm increases production by 1 unit of output (QQ). Therefore, you can compute the marginal cost of the first unit of output in the following way: Marginal CostMarginal Cost = = ΔTCΔQΔTCΔQ = = $380−$3201−0$380−$3201−0 = = $60$60 If instead you use variable cost to determine marginal cost, you can compute the marginal cost of the first unit of output in this way: Marginal CostMarginal Cost = = ΔVCΔQΔVCΔQ = = $60−$01−0$60−$01−0 = = $60$60 Similar calculations can be made to complete the remainder of the table. See Section: Average and Marginal Cost. True or False: It doesn't matter whether you compute marginal cost using total cost or variable cost. True False Points: 1/1 Close Explanation Explanation: Marginal cost equals the change in total cost for each additional unit of output. It is also equal to the change in variable cost for each additional unit of output. This occurs because total cost equals the sum of variable cost and fixed cost, and fixed cost does not change as the quantity changes. Thus, as quantity increases, the increase in total cost equals the increase in variable cost. See Section: Average and Marginal Cost

1. Profit maximization using total cost and total revenue curves

Suppose Rina runs a small business that manufactures frying pans. Assume that the market for frying pans is a competitive market, and the market price is $20 per frying pan.

The following graph shows Rina's total cost curve. Use the blue points (circle symbol) to plot total revenue and the green points (triangle symbol) to plot profit for frying pans quantities zero through seven (inclusive) that Rina produces. Correct AnswerTotal RevenueProfit0123456782001751501251007550250-25TOTAL COST AND REVENUE (Dollars)QUANTITY (Frying pans)Total Cost1, 30 Your Answer Points: 0/1 Close Explanation Explanation: Total revenue is equal to price times quantity. Therefore, the total revenue curve is an increasing line with a slope of $20 per unit. Profit is equal to total revenue minus total cost. The following table captures the data needed to plot the total revenue curve and profit curve:

Quantity (Frying pans)

Total Revenue (Dollars)

Total Cost (Dollars)

Profit (Dollars )

0

0

15

-15

1

20

30

-10

2

40

40

0

3

60

45

15

4

80

50

30

5

100

60

40

6

120

75

45

7

140

100

40

Calculate Rina's marginal revenue and marginal cost for the first seven frying pans she produces, and plot them on the following graph. Use the blue points (circle symbol) to plot marginal revenue and the orange points (square symbol) to plot marginal cost at each quantity. Correct AnswerMarginal RevenueMarginal Cost0123456784035302520151050COSTS AND REVENUE (Dollars per frying pan)QUANTITY (Frying pans)0.5, 15 Your Answer Points:

0/1 Close Explanation Explanation: Marginal revenue is equal to the additional revenue earned for each additional frying pan sold. For a competitive firm, marginal revenue is always equal to the market price. Since Rina can sell as many frying pans as she can make at a price of $20 per frying pan, her marginal revenue from selling any given frying pan is $20. Marginal cost is the change in cost when Rina increases production by one frying pan. You can find this by calculating the difference between each total cost given in the following table. For instance, the marginal cost of the third frying pan ($5) is equal to the total cost of producing three frying pans ($45) minus the total cost of producing two frying pans ($40):

Quantity

Total Revenue

Marginal Revenue

Total Cost

Marginal Cost

(Frying pans)

(Dollars)

(Dollars)

(Dollars)

(Dollars)

0

0

15

20

1

20

15

30

20

2

40

10

40

Quantity

Total Revenue

Marginal Revenue

Total Cost

Marginal Cost

(Frying pans)

(Dollars)

(Dollars)

(Dollars)

(Dollars)

20 3

60

5 45

20

4

80

5

50

20

5

100

10

60

20

6

120

7

140

15

75

20

25 100

Quantity

Total Revenue

Marginal Revenue

Total Cost

Marginal Cost

(Frying pans)

(Dollars)

(Dollars)

(Dollars)

(Dollars)

Rina's profit is maximized when she produces

frying pans. When she does this, the marginal cost of the last frying pan she produces is

$ , which is

than the price Rina receives for each frying pan she sells. The marginal cost of

producing an additional frying pan (that is, one more frying pan than would maximize her profit) is

$ , which is

than the price Rina receives for each frying pan she sells. Therefore, Rina's profit-

maximizing quantity corresponds to the intersection of the

taker, this last condition can also be written as

curves. Because Rina is a price

.

Points: 0/1 Close Explanation Explanation: As shown on the first graph, profit is maximized at an output level of 6 frying pans. At this quantity, the difference between total revenue and total cost is greatest. Another way of thinking about this is to realize that for the first 6 frying pans that Rina produces, the marginal cost ( MCMC) of producing each frying pan is less than the marginal revenue (MRMR) she receives from selling the frying pan. Beyond the sixth frying pan she produces each hour, the marginal cost of producing that frying pan is greater than the price Rina receives for it; therefore, choosing to produce more than 6 frying pans reduces Rina's profit. Because and

MR>MCMR>MC ($20>$15$20>$15) to the left of the optimal quantity

MR...