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CHAPTER 8 - HOW FIRMS MAKE DECISIONS:
PROFIT MAXIMIZATION
ANSWERS TO EVEN-NUMBERED PROBLEMS
2.
a. Annual explicit costs:
cost of office equipment:
programmer’s salary:
heat and light:
total explicit costs:
b. Annual implicit costs:
salary foregone:
investment income
foregone:
rent foregone:
total implicit costs:
c. Congratulations are not in order since
$55,000 – ($29,200 + $38,500) = –$12,700.
$3,600
25,000
600
$29,200
$35,000
500
3,000
$38,500
economic
profit
for
the
year
is
4.
The profit-maximizing level of output is 14. As the firm chooses to produce the 11 th, 12th and
13th unit MR>MC so it is clear that they should continue to increase their quantity and thereby
increase profits. As the firm considers the production of the 14th unit they see that MR=MC,
i.e. they cannot make any additional profit by producing the 14th unit. Hence, we deduce that
the firm is indifferent between producing 13 or 14 units because their overall profit is the
same. They would definitely not produce the 15th unit as MR<MC, which indicates that they
would earn negative profit on the 15th unit, or equivalently that their overall profit would be
lower if they produced 15 units than if they produced 14.
6.
If the firm’s fixed costs are $3,000 per day, then its variable costs are $7,000 - $3,000 =
$4,000 per day. Since its total revenue is less than this amount, this firm should shut down in
the short run.
b. Since the firm is earning enough total revenue to cover these variable costs, it should
continue to operate in the short run.
8.
a. The tax hike does not affect Ned’s MC and MR curves.
b. Ned should continue to produce 5 beds in the short run.
10.
a. When price falls from $450 to $400, quantity rises from 5 to 6 units per day.
%∆P = ($400 - $450) / $425 = -11.8%.
%∆Q = (6 – 5) / 5.5 = 18.2%.
ED = 18.2% / 11.8% = 1.54
When price falls from $400 to $350, quantity rises from 6 to 7 units per day.
%∆P = ($350 - $400) / $375 = -13.3%.
Chapter 8 How Firms Make Decisions: Profit Maximization
%∆Q = (7 – 6) / 6.5 = 15.4%.
ED = 15.4% / 13.3% = 1.16.
When price falls from $350to $300, quantity rises from 7 to 8 units per day.
%∆P = ($300 - $350) / $325 = -15.4%.
%∆Q = (8 – 7) / 7.5 = 13.3%.
ED = 13.3% / 15.4% = 0.86
b. In Table 1, Total revenue rises when output rises from 5 to 6, and from 6 to 7. These are
the output changes for which demand was found to be elastic (ED > 1) in part a. When
demand is elastic, a drop in price (and a rise in quantity) should increase total revenue. So
the rise in total revenue is consistent with the elasticities.
Total revenue falls when output rises from 7 to 8. For this output change, demand was
found to be inelastic (ED < 1) in part a. When demand is inelastic, a drop in price (and a
rise in quantity) should decrease total revenue. So the behavior of total revenue is once
again consistent with the elasticities.
c. In Table 1, marginal revenue is positive when output rises from 5 to 6, and from 6 to 7.
These are the output changes for which demand was found to be elastic (ED > 1) in part a.
When demand is elastic, a drop in price (and a rise in quantity) should increase total
revenue, which means marginal revenue should be positive. So these values for marginal
revenue are consistent with the elasticities.
Marginal revenue is negative when output rises from 7 to 8. For this output change,
demand was found to be inelastic (ED < 1) in part a. When demand is inelastic, a drop in
price (and a rise in quantity) should decrease total revenue, which means marginal revenue
should be negative. So the value of marginal revenue is once again consistent with the
elasticities.
12.
a. Over the short run (a few months), the bakery’s TFC = $4,000 per month, and its TVC =
$1 x 5,000 = $5,000 per month, so TC = TFC + TVC = $4,000 + $5,000 = $9,000. The
bakery’s total revenue is $1.50 x 5,000 = $7,500 per month. So monthly profit = TR – TC
= $7,500 - $9,000 = -$1,500 (a monthly loss of $1,500).
b. Over the short run (for the next few months), the bakery should keep operating, because
TR of $7,5000 is greater than TVC of $5,000. Staying open gives the bakery an operating
profit, and helps it pay its fixed costs.
c. If the bakery’s current plant is also its least cost plant, it will not be able to reduce costs in
the long run. Since it will be suffering a long-run loss, it should exit the industry in the
long run (i.e., after a year has passed and its lease runs out).
14.
To answer this question, we need to compare the marginal revenue and marginal cost
of the action. Marginal cost can be computed from average total cost by first
computing total cost.
Unit
74
ATC
$10,000
TC
$740,000
MC
$160,000
75
$12,000
$900,000
$164,000
76
$14,000
$1,064,000
Chapter 8 How Firms Make Decisions: Profit Maximization
The marginal cost for the 76th unit is $164,000. Marginal revenue of the 76th unit is
what Backus Electronics is offering to pay for it, or $150,000. Howell should not
accept the offer since marginal cost exceeds marginal revenue.