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Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
19
Chapter 6 Production and Cost
Review Questions
2. Advantages to locating production in firms with employees, instead of independent contractors,
include the following:
• Firms enjoy gains from specialization and save on transaction costs as a result. Firms with
employees can thus produce a given amount of output using fewer resources than they would
using a collection of independent contractors.
• The lower costs enjoyed by firms means they can charge lower prices than independent
contractors and pay higher wages.
• Owners of a firm can benefit from diversification—they can own shares in several firms,
thus reducing their risk exposure in any one firm.
4.
Bigger is not always better. Increased firm size creates several problems, such as greater
difficulty and expense in communication, hiring, decision-making, and monitoring workers. In
any industry, a point is reached where the advantages of further firm growth are outweighed by
the disadvantages.
6.
a. Fixed. Ordering and installing more ovens probably takes longer than a month.
b. Variable. The furniture manufacturer will increase this input in step with the quantity of its
output.
c. Variable. Same reasoning as (b).
d. Variable. When not covered under some long-term contract, labor is almost always a variable
input.
e. Probably variable in a month. Hertz can add cars to its fleet quickly; however, if governed
by longer-term contracts with automakers, its fleet may be more of a fixed input over a
month.
8.
Fixed costs are the costs involved in purchasing a firm’s fixed inputs; variable costs are costs of
obtaining a firm’s variable inputs. Using this classification:
a. Variable. Steel is a variable input for GM that changes when output changes.
b. Fixed. Rent does not vary with output.
c. Variable. Varies with the number of papers printed, i.e., output.
10.
While there is no logical necessity for the U shape of the typical LRATC curve, it seems to typify
the cost structure of firms in a variety of industries.
The downward sloping portion of the curve results from economies of scale. These are
realized when long-run total cost rises proportionately less than output, due to gains from
specialization or more efficient use of lumpy inputs.
At some point, these economies are exhausted; however, as output continues to increase,
diseconomies of scale are encountered. In this situation, long-run total cost rises more than in
proportion to output.
20 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
Problems and Exercises
2.
One reason why firms producing the same product merge is to take advantage of economies of
scale. By merging, the owners can take advantage of the gains to be had from specialization and
from more efficient use of lumpy inputs. A major reason firms merge with firms in unrelated
areas of business is diversification. By not “putting all their eggs in one basket,” firms are not as
exposed to as much risk should their primary business suffer a downturn. A good example is
tobacco—when it was clear that public and government opinion had turned hostile to cigarette
smoking, many tobacco firms bought out companies in totally unrelated businesses. If their
cigarette business foundered, their other, unrelated businesses might still prosper.
4.
The increase in demand for petroleum products must have increased their price. Since fuel is a
major variable input for any airline, Continental’s MC, AVC, and ATC curves must have all
shifted upward. Its AFC, however, would be unaffected, since fixed costs are the cost of fixed
inputs such as hangars and aircraft.
6.
Output
0
Capital
1
Labor
0
TFC
$75
TVC
$ 0
TC
$75
30
1
1
75
50
125
70
1
2
75
100
175
MC
AFC
—
AVC
—
ATC
—
$2.50
$1.67
$4.17
1.00
1.42
2.50
0.63
1.25
1.88
0.47
1.25
1.72
0.39
1.32
1.71
0.36
1.43
1.79
$1.67
1.25
1.00
120
1
3
75
150
225
160
1
4
75
200
275
1.25
1.67
190
1
5
75
250
325
210
1
6
75
300
375
2.50
a. Clean n’ Shine experiences increasing marginal returns to labor over the range of
0-120 units of output. It experiences decreasing marginal returns to labor at all output levels
beyond 120.
b. Yes. Average fixed costs fall as output rises.
c. Yes. First, they all fall as output rises, then begin to rise as output continues to rise.
d. Yes. AVC and ATC both fall until they intersect MC, and then the rising marginal costs pull
them up.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
8.
21
a. No. He can fill in the rest of the entries on his own.
Units Number
Output
of
of
Per Day Capital Workers TFC
0
10
0
$1,000
TVC
$0
TC
$1,000
20,000
10
100
$1,000
$9,000
$10,000
40,000
10
133.3
$1,000
$12,000
$13,000
60,000
10
225
$1,000
$20,250
$21,250
MC
$0.450
AFC
AVC
ATC
-
-
-
$0.050
$0.450
$0.500
$0.025
$0.300
$0.325
$0.017
$0.338
$0.355
$0.013
$0.325
$0.338
$0.150
$0.413
$0.288
80,000
10
289
$1,000
$26,000
$27,000
b. MC, AVC and ATC have the right relationship for an output below 60,000. However, when
output increases from 60,000 to 80,000, the MC falls again, thus causing both AVC and ATC
to fall.
10. Assume that each firm in the industry originally produced at its MES, shown by point A. The
initial decrease in demand for personal computers pushed each firm up its LRATC curve to point
B. Meanwhile, Dell’s cost-cutting innovations changed the shape of its LRATC curve, allowing it
to achieve MES at a larger level of output. (The LRATC curves for Dell are shown in panel b. Dell
originally operated at point A on its original cost curve, LRATC1. After its innovations changed
the shape of its cost curve to LRATC2, Dell moved to point D.) This allowed Dell to cut prices for
its personal computers, which further decreased demand for the other firms in the industry,
pushing them further up their LRATC curves to point C.
12.
If the LRATC curve lies above the demand curve at each and every quantity, there is no quantity at
which a firm could cover its costs. The orphan drug will not be produced.
22 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
Challenge Questions
2.
Whenever the MC curve is below ATC, ATC must fall, and whenever the MC curve is above
ATC, then ATC must rise. Keeping this in mind, the MC curve would be graphed as:
Economic Applications Exercises
2.
a. There have been a significant number of technological advances that allow users to become
more productive.
b. There does seem to be a positive relationship between labor productivity and real GDP.
c. These changes are likely to be long run, since they were the result of technological advances
in production. As a result, they do not appear to be short-lived.
Chapter 7 How Firms Make Decisions: Profit Maximization
Review Questions
2.
A firm can earn an accounting profit at the same time it is suffering an economic loss. For
example, consider an entrepreneur who purchases $100,000 worth of raw materials and foregoes
a salary of $50,000 to devote his time to his business. If his total revenues equal 120,000, he has
earned an accounting profit of $20,000, and an economic loss of $30,000. It is not possible to
earn an economic profit while at the same time suffer an accounting loss.
4.
A market demand curve gives the quantity demanded by all consumers from all firms in the
market for each price. The demand curve facing the firm gives the quantity demanded from a
single firm.
6.
a. The firm calculates profit as total revenue minus total cost and selects the output level that
gives maximum profit. Graphically, the firm produces output where the vertical distance
between the total revenue and total cost curve is greatest and where the total revenue curve
lies above the total cost curve.
b. The firm increases output when marginal revenue is above marginal cost and decreases
output when marginal revenue is less than marginal cost. Graphically, the firm produces the
level of output closest to where the marginal cost and marginal revenue curves intersect.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
23
Problems and Exercises
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 explicit costs:
$50  12 =
$3,600
25,000
600
$29,200
$35,000
$10,000  .05 =
$250  12 =
c. Congratulations are not in order since
$55,000 – ($29,200 + $38,500) = –$12,700.
500
3,000
$38,500
economic
profit
for
the
year
is
4.
The profit-maximizing level of output is 14, since the marginal revenue associated with the 14th
unit equals the marginal cost of that unit ($25). When output rises from 14 to 15, the marginal
revenue of the 15th unit ($23) is less than MC of that unit ($27).
6.
a. 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.
c. Since the best that Ned can do is to earn a -$100 profit if he continues to operate, he should
shut down and produce 0 beds in the long run.
Challenge Questions
2.
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
ATC
TC
74
$10,000
$740,000
75
$12,000
$900,000
76
$14,000
$1,064,000
MC
$160,000
$164,000
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.
24 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
Economics Applications Exercises
2.
Sony’s decision highlights the impact – or lack thereof – of fixed costs on its production decision. By
eliminating Ms. Carey’s contract, which can be considered a fixed cost, Sony can focus on lower-volume
contracts, allowing it to increase profit there.
Chapter 8 Perfect Competition
Review Questions
2.
Many markets are reasonably close to perfect competition, and by using the model of perfect
competition, we can make valuable predictions about those markets. Perfect competition
approximates and gives accurate enough predictions in a variety of markets.
4.
The demand curve facing a perfectly competitive firm is infinitely elastic since a perfectly
competitive firm is a price taker. If such a firm increases its price above the going market price,
it would lose all of its customers; it won’t lower its price below the market price because it never
has to (it can sell all the output it wants without lowering its price).
6.
Comparing price and ATC tells us the firm’s profit per unit, which can then be multiplied by the
number of units to obtain total profit. But the firm’s goal is to maximize total profit, not profit
per unit; looking at price and ATC doesn’t tell us what level of output maximizes total profit. For
this, we need to look at price and marginal cost.
8.
a. Uncertain. When price exceeds minimum AVC, the firm will not shut down, but its profit
could be positive (if P > ATC > AVC) or negative (if AVC < P < ATC).
b. False. A competitive firm’s supply curve coincides with the marginal cost curve for all
prices above the minimum point on the AVC curve. For all prices below the minimum point
on the AVC curve, the supply curve is vertical at zero units of output.
10.
False. Output increases in the long run as more firms enter the market. If the firms are entering a
constant cost industry or a decreasing cost industry, the price will not increase.
Problems and Exercises
2.
Q
TVC
0
$0
MC
6
1
3
TR
Economic
Profit
$6
$6
$0
–$6
6
12
5
–7
6
17
10
–7
6
21
15
–6
5
15
4
TC
5
11
4
TFC
5
6
5
2
MR
5
(Continues)
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
Q
TVC
4
18
MC
4
5
28
TFC
TC
TR
Economic
Profit
6
24
20
–4
6
28
25
–3
6
34
30
–4
5
22
6
6
MR
25
5
a. Set MR equal to MC when MC is rising to find Q* = 5 (assuming that only discrete units of
output can be produced). The firm will not produce a 6th unit of output since the marginal cost
of the 6th unit exceeds the marginal revenue from the sale of the 6th unit.
b. Since the firm’s TC always exceeds its TR, its goal becomes to minimize its economic loss.
This occurs at Q* = 5, where economic profit = –$3.
4.
a. The market equilibrium price—where quantity supplied equals quantity demanded—is $2.00
per pound. Thus, each individual firm will face a price of $2.00, which is also its marginal
revenue. From the total cost column, we can calculate that marginal cost is $1.00 per pound
for increases from 60,000 to 61,000, and from 61,000 to 62,000. When output increases from
62,000 to 63,000, however, MC = $3.00. Since MR > MC for increases in output up to
62,000, but MR < MC beyond 62,000, the typical firm should produce 62,000 pounds.
b. At 62,000 pounds, ATC = TC/Q = $112,000/62,000 = $1.81. Since P > ATC, the firm is
earning a profit. Profit will attract entry, so this market is not in long-run equilibrium.
c. The profit that the firm is earning will attract entry, so that the number of firms will increase.
6.
Yes. In the short run, a higher price induces existing firms to produce more output, while in the
long run, a higher price also induces entry.
8.
In this situation, the technological advance shifts each firm’s ATC downward, leading to a
temporary burst of profit. The profit will attract entry, shifting the market supply curve
rightward. The new equilibrium will occur at point B, where there is a lower equilibrium price.
The only difference between this situation and the one described in the Using the Theory section
of this chapter is that the equilibrium quantity does not change when the market demand curve is
inelastic.
26 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
10. a.
Output
0
Price
$50
Total
Revenue
$0
1
$50
$50
2
$50
$100
Marginal
Revenue
Total Cost
$5
$50
$15
$150
$50
$45
$35
$90
$50
4
$10
$55
$50
$50
$200
Profit
-$5
$35
$40
$50
3
Marginal
Cost
$60
$55
$145
$55
$65
This firm’s short run profit-maximizing quantity of output is 3, found by expanding output as
long as marginal revenue exceeds marginal cost. This firm will earn a profit of $60.
b.
Output
0
Price
$50
Total
Revenue
$0
Marginal
Revenue
Total Cost
$10
$50
1
$50
$50
$50
$45
$100
$50
$150
4
$50
$200
$5
$15
$60
$50
3
Profit
-$10
$35
$50
2
Marginal
Cost
$40
$35
$95
$50
$55
$55
$150
$50
$50
$65
The firm’s profit-maximizing quantity of output stays at 3 units, but its profit falls to $55.
c.
Output
0
Price
$50
Total
Revenue
$0
1
$50
$50
Marginal
Revenue
Total Cost
$5
$50
$50
$100
$50
$95
$150
$50
$5
$55
$150
$50
4
-$10
$35
$50
3
$200
$0
$75
$225
$50
Profit
-$5
$55
$60
$50
2
Marginal
Cost
-$25
$85
The firm’s profit-maximizing quantity of output falls to 2 units, and its profit falls to $5.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
27
Challenge Questions
2.
a. At point A in panel (a), the market is in long-run equilibrium. The typical firm in panel (b)
earns zero economic profit. If demand increases, market price rises. Individual firms increase
output and earn an economic profit. Profit attracts entry, increasing market supply, while
ATC does not change. When long-run equilibrium is reestablished at point C in panel (c),
price has returned to P1, and the typical firm again earns zero economic profit.
b. Instead of being upward-sloping, the long-run market supply curve is a horizontal line found
by connecting points like A and C in panel (c). More output is offered at point C, because,
although each firm in the industry is producing the same quantity of output as they were at
price P1, there are now more firms in the industry.
28 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
4.
Banning a technology that is in common use in a competitive industry may increase ATC. In
panel (b), firms will earn an economic loss at output level q1. This economic loss will lead to
exit, shifting the supply curve in panel (a) from S1 to S2. As supply decreases, the price rises until
each firm is once again earning zero economic profit.
Economic Applications Exercises
2.
Price
MC
MR2
MR1
Quantity
As more and more farmers lose production due to weather-related circumstances, market supply
falls, raising the market price. Those farmers still in the market see their marginal revenue
increase.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
29
Chapter 9 Monopoly
Review Questions
2.
Monopolies arise because of barriers to entry such as economies of scale, control of a scarce
input, or barriers created by government. Economies of scale over a very large range of output
are a barrier to entry since they mean that one firm can produce at a lower cost per unit than can
two or more firms. If a firm has control of a scarce input needed for production, other firms may
not be able to enter that market. Finally, when a government believes that it is in the public’s
interest to have a single seller, it will prevent entry.
4.
The CEO is wrong to believe that he can set any price he wants and sell as many units as he
wants at that price. Once the CEO decides what price he wants to sell at, the demand curve will
dictate how much output can be sold at that price. Conversely, the CEO may decide how much
output he wants to sell, and the demand curve will give the maximum price at which he can sell
that output.
6.
Unlike a perfectly competitive firm, a monopoly will not always shut down if price is less than
AVC. If the monopoly provides goods or services considered vital, the government may not let it
shut down. Also, the monopoly may not shut down if it views the situation of price less than AVC
as temporary. For example, the monopoly may endure losses in the short run if it feels that doing
so will promote the goodwill of its customers and profits in the long run.
8.
In perfect competition, the market supply curve gives the marginal cost of producing one more
unit of output at each of the perfectly competitive firms. When the monopoly takes over, it will
produce output at one of the previously competitive firms, and the marginal cost of producing
that output will be the same as it was for the previously perfectly competitive firms. Thus, the
marginal cost for the monopoly will be the dollar amount given by the competitive market supply
curve.
10.
For a given technology of production, monopolies charge higher prices and produce lower output
than perfectly competitive firms. Monopolies may, however, be able to change the technology of
production and shift down the marginal cost curve. This would cause prices to fall and output to
increase. The net effect depends on the strength of each of these forces.
12.
A single-price monopoly charges the same price to everyone, while a price-discriminating
monopoly charges different prices to different customers for reasons other than differences in
production costs. In order for a monopoly to price discriminate, it must face a downward-sloping
demand curve; it must be able to identify consumers who are willing to pay more, and it must be
able to prevent low-price consumers from reselling to high-price consumers. A downwardsloping demand curve means that there are some customers who are willing to pay for the
product at a higher price. To charge some consumers a higher price, the firm must be able to
identify those who are willing to do so. Finally, if low-price customers could resell the product to
high-price customers, then no one would pay the high price to the firm, so price discrimination
would be impossible.
30 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
Problems and Exercises
2.
$
$
d = MR
D
MR
Quantity
Perfectly competitive
Quantity
Monopoly
firm
a. In perfect competition, the market demand curve is downward sloping, while the demand
curve facing an individual firm is horizontal, indicating that it is a price taker. In monopoly,
the market demand curve and the demand curve facing the firm are both the same—a
downward-sloping curve.
b. In perfect competition, the firm’s marginal revenue curve coincides with its demand curve,
since every unit is sold at the same price. In the case of a monopoly, the marginal revenue
curve lies below the demand curve, and both curves are downward sloping. To sell an
additional unit of output, the monopoly must lower the price on that unit and all previous
units of output.
4.
For a perfect price discriminator, the marginal revenue curve is the same as the demand curve.
While a single-price monopoly must lower the price on all units of output if it wants to sell
another unit, a perfect-price discriminator only has to lower the price on the additional unit that
she wants to sell. This implies that the price-discriminating monopolist’s revenue rises by the
price of the additional unit, so the marginal revenue curve coincides with the demand curve.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
31
6.
The marginal revenue curve was drawn under the assumption that No-Choice Airline charges a
single price. When No-Choice begins charging two different prices, there is a different marginal
revenue curve. Firms still equate MR and MC to find output, but with price discrimination,
marginal revenue is different for different types of consumers. Equating MR and MC for the
different types of consumers will give the level of output that the firm should allocate to each
type.
8.
a. You will tutor two students, and will charge them each $35, for total weekly earnings of $70.
b. You will tutor four students, charging each student the highest price they are willing to pay.
That is, you will charge prices of $40, $35, $27, and $26. Your total weekly earnings will be
$128.
c. No, because your total revenue ($70) from two students will be less than your total costs
($75).
d. Yes, because your total revenue ($128) from these four students will be more than your total
costs ($125).
10.
A technological change that reduced only the monopolist’s fixed costs would shift only its ATC
curve downward. If the new ATC curve fell below point E at Q*, then the monopolist would no
longer incur an economic loss, and would no longer have an incentive to shut down. For
example, if the ATC curve shifted to ATC2, the monopolist would produce at Q*, and would earn
the economic profit shown by the shaded area.
32 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
A technological change that reduced the monopolist’s variable costs, while leaving its fixed costs
alone, would shift its AVC, MC, and ATC curves downward. If these curves shifted down by enough
to allow the firm to cover its average total costs at its new profit-maximizing quantity of output, the
firm would not have to go out of business. (The graph shows the case where the technological change
will allow the monopolist to earn zero profits.)
Challenge Questions
2. Setting MR = 20 – 8Q and MC = Q2 equal to each other, we have 20 – 8Q = Q2, or Q2 +
8Q – 20 = 0. This is a quadratic equation with solution Q = 2.
Economics Applications Exercises
2. a.
A menu of prices allows a firm to discriminate among consumers, hoping to charge those
willing to pay a higher price more, allowing them to increase their profit.
b. If a firm price discriminates, then it can charge higher prices to those with lower price
elasticity of demand. For those with higher price elasticities, firms will charge lower prices.
c. If an online company can place an individual within a particular category – student; longtime customer; large wish list but no purchases; etc – then it can charge different prices to
different individuals. Because a person is only in one group, and not the others, it does not
know what other prices are available.
Chapter 10 Monopolistic Competition and Oligopoly
Review Questions
2.
False. In the long run, a monopolistic competitor will not produce at minimum ATC. In long-run
equilibrium, there are too many firms producing too little output to achieve minimum ATC.
4.
In oligopoly there are fewer firms than in perfect competition or monopolistic competition, but
more than in monopoly. Unlike perfectly or monopolistically competitive markets, there are
barriers to entry and exit.
6.
In a natural monopoly, economies of scale extend over a wide-enough range of output that the
lowest cost per unit is attained when a single firm produces for the entire market. In a natural
oligopoly, economies of scale do not extend over as wide a range of output, allowing more than
one competitor to enter.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
33
8.
Difficulty observing other firms’ prices, unstable market demand, and a large number of firms
promote cheating—since they lessen the probability of detection. In addition, unstable market
demand means new terms for collusion must be periodically renegotiated, giving firms the
opportunity to cheat in the interim. Finally, if many firms are involved in collusion, any
individual firm may face a smaller chance of getting caught and facing punishment, thereby
increasing the probability of cheating.
10.
New technologies limit the degree of concentration in an industry by creating new substitute
goods and by breaking down barriers to entry. Two examples are cable television and local
phone companies; both face new competition made possible by technological advances (satellite
dishes in the case of cable TV, and cell phones in the case of local phone companies).
12.
It is difficult to apply the definition of oligopoly to real-world markets since doing so involves
defining the relevant market, deciding what number qualifies as “a few,” and deciding whether
market domination by a few firms occurs.
Problems and Exercises
2.
Initially, the monopolist earns an economic profit by producing where MR = MC. Entry will
occur, shifting the firm’s demand and marginal revenue curves leftward (to D2 and MR2). Long
run equilibrium will occur at a point like B, where the firm earns zero economic profit.
4.
a.
Price per
Taco Plate
$5
Taco plates
per Week
50
Total Cost
per Week
$30
Total
Revenue per
Week
$250
4
80
$50
$320
3
150
$176
$450
2
800
$1476
$1600
Marginal
Revenue
Marginal
Cost
$2.33
$0.67
$1.86
$1.80
$1.77
$2.00
34 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
-$1.67
1
1100
$2136
$2.20
$1100
Tino should expand his output as long as MR exceeds MC. His profit-maximizing price is $3
and his profit-maximizing number of taco plates is 150.
b. Tino’s customers will substitute away from Tino’s tacos towards food from his competitor.
Demand for Tino’s tacos will fall, and Tino’s profits will fall.
c.
Price per
Taco Plate
$5
Taco plates
per Week
60
Total Cost
per Week
$130
Total
Revenue per
Week
$300
4
96
$150
$384
3
180
$276
$540
2
960
$1576
$1920
1
1320
$2236
$1320
Marginal
Revenue
Marginal
Cost
$2.33
$0.55
$1.86
$1.50
$1.76
$1.66
-$1.67
$1.83
Tino’s profit-maximizing price is $2, and his profit-maximizing number of taco plates is 960.
Since Tino earns an economic profit of $344 with this combination, entry will occur until
Tino’s economic profit falls to $0.
6. a.
The typical plastics firm produces the output level where MC = MR, charges the
corresponding price given by the demand curve, and earns zero economic profit.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
35
b.
Oil is a variable input, so when oil prices increase, the ATC curve and the MC curve at all
firms shift upward. In the short run, the typical plastics firm suffers economic losses.
c. If prices remained high, and profits remained negative, some firms would exit. Other
firms would experience a rightward shift of their demand curves, and in long-run
equilibrium, the remaining firms would earn zero economic profit.
8.
a. In the payoff matrices below, Road Kill’s payoffs are listed on the left side of each square:
Sal Monella
Clean up
Don't Cleanup
5,000
3,000
Clean up
5,000
12,000
Road Kill
Café
12,000
7,000
Don't
Cleanup
3,000
7,000
b. Both Road Kill Café and Sal Monella have a dominant strategy to clean up.
c. If Road Kill Café and Sal Monella act independently, they’ll both clean up and earn $5,000.
d. When facing the same decision repeatedly, Sal Monella and Road Kill Café might decide to
cooperate. By both agreeing to not clean up, they can each increase their income to $7,000
each.
36 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
e.
Sal Monella
Clean up
Don't Cleanup
5,000
3,000
Clean up
5,000
6,000
Road Kill
Café
6,000
7,000
Don't
Cleanup
3,000
7,000
The restaurants no longer have dominant strategies. For example, Road Kill’s best action
now depends on what Sal Monella chooses. Without cooperation, we would need a more
sophisticated analysis to predict an outcome. With cooperation, however, the firms will
decide not to clean up, and each will earn $7000.
10. a. Nike has a dominant strategy to go “high.” Adidas does not have a dominant strategy.
b. This game will still have an outcome: Adidas can determine that Nike will go high, so it will
go high also.
c. Nike would choose the outrageously high price if it believed that Adidas would follow. Nike
would earn $1.2 million in profits and Adidas would earn $600,000 in profits. While Nike
would have an incentive to charge the high price if Adidas charged the outrageously high
price, Nike would know that Adidas would follow Nike’s pricing, and this would reduce
Nike’s profit. Therefore, the outcome of the game with Nike as price leader is that both
charge the outrageously high price.
Challenge Questions
2.
a. Neither player has a dominant strategy.
b. The outcome of the game cannot be determined from the information in the payoff matrix
using the tools learned in this chapter.
c. Player 2 has a dominant strategy; it is to choose “B”. When one player has a dominant
strategy, we can predict the outcome. Since Player 1 knows that Player 2 will choose “B,”
Player 1 will maximize his payoff by also choosing “B.”
Economics Applications Exercises
2.
a. Answers may vary.
b. Answers may vary.
c. Answers may vary.