Download Econ 22060, Section 004 - Principles of

Econ 22060, Section 004 - Principles of Microeconomics
Fall, 2001
Dr. Kathryn Wilson
Due: Thursday, October 18
Homework #3 – Answer Sheet
In honor of the Cleveland Indian’s being in the playoffs, this homework has a baseball theme.
Go Tribe!
1. The following table shows the number of bags of peanuts that can be produced by the
Peterson Nut Company depending on how many workers the company has working.
Number of
Worker
10
11
12
13
14
15
Bags of
Peanuts
500
550
590
620
640
650
Marginal
Physical Product
---50
40
30
20
10
a. In the table, fill in the marginal physical product for the 11th through 15th workers.
b. Is the law of diminishing marginal returns consistent with what we see for the workers in the
Peterson Nut Company? In your answer make sure you explain what the law of diminishing
marginal returns is. Yes. As the number of workers increases, the marginal physical
product (extra output produced by adding an additional worker) goes down. When we go
from 10 to 11 workers, we get an extra 50 bags of peanuts; when we go from 14 to 15
workers, we only get an additional 10 bags of peanuts. This implies there must be some
fixed input in production.
c. Give examples of at least 2 fixed inputs in the production of peanuts and 2 variable inputs in
the production of peanuts. Answers will vary. Here as some examples.
fixed inputs
variable inputs
the factory
labor
insurance
peanuts
d. Explain how the law of diminishing marginal returns is related to the shape of the marginal
cost curve. The law of diminishing marginal returns results in the marginal cost curve eventually
being upward sloping. For example, look at the table above. If we want to make 550 instead of
500, we only have to add 1 worker to get those extra 50 bags of peanuts. The marginal cost of
making the bags of peanuts is pretty low. If we want to go from 650 to 700 peanuts, we would have
to add more than 5 workers to get those extra 50 bags of peanuts. The marginal cost of making the
bags of peanuts is quite high. Under the law of diminishing marginal returns, as we increase the
quantity we make, the marginal cost of making the product increases.
2. Based on his dominating performance in game one of the series with Seattle, a company
decides to make a life-size Bartolo Colon bobble-head doll. The table shows the costs for the
firm. Fill in the remaining spaces.
Quantity
0
1
2
3
4
5
6
7
8
9
Fixed
Costs
500
500
500
500
500
500
500
500
500
500
Variable
Costs
0
200
380
580
800
1040
1300
1580
1880
2200
Total
Costs
500
700
880
1080
1300
1540
1800
2080
2380
2700
Marginal
Costs
----200
180
200
220
240
260
280
300
320
Average
Fixed
Costs
----500
250
166.7
125
100
83.3
71.4
62.5
55.6
Average
Variable
Costs
----200
190
193.3
200
208
216.7
225.7
235
244.4
Average
Total
Costs
----700
440
360
325
308
300
297.1
297.5
300
3. A firm produces replica Omar Vizquel diamond studded earrings. The average total cost of
making an earring is $8. With the number of earrings they are currently selling, the marginal cost
of making the last earring is $12. The firm can sell as many earrings as it wants for a price of
$10. Would you suggest that the firm should sell more earrings for $10, fewer earrings for $10,
or congratulate them because the number of earrings they are selling is maximizing profit?
Justify your answer. (Just for clarification, the product is named for Omar not because Omar
wears earrings but rather because earlier in the season a Seattle pitcher got thrown out of a
ballgame for his behavior after Omar complained that the reflection from the pitcher’s diamond
earring made it hard to see the pitch.) We know firms maximize profits by selling the quantity
where marginal revenue equals marginal costs. The marginal revenue of selling one more unit is
$10 (each extra earring they sell they bring in an extra $10). The marginal cost of the last unit is
$12. Since marginal cost > marginal revenue, the firm is not maximizing profits; the firm would
have higher profits if it sold fewer earrings. We can see this by the fact that the last earring they
sold cost them $12 to make and they only got paid $10 for it – they lost $2 on that earring so their
profits would have been $2 higher if they hadn’t sold it. The firm is still making a profit (price is
higher than average total cost), but the profit is not as high as it could have been.
4. Susan quit her job as a schoolteacher, took her life savings of $10,000, and bought a stand
outside of Jacob’s Field where she sells Tribe gear. She loves her job. Her accountant tells her
she is making $15,000 in profit for the year. What would you tell Susan about her economic
profits? (Are her economic profits more or less than $15,000 and what is the difference between
economic profits and accounting profits?) Do you think she is earning positive economic
profits? The difference between economic profit and accounting profit is that accounting profit
does not take into account opportunity costs but economic profit does. In other words, economic
profit considers what the person is giving up as a cost. In this case, Susan is giving up the salary
she could have made as a schoolteacher and she is giving up the interest she could have made on
her life savings if instead of buying the stand she had left the $10,000 invested. If we include these
as costs, her profit will be much lower (economic profit is much lower than accounting profit). In
fact, providing that teaching pays more than $15, 000 per year, she has negative economic profit.
5. Wisconsin has cheeseheads to wear for games, but alas Cleveland has nothing comparable. To rectify
this situation, a company decides to make “glove heads” to sell to fans sitting in the bleacher seats. The
product is an oversized foam baseball glove that you wear on your head to catch homerun balls hit by the
Tribe. The quantity where marginal revenue equals marginal cost is 2,000 glove heads. When the firm
makes 2,000 glove heads, it has fixed costs of $21,000 and variable costs of $15,000. The price of glove
heads is $10.
a. What are the firm’s profits if they stay in business in the short run?
Profits = Total Revenue – Total Cost = Price * Quantity – Total Cost = $10*2000 – (21,000+15,000)
= $-16,000 The firm is losing $16,000.
b. What are the firm’s profits if they shut down in the short run?
If they shut down, they will have zero total revenue but will still have to pay their fixed costs.
Profit = $0 - $21,000 = -$21,000. The firm is losing $21,000
c. You are hired as a consultant to the firm. Do you recommend they stay open in the short run or shut
down in the short run? You must not only give your recommendation, but explain to the owner of the
company the rationale for your decision. I recommend the firm stay open in the short run since it is
losing less money by staying open than it would lose by shutting down ($16,000 compared to
$21,000). The reason the firm should stay open is that it is covering its variable costs, the extra
costs of staying open (total revenue = $20,000 and variable costs = $15,000). As long as a firm is
covering variable costs, any extra money can help to pay for the fixed costs, which the firm has to
pay whether it is open or closed.
d. You are hired as a consultant to the firm. Do you recommend they stay open in the long run or shut
down in the long run? You must not only give your recommendation, but explain to the owner of the
company the rationale for your decision. The firm should shut down in the long run since it has
negative profit. In the long run, the firm can get out of its fixed obligations (sell the building, get
out of a lease, etc.). Once it can get out of these obligations, it should and go do whatever the next
best alternative is since that pays $16,000 better than staying in business.
6. Suppose the industry for Cleveland Indian flags is perfect competition. The Acme Flag Company can
sell flags for $50 and has the total costs indicated in the table below.
Quantity
Total Cost
Marginal Cost
50
2300
51
2340
40
52
2385
45
53
2435
50
54
2490
55
55
2550
60
a. What quantity of flags should Acme sell to maximize profits? How much are their profits? We know
firms maximize profit by selling the quantity where marginal revenue = marginal cost. The
marginal revenue for the firm is the $50 price it charges for the flags. The marginal cost for the
firm can be calculated from the total costs that are given. The firm wants to sell 53 flags to
maximize profit. Profit = total revenue * total cost = 53*$50 - $2435 = $2650 - $2435 = $215.
b. If the Acme Flag Company increased the price of their flags to $60, given the market is characterized
by perfect competition, what do you think would happen to their profits? (You do not have to give me a
specific number for their profits, but explain what would happen.) Since the market is perfect
competition, there are many companies all selling identical flags. If the Acme Flag Co. tried to
charge a price higher than the market price, they would not be able to sell any flags because people
would just buy the flags from the other companies instead. Their profits would fall a lot.