Chapters 5 & 6 Practice A 1.

A firm faces the following demand and total cost schedules, with all quantities listed on a permonth basis. Suppose that it is required to produce a whole number of items each month. Demand P Q $20 1 18 2 15 3 12 4 8 5 Total Cost Q TC 1 $5 2 15 3 30 4 50 5 75

a. How much does the firm produce, and at what price? How do you know? b. Suppose that the firm is subject to an excise tax of $5 per item sold. How much does it produce, and at what price? How do you know? c. Suppose, instead, that the firm is subject to a tax of $20 per month, regardless of how much it produces. How much does it produce, and at what price? How do you know? d. Suppose, instead, that the firm is subject to a tax of $25 per month, regardless of how much ir produces. How much does it produce, and at what price? How do you know? (HINT: You have to figure out MR and MC before you can answer these questions. MC may or may not change between parts a, b, c, and d.)

2. On the graph below, label the points where: i. marginal product is highest ii. AP = MP iii. MP = 0

3. Amalgamated SteelWorks has the following production function: Q = (0.25KL)1/2 (which can be written equivalently as Q = 0.251/2K1/2L1/2) (note: X1/2 = X ) The wage rate is $60 and the rental rate of capital is $200. In the short run, the firm has rented 400 units of capital. a. What is the firms short run total cost function (in terms of Q)? b. What are the firms average total cost function (ATC), average variable cost function (AVC), average fixed cost function (AFC), and marginal cost function (MC)?

4. For the following total variable cost and total fixed cost curves, derive the associated total cost, marginal cost, average variable cost, and average total cost curves, explaining the key relationships.

(change in convexity) 5. Evaluate the following statement and explain your answer both graphically and in words: If marginal cost rises when output is increased, then the average cost of production is also increasing. 6. We know that to be at an optimal production input combination, MRTSLK = PL/PK. We know that Q = MPLL + MPKK (then set Q = 0 to stay on the same isoquant). How can we take these two things and then find the result that the marginal product per dollar spent on every input must be the same if a firm is at the optimal input combination?

7. Suppose you are hired as a new manager of a firm producing 40 units of output with 8 units of labor and 3 units of capital. Assume the price of labor is $50 and the price of capital is $150. Along the isoquant, the MRTSLK is as noted in Table 1. Answer the questions below using the graph and the table below:

a. Explain how the firm can determine whether it is minimizing the cost of producing 40 units of output. b. In detail, explain how, as a manager, you make the optimizing decisions to minimize cost. c. To minimize cost, you should use _____ workers and _____ units of capital. 8. Use the following production schedule to answer the questions below. Assume that this firm can only use whole units of capital and labor, and that the price of capital is $10 and the price of labor is $30.

a. If this firm is using 4 units of capital, at what point does diminishing marginal return of labor set in? b. If this firm is using 3 units of capital, what is the marginal cost if production increases from 265 to 285? c. If this firm is using 3 units of capital, why would we expect to see a U-shaped marginal cost curve? Between what levels of output would the MC curve bottom out? d. If this firm is producing 400 units of output with 5 units of capital and 5 units of labor, what is the MRTS?

e. If this firm is producing 400 units of output with 5 units of capital and 5 units of labor, is the firm experiencing increasing, decreasing, or constant returns to scale? Explain how you know. f. If this firm is producing with 4 units of capital and 2 units of labor, is the firm minimizing its cost? If so, how do you know? And if not, should they be using more capital and less labor OR less capital and more labor, and how do you know that? 9. Jennys Donut Factory produces 5,000 donuts per day using 2 inputs, capital (K) and labor (L). Jenny rents capital at $100 per unit per day, and each worker gets paid $50 per day. Jenny chooses to spend $1,000 per day. Jennys Donut Factory has been producing on its expansion path using 12 units of labor. a. Draw the isoquant and isocost curves that match the situation outline above. Clearly label all relevant parts of your diagram. b. How many units of capital are employed? c. What is the MRTS at the cost-minimizing output combination? Suppose Jenny decides to increase production to 8,000 donuts and to do so will require an extra 6 units of capital (and L is fixed in the short run at 12 units). Assume the expansion path is a straight line from the origin through the current input choice. d. What is Jennys new total cost? e. Draw the new isoquant and isocost curves in the graph above. f. Is she on her expansion path? How do you know? Explain whether
M PK . PK M PL will be < or > PL

g. Assume Jenny has hired you as her economic advisor. Explain to her how she can lower her cost of producing 8,000 units by changing her input mix.