Econ 22060 – Principles of Microeconomics

Spring, 2001

Dr. Kathryn Wilson

Due: Tuesday, February 6

Homework 3 – Answer Key

1. The following table shows the costs for a firm. Fill in the remaining spaces.

Quantity / Fixed
Costs / Variable
Costs / Total
Costs / Marginal
Costs / Ave. Fixed
Costs / Ave. Var. Costs / Ave. Total Costs
10 / 300 / 200 / 500 / -- / 30 / 20 / 50
11 / 300 / 240 / 540 / 40 / 27.27 / 21.82 / 49.09
12 / 300 / 300 / 600 / 60 / 25 / 25 / 50
13 / 300 / 380 / 680 / 80 / 23.08 / 29.23 / 52.31
14 / 300 / 480 / 780 / 100 / 21.43 / 34.29 / 55.71
15 / 300 / 600 / 900 / 120 / 20 / 40 / 60
16 / 300 / 740 / 1040 / 140 / 18.75 / 46.25 / 65
17 / 300 / 910 / 1210 / 170 / 17.65 / 53.53 / 71.18
18 / 300 / 1120 / 1420 / 210 / 16.67 / 62.22 / 78.89
19 / 300 / 1380 / 1680 / 260 / 15.79 / 72.63 / 88.42
20 / 300 / 1700 / 2000 / 320 / 15 / 85 / 100

2. A firm produces Cleveland Indians t-shirts. The average total cost of making a shirt is $10. The marginal cost of making the last shirt is $15. The firm can sell as many t-shirts as it wants for $12. Would you suggest that the firm should sell more t-shirts for $15, less t-shirts for $15 or congratulate them because the number of shirts they are selling is maximizing profit? JUSTIFY YOUR ANSWER.

First, I give my apologies. The question was supposed to say should they sell more or less for $12 (not $15) since $12 is the price. If you answered the question based on them selling the shirts for $15, the correct answer would be that they are maximizing profit and should sell the same amount since marginal revenue ($15) equals marginal cost ($15). If you used $12 for the price, then the correct answer is that they should sell fewer shirts. The marginal cost of the last shirt is $15, which is less than the price of $12 that they get paid. While they are still earning a profit (price is $12 and average total cost is $10), they would earn a bigger profit if they sold fewer shirts.

3. A firm has variable costs of $1000, total fixed costs of $700 and total revenue of $800. Calculate the firm’s profits. Should the firm stay open in the short run or should it shut down in the short run? Explain. Should the firm stay open in the long run or should it shut down in the long run? Explain.

The firm is losing money. It’s total cost is $1000+700=$1700 (variable cost plus fixed cost) and its total revenue is only $800. Profits = total revenue – total cost = $800 - $1700 = -$900. To decide if the firm should stay open in the short run, they must compare total revenue to variable costs – are they able to cover the extra costs of staying open. Since total revenue is less than variable costs, the firm should shut down in the short run and stay shut down in the long run. Put differently, they lose $900 by staying open but if they shut down they will only lose the fixed costs of $700.

4. The average total cost of the last unit of production for a firm was $100. The marginal cost of the last unit of production for a firm was $80. Is the firm experiencing economies of scale or diseconomies of scale at its current level of production? Explain how you know. (Hint: think about if the average total cost curve is rising or falling based on the information given.)

Since marginal cost is less than average total cost, average total cost must be falling. We know that when ATC is falling, we have economies of scale.


5. Suppose Sam’s Beef sells sides of beef and the beef industry is perfectly competitive. Sam’s Beef can sell each side of beef for $200 and has marginal costs indicated in the table below.

Quantity Marginal Cost Total Cost

0 300

1 140 440

2 120 560

3 110 670

4 130 800

5 160 960

6 190 1150

7 220 1370

8 250 1620

a) Suppose Sam’s total fixed cost is $300. How many sides of beef does Sam’s produce in the short run? What is Sam’s profits in the short run? What does Sam’s Beef do in the long run? Why?

Sam maximizes profit by producing where MR = MC. His marginal cost is given in the table, and his marginal revenue is the $200 he gets paid for each side of beef he sells. Given this, he wants to sell 6 sides of beef. (At 6, MR is not exactly equal to MC; if he could, he would want to sell something like 6.2 where MR equals MC. However, he does want to sell the 6th one since MR>MC and does not want to sell the 7th one since MR<MC.) To find his profits, we must first calculate his total cost. When Sam produces zero, he still has to pay his fixed costs so he has a total cost of $300. We can then use marginal cost to find that when he makes 6 he has total cost of $1150. His profit = total revenue – total cost = (6*$200) - $1150 = $1200 - $1150 = $50. Since Sam has a profit, he wants to stay in business in the short run and the long run.

b) Suppose Sam’s total fixed cost is $400. How many sides of beef does Sam’s produce in the short run? What is Sam’s profits in the short run? What does Sam’s do in the long run? Why?

The only thing that changes is Sam’s total cost. They are now $100 higher for each quantity so his total cost of making 6 is $1250. His profit = $1200 - $1250 = -$50. Sam is losing money but he would rather stay open in the short run and lose $50 than shut down and lose $400 (his fixed costs). In the long run, Sam will shut down since he is losing money.

6. Explain, in your own words, the difference between accounting profit and economic profit. Why would someone want to stay in business if they were only making $1 of economic profit?

Economic profit includes opportunity cost, which is the value of what you are giving up, while Accounting profit does not include opportunity cost. A person would stay in business with only $1 of economic profit because this means that they are doing $1 better than their next best alternative. There is no other way for them to make that much money.

7. Assuming you are talking with someone who has never taken an economics class, explain in terms he or she would understand why a firm that is losing money (has negative profits) might want to stay in business in the short run and how they should decide if they should stay open or shut down.

If a business has some costs that they have to pay even if they shut down, then it might be worth it for them to stay open even though they are losing money. For example, if a company has a building leased for 1 year and has to pay that lease even if they close, then they want to compare how much money they would lose by being open to how much money they would lose if they had no revenues but kept paying the lease. If they lose less money by staying open than by shutting down, they will stay open. A different way of looking at this is if they can cover they extra cost of staying open, it is worth it to stay open.

8. Answers will vary based on the article you cut out.