Answers
1.H suggests looking at whether productivity would rise or fall. Productivity is certainly important, since the more productive workers are, the lower the cost per gallon of beer. R wants to look at average cost. But both H and Rare missing the other side of the equationrevenue. A firm wants to maximize its profits, so it needs to examine both costs and revenues. Thus, T is right it’s best to examine whether the extra revenue would exceed the extra costs. T is the only one who is thinking at the margin.
2. If the price of tap water rises, the demand for bottled water increases. This is shown in Figure 2 as a shift to the right in the demand curve from D1 to D2. The corresponding marginal-revenue curves are MR1 and MR2. The profit-maximizing level of output is where marginal cost equals marginal revenue. Prior to the increase in the price of tap water, the profit-maximizing level of output is Q1; after the price increase, it rises to Q2. The profit-maximizing price is shown on the demand curve: it is P1 before the price of tap water rises, and it rises to P2 after. Average cost is AC1 before the price of tap water rises and AC2 after. Profit increases from (P1 - AC1) x Q1 to (P2 - AC2) x Q2.
Figure 1 (you might want to draw a simpler figure with constant marginal = average cost)
3. a.The following table shows total revenue and marginal revenue for each price and quantity sold:
Price / Quantity / Total Revenue / Marginal Revenue / Total Cost / Profit24 / 10,000 / £ 240,000 / ---- / £ 50,000 / £ 190,000
22 / 20,000 / 440,000 / £ 20 / 100,000 / 340,000
20 / 30,000 / 600,000 / 16 / 150,000 / 450,000
18 / 40,000 / 720,000 / 12 / 200,000 / 520,000
16 / 50,000 / 800,000 / 8 / 250,000 / 550,000
14 / 60,000 / 840,000 / 4 / 300,000 / 540,000
b.Profits are maximized at a price of £16 and quantity of 50,000. At that point, profit is £550,000.
c.As Jimmy's agent, you should recommend that he demand (slightly less than) £550,000 from them, so he instead of the record company receives (almost) all of the profit.
4. Larry wants to sell as many drinks as possible without losing money, so he wants to set quantity where price (demand) equals average cost, which occurs at quantity QL and price PL in Figure 3. Curly wants to bring in as much revenue as possible, which occurs where marginal revenue equals zero, at quantity QC and price PC. Moe wants to maximize profits, which occurs where marginal cost equals marginal revenue, at quantity QM and price PM.
Figure 2 (you might want to draw a simpler figure with constant marginal = average cost)
5.If a 10% increase in price would decrease demand by only 5%, the firm must be operating at a point where marginal revenue is negative, and hence profits cannot possibly be maximised. In particular, the output is above the profit maximising level. To avoid being fired, Paul might argue that although this strategy does not maximise the firm profit in the short run, it is optimal in the long run because it reduces future costs (e.g. through a learning by doing effect) or increases future demand (e.g. by driving competitors out of the market).
6. a.If the products are sold separately, the profit maximising price is £8 and the total profit is £24 (that is, £12 on each product). The detailed calculation is
b.If the firm bundles the two products, since the products are independent both consumers will have a willingness to pay for the bundle equal to £18 (= £10 + £8 = £8 + £10). The unit cost of each bundle would be 4. Clearly, the profit maximizing bundle price would be 18, with a total profit of £28. By bundling the two products, the firms earns £4 extra profit.
7. The following table illustrates average fixed cost (AFC), average variable cost (AVC), and average total cost (ATC) for each quantity. The efficient scale is 4 houses per month, since that minimizes average total cost.
Quantity / Variable Cost / Fixed Cost / Total Cost / Average Fixed Cost / Average Variable Cost / Average Total Cost0 / £0 / £200 / £200 / --- / --- / ---
1 / 10 / 200 / 210 / £200 / £10 / £210
2 / 20 / 200 / 220 / 100 / 10 / 110
3 / 40 / 200 / 240 / 66.7 / 13.3 / 80
4 / 80 / 200 / 280 / 50 / 20 / 70
5 / 160 / 200 / 360 / 40 / 32 / 72
6 / 320 / 200 / 520 / 33.3 / 53.3 / 86.7
7 / 640 / 200 / 840 / 28.6 / 91.4 / 120
8. Once you have ordered the dinner, its cost is sunk, so it does not represent an opportunity cost. As a result, the cost of the dinner should not influence your decision about stuffing yourself.
9. Though Britney Spears has a monopoly on her own singing, there are many other singers in the market. If Spears were to raise her price too much, people would substitute to other singers. So there is no need for the government to regulate the price of her concerts.
10. a.Dropping the letter grade by two letters (e.g., A to C) if you have no fun gives the payoffs shown in this table:
Your DecisionWork / Shirk
Classmate's
Decision / Work / You get a C
Classmate gets a C / You get a B
Classmate gets a D
Shirk / You get a D
Classmate gets a B / You get a D
Classmate gets a D
b. The likely outcome is that both of you will shirk. If your classmate works, you're better off shirking, because you would rather have an overall B (a B grade and fun) then an overall C (an A grade and no fun). If your classmate shirks, you are indifferent between working for an overall D (a B grade with no fun) and shirking for an overall D (a D grade and fun). So your dominant strategy is to shirk. Your classmate faces the same payoffs, so will also shirk. But if you are likely to work with the same person again, you have a greater incentive to work, so that your classmate will work, so you will both be better off. In repeated games, cooperation is more likely.