Economics 0105

                      Homework #6-Answers

 

                            Table 1

 

     P       QD       TR       MR        MC       TC

 

   $40       5      $200      $32      $16      $196

 

    38       6       228       28       12       208

 

    36       7       252       24        8       216

 

    34       8       272       20        4       220

 

    32       9       288       16        8       228

 

    30      10       300       12       12       240

 

    28      11       308        8       16       256

 

    26      12       312        4       20       276

 

    24      13       312        0       24       300

 

    22      14       308       -4       28       328

 

    20      15       300       -8       32       360

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1. Fill in the blank columns in Table 1. Then use the data in the table to draw a graph, label the points with numbers, and do the following:

 

a. Find the profit-maximizing price and quantity and label them on your graph. For what range of output is ED > 1? For what range of output is ED <1? Explain.

Profits are maximized at $60 when MR = MC = $12 so P* = $30 and Q* = 10. The unit elastic point occurs at P = $24 and Q = 13 for a TR = $312. For all Q < 13 (P > $24), ED > 1 while for all Q > 13 (P < $24), ED < 1.

 

b. Calculate profits at the profit-maximizing price and quantity and indicate the area on your graph (Hint: What is LRAC at profit-maximizing output?).

 

TR - TC = $300 - $240 = $60. LRAC = TC/Q = $240/10 = $24

 

c. Identify the price and output level that would occur in a      competitive industry.

 

PC = $24 and QC = 13 where LRMC crosses demand

(LRMC = P).

 

 

 

 

 

d. Calculate profits at some level of output where MR > MC and      where MR < MC and explain your results.

 

Q = 7 and MR > MC. TR - TC = $252 - $216 = $36

(Increase Q to increase profits.)

 

Q = 13 and MR < MC. TR - TC = $312 - $300 = $12

(Decrease Q to increase profits.)

 

 2. If a single price monopolist/price-searcher is earning negative economic profit, show this graphically. Explain under what circumstances this firm should shut-down and under what circumstances it should keep producing output.

 

        

EXTRA CREDIT: The basic idea here concerns the effect of SR sunk or fixed costs on decisions to exit or stay in the industry: These costs are irrelevant to current decision-making. That is, only marginal costs (at the margin) affect decisions to stay in the industry or exit.

 

That means that the firm should shut down in the short-run only if its losses from continuing operations with negative profits (say -$10,000) exceed its losses from the fixed costs of producing at zero output when the firm shuts down (say -$5,000).

 

 

 

Otherwise, the firm should continue to operate in the short-run with negative profits if its losses from continuing operations (say -$3,000) are less than the losses (fixed or sunk costs) that would occur if the firm shut down (say -$5,000).