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ECON 1001 AB Introduction to Economics I Dr. Ka-fu WONG

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### ECON 1001 ABIntroduction to Economics IDr. Ka-fu WONG

Sixth weekof tutorial sessions

KKL 925, K812, KKL 106

Clifford CHAN

KKL 1109

Covered and to be covered

- Covered the week before the break
- Dr. Wong finished up to kf006.ppt
- You should have at least read up toChapter 6Perfectly competitive supply: The cost side of the market
- If not, please press hard on it. Start reading Chapter 7
- To be covered in the tutorial sessions this week
- Problems in chapter 6: #1, #3, #5, #7 and#9
- You are advised to work on the even ones as well

Problem #1, Chapter 6 (1)

- Zoe is trying to decide how to divide her time between her job as a wedding photographer, which pays $27 per hours for as many hours as she chooses to work, and as a fossil collector, in which her pay depends both on the price of fossils and the number of them she finds. Earnings aside, Zoe is indifferent between the two tasks, and the number of fossils she can find depends on the number of hours a day she researches, as shown in the table below.

Solution to Problem #1 (1)

- Derive a table with a price in dollar increments from $0 to $30 in the first column and the quantity of fossils Zoe is willing to supply per day at that price in the second column

Solution to Problem #1 (2)

- In the first hour, Zoe can collect 5 fossils
- If the price of a fossil is $5, Zoe can make a total $25 in an hour if she devotes all her time to collecting fossils, which is less than the money she can earn from photography
- Thus, she won’t collect fossil if the price of a fossil is less than $5
- If the price of a fossil is $6 Zoe should devote all her time to photography, as she can make $30 an hour from photography

Solution to Problem #1 (3)

- An additional hour would yield only 4 additional fossils or $24 additional revenue, so she should not spend any further time looking for fossils
- If the price of fossils rises to $7, however, the additional hour gathering fossils would yield an additional $28, so gathering fossils during that hour would then be the best choice, and Zoe would therefore supply 9 fossils per day

Solution to Problem #1 (5)

- Plot these points in a graph with price on the vertical axis and quantity per day on the horizontal. What is this curve called?
- The curve will depict a price-quantity supplied relationship for fossils as follows
- In other words, it is SUPPLY CURVE for fossils

Problem #3, Chapter 6 (1)

- The Paducah Slugger Company makes baseball bats out of lumber supplied to it by Acme Sporting Goods, which pays Paducah $10 for each finished bat. Paducah’s only factors of production are lathe operators and a small building with a lathe. The number of bats per day it produces depends on the number of employee-hours per day, as shown in the table below.

Problem #3, Chapter 6 (3)

- If the wage is $15 per hour and Paducah’s daily fixed cost for the lathe and building is $60, what is the profit-maximizing quantity of bats?
- What would be the profit-maximizing number of bats if the firm’s fixed cost were not $60 per day but only $30?

Solution to Problem #3 (2)

- Based on the above table, we note that the profit-maximizing quantity of bats is 20, as it yield the highest profit of $35
- If the firm’s fixed cost decreases from $60 to $30, what is the profit maximizing quantity of bats?
- It is still 20 bats
- Why?
- Decrease in fixed cost will increase the profits across different quantities of bats by the same amount ($30)
- 20 bats will yield a new highest profit of $35 +$30 = $65

Problem #5, Chapter 6

- The supply curve for the only two firms in a competitive industry are given by P=2Q1 and P= 2+Q2, where Q1 is the output of firm 1 and Q2 is the output of firm 2. What is the market supply curve for this industry? (Hint: graph the two curves side by side, then add their respective quantities at a sample of different prices.)

Solution to Problem #5 (1)

- Horizontal summation means holding price fixed and adding the corresponding quantities

Market supply curve

Firm 1

Firm 2

P

P

P

P =2+Q2

P =2Q1

S

6

6

6

P= (4/3) + (2/3)Q for P>2

4

4

4

2

2

2

P= 2Q for P<2

Q1

Q2

Q

2

1

2

3

4

1

4

7

Problem #7, Chapter 6

- For the pizza seller whose marginal, average variable, and average total cost curves are shown in the accompanying diagram, what is the profit-maximizing level of output and how much profit will this producer earn if the price of pizza is $2.50 per slice?

Solution to Problem #7 (2)

MC

ATC

Price ($/slice)

2.50

AVC

1.40

0

0

0

570

Quantity (slices/day)

Wrong! MC cuts ATC at its minimum.

Solution to Problem #7 (3)

MC

ATC

Price ($/slice)

2.50

AVC

1.40

0

0

0

570

Quantity (slices/day)

Wrong! MC cuts AVC at its minimum.

Solution to Problem #7 (4)

MC

ATC

Price ($/slice)

2.50

AVC

1.40

0

0

0

570

Quantity (slices/day)

Wrong! AVC and ATC approaches each other as quantity increases.

Solution to Problem #7 (5)

- Unless specific, assume it is a perfectly competitive market
- Firms are earning a zero economic profit
- Firms should always charge at a price that is equal to their marginal cost

Solution to Problem #7 (6)

- If P > ATC > AVC, the firm operates with a profit
- If ATC > P > AVC, the firm still operates but with a loss- the operation can cover part of its cost
- If ATC > AVC > P, the firm should shut down as it cannot even cover part of its cost

Solution to Problem #7 (7)

- To maximize profit, the firm will produce 570 slices of pizza a day
- Why?
- A perfectly competitive firm should always charge at a price that is equal to their marginal cost
- The associated profit is (P or MC – ATC)*Q
- ($2.5 / slice - $1.4 / slice) * 570 slices / day
- $627 / day

Problem #9, Chapter 6

- For the pizza seller whole marginal, average variable, and average total cost curves are shown in the accompanying diagram, what is the profit-maximizing level of output and how much profit will this producer earn if the price of pizza is $0.50 per slice?

Solution to Problem #9 (2)

- Recall from Problem #7
- If P > ATC > AVC, the firm operates with a profit
- If ATC > P > AVC, the firm still operates but with a loss- the operation can cover part of its cost
- If ATC > AVC > P, the firm should shut down as it cannot even cover part of its cost
- Based on the diagram above, where is the firm’s shut down point in the short run?
- The firm should shut down at a point where P = $0.68 per slice (where P = AVC)
- If a slice of pizza is sold for only $0.50, the firm will definitely not produce any pizza and shut down

Solution to Problem #9 (3)

- If the firm shuts down, there will be no (average) variable cost
- By shutting down the plant, the firm will have a negative profit that is exactly equal to the fixed cost
- Fixed cost = Total cost – variable cost
- Total cost
- ATC * Q
- $1.18 / slice * 260 slices = $306.80 / day
- Variable cost
- AVC * Q
- $0.68 / slice * 260 slices = $176.80 / day

Solution to Problem #9 (4)

- Fixed cost = $306.80/day - $176.80/day =$130/day
- Thus, by shutting down the plant in the short run, the firm will loss $130 a day
- In other words, the firm earns a profit of -$130 per day if the price for a slice of pizza is just $0.50

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