Answers to Back-of-the-Chapter Problems
1. The fact that the product development was lengthier and more expensive
than initially anticipated is no reason to charge a higher price. These
2. This statement confuses average quantities and marginal quantities.
Though average total cost is always greater than average variable cost,
3. a. The profit associated with an electronic control device (ECD) is:
E = 1,500 – [500 + (2)(300)] = $400. If the firm sells the two
microchips separately (instead of putting them into an ECD), its total
b. If there is unused microchip capacity, the firm earns $400 in additional
c. If $200 (of the $500 average cost) is fixed, each ECD’s contribution
4. a. In the short run, the merged banks hope for sizeable cost savings by
eliminating redundant operations, for instance, closing branch banks. In
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the longer term, the banks, by combining the provision of several
related services, hope to benefit from economies of scope on both the
b. It is possible for national banks to operate more efficiently than regional
banks or state banks, but this depends on both production and
transaction costs. Since banking is an information intensive industry,
banks may be able to take advantage of economies of scope and scale in
information collection and transmission. For example, national banks
c. Some of the mergers are based on economies of scope, particularly
where the institutions have different but related products, such as
banking and insurance. Other mergers are based on geographical
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b. The contribution is: R – VC = ($150,000 – 45,000) – ($4,000)(15) =
$45,000. The opportunity cost of the entrepreneur’s labor is $20,000,
6. a. The running shoe producer’s demand is P = 48 – Q/200. and its costs
b. The firm maximizes profit by setting MR = MC. Therefore, MR = 48 –
7. a. To maximize profit set MR = MC. Therefore, 10 -.5w = 5, or w = 10
b. The “total” marginal cost (including the opportunity cost of lost
c. On the cost side, there are economies of scale and scope. (With
shared fixed costs, 10 screens under one roof are much cheaper than
d. Obviously, DVD rentals and sales compete with (and potentially
cannibalize) theater revenues. The delay makes sense as long as the
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b. She is correct that Qmin = 40 units. At this output, AC = 960/40 = 24
c. Yes, it is cheaper to produce 80 units in two plants (each producing at
9. a. We are given that MC = $20,000, and from the price equation, we
b. Fixed costs should not be mixed with variable costs in determining
output and price decisions. Removing the allocated fixed cost means
taking out 160,000,000/40,000 = $4,000 per unit. Thus, the true
10. a. Given that C = 175,000 + 300Q + .1Q2, Firm K’s marginal cost, is:
dC/dQ = 300 + .2Q. Setting MR = MC implies: 800 – .3Q = 300 + .2Q.
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b. If Firm K continues to produce 1,000 regular coats (as in part a) it will
be able to fulfill only 100 coats of the 200 corporate coats ordered,
implying an opportunity cost of $200 per coat (in foregone profit).
Rather than cut winter production of regular coats, the firm should
consider whether it is more profitable to make additional coats during
c. When demand falls permanently to P = 600 – .2Q, the firm’s new
optimal output and price (after setting MR = MC) are Q* = 500 and P*
= 500. Firm K’s profit from coats drops to: = R – C = 250,000 –
11. a. We have: MCE = 1,000 + 10Q and MC = 3000 + 10Q. Setting MR =
b. Purchasing engines implies a marginal cost of 2,000 + 1,400 = $3,400
(compared to the $4,000 MC in part a). Again setting MR = MC
implies: Q = 110 and P = $6,700. However, the firm should continue to
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*12. a. MPL = 120,000 watches/60,000 labor hours = 2 watches per hour. The
marginal labor cost is: ($8/hour)/(2 watches/hour) = $4/watch. Total
MC is: $6 + $4 = $10/watch. To maximize profit, the firm sets MR =
b. Marginal labor cost on the night shift is $12/2 = $6. The relevant MC
c. Demand drops permanently to P = 20 – Q/20,000. A good bet is that
the firm will now use only the day shift, implying MR = MC = 10. It
follows that 20 – Q/10,000 = 10 or Q* = 100,000 watches. In turn, P*
Discussion Question
Most information goods are characterized by high fixed costs and low
or negligible marginal costs. In this case, the firm’s average total cost
Home grocery delivery (though it involves the internet for securing
customers and defining the transactions) has a significant marginal cost
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Conversely, the lower transaction cost of e-commerce allows small
sellers to cheaply transact with potential buyers (and allows buyers to
find small sellers). A small seller of rare books or a provider of
Network externalities operate on the demand side to explain why
bigger can be better. They simply reinforce the economic and strategy
implications of (supply-side) economies of scale and scope. Network
Spreadsheet Problems
S1. a. and b. Varying labor usage in the spreadsheet from 1 thousand hours
c. At L = 9 and K = 9, the resulting output is Q = 108. What input mix
should the firm use to produce this output at minimum cost in the long
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d. Doubling the inputs of part c (setting L* = 12 and K* = 27) generates
e. The firm’s inverse demand curve is: P = 9 – Q/72. In the short run with
K = 9, we invoke the optimizer to maximize total profit in cell I12 by
changing labor usage in cell C5. Thus, L* = 9, K = 9, and * = 342.
S2. a. Using the spreadsheet optimizer, we determine the multinational firm’s
optimal plan: Maximize total profit in cell E20 by changing outputs
b. If the firm must charge a uniform worldwide price, we reoptimize the
spreadsheet after adding the constraint that the price difference in cell
Appendix Problems
Transfer Pricing:
1. a. The transfer price should reflect the marginal cost associated with the
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b. A markup policy maximizes the chip division’s internal profit but at the
2. a. Facing PT = $600, the copier division’s profit is:
b. With the proper transfer price set, the copier division should simply
3. The chip division produces a quantity such that MCM = PM = $300.
Therefore, 200 + QM = 300, or QM = 100. Facing a $300 chip price, the
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