978-1259291814 Chapter 8 Solution Manual

Chapter 8: The Competitive Firm

Solutions Manual

Questions for Discussion

1. What economic costs will a large corporation likely overlook when computing its profits?

How about the owner of a family-run business or farm? (LO 08-01)

Answer: Opportunity costs would not likely be considered when computing the profits of a

2. How can the demand curve facing a firm be horizontal if the market demand curve is

downward-sloping? (LO 08-02)

3. How many fish should a commercial fisher try to catch in a day? Should he catch as many as

possible or return to dock before filling the boat with fish? Under what economic

circumstances should he not even take the boat out? (LO 08-03)

4. If a firm is incurring an economic loss, would society be better off if the firm shut down?

Would the firm want to shut down? Explain. (LO 08-04)

5. Why isn’t the rate of output that minimizes average total cost the most profitable rate of

output? (LO 08-03)

6. What rate of output is appropriate for a nonprofit corporation (such as a hospital)?

(LO 08-03)

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7. What costs did GM eliminate when it shut down its plants? (World View, p. 180.) How about

Ford? (LO 08-04)

8. What was the opportunity cost of Hiroshi Fujishige’s farm? (See News, p. 165.) Is society

better off with another Disney theme park? Explain. (LO 08-01)

9. Is Apple Computer a perfectly competitive firm? Explain your answer. (LO 08-02)

10. If a perfectly competitive firm raises its price above the prevailing market rate, how much of

its sales might it lose? Why? Can a competitive firm ever raise its prices? If so, when?

(LO 08-02)

11. Under what conditions would a firm decide to shut down in the short run but remain invested

in the market in the long run? (LO 08-05)

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12. How does an employer-paid Social Security tax on wages affect a competitive firm’s supply

curve? (LO 08-06)

Problems

1. If the owner of the Table 8.1 drugstore hired a manager for $10 an hour to take his place, how

much of a change would show up in

(a) Accounting profits?

(b) Economic profits?

(LO 08-01)

Answers:

Feedback:

(a) 300 hours × $10/hour = $3,000. The drugstore owner pays the manager a wage of

(b) Now that the owner has hired a manager, the cost of managing the store has moved from

2. If the price of catfish fell from $13 to $7 per bushel, use Figure 8.7 to determine the

(a) Profit-maximizing output.

(b) Profit or loss per bushel.

(c) Total profit or loss.

(LO 08-01)

Feedback:

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(a) A competitive firm maximizes total profit at the output rate where Marginal Cost = Price

(b) Total Revenue − Total Cost = Total Profit (or Loss);

(c) Total Revenue − Total Cost = Total Profit (or Loss);

3. (a) Complete the following cost and revenue schedules

Quantity Price Total Revenue Total Cost Marginal Cost

0 $60 $50

1 60 60

2 60 90

3 60 140

4 60 200

5 60 280

(b) Graph MC and p.

(c) What rate of output maximizes profit?

(d) What is MC at that rate of output?

(LO 08-02)

Answers:

(a)

Quantit

y

Price

=

MR

Total

Revenu

e

Total

Cost

Profi

t

Marginal

Cost

0$60 $0 $50 –$50 —

1$60 $60 $60 $0 $10

(b)

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Feedback:

(a) Total revenue = Price × Quantity; Marginal cost = the increase in total costs associated

(b) After finding marginal cost in part (a), you should graph this number as well as price at

(c) MR = P = MC at 4 units of output. For perfectly competitive firms, profits are maximized

(d) When production is increased from 3 units to 4, total cost increases by $60. Therefore

4. Complete the following cost schedules:

Quantity 0 1 2 3 4 5 6 7

Total cost $9 $12 $16 $21 $30 $40 $52 $66

ATC __ __ __ __ __ __ __ __

MC __ __ __ __ __ __ __ __

Assuming the price of this product is $12, at what output rate is

(a) Total revenue maximized?

(b) ATC minimized?

(c) Profit per unit maximized?

(d) Total profit maximized? (LO 08-02)

Answers:

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Total cost $9 $12 $16 $21 $30 $40 $52 $66

ATC — $12 $8 $7 $7.50 $8 $8.67 $9.43

Feedback:

Average Total Cost = Total Cost / Quantity.

(a) Total revenue is maximized at 7 units. 7 units × $12 per unit = $84, the largest amount of

(b) Average total cost is calculated as total cost / quantity. Average total cost is minimized at

(c) Profit per unit is price − ATC or alternatively (profit / quantity). Profit per unit is

(d) For a competitive firm, the profit-maximizing output occurs at the point where MC = P =

5. Assume that the price of silk ties in a perfectly competitive market is $21 and that the typical

firm confronts the following costs:

Quantity

(Ties per Day) 0 1 2 3 4 5 6 7 8 9 10

Total Cost $10 $17 $26 $37 $50 $65 $82 $101 $122 $145 $170

(a) What is the profit-maximizing rate of output for the firm?

(b) How much profit does the firm earn at that rate of output?

(c) If the price of ties falls to $15, how many ties should the firm produce?

(d) At what price should the firm shut down?

(LO 08-03)

..

Answers:

Outpu

t

Total

Cost AVC

Margina

l Cost

Total

Revenu

e

($21)

Profit

at

P=$21

Total

Revenu

e

($15)

Profit

at

P=$15

0 $10* $0 — $0 –$10 $0 –$10

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…

Feedback:

(a) The profit-maximizing output is 8 units where MC is equal to MR (or price, which in this

(b) The profit associated with the profit-maximizing output of 8 units is $46.

(c) The profit-maximizing output is 5 ties per day at a price of $15. Once again, the

(d) When price is $7, output would be 1 unit (P = MC). This would yield a profit of $7 – $17

6. Using the data from Problem 5 (at the original price of $21), determine how many ties the

producer would supply if

(a) A tax of $2 per tie were collected from the producer.

(b) A property tax of $2 were levied.

(c) Profits were taxed at 50 percent. (LO 08-06)

Answers:

Feedback:

(a) Marginal cost increases by $2 at all levels of output. However, marginal revenue stays the

(b) Property taxes have to be paid regardless of whether the factory is used. Hence property

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(c) A tax on profits does not affect the marginal cost curve. Profits are not a fixed or variable

7. Were the costs of maintaining Ford’s Australian plants (World View, p.180) more or less than

$140 million per year? (LO 08-4)

Answer:

Feedback:

Ford’s Australian plants lost nearly $600 million in the last five years.

8. Illustrate on the accompanying graph the impact on desired output of

(a) Reduced feed prices

(b) Higher wage rates

(c) Increased profits tax (LO 08-06)

Answer:

Feedback:

(a) Reduced feed prices will lower the AVC which in turn lowers the ATC and MC.

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9. Complete the following table:

Output Total Cost Marginal Cost

Average Total

Cost

Average Variable

Cost

0 $100.00

5 $110.00

10 $130.00

15 $170.00

20 $220.00

25 $290.00

30 $380.00

35 $490.00

According to the table above,

(a) If the price is $10, how much output will the firm supply?

(b) How much profit or loss will it make?

(c) At what price will the firm shut down? (LO 08-04)

Answers:

Output Total Cost Marginal Cost

Average Total

Cost

Average Variable

Cost

0 $100.00 — — —

5 $110.00 $2.00 $22.00 $2.00

Feedback:

(a) A competitive firm maximizes total profit at the output rate where Marginal cost = Price =

(b) Total revenue − Total cost = Total profit (or Total loss)

where Total revenue = Price × Quantity.

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(c) Firms will continue to operate as long as their average variable cost is less than marginal

revenue (or price.) Alternatively, a firm will shut down at the price that is equal to the

10. A firm has leased plant and equipment to produce video game cartridges, which can be sold

in unlimited quantities at $21 each. The following figures describe the associated costs of

production:

Rate of output / day 0 1 2 3 4 5 6 7 8

Total cost / day $50 $55 $62 $75 $96 $125 $162 $203 $248

(a) How much are fixed costs?

(b) Draw total revenue and cost curves on the graphs here.

(c) Draw the average total cost (ATC), marginal cost (MC), and demand curves of the firm.

(d) What is the profit-maximizing rate of output?

(e) Should the producer stay in business?

(f) What is the size of the loss if production continues?

(g) How much is lost if the firm shuts down? (LO 08-05)

Answers:

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O UTPUT (ca rtridges per da y )

REVENUE OR COST (per day)

0

50

100

150

200

250

1 2 3 4 5 6 7 8

TC

TR

…

(c) See the graph below:

O UTPUT (c a rtridges per da y )

PRICE OR COST (per cartridge)

0

10

20

30

40

50

6 0

1 2 3 4 5 6 7 8

Demand

MC

AT C

Feedback:

(a) Fixed cost is the total cost when production or output is zero. In this case, at an output of

(b) Total revenue = Price × Quantity. The price of the video games is $21 each. Therefore, if

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(c) To find average total costs, simply divide total costs by output.

Marginal cost is the increase in total costs associated with a one-unit increase in production.

(d) A competitive firm maximizes total profit at the output rate where Marginal cost =

(e) Firms should continue to operate as long as they are covering their average variable costs.

In this case the firm should continue to produce video cartridges because the price of $21

(f) If production continues, although profit-maximizing, the firm will incur a loss. The loss is

(g) The firm must still pay fixed costs if it shuts down because these costs are incurred

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