Managerial Economics - Quiz #3

Consider the following graph showing three short-run average cost curves for a firm using one, two or three plants. (check quiz #3 - question #12 for picture) 1) 5,000 left of min 2) 13,000 barely left of min 3) 150,000 far right of min If the firm plans on selling 5,000 units, then it should choose [SELECT] plants and it will experience [SELECT] at that production level.

1) 1 2) Economies of Scale Explanation: 1) n/a 2) Choose lowest AC and that is with 1 plant. The LRAC (smoothly connecting the lower bound of the AC curves) at Q=5000 is decreasing which is economies of scale.

If a firm is producing where MR=MC and is selling at a price below their average cost, but above their average variable cost, then the firm should [SELECT] in the short run and [SELECT] in the long run.

1) continue producing 2) exit Explanation: In the short run produce as long as price is above AVC, but in the long run produce only if price is above the AC.

You are the manager of a firm that sells its product in a competitive market at a price of $60. Your firm's cost function is C = 50 + 3Q2. The profit-maximizing output for your firm is:

10 Explanation: Want Q where MR=MC and in Perfect Competition MR=P so want Q where P=MC: 60 = 6Q so Q=10

For the cost function C(Q) = 97 + 2Q + 3Q2, what is the average variable cost of producing 3 units of output? (Round your answer to two decimals as needed)

11

Consider a firm with the production function: 10KL + 2K2L2 - 0.1K3L3. The firm currently has K fixed at K=2 and cannot adjust that in the short run. What is the short run production function?

20L + 8L2 - 0.8L3 Explanation: Plug in K=2 to get 10(2)L + 2(4)L2 - 0.1(8)L3 = 20L + 8L2 - 0.8L3

You are the manager of a firm that sells its product in a competitive market at a price of $60. Your firm's cost function is C = 50 + 3Q2. Your firm's maximum profits are:

250 Explanation: Want Q where MR=MC and in Perfect Competition MR=P so want Q where P=MC: 60 = 6Q so Q=10. The profit with Q=10: PQ - Cost = 6010 - (50 + 3(100)) = 600 - 350 = 250

For the cost function C(Q) = 54 + 3Q + 2Q2, what is the total fixed cost of producing 3 units of output?

54

Again consider a firm with the production function: 10KL + 2K2L2 - 0.1K3L3. The firm currently has K fixed at K=2 and cannot adjust that in the short run. If the firm sets L=2, how much will be produced?

65.6 Explanation: Plug in K=2 and L=2 to get 10(2)(2) + 2(4)(4) - 0.1(8)(8) = 40 + 32 - 6.4 = 65.6

Consider a firm with a fixed amount of capital, but can adjust the number of workers. Assume they cannot hire fractional amounts of labor. Below is a table showing their total monthly production at different numbers of workers hired. If they sell their product in a competitive market for a price of $50, how many workers should they hire if the monthly wage is $2,900? Workers: 0, 1, 2, 3, 4, 5, 6, Production: 0, 100, 220, 320, 410, 490, 560, Workers: 7, 8, 9 Production: 620, 670, 710

7 (with margin: 0) Explanation: Hire until diminishing returns begins and then hire as long as VPML > w. The marginal product is increasing until after the 2nd worker is hired. Hiring the 7th worker gives VPML = 5060 = $3000 which is greater than 2900 but the 8th gives VPML = $5050 = $2500 which is less than 2900, so hire 7 workers.

Which of the following is not an aspect of perfect competition?

Differentiated products

The law of diminishing returns says that as you continue to expand your business by adding more of all inputs, your productivity will eventually decline.

False Explanation: Law of diminishing returns is predicated on adding more of one input while others are held constant.

Which of the following statements is incorrect?

Fixed costs are always greater than sunk costs.

Again consider the following graph showing three short-run average cost curves for a firm using one, two or three plants. (check quiz #3 - question #13 for picture) 1) 5,000 left of min 2) 13,000 barely left of min 3) 150,000 far right of min If total industry sales for this good are typically about 2 million units, and the production technology is fairly standardized so that most firms will have cost structures similar to the one above, would you expect this industry to be dominated by just a few firms (say less than 6) or have many firms competing?

Many firms Explanation: There is a cost advantage to try and grow to the MES production level of around 13,000. With over 2,000,000 total industry production that will leave plenty of room to have many cost competitive firms.

Which of the following is true under perfect competition?

P = MR

In a perfectly competitive industry with identical firms, long-run equilibrium is characterized by:

Profit moves to zero.

You are a manager in a perfectly competitive market. The price in your market is $14. Your total cost curve is C(Q) = 10 + 4Q + 0.5Q2. What will happen in the long run if there is no change in the demand curve?

Some firms will enter the market eventually. Explanation: Want Q where MR=MC and in Perfect Competition MR=P so want Q where P=MC: 14 = 4 + Q so Q=10. The profit with Q=10: PQ - Cost = 1410 - (10 + 4(10) + 0.5(100)) = 140 - 100 = 40. Positive profits will attract new firms to enter the industry and that increase in supply will make the market price fall.

Suppose the cost function is C = 50 + 4Q - 3Q2 + Q3. At 5 units of output, the average cost curve is:

in the increasing stage. Explanation: At Q=5 the AC = (50 + 4(5) - 3(25) + 125)/3 = 120/5 = 24 and the MC = 4 - 6Q + 3Q2 = 4 - 6(5) + 3(25) = 49. Since the MC > AC the AC is increasing.

The short run is defined as the time frame:

in which there are fixed factors of production.

The point where diminishing marginal returns begins to impact production is best characterized by the point where the:

marginal product curve begins to be negatively sloped.

You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = $40, r = $100, MPL = 4, and MPK = 40 the firm:

should use more K and less L to cost minimize. Explanation: MPL/w = 4/40 = 0.1 < 0.4 = 40/100 = MPK/r so shift to using more capital and less labor because capital is giving you more output per dollar spent.