1

INTRODUCTION TO MICROECONOMICS
MODULE

TEACHING ASSISTANTS OF MICROECONOMICS AND

MACROECONOMICS
UNDERGRADUATE ECONOMICS PROGRAM
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITAS PADJADJARAN
2019
2
 ACKNOWLEDGEMENT
In the name of Allah, The Most Gracious, The Most Merciful
Alhamdulillah, all praises to Allah SWT, The Almighty, for giving
belief, health, confidence and blessing for the writers to accomplish this Module
of Introduction to Microeconomics. Shalawat and Salam be upon our prophet
Muhammad SAW, who has brought us from the darkness into the brightness and
guided as into the right way of life.
In this opportunity, we would like to express our deep gratitude to the
Head of Department of Economics, all of the lecturers, and those who contributed
in the process of making this module. All of your kindness and help means a lot
to us. Thank you very much. Hopefully this module can be the short guide for the
students in order to deepen their understanding about Microeconomics.

List of the Module Writers:

1. Mochamad Thoriq Akbar 120210160063

2. Insan Lutfiana Alfarizy 120210160112
3. Nur’ainun Marfuah M. 120210160060
4. Dinda Ayu Maharani 120210160077
5. Endah Budiarti Sagala 120210160111
6. Moh. Taufan 120210160085
7. Syarifah Rahmani P. 120210170060
8. Karmila Peronica S. 120210170081
9. Fariza Zahra K. 120210170076
10. Anindito Widiatmojo 120210170061
11. Zaki Intan C. 120210160094
12 Adlan Ramadhan 120210170114

Acknowledge and Agree,

Head of Undergraduate Program of Department of Economics

Rudi Kurniawan, S.E., MSi., Ph.D.

3
 NIP. 19700310199702100

4
 CONTENTS

CHAPTER 1 THE SCOPE AND METHOD OF ECONOMICS & THE

ECONOMIC PROBLEM: SCARCITY AND CHOICE...................................5
CHAPTER 2 DEMAND, SUPPLY, MARKET EQUILIBRIUM & ITS
ELASTICITY.........................................................................................11
CHAPTER 3 HOUSEHOLD BEHAVIOUR AND CONSUMER CHOICE......18
CHAPTER 4 THE PRODUCTION PROCESS............................................22
CHAPTER 5 SHORT RUN COSTS AND OUTPUT DECISIONS.................28
CHAPTER 6 LONG-RUN COSTS AND OUTPUT DECISIONS...................34
CHAPTER 7 INPUT MARKET................................................................41
CHAPTER 8 MONOPOLY MARKET, OLIGOPOLY MARKET, GAME
THEORY, & MONOPOLISTIC MARKET.................................................47
CHAPTER 9 GENERAL EQUILIBRIUM AND THE EFFICIENCY OF PERFECT
COMPETITION....................................................................................54

5
 CHAPTER 1
THE SCOPE AND METHOD OF ECONOMICS & THE
ECONOMIC PROBLEM: SCARCITY AND CHOICE

 Economics is the study of how individuals and societies choose to use

the scarce resources that nature and previous generations have provided.

 There are many reasons to study economics, including to learn a way of

thinking, to understand society, to understand global affairs, and to be an
informed citizen.

 Economics is a broad and diverse discipline with many special fields of

inquiry. These include economic history, international economics, and
urban economics.

 Microeconomics deals with the functioning of individual markets and

industries and with the behavior of individual decision-making units:
business firms and households. Macroeconomics looks at the economy
as a whole. It deals with the economic behavior of aggregates national
output, national income, the overall price level, and the general rate of
inflation.

 The best alternative that we forgo when we make a choice or a decision

is the opportunity cost of that decision.

 Cost that can’t be avoided because they have already been incurred is
called sunk cost

 Economics asks and attempts to answer two kinds of questions: positive

and normative. Positive economics attempts to understand behavior and
the operation of economies without making judgments about whether the
outcomes are good or bad. Normative economics looks at the results of
economic behavior and asks whether they are good or bad and whether
they can be improved.

6
 Positive economics is often divided into descriptive economics and
economic theory. Descriptive economics is simply the compilation of
data that describe phenomena and facts.

 An economic model is a formal statement of an economic theory.

Models simplify and abstract from reality.

 Models and theories can be expressed in many ways. The most common
ways are in words, in graphs, and in equations.

 A device used to analyze the relationship between two variables while

the values of other variables are held unchanged is called ceteris
paribus

 Theories often make statements or sets of statements about cause and

effect. It can be quite tempting to look at two events that happen in
sequence and assume that the first caused the second to happen. This
common error is called the post hoc, ergo propter hoc (or “after this,
therefore because of this”) fallacy.

 The erroneous belief that what is true for a part is necessarily true for the
whole is called the fallacy of composition.

 A producer has a comparative advantage over another in the

production of a good or service if he or she can produce that product at a
lower opportunity cost.

 A producer has an absolute advantage over another in the production of

a good or service if he or she can produce that product using fewer
resources.

 Empirical economics involves the collection and use of data totest

economic theories. In principle, the best model is the one that yields the
most accurate predictions.

7
 To make economic policy, one must be careful to specify criteria for
making judgments. Four specific criteria are used most often in
economics: efficiency, equity, growth, and stability.

 Every society has some system or process for transforming into useful
form what nature and previous generations have provided. Economics is
the study of that process and its outcomes.

 The Three Problems of Economic: What kinds and quantities are

produced among the wide range of all possible goods and services? How
are resources used in produc-ing these goods? And for whom are the
goods produced?

 Because resources are scarce relative to human wants in all societies,

using resources to produce one good or service implies not using them to
produce something else. This concept of opportunity cost is central to an
understanding of economics.

 Because resources are scarce relative to human wants in all societies,

using resources to produce one good or service implies not using them to
produce something else. This concept of opportunity cost is central to an
understanding of economics.

 Goods produced for present consumption is called consumer goods

 Anything that has already been produced that will be used to produce
other valuable goods or services over time is called capital goods

 A production possibility frontier (ppf) is a graph that showsall the

combinations of goods and services that can be produce if all of society’s
resources are used efficiently. The ppf illustrates a number of important
economic concepts: scarcity, unemployment, inefficiency, increasing
opportunity cost, and economic growth.

 Economic growth occurs when society produces more, either by

acquiring more resources or by learning to produce more with existing
resources. Improved productivity may come from additional capital or
8
 from the discovery and application of new, more efficient techniques of
production.

 In some modern societies, government plays a big role in

answering the three basic questions. In pure command economies, a central
authority directly or indirectly sets output targets, incomes, and prices.

 A laissez-faire economy is one in which individuals independently

pursue their own self-interest, without any central direction or regulation,
and ultimately determine all basic economic outcomes.
 A market is an institution through which buyers and sellers interact and
engage in exchange. Some markets involve simple face-to-face
exchange; others involve a complex series of transactions, often over
great distances or through electronic means.

9
 CHAPTER 1
THE SCOPE AND METHOD OF ECONOMICS & THE ECONOMIC
PROBLEM : SCARCITY AND CHOICE

TRUE OR FALSE
1. Economics is the study of how individuals and societies choose to
use the scarce resources that nature and previous generations have
provided.
2. Ceteris paribus used to analyze the relationship between two
variables while the values of other variables are 1.
3. PPF curve will be moving up and right caused by economic growth.
4. Michael produced 20 sheets of paper from a piece of wood. At the
same time and the same piece of wood, Daniel produced 18 sheets
of paper. So, Michael has a comparative advantage in producing
paper over Daniel.
5. Human have to choose unlimited resources to get their maximum
needs
.
ESSAY
1. Explain briefly the differences between microeconomics and
macroeconomics! Give 2 example cases for both of them.
2. There are four main reasons why we study economics. What are
they? Explain each reason.
3. Which of the following statements are examples of positive
economic analysis or normative economic analysis? Explain your
answer!
a. Inflation in country X increased sharply to 40% increase from
2010 to 2011.
b. The inheritance tax should be repealed because it is unfair.
c. Allowing Chile to join NAFTA would cause wine prices in the
United States to drop.
d. The first priorities of the new regime in the Democratic
Republic of Congo (DRC, formerly Zaire) should be to rebuild
schools and highways and to provide basic health care.

10
4. Look at the PPF curve below :

Please explain each point of the PPF curve above (A, B, C, D, X, Y,

Z)!

5. In one day the country X can produce 4 tons of wheat and 8 tons of
potatoes. While in country Y can produce 3 tons of wheat and 12
tons of potatoes. Assume that the number of labor in theese 2
countries are equal, 1200.
a. Calculate the opportunity costs of both countries in producing
wheat!
b. Calculate the opportunity costs of both countries in producing
potatoes!
c. Which countries have an absolute advantages in producing
wheat? Then how about potatoes? Explain briefly!
d. Which countries have a comparative advantages in producing
wheat? Then how about potatoes? Explain briefly!

11
 CHAPTER 2
DEMAND, SUPPLY, MARKET EQUILIBRIUM & ITS
ELASTICITY

 All societies face the economic problem, which is the problem of how to

make the best use of limited, or scarce, resources. The economic
problem exists because, although the needs and wants of people are
endless, the resources available to satisfy needs and wants are limited.
Resources are limited in two essential ways:

- Limited in physical quantity, as in the case of land, which has a

finite quantity.
- Limited in use, as in the case of labour and machinery, which
can only be used for one purpose at any one time.
Simple explanation of the economic problem :

- What to Produce?
Societies have to decide the best combination of goods and
services to meet their needs. For example, how many resources
should be allocated to consumer goods, and many resources to
capital goods, or how many resources should go to schools, and
how many to defence, and so on.
- How to Produce?
Societies also have to decide the best combination of factors to
create the desired output of goods and services. For example,
precisely how much land, labour, and capital should be used
produce consumer goods such as computers and motor cars.
- For whom to Produce?
Finally, all societies need to decide who will get the output from
the country’s economic activity, and how much they will get.
For example, who will get the computers and cars that have
been produced? This is often called the problem of distribution.

12
 Circular Flow Diagram

(or circular-flow model) is a graphical representation of the flows

of goods and money between two distinct parts of the economy:
- market for goods and services, where households purchase
goods and services from firms in exchange for money;
- market for factors of production (such as labour or capital),
where firms purchase factors of production from households in
exchange for money.
 Demand
o The law of demand indicates a negative relationship between price
level and quantity of demand in a period so when price level
increased causes quantity of demand decreased, vice versa.

o Quantity demanded may change due to changes in the price level that
caused movement along the demand curve, while the demand for
most goods may change due to changes in income, wealth, tastes,
prices of other goods, and expectations that caused a shift in the
demand curve.
 Supply
o The law of supply indicates a positive relationship between
price level and quantity of supply in a period so when price
level increased causes quantity of supply increased, vice versa.
o Quantity supplied may change due to changes in the price level
that causes movement along the supply curve, while the supply
13
 for most goods may change due to changes in cost of
production, and prices of related goods that caused a shift in the
supply curve.

 Market Equilibrium
o Market equilibrium occurs when the quantity demanded equals
the quantity supplied which resulting equilibrium price level
and equilibrium output. When the quantity demanded exceeds
the quantity supplied will occur excess demand (shortage),
could be caused by a price ceiling which the price level is
below the equilibrium price. When the quantity supplied
exceeds the quantity demanded will occur excess supply
(surplus), could be caused by a price floor which the price
level is above the equilibrium price.

Consumer Surplus
Producer Surplus

o Consumer surplus is the difference between the maximum

amount a person is willing to pay for a good and its current
market price, the area is below a demand curve and above a
price level. Producer surplus is difference between the full
cost of production for the firm and the current market price, the
area is above a supply curve and below a price level.

14
 o The dead weight loss (DWL) is the net loss in consumer
surplus and producer surplus due to reduced production or
excess in production.
 Elasticity

o Elasticity refers to the responsiveness of one economic variable,

such as quantity demanded, to a change in another
variable, such as price. Elasticity can provide important
information about the strength or weakness of such
relationships.

o There are four types of elasticity, each one measuring the

relationship between two significant economic variables. They
are:
- Price elasticity of demand (PED), which measures
the responsiveness of the quantity demanded to a
change in price. PED can be mmeasured over a price
range, called arc elasticity, or at one point, called point
elasticity.
% ∆ Qd ∆ Qd Pd 1
ε d= → ×
% ∆ Pd ∆ Pd Qd 1
- Price elasticity of supply (PES), which measures the
responsiveness of the quantity supplied to a change
in price.
% ∆ Qs ∆ Qs Ps1
ε s= → ×
% ∆ Ps ∆ Ps Qs1
- Cross elasticity of demand (XED), which measures
the responsiveness of the quantity demanded of one
good, good X, to a change in the price of another
good, good Y.
∆ Q x Py 1
ε= ×
∆ P y Qx 1
- Income elasticity of demand (YED), which measures
the responsiveness of the quantity demanded to a
change in consumer incomes.

15
o 5 type of Price Elasticity

|ε|>1 Elastic Q changes more than P

|ε|=1 Unit Elasic Q changes like P
|ε|<1 Inelastic Q changes less than P
|ε|=0 Perfect P-Inelasticity P changes while Q is Constant
|ε|→∞ Perfect P-Elasticity Q changes while P is Constant

16
 CHAPTER 2
DEMAND, SUPPLY, MARKET EQUILIBRIUM & ITS ELASTICITY

True or False

1. In the market for gasoline, the reason that the equilibrium quantity
increased was that the increase in demand was less than the decrease
in supply.
2. A fall in the price of iPads would shift the demand curve for iPads to
the right.
3. Percentage an increase in the price of good Y is 40% causes a
decrease in the quantity demanded of the X by 20%, then good X
and good Y are complements.
4. Increasing in the apple price by 40% led to an decrease in the
quantity of apple demanded by 60%, then the elasticity of demand is
an inelastic type.
5. A price floor set by government will increase the equilibrium price
and quantity in a Market

Essay

1. Suppose the market demand for pizza is given by

Qd=300−20 P and the market supply for pizza is given by
Qs=20 P−100, where P= Price (per pizza).
a. Graph the supply and demand schedules for pizza using $5
through $15 as the value of P.
b. In equilibrium, how many pizzas would be sold and at what
price?
c. What would happen if suppliers set the price of pizza at $15?
Explain the market adjustment process.
d. Suppose the price of hamburgers, a substitute for pizza,
doubles. This leads to a doubling of the demand for pizza. (At
each price, consumers demand twice as much pizza as before.)
Write the equation for the new market demand for pizza.
e. Find the new equilibrium price and quantity of pizza.
2. The following sets of statements contain common errors. Identify
and explain each error:
17
 a. Demand increases, causing prices to rise. Higher prices cause
demand to fall. Therefore, prices fall back to their original
levels.
b. The supply of meat in Russia increases, causing meat prices to
fall. Lower prices always mean that Russian households spend
more on meat.
3. Give complete explanation about law of supply and law of demand!
And complete your answer with the graph!
4. What will happen to the demand curve if:
a. the demand for the product by labor declines.
b. the prices of substitute inputs fall.
c. the productivity of labor increases.
d. the wage rate declines
5. The U.S. government administers two programs that affect the
market for cigarettes. Media campaigns and labeling requirements
are aimed at making the public aware of the health dangers of
cigarettes. At the same time, the Department of Agriculture
maintains price supports for tobacco. Under this program, the
supported price is above the market equilibrium price and the
government limits the amount of land that can be devoted to tobacco
production. Are these two programs at odds with the goal of
reducing cigarette consumption? As part of your answer, illustrate
graphically the effects of both policies on the market for cigarettes.

18
 CHAPTER 3
HOUSEHOLD BEHAVIOUR AND CONSUMER CHOICE

 Income, wealth, and prices define household budget constraint. The

budget constraint separates those combinations of goods and
services that are available from those that are not. All the points
below and to the left of a graph of a household budget constraint
make up the choice set, or opportunity set.
 It is best to think of the household choice problem as one of
allocating income over a large number of goods and services. A
change in the price of one good may change the entire allocation.
Demand for some goods may rise, while demand for others may fall.
 Whether one item is preferable to another depends on how much
utility, which denotes the relative satisfaction that a consumer
obtains from using different commodities. The additional
satisfaction obtained from consuming an additional unit of a good is
given the name marginal utility, where “marginal” means the extra
or incremental utility. The law of diminishing marginal utility states
that the more of any good we consume in a given period of time, the
less satisfaction, or utility, we get out of each additional (or
marginal) unit of that good.
 Economists assume that consumers allocate their limited incomes so
as to obtain the greatest satisfaction or utility. To maximize utility, a
consumer must satisfy the equimarginal principle that the marginal
utilities of the last dollar spent on each and every good must be
equal.
 Utility maximizing rule:

19
 −MU X −P X
=
MU Y PY

Slope in Slope of
=
indifference budget
curve constraint

 The fact that demand curves have a negative slope can be explained
in two ways: (1) Marginal utility for all goods diminishes. The
concept of diminishing marginal utility offers one reason people
spread their incomes over a variety of goods and services instead of
spending all income on one or two items. It also leads us to conclude
that demand curves slope downward. (2) The income and
substitution effect. The substitution effect occurs when a higher
price leads to substitution of other goods to meet satisfactions; The
income effect means that a price increase lowers real income and
thereby reduces the desired consumption of most commodities. For
most goods, substitution and income effects of a price increase
reinforce one another and lead to the law of downward-sloping
demand.

 In the labor market, a trade-off exists between the value of the goods
and services that can be bought in the market or produced at home
and the value that one places on leisure. The opportunity cost of
paid work is leisure and unpaid work. The wage rate is the price, or
opportunity cost, of the benefits of unpaid work or leisure.
 In addition to deciding how to allocate its present income among
goods and services, a household may also decide to save or borrow.
When a household decides to save part of its current income, it is
using current income to finance future spending. When a household
borrows, it finances current purchases with future income.

20
 CHAPTER 3
HOUSEHOLD BEHAVIOUR AND CONSUMER CHOICE

TRUE OR FALSE
1. As the price of a good falls, the intercept for that good on a budget
constraint shifts near the origin.
2. Suppose Ben has a fixed budget for two goods, donut and candy.
Pd=$10 and Pc=5.Marginal utilities of donut and candy are MU d=90
and MUc=40. Then, to reach the maximum utility both consumption
of goods donut and candy should be decreased.
3. If marginal utility is zero, then total utility is zero.
4. Both the income and substitution effect imply a negative relation
between price and quantity demanded. When the price of a good
falls, the substitution effect tells us that we can buy more of that
good and other goods.
5. Indifference curve is a set of points, each representing a
combination of some amount of good X and some amount of good
Y, that all yield the same amount of total utility.
ESSAY
1. Suppose the price of X is $5 and the price of Y is $10 and a
hypothetical household has $500 to spend per month on goods X
and Y.
a. Sketch the household budget constraint.
b. Assume that the household splits its income equally
between X and Y. Show where the household ends up on
the budget constraint.
c. Suppose the household income doubles to $1,000. Sketch
the new budget constraint facing the household.
d. Suppose after the change the household spends $200 on Y
and $800 on X. Does this imply that X is a normal or an
inferior good? What about Y?
2. For most normal goods, the income effect and the substitution effect
work in the same direction; so when the price of a good falls both
the income and substitution effects lead to a higher quantity
demanded. Would this change if the good is an inferior good?

21
3. Suppose utility function given by
0.3 0.7
u ( x , y )=x y
If price of goods X ( P x =$ 6 ¿, price of goods Y ( P y =$ 7 ),
income equals $300, what is the amount of goods consumed to
maximize utility?
4. How can the water-diamond paradox be resolved by using the
concept of marginal utility?
5. Coco is a Lego maniac, but he also likes Super Soaker squirt guns.
The following table shows Coco’s total utility and marginal utility
from Legos and squirt guns measured in utils.

a. Suppose the price of Legos is $5 per set and the price of a

squirt gun is $8 per gun. Compute the marginal-utility-to-
price ratios for Legos and squirt guns and enter these
values in the table.
b. How many sets of Legos and how many squirt guns will
Coco purchase if he has $26 to spend? Carefully explain
how you arrived at your answer.
c. Now suppose the price of Legos falls to $2.50 per set while
the price of squirt guns stays the same. How many sets of
Legos and how many squirt guns will he purchase? Show
how you arrived at your answer.
d. Draw Coco’s demand curve for Legos between the prices
$5 per set and $2.50 per set. Why does it have a negative
slope?

22
 CHAPTER 4
THE PRODUCTION PROCESS

 Production: The process by which inputs are combined,

transformed, and turned into outputs.
 Firm is an organization that comes into being when a person or a
group of people decides to produce a good or service to meet a
perceived demand.
 The three decisions that all firms must make to achieve maximum
profits: (1) How much output to supply (quantity of product) , 2.
How to produce that output (which production technique/technology
to use), (3) How much of each input to demand.
 The first and last choices are linked by the second choice. Once a
firm has decided how much to produce, the choice of a production
method determines the firm’s input requirements.
 Similarly, given a technique of production, any set of input
quantities determines the amount of output that can be produced.
Changing the technology of production will change the relationship
between input and output quantities.
 A profit maximizing firm chooses the technology that minimizes its
costs for a given level of output.
 We assume that firms are in business to make a profit and that a
firm’s behavior is guided by the goal of maximizing profits.
 Profit is the difference between total revenue and total cost.
Profit = total revenue - total cost
 Total revenue is the amount received from the sale of the product
(q x P).
 Total cost (total economic cost) is the total of (1) out-of-pocket
costs and (2) opportunity cost of all factors of production, including
a normal rate of return on capital.
 Out-of-pocket costs are sometimes referred to as explicit costs or
accounting costs. These refer to costs as an accountant would
calculate them.

23
 Economic costs include the opportunity cost of every input. These
opportunity costs are often referred to as implicit costs. The term
profit will from here on refer to economic profit.
 The most important opportunity cost that is included in economic
cost is the opportunity cost of capital. The way we treat the
opportunity cost of capital is to add a normal rate of return to capital
as part of economic cost.
 Rate of return is the annual flow of net income generated by an
investment expressed as a percentage of the total investment.
 Normal rate of return is a rate of return on capital that is just
sufficient to keep owners and investors satisfied. For relatively risk-
free firms, it should be nearly the same as the interest rate on risk-
free government bonds.
 Short run: The period of time for which two conditions hold: The
firm is operating under a fixed scale (fixed factor) of production,
and firms can neither enter nor exit an industry.
 Long run: That period of time for which there are no fixed factors
of production: Firms can increase or decrease the scale of operation,
and new firms can enter, and existing firms can exit the industry.
 To know how much it costs to produce a good or service, a firm
needs to know three things (the bases of decisions) : (1) The
market price of output, (2) The techniques of production that are
available, and (3) The prices of inputs.
 Labor-intensive technology: Technology that relies heavily on
human labor instead of capital.
 Capital-intensive technology: Technology that relies heavily on
capital instead of human labor.
 Production function or total product function: A numerical or
mathematical expression of a relationship between inputs and
outputs. It shows units of total product as a function of units of
inputs.
 Marginal product: The additional output that can be produced by
adding one more unit of a specific input, ceteris paribus.
 Law of diminishing returns: When additional units of a variable
input are added to fixed inputs, after a certain point, the marginal
product of the variable input declines.

24
 Average product: The average amount produced by each unit of a
variable factor of production.

total product
 Average Product of Labor =
total units of labor

 Marginal Product > Average Product : Average Product increase

 Marginal Product < Average Product : Average Product decrease
 Marginal Product = Average Product : Average Product maximum
 Two things determine the cost of production:
(1) Technologies that are available
(2) Input prices.

25
 CHAPTER 4
THE PRODUCTION PROCESS

TRUE OR FALSE
1. A normal rate of return on capital is included in total revenue
because tying up resources in a firm’s capital stock has an
opportunity cost.
2. For companies in the economy with cheap labor costs, optimal
production methods will involve labor intensive techniques.
3. According to the law of diminishing returns, when additional units
of a variable input are added to fixed inputs, after a certain point, the
marginal product of the variable input will decline.
4. Average product “follows” marginal product, and it does change as
quickly. If marginal product is above average product, the average
falls; if marginal product is below average product, the average
rises.
5. Capital and labor are complementary but not substitutable inputs.
Capital enhances the productivity of labor, but it can’t be substituted
for labor.

ESSAY
1. Which of the following are short-run decisions and which are long-
run decisions?
a. General Motors decides to add a second shift to its Arlington,
Texas production plant.
b. Gotham Foods International chooses to exit the restaurant
industry to concentrate on its wholesale grocery supply
business.
c. The Sahara Hotel and Casino in Las Vegas closes two of its
three hotel towers in response to low demand.
d. Tony Andretti, owner of Tony the Taxman, hires five new
CPAs to work at his tax preparation business.
e. German tool and appliance manufacturer Bosch enters the
electric bicycle industry in 2010.
f. General Electric builds a new offshore wind manufacturing
plant in the United Kingdom.

26
2. Consider a firm that uses capital and labor as inputs and sells 5,000
units of output per year at the going market price of $10. Also
assume that total labor costs to the firm are $45,000 annually.
Assume further that the total capital stock of the firm is currently
worth $100,000, that the return available to investors with
comparable risks is 10 percent annually, and that there is no
depreciation. Is this a profitable firm? Explain your answer.

3. Suppose that in 2010, you became president of a small nonprofit

theater company. Your playhouse has 120 seats and a small stage.
The actors have national reputations, and demand for tickets is
enormous relative to the number of seats available; every
performance is sold out months in advance. You are elected because
you have demonstrated an ability to raise funds successfully.
Describe some of the decisions that you must make in the short run.
What might you consider to be your “fixed factor”? What alternative
decisions might you be able to make in the long run? Explain.

4. A firm can use three different production technologies, with capital

and labor requirements at each level of output as follows:

a. Suppose the firm is operating in a high-wage country, where capital

cost is $100 per unit per day and labor cost is $80 per worker per
day. For each level of output, which technology is cheapest?

27
b. Now suppose the firm is operating in a low-wage country, where
capital cost is $100 per unit per day but labor cost is only $40 per
unit per day. For each level of output, which technology is cheapest?
c. Suppose the firm moves from a high-wage to a low wage country
but its level of output remains constant at 200 units per day. How
will its total employment change?

5. The following table gives total output or total product as a function

of labor units used.

a. Define diminishing returns.

b. Does the table indicate a situation of diminishing returns? Explain
your answer.

28
29