Practice problem set 4

Managerial Economics
PGP, 2020-2022

Figure 7.1
1 ) Refer to Figure 7.1. At output level Q 1, as Q rises a little
A) marginal cost is falling.
B) average total cost is falling.
C) average variable cost is less than average fixed cost.
D) marginal cost is less than average total cost.
E) all of the above
Answer: E
Section: 7.2

2) From Equation (7.1) in the book, the short-run marginal cost of production is MC =
w/MPL. Based on this equation, which of the following statements is NOT true?
A) If the marginal product of labor is constant, then MC is constant.
B) If the marginal product of labor is a concave curve to Q-axis, then the MC curve is also
concave.
C) If the marginal product of labor is a concave curve, then the MC curve is U-shaped.
D) MC increases as the marginal product of labor declines.
Answer: B
Section: 7.2

3) In the short run, suppose average total cost is a straight line and marginal cost is positive
and constant. Then, we know that fixed costs must:
A) be declining with output.
B) be positive.
C) equal zero.

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D) We do not have enough information to answer this question.
Answer: C

4) Which of the following is NOT an expression for the cost minimizing combination of
inputs?
A) MRTS = MPL /MPK
B) MPL/w = MPK/r
C) MRTS = w/r
D) MPL/MPK = w/r
E) none of the above
Answer: A
Section: 7.3

5) Suppose that the price of labor (PL) is $10 and the price of capital (PK) is $20. What is the
equation of the isocost line corresponding to a total cost of $100?
A) PL + 20PK
B) 100 = 10L + 20K
C) 100 = 30(L+K)
D) 100 + 30 (PL + PK)
E) none of the above
Answer: B
Section: 7.3

6) Which of following is a key assumption of a perfectly competitive market?

A) Firms can influence market price.
B) Commodities have few sellers.
C) It is difficult for new sellers to enter the market.
D) Each seller has a very small share of the market.
E) none of the above
Answer: D
Section: 8.1

7) Because of the relationship between a perfectly competitive firm's demand curve and its
marginal revenue curve, the profit maximization condition for the firm can be written as
A) P = MR.
B) P = AVC.
C) AR = MR.
D) P = MC.
E) P = AC.
Answer: D
Section: 8.3

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8) Marginal profit is negative when:
A) marginal revenue is negative.
B) total cost exceeds total revenue.
C) output exceeds the profit-maximizing level.
D) profit is negative.
Answer: C
Section: 8.3

Consider the following diagram where a perfectly competitive firm faces a price of $40.

Figure 8.1

9) Refer to Figure 8.1. At the profit-maximizing level of output,

A) AVC is minimized.
B) ATC is minimized.
C) MC is minimized.
D) total cost is minimized.
E) no costs are minimized.
Answer: E
Section: 8.4

10) Suppose a plant manager ignores some implicit marginal costs of production so that the
perceived MC curve is below the actual MC curve. What is the likely outcome from this
error?
A) Firm produces less than optimal quantity and earns lower profits
B) Firm produces less than optimal quantity and earns higher profits
C) Firm produces more than optimal quantity and earns lower profits
D) Firm produces more than optimal quantity and earns higher profits
Answer: C

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Section: 8.4

11) Short-run supply curves for perfectly competitive firms tend to be upward sloping
because:
A) there is diminishing marginal product for one or more variable inputs.
B) marginal costs increase as output increases.
C) marginal fixed costs equal zero.
D) A and B are correct.
E) B and C are correct.
Answer: D
Section: 8.5

12) What happens in a perfectly competitive industry in long run when economic profit is
greater than zero?
A) Existing firms may get larger.
B) New firms may enter the industry.
C) Firms may move along their LRAC curves to new outputs.
D) There may be pressure on prices to fall.
E) All of the above may occur.
Answer: E
Section: 8.7

13) A monopolist has equated marginal revenue to zero. The firm has:
A) maximized profit.
B) maximized revenue.
C) minimized cost.
D) minimized profit.
Answer: B
Section: 10.1

Scenario 10.1:
Barbara is a producer in a monopoly industry. Her demand curve, total revenue curve,
marginal revenue curve and total cost curve are given as follows:
Q = 160 - 4P TR = 40Q - 0.25Q2 MR = 40 - 0.5Q TC = 4Q MC = 4

14) Refer to Scenario 10.1. How much output will Barbara produce?
A) 0
B) 22
C) 56
D) 72
E) none of the above
Answer: D
Section: 10.1

15) Refer to Scenario 10.1. The price of her product will be ________.

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A) 4
B) 22
C) 32
D) 42
E) 72
Answer: B
Section: 10.1

16) Refer to Scenario 10.1. How much profit will she make?
A) -996
B) 0
C) 1,296
D) 1,568
E) none of the above
Answer: C
Section: 10.1

17) For a monopolist, at the profit-maximizing level of output, demand is

A) completely inelastic.
B) inelastic, but not completely inelastic.
C) unit elastic.
D) elastic, but not infinitely elastic.
E) infinitely elastic.
Answer: D
Section: 10.1

18) Bancroft Pharmaceuticals has a patent on a new medication used to treat high blood
pressure, so it is the monopoly seller of this new drug product. The marginal cost of
producing one dose of the drug is $10, and the elasticity of demand for the product is -3.
What is the profit maximizing monopoly price for this patented drug product?
A) $10
B) $12.50
C) $15
D) $30
Answer: C
Section: 10.1

19) DVDs can be produced at a constant marginal cost of $10 per disk, and Roaring Lion
Studios is releasing the DVDs for its last two major films. The DVD for Rambeau 17 is priced
at $20 per disk, and the DVD for Schreck 10 is priced at $30 per disk. What are the Lerner
indices for these two movies?
A) Both equal one.
B) 2 and 3, respectively
C) 0.5 and 0.67, respectively
D) 1 and 2, respectively
Answer: C
Section: 10.2

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20) You produce stereo components for sale in two markets, foreign and domestic, and the
two groups of consumers cannot trade with one another. If your firm practices third-degree
price discrimination to maximize profits, the marginal revenue
A) in the foreign market will equal the marginal cost.
B) in the domestic market will equal the marginal cost.
C) in the domestic market will equal the marginal revenue in the domestic market.
D) all of the above
E) none of the above
Answer: D
Section: 11.2

21) Your local grocery store offers a coupon that reduces the price of milk during the coming
week. The regular retail price of milk in the store is $3.00 per gallon, and the coupon price is
$2.00 per gallon for the next week. If the store maximizes profits and the price elasticity of
demand for milk is -2 for coupon users, what is the price elasticity of demand for non-users?
A) -0.67
B) -1.0
C) -1.5
D) We do not have enough information to answer the question.
Answer: C
Section: 11.2

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Short answer question

22) A firm's total cost function is given by the equation:

TC = 4000 + 5Q + 10Q2; MC = 5 + 20Q.

Determine the quantity that minimizes average total cost. Demonstrate that the predicted
relationship between marginal cost and average cost holds at that quantity of output.

Answer:

ATC is minimized where MC is equal to ATC.

Equating MC to ATC

= 5 + 20Q
4000 +5Q + 102 = 5Q + 20Q2
4000 = 10Q2
Q2 = 400
Q = 20

ATC is minimized at 20 units of output. Up to 20, ATC falls, while beyond 20 ATC rises.

MC should be less than ATC for any quantity less than 20.
For example, let Q = 10:
MC = 5 + 20(10) = 205

ATC = = 505
MC is indeed less than ATC for quantities smaller than 20.
MC should exceed ATC for any quantity greater than 20.
For example, let Q = 25:
MC = 5 + 20(25) = 505

ATC = = 415
MC is indeed greater than ATC for quantities greater than 20.
Section: 7.2

23) Ronald's Outboard Motor Manufacturing plant has the following short-run cost function:

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C(q, A, K) = + 500K, where q is the number of motors produced, K is the number of
machines leased, and A is a productivity factor of technology. Currently, A is 25 and Ronald
uses 20 machines. Ronald is investigating a new production technique. If he adopts the new
technique, the productivity factor will become 36. If Ronald adopts the new technique, what
is his average total cost of manufacturing 140 motors? Did the increase in the productivity
factor increase or decrease the average total cost of producing 140 motors?

Answer: Initially, Ronald's average total cost of producing 140 motors is:

ATC(140, 25, 20) = = 88.23. With the new technique, Ronald's

average total cost of producing 140 motors is: ATC(140, 36, 20) = =
79.53. The increase in the productivity factor associated with the new technique decreases
the average total cost of producing 140 units by $8.70 per unit.
Section: 7.4

24) One Guy's Pizza jointly produces pizzas and calzones. The joint cost function is:

CP,C( q1, q2) = 4 q1 + 0.8 - 1.5 q11/5 q21/5, where q1 is the number of pizzas and q2 is the
number of calzones One Guy's Pizza produces. If One Guy produces pizzas alone, the cost
function is:
CP (q1) = 4 q1. If One Guy produces calzones alone, the cost function is: CC (q2) = 0.8 q2.
Calculate One Guy's degree of economies of scope if they produce 1,024 pizzas and 243
calzones.

Answer: SC = =

=0.72. Since the measure is positive, One Guy's

Pizza enjoys economies of scope for pizza and calzone production.
Section: 7.5

25) Laura's internet services has the following short-run cost curve: C(q, K) = + rK
where q is Laura's output level, K is the number of servers she leases and r is the lease rate of

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servers. Laura's short-run marginal cost function is: MC(q, K) = . Currently, Laura
leases 8 servers, the lease rate of servers is $15, and Laura can sell all the output she
produces for $500. Find Laura's short-run profit maximizing level of output. Calculate
Laura's profits. If the lease rate of internet servers rise to $20, how does Laura's optimal
output and profits change?

Answer: The profit maximizing output level is where the market price equals marginal cost
(providing the price exceeds the average variable cost). To determine the optimal output

level, we need to first equate marginal cost to the market price. That is, MC(q, 8) = 50

= P = 500  q = 40. The average variable cost at this output level is: AVC(40, 8) = =

= 250.
Since P > AVC(40, 8), Laura will maximize profits at 4 units. Laura's profits are:

π = Pq - C(q, 8) = 500(40) - { + 15(8)} = 9,880. If the lease rate of servers rise to $20,
Laura's short-run output level doesn't change as average variable cost and marginal cost are
unaffected by the lease rate. Laura's profits will be affected. New profits are:

= Pq - C(q, 8) = 500(40) - { + 20(8)} = 9,840. Thus, the $5 increase in the rental rate
reduced Laura's short-run profits by $40.
Section: 8.4

26) Davy Metal Company produces brass fittings. Davy's engineers estimate the production
function represented below as relevant for their long-run capital-labor decisions.
Q = 500L0.6K0.8,
where Q = annual output measured in pounds,
L = labor measured in person hours,
K = capital measured in machine hours.
The marginal products of labor and capital are:
MPL = 300L-0.4K0.8 MPK = 400L0.6K-0.2
Davy's employees are relatively highly skilled and earn $15 per hour. The firm estimates a
rental charge of $50 per hour on capital. Davy forecasts annual costs of $500,000 per year,
measured in real dollars.

a. Determine the firm's optimal capital-labor ratio, given the information above.

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b. How much capital and labor should the firm employ, given the $500,000 budget?
Calculate the firm's output.
c. Davy is currently negotiating with a newly organized union. The firm's personnel
manager indicates that the wage may rise to $22.50 under the proposed union contract.
Analyze the effect of the higher union wage on the optimal capital-labor ratio and the firm's
employment of capital and labor. What will happen to the firm's output?

Answer:
a.

MPL = 300 L-0.4K0.8 = 300

MPK = 400 L0.6K-0.2 = 400

MRTS = = 0.75

MRTS = 0.75

Equate MRTS to = .

0.75 =

0.75 = 0.3

= 0.4; K=0.4L

b.
C = 500,000
C = wL + rK
500,000 = 15L + 50K
K = 0.4L from optimal ratio
500,000 = 15L + 50(0.4L)
500,000 = 15L + 20L
500,000 = 35L
L = 14,285.71 or 14,286 hours
Substitute to solve for K.
500,000 = 15(14286) + 50K

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 500,000 = 214,290 + 50K
285,710 = 50K
K = 5714.20
or K = 5714
Q = 500(14,286)0.6(5,714)0.8
Q = 157,568,191

c.

MRTS = 0.75

New = = 0.45

Equating MRTS to = .

0.75 = 0.75

= 0.6
K = 0.6L

Substitute into C:
500,000 = 22.50L + 50K
K = 0.60L
500,000 = 22.50L + 50(0.6L)
500,000 = 22.50L + 30L
500,000 = 52.50L
L = 9,523.8 or 9,524
L fell from 14,286 to 9,524. Substitute to solve for K.
500,000 = 22.50(9,524) + 50K
285,710 = 50K
K = 5,714.20 or 5,714
K remains constant.
Q = 500(9524)0.6(5714)0.8
Q = 123,541,771.8
Output fell from 157,568,202.5 to 123,541,771.8.
Section: 7.3

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