7.7 PROBLEMS

Question 7.6

1. For each of the following, is the business a price-taking producer? Explain your answers.

  1. A cappuccino café in a university town where there are dozens of very similar cappuccino cafés

  2. The makers of Pepsi-Cola

  3. One of many sellers of zucchini at a local farmers’ market

Question 7.7

2. For each of the following, is the industry perfectly competitive? Referring to market share, standardization of the product, and/or free entry and exit, explain your answers.

  1. Aspirin

  2. Adele concerts

  3. SUVs

Question 7.8

3. Bob produces Blu-ray movies for sale, which requires a building and a machine that copies the original movie onto a Blu-ray. Bob rents a building for $30,000 per month and rents a machine for $20,000 a month. Those are his fixed costs. His variable cost per month is given in the accompanying table.

Quantity of Blu-rays VC
0 $0
1,000 5,000
2,000 8,000
3,000 9,000
4,000 14,000
5,000 20,000
6,000 33,000
7,000 49,000
8,000 72,000
9,000 99,000
10,000 150,000

  1. Calculate Bob’s average variable cost, average total cost, and marginal cost for each quantity of output.

  2. There is free entry into the industry, and anyone who enters will face the same costs as Bob. Suppose that currently the price of a Blu-ray is $25. What will Bob’s profit be? Is this a long-run equilibrium? If not, what will the price of Blu-ray movies be in the long run?

Question 7.9

4. Consider Bob’s Blu-ray company described in Problem 3. Assume that Blu-ray production is a perfectly competitive industry. For each of the following questions, explain your answers.

  1. What is Bob’s break-even price? What is his shut-down price?

  2. Suppose the price of a Blu-ray is $2. What should Bob do in the short run?

  3. Suppose the price of a Blu-ray is $7. What is the profit-maximizing quantity of Blu-rays that Bob should produce? What will his total profit be? Will he produce or shut down in the short run? Will he stay in the industry or exit in the long run?

  4. Suppose instead that the price of Blu-rays is $20. Now what is the profit-maximizing quantity of Blu-rays that Bob should produce? What will his total profit be now? Will he produce or shut down in the short run? Will he stay in the industry or exit in the long run?

Question 7.10

5. Consider again Bob’s Blu-ray company described in Problem 3.

  1. Draw Bob’s marginal cost curve.

  2. Over what range of prices will Bob produce no Blu-rays in the short run?

  3. Draw Bob’s individual supply curve. In your graph, plot the price range from $0 to $60 in increments of $10.

Question 7.11

6.

  1. A profit-maximizing business incurs an economic loss of $10,000 per year. Its fixed cost is $15,000 per year. Should it produce or shut down in the short run? Should it stay in the industry or exit in the long run?

  2. Suppose instead that this business has a fixed cost of $6,000 per year. Should it produce or shut down in the short run? Should it stay in the industry or exit in the long run?

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Question 7.12

7. The first sushi restaurant opens in town. Initially people are very cautious about eating tiny portions of raw fish, as this is a town where large portions of grilled meat have always been popular. Soon, however, an influential health report warns consumers against grilled meat and suggests that they increase their consumption of fish, especially raw fish. The sushi restaurant becomes very popular and its profit increases.

  1. What will happen to the short-run profit of the sushi restaurant? What will happen to the number of sushi restaurants in town in the long run? Will the first sushi restaurant be able to sustain its short-run profit over the long run? Explain your answers.

  2. Local steakhouses suffer from the popularity of sushi and start incurring losses. What will happen to the number of steakhouses in town in the long run? Explain your answer.

Question 7.13

8. A perfectly competitive firm has the following short-run total cost:

Quantity TC
0 $5
1 10
2 13
3 18
4 25
5 34
6 45

Market demand for the firm’s product is given by the following market demand schedule:

Price Quantity demanded
$12 300
10 500
8 800
6 1,200
4 1,800

  1. Calculate this firm’s marginal cost and, for all output levels except zero, the firm’s average variable cost and average total cost.

  2. There are 100 firms in this industry that all have costs identical to those of this firm. Draw the short-run industry supply curve. In the same diagram, draw the market demand curve.

  3. What is the market price, and how much profit will each firm make?

Question 7.14

9. A new vaccine against a deadly disease has just been discovered. Presently, 55 people die from the disease each year. The new vaccine will save lives, but it is not completely safe. Some recipients of the shots will die from adverse reactions. The projected effects of the inoculation are given in the accompanying table:

Percent of population inoculated Total deaths due to disease Total deaths due to inoculation Marginal benefit of inoculation Marginal cost of inoculation “Profit” of inoculation
0 55 0
— — —
10 45 0
— — —
20 36 1
— — —
30 28 3
— — —
40 21 6
— — —
50 15 10
— — —
60 10 15
— — —
70 6 20
— — —
80 3 25
— — —
90 1 30
— — —
100 0 35

  1. What are the interpretations of “marginal benefit” and “marginal cost” here? Calculate marginal benefit and marginal cost per each 10% increase in the rate of inoculation. Write your answers in the table.

  2. What proportion of the population should optimally be inoculated?

  3. What is the interpretation of “profit” here? Calculate the profit for all levels of inoculation.

Question 7.15

10. Evaluate each of the following statements. If a statement is true, explain why; if it is false, identify the mistake and try to correct it.

  1. A profit-maximizing firm in a perfectly competitive industry should select the output level at which the difference between the market price and marginal cost is greatest.

  2. An increase in fixed cost lowers the profit-maximizing quantity of output produced in the short run.

Question 7.16

11. The production of agricultural products like wheat is one of the few examples of a perfectly competitive industry. In this question, we analyze results from a study released by the U.S. Department of Agriculture about wheat production in the United States back in 2013.

  1. The average variable cost per acre planted with wheat was $127 per acre. Assuming a yield of 44 bushels per acre, calculate the average variable cost per bushel of wheat.

  2. The average price of wheat received by a farmer in 2013 was $7.58 per bushel. Do you think the average farm would have exited the industry in the short run? Explain.

  3. With a yield of 44 bushels of wheat per acre, the average total cost per farm was $4.80 per bushel. The harvested acreage for rye (a type of wheat) in the United States increased from 242,000 in 2010 to 306,000 in 2013. Using the information on prices and costs here and in parts a and b, explain why this might have happened.

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  4. Using the above information, what do you think will happen to wheat production and prices after 2013?

Question 7.17

12. The accompanying table presents prices for washing and ironing a man’s shirt taken from a survey of California dry cleaners.

Dry cleaner City Price
A-1 Cleaners Santa Barbara $1.50
Regal Cleaners Santa Barbara 1.95
St. Paul Cleaners Santa Barbara 1.95
Zip Kleen Dry Cleaners Santa Barbara 1.95
Effie the Tailor Santa Barbara 2.00
Magnolia Too Goleta 2.00
Master Cleaners Santa Barbara 2.00
Santa Barbara Cleaners Goleta 2.00
Sunny Cleaners Santa Barbara 2.00
Casitas Cleaners Carpinteria 2.10
Rockwell Cleaners Carpinteria 2.10
Norvelle Bass Cleaners Santa Barbara 2.15
Ablitt’s Fine Cleaners Santa Barbara 2.25
California Cleaners Goleta 2.25
Justo the Tailor Santa Barbara 2.25
Pressed 4 Time Goleta 2.50
King’s Cleaners Goleta 2.50

  1. What is the average price per shirt washed and ironed in Goleta? In Santa Barbara?

  2. Draw typical marginal cost and average total cost curves for California Cleaners in Goleta, assuming it is a perfectly competitive firm but is making a profit on each shirt in the short run. Mark the short-run equilibrium point and shade the area that corresponds to the profit made by the dry cleaner.

  3. Assume $2.25 is the short-run equilibrium price in Goleta. Draw a typical short-run demand and supply curve for the market. Label the equilibrium point.

  4. Observing profits in the Goleta area, another dry cleaning service, Diamond Cleaners, enters the market. It charges $1.95 per shirt. What is the new average price of washing and ironing a shirt in Goleta? Illustrate the effect of entry on the average Goleta price by a shift of the short-run supply curve, the demand curve, or both.

  5. Assume that California Cleaners now charges the new average price and just breaks even (that is, makes zero economic profit) at this price. Show the likely effect of the entry on your diagram in part b.

  6. If the dry cleaning industry is perfectly competitive, what does the average difference in price between Goleta and Santa Barbara imply about costs in the two areas?

WORK IT OUT

image | interactive activity

Question 7.18

13. Kate’s Katering provides catered meals, and the catered meals industry is perfectly competitive. Kate’s machinery costs $100 per day and is the only fixed input. Her variable cost consists of the wages paid to the cooks and the food ingredients. The variable cost per day associated with each level of output is given in the accompanying table.

Quantity of meals VC
0 0
10 200
20 300
30 480
40 700
50 1,000

  1. Calculate the total cost, the average variable cost, the average total cost, and the marginal cost for each quantity of output.

  2. What is the break-even price and quantity? What is the shut-down price and quantity?

  3. Suppose that the price at which Kate can sell catered meals is $21 per meal. In the short run, will Kate earn a profit? In the short run, should she produce or shut down?

  4. Suppose that the price at which Kate can sell catered meals is $17 per meal. In the short run, will Kate earn a profit? In the short run, should she produce or shut down?

  5. Suppose that the price at which Kate can sell catered meals is $13 per meal. In the short run, will Kate earn a profit? In the short run, should she produce or shut down?