Unit 3A Review Problems Part II - Quia



Unit 8 Review Problems

1. Your Aunt is thinking about opening a hardware store. She estimates that it would cost $500,000 per year to rent the location and buy the stock. In addition, she would have to quit her $50,000 per year job as an accountant.

a. Define opportunity cost.

b. What is your aunt’s opportunity cost of running a hardware store for a year? If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain.

2. In the following case all taxes are to be ignored. Mary Hadalam inherited a parcel of vacant land in a busy downtown location. Mary spent $2,600 on legal and engineering fees to ensure that the land could be built upon. The McDonald Corporation offered Mary $100,000 for the land. Mary decides to turn down the offer and build her own restaurant. With $80,000 that she had in the bank earning 6% interest, Mary constructs a building and buys equipment and furniture and leaves her $25,000 a year job and opens up her own restaurant firm. After one month John Cook, offers Mary $90,000 for the building, equipment and furniture which he plans to move to another town. Mary refuses. After the first year, Mary receives the profit statement from her accountant and it is as follows:

Revenue 250,000

Cost of Food Sold (120,000)

*Cost of Labor (80,000)

Cost of Other Expenses (20,000)

Net Profit 30,000

* Does not include payment to Mary Hadalam

The restaurant business in Mary’s community is very competitive. Mary is very happy and smug because she recalls her high school economics teacher stating in a competitive market firms earn no profit. She has defied economic theory and earned a profit in a very competitive market in her first year. Undoubtedly she is a superior business woman. Is Mary correct in assuming her economic profit is $30,000? If not, what is her situation economically? Show your work.

3. Explain how the listed events (a-d) would affect the following at the Ford Motor Company:

I. Marginal Cost

II. Average Variable Cost

III. Average Fixed Cost

IV. Average Total Cost

a. Ford signs a new contract with the United Automobile Workers Union that requires the company to pay higher wages.

b. The federal government starts to levy a $1,500 per vehicle tax on sport utility vehicles.

c. The company decides to give its senior executives a one-time $100,000 bonus.

d. Ford decides to increase the amount it spends on designing new car models by $1,000,000.

4. Your cousin Vinnie owns a painting company with fixed costs of $200 and the following schedule for variable costs:

Quantity of Houses per month |1 |2 |3 |4 |5 |6 |7 | |Variable Costs |$10 |$20 |$40 |$80 |$160 |$320 |$640 | |

Calculate average fixed costs, average variable cost, and average total cost, for each quantity. What is the efficient scale of the painting company?

5. Consider the following table of long-run total cost for three different firms:

Quantity |1 |2 |3 |4 |5 |6 |7 | |Firm A |60 |70 |80 |90 |100 |110 |120 | |Firm B |11 |24 |39 |56 |75 |96 |119 | |Firm C |21 |34 |49 |66 |85 |106 |129 | |

Does each of these firms experience economies of scale or diseconomies of scale? Explain.

6. Stephanie sells earrings in the perfectly competitive earring market. Her output per day and costs are as follows:

Output per day |0 |1 |2 |3 |4 |5 |6 |7 |8 |9 | |Total Cost |$1.00 |2.50 |3.50 |4.20 |4.50 |5.20 |6.80 |8.70 |10.70 |13.00 | |

a. If the current equilibrium price in the earring market is $1.80, how many earrings will Stephanie produce, what price will she charge, and how much profit (or loss) will she make? Draw a graph to illustrate your answer. Your graph should be clearly labeled and should include Stephanie’s demand, ATC, AVC, MC, and MR curves, the price she is charging, the quantity she is producing, and the area representing her profit (or loss).

b. Suppose the equilibrium price of earrings falls to $1.00. Now how many earrings will Stephanie produce, what price will she charge, and how much profit (or loss) will she make? Show your work. Draw a graph to illustrate this situation, using the instructions in question a.

c. Suppose the equilibrium price of earrings falls to $0.25. Now how many earrings will Stephanie produce, what price will she charge, and how much profit (or loss) will she make?

7. You go to the best restaurant in town and order a lobster dinner for $40. After eating half of the lobster, you realize that you are quite full. Your date wants you to finish your dinner because you cannot take it home and because “you have already paid for it.” What should you do? Relate your answer to the material in this chapter.

8. J & G Company operates in a perfectly competitive market for smoke alarms. J & G is currently earning short run positive economic profits.

a. Using correctly labeled side-by-side graphs for the smoke alarm market and J & G Company, indicate each of the following for both the market and the J & G Company.

i. Price

ii. Output

b. In the graph in part (a) for J & G, indicate the area of economic profits that J & G Company is earning in the short run.

c. Using a new set of correctly labeled side-by-side graphs for the smoke alarm market and J & G Company, show what will happen in the long run to each of the following.

i. Long-run equilibrium price and quantity in the market

ii. Long-run equilibrium price and quantity for J & G Company

d. (Unit 3 Review) Assume that purchases of smoke alarms create positive externalities. Draw a correctly labeled graph of the smoke alarm market.

i. Label the market equilibrium quantity as Qm.

ii. Label the socially optimum equilibrium quantity as Qs.

e. (Unit 3 Review) Identify one government policy that could be implemented to encourage the industry to produce the socially optimum level of smoke alarms.

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