HA 191 Lecture 1 - Kent State University



Econ 22060, Section 004 - Principles of Microeconomics

Fall, 2001

Dr. Kathryn Wilson

Due: Thursday, October 18

Homework #3 – Answer Sheet

In honor of the Cleveland Indian’s being in the playoffs, this homework has a baseball theme. Go Tribe!

1. The following table shows the number of bags of peanuts that can be produced by the Peterson Nut Company depending on how many workers the company has working.

|Number of |Bags of |Marginal Physical Product |

|Worker |Peanuts | |

|10 |500 |---- |

|11 |550 |50 |

|12 |590 |40 |

|13 |620 |30 |

|14 |640 |20 |

|15 |650 |10 |

a. In the table, fill in the marginal physical product for the 11th through 15th workers.

b. Is the law of diminishing marginal returns consistent with what we see for the workers in the Peterson Nut Company? In your answer make sure you explain what the law of diminishing marginal returns is. Yes. As the number of workers increases, the marginal physical product (extra output produced by adding an additional worker) goes down. When we go from 10 to 11 workers, we get an extra 50 bags of peanuts; when we go from 14 to 15 workers, we only get an additional 10 bags of peanuts. This implies there must be some fixed input in production.

c. Give examples of at least 2 fixed inputs in the production of peanuts and 2 variable inputs in the production of peanuts. Answers will vary. Here as some examples.

fixed inputs variable inputs

the factory labor

insurance peanuts

d. Explain how the law of diminishing marginal returns is related to the shape of the marginal cost curve. The law of diminishing marginal returns results in the marginal cost curve eventually being upward sloping. For example, look at the table above. If we want to make 550 instead of 500, we only have to add 1 worker to get those extra 50 bags of peanuts. The marginal cost of making the bags of peanuts is pretty low. If we want to go from 650 to 700 peanuts, we would have to add more than 5 workers to get those extra 50 bags of peanuts. The marginal cost of making the bags of peanuts is quite high. Under the law of diminishing marginal returns, as we increase the quantity we make, the marginal cost of making the product increases.

2. Based on his dominating performance in game one of the series with Seattle, a company decides to make a life-size Bartolo Colon bobble-head doll. The table shows the costs for the firm. Fill in the remaining spaces.

| | | | | |Average Fixed |Average Variable |Average |

| |Fixed |Variable |Total |Marginal |Costs |Costs |Total Costs |

|Quantity |Costs |Costs |Costs |Costs | | | |

|0 |500 |0 |500 |----- |----- |----- |----- |

|1 |500 |200 |700 |200 |500 |200 |700 |

|2 |500 |380 |880 |180 |250 |190 |440 |

|3 |500 |580 |1080 |200 |166.7 |193.3 |360 |

|4 |500 |800 |1300 |220 |125 |200 |325 |

|5 |500 |1040 |1540 |240 |100 |208 |308 |

|6 |500 |1300 |1800 |260 |83.3 |216.7 |300 |

|7 |500 |1580 |2080 |280 |71.4 |225.7 |297.1 |

|8 |500 |1880 |2380 |300 |62.5 |235 |297.5 |

|9 |500 |2200 |2700 |320 |55.6 |244.4 |300 |

3. A firm produces replica Omar Vizquel diamond studded earrings. The average total cost of making an earring is $8. With the number of earrings they are currently selling, the marginal cost of making the last earring is $12. The firm can sell as many earrings as it wants for a price of $10. Would you suggest that the firm should sell more earrings for $10, fewer earrings for $10, or congratulate them because the number of earrings they are selling is maximizing profit? Justify your answer. (Just for clarification, the product is named for Omar not because Omar wears earrings but rather because earlier in the season a Seattle pitcher got thrown out of a ballgame for his behavior after Omar complained that the reflection from the pitcher’s diamond earring made it hard to see the pitch.) We know firms maximize profits by selling the quantity where marginal revenue equals marginal costs. The marginal revenue of selling one more unit is $10 (each extra earring they sell they bring in an extra $10). The marginal cost of the last unit is $12. Since marginal cost > marginal revenue, the firm is not maximizing profits; the firm would have higher profits if it sold fewer earrings. We can see this by the fact that the last earring they sold cost them $12 to make and they only got paid $10 for it – they lost $2 on that earring so their profits would have been $2 higher if they hadn’t sold it. The firm is still making a profit (price is higher than average total cost), but the profit is not as high as it could have been.

4. Susan quit her job as a schoolteacher, took her life savings of $10,000, and bought a stand outside of Jacob’s Field where she sells Tribe gear. She loves her job. Her accountant tells her she is making $15,000 in profit for the year. What would you tell Susan about her economic profits? (Are her economic profits more or less than $15,000 and what is the difference between economic profits and accounting profits?) Do you think she is earning positive economic profits? The difference between economic profit and accounting profit is that accounting profit does not take into account opportunity costs but economic profit does. In other words, economic profit considers what the person is giving up as a cost. In this case, Susan is giving up the salary she could have made as a schoolteacher and she is giving up the interest she could have made on her life savings if instead of buying the stand she had left the $10,000 invested. If we include these as costs, her profit will be much lower (economic profit is much lower than accounting profit). In fact, providing that teaching pays more than $15, 000 per year, she has negative economic profit.

5. Wisconsin has cheeseheads to wear for games, but alas Cleveland has nothing comparable. To rectify this situation, a company decides to make “glove heads” to sell to fans sitting in the bleacher seats. The product is an oversized foam baseball glove that you wear on your head to catch homerun balls hit by the Tribe. The quantity where marginal revenue equals marginal cost is 2,000 glove heads. When the firm makes 2,000 glove heads, it has fixed costs of $21,000 and variable costs of $15,000. The price of glove heads is $10.

a. What are the firm’s profits if they stay in business in the short run?

Profits = Total Revenue – Total Cost = Price * Quantity – Total Cost = $10*2000 – (21,000+15,000) = $-16,000 The firm is losing $16,000.

b. What are the firm’s profits if they shut down in the short run?

If they shut down, they will have zero total revenue but will still have to pay their fixed costs. Profit = $0 - $21,000 = -$21,000. The firm is losing $21,000

c. You are hired as a consultant to the firm. Do you recommend they stay open in the short run or shut down in the short run? You must not only give your recommendation, but explain to the owner of the company the rationale for your decision. I recommend the firm stay open in the short run since it is losing less money by staying open than it would lose by shutting down ($16,000 compared to $21,000). The reason the firm should stay open is that it is covering its variable costs, the extra costs of staying open (total revenue = $20,000 and variable costs = $15,000). As long as a firm is covering variable costs, any extra money can help to pay for the fixed costs, which the firm has to pay whether it is open or closed.

d. You are hired as a consultant to the firm. Do you recommend they stay open in the long run or shut down in the long run? You must not only give your recommendation, but explain to the owner of the company the rationale for your decision. The firm should shut down in the long run since it has negative profit. In the long run, the firm can get out of its fixed obligations (sell the building, get out of a lease, etc.). Once it can get out of these obligations, it should and go do whatever the next best alternative is since that pays $16,000 better than staying in business.

6. Suppose the industry for Cleveland Indian flags is perfect competition. The Acme Flag Company can sell flags for $50 and has the total costs indicated in the table below.

|Quantity |Total Cost |Marginal Cost |

|50 |2300 | |

|51 |2340 |40 |

|52 |2385 |45 |

|53 |2435 |50 |

|54 |2490 |55 |

|55 |2550 |60 |

a. What quantity of flags should Acme sell to maximize profits? How much are their profits? We know firms maximize profit by selling the quantity where marginal revenue = marginal cost. The marginal revenue for the firm is the $50 price it charges for the flags. The marginal cost for the firm can be calculated from the total costs that are given. The firm wants to sell 53 flags to maximize profit. Profit = total revenue * total cost = 53*$50 - $2435 = $2650 - $2435 = $215.

b. If the Acme Flag Company increased the price of their flags to $60, given the market is characterized by perfect competition, what do you think would happen to their profits? (You do not have to give me a specific number for their profits, but explain what would happen.) Since the market is perfect competition, there are many companies all selling identical flags. If the Acme Flag Co. tried to charge a price higher than the market price, they would not be able to sell any flags because people would just buy the flags from the other companies instead. Their profits would fall a lot.

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