Question 1

A.

A competitive industry meets profit maximization in the short-run when its marginal
cost (MC) equals its marginal revenue1 (MR):

MC=MR (i)

The MC function can be easily computed from the 1st derivative of the total cost (TC)
function:

2
TC= y +5 y+ 50

thus

2
dTC d( y +5 y +50)
MC= = =2 y +5(ii)
dy dy

The MR function can be easily computed from the 1 st derivative of the total revenue
(TR) function. TR though is equal to the price (P) times the product quantity (y):

TR=P∗y =35 y (iii)

thus

dTR d (35 y )
MR= = =35 (iv)
dy dy

Equating MC & MR as in (i) and based on (ii) & (iv) and solving for y we can
compute the profit maximizing output level (y) for each industry. Thus:

2 y +5=35=¿

y=15

Based on the above result and function (iii) we can compute the TR for each firm.
Thus:

TR=P∗y =35∗15=525 (v)

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 402)
The profit π of each firm is calculated if we subtract TC from TR2.

π=TR−TC (vi)

First we need to calculate TC from its function and for y = 15, thus:

2 2
TC= y +5 y+ 50=15 +5∗15+50=350(vii)

Replacing TR & TC in (vi) based on results (v) & (vii) we can now calculate profit π,
thus:

π=525−350=175

Based on the Principle3 that states that a firm will shut down and produce nothing if
price is less than the average variable cost ( P < AVC ), in order to calculate the shut
down price in the short-run we need to find the minimum of the AVC function, but
first we need to derive the AVC function.

The AVC can be easily computed if we divide the total variable cost (VC) with the
total quantity produced (y)

VC
AVC= (viii)
y

The VC function can be derived from the TC function.

We know that:

TC = VC + FC (ix),

Where FC is the fixed cost that a firm faces even if it produces nothing (y = 0).

From the TC function and for y = 0 we conclude that:

2
TC=0 +5∗0+50=50=FC (x)

Thus from (ix) & (x) we get that:

VC=TC−FC=( y 2+5 y +50 ) −50= y 2+5 y (xi)

Thus from (viii) & (xi) we can derive the AVC function:
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 399)
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 404)
 2
y +5 y
AVC= = y +5
y

From the above equation and since there cannot be negative product we can easily
derive that for y = 0, which is the minimum value that y can get we also get the
AVCmin:

AVC min =0+5=5

Thus we conclude that the firm will shut down if the price P < 5.

B.

Based on the Principle4 that states: In long-run (L-R) competitive equilibrium the
market adjusts so that P = LMC = LAC, which is at the minimum point on LAC curve,
where P is the equilibrium price, LMC stands for Long-run Marginal Cost & LAC
stands for Long-run Average Cost, we can initially calculate the quantity per firm at
equilibrium.

Since, TC=2 y 2+ 8

And based on the definitions of LAC & LMC we can derive their functions as shown
below:

2
TC 2 y +8 8
LAC = = =2 y + (i)
y y y

2
dTC d (2 y +8)
LMC= = =4 y (ii)
dy dy

As stated above at Long-run equilibrium LAC = LMC thus from (i) & (ii) we can
calculate the quantity per firm at equilibrium:

8
2 y + =4 y => yfirm = 2 (iii)
y

From (i) & (iii) we can now compute the LACmin:

8 8
LAC min =2 y + =2∗2+ =8
y 2

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 414)
Since at L-R equilibrium LACmin = Pequil we have that:

Pequil = 8

The market quantity at equilibrium can be easily computed from the market demand
function, where p = Pequil, thus:

y=24− p=24−8=16 (iv)

The number of firms N can be computed if we divide the market quantity y computed
above (iv) by the output of each firm at equilibrium (iii), thus:

y 16
N= = =8
y firm 2

Question 2

Based on:

a. The Principle5 that states: For a firm that produces using two plants, A and B,
with marginal costs MCA and MCB, respectively, the total cost of producing
any given level of total output y = y A + yB, is minimized when the production is
allocated between the two plants so that the marginal costs are equal,
MCA=MCB.
b. The definition of total marginal cost curve 6 MCT stating that MCT equals the
horizontal summation of all plants’ marginal cost curves with the requirement
that MCA=MCB= MCT for all levels of total output y.

We can initially compute the MCT function with the following procedure:

2
d c A d (10+ 2 y A ) MC A MC T
MC A = = =4 y A MC A= MCT y A= =
d yA d yA ⇒ 4 4

2
d c B d (2+ 3 y B ) MC B MC T
MC B = = =6 y B MC B =MC T y B= =
d yB d yB ⇒ 6 6

Replacing yA & yB from the above in y = yA + yB, we have:

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 482)
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 482, 483)
 MC T MC T
y= + ❑
4 6 ⇔

And solving for MCT we have:

MC T =2 , 4 y (i)

The inverse demand function can be derived from the demand function solving for p
(price) as follows:

y=100−2 p ❑ p=50−0 , 5 y
⇒

Based on the above and the relation7 stating that: When inverse demand is linear,
P=A+BQ (A>0, B<0), marginal revenue MR is also linear, intersects the price axis
at the same point demand does, and is twice as steep as the inverse demand function.
The equation of the linear marginal revenue curve is MR=A+2BQ.

We can easily derive the MR equation:

Since p=50−0 , 5 y

MR=50−2 ( 0 , 5 y )=50− y (ii)

At the profit-maximization level the marginal revenue equals the marginal cost 8.
Thus, equating marginal revenue (ii) and marginal cost (i) we have,

50− y=2 , 4 y

and solving for y, the profit-maximizing level of output is:

y=14 ,7 ≅ 15(iii)

Replacing the above in (ii) we can compute the MR:

MR=50− y=50−14 , 7=35 , 29=MC T (iv)

From the formerly derived reverse demand function, we can also compute the Price at
equilibrium based on the output calculated above at (iii). Thus:

p=50−0 , 5 y=50−0 ,5∗15=42 , 5

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 224)
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 402)
Based on (iv) the marginal cost of last unit produced in either plant is 35,29 thus the
total quantity produced will be allocated between the two plants as follows:

MC A MC T 35 , 29
y A= = = =8 , 82 ≅ 9
4 4 4

MC B MC T 35 , 29
yB= = = =5 , 88 ≅ 6
6 6 6

Question 3

A.

A consumer would prefer between two identical products the one with the lower
price. In order to define which of the two producers consumers would prefer to face,
we need to calculate the price at which each of the producers has decided to sell their
product.

The monopolistic firm A, will decide to produce at the level where its marginal
revenue equals its marginal cost9:

MR A=SMC A ( i )

Based on the relation10 stating that: When inverse demand is linear, P=A+BQ (A>0,
B<0), marginal revenue MR is also linear, intersects the price axis at the same point
demand does, and is twice as steep as the inverse demand function. The equation of
the linear marginal revenue curve is MR=A+2BQ, and since the inverse demand
function is p = 20 – y, we can derive the MR function which is:

MR A=20−2 y A (ii)

Additionally the SMCA function can be easily derived from the 1 st derivative of total
cost function, cA . Thus we have:

d c A d ( 4+ 2 y A )
SMC A= = =2 ( iii )
d yA d yA

From (i),(ii),(iii) solving for yA we can define the output decision for firm A:

9
Since a firm cannot produce decimal amounts of output we round the result.
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 464)
 20−2 y A =2❑ y A=9 (iv )
⇒

From the inverse demand function and (iv) we can compute the price of product for
firm A:

p A =20− y A=20−9=11(v)

The perfectly competitive firm B, on the other hand will decide to produce at the level
where its product’s price equals its marginal cost11:

pB =SMC B ( vi )

Additionally the SMCB function can be easily derived from the 1 st derivative of total
cost function, cB . Thus we have:

d c B d ( 10 y B )
SMC B= = =10 ( vii )
d yB d yB

Thus from (vi) & (vii) we have that:

pB =10(viii)

As shown from (v) & (viii):

pB < p A

Thus the consumers would prefer to face perfect competitor in this market.

B.

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 224)
From the given production plan we derive the following table. The two first columns
of the table below represent the Labor Units (L) and Total Product (Q) produced when
the amount of Land (K) is held constant and equal to 3 acres.

K=3
Labor Units Total Product Marginal Product
(L) (Q) (MP=ΔQ/ΔL)
0 0 -
1 12 12.00
2 16 4.00
3 18 2.00
4 19 1.00
5 20 1.00
6 21 1.00
7 22 1.00

In order to examine if the technology exhibits diminishing marginal returns to the

inputs we need to calculate the Marginal Product (MP) as shown in column 3 of the
table above for this random chosen set of data. As shown, the Law of diminishing
marginal product12 is confirmed, since we see that as the number of units of the
variable input increases (Labor increases) while the other input is held constant
(Capital constant), there is a point reached beyond which that the marginal product
decreases. The same can be visually shown if we plot the MP curve as shown in the
figure below:

Chart Title
16.00
14.00
12.00
10.00
8.00 Marginal
Product
6.00 (K = 3)
4.00
2.00
0.00
1 2 3 4 5 6 7

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 402)
Further more from the given data we can derive that the specific production plan is
characterized by constant returns to scale13since we can see that when both inputs
double the output also doubles. These figures are extracted in the following table:

Units of Labor (L)

0 1 2 4
0 0
Units of Land

1 6
(K)

2 12
4 24

Question 4

A.

Supposing that the total Income (M) of the consumer is spent for the purchase of the
two Products, X & Y and based on the assumption that no matter what his income is
he always spends an equal amount of it on each good we have:

M =P x∗x + P y∗y

where Px is the price of product X and Py is the price of product Y while x, y are the
quantities of products X, Y purchased respectively.

From the above equation we have that:

M⇔
P x∗x=P y∗ y= ❑
2

Px y
= (i )
Py x

The rate y/x though represents the marginal rate of substitution MRS 14 thus equation
(i) can be rewritten as:

Px y
=MRS= (ii)
Py x

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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 296)
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 336)
Additionally the following Principle15states that: A consumer maximizes utility subject
to a limited money income at the combination of goods for which the marginal rate of
substitution MRS is equal to the price ratio.

From that we see that equation (ii) is confirmed from the Principle, thus our consumer
is a utility maximizer.

B.

For a linear demand function like this, y = 36 - 3p, the price elasticity of demand (E)
can be computed using the following formula16:
P
E= (i)
P−A
Where P is the value of price at the point of measure on demand, and A is the price-
intercept of demand.

For the specific demand function the price-intercept A can be computed by setting y =
0. (The point that the demand curve intercepts the vertical axis.) Thus:

For y =0∧ y=36−3 p=¿ p=12 ( ii )

From (ii) we have that A = 12 thus from (i) & (ii) we have that the price elasticity of
the market for the specific demand curve is:

P
E= (iii )
P−12

In order to find the price level when demand is unit elastic we set E= -1 in (iii) and we
solve for P as follows:

P
−1= =¿−P+12=P=¿ P=6 ( iv )
P−12

From the demand curve and for P = 6 we have:

y=36−3∗6=18(v)

Thus the values of Price (P) & Quantity (Y) when demand is unit elastic as derived
from (iv) & (v) are: P = 6 & Y=18
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 176)
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Thomas C. & Maurice S., Managerial Economics, 9th edn, McGraw-Hill Irwin (p. 176)