ADDIS ABABA UNIVERSITY

SCHOOL OF COMMERCE

MICROECONOMICS GROUP ASSIGNMENT

By: Tadesse Gedefa,

Rahel Jofe,
Melkamu Dessie,
Wudasse Ephrem,
Tigist Demeke,

SUBMITTED TO: MR EPHREM ANDARGIE (INSTRUCTOR)

ECONOMICS PROGRAM UNIT

October 4, 2021

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I. Discuss the following concepts

A- Why are AVC and ATC curves U- shaped in the short run?

- AVC and ATC curves U- shaped in the short run because

of diminishing marginal returns (the law of variable proportions). In the
short run, capital fixed whereas labor is variable. Increasing labor to the
fixed capital will, after a certain point, result in a decrease in productivity.
The decrease in productivity means an increase in AC.

B- Which stage of production is efficient region of production in the short run?

Why?

- Stage II is the efficient region of production. This is because, at this, stage

additional inputs are contributing positively to the total product and
marginal product of successive units of variable input is declining
(indicating that the fixed input optimally used). Hence, the efficient region
of production is over that range of employment of variable input where the
marginal product of the variable input is declining but positive.

C- Is it possible to get so much of a good that it turns into a bad? If so, give an
example

- Yes, it is certainly possible to get "too much" utility from a given good.
Consider, for example, an all you can drink Wine. In that case, you are
getting so much utility from your good (the Wine you paid for) that you
overdrunk it and get sick. At that point, your "good" has become a "bad."

D-If the ATC curve is continually declining, what does this imply about
the MC curve? Explain your answer.

- If the ATC curve is continually declining, the MC must be less than ATC,
which would mean the MC curve would stay underneath ATC curve.

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E- The average variable cost curve and the average total cost curve get
closer to each other as output increases. What explains this?

- As the Average total cost is calculated as the sum of Average

variable cost and Average fixed cost, and Average fixed cost
inevitably decrease as output expand, so Average total cost
increasingly consist of Average variable cost. That’s why Average
total cost curve and the Average variable cost curve moves closer
together in the case of output expand.

F- Accounting rules determine a firm’s ‘‘profits’’ for tax- and dividend-

paying purposes. So why any firm should be concerned about its
economic profits? Specifically, why should a firm be concerned about
the opportunity costs of the people who invest in it when those costs
never enter into its accounting statements?

- Profit is the difference between costs and revenue, but there is a

difference between accounting profit and economic profit. The
biggest difference between accounting and economic profit is that
economic profit reflects explicit and implicit costs, while
accounting profit considers only explicit costs. Explicit costs are
costs that involve direct monetary payment. Wages paid to
workers, rent paid to a landowner, and material costs paid to a
supplier are all examples of explicit costs. In contrast, implicit costs
are the opportunity costs of factors of production that a producer
already owns. The implicit cost is what the firm must give up in
order to use its resources; in other words, an implicit cost is any
cost that results from using an asset instead of renting, selling, or
lending it. Accounting profit is the difference between total
monetary revenue and total monetary costs, and computed by
using generally accepted accounting principles.
- Put another way, accounting profit is the same as bookkeeping
costs, consists of credits, and debits on a firm’s balance sheet.
Economic profit is the difference between total monetary revenue

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 and total costs, but total costs include both explicit and implicit
costs. Economic profit includes the opportunity costs associated
with production and is therefore lower than accounting profit.
Economic profit also accounts for a longer span of time than
accounting profit.

G-Two students are preparing for their micro exam, but they seem
confused: Student A: ‘‘we learned that demand curves always slope
downward. In the case of a competitive firm, this downward sloping
demand curve is also the firm’s marginal revenue curve. So that is why
marginal revenue is equal to price.’’ Student B: ‘‘I think you have it
wrong. The demand curve facing a competitive firm is horizontal. The
marginal revenue curve is also horizontal, but it lies below the demand
curve. So marginal revenue is less than price.’’ Can you clear up this
drivel? Explain why neither student is likely to warrant a grade
commensurate with his or her name.

- Because the demand curve for a commodity is negatively sloped,

student A's statement is incorrect. Meaning that more will be
demanded at lower prices; but, in perfect competition, the price is
set, and a firm can sell any amount of goods at the set price. The
demand curve is horizontal, as stated by student B, but the student
should be aware that if the firm is a price maker, the demand curve
corresponds with the Marginal revenue curve since every surplus
unit can only be sold at the provided price, hence price equals
Marginal revenue.

H-What is a production function? How does a long-run production

function differ from a short-run production function?

- A production function is a function showing the highest output

that a firm can produce for every specified combination of
inputs. In the long-run production function, all inputs are
variable, whereas in the short-run production function has at

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 least one fixed input.

I- Why the marginal product of labor is likely to increase initially in

the short run as more of the variable input is hired?

- When additional units of labor are added to a fixed quantity of

capital, we see the marginal product of labor rise, reach a
maximum, and then decline. The marginal product of labor
increases because, as the first workers are hired, they may
specialize in those tasks in which they have the greatest ability.
Eventually, with the quantity of capital fixed, the workplace
becomes congested and the productivity of additional workers
declines.

J- You are an employer seeking to fill a vacant position on an assembly

line. Are you more concerned with the average product of labor or
the marginal product of labor for the last person hired? If you observe
that your average product is just beginning to decline, should you
hire any more workers? What does this situation imply about the
marginal product of your last worker hired?

- In filling a vacant position, you should be concerned with the

marginal product of the last worker hired because the last worker
hired will influence total product. The point at which the average
product begins to decline is the point where average product is
equal to marginal product. Although adding more workers results in
a further decline in average product, total product continues to
increase. Only when total product declines we necessarily stop
hiring. When average product declines, the marginal product of the
last worker hired is lower than the average product of previously
hired workers.

K- Isoquants can be convex, linear, or L-shaped. What does each of these

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 shapes tell you about the nature of the production function? What does
each of these shapes tell you about the MRTS?

- Convex isoquants indicate that some units of one input can be

substituted for a unit of the other input while maintaining output at
the same level. In this case, the MRTS is diminishing as we move
down along the isoquant. This tells us that it becomes more and more
difficult to substitute one input for the other while keeping output
unchanged.

- Linear isoquants imply that the slope, or the MRTS, is constant. This
means that the same number of units of one input can always be
exchanged for a unit of the other input holding output constant. The
inputs are perfect substitutes in this case. L-shaped isoquants imply
that the inputs are perfect complements, and the firm is producing
under a fixed proportions type of technology. In this case the firm
cannot give up one input in exchange for the other and still maintain
the same level of output. For example, the firm may require exactly 4
units of capital for each unit of labor, in which case one input cannot
be substituted for the other.

L- Assume that the marginal cost of production is increasing. Can you

determine whether the average variable cost is increasing or
decreasing? Explain.
- Marginal cost can be increasing while average variable cost is either
increasing or decreasing. If marginal cost is less (greater) than
average variable cost, then each additional unit is adding less (more)
to total cost than previous units added to the total cost, which implies
that the AVC declines (increases). Therefore, we need to know
whether marginal cost is greater than average variable cost to
determine whether the AVC is increasing or decreasing.

M- Assume that the marginal cost of production is greater than the average
variable cost. Can you determine whether the average variable cost is
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 increasing or decreasing? Explain.
- If the average variable cost is increasing (decreasing), then the last unit
produced is adding more (less) to total variable cost than the previous
units did, on average. Therefore, marginal cost is above (below) average
variable cost. In fact, the point where marginal cost exceeds average
variable cost is also the point where average variable cost starts to rise.
N-Why would a firm that incurs losses choose to produce rather than shut down?

- Losses occur when revenues do not cover total costs. If revenues are
greater than variable costs, but not total costs, the firm is better off
producing in the short run rather than shutting down, even though it is
incurring a loss. The reason is that the firm will be stuck will all its fixed
cost and have no revenue if it shuts down, so its loss will equal its fixed
cost. If it continues to produce, however, and revenue is greater than
variable costs, the firm can pay for some of its fixed cost, so its loss is
less than it would be if it shut down. In the long run, all costs are variable,
and thus all costs must be covered if the firm is to remain in business

O-Explain why the industry supply curve is not the long run industry marginal
cost curve.

- In the short run, a change in the market price induces the profit-
maximizing firm to change its optimal level of output. This optimal output
occurs where price is equal to marginal cost, as long as marginal cost
exceeds average variable cost. Therefore, the short-run supply curve of the
firm is its marginal cost curve, above average variable cost. (When the
price falls below average variable cost, the firm will shut down.) In the long
run, a change in the market price induces entry into or exit from the
industry and may induce existing firms to change their optimal outputs as
well. As a result, the prices firms pay for inputs can change, and these will
cause the firms’ marginal costs to shift up or down. Therefore, long-run
supply is not the sum of the existing firms’ long-run marginal cost curves.
The long-run supply curve depends on the number of firms in the market
and on how their costs change due to any changes in input costs. As a
simple example, consider a constant-cost industry where each firm has a
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 U-shaped LAC curve. Here the input prices do not change, only the number
of firms changes when industry price changes. Each firm has an increasing
LMC, but the industry long-run supply is horizontal because any change in
industry output comes about by firms entering or leaving the industry, not
by existing firms moving up or down their LMC curves.

P- Why do firms enter an industry when they know that in the long run economic
profit will be zero?

- Firms enter an industry when they expect to earn economic profit, even if
the profit will be short-lived. These short-run economic profits are enough
to encourage entry because there is no cost to entering the industry, and
some economic profit is better than none. Zero economic profit in the long
run implies normal returns to the factors of production, including the labor
and capital of the owner of the firm. So even when economic profit falls to
zero, the firm will be doing as well as it could in any other industry, and
then the owner will be indifferent to staying in the industry or exiting.

Part II. Do the following questions with all necessary steps

1. Assume labor (L) is the only variable input used in the production process,
a firm’s production function is given by Q = 7L + 10 L2 - L3 where Q represents
total product. Classify the production function in to the three stages of

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production.

Given: Q = 7L + 10 L2 - L3

Solution:
To classify the given production function in to the three stage of
production let us first drive AP and MP.

APL = = 7 + 10L – L2 , and

MPL = = 7 + 20L – 3L2

Therefore, when AP is at maximum AP = MP, which is

7 + 10L – L2 = 7 + 20L – 3L2

L* = 5 and When TPL is maximum MPL = 0, and hence L** = 7

Output
TPL

Stage I Stage II Stage III

Labor

Output

APL

MPL Labor

Therefore, Stage I: MPL > APL and positive when L < 5

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 Stage II: MPL < APL and positive when 5 < L < 7

Stage III: MPL < APL and negative when 7 < L

In general, it is noted that when TP increases at an increasing rate, MP

increases. When TP increases at diminishing rate, MP declines. When TP
is maximum, MP is Zero. When TP begins to decline, MP becomes
negative

2. Answer the following questions based on the following information

Labor input(in hour) 0 1 2 3 4 5 6 7 8 9 10

Total Product(in kg) 0 40 120 220 312 390 455 515 565 565 563

 The firm uses capital as a fixed input and labor as a variable input. The
total cost of capital it uses is birr 100 and the price of labor is 40 per unit.
Calculate:

A- The marginal product of the 6th unit of labor?

Solution:

Marginal Product of Labor of the 6th unit is:

(MPL) = = 65

B- At what level of labor APL and MPL equal?

At The 5th level of labor APL is equal to MPL = 78, (See the table
below).

C- The total cost of producing 455 units of output

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 Average Marginal
Labor (in Total Product (in Product of Product of
hour) (L) Kg) (TPL) Labor Labor
(APL) (MPL)=
0 0 - -
1 40 40 40
2 120 60 80
3 220 73.33 100
4 312 78 92
5 390 78 78
6 455 75.83 65
7 515 73.57 60
8 565 70.63 50
9 565 62.78 0
10 563 56.3 -2

3. Suppose the short – run cost function of a firm is given by:

TC = 6Q3 –18Q2 + Q + 100

Find:

A- The expressions for TFC and TVC

Solution:
TFC = 100 and TVC = 6Q3 –18Q2 + Q

B- The expressions for AFC, AVC , AC and MC

Solution:

AFC = = =

AVC = = = 6Q2 – 18Q + 1

AC = = = 6Q2 – 18Q + 1 +

MC = = 18Q2 –36Q + 1

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 C- The minimum value of MC and the minimum value of AVC.

To find minimum value of MC:

= 36Q –36 = 0

Q= 1, MC is minimized when Q = 1.
The minimum value of MC will be:
MC = 18Q2 –36Q + 1
= 18 (1)2 – 36(1) +1
= -17

To find minimum value of AVC:

= 12Q – 18 = 0

Q= , AVC is minimized when Q =

The minimum value of AVC will be:

2
AVC = 6 – 18( +1

= – +1

= -12.5

D- What is the value of MC at the minimum AVC

The value of MC is calculated by

MC = 18Q2 –36Q + 1
= 18 (-12.5)2 - 36 (-12.5)
= 3,263.5

4. ABC is a firm operating in a perfectly competitive market, engaged in the

production of consumer goods. The company’s total cost is TC = Q3 -

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12Q2+70Q+100 and TR=100Q, the market demand and supply function
given by Q = 760 -1.4P and Q= 620 + 0.6P respectively.
Given:
TC = Q3 - 12Q2+70Q+100
TR=100Q
QD = 760 -1.4P
QS= 620 + 0.6P

A- Is the firm producing gain in the long run or short run? Explain

The firm producing gain in the short run because it has fixed cost,
which equals 100

B- Find the price and quantity when the industry is at equilibrium

At equilibrium market demand (QD) = market supply (QS).

Therefore, 760 -1.4P = 620 + 0.6P
P* = 70
Q = 760 -1.4 (70) = 760 – 98
Q* = 662
C- Compute firm’s output level (Q*)that maximize profit

The profit-maximizing choice for a perfectly competitive firm will

occur at the level of output where marginal revenue is equal to
marginal cost—that is, where MR = P = 70. Therefore,
Hence MR =70 and MC = 3Q2 - 24Q+70;
70 = 3Q2 - 24Q+70
0 = 3Q2 - 24Q
3Q2 - 24Q – 30 = 0
Q (3Q – 24) = 0
Q = 0 or Q* = 8
D- Calculate the maximum profit or minimum loss of the firm
Profit = TR – TC
= 100 (Q) - Q3 - 12Q2+70Q+100

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 = [100 (8)] – [83 – 12(8)2+70(8) +100]
= 800 – 512 + 768 - 560 - 100
= 800 – 512 + 768 – 560 -100
= 396
E- Compute the shut-down price and the shutdown level of quantity
F- Consider ABC is operating in a monopoly environment , find the
price , quantity and profit at equilibrium
G- Compare and contrast perfect competitive and the monopoly
based on the result you got.

5. Do the following functions exhibit increasing, constant, or decreasing

returns to scale? What happens to the marginal product of each individual
factor as that factor is increased and the other factor held constant?
A-

Solution:

This function exhibits decreasing returns to scale. For example, if L is 2

and K is 2 then q is 2.8. If L is 4 and K is 4 then q is 4. When the inputs
are doubled, output increases by less than double. The marginal
product of each input is decreasing. This can be determined using
calculus by differentiating the production function with respect to one
input while holding the other input constant. For example, the marginal

product of labor is =

Since L is in the denominator, as L gets bigger, the marginal product

gets smaller. If you do not know calculus, you can choose several
values for L (holding K fixed at some level), find the corresponding q
values and see how the marginal product changes. For example, if L  4
and K  4 then q  4. If L  5 and K  4 then q  4.24. If L  6 and K 
4 then q  4.47. Marginal product of labor falls from 0.24 to 0.23. Thus,
MPL decreases as L increases, holding K constant at 4 units.

B-

Solution:
This function exhibits constant returns to scale. For example, if L is 2
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 and K is 2 then q is 2. If L is 4 and K is 4 then q is 4. When the inputs
are doubled, output will exactly double. Notice also that if we increase
each input by the same factor,, then we get the following:

q = (L)1/2(K)1/2

= L1/2K1/2
= q
Since  is raised to the power 1, there are constant returns to scale. The
marginal product of labor is decreasing and the marginal product of
capital is decreasing.
Using calculus, the marginal product of capital is

MPK =

For any given value of L, as K increases, MPK will decrease. If you do not
know calculus then you can fix the value of L, choose a starting value
for K, and find q. Let L  4 for example. If K is 4 then q is 4, if K is 5 then
q is 4.47, and if K is 6 then q is 4.90. The marginal product of the 5th
unit of K is 4.47  4  0.47, and the marginal product of the 6th unit of K
is 4.90  4.47  0.43. Hence we have diminishing marginal product of
capital. You can do the same thing for labor.

C-

Solution:
This function exhibits decreasing returns to scale. For example, if L is 2
and K is 2 then q is 13.66. If L is 4 and K is 4 then q is 24. When the
inputs are doubled, output increases by less than double. The marginal
product of labor is decreasing and the marginal product of capital is
constant. For any given value of L, when K is increased by 1 unit, q goes
up by 4 units, which is a constant number. To see that the marginal
product of labor is decreasing, fix K  1 and choose values for L. If L  1
then q  8, if L  2 then q  9.66, and if L  3 then q  10.93. The
marginal product of the second unit of labor is 9.66  8  1.66, and the
marginal product of the third unit of labor is 10.93  9.66  1.27.
Marginal product of labor is diminishing.

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6. The short-run cost function of a company is given by the equation TC = 200
+ 55q, where TC is the total cost and q is the total quantity of output, both
measured min thousands.

Given: TC = 200 +55q

A- What is the company’s fixed cost?

Solution:

When q = 0, TC = 200, so FC = 200, or $200,000.

B- If the company produced 100,000 units of goods, what is its average
variable cost?

Solution:

With 100,000 units, q = 100.

VC = 55q = (55)(100) = 5500, or $5,500,000.

Therefore, AVC = = = $55, or $55,000

C- What would be its marginal cost of production?

Solution:

With constant AVC, MC = AVC, which is $55, or ($55,000).

D- What would be its average fixed cost?

Solution:

At q = 100, AFC = = = $2, or $2,000

E- Suppose the company borrows money and expands its factory. Its
fixed cost rises by $50,000, but its variable cost falls to $45,000 per
1,000 units. The cost of interest (i) also enters into the equation.

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 Each one-point increase in the interest rate raises costs by $3,000.
Write the new cost equation.

Solution:

Fixed cost changes from 200 to 250, measured in

thousands. Variable cost decreases from 55 to 45,
also measured in thousands. Fixed cost also includes
interest charges: 3i. The cost equation is C = 250 +
45q + 3i.

7. A chair manufacturer hires its assembly-line labor for $30 an hour and calculates
that the rental cost of its machinery is $15 per hour. Suppose that a chair can
be produced using 4 hours of labor or machinery in any combination. If the firm
is currently using 3 hours of labor for each hour of machine time, is it
minimizing its costs of production? If so, why? If not, how can it improve the
situation? Graphically illustrate the isoquant and the two-isocost lines for the
current combination of labor and capital and for the optimal combination of
labor and capital.

Solution:
If the firm can produce one chair with either four hours of labor or four
hours of machinery (i.e., capital), or any combination, then the isoquant
is a straight line with a slope of -1 and intercepts at K = 4 and L = 4, as
depicted by the dashed line on the graph below.

The isocost lines, TC = 30L + 15K, have slopes of - = -2 when plotted

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 with capital on the vertical axis and intercepts at K = and L = . The

cost minimizing point is the corner solution where L = 0 and K = 4, so

the firm is not currently minimizing its costs.

At the optimal point, total cost is $60. Two isocost lines are illustrated
on the graph. The first one is further from the origin and represents the
current higher cost ($105) of using 3 labor and 1 capital. The firm will
find it optimal to move to the second isocost line which is closer to the
origin, and which represents a lower cost ($60).

In general, the firm wants to be on the lowest isocost line possible,

which is the lowest isocost line that still intersects the given isoquant.

8. A computer company produces hardware and software using the same

plant and labor. The total cost of producing computer processing units H
and software programs S is given by TC = aH + bS – cHS where a, b, and c
are positive. Is this total cost function consistent with the presence of
economies or diseconomies of scale? With economies or diseconomies of
scope?

Solution:
There are two types of scale economies to consider: multiproduct
economies of scale and product-specific returns to scale. From
multiproduct economies of scale for the two-product case, S H,S,
are:

Where MCH is the marginal cost of producing hardware and MC S is

the marginal cost of producing software.

The product-specific returns to scale are:

and

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Where TC (0,S) implies no hardware production and TC(H,0)
implies no software production. We know that the marginal cost
of an input is the slope of the total cost with respect to that input.

Since

We have MCH = a - cS and MCS = b - cH.

Substituting these expressions into our formulas for SH,S, SH,

and SS:

or

, because cHS > 0. Also,

, or

and similarly

There are multiproduct economies of scale, SH,S > 1, but

constant product-specific returns to scale, SH = SC = 1.

Economies of scope exist if SC > 0,

, or,

, or

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 Because cHS and TC are both positive, there are economies of
scope.

9. Suppose you are the manager of a watchmaking firm operating in a

competitive market. Your cost of production is given by C = 200 + 2q2,
where q is the level of output and C is total cost. (The marginal cost of
production is 4q; the fixed cost is $200.)

Given:
C = 200 + 2q2
MC = 4q
FC = 200

A- If the price of watches is $100, how many watches should you produce to
maximize profit?

Solution:
Profits are maximized where marginal cost is equal to marginal
revenue. Here, marginal revenue is equal to $100; recall that
price equals marginal revenue in a competitive market:
100 = 4q, or
q = 25.

B- What will the profit level be?

Solution:
Profit ( is equal to total revenue (TR) minus total cost (TC) :

Profit ( qp] – [200 + 2q2]

C- At what minimum price will the firm produce a positive output?

Solution:

A firm will produce in the short run if the revenues it receives are
greater than its variable costs. Remember that the firm’s short-run
supply curve is its marginal cost curve above the minimum of average
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 variable cost. Here, average variable cost is AVC = = = 2q; also,

MC is equal to 4q. So, MC is greater than AVC for any quantity greater
than 0.

This means that the firm produces in the short run as long as price is
positive.

10.Suppose that a competitive firm’s marginal cost of producing output q is

given by MC(q)= 3 +2q. Assume that the market price of the firm’s product
is $9. Suppose that the average variable cost of the firm is given by AVC(q)
= 3 + q. suppose that the firm’s fixed costs are known to be $3. Will the
firm be earning a positive, negative, or zero profit in the short run?
Given: MC(q)= 3 +2q
M(p)= $9
AVC =3+q
(q)

F(c) = $3

Solution:

Profit ( is equal to total revenue (TR) minus total cost (TC). Total cost

(TC) is equal to total variable cost (TVC) plus fixed cost (FC). Total
variable cost is equal to (AVC) (q).
Therefore, at q = 3, TVC = (3 + 3)(3) = $18. Fixed cost is equal
to $3.
Therefore, total cost equals TVC plus TFC, or TC = 18 + 3 = $21.

TR = (P) (q) TR = ($9)(3) = $27.

Profit = TR – TC = $27 - $21 = $6.

Therefore, the firm is earning positive economic profits.

11.A firm produces a product in a competitive industry and has a total cost
function C=50 +4q+ 2q2 and a marginal cost function MC =4+ 4q. At the
given market price of $20, the firm is producing 5 units of output. Is the

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 firm maximizing its profit? What quantity of output should the firm
produce in the long run?
Given: C=50 +4q+ 2q2
MC =4+ 4q

M(P) = 20

Q=5
Solution:
If the firm is maximizing profit, then price will be equal to marginal cost.
P=MC. Which is P=20=4+4q=MC, or q=4.
The firm is not maximizing profit, since it is producing too much output.
The current level of profit is profit = 20*5-(50+4*5+2*5*5) = –20, and
the profit maximizing level is profit = 20*4-(50+4*4+2*4*4) = –18.

Given no change in the price of the product or the cost structure of the
firm, the firm should produce q=0 units of output in the long run since
at the quantity where price is equal to marginal cost, economic profit is
negative. The firm should exit the industry.

12.A competitive firm has the following short-run cost function: C(q) =q3-8q2+30q+5.

Given:
C(q) =q3-8q2+30q+5.
A- Find MC, AC, and AVC and sketch them on a graph.

Solution:

MC = = 3q2 – 16q +30

AC = = = q2 -8q + 30 +

AVC = = = q2 -8q + 30

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 Cost MC = 3q2 – 16q +30

AC = q2 -8q + 30 +

AVC = q2 -8q + 30

Output
Graph of the three functions

As we can see from the graph, all three cost functions are u-shaped in that
cost declines initially as q increases, and then cost increases as q increases.
Average variable cost is below average cost. Marginal cost will be initially
below AVC and will then increase to hit AVC at its minimum point. MC will be
initially below AC and will also hit AC at its minimum point.

B- At what range of prices will the firm supply zero output?

Solution:
The firm will find it profitable to produce in the short run as long as
price is greater than or equal to average variable cost. If price is less
than average variable cost then the firm will be better off shutting down
in the short run, as it will only lose its fixed cost and not fixed plus some
of variable cost. Here we need to find the minimum average variable
cost, which can be done in two different ways. You can either set
marginal cost equal to average variable cost, or you can differentiate
average variable cost with respect to q and set this equal to zero. In
both cases, you can solve for q and then plug into AVC to find the
minimum AVC. Here we will set AVC equal to MC:

MC = AVC

3q2 – 16q +30 = q2 -8q + 30

2q2 = 8q
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 q=4
AVC = 42 -8(4) + 30 = 14 Hence, the firm supplies zero output if P<14.
C- Identify the firm’s supply curve on your graph.

Solution:
The firm supply curve is the MC curve above the point where
MC=AVC. The firm will produce at the point where price equals
MC as long as MC is greater than or equal to AVC.

D- At what price would the firm supply exactly 6 units of output?

Solution:
The firm maximizes profit by choosing the level of output such
that P=MC. To find the price where the firm would supply 6 units
of output, set q equal to 6 and solve for MC:

P = MC

P = 3(6)2 – 16(6) +30 = 108- 96 +30 = 42

13.A sales tax of $1 per unit of output is placed on a particular firm whose product
sells for $5 in a competitive industry with many firms.

A- How will this tax affect the cost curves for the firm?

Solution:
With the imposition of a $1 tax on a single firm, all its cost curves
shift up by $1. Total cost becomes TC+tq, or TC+q since t=1.
Average cost is now AC+1. Marginal cost is now MC+1.

B- What will happen to the firm’s price, output, and profit?

Solution:

Since the firm is a price-taker in a competitive market, the

imposition of the tax on only one firm does not change the
market price. Since the firm’s short-run supply curve is its
marginal cost curve above average variable cost and that
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 marginal cost curve has shifted up (inward), the firm supplies less
to the market at every price. Profits are lower at every quantity.

C- Will there be entry or exit in the industry?

Solution:
If the tax is placed on a single firm, that firm will go out of
business. In the long run, price in the market will be below the
minimum average cost point of this firm.

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