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2010/2011 EC1301 Principles of Economics Semester II

Tutorial 3

Short Answer Questions

PRODUCTION TECHNOLOGY AND COST

1. Consider the paddle production example shown in Table 23.2 (see Lecture 3). Compute the short-run average cost for 10 paddles with the following changes. a) Your opportunity cost of work time triples, from $50 to 150. b) The interest rate for invested funds is cut in half, from 10 to 5 percent. c) Labor productivity (the quantity produced by each worker) doubles.

2. Consider the long-run production of shirts. The cost of the indivisible inputs used in the production of shirts is $400 per day. To produce 1 shirt per day, the firm must also spend a total of $5 on other inputs, such as labor, materials, and other capital. For each additional shirt, the firm incurs the same additional cost of $5. a) Compute the average cost for 40 shirts, 100 shirts, 200 shirts and 400 shirts

15, 9,7, 6
b) Draw the long-run average cost curve for 40 to 400 shirts per day.
Price X

15

6

Output
40 400

PERFECT COMPETITION

3. You’ve been hired as an economic consultant by a price-taking firm that produces scarves. The firm already has a factory, so it is operating in the short run. The price of scarves is $9, the hourly wage is $24, and each scarf requires $1 worth of material. The following table shows the relationship between the number of workers and the output of scarves.

Workers| 10| 11| 12| 13| 14| 15|
Output| 5| 29| 41| 47| 50| 52|
Labor cost| 240| 264| 288| 312| 336| 360|
Material cost| 5| 29| 41| 47| 50| 52|
Fixed cost| $2| $2| $2| $2| $2| $2|
Total cost | 247| 295| 331| 361| 388| 414|
Marginal cost | | 2| | | | |

4. You’ve been hired as an economic consultant by a price-taking firm that produces baseball caps. The firm already has a factory, so it is operating in the short run. The price of caps is $5, the hourly wage is $12 and each cap requires $1 worth of material. The firm has experimented with different workforces and the results are shown in the first two columns of the following table. a) Fill the blanks in the table.

Workers| Caps| Labor Cost| Material Cost| Variable Cost| Total Revenue| Marginal Cost of Caps| 14| 56| 168| 56| 224| 280| 5|
15| 60| 180| 60| 240| 300| |

b) Is it sensible to continue to operate at a loss with 14 workers?
(in SR, may make loss, but in the LR will earn opportunity cost, assuming firm does not close down) c) Would it be better to operate with 15 workers? Explain, using the marginal principle

(Not possible to increase production to increase revenue, as marginal cost equals price of caps)

5. Consider the following statement from a wheat farmer to his workers: “The price of wheat is very low this year, and the most I can get for the crop is $35,000. If I paid you the same amount as I paid you last year ($30,000), I’d lose money because I also have to worry about the $20,000 I paid three months ago for seed and fertilizer. I’d be crazy to pay a total of $50,000 to harvest a crop I can sell for only $35,000. If you are willing to work for half as much as last year ($15,000), my total cost will be $35,000, so I’ll break even. If you don’t take a pay cut, I won’t harvest the wheat.” Is the farmer bluffing, or will the farm workers really lose their jobs if they reject the proposed pay cut? Without Harvesting: TC = 20,000 P = (20,000)

With Harvesting: TC = 50,000 R = 35,000 P = (15000)
He will still hire them, even if they do not accept the pay cut.

6. Explain why perfectly competitive firms make zero economic profit in the long run? In perfect competition, there is
1) No Barriers to entry,
2) Infinitely many firms selling
3) The same,...
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