ECON 1001 AB Introduction to Economics I Dr. Ka-fu WONG

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ECON 1001 ABIntroduction to Economics IDr.
Ka-fu WONG

• Sixth week of tutorial sessions
• KKL 925, K812, KKL 106
• Clifford CHAN
• KKL 1109
• givencana_at_yahoo.ca

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Covered and to be covered

• Covered the week before the break
• Dr. Wong finished up to kf006.ppt
• You should have at least read up to Chapter 6
  Perfectly competitive supply The cost side of
  the market
• If not, please press hard on it. Start reading
  Chapter 7
• To be covered in the tutorial sessions this week
• Problems in chapter 6 1, 3, 5, 7 and 9
• You are advised to work on the even ones as well

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Problem 1, Chapter 6 (1)

• Zoe is trying to decide how to divide her time
  between her job as a wedding photographer, which
  pays 27 per hours for as many hours as she
  chooses to work, and as a fossil collector, in
  which her pay depends both on the price of
  fossils and the number of them she finds.
  Earnings aside, Zoe is indifferent between the
  two tasks, and the number of fossils she can find
  depends on the number of hours a day she
  researches, as shown in the table below.

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Problem 1, Chapter 6 (2)
Hours per day Total fossils per day
1 5
2 9
3 12
4 14
5 15
5
Solution to Problem 1 (1)

• Derive a table with a price in dollar increments
  from 0 to 30 in the first column and the
  quantity of fossils Zoe is willing to supply per
  day at that price in the second column

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Solution to Problem 1 (2)

• In the first hour, Zoe can collect 5 fossils
• If the price of a fossil is 5, Zoe can make a
  total 25 in an hour if she devotes all her time
  to collecting fossils, which is less than the
  money she can earn from photography
• Thus, she wont collect fossil if the price of a
  fossil is less than 5
• If the price of a fossil is 6 Zoe should devote
  all her time to photography, as she can make 30
  an hour from photography

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Solution to Problem 1 (3)

• An additional hour would yield only 4 additional
  fossils or 24 additional revenue, so she should
  not spend any further time looking for fossils
• If the price of fossils rises to 7, however, the
  additional hour gathering fossils would yield an
  additional 28, so gathering fossils during that
  hour would then be the best choice, and Zoe would
  therefore supply 9 fossils per day

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Solution to Problem 1 (4)
Price of fossils () of fossils supplied / day
0 5 0
6 5
7, 8 9
9 13 12
14 26 14
27 15
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Solution to Problem 1 (5)

• Plot these points in a graph with price on the
  vertical axis and quantity per day on the
  horizontal. What is this curve called?
• The curve will depict a price-quantity supplied
  relationship for fossils as follows
• In other words, it is SUPPLY CURVE for fossils

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Solution to Problem 1 (6)
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Problem 3, Chapter 6 (1)

• The Paducah Slugger Company makes baseball bats
  out of lumber supplied to it by Acme Sporting
  Goods, which pays Paducah 10 for each finished
  bat. Paducahs only factors of production are
  lathe operators and a small building with a
  lathe. The number of bats per day it produces
  depends on the number of employee-hours per day,
  as shown in the table below.

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Problem 3, Chapter 6 (2)
of bats per day of employee-hours per day
0 0
5 1
10 2
15 4
20 7
25 11
30 16
35 22
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Problem 3, Chapter 6 (3)

• If the wage is 15 per hour and Paducahs daily
  fixed cost for the lathe and building is 60,
  what is the profit-maximizing quantity of bats?
• What would be the profit-maximizing number of
  bats if the firms fixed cost were not 60 per
  day but only 30?

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Solution to Problem 3 (1)
Quantity (bats/day) Total Revenue (/day) Total labour cost (hours X wage) Total cost (labour cost fixed cost) Profit (/day) (revenue cost)
0 0 0 15 0 0 60 60 -60
5 50 1 15 15 15 60 75 -25
10 100 2 15 30 30 60 90 10
15 150 4 15 60 60 60 120 30
20 200 7 15 105 105 60 165 35
25 250 11 15 165 165 60 225 25
30 300 16 15 240 240 60 300 0
35 350 22 15 330 330 60 390 -40
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Solution to Problem 3 (2)

• Based on the above table, we note that the
  profit-maximizing quantity of bats is 20, as it
  yield the highest profit of 35
• If the firms fixed cost decreases from 60 to
  30, what is the profit maximizing quantity of
  bats?
• It is still 20 bats
• Why?
• Decrease in fixed cost will increase the profits
  across different quantities of bats by the same
  amount (30)
• 20 bats will yield a new highest profit of 35
  30 65

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Problem 5, Chapter 6

• The supply curve for the only two firms in a
  competitive industry are given by P2Q1 and P
  2Q2, where Q1 is the output of firm 1 and Q2 is
  the output of firm 2. What is the market supply
  curve for this industry? (Hint graph the two
  curves side by side, then add their respective
  quantities at a sample of different prices.)

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Solution to Problem 5 (1)

• Horizontal summation means holding price fixed
  and adding the corresponding quantities

Market supply curve
Firm 2
Firm 1
P
P
P
P 2Q1
P 2Q2
S
6
6
6
P (4/3) (2/3)Q for Pgt2
4
4
4
2
2
2
P 2Q for Plt2
Q1
Q2
Q
2
1
2
3
4
1
4
7
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Problem 7, Chapter 6

• For the pizza seller whose marginal, average
  variable, and average total cost curves are shown
  in the accompanying diagram, what is the
  profit-maximizing level of output and how much
  profit will this producer earn if the price of
  pizza is 2.50 per slice?

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Solution to Problem 7 (1)
MC
Price (/slice)
2.50
ATC
AVC
1.40
0
0
0
570
Quantity (slices/day)
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Solution to Problem 7 (2)
MC
ATC
Price (/slice)
2.50
AVC
1.40
0
0
0
570
Quantity (slices/day)
Wrong! MC cuts ATC at its minimum.
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Solution to Problem 7 (3)
MC
ATC
Price (/slice)
2.50
AVC
1.40
0
0
0
570
Quantity (slices/day)
Wrong! MC cuts AVC at its minimum.
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Solution to Problem 7 (4)
MC
ATC
Price (/slice)
2.50
AVC
1.40
0
0
0
570
Quantity (slices/day)
Wrong! AVC and ATC approaches each other as
quantity increases.
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Solution to Problem 7 (5)

• Unless specific, assume it is a perfectly
  competitive market
• Firms are earning a zero economic profit
• Firms should always charge at a price that is
  equal to their marginal cost

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Solution to Problem 7 (6)

• If P gt ATC gt AVC, the firm operates with a profit
• If ATC gt P gt AVC, the firm still operates but
  with a loss- the operation can cover part of its
  cost
• If ATC gt AVC gt P, the firm should shut down as it
  cannot even cover part of its cost

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Solution to Problem 7 (7)

• To maximize profit, the firm will produce 570
  slices of pizza a day
• Why?
• A perfectly competitive firm should always charge
  at a price that is equal to their marginal cost
• The associated profit is (P or MC ATC)Q
• (2.5 / slice - 1.4 / slice) 570 slices / day
• 627 / day

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Problem 9, Chapter 6

• For the pizza seller whole marginal, average
  variable, and average total cost curves are shown
  in the accompanying diagram, what is the
  profit-maximizing level of output and how much
  profit will this producer earn if the price of
  pizza is 0.50 per slice?

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Solution to Problem 9 (1)
MC
ATC
Price (/slice)
AVC
1.18
0.68
0.50
0
0
0
260
Quantity (slices/day)
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Solution to Problem 9 (2)

• Recall from Problem 7
• If P gt ATC gt AVC, the firm operates with a profit
• If ATC gt P gt AVC, the firm still operates but
  with a loss- the operation can cover part of its
  cost
• If ATC gt AVC gt P, the firm should shut down as it
  cannot even cover part of its cost
• Based on the diagram above, where is the firms
  shut down point in the short run?
• The firm should shut down at a point where P
  0.68 per slice (where P AVC)
• If a slice of pizza is sold for only 0.50, the
  firm will definitely not produce any pizza and
  shut down

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Solution to Problem 9 (3)

• If the firm shuts down, there will be no
  (average) variable cost
• By shutting down the plant, the firm will have a
  negative profit that is exactly equal to the
  fixed cost
• Fixed cost Total cost variable cost
• Total cost
• ATC Q
• 1.18 / slice 260 slices 306.80 / day
• Variable cost
• AVC Q
• 0.68 / slice 260 slices 176.80 / day

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Solution to Problem 9 (4)

• Fixed cost 306.80/day - 176.80/day 130/day
• Thus, by shutting down the plant in the short
  run, the firm will loss 130 a day
• In other words, the firm earns a profit of -130
  per day if the price for a slice of pizza is just
  0.50

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The end

• Thanks for coming!
• See you next week!!!