Introduction to Microeconomics

PART 1: FILL-INS

1)      What are two important characteristics of a perfectly competitive market?

Firms in a perfectly competitive market are price takers. This is because of the small market share of individual firms

Firms in a perfectly competitive market sell homogenous products or services. All commodities or services are identical.

There are also no barriers to entry or exit in a perfectly competitive market. Firms enter and leave freely.

There is perfect information on all market conditions within a perfectly competitive market. Firms are aware of the prices and costs of production in the market.

Perfectly competitive markets have many small firms. This is because of the lack of barriers to entry in the market

2)      What is the relationship between the price charged by a perfectly competitive firm and its marginal revenue?

Firms in a perfectly competitive market offer commodities and services at a price equal to the marginal revenue from each unit that a firm sells. i.e. P=MR

P = MR

3)      What is the price elasticity of demand of the demand curve faced by a perfectly competitive firm?

Firms in a perfectly competitive market face a perfectly inelastic demand schedule. This is because a change in price does not affect the quantity that firms produce. Firms have a small market share and cannot, therefore, affect the demand by changing commodity prices

4)      What is the main difference between the demand curves faced by a single perfectly competitive firm and the entire industry?

Since individual firms are price takers, their demand curves are perfectly horizontal. The individual firms produce any level of output at the prices set by the industry.

The demand curve for the entire industry is downward sloping because output that the industry produces is inversely proportional to the current price levels.

5)      What condition holds when the profit-maximizing output is produced by a perfectly competitive firm?

A profit maximizing firm in a perfectly competitive market produces at the level where marginal revenue equals marginal cost. At this point, all firms in the market make normal profits, just enough to take care of all costs of producing output. I.e. MR=MC

6)      The shut-down point occurs when price equals what type of cost?

The shut down point occurs at the point where the price level equals the average variable cost (AVC). Since the average fixed cost of a product is constant, firms will only operate at a minimum point where price equals average variable cost. Below this point, firms will be making losses.

7)      If a firm is earning zero economic profits, the price equals what type of cost?

At zero economic profits, a firm operates at a point where revenues equal the cost of production. At this point, the price level equals the average total cost of production. I.e. P=ATC

8)      The break-even point occurs when price equals what type of cost?

At breakeven point, the total cost of a firm equals the total revenue of the firm under a perfectly competitive market. This is the point where a firm makes normal profits. The price of a unit item equals the average total cost of producing the item. I.e. P=ATC

9)      What is a monopoly?

A monopoly market structure is a situation where there is only one supplier of a product or service in the market. Under monopoly, the monopolist sets the price and output level of the commodities or products that he supplies. There are barriers to entry in the industry.

10)  What is monopolistic competition?

A monopolistic competition market structure is one where there are several firms in the industry. The firms offer similar products to consumers, though the firms tend to differentiate their products or services slightly. Firms in monopolistic competition invest a lot in advertisement as a way of promoting their brands of the similar products in the industry.

11)  What is an oligopoly?

An oligopoly is a market structure that consists of few large firms that sell similar products or provide similar services. An oligopoly market structure has restrictions to entry in to the market. This is because the players in an oligopoly market structure form cartels that create rules to entry and exit. The cartels also set prices for products and services.

12)  How is the marginal product of labor calculated?

Marginal productivity of labor is the increase in the level of output of a firm or business when the firm increases the units of labor by one unit. One can compute the marginal product of labor by getting the difference in the total outputs after an increase in the number of labor by one unit.

13)  What is the Law of Diminishing Returns?

The law of diminishing returns explains the trend of marginal productivity when a firm increases the number of units of input. The law states that output increases at a decreasing rate when a firm increases the number of units of input in its production. For instance, the first unit of labor is more productive than the 20th unit of labor.

14)  What is the difference between an explicit and an implicit cost?

An explicit cost is that direct cost that a firm spends on resources or inputs for the production of output. On the other hand, an implicit cost is the value of the next best alternative use of resources that a firm has used for production of output.

15)  What is a fixed cost?

Fixed costs are the costs that are not dependent of the quantity of output or the number of units that a firm produces.

16)  How does an increase in technology affect the total product curve?

An increase in technology is an indication of an increase in the feasibility position of a firm. It implies that a firm can produce more units of output with the existing units of labor and capital. Thus, graphically, an increase in technology will lead to an upward shift in the production curve.

17)  At what point do the marginal and average total cost curves intersect?

The marginal cost curve and the average total cost curve intersect at the minimum point of the average total cost curve.

18)  Which two total cost curves are parallel to each other?

The total cost of a firm is a summation of the fixes cost and the variable cost. Since the total fixed cost is constant, it is the total variable cost that varies with output. This means total variable cost shares the same slope with the total cost, with the total cost higher than the total variable cost.

19)  Which total cost curve has a slope of zero?

The total fixed cost of a firm has a zero slope because the level of fixed cost does not vary with the level of units of output. The change in total fixed cost due to a change in output is zero.

20)  Which average cost curve continues to decline as output rises?

One can compute the average cost of a firm by dividing the total cost, total fixed cost or total variable cost by the number of units that the firm produces. Since fixed cost is constant regardless of output, the average fixed cost will decline when the number of units of output increases.

PART 2: PROBLEMS

1)      Suppose that Starbucks buys new coffee bean grinders. The following table show the number of one-pound bags of coffee that can be ground each day for different quantities of labor.

 Quantity of labor Bags ground per day APL=Total output/quantity of labor MPL=%u2206Total output/%u2206 labor units 0 0 0 0 1 25 25 25 2 55 27.5 30 3 75 25 20 4 90 22.5 15 5 100 20 10

a)      Compute the average product of labor at each level of output.

One can compute the average product of labor by dividing the total level of output by the number of units of labor that the firm uses for the production of the output.

For example, Average product of labor= total output/ units of labor

b)      Compute the marginal product of labor at each level of output.

The marginal productivity of labor is the change in the level of output that comes because of a unit change in the labor used for producing the output.

c)      At what quantity of labor do diminishing returns set in?

This is level of labor employment where an additional labor unit yields a declining level of output. From the above analysis, output starts to decline at the point where the quantity of labor is 3.

2)      The following table gives the marginal product that result from using 20 units of capital with varying levels of labor. Use this information to determine the total and average product of labor.

 Capital units Labor units Total product of labor Average product of labor Marginal product of labor 20 0 0 0 0 20 2 100 50 50 20 4 260 65 80 20 6 460 76.67 100 20 8 690 86.25 115 20 10 940 94 125 20 12 1206 100.5 133 20 14 1484 106 139 20 16 1770 110.63 143 20 18 2056 114.2 143 20 20 2336 116.8 140

One can obtain the marginal product of labor by obtaining the change in total product and dividing by the change in the labor units. I.e. MPL= TPL/ labor units.

Thus, to obtain total product, we multiply the change in units of labor by the corresponding marginal product of labor. We then add the resulting value to the initial value to get the total product at that level of input.

For example

At 2 units of labor, Total output= 2*50= 100.

Total product at 2 units=100+0=100

At 4 units of labor, Total output =100+ (80*2) = 260

At 6 units of labor, total output = 260+ (100*2) = 460

At 8 units of labor, Total output= 460+ (115*2) =690

The procedure continues for the rest of the labor input levels.

To compute the average product of labor, we divide the total output at each level by the level of inputs of labor at each point.

For example

At 2 units of labor, APL= 100/2 = 50

At 4 units of labor, APL= 260/4 = 65

At 6 units of labor, APL= 460/6 = 76.67

The procedure continues for the rest of levels of labor input.

3)      The following table indicates the total product that a firm can produce with 30 units of capital and varying levels of labor. Each unit of capital costs \$40 and each unit of labor costs \$20. Use this information to determine the short-term costs of the firm.

 Capital Labor Total product Total fixed cost Total variable cost Total cost Average fixed cost Average variable cost Average Total cost Marginal cost 30 0 0 1200 0 1200 Infinite 0 Infinite Infinite 30 2 20 1200 40 1240 60 2 62 2 30 4 33 1200 80 1280 36.36 2.42 38.78 3.08 30 6 48 1200 120 1320 25 2.5 27.5 2.67 30 8 61 1200 160 1360 19.67 2.62 22.3 3.08 30 10 71 1200 200 1400 16.9 2.82 19.72 4 30 12 80 1200 240 1440 15 3 18 4.44 30 14 88 1200 280 1480 13.64 3.18 16.81 5 30 16 95 1200 320 1520 12.63 3.37 16 5.71

We compute the total fixed cost by multiplying the cost of a unit of capital by the number of units of capital that the firm uses for producing output

I.e. Total fixed cost= 30* 40 = 1200

This cost is constant for all levels of production because fixed cost is independent of output level.

We compute total variable cost by multiplying the number of units of labor that the cost of each unit of labor.

I.e. Total variable cost at 2 units of labor= 2*20= 40

At 4 units = 4* 20= 80

At 6 units = 6* 20= 120

Total cost at each level is the summation of the total fixed cost and the total variable cost at each level of input.

I.e. Total cost at 2 units of labor= 1200+40= 1240

TC at 4 units= 1200+80= 1280

TC at 6 units= 1200+ 120= 1320

The average fixed cost is obtained by dividing the total fixed cost by the number of units of output at each production level.

I.e. AFC at 2 units= 1200/20=60

AFC at 4 units=1200/33=36.36

AFC at 6 units=1200/48=120

The average variable cost is obtained by dividing the total variable cost at each level of output by the number of units of output.

I.e. AVC at 2 units of labor= 40/20=2

AVC at 4 units= 80/33=2.42

AVC at 6 units= 120/48=2.5

Average total cost is obtained by dividing the total cost of production by the number of units of output at each level of production.

I.e. ATC at 2 units=1240/20=62

ATC at 4 units=1280/33=38.78

ATC at 6 units=1320/48=27.5

The marginal cost is obtained by dividing the change in total cost by the change in units of output that a firm produces.

I.e. MC at 2 units = 1240-1200/20-0=2

At 4 units, MC=1280-1240/33-20=3.08

At 6 units, MC=1320-1280/48-33=2.67

4)

1. Show graphically the demand curve for a perfectly competitive firm.

Draw the marginal cost, average total cost and average variable cost curves.

Identify the point of profit maximization.

2. What condition is true if the firm sells more than the profit-maximizing output?

Firms must reduce the price level of its products in order to sell more than the profit maximizing level of output. This implies that the marginal revenue of a unit of output must be less than the marginal cost of producing the unit. I.e. MR%u02C2 MC

3. What condition is true if the firm sells less than the profit-maximizing output?

If firms sell output that is below the profit maximizing level, it means that the marginal revenue of a unit of output is greater than the marginal cost of producing that unit. I.e. MR%u02C3 MC

4. What would happen if the firm tries to charge a higher price for the good than its competitors?

Consumers are rational, and would prefer to consume commodities that are available at a low price, than similar products at a high price. Thus, if a firm tries to raise prices in a competitive market, it may not realize any sales. This is because there are alternative suppliers of the same product at a relatively low price.

5. What is the price elasticity of demand for the good sold by a perfectly competitive firm?

The price elasticity of demand for a commodity in a perfectly competitive firm is perfectly inelastic or infinite. This is because an increase in price does not affect the quantity that consumers demand. When a firm increases the price of a commodity, consumers will shift to other suppliers of the commodity in order to maintain the same level of consumption.