ECO-6655: Application Problem Set 4, T5-12 Dr. Dominic F. Minadeo

Make sure you show ALL your work and explain where asked. Groups who do not provide explanations or simply provide final answers will not receive credit for that question. See the assignment handout for more information.

Groups should answer the following questions:

1.(20 points) Cold Case, Inc., produces beverage containers used by fast food franchises. This is a perfectly competitive market. Production limitations require that cup lots be produced only in units of 100 as shown in the table below. The following relation exists between the firm's beverage container output per hour and total production costs:

Q / TC
0 / $ 35.00
100 / $ 65.00
200 / $ 93.00
300 / $120.00
400 / $155.00
500 / $210.00
600 / $285.00
700 / $365.00
A. / Construct a table showing the average variable, average total, and marginal costs of paper cup production. Show your work or embed an Excel spreadsheet into your file showing the formulas you used.
B. / At what price would the firm earn a normal profit? Explain and show your work.
C. / What is the lowest price this firm would accept and still be willing to produce? Explain and show your work.
D. / How many cups would the company supply at industry prices of $0.45 and $0.30? Be sure to show all your calculations and explain your answers well.

2.(20 points) The Los Angeles retail market for widgets is fiercely price competitive. The typical retailer has the following total cost (TC) and marginal cost (MC) relations:

TC = $1562.5 + $1.25Q + $0.00001Q2

MC = dTC/dQ = $1.25 + $0.00002Q

and Q is number of widgets. Total costs include a normal profit.

A. / Calculate the firm’s profit-maximizing output level assuming the current price of widgets is $1.75. Make sure you explain your work and answers.
B. / Explain why the price above is not sustainable in the long run. Explain the adjustment process that would take place to reach long-run equilibrium using supply-demand analysis. As part of your answer, determine the appropriate long-run equilibrium price and output level for the typical retailer.

3.(15 points) Indicate whether each of the following statements is true or false, and explain why. If a statement is false or true, do not simply give a corrected statement -- you must provide a full explanation as to why that statement is correct or not.

A. / Producer surplus tends to fall as the supply curve becomes more elastic.
B. / Consumer surplus tends to rise as demand becomes more elastic.
C. / The market demand curve indicates the minimum price buyers are willing to pay at each level of production.
D. / The market supply curve indicates the minimum price required by sellers as a group to bring forth production.
E. / Consumer surplus is the amount that consumers are willing to pay for a given good or service above and beyond the amount actually paid.

4.(15 points) The U. S. wheat crop averages about 2 billion bushels per year, and is about 10 percent of the 20 billion-bushel foreign wheat crop. Typically, the market has a relatively good estimate of the wheat crop from the United States and Canada, but wheat crops from the Southern Hemisphere are much harder to predict. Argentina's wheat acreage varies dramatically from one year to another, for example, and Australia has hard-to-predict rainfall in key wheat production areas. To illustrate some of the cost in social welfare from agricultural price supports, assume the following market supply and demand conditions for wheat:

P = $2 + 0.001QS / (Market Supply)
P = $4.80 - $0.0004QD / (Market Demand)

where Q is output in bushels of wheat (in millions), and P is the market price per bushel.

A. / Calculate the equilibrium price/output solution. Explain your answers and show all work.
B. / Determine the loss in consumer surplus due imposition of a $4.40 per bushel price support program. Explain your answers well.

5.(5 points) Why would a firm in a perfectly competitive market always choose to set its price equal to the current market price? If a firm set its price below the current market price, what effect would this have on the market?

6.(10 points) “I really don’t get why a perfectly competitive firm wants to produce so that MR = MC. I mean, the goal of the firm is to earn the most profit possible. Why does it produce so that MR = MC? I think that it ought to want to produce so that MR > MC; that is, so that revenues exceed costs and it earns a profit.” This student is making a fundamental error. Correct the student’s analysis.

7.(15 points) The demand and supply schedules for widgets are below. Answer the following questions:

Price / Quantity demanded / Quantity supplied
$4.00 / 140 / 20
4.10 / 130 / 40
4.20 / 120 / 60
4.30 / 110 / 80
4.40 / 100 / 100
4.50 / 90 / 120
4.60 / 80 / 140
4.70 / 70 / 160
4.80 / 60 / 180
4.90 / 50 / 200
5.00 / 40 / 220

A. What is the equilibrium price and quantity of widgets at present?

B. Suppose that the government levies a $0.30 per unit tax on widgets. Determine the new equilibrium price and quantity. Be sure to show all calculations and to explain your work and answers. Assume the tax is levied on suppliers so they receive the price less the tax when they sell each widget (you'll be determining a new supply schedule in other words).Show all your work and explain all calculations.

C. Determine the total tax collected by the government on widgets. How much of this tax is paid by consumers? by producers? Show all calculations and explain your work.

D. Based on your results in part C, is the demand or supply curve relatively more inelastic? How do you know? Explain.

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