Question

4) Consider total cost and total revenue given in the following table:

Quantity 0 1 2 3 4 5 6 7 7

Total Cost $120 150 160 170 190 230 300 410 610

Total Revenue $0 70 140 210 280 350 420 490 560

A. Create a table that includes the fixed cost at each level of output as well as the variable cost

at each level of output. If capital is fixed and the firm uses 10 units of capital, then what is

the price of capital? If labor is variable and the firm uses 5 units of labor to produce 3 units

of output, then what is the price of labor?

B. Create a table that includes the marginal cost, average variable cost, and average total cost

associated with each level of production. Graph these three cost measures on a single graph

with quantity on the horizontal axis. Explain how you know the firm exhibits the law of

diminishing returns.

C. Calculate profit (revenue minus costs) for each quantity. Calculate marginal revenue for

each quantity. Verify that the profit maximizing firm will choose the highest level of profit

at a point where MR = MC.

D. This firm is in a perfectly competitive industry? Explain how we know this is true. What

do you expect to happen in the long run in this industry? Will firms enter or leave the

market in the long run? Will the market price increase or decrease in the long run?

Answer 1

a)

Quantity, Q	Total Cost, TC	Fixed Cost, TFC	Variable Cost, TVC=TC-TFC
0	120	120	0
1	150	120	30
2	160	120	40
3	170	120	50
4	190	120	70
5	230	120	110
6	300	120	180
7	410	120	290
8	610	120	490

Fixed cost is equal to total cost at zero output. It means that fixed cost is $120 in this case.

Variable cost can be found by the following relation.

TVC=TC-TFC

Price of capital=r=TFC/Number of capital units=120/10=$12

Total Variable cost at output of 3 units=$50

Price of labor=w=TVC/Number of labor units=50/5=$10

B)

Quantity, Q	Total Cost, TC	Fixed Cost, TFC	Variable Cost, TVC=TC-TFC	AVC=TVC/Q	ATC=TC/Q	MC=Change in TC/Change in Q
0	120	120	0
1	150	120	30	30.00	150.00	30.00
2	160	120	40	20.00	80.00	10.00
3	170	120	50	16.67	56.67	10.00
4	190	120	70	17.50	47.50	20.00
5	230	120	110	22.00	46.00	40.00
6	300	120	180	30.00	50.00	70.00
7	410	120	290	41.43	58.57	110.00
8	610	120	490	61.25	76.25	200.00

Marginal Cost is increasing after Q=3. It means that firms exhibits law of diminishing returns.

C)

Quantity, Q	Total Cost, TC	Total Revenue, TR	Profit= TR-TC	MR=Change in TR/Change in Q
0	120	0	-120
1	150	70	-80	70
2	160	140	-20	70
3	170	210	40	70
4	190	280	90	70
5	230	350	120	70
6	300	420	120	70
7	410	490	80	70
8	610	560	-50	70

We can observe that maximum profit is $120 which is achieved at Q=6

Refer to table in part B and Part C,

We can see that MR=MC=70 at Q=6. Maximum profit is achieved at this level of output level only.

So, we can say that profit maximizing firm will choose the highest level of profit at a point where MC=MR=70.

D)

Marginal Revenue is same for all levels of output. So, we can say that firm is in a perfectly competitive market.

Profit at optimal level i.e. at Q=6 can be taken from table in par C

Profit at optimal level=$120

It means that firm is making positive profit. It will attract other firms to enter the market in long run.  

More number of firms will increase the supply and the price will come down in long run.

Economic profit will be zero in long run as price will be equal to minimum average total cost.