ECO100 Introduction To Economics

Answer 1

a) The diminishing returns tend to set in when the quantity produced exceed 5. This is because the marginal cost tends to keep decreasing from Q =1 to Q =5. However, when the production is further increased, then the marginal cost keeps on progressively increasing with every additional unit produced. Thus, from Q =6, there is onset of diminishing returns for the firm.

b) ATC is the average total cost while MC is the marginal cost. ATC is the average total cost for each unit produced at a given level of production. MC is the incremental cost associated with an incremental change in production. When MC decreases, ATC will always decrease. When MC increases, the rate of decrease of ATC will reduce and eventually it will start increasing.

AVC is the average variable cost at a given level of production. Change in the variable costs of consecutive units is defined as the marginal cost. When MC is decreasing, then AVC keeps on declining. However, when MC increases, the rate of decrease of AVC will reduce and eventually it will start increasing.

c) AF’s minimum efficient scale essentially would be the output level or range where the firm’s ATC in the long run would be minimized. In the long run, fixed costs are essentially zero. Therefore, in order to determine the MES for AF, we would focus on minimising the AVC. Based on the table completed in part (a), it is apparent that the minimum variable cost is $13.33 which is attained when the quantity produced is 6 units. Thus, this would represent the MES for AF.

d) The total cost at various quantity levels has been highlighted in part (a). The selling price per unit is $40. Hence, the profit made by the firm is total revenue minus total cost. This has been summarised in the table shown below.

From the above table, the profit maximising output for AF is 9 units where the total profit is $162. Infact the firm should produce till the level where marginal cost reaches $40. Since the price charged i.e. $40 is higher than the marginal cost (<$40), hence AF should keep on producing in the long run. However, in the long run more firms would enter and thereby push price lower to an extent where the economic profit made by AF would be zero.F

e) The total cost at various quantity levels has been highlighted in part (a). The selling price per unit is $20. Hence, the profit made by the firm is total revenue minus total cost. This has been summarised in the table shown below.

From the table shown above, it is evident that the firm is incurring losses at all levels expect Q =7. Thus, the firm in the short run should produce at Q =7 where there would be no expected profit or loss. The firm should not continue to produce in the long run as with increasing supply and declining prices the firm may not be able to cover the variable costs also.

Answer 2

• The demand function is P = 10 –Q
1. The supply function is P = Q – 4
2. At equilibrium demand = supply
3. Hence, 10 – Q = Q – 4
4. 10 + 4 = Q+ Q
5. Thus, Q = (14/2) = 7 cartons
6. P = 7 -4 = $3

Hence, the equilibrium price is $3 and equilibrium quantity is 7 cartons.

• The demand function would not be impacted by the tax imposed by the government. However, the supply function would alter. Since $1 tax per unit has been imposed by the government, hence the new supply function would be as follows.
1. P = Q -4 +1 = Q- 3
2. At equilibrium demand = supply
3. Hence, 10 – Q = Q – 3
4. Thus, Q = (13/2) = 6.5
5. P = 6.5 – 3 = $3.5
6. The new equilibrium quantity is 6.5 cartons.
7. The buyer will have a pay a price of $3.50.
8. Amount received by the seller per carton would be ($3.5 - $1) = $2.50
9. Thus, the tax burden is shared equally ($0.50) each by the buyers and sellers. A graphical representation of this is shown below.
10. Due to tax being imposed by the government, inefficiency arises which is represented by the deadweight loss highlighted in the diagram above.
11. Amount of deadweight loss = 0.5*(7-6.5)*($3.5 - $2.5) = $0.25

Hence, the amount of inefficiency in the economy owing to the tax is $0.25 as computed above.

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