Gallaway 

ECO 165

Homework: Unit 2
 

These answers are abbreviated and should be used as a guide to help you get started or to confirm you are on the right path.  Student answers should be longer, more complete, and may require a diagram.

1. Say I increase the price of movie tickets from $5 to $7 and sales fall from 350 to 250. Calculate the price elasticity of demand. Is the demand this level elastic or inelastic? If my costs remain the same, was increasing prices a good idea? Explain.

• Elasticity = |(Q₁ - Q₂)/((Q₁ + Q₂)/2) ÷  (P₁ - P₂)/((P₁ + P₂)/2)|
               = |-100/300 ÷ 2/6|
               = |-1/3 * 6/2|
               = 1     
• 
          The demand for this good is unit elastic.  If I raise or lower my prices, my revenue stays the same.  If it were elastic, I'd be better off lowering prices.  If it were inelastic, then raising prices would be a good idea.

Labor	TPP	MPPL Formula: DTPP/DQinput	FC Formula:	VC Formula: Qinput* Pinput	TC Formula: FC + VC	AVC Formula: VC/Qoutput	ATC Formula: TC/Qoutput	MC Formula: DTC/DQoutput	MRPL Formula: MPP*P
1	10	10	$40	$5	$45	$0.50	$4.50	$.50	$50.00
2	30	20	$40	$10	$50	$0.33	$1.67	$0.25	$100.00
3	45	15	$40	$15	$55	$0.33	$1.22	$0.33	$75.00
4	50	5	$40	$20	$60	$0.40	$1.20	$1.00	$25.00
5	51	1	$40	$25	$65	$0.49	$1.27	$5.00	$5.00
6	50	-1	$40	$30	$70	$0.60	$1.20	$XX	$-5.00

2. Say this table describes the production & cost information of a pizza parlor. Assume Labor costs are $5 per unit & that Pizzas sell for $5. Fill out the table.
3. What is the relationship between MPP_L and MC? Use numbers from the table to explain your answer.   Marginal cost is minimized when marginal productivity is maximized.
4. What is the relationship between MC & ATC?     Between MC & AVC? Use numbers from the table to explain your answer. Sketch a graph showing your results.  Marginal leads average, crosses at average's lowest point.  
5. How many units of labor should be hired? Why?   Hire workers as long as they "pay for themselves." Hire 5 workers; you would loose money on the 6th. 
6. Is this the long run or short run? How do you know? There are fixed costs; it is the short run.

7. Assume a perfectly competitive firms MR & MC are equal when the firm produces 100 units.  At this quantity, the firm is  faced by the following:

   •  P = $9
   •  TC = $1000
   •  TVC = $ 800
   What are the firms profits or losses?  In the short-run, what should this firm do? Explain.  What will happen  to the firm & the industry in the long run?
   • The firm is loosing $100.  In the short run it should stay open as long as the price covers AVC. (Fixed costs are $200 and this would all be lost if the firm produced nothing--by staying open this firm cuts its losses in half.)  In the long run, we would expect firms to leave this industry.  This would allow price to increase until profits and losses are eliminated.
8. What is marginal revenue equal to when total revenue is maximized?  Explain.
   • Marginal revenue is equal to zero when total revenue is maximized.  As long as MR is positive--even if it is a very small amount--it is contributing some to TR.  Also, MR is equal to the slope of the TR curve.  At the top of the TR "hill," the slope is neither increasing nor decreasing; its slope (and therefore MR) is zero.
9. If marginal costs are decreasing, will this cause total costs to decrease?  Will it cause average costs to decrease?  Explain.
   • As long as marginal costs are positive,  they will cause total costs to increase. If MC > AC, AC will increase.  If MC < AC, AC will decrease.  The issue of whether MC is increasing or decreasing is not relevant to these two questions.