Microeconomic Theory - Assignment Example

BUECO 1507 Assignment Name Institution Qn. 1 (i) Units of Labour Total Product (boxes per hour) Marginal Product (boxes per extra worker) Average product (boxes per worker) A 0 0 ////////////////// /////////////////// B 1 25 25 25 C 2 60 35 30 D 3 80 20 26.67 E 4 90 10 22.5 F 5 95 5 19 (ii) The marginal product is the extra unit of output that can be produced through the application of a single unit of output (Tian, 2002). For instance, when you increase the input from one to two units, the difference in the levels of output constitute the marginal product. (iii) The law of diminishing returns states that the volumes of output levels increases steadily with every additional units of input up to a point where additional units of input lead to a negative increase in marginal output levels. In the above table, we can observe that when the units of input are increased from 1 worker to 2, the output scales rise from 25 to 60, bringing in a marginal product of 35. From this level, additional units of labor only lead to a decline in marginal output levels from 35 at 2 units to 5 at 5 units of labor. The law shows that it is only economical to increase the value and volume of inputs up to a certain point where further increase starts bringing in losses resulting from diseconomies of scale. (iv) Marginal product shows the output presented by one additional unit of input while average productivity shows the output of every single unit of input in production. When a company wishes to hire an additional worker, they need to use the concept of marginal product, that will show how much this worker brings to the company in form of output. On the other hand, when the company wishes to know how much each worker in the company produces as output, it finds the average of the same. The following diagram offers a relationship between the two. Output Average product Marginal product Input (v) Marginal cost is the cost incurred during the process of bringing in an additional unit of input. When an additional unit of input is done, there is a marginal production. The costs involved in bringing in this marginal production is what is being referred to as the marginal cost. Question 2 (i) Total Product Total Fixed Cost Total Variable Cost Total Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost 0 100 0 100 /////////// //////////// /////////// /////////// 1 100 90 190 100 90 190 90 2 100 170 270 50 85 135 80 3 100 240 340 33.37 80 113.33 70 4 100 300 400 25 75 100 60 5 100 370 470 20 74 94 70 6 100 450 550 16.67 75 91.67 80 (ii) Fixed costs are those costs that do not change irrespective of the changes in the amounts of output provided. For instance, if the fixed costs for producing 1 unit of good is 100, the cost remains the same even when the quantity of goods produced increases to 5. Variable costs on the other hand are those costs which increase relatively to increment in the quantity of goods produced. For instance, it may cost say 100 to produce 1 unit of good. When the units produced increase to 5, the cost also rise to say 500. (iii) Costs Total costs Variable costs Fixed costs Output From the diagram, Total costs = Fixed costs + variable costs. When the output is 0, TC=FC. And VC=O As output increases, VC also increases, FC remain constant and TC becomes a factor of both FC and VC making the graph rise above others as shown in the diagram (iv) A straight horizontal line defines the fixed cost from the graph above. This shows that the costs do not change irrespective of changes in the units of output produced. (v) At the highest point of the marginal cost curve, this is where the intersection between the curve and the average cost curve occurs. This shows the point where further addition of input will no longer cause an increase in the marginal cost curve. At this juncture, the concept of law of diminishing returns apply. (vi) Marginal costs are variable costs. Every additional unit of input brought in leads to an increase in marginal cost. Question 3. Output Total Fixed Cost Total Variable Cost Total Cost Total Revenue Profit or loss (economic or normal) 1 $100 $120 $220 $150 $ -70 2 $100 $200 $300 $300 $ 0 3 $100 $290 $390 $ 450 $ 60 4 $100 $430 $ 530 $ 600 $ 70 5 $100 $590 $ 690 $ 750 $ 60 Ep = 150 (ii) To maximize profits in the short-run, the firm needs to produce 5 units of output where there is a maximum profit of $ 70 (iii) (70) + 0 + 60 + 70 + 60 =120 This presents an economic profit. To get the profit, all the profit levels are added up. This shows that the company will have an economic profit of $ 120 (iv) Economic profit is the profit received following the sale of various outputs and the opportunity cost of inputs used. Normal profit shows the difference between the total revenues received and the cost used to generate these revenues. This outcome is an economic profit. From the diagram it can be observed that the cost of producing this output is 530. If the company produced an extra unit of output, they would still make a profit of 60, but this profit is lower and has a higher cost of production compared to output 4. This makes output 4 an economic profit output. (v) Break- even level of output is the output level for which the costs incurred in the production of the output is equivalent to the revenues received from the sale of the output. (vi) In the above diagram, the break even output is 2 where the profit is 0. Question 4 Output/Sales Price Total Revenue Average Revenue Marginal Revenue 0 $6.00 $ 0 $ 0 /////////////////// 1 $5.50 $ 5.50 $ 5.50 $ 5.50 2 $5.00 $ 10.00 $ 5.00 $ -0.50 3 $4.50 $ 13.50 $ 4.50 $ -0.50 4 $4.00 $ 16.00 $ 4.00 $ -0.50 5 $3.50 $ 51.00 $ 3.50 $ -0.50 6 $3.00 $ 18.00 $ 3.00 $ -0.50 7 $2.50 $ 17.50 $ 2.50 $ -0.50 8 $2.00 $ 16.00 $ 2.00 $ -0.50 9 $1.50 $ 13.50 $ 1.50 $ -0.50 10 $1.00 $ 10.00 $ 1.00 $ -0.50 11 $0.50 $ 5.50 $ 0.50 $ -0.50 12 $0 $ 0 $ 0 $ -0.50 (ii) Graph of Average revenue and marginal revenue and total revenue curve The marginal revenue is constant from the second output level. This means that additional units of input will not lead to an increase in the marginal revenue. The average revenue is downward sloping. The implication in this case is that as the firm produces more, the amount of revenues received decreases. (iii) The total revenue curve shows that additional units of output will produce additional revenue up to a point where any extra additional of output starts leading to diminishing returns. The firm should stop producing more at the point where the total revenue curve is highest. (iv) To get average revenue, the total revenue is divided over the number of units sold. To get the total revenue, the number of units are multiplied by the price of each units. So to get the average revenue, one must know the price of the units sold. (v) Ped = {(6-0)/0}/ (3-6)/6 = 0/0.5 = 0. The demand is perfectly inelastic. This means that the demand does not change with changes in price levels. (vi) Ped = {(3-11)/3}/ (0.5-3)/3 = -2.67/-0.83= 3.22. The demand here is elastic. The demand of units of output sold increases with decrease in price. (vii) “The monopolist will always choose to operate in the elastic portion of its linear demand curve.” This is because at this point, the monopolist will be able to acquire more profits than he would if he operated along any other lines. For instance, in this case, the monopolist may operate optimally between price levels 6 and 3 where the demand is inelastic. At this point, the monopolist can be able to maximize their revenues. Question 5 Output (in 1,000 tonne lots) Factory with one blast furnace Factory with 2 blast furnaces Factory with 3 blast furnaces 1 30 - - 2 25 30 - 3 21 23 30 4 18 19 25 5 19 16 21 6 21 14 18 7 24 13 16 8 30 12 15 9 38 13 14 10 50 17 13 11 - 24 12 12 - 35 13 13 - - 17 14 - - 24 15 - - 35 (i) The long-run average cost curve shows the lowest level of cost that a firm can produce any given amount of output in the long- run. Economies of scale are those benefits that a firm gets through its advantage of increasing in size. These may include benefits such as trade discounts and capacity to sell goods at a relative low price. diseconomies of scale on the other hand are disadvantages accrued to a firm because of its growth in size. Mostly these are overhead costs and management costs. (ii) Cause of economies of scale is primarily on the reduction of costs involved during the production process. For instance, fixed costs may be split over a large number of output making it viable economically to process, produce and sell those units of output at a lower price. When a firm is large it has the resources needed to buy goods in bulk and as such they acquire trade discounts. This translates into low prices for these goods. Diseconomies of scale mainly arise from increased costs of management. Large firms require higher skills of management and large number of administrative personnel. These personnel exert pressure on the organization and lead to increase in costs. (iii) Output (in 1,000 tonne lots) Factory with one blast furnace LRAC Factory with 2 blast furnaces LRAC Factory with 3 blast furnaces LRAC 1 30 30 - - - - 2 25 12.5 30 15 - - 3 21 7 23 7.67 30 10 4 18 4.5 19 4.75 25 6.25 5 19 3.8 16 3.2 21 4.2 6 21 3.5 14 2.33 18 3 7 24 3.43 13 1.86 16 2.29 8 30 3.75 12 1.5 15 1.88 9 38 4.22 13 1.44 14 1.56 10 50 5 17 1.7 13 1.3 11 - 24 12 12 - 35 13 13 - - 17 14 - - 24 15 - - 35 (iii) The LRAC for producing 7000 tonnes is 1.86. The firm should adopt the factory with 2 furnaces because the LRAC is cheaper here than in the other two forms. (iv) The firm’s long-run profit maximization output for the firm is 8000 tonnes. This is because at this level, the firms will have the least costs. Question 6 (i) A natural monopoly is a firm which is the only one given the mandate to produce and sell certain products. The monopoly exists after it is considered that it would be most efficient to have the production of a certain product concentrated in one firm. An example would be the military and security of a nation (ii) Barriers to entry in the market relates to the restrictions that have been put in place to minimize the entry of new firms in the market. Sometimes, in a market, it is vital to restrict the number of firms present in the market so that economic viability and profitability may be attained. In most cases, the restriction comes so that they may allow for efficient utilization of resources and to avoid unnecessary competition. (iii) Barriers to entry determine the kind of market structure that exist in the market. If there are no barriers to entry in the market, then there is no limit to the number of buyers and sellers entering the market. The market therefore becomes a perfect competitive market. If there are barriers to entry that inhibit the entry of sellers but not buyers, such that there are many buyers and one seller, then the market structure is a monopoly. A monopsonistic market structure arises when then the barriers to entry into a market are put on the buyers and not the sellers, meaning that there are many sellers but one buyer. Reference Tian, G. (2002). Microeconomic theory. Retrieved from http://econweb.tamu.edu/~tian/micro1.pdf Read More