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Solution Manual for Economics for Managers, 3rd Edition

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    S - 1 Solutions to End of Chapter Pro b lems Farnham, Economics for Managers, 3 /e Chapter 1 Technical Questions 1. Microeconomics focuses on the behavior of individual consumers, firms, and industries as they operate in a market economy. It analyzes how these various groups respond to changes in prices that affect their consumption, production, and selling decisions. It also describes how firms and consumers interact in various types of markets and can be used as a basis for determining competitive strategies. Macroeconomics focuses on the overall economic environment in which businesses operate. It analyzes the spending decisions of different sectors of the economy — the household, business, government, and foreign sectors. Macroeconomic policy deals with the issues of inflation, unemployment, and economic growth. Changes in the macroeconomic environment influence firms through the microeconomic issues of demand, cost, revenues, and profits. 2. Outputs are the final goods and services that firms and industries sell to consumers. Consu m- ers create a demand for all of these goods and services. Inputs are the resources or factors of production that are used to produce the f i nal outputs. Inputs include land, labor, capital, raw materials, and entrepreneurship. Firms’ use of these inputs is related to the demand for their products.

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    S - 2 3. The four major types of markets are perfect competition, monopolistic competition, oligopoly, and monopoly. The key characteristics that distinguish these markets are (1) the number of firms competing with each other, (2) whether the products sold in the markets are differentiated or undifferentiated, (3) whether entry into the market by other firms is easy or difficult, and (4) the amount of information available to market participants. 4. In the model of perfect competition, firms are price - takers because it is a s sumed there are so many firms in each industry that no single firm has any i n fluence on the price of the product. Each firm’s output is small relative to the entire market, so that the market price is dete r- mined by the actions of all suppliers and demanders. In the other market models, firms have an influence over the price. If they raise the price of the product, consumers will demand a smaller quan tity; if they lower the price, consumers will increase the quantity demanded. 5. In macroeconomics, the five major categories of spending are consumption ( C ), investment ( I ), government ( G ), export ( X ), and import ( M ). GDP = C + I + G + X – M . The first four categories are added together, while import spending is subtracted because it represents a flow of expenditure out of the domestic economy to the rest of the world. 6. Fiscal policies are implemented by the n a tional government and involve changing taxes ( T ) and government expenditure ( G ) to stimulate or slow the eco n omy. These decisions are made by the political institutions in the country. Monetary po l icies are implemented by a country’s central bank — the Federal Reserve in the United States. These policies focus on changing the money supply in order to influence interest rates, which then affect real consumption, i n- vestment spending, and the resulting level of income and ou t put. Application Questions

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    S - 3 1. Microeconomic factors facing the global automobile industry include consumer demand for increased automobile quality and additional features, the increased preferences for sport util i- ty vehicles, the differing preferences of Chinese versus U.S. consumers, and the continued need to redesign production processes to lower production costs. Macroeconomic factors i n- clude the continuing weak recovery in global economic activity especially in Europe and the fluctuations in currency exchange rates. 2 a. This is a description of a perfectly competitive market. It discusses factors influencing the demand and supply of corn , where the focus is on the price and quantity in the entire market, not the decisions of individual producers. The drought decreased the supply of corn in the U.S., which caused prices to increase. Countries such as China, Japan, and South Korea then turned to find substitute sources of corn in Argentina and Brazil. b . Staples, OfficeMax, and Office Depot operate in an oligopoly market with interdependent behavior. All three companies have been forced to close stores, downsize their existing stores, and increase their online operations. c. This discussion describes the attempt by the U.S. wireless telecommunications industry to gain monopoly or market power through mergers of independent firms. The federal government prohibited T - Mobile from merging with AT&T, given concerns over the market power of that combined firm. T - Mobile then announced a merger with its smaller rival, MetroPCS, that would still allow it to cut costs and expand its operations.

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    S - 4 d. Chinese restaurants represent monopolistic competition. There are 36,000 Chinese restaurants, most of them small, family operations. No national chain dominates these restaurants, largely due to the use of the wok for cooking. Specialized stoves and chefs are required for this type of cooking, which has limited the expansion of these firms into large - scale production. 3 . Numerous examples can be found. In general, the more competitive the market is, the more firms will have to rely on reducing the costs of production, as they have less control over price. Firms with market power often use all types of strategies. For example, many resta u- rants responded to the economic slowdown in 2007 and 2008 by scaling back expansion plans, skimping on items like extra sauce and free sour cream, closing sites, and laying off workers. After examini ng rivals’ portions of hash browns and french fries and analyzing leftovers, Vicorp, which owns 400 - plus Village Inn and Bakers Square restaurants, cut back as much as an ounce from each serving of these foods with a projected annual savings of more than $500,000. See Jeffrey McCracken and Janet Adamy, “Restaurants Feel Sting of Surging Costs, Debt,” Wall Street Journal , April 24, 2008. 4 . Examples of these types of strategies are discussed in Ch apter 14. Firms looked for ways to increase productivity and cut costs. Many also develo ped new pricing strategies to increase their profits or minimize their losses. Chapter 2 Technical Questions 1. a. Demand increases (assuming that computers are a normal good). b. There is a decrease in the quantity demanded of computers (and no change in the demand

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    S - 5 curve). c. Demand increases, as the price of a complementary good has fallen. d. There is no change in demand, as semiconductors are an input to computer production and thus a determinant of supply. e. Demand decreases in October, as consumers wait to buy at a lower price in Dece m ber. 2. a. Su p ply increases. b. Supply decreases. c. There i s a decrease in the quantity supplied of computers (and no change in the supply curve). d. Supply decreases (because costs of production have i n creased). e. There is no change in supply, as consumer incomes are a determinant of d e mand. 3. a. X is a normal good. We know this because there is a positive relationship between income and the quantity demanded of good X . b. X and Y are substitutes. We know this because there is a positive relationship between the price of good Y and the demand for good X (thus, as the price of Y rises, consumers buy more X ). c. X and Z are complements. We know this because there is a negative relationship between the price of good Z and the demand for good X (thus, as the price of Z rises, consumers buy less X ). d. Q D = 500 – 5 P X + 0.5 I + 10 P Y – 2 P Z

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    S - 6 = 500 – 5 P X + 0.5(30) + 10(10) – 2(20) = 575 – 5 P X e. Price intercept = $115; Quantity intercept = 575; Slope = - 0.2. f. The quantity demanded is 500. g. The equation of the demand curve is Q D = 625 – 5 P X Price intercept = $125; Quantity intercept = 625; Slope = - 0.2. 4. a. X and Z are complements in production. We know this because there is a positive relatio n- ship between the price of good Z and the supply of good X (thus, as the price of Z rises, producers produce more X ). b. Q S = – 200 + 20 P X – 5 P I + 0.5 P Z = – 200 + 20 P X – 5(10) + 0.5(20) = – 240 + 20 P X c. Price intercept = $12; Slope = 0.05 . See text answers for graph. d. Set Q S = 0. The minimum price is $12.00. e. Q S = – 240 + 20(25) = 260. f. Q S = – 200 + 20 P X – 5(5) + 0.5(20) = – 215 + 20 P X ; Price intercept = $10.75; Slope = 0.05. 5. a. Demand curve: Price intercept = $250; Quantity intercept = 500. Supply curve: Price intercept = $33.3; Slope = 0.33. b. Q * = 260; P * = 120.

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    S - 7 c. At P = $100, the quantity demanded is 300, while the quantity supplied is 200. Thus, there is a shortage, and the market price will rise. d. At P = $150, the quantity demanded is 200, while the quantity supplied is 350. There is a surplus, and the market price will fall. e. P * = 140; Q * = 320. New demand curve: Price intercept = $300; Quantity intercept = 600. 6. a. Demand increases (the price of a substitute has risen); equilibrium price and quantity rise. See text answers for graphs. b. Supply decreases (the price of an input has risen); equilibrium price rises and quantity falls. c. Demand i n creases; equilibrium price and quantity rise. d. Supply i n creases; equilibrium price falls and quantity rises. e. Demand d e creases; equilibrium price and quantity fall. 7. a. The increase in the price of gasoline causes the demand for automobiles to decrease (leftward shift of the demand curve), while the decrease in the price of steel causes the supply of automobiles to increase (rightward shift of the supply curve). With no further information, we know that the equilibrium price will fall, but the effect on quantity cannot be determined.

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    S - 8 b. The rise in gasoline prices will cause demand to decrease, which will cause the quantity to fall, all other things held constant. If this effect is larger than the effect of the reduction in steel prices (which will increase supply and cause the quantity to rise), then we may now be able to conclude that the equilibrium quantity of automobiles is likely to fall. 8. a. Because hamburger is an inferior good, demand will increase as incomes decrease, causing the price to rise (rightward shift of demand curve). The improvement in technology that lowers production costs causes supply to increase and tends to lower price (rightward shift of supply curve). With no further information, we know that the equilibrium quantity will rise, but the effect on price cannot be determined. See text answers for graphs. b. The fall in consumer incomes will cause demand to i n crease (for an inferior good), which will cause the price to rise, all other things held constant. If this effect is smaller than the effect of the improvement in technology (which will increase supply and cause the price to fall), then we may now be able to conclude that the equilibrium price of hamburger is lik e- ly to fall . See text answers for graphs. Application Questions 1. Although copper prices reached an all - time high in February 2011, there was concern that the demand from China would not continue, causing a leftward shift in the demand curve and lowering prices. The worldwide economic downturn in 2010 and 2011 also caused d e mand to decrease, putting downward pressure on copper prices. The supply curve could shift to the left from severe winter weather in Chile, a major copper producer. However, there were also previously unknown stockpiles of copper in China which could be released and cause the supply to increase. Increases in copper prices had caused consumers to decrease the quantity demanded (movement along the demand curve) and to substitute cheaper alternative mater i-

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    S - 9 als, such as aluminum and plastic. The extreme volatility of prices in the copper market was illustrated in the case for the chapter. 2. In February 2013 copper futures prices were at their highest level in nearly four months. This change was another sign that the U.S. economy was growing stronger. Increased manufacturing and construction activity appeared to be increasing the demand for copper and supporting higher prices. Consumers were also demanding more phones, laptops, and air conditioners, all of which use copper as an input. See: Tatyana Shumsky, “Copper Settles 1.4% Higher,” Wall Street Journal (Online) , February 1, 2013. 3. a. The drought conditions in the Black Sea wheat belt caused the supply of wheat to decrease and the price of wheat to rise. These conditions were easing,which resulted in an increased supply and lower prices. b. The increased demand from China for soybeans caused the demand curve to shift to the right and prices to increase. c. Farmers responding to high prices and planting more land represents an increase in the number of producers and a rightward shift of the supply curve. d. The USDA prediction also shows the increase in supply as a response to high crop prices. e. Although cocoa production in the Ivory Coast increased in the previous year, possible civil war could cause a decrease in supply and higher prices. f. Weather problems in major wheat - producing countries caused a decrease in the supply of wheat, which increased prices. 4. a. The hot summer and the lack of rain caused a significant decrease in the supply of pe a- nuts. This caused a leftward shift in the supply curve that increased the price of peanuts.

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    S - 10 b. Because peanuts are an input to the production of peanut butter, the increase in peanut prices shifted the supply curve of peanut butter to the left, thus increasing its price. Peanut butter producers worried about the impact of price increases on their customers, so they tried to find ways to cut other costs, such as shipping and warehousing, to offset the i n- crease in peanut prices. c. The supply of peanuts also decreased due to the high price of co t ton. Farmers shifted some of their land from peanut to cotton production. d. The heat also influenced the quality of the peanut plants. Because many plants were scorched, the supply of peanuts used for peanut butter decreased, while the supply for pe a- nut oil increased. 5 . a. Prices in the chicken market had been low relative to the costs of production. The i n- creased costs of production have caused a decrease in supply (leftward shift of the supply curve). This change, combined with increased seasonal demand for chicken (rightward shift of the demand curve) has caused chicken prices to rise. b. The diversion of corn to make ethanol has increased the price of corn. This increase co m- bined with soybean - meal price increases led to higher production costs for chickens. Higher production costs caused a decrease in the supply of chickens and chicken prices to increase. Chapter 3 Technical Questions 1. a. Price elasticity = – 1 (unitary elasticity) b. Price elasticity = – 5.4 (elastic)

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    S - 11 c. Price elasticity = – 0.54 (inelastic) 2. a. Price elasticity = – 1 (unitary elasticity) b. Price elasticity = – 3.0 (elastic) c. Price elasti c ity = – 0.33 (inelastic) 3. a. Revenue will rise because demand is inelastic. A 10 percent price increase will cause the quantity demanded to fall by 5 percent, but that will be more than offset by the 10 percent increase in price on the units that are still sold. b. Revenue will rise because demand is elastic. A 5 percent price decrease will cause the quantity demanded to rise by 12.5 percent, and that will more than offset the lower price on the original units. c. Revenues will not change. Because elasticity is – 1, a 1 percent increase in price will result in a 1 percent decrease in quantity demanded, and thus revenue will not change. d. Revenues will rise. Because demand is perfectly inelastic, there will be no change in the quantity demanded when price increases, and, thus, revenues will i n crease. 4. a. P X = 250 – 1/2 Q TR = PQ = (250 – 1/2 Q ) Q = 250 Q – 1/2 Q 2 b. See text answers for graphs. c. At Q = 250, MR = 0, and, thus, revenue is maximized. At that point, P = $125, and, thus, TR = $31,250. d. The midpoint of the demand curve is at Q = 250, P = $125. Above that point, demand is

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    S - 12 elastic, and below that point, demand is inelastic. 5. Demand is elastic (and, thus, revenues will fall if you increase the price and rise if you lower it). Your good is a normal good and is income elastic (or a luxury good). The related good is a complement because a rise in the price of the other good causes a decrease in demand for your product; the goods are fairly strong complements, as the demand for your product is elastic with respect to the price of the other good. 6. Demand is inelastic (and, thus, revenues will rise if you increase the price and fall if you lo w er it). Your good is a normal good and is income inelastic (or a necessity good). The re- lated good is a substitute because a rise in the price of the other good causes an increase in demand for your product; the goods are fairly good substitutes as the demand for your prod- uct is ela s tic with respect to the price of the ot h er good. Application Questions 1.a. The percent change in price from the discounting policy is - 32.6% calculated as follows us- ing the arc elasticity formula: [1.00 – 1.39] / [(1.39 + 1.00) / 2] = - .39 / 1.195 = - 0.326 Therefore, the quantity demanded would have to increase by at least 32.6% for the demand to be elastic and total revenue to increase. b. The implied cross - price elasticity is positive, assuming that drinks at McDonald’s and its competitors are substitute goods. A decrease in the price of drinks at McDonald’s will d e- crease the demand for drinks at Burger King and Taco Bell. c. Although the drink discount is designed to increase revenues from the sale of drinks at McDonald’s, the company and its franchisees have to consider other effects of the policy.

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    S - 13 Revenue from drinks typically compensates for discounts and lost revenue on other products. Discounting drinks might encourage customers to purchase more items from the Dollar Menu and less from the regular menu. Sales of the pric i er es presso beverages had been hurt in pr e- vious years by the discounted drink policy. However, McDonald’s hopes that the discount policy combined with its new beverages will attract enough customers from its competitors to offset any negative effects on its own menu. 2. We can use the facts in the question to make inferences about the price elasti c ity of demand for walk - up, unrestricted business ai r fares. a. On the Cleveland – Los Angeles route, the decrease in fare resulted in about the same rev e- nue as the higher fare. This implies a consumer price elasticity of demand around – 1.00. At unit elasticity, any change in price results in no change in total revenue. On the Clev e- land – Houston route, the decrease in price resulted in less revenue, but greater market share. Demand was inelastic on this route because quantity demanded increased as the price was lowered, but total revenue decreased. Demand was price elastic on the Houston – Oakland route because the lower airfares resulted in increased total revenue for Continen- tal on this route. b. Consumer behavior differs on the three routes, but is also different from prior expect a- tions. As discussed in the chapter, the airlines typically a s sumed that demand for business travel was inelastic, while demand for leisure travel was elastic. Under this assumption, airline companies did not decrease business fares because they believed they would have lost re v enue in doing so. c. Many businesses have gotten tired of paying the high, u n restricted fares for their business travelers. Employees began searching for lower restricted fares that would meet their

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    S - 14 schedules or using videoconferencing or driving as a substitute for air travel. The terrorist attacks on September 11, 2001, also had a major impact on the airline industry, with many employees refusing to fly in the months following the attacks and with business only slo w- ly recovering in the following years. All of these factors resulted in major changes in bus i- ness traveler behavior and a probable increase in their price elasticity of demand. The above market tests show that business demand is actually pr ice elastic in certain markets. 3. Public health officials advocate the use of cigarette taxes to reduce teenage smoking b e cause the data in Table 3.7 show that the teenage price elasticity of demand for cigarettes is appro x- imately 1 or higher in absolute value. Thus, demand is unit or even price elastic. Tee n agers are sensitive to the price of cigarettes and will reduce or quit smoking in r e sponse to the taxes imposed on cigarettes. Cigarette taxes are a good source of revenue for state and local go v- ernments, given that the price ela sticity of demand for adults is inelastic. This means that an increase in price results in an increase in total revenue, given that the percentage change in quantity is less than the percentage change 4. A price elasticity of demand for urban transit between – 0.1 and – 0.6 means that demand is inelastic for transit users. Thus, increased fares will result in higher revenue for local go v- ernments and transit authorities. This is the economic argument for raising transit fares. However, there may be political constraints on raising fares. The inelastic demand may result from the low income levels and lack of automobiles and other substitute forms of travel of transit riders. Vot ers may perceive increased fares as placing an unfair burden on these low - income riders. Transit authorities often obtain voter approval for new transit systems by promising not to raise fares for a certain number of years. Governmental decisions are typ i- cally based on many factors other than economic a r guments.

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    S - 15 5. Information for case studies can be found in sources such as the following: Butscher , Step h- an A. Consumer Loyalty Programmes and Clubs , Aldershot, UK and Burlington, VT: Gow- er, 2002; Basso LJ, Clements MT, Ross TW. Moral Hazard and Consumer Loyalty Pro- grams. American Economic Journal: Microeconomics 2009; 1 (1): 101 - 123. 6. The price elasticity of demand for the product of an individual firm is typically greater than the price elasticity for the product overall because the individual firm competes with all the other producers of the same product. There are more substitutes for the product of an ind i- vi d ual firm than for the product overall. This outcome is most clearly shown in Table 3.7 for a g ricultural products. The demand for many of the products in the table is inelastic for the product overall, while the table shows a price elasticity of demand for individual produ c ers ranging from – 800 to – 31,000 (extremely elastic). The price elasticity of demand for i n divi d- ual physicians is also much larger than that for medical or dental care as a commodity. The demand for dental care may be inelastic, while the demand for care from any given de n tist is price elastic, given the number of other dentists providing similar care. 7. EBay has been shifting the site’s emphasis away from auctions and toward fixed - price lis t- ings in response to increased competition from Amazon.com and other rivals. The company reduced the charge to post items and increased what it collected when an item sold. The company also installed a new system to determine which items appear first in a search , which uses a formula that takes into account price and how well an item’s seller ranks in consumer satisfaction. EBay also offered fee discount s to their best - rated sellers. See: Geoffrey A. Fowler, “Auctions Fade in eBay’s Bid for Growth,” Wall Street Journal , May 26, 2009. For a review of online auctions, see Young - Hoon Park and Xin Wang, “Online and name - your - own price auctions: a literature review,” in Vithala R. Rao (ed.), Handbook of Pricing R e-

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    S - 16 search in Marketing (Cheltenham UK: Edward Elgar, 2009) , 419 - 434; and Kevin Hasker and Robin Sickles, “eBay in the Economics Literature: Analysis of an Auction Marketplace,” R e- view of Industrial Organization 37 (2010): 3 - 42. 8. The U.S. Postal Service raised Priority Mail rates by 16 percent, and Bear Creek Corporation reduced its package shipping by 15 to 20 percent. The implied price elasticity of demand (%  Q /%  P ) ranges from – 15/16 = – 0.94 to – 20/16 = – 1.25. If this response is typical for all Postal Service customers, revenues will either remain approximately the same or decrease, given that the price elasticity of demand is appro ximat e ly unitary or price elastic. Particularly if the demand is elastic, the Postal Service will not be able to reduce its deficit by this strat e- gy because revenues will decrease. Consumers will use Federal Express or UPS instead of the Postal Service to ship their pac k ages. Chapter 4 Technical Questions 1.a. Auto industry executives have analyzed the shifting population demographics and are now beginning to target younger customers rather than the baby boomer generation. They used census and other marketing data to analyze the size of the population trends and the prefe r- ences of the younger generations. b. Many companies are using the latest technology, including retina - tracking cameras, to mea s- ure consumer behavior for their products. These techniques have again shown that what pe o ple want to do and what they say they want to do are often quite different. c. Beer producers are responding to changing consumer tastes by developing new beers and changed packaging. They test a variety of new beers in their research breweries before these

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    S - 17 products reach the market. 2. The plotted data are simply price and quantity combinations for each of the 10 years. Al t- hough the data appear to indicate a downward sloping demand curve for potatoes, many fa c- tors other than the price of potatoes changed over this period. These factors i n cluded co n- sumer incomes, the prices of other vegetables that could be substituted for pot a toes, the i n- troduction of packaged dried potatoes in grocery stores, and the changing tastes for French fries at fast - food outlets. Thus, each data point is probably on a separate demand curve for that year, and the data points in the figure result from shifts in those demand curves. To d e- rive a demand curve from this time - series data, a multiple regression analysis should be run that includes other variables, such as income and the prices of substitute goods. Once these other variables are held constant statistically, the regression results can be used to plot the relevant demand curve showing the relationship between price and quantity d e manded, all else h eld constant. . 3 . In multiple regression analysis, researchers try to include all the relevant variables that infl u- ence the demand for a product based on economic theory, market analysis, and common sense. The regression coefficients then show the effect of each variable, while statistically holding constant the effects of all other variables. Because each study is based on a limited set of data, researchers want to be able to generalize the results. Therefore, th ey test hypoth e- ses about whether each coefficient is significantly different from zero (i.e., whether the vari- a ble actually has a positive or negative effect on demand) in a statistical sense. If the variable is not significantly different from zero, its positive or negative coefficient is likely to result only from the given sample of data. The variable does not have an effect on demand in the

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    S - 18 larger pop u lation. Economic theory may give the researcher some knowledge of the expected sign of the variable (i.e., a price variable should have a negative coefficient in a demand equation). In many cases, however, the researcher does not know the expected sign of the variable, so the test is simply to determine whether the variable is significantly different from z e ro. Application Questions 1. Deloitte Consulting executives have argued that technology innovations have rewired co n- sumers’ brains and behaviors and that managers must be able to adapt to these changes. R e- tailers should invest in Wi - Fi so that consumers will be encouraged to check product reviews and compare prices. They should be prepared to deal both with customers who want to visit physical locations and those who are content to shop online. See “The Rewired Customer,” CIO - Wall Street Journal, June 4. 2013. 2. Test marketing and price experiments can be established so that consumer characte r istics in addition to price, such as income and other demographics, can be varied in the different se t- tings. Thus, consumer reaction to price can be measured while holding income constant in one setting and changing it to another level in a different setting. Individuals of various bac k- grounds can be specifically selected for different focus groups and laboratory experiments. Thus, test m arketing, price experiments, focus groups, and laboratory experiments can be constructed to vary one characteristic (usually price), while holding other factors constant. Multiple regression analysis accomplishes this same task statistically. When variables are e n- tered into a multiple regression analysis equ a tion, their effects are statis tically held constant. Each estimated coefficient shows the effect on the dependent variable of a one - unit change in an independent variable, h olding the values of all other variables in the equation constant.

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    S - 19 3. Using expert opinion may bias the results regarding consumer behavior because sales personnel and others closely connected with an industry may have strong incentives to overstate consumer interest in a product. Experts may also have a limited view of the entire set of factors influencing consumer demand. With direct surveys, consumer responses may not accurately reflect their actual behavior in the marketplace. Interviewees may be reluctant to admit that they will not pay a certain price for a product. In any experiment or laboratory situation, there is always the issue of whether consumers will behave the same in the laboratory situation as when facing real - world market decisions. In regression analysis, biases and other statistical problems can arise if relevant variables are omitted from the estimating equations or if irrelevant variables are included. Yet appropriate data may not be available for all relevant variables. There can also be problems interpreting the effects of individual variables if the variables in the equation are highly correlated with each ot h er. 4. The estimating equation included variables measuring the monetary price of the cars as well as variables measuring the search costs of subsequent visits to a dealer and whether a co n- sumer repurchases the same brand of vehicle (which lowers search costs). Because these va r- iables, as well as the monetary price variable, were statistically significant in the analysis, they indicate that consumers do consider the full price of purchasing an automobile and not just the monetary p rice. Chapter 5 Technical Questions 1.a. Capital (K) Labor (L) Total Product Average Marginal

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    S - 20 (TP) Product (AP) Product (MP) 10 0 0 -- -- 10 1 5 5 5 10 2 15 7.5 10 10 3 30 10 15 10 4 50 12.5 20 10 5 75 15 25 10 6 85 14.2 10 10 7 90 12.9 5 10 8 92 11.5 2 10 9 92 10.2 0 10 10 90 9 - 2 b. See shapes of graphs in Figure 5.1 in the text. c. After the fifth worker (or output of 75), there are diminishing marginal returns. d. Average product is maximized at an output level between 75 and 85 (between 5 and 6 wor k- ers). 2. a. Total Average Marginal Capital ( K ) Labor ( L ) Product ( TP ) Product ( AP ) Product ( MP ) 10 0 0 — —

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    S - 21 10 1 25 25 25 10 2 100 50 75 10 3 220 73 120 10 4 303 76 83 10 5 357 71 54 10 6 392 65 35 10 7 414 59 22 10 8 424 53 10 10 9 428 48 4 10 10 429 43 1 b. See text a n swers for graphs. c. After the third worker (or output of 220), there are diminishing marginal returns. d. Average product is maximized at an output level of 303. 3. a. Explicit: lease, inventory, wages, electricity, insurance. Implicit: Jim’s forgone salary and the forgone interest on his savings. b. Fixed: Lease, insurance. Variable: Inventory, wages, electricity (probably varies with ou t put). 4. a. Accounting profit is total revenue less explicit costs = $150,000 – [25,000 + 12,000 + 30,000 + 20,000] = $150,000 – 87,000 = $63,000. b. Economic profit = total revenue – explicit costs – implicit costs = $150,000 – 87,000 – 50,000 – 5,000 = $8,000

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    S - 22 5.a K L TP TFC TVC TC AFC AVC ATC MC 10 0 0 200 0 200 -- -- -- -- 10 1 5 200 10 210 40.00 2.00 42.00 2.00 10 2 15 200 20 220 13.33 1.33 14.66 1.00 10 3 30 200 30 230 6.67 1.00 7.67 0.67 10 4 50 200 40 240 4.00 0.80 4.80 0.50 10 5 75 200 50 250 2.67 0.67 3.34 0.40 10 6 85 200 60 260 2.35 0.71 3.06 1.00 10 7 90 200 70 270 2.22 0.78 3.00 2.00 10 8 92 200 80 280 2.17 0.87 3.04 5.00 b. See Figure 5.2 in the text. c. Average total cost is minimized at an output level of approximately 91. Ave r age variable cost is minimized at an output level of approximately 80. 6. a. K L MP/TP TFC TVC TC AFC AVC ATC MC 10 0 — /0 500 0 500 — — — — 10 1 25/25 500 20 520 20 0.80 20.80 0.80 10 2 75/100 500 40 540 5 0.40 5.40 0.27 10 3 120/220 500 60 560 2.27 0.27 2.54 0.17 10 4 83/303 500 80 580 1.65 0.26 1.91 0.24 10 5 54/357 500 100 600 1.40 0.28 1.68 0.37 10 6 35/392 500 120 620 1.28 0.31 1.59 0.57 10 7 22/414 500 140 640 1.21 0.34 1.55 0.91 10 8 10/424 500 160 660 1.18 0.38 1.56 2.00

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    S - 23 10 9 4/428 500 180 680 1.17 0.42 1.59 5.00 10 10 1/429 500 200 700 1.16 0.47 1.63 20.00 b. See text answers for graphs. c. Average total cost is minimized at an output level of approximately 414 (or average total cost of $1.55). Average variable cost is minimized at an output level of approximately 303 (or average variable cost of $0.26). 7. a See Figure 5.4 in the text. b. The total product curve has a diminishing slope everywhere. Both the ma r ginal product and average product curves are downward sloping with marginal product everywhere below average product after their point of equality. The total variable cost and total cost curves are upward sloping everywhere. The marginal cost and average variable cost curves are upward sloping with marginal cost greater than average variable cost after their point of equality. The marginal cost curve intersects the average total cost curve at its minimum point. 8. An improvement in technology lowers (shifts rightward) marginal cost and all other cost curves (except fixed cost, which is not affected by marginal product). The minimum points on the average total and average variable cost curves will be at higher outputs and lower costs. 9. L = 50; AP L = 50; MP L = 75; P L = $80; TFC = $500. a. AP = Q / L 50 = Q /50

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    S - 24 Q = 2,500 AVC = TVC / Q = (80)(50)/2,500 = 4,000/2,500 = $1.60 b. MC = P L / MP L = 80/75 = $1.07 c. ATC = TC / Q = [ TVC + TFC ]/ Q = [4,000 + 500]/2,500 = 4,500/2,500 = $1.80 d. (1) We don't know if marginal cost is increasing or decreasing, as we have only one data point. (2) Average variable cost must be decreasing, as marginal cost is less than AVC . (3) Average total cost must be decreasing for the same reason. Application Question 1. With a given technology and fixed inputs, as employees at the drive - through windows worked faster to achieve the goal of a 90 - second turnaround time for a drive - through customer, the quality of the service began to decline, and worker frustration and dissatisfaction increased. This situation represents diminishing returns as more variable inputs are used relative to the amount of fixed inputs. The management response to these problems was to implement new technologies for the production process: placing an intercom at the end of the drive - through line to correct mistakes in orders and finding better ways for employees to perform multiple tasks in terms of kitchen arrangement. In an attempt to cut costs and increase productivity even further, approximately 50 McDonald’s franchises have been testing remote order - taking. With a remote call center, an order - taker can answer a call from a different McDonald’s where another customer has already pulled up. 2. a. There will be diminishing returns in the drug manufacturing process because much of the testing for quality, gauging of dryness, and testing for bacterial co n tamination is done by

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