Problem Set 3 Solutions

Ch. 8, Q. 3. a. Because Kelsons marginal cost function is linear, it implies that its total cost function is quadratic. This indicates that the law of diminishing returns takes effect as soon as production begins. b. At Q = 1500, MC = $157.50 At Q = 2000, MC = $160.00 At Q = 3500, MC = $167.50 c.MC = $150 + 0.005Q = $175 Q* = 5000 d. The supply curve is essentially the portion of a firms marginal cost curve above its average variable cost (i.e., the shut down point). Although fixed and variable cost is not provided, we can assume that over a certain range, the firm is earning either a profit or is incurring a loss greater than its fixed cost. Thus, the following is a suggested short run supply schedule: P $175 180 185 190 etc. Q 5000 6000 7000 8000

Ch. 8. Q. 7. a. To answer this question, we illustrate how Excel software can help to answer this question. Using the online software provided for users of this text, we arrive at the following: Total Revenue 0 92 168 228 272 300 312 308 288 252 200 100 80 Total Fixed Cost 50 50 50 50 50 50 50 50 50 50 50 8 Total Variable Cost 0 71 125 166 198 225 250 276 307 347 400
Fixed Cost

Quantity 0 1 2 3 4 5 6 7 8 9 10

Price 100 92 84 76 68 60 52 44 36 28 20

Total Cost 50.00 120.60 174.80 216.20 248.40 275.00 299.60 325.80 357.20 397.40 450.00

Total Profit -50.00 -28.60 -6.80 11.80 23.60 25.00 12.40 -17.80 -69.20 -145.40 -250.00 50.00 0.6

Demand Coefficient Cost coefficients

10

The optimal price is $60 and the optimal quantity is 5. We can be more precise if we employ calculus to find the short run profit maximizing price. Let us follow the procedure explained in detail in the appendix to Chapter 2. We simply state the profit function as TR - TC. We then take the first derivative of this function, set it equal to zero and solve for Q. We can then find the optimal price by inserting this value of Q into the demand equation. TR = 100Q - 8Q2

II = 100Q - 8Q2 - 50 - 80Q + 10Q2 - 0.6Q3 dII/dQ = 100 - 16Q - 80 + 20Q - 1.8Q2 = 0 Using the formula for finding the roots of a quadratic equation, we arrive at: Q = -4 + or - 12.65 -3.6 * Q = 4.625 and P* = $63 b. In order to find the price that maximizes total revenue, we can use the spreadsheet above. We see total revenue is maximized at a price of $52. Using calculus simply involves taking the first derivative of the total revenue function (i.e., MR), setting it equal to zero and solving for Q. Using this Q in the demand equation will give us the revenue maximizing price. TR/Q = 100 - 16Q = 0 Q* = 6.25 P* = $50 (Notice that the spreadsheet will also indicate a price of $50 if the values of quantity were set for small intervals.) c.If the firm wanted to use a linear approximation of the cubic equation, it might simply derive the linear equation in the manner shown in the figure below.
50 0

40 0

30 0
$ TC1 TC2

20 0

10 0

0 0 1 2 3 4 5
Q

1 0

Figure 8.3
Ch.8, App. 8B, Q. 1.

1.

a.Q = 30000/(25-10) = 30000/15 = 2000 b. 2000 x 25 = 50000 c. TR (3000 x 25) TFC TVC (3000 x 10) Profit 75,000 30,000 30,000 15,000

d. Q = 37500/(25-10) = 37500/15 = 2500 e. 2500 = (37500+15000)/(P-10) = 52500/(P-10) 2500P - 25000 = 52500 2500P = 77500 P = 31