Chapter 8 (Question no.

4, page174)
4. Complete the table directly below by calculating marginal product and average
product. Plot the total, marginal, and average products and explains in details the
relationship between each pair of curves. Explain why marginal product first rises,
then declines, and ultimately become negative. What bearing does the law of
diminishing returns have on short-run costs? Be specific, “When marginal product
is rising, marginal cost is failing. And when marginal product is diminishing,
marginal cost is rising.” Illustrate and explain graphically.

Marginal product rises when they hired 2 labors because of increased of the used of
labor efficiency and effectiveness. If they hired just one labor, total output &
productivity would be very low. The labor would have to perform many different jobs,
and the specialization would not be realized. Time would be lost in switching from one
job to another, and machine would be idle much of the time. The plan would be
understaffed, and production would be inefficient because there would be too much
capital relative to the amount of labor. They could eliminate those difficulties by hiring
more labors. Hiring more labors means job can be divided. Each labors may now just
have one task to perform, instead of five or six. By working at fewer tasks, labors become
even more proficient at those task. Time would no longer be lost switching from job to
job. As more labor were added, production would become more efficient and the
marginal product of each succeed of labor rise.

But the rise could not go indefinitely. If still more labor were added, beyond a certain
point, overcrowding would set in. Marginal product is diminishing from 3 to7 labors,
because the additional labors are hired to work out will eventually rise by smaller and
smaller amount, as more labors are hired. Since labor would then have to wait in line to
use the machinery, they would be underused. Total output would increase at a
diminishing rate because given the fixed size of plant, each labor would have less capital
equipment to work as more and more labor are hired. The marginal product of additional
labor would decline because there would be more labor in proportion to the fixed amount
of capital. Eventually , adding the eight labors, would cost so much congestion that
marginal product would become negative, and the total product would decline.
When marginal product is rising, marginal cost is falling. If all units of a labor at same
price, the marginal cost of each extra unit of output will fall as long as the marginal
product additional labors of each additional labors is rising. For example, let we assume
if each labor can be hired for $100. Because the first labor marginal product is 15 units
of output , and hiring this labor increases the firm cost by $100 , the marginal cost of each
of these first units of output is $6.7 (100/15). The second labor increase their cost by
$100 and the marginal product is 19, so the marginal cost of each of those 19 extra unit
of output is $5.3 (100/19. A we can see, as the marginal product increased from 15 to
19, the marginal cost will decrease from $6.3 to $5.3.

But with the third labors, when the marginal product decline and the diminishing returns
set in, the marginal cost begin to rise. For the third labor, marginal cost is $5.9 (100/17),
for the fourth labor $7.1 (100/14), for the fifth is 11.1 (100/9) , the sixth labor 16.7
(100/6), and seventh labor is 33.3 (100/3).
 Margin Avera
Input Total al ge
s of produ Produc Produ
labor ct t ct
0 0 0
1 15 15 15
2 34 19 17
3 51 17 17
4 65 14 16
5 74 9 15
6 80 6 13
7 83 3 12
8 82 -1 10

Chapter 9 (Question no.5&7, page199)

5. Why is the equality of marginal revenue and marginal cost essential for profit
maximization in all market structures? Explain why price can be substituted for
marginal revenue in the MR = MC rule when an industry is purely competitive.
The relation between marginal revenue and marginal cost is essential for profit
maximization as a perfectly competitive firm maximizes economic profit by choosing its
output level. Marginal analysis could be used to find the profit maximizing output
whereby a comparison is done between the marginal revenue and marginal cost. As
output increases, marginal revenue remains constant but marginal cost changes. At low
output levels, marginal cost decreases, but it eventually increases. So where the marginal
cost curve intersects the marginal revenue curve, marginal cost is rising.
If marginal revenue exceeds marginal cost, then the extra revenue from selling one more
unit exceeds the extra cost incurred to produce it. The firm makes an economic profit on
marginal unit, so its economic profit increases if output increases.
If marginal revenue is less than marginal cost, the extra revenue from selling one more
unit is less than the extra cost incurred to produce it. The firm incurs an economic loss on
the marginal unit, so its economic profit decreases if output increases and its economic
profit increases if output decreases.
If marginal revenue equals marginal cost, economic profit is maximized. The rule MR =
MC is an example of marginal analysis.

Quantity Total Revenue Total Cost Economic Profit

(unit) ( RM) (RM) (RM)
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10
4 100 100 0
5 125 114 11
6 150 126 24
7 175 141 34
8 200 160 40
9 225 183 42
10 250 210 40
11 275 245 30
12 300 300 0
13 325 360 -35
The table records marginal revenue and marginal cost. Marginal revenue is a constant
RM25 per unit. Over the range of outputs shown in the table, marginal cost increases
from RM19 per unit to RM35 per unit.
If output is increased from 8 units to 9 units, marginal revenue is RM25 and marginal
cost is RM23. Because marginal revenue exceeds marginal cost, economic profit
increases. The last column of the table shows that economic profit increases from RM40
to RM42, an increase of RM2.
If output were to increase from 9 units to 10 units, marginal revenue is still RM25 but
marginal cost is RM27. Because marginal revenue is less than marginal cost, economic
profit decreases. The last column of the table shows that economic profit decreases from
RM42 to RM40.
Economic profit could be maximized by producing 9 units a day, the quantity at which
marginal revenue equals marginal cost.

7. In long-run equilibrium, P = minimum ATC = MC. Of what significance for

economic efficiency is the equality of P and minimum ATC? The equality of P and
MC? Distinguish between productive efficiency and allocative efficiency in your
answer.
In long-run equilibrium, an industry adjusts in two ways:
- Entry and exit

As new firms enter an industry, the price falls and the economic profit each
existing firm decreases.

As firms leave an industry the price rises and the economic loss of each remaining
firm decreases.
 - Changes in plant size

A firm changes its plant size if, by doing so, it can lower its cost and increase its
economic profit .

Long run equilibrium occurs in a competitive industry when economic profit is zero. If
the firms in a competitive industry are making economic profit, new firms enter the
industry. If firms can lower their costs by increasing their plant size, they expand. Each of
these actions increases industry supply, shifts the industry supply curve rightward, lowers
the price and decreases economic profit.
Reflective of its name, productive efficiency occurs when the economy is operating at its
production possibility frontier (the production possibility frontier is the boundary
between the combination of goods and services that can be produced and those that
cannot). This takes place when production of one good is achieved at the lowest cost
possible, given the production of the other goods. Equivalently, it is when the highest
possible output at one good is produced, given the production level of the other goods. In
an equilibrium position, price must equal to minimum average total cost or the nomal
profit in order for the industry to be producing efficiently. If a firm produced the same
output with higher than industry’s average cost, this would mean the firm is using its
resources inefficiently.
Allocative efficiency is achieved when it is impossible to obtain any net gains by simply
altering the combination of goods and services that are produced from society’s limited
supply resources.
In pure competition, resources are being allocated efficiently when profit oriented firms
produce each good or service to the point where the marginal benefit and marginal cost
are equal. Producing goods or services beyond the price and marginal equality point
would sacrifice alternative goods whose value to society exceeds that of the extra goods
or services. Producing goods or services short of the price and marginal equality point
would sacrifice products that society values more than the alternative goods its resources
could produce.

Chapter 10 (Question no.5, page 220)

5. Suppose a pure monopolist is faced with the demand schedule shown below and
the same cost data as the competitive producer discussed in question 4 at the end of
chapter 9. Calculate the missing total-revenue and marginal revenue amounts, and
determine the profit maximizing price and profit-earning output for this
monopolist. What is the monopolist’s profit? Verify your answer graphically and by
comparing total revenues and total cost.

QD P TR MR ATC TC MC Profit(+) / Loss(-)

0 $115 0 0 0
1 100 100 100 105 105 105 -5
2 83 166 66 72.50 145 40 21
3 71 213 47 60 180 35 33
4 63 252 39 52.50 210 30 42
 5 55 275 23 49 245 35 30
6 48 288 13 47.50 285 40 3
7 42 294 6 47.14 329.98 45 -35.98
8 37 296 2 48.13 385.04 55 -89.04
9 33 297 1 50 450 65 -153
10 29 290 -7 52.50 525 75 -235

Profit maximization by pure monopolist

$140
$120
Price,costs and revenue

$100

$80

$60
Econom ic profit
$40
$20
MC=MR Qm = 5 units
$0
1 2 3 4 5 6 7 8 9 10 11
($20)
Quantity

Demand (D) Marginal Revenue (MR) Average Total Cost (ATC) Marginal Cost (MC)

If producing is preferable to shutting down it will produce up to the output at which

marginal revenue equals marginal cost (MR=MC)

A comparison of column 4(MR) and 7(MC) as table above indicates that the profit-
maximizing output is 4 units because the fourth unit is the last unit of output whose
marginal revenue exceed its marginal cost.

The profit-maximizing price is $63. It shows that 4 units of output, the product price
($63) exceeds the average total cost ($52.50).

The monopolist thus obtains an economic profit of $10.50 per unit and total economic
profit is $42 ($10.50 x 4).