Problem Set 8

Econ 130, Sec. 1-6 Michael J.
Roberts
Fall 2021 Homework 8 University of Hawaii at Manoa
Due Friday, November 5, 11:55 pm

First read Krugman & Wells Chapters 9-10. Submit to
to your TA through Laulima.
1. Suppose you own a small T-shirt shop near campus. The only fixed cost involved in your
business is renting of space, which comes to $12 a week.
(a) Given the following total cost figures, compute average and marginal costs. Define
MC as the extra cost of one extra unit rather than the MC of the previous unit. For
example, the MC at 4 units is the cost of increasing from 4 to 5 units. Compute your
answers to 2 decimal points – pennies sometimes count in economics!
Quantity Total Cost
of T-shirts of T-shirts ($)
1 34
2 47
3 55
4 59
5 62
6 66
7 72
8 80
9 92
10 109
11 132
12 161
Econ 130, Sec. 1-6 Michael J. Roberts
(b) Plot your results for AC and MC on a single graph.
(c) Suppose that you are operating in a perfectly competitive market for T-shirts. At the
moment, the market price is $18.
i. What is the profit-maximizing output for your firm? Explain why you chose that
output level.
The profit-maximizing output for the firm would be 10 shifts because it would
make the most profit which would be around $6 a shirt.
ii. Why would producing one more or one less shirt lower your profits?
Producing one more or one less shift lower your profits because the firms would
not be maximizing their profits.
iii. Now that you’ve maximized profits, calculate how much profit you actually
make.
(10*18)-121=$59
(d) Lots of people can produce T-shirts at the same costs as you. Do you think that the
market price for T-shirts will remain at $18? Explain what will happen to change the
market price of T-shirts.
As more and more people produce T-shirts at the same costs as me, the market’s
supply for T-shirts would increase which would lower the market price of T-shirts.
(e) Suppose that everyone who wanted to open a T-shirt shop near campus did so. What
would the market price for T-shirts eventually be? Explain why.
If everyone who wanted to open a T-shirt shop near campus did so then the market
price for T-shirts would continue to decrease as to remain competitive.
(f) In reality, it is probably not possible for everyone who wants to sell T-shirts near
campus to do so. Explain what real-world factors would prevent entry into your T-
shirt market? Explain how these factors would prevent the market price from
dropping to the level you give in part (e).
To even enter the T-shirt market near campus, you would need to buy out land,
production materials, labor, etc. which is not accessible to most people.
2. In problem 1, price does not exactly equal marginal cost at the profit-maximizing output
even though the firm is in a competitive market. This is because the firm cannot sell
fractional units (such as 9.5 units), and so its ability to optimize is somewhat constrained.
Suppose now that q is measured in thousands, such that, e.g., q=8.743 represents 8,743
T-shirts. Suppose also, that MC for outputs between q=9 and q=12 (ie., between 9,000 and
12,000) is given by this formula:
MC = 5q − 30.
How much output will the firm produce? Does P=MC at this output level?
MC = 5q – 30
18 = 5q – 30
Q = 9.6
The amount of T-shirts produce would be 9,600 T-shirts.
3. (20 points) Consider a competitive industry in stage 2 equilibrium, as depicted in the

graphs below. Congress passes a new law that requires each firm to obtain a license that
costs $50,000, independent of the size or sales of the firm.
S
P P
MC
AC
P**
q** q Q** Q
Representative Firm Market
(a) Show the effect of this new license on the AC and MC curves of the typical firm. Show
the changes on the graph above and explain briefly in words. (The size of the cost
increase is little arbitrary–it’s as large as you draw it.)
The AC and MC curves of the typical firm would increase because the cost of the
license required.
(b) What is the effect of this license on the quantity produced by each firm in stage 1
equilibrium? What happens to profit? Show the effects on the graph and explain
briefly in words.
The quantity produced by each firm in stage 1 equilibrium would be decreased and
so would the total amount of profit.
(c) What is the effect of this license on market price, total quantity produced, and the
quantity produced by each firm in stage 2 equilibrium? Show the effects on the graph
and explain briefly in words.
The license would increase the market price and reduce the total quantity produced
and the quantity produce by each firm in stage 2 equilibrium.
4. It is important to be able to determine whether an industry is competitive since we might

want to regulate industries that are not competitive. Think about the retail food industry
and determine for yourself whether, or the extent to which, you think this industry is
competitive. Answering the following questions will help you in your analysis:
(a) Are there lots of firms or only a few?

There are a lot of firms.
(b) Is each firm small compared to the market?
Each firm is small compared to the market.
(c) Do all firms charge the same prices? Or do some firms charge higher prices than
others? If some firms charge higher prices, how do they get away with it (that is, why
does anyone buy from them at the higher prices?)
All firms do not charge the same prices. Some firms do charge higher prices than
others and that could be due to factors such as quality.
(d) Do all firms face the same costs? That is, do they all have access to the same food
suppliers, do they pay the same wages for workers, and so on?
All firms have different costs because expenses are different for each firm.
(e) Is there free entry into the market? That is, is there anything preventing a new firm
from entering and competing with existing firms?
There is no free entry into the market as there are many factors preventing a new
firm from entering and competing with existing firms such as employees, customers,
and sourcing.
(f) Do you think profits (economic profits, that is) are zero for retail food firms? How
does your answer about profits relate to your answer to part (e).
Profits are not zero for retail food firms as long as you are able to provide food that
is desirable for the market.
(g) In light of all your answers, how competitive do you think the industry is? Is it
sufficiently competitive that we need not worry about it? Or do you feel that it is
sufficiently noncompetitive that some form of government intervention is needed?
(Obviously, there is no ”right” answer here.)
The retail food industry is already sufficiently competitive that we need not worry
about it, if anything it might be too competitive in certain areas.

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Econ 130, Sec. 1-6 Michael J.

Due Friday, November 5, 11:55 pm

(b) Plot your results for AC and MC on a single graph.

The amount of T-shirts produce would be 9,600 T-shirts.

3. (20 points) Consider a competitive industry in stage 2 equilibrium, as depicted in the

Representative Firm Market

4. It is important to be able to determine whether an industry is competitive since we might

(a) Are there lots of firms or only a few?

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