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EC216 Class Questions

Chapters 6 & 7 | Production


(Week 11) Dec 13 & 15, 2023

1. Do the following functions exhibit increasing, constant, or decreasing returns to scale?


What happens to the marginal product of each individual factor as that factor is in-
creased and the other factor held constant?

(a) q = 2L + 2K (b) q = 3LK 2

2. Consider a firm that is currently deciding how to allocate its budget between labor and
capital. The wage rate for labor w is $10 per unit, and the rental rate for capital r is $2
per unit. The firm finds that adding one unit of either labor L or capital K increases
output by 20 units.

(a) Calculate the additional output per dollar for labor ( MwPL ) and capital ( MrPK ).

(b) Determine if the firm is cost-minimizing. If not, should it use more L or K?

3. Consider a firm with the production function Q = 2K 0.5 L 0.5 . The firm faces a wage rate
of $20 per unit of labor and a rental rate of $10 per unit of capital.

(a) Calculate the MRTS for labor and capital based on the given production function.

(b) Determine the isocost equation for a total budget of $1000.

(c) Identify the optimal labor-capital combination for maximizing output within the
budget.

4. A firm has the total cost function C = 40L + 20K and the production function q =
L 0.5 K 0.5 .

(a) Formulate the firm’s cost minimization problem to produce 100 units.

(b) Use the Lagrange method to find the combination of labor and capital that mini-
mizes the total cost.

1
Chapter 8 | Perfect Competition

Some notes
Short-run

• In competitive markets, MR = P, as firm is price taker.

• A firm maximizes profit where MR = MC.

• A firm should shut down if P < AVC.

• The supply curve for a firm is its MC curve above the minimum point of the AVC.

Long-run

• Firm will enter the market if existing firms are making a profit, and exit if they are mak-
ing losses.

• In competitive markets, firm will make 0 economic profit (normal profit) due to free
entry and exit.

• Firm operates where P = minimum ATC.

• Firm adjusts output to the point where P = MR = MC = minimum ATC.

2
1. A firm in a competitive market has a total cost function C(q) = 30q + 10q2 . The market
price is $70 per unit.

(a) Calculate the profit-maximizing level of output for the firm.

(b) Analyze the impact on the firm’s output and profits if the market price drops to
$50 per unit.

2. Suppose you are the manager of a watchmaking firm operating in a competitive market.
Your cost of production is given by the function C = 200 + 2q2 .

(a) If the price of a watch is $100, how many watches should you produce to maxi-
mize profit?

(b) What will the profit level be?

3. A firm produces a product in a competitive industry and has a total cost function C =
50 + 4q + 2q2 . At the given market price of $20, the firm is producing 5 units of output.

(a) Is the firm maximizing its profit?

(b) Find the profit maximizing output in the short-run.

(c) What quantity of output should the firm produce in the long-run?

4. Suppose that a competitive firm’s marginal cost of producing output q is given by MC(q) =
3 + 2q. Assume that the market price of the firm’s product is $9.

(a) What level of output will the firm produce?

(b) Suppose that the firm’s average variable cost is given by AVC(q) = 3 + q and
fixed costs are $3. Will the firm be earning a positive, negative, or zero profit in
the short run?

3
5. Consider a firm in a competitive market facing a marginal cost function MC = 10 + 2q
and a market price of $30.

(a) Explain how the firm determines the optimal level of output in the short run. Cal-
culate the specific quantity that will be supplied by the firm.

(b) Given that the firm’s AVC at the calculated output level is $20, evaluate whether
the firm should continue production or shut down in the short run.

6. Suppose you are given the following information about a particular industry:

• Market demand: Q D = 6500 − 100P • Firm TC: C(q) = 722 + q2 /200

• Market supply: Q S = 1200P • Firm MC: MC(q) = 2q/200

Assume that all firms are identical and that the market is characterized by perfect com-
petition.

(a) Find the equilibrium price, the equilibrium quantity, the output supplied by the
firm, and the profit of each firm.

(b) Would you expect to see entry into or exit from the industry in the long run? Ex-
plain. What effect will entry or exit have on market equilibrium?

(c) What is the lowest price at which each firm would sell its output in the long run?
Is profit positive, negative, or zero at this price? Explain.

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