Principles Of Microeconomics A Sample of Economics Solution

Questions: 1. For the pizza seller whose marginal, average variable and average total cost curves are shown in the diagram What is the profit-maximising level of output and how much profit will this producer earn if the price of pizza is $1.18 per slice? 2. Think about the demand for the three popular game consoles: XBox, PS3, and Wii. Using supply and demand diagrams to illustrate your answers, what is the effect on the demand for XBox games or the quantity demanded of XBox games (other things remaining the same) as a result of the following: a. The price of an XBox falls? b. The prices of a PS3 and a Wii fall? c. Programmers who write code for XBox games become more costly to hire? 3. Kim can produce 40 pies or 400 cakes an hour. Liam can produce 100 pies or 200 cakes an hour. a. If Kim and Liam spend 30 minutes of each hour producing pies and 30 minutes producing cakes, how many pies and cakes does each of them produce? b. Who has a comparative advantage in producing pies, and in producing cakes? c. If Kim and Liam specialise and trade, what is the highest price of a pie at which Kim and Liam would agree to trade pies and cakes? What are the gains from trade? Answers: 1. Here at quantity 435, the price is greater than average total cost, which implies that the firm is making profit. At quantity 260, the price is just equal to average total cost. Hence the profit maximizing output is 435 slices. PROFIT= Total revenue (TR)-Total Cost (TC) We find FC : TC= 260*1.18=306.8, AVC= 0.69*260=176.8 ... FC= 306.8-176.8= $130 TR FOR 260 SLICES= 1.18*260= 306.8 Profit= 306.8-30.8= 0 Now for 435 slices: TR= P*Q= 1.18*435= $513.3 TC=FC+VC At output 435 slices, average variable cost (AVC) = $0.77/ slice; VC= AVC*Q= 0.77*435= $334.95 Now, TC for 435 slices= 130+334.95= $464.95 Profit= TR-TC= 513.3-464.95= $48.35 Hence we get higher profit for 435 slices, which makes it the profit maximizing output. The firm earns $48.35 profit. 2. (a) If the price of Xbox falls, then the demand for it rises. The demand curve shifts upward from D0 to D1, with rise in equilibrium quantity Q0 to Q1. (b) As prices of PS3 and Wii falls, the demand for Xbox decreases, and D0 shifts downward to D1. Quantity falls from Q0 to Q1. (c) As the programmers become costly to hire, the cost of producing Xbox games increases, which makes producers decrease supply of Xbox games, hence the supply curve shifts from S0 to S1, so the market equilibrium now shifts to E1 with lower equilibrium output and higher prices. 3. (a) Kim produces 20 pies and 200 cakes whereas Liam produces 50 pies and 100 cakes when given 30mins for each. (b) Liam has comparative advantage in producing pies with a lower opportunity cost of 200/100=2 cakes for baking 1 pie compared to Kims 400/40=10 cakes. Whereas Kim has a comparative advantage in baking cakes with lower opportunity cost of 40/400=1/10 pie per cake compared to Liams 100/200=1/2 pie. (c) In trade Liam sells pies to Kim for cakes at a maximum price of 10 cakes per pie, whereas Kim sells cakes to Liam for pies at a price of 0.5 pies per cake. Each trading at their opportunity costs.As the trade takes place, total production of pies and cakes increase which is the gains from trade. References: Mankiw, G 2007, Economics: principles and applications, Cengage learning, New Delhi Varian, H 2010, Intermediate economics, East west press, New Delhi