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Price Ceilings and Floors

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How much rent do you pay per month during the academic year? (Enter DK if you dont know.)

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The price elasticity of demand for rental housing is –1, and the price elasticity of supply is +1/4. A rent ceiling is set at 20% below equilibrium price. The number of units rented A)Increases by 20%. B)Decreases by 20%. C)Decreases by 5%. D)Increases by 25%. E)Decreases by 10%.

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What percentage of new restaurants fail during the first three years of operation? A)10-20% B)20-30% C)30-40% D)40-50% E)50-60%

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Whats the answer? About 59% of new restaurants fail in first 3 years of operation according to a 2005 study. See the link to the article Why restaurants fail on the class web page.

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A profit maximizing firm has fixed costs of $100, variable costs of $20 per unit and capacity of 10. The price of output is $15. In the short run, how many units should it sell? A)0 B)6 and 2/3 C)10 D)4 E)20

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A profit maximizing firm has fixed costs of $100, variable costs of $20 per unit and capacity of 10. The price of output is $25. In the short run, how many units should it sell? A)0 B)8 C)10 D)5 E)20

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And on to our lecture… But dont shut off your clicker.

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A profit maximizing firm has fixed costs of $100, variable costs of $20 per unit and capacity of 10. In the long run, the firm can escape its fixed costs by shutting down. What is the lowest price at which it would stay in business in the long run? A)$20 B)$25 C)$30 D)$100 E)$120

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Why is this? If the firm operates at full capacity, its total costs will be $300=$100+$20x10. Its average costs will be $30=$300/10. It will want to shut down if price is less than average cost. It will be better off staying in business than shutting down if price is greater than average cost.

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A restaurant has fixed costs of $100 and variable costs of $10 per meal. How does a sales tax of $5 per meal sold affect a restaurants costs? A)Increases marginal cost by $5. B)Increases average cost by $5. C)Both A and B.

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Whoops! In class, I said the correct answer was A. – I goofed! It is true that marginal cost rises by $5, but as Andy Shu pointed out to me right after class, so does average cost, so the correct answer is C. Here is Andys argument. –With no tax, when n meals are sold, total cost is 100+10n and average cost is (100+10n)/n=(100/n)+10. –With a tax of $5 per meal, total cost is 100+15n and average cost is (100+15n)/n=(100/n)+15. –Therefore average cost rises by $5.

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