1. THE ECONOMY: THE CORE PROJECT

2. UNIT 7. THE FIRM AND ITS CUSTOMERS

3. T7.1 Profit-maximising choice
The following diagram shows the market demand curve of Apple Cinnamon Cheerios, the isoprofit curves of the producer firm, and the firm’s profit function curve. Based on the graph, which of the following statements are correct?
Select all correct answers
The highest profit that the firm can make is $60,000.
The profit-maximising choice for the firm is where the highest attainable isoprofit curve is tangent to the demand curve.
The profit-maximising choice for the firm is where its marginal rate of substitution between the price charged and the quantity produced is equal to its marginal rate of transformation.
The profit-maximising choice for the firm is at the peak of its profit function curve.
Section 7.1

4. ANSWER: T7.1 Profit-maximising choice
The following diagram shows the market demand curve of Apple Cinnamon Cheerios, the isoprofit curves of the producer firm, and the firm’s profit function curve. Based on the graph, which of the following statements are correct?
Select all correct answers
The highest profit that the firm can make is $60,000.
The profit-maximising choice for the firm is where the highest attainable isoprofit curve is tangent to the demand curve.
The profit-maximising choice for the firm is where its marginal rate of substitution between the price charged and the quantity produced is equal to its marginal rate of transformation.
The profit-maximising choice for the firm is at the peak of its profit function curve.
Feedback
The highest profit that the firm can make is $34,000, which is the highest attainable isoprofit curve, given the demand curve.
This is the point where the tradeoff between price and quantity that the firm is willing to make exactly equals the tradeoff that the firm is constrained to make.
This statement must be true, otherwise there would be another feasible price-quantity combination that gives weakly higher profits.
Section 7.1

5. T7.2 Returns to scale and economies of scale
Which of the following events would contribute to economies of scale?
Select all correct answers
Large supermarkets being able to drive down the cost of purchasing milk as it increases its scale of business.
The expansion of the workforce requiring extra layers of management for better performance monitoring.
A merger of two firms leading to savings on the costs of HR, IT, and legal departments.
The higher the number of users of Windows 10, the more likely it is that Microsoft will be able to achieve a higher sale of its operating system.
Section 7.2

6. ANSWER: T7.2 Returns to scale and economies of scale
Which of the following events would contribute to economies of scale?
Select all correct answers
Large supermarkets being able to drive down the cost of purchasing milk as it increases its scale of business.
The expansion of the workforce requiring extra layers of management for better performance monitoring.
A merger of two firms leading to savings on the costs of HR, IT, and legal departments.
The higher the number of users of Windows 10, the more likely it is that Microsoft will be able to achieve a higher sale of its operating system.
Feedback
This is a cost advantage of being a larger firm.
This extra cost leads to diseconomies of scale (see the Dilbert law of firm hierarchy in the text).
This is a demand-side benefit of scale, called network economies of scale.
Section 7.2

7. T7.3 Average cost and marginal cost
The following is a table of the total cost (TC) of producing output Q for a particular firm. Based on this information, which of the following statements is correct?
Select one answer
The average cost at Q = 40 is £7.
The marginal cost at Q = 80 is £9.50.
The marginal cost is higher than the average cost at Q = 50.
The marginal cost curve intersects the average cost curve at Q = 60.
Section 7.3

8. ANSWER: T7.3 Average cost and marginal cost
The following is a table of the total cost (TC) of producing output Q for a particular firm. Based on this information, which of the following statements is correct?
Select one answer
The average cost at Q = 40 is £7.
The marginal cost at Q = 80 is £9.50.
The marginal cost is higher than the average cost at Q = 50.
The marginal cost curve intersects the average cost curve at Q = 60.
Feedback
The average cost at Q = 40 is £310 / 40 = £7.75.
The marginal cost at Q = 80 is (660 – 570) / (90 – 10) = £9.
At Q = 50, MC = (420 – 360) / (60 – 50) = £6 which is lower than AC = 360 / 50 = £7.20.
At Q = 60, MC = ( ) / ( ) = £7, and AC = 420 / 60 = £7.
Section 7.3

9. T7.4 Fixed cost
Suppose that the marginal cost of producing a pound of cereal is $2, irrespective of the level of output, but there are also some fixed costs of production. Which of the following statements is correct?
Select one answer
The total cost curve is an upward-sloping straight line through the origin.
The average cost curve is U-shaped.
The marginal cost curve is a horizontal straight line.
The marginal cost curve intersects the average cost curve at its minimum point.
Section 7.3

10. ANSWER: T7.4 Fixed cost
Suppose that the marginal cost of producing a pound of cereal is $2, irrespective of the level of output, but there are also some fixed costs of production. Which of the following statements is correct?
Select one answer
The total cost curve is an upward-sloping straight line through the origin.
The average cost curve is U-shaped.
The marginal cost curve is a horizontal straight line.
The marginal cost curve intersects the average cost curve at its minimum point.
Feedback
The total cost = F + 2Q, where F is the fixed costs and Q is the output. This is an upward-sloping straight line, but not through the origin (the intercept with the y-axis is at F > 0).
The average cost = F/Q + 2, where F is the fixed costs and Q is the output. This is a downward-sloping curve that asymptotically approaches the horizontal and straight marginal cost line.
The marginal cost curve would be a horizontal straight line at $2.
The average cost curve is a downward-sloping curve that asymptotically approaches the horizontal marginal cost line. Therefore, they do not intersect.
Section 7.3

11. T7.5 Consumer and producer surplus
The following figure depicts a firm’s profit-maximising choice at point E, given the market demand curve and the firm’s marginal cost curve. You are given that the firm’s marginal costs are $400, $2,960 and $4,200 at output levels Q = 0, Q* = 32 (point E) and Q0 = 48 (point F), respectively. Based on this information, which of the following statements is correct?
Select one answer
The consumer surplus at E is $41,000.
The producer surplus at E is $120,320.
The deadweight loss at E is $19,840.
The gains from trade at E are $120,320.
Section 7.7

12. ANSWER: T7.5 Consumer and producer surplus
The following figure depicts a firm’s profit-maximising choice at point E, given the market demand curve and the firm’s marginal cost curve. You are given that the firm’s marginal costs are $400, $2,960 and $4,200 at output levels Q = 0, Q* = 32 (point E) and Q0 = 48 (point F), respectively. Based on this information, which of the following statements is correct?
Select one answer
The consumer surplus at E is $41,000.
The producer surplus at E is $126,720.
The deadweight loss at E is $19,840.
The gains from trade at E are $120,320.
Feedback
The consumer surplus at E is (1/2) x (7920 – 5440) x 32 = $39,680.
The producer surplus at E is (1/2) x ( ) x 32 = $120,320.
The deadweight loss at E is (5440 – 2960) x (48 – 32) / 2 = $19,840.
The gains from trade at E are the sum of consumer surplus and producer surplus: CS + PS = 40, ,080 = $167,040.
Section 7.7

13. T7.6 Elasticity and expenditure
The following information is the data on a survey of demand elasticity for low calorie fruit and vegetables. The total expenditure of the consumer is $80 per week. Suppose now that the price of low calorie fruit and vegetables increases by 10%. Based on this information, we can conclude that:
Select one answer
The demand for low-calorie fruit and vegetables rises by 8.3%.
The quantity the consumer consumes before the price change is 344g per week.
The quantity the consumer consumes after the price change is g per week.
The consumer’s expenditure on low calorie fruit and vegetables increases by $0.08.
Section 7.8

14. ANSWER: T7.6 Elasticity and expenditure
The following information is the data on a survey of demand elasticity for low calorie fruit and vegetables. The total expenditure of the consumer is $80 per week. Suppose now that the price of low calorie fruit and vegetables increases by 10%. Based on this information, we can conclude that:
Feedback
The data shows that ε = – (ΔQ/Q)/(ΔP/P) = – (ΔQ/Q)/0.10 = Therefore ΔQ/Q = – 0.083, meaning or an 8.3% fall (not a rise).
The quantity consumed before the price change is 3.44 / 0.36 x 100 = g.
When the price increases by 10%, demand falls by 8.3%. The quantity consumed before the price change is 3.44 / 0.36 x 100 = g, so the quantity consumed after the price change is x (1 – 0.083) = g per week.
The new price of low-calorie fruit and vegetables is 0.36 x 1.1 = $0.396 per 100g. The expenditure on this good after the price change is therefore ( / 100) x = $3.47. Hence, expenditure increases by $3.47 – $3.44 = $0.03.
Select one answer
The demand for low-calorie fruit and vegetables rises by 8.3%.
The quantity the consumer consumes before the price change is 344g per week.
The quantity the consumer consumes after the price change is g per week.
The consumer’s expenditure on low calorie fruit and vegetables increases by $0.08.
Section 7.8