ASSIGNMENT: SECOND HALF

Microeconomic Theory 1
Nopphol Witvorapong, Ph. D., Assoc. Prof.
RE: Bergstrom & Varian (1999), “Workouts in Intermediate Microeconomics”

1. (18.0) Find the marginal product of input 1, of input 2 and the technical rate of
substitution of the following production functions and determine if such production
function displays constant, increasing or decreasing returns to scale.
(a) 𝑥1 + 2𝑥2
(b) √𝑥1 + 2𝑥2
(c) 0.2𝑥1 𝑥22
(d) 𝑥1 1/4 𝑥2 3/4
(e) 𝑥1 + √𝑥2
(f) (𝑥1 + 1)0.5 𝑥2 0.5
(g) (𝑥1 1/3 + 𝑥21/3 )3

2. (18.6) You manage a crew of 160 workers who could be assigned to make either of
two products. Product A requires 2 workers per unit of output and Product B requires
4 workers per unit of output.
(a) Write an equation expressing the combinations of products A and B that
could be produced with exactly 160 workers. Draw the isoquant.
(b) Suppose now that every unit of Product A that is produced requires the use
of 4 shovels as well as 2 workers and that every unit of Product B produced
requires 2 shovels and 4 workers. Write down an equation expressing
combinations of A and B that could be produced with 180 shovels and
unlimited labor supply. Draw the isoquant.
(c) Shade in the area that represents possible output combinations when one
takes into account both the limited supply of labor and the limited supply of
shovels.
(d) If you have 160 workers and 180 shovels, what is the largest amount of
product A that could be produced? Producing this amount, you will not use
your entire supply of one of the inputs, which one? And how many will be left
unused?

3. (19.2) A firm uses a single input to produce a commodity with this production
function: 𝑓(𝑥) = 4√𝑥, where x is the number of units of input. The commodity sells
for $100 per unit and the input costs $50 per unit.
(a) Write down the firm’s profit function in terms of x. Solve for x, the optimal
amount of output and profits earned by this firm.
(b) Suppose that the firm is taxed $20 per unit of its output and the price of its
input is subsidized by $10. What is the new input level? Output level? And
profits?
(c) Suppose that instead of taxes and subsidies in (b), the firm is now taxed
50% of its profits. Write down its after-tax profits as a function of the amount

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 of input. What is the optimal level of output? And how much profit does the
firm make after taxes?

4. (19.6) T-bone Pickens is a corporate raider. This means that he looks for companies
that are not maximizing profits, buys them and then tries to operate them at higher
profits. He looks now at two companies he might buy: Shill Oil Company and Golf Oil
Company, both of which buy oil and produce gasoline. We assume that oil is the only
input in gasoline production. During the time period covering the following records,
oil cost $10 per barrel.

Shill Oil produced 1 million barrels of gasoline using 1 million barrels of oil when the
price of gasoline was $10 a barrel. When the price of gasoline was $20 a barrel, Shill
produced 3 million barrels of gasoline using 4 million barrels of oil. Finally when the
price of gasoline was $40 a barrel, Shill used 10 million barrels of oil to produce 5
million barrels of gasoline.

Golf Oil did exactly the same when the price of gasoline was $10 and $20, but when
the price of gasoline hit $40, Golf produced 3.5 million barrels of gasoline using 8
million barrels of oil.

(a) Plot the isoprofit lines regarding all three prices for both Shill Oil and Golf
Oil.
(b) How much profits could Golf Oil have made when the price of gasoline was
$40 a barrel and it had chosen to produce the same amount that it did when
the price was at $20 a barrel? What profits did Golf actually make when the
price of gasoline was $40?
(c) Is there any evidence that Shill and/or Golf Oil is not maximizing profits?
Explain.

5. (20.12) Al makes plastic deer for lawn ornaments. Al has found a way to automate
the production process completely and his production function is given by 𝑓(𝑥1 , 𝑥2 ) =
(2𝑥1 + 𝑥2 )1/2, where the first input is plastic and the second input is wood.
(a) Draw an isoquant representing 4 deer and one representing 6 deer.
(b) Does this production function exhibit increasing, decreasing or constant
returns to scale?
(c) If Al faces factor prices (1, 1), what is the cheapest way for him to produce
4 deer? And 6 deer?
(d) At the factor prices (1, 1), the cost of producing y deer with this technology
is c(1, 1, y). Write down the cost function in terms of y.
(e) And at the factor prices of (3, 1), we have c(3, 1, y). Write down the cost
function in terms of y.

6. (21.4) Mary wants to open a flower shop in a mall. She has three choices of floor
sizes: 200 sq feet, 500 sq feet or 1,000 sq feet. The monthly rent will be $1 a sq foot.
Mary estimates that if she has F sq feet and sells y bouquets per month, her variable
costs will be 𝑐𝑣 (𝑦) = 𝑦 2 /𝐹 per month.

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Do: 1) write down the MC function; 2) Find the output where AC is minimized and 3)
Find the average cost at the level of output found in 2)—all for the following
scenarios.

(a) When Mary has 200 sq feet of floor space.

(b) When Mary has 500 sq feet.
(c) When Mary has 1,000 sq.
(d) Draw the AC and MC cost curves for all three scenarios in the same
diagram.
(e) On the diagram in (d), identify LRAC and LRMC.

7. (22.8) Irma’s production function is 𝑓(𝑥1 , 𝑥2 ) = (min{𝑥1 , 2𝑥2 })1/2, where input 1 is
plastic, input 2 is labor and the output is lawn ornaments. Suppose the price per unit
of plastic is 𝑤1 and the price per unit of labor is 𝑤2 .
(a) Write down Irma’s cost function: 𝐶(𝑤1 , 𝑤2 , 𝑦).
(b) If 𝑤1 = 𝑤2 = 1, then write down Irma’s MC function, her supply function
and her AC function.
(c) If the competitive price of lawn ornaments she sells is p = 48 and the wages
are as in (b), how many will Irma produce? How much profit will she make?

8. (23.4) Consider a competitive industry with a large number of firms, all of which
have identical cost function: 𝑐(𝑦) = 𝑦 2 + 1 for y > 0 and c(0) = 0. Suppose the
industry’s demand curve is 𝐷(𝑝) = 52 − 𝑝. The output of a firm does not have to be
an integer but the number of firms does have to be an integer.
(a) What is the supply curve of an individual firm? What about the industry’s
supply curve when there are n firms?
(b) What is the smallest price at which the product can be sold?
(c) What will be an equilibrium number of firms? Equilibrium price?
Equilibrium output of each firm? Equilibrium output of the industry?
(d) Suppose that the demand curve shifts to 𝐷(𝑝) = 52.5 − 𝑝. What will be the
equilibrium number of firms? Equilibrium price? Equilibrium output of each
firm? Profits of each firm?
(e) Suppose that the demand curve shifts to 𝐷(𝑝) = 53 − 𝑝. What will be an
equilibrium number of firms? Equilibrium price? Equilibrium output of each
firm? Profits of each firm?

9. (24.2) Peter Morgan sells pies in Central Park and is the only supplier in the park.
His costs are zero.
(a) When he first started his business, the inverse demand curve for pies was
p(y) = 100 – y, where the price is measured in cents and y measures the
number of pies sold. What level of output will maximize his profits? And what
price will he charge? Draw a corresponding diagram.
(b) After Peter had been in business for several months, he noticed that the
demand curve had shifted to p(y) = 75 – y/2. What is the profit-maximizing
price? And output?

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10. (24.3) Suppose the demand function for Japanese cars in the US is Y(p) = 250 – 2P,
where Y(p) is the number of cars sold in thousands and P is the price in thousands of
dollars.
(a) If the supply schedule is horizontal at $5,000, what will be the equilibrium
number of Japanese cars sold?
(b) Suppose now that the US government imposes an import duty on Japanese
cars of 2,000 USD for every car imported into the country. How many Japanese
cars will be sold now? And at what price? How much revenue will the US
government collect with this tariff?
(c) Suppose that instead of imposing an import duty, the US government
persuades the Japanese government to impose “voluntary export restrictions”
on their exports of cars to the US. Suppose that they agree and now issue only
236,000 export licenses and sells these licenses to Japanese firms. If the
Japanese firms know the American demand curve, what price will they be able
to charge in the US for their cars now?
(d) How much will a Japanese firm be willing to pay for an export license? How
much revenue will the Japanese government collect?
(e) Why might the Japanese ‘voluntarily’ submit to export controls? (Think
about how much money the Americans spend on Japanese cars.)

11. (25.3) Banana Computer Company sells Banana computers in domestic and
foreign markets. Because of differences in the power supplies, a Banana purchased in
one market cannot be used in the other market. The D curves associated with the two
markets are as follows: 𝑃𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 = 20,000 − 20𝑄 and 𝑃𝑓𝑜𝑟𝑒𝑖𝑔𝑛 = 25,000 − 50𝑄 .
Banana’s production process exhibits constant returns to scale and it takes
$1,000,000 to produce 100 computers.
(a) What is Banana’s LRAC function? And LRMC?
(b) Draw the D-curves, MR curves for both markets, LRAC and LRMC on the
same diagram.
(c) What quantity will Banana supply in the domestic market and at what
price? What about in the foreign market? What are Banana’s total profits?
(d) At the profit-maximizing price, what is the price elasticity of demand in the
domestic market? And in the foreign market? Explain this type of price
discrimination.
(e) Suppose Banana computers can now be converted to work anywhere in
the world and, for now, ignore transportation costs. How many computers
should be sold now? At what price? And profits?

12. (25.5) The Grand Theater is a movie house. If it is open, the owners have to pay a
fixed nightly amount of $500 for films, ushers and so on, regardless of how many
people come to the movie. Assume that if the theater is closed, its costs are zero. The
nightly demand for Grand Theater movies by students is 𝑄𝑆 = 220 − 40𝑃𝑆 , where s
refers to students. The nightly demand for non-student moviegoers is 𝑄𝑁 = 140 −
20𝑃𝑁 .

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 (a) If the theater charges a single price 𝑃𝑇 to everybody, then at prices between
0 and $5.50, what is the demand function for movie tickets? What is the profit-
maximizing number of tickets? At what price? How much profit? How many
tickets will be sold to students? And how many to non-students?
(b) Suppose that the cashier can accurately separate the students from the
non-students. Students cannot resell their tickets. What price will be charged
to students? How many tickets will be sold to students? What about non-
student price and number of tickets sold? What is the theater’s total profits?
(c) Suppose that the Grand Theater can only hold 150 people and the manager
engages in price discrimination. Write an expression for profits as a function
of 𝑄𝑆 only. What price will be charged to students? How many tickets will be
sold to students? What about non-student price and number of tickets sold?
What is the theater’s total profits?

13. (27.4) The inverse market demand curve for bean sprouts is P(Y) = 100 – 2Y and
the total cost function for any firm in the industry is given by TC(y) = 4y.
(a) If the bean sprout industry were perfectly competitive, what would be the
industry supply and the industry price?
(b) If two Cournot firms operated in the market, what would be the industry
supply? Each firm’s supply? And the market price?
(c) If the two firms decided to collude, what would be the industry supply and
the industry price?
(d) Suppose both of the colluding firms are producing equal amounts. If one
assumes that the other firm would not react to a change in industry output,
what would happen to the firm’s own profits if it increased its output by one
unit?
(e) Suppose one firm acts as a Stackelberg leader and the other firm behaves
as a follower. What would be the industry supply and the industry price?

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MARKET QUESTIONS (FROM PERFECT COMPETITION ONWARDS)
Re: Nicholson & Snyder (2008), “Microeconomic Theory: Basic Principles and
Extensions”

1. (10.3) A perfectly competitive market has 1,000 firms. In the very short
run, each of the firms has a fixed supply of 100 units. The market demand is
given by Q = 160,000 – 10,000P.
a. Calculate the equilibrium price in the very short run.
b. Calculate the demand schedule facing any one firm in this industry.
c. Calculate what the equilibrium price would be if one of the sellers
decided to sell nothing or if one seller decided to sell 200 units.
d. At the original equilibrium point, calculate the elasticity of the industry
demand curve and the elasticity if the demand curve facing any one
seller.

Suppose now that in the short run, each firm has a supply curve that shows the
quantity the firm will supply (qi) as a function of market price. The specific
form of this supply curve is given by
qi = -200 +50P.
Using this short-run supply response, answer questions (a) through (d) above.

2. (10.8) Suppose that the long run total cost function for the typical mushroom
producer is given by C(q, w) = wq2 – 10q + 100, where q is the output of the
typical firm and w represents the hourly wage rate of mushroom pickers.
Suppose also that the demand for mushrooms is given by Q = -1,000P + 40,000,
where Q is total quantity demanded and P is the market price of mushrooms.
a. If the wage rate for mushroom pickers is $1, what will be the long-run
equilibrium output for the typical mushroom picker?
b. Assuming that the mushroom industry exhibits constant costs and that
all firms are identical, what will be the long run equilibrium price of
mushrooms and how many mushroom firms will there be?
c. Suppose the government imposed a tax of $3 for each mushroom picker
hired. Assuming that the typical firm continues to have costs given by
C (q, w) = wq2 – 10q + 100, how will your answers to parts (a) and (b)
change?

3. (11.2) The handmade snuffbox industry is composed of 100 identical firms,

each having short-run total costs given by
STC = 0.5q2 + 10q +5,
Where q is the output of snuffboxes per day.
a. What is the short-run supply curve for each snuffbox maker? What is
the short-run supply curve for the market as a whole?
b. Suppose the demand for total snuffbox production is given by
Q = 1,100 – 50P.
What will be the equilibrium in this marketplace? What will each firm’s
total short run profits be?

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 c. Graph the market equilibrium and compute total short-run producer
surplus in this case.
d. Show that the total producer surplus you calculated in part c) is equal
to total industry profits plus industry short-run fixed costs.

4. (11.6) Suppose the government imposed a $3 tax on snuffboxes in the industry

described in Question 3.
a. How would this tax change the market equilibrium?
b. How would the burden of this tax be shared between snuffbox buyers
and sellers?
c. Calculate the total loss of producer surplus as a result of the taxation.
Show that this loss equals the change in total short-run profits in the
snuffbox industry. Why don’t fixed costs enter into this computation of
the change in short-run producer surplus?

5. (13.2) A monopolist faces a market demand curve given by

Q = 70 – P.
a. If the monopolist can produce at constant average and marginal costs
of AC = MC = 6, what output level will the monopolist choose in order
to maximize profits? What is the price at this output level? What are the
monopolist’s profits?
b. Assume instead that the monopolist has a cost structure where total
costs are described by
C(Q) = 0.25Q2 – 5Q + 300.
With the monopolist facing the same market demand and marginal
revenue, what price-quantity combination will be chosen now to
maximize profits? What will profits be?
c. Assume now that a third cost structure explains the monopolist’s
position, with total costs given by
C(Q) = 0.0133Q3 – 5Q + 250.
Again, calculate the monopolist’s price-quantity combination that
maximizes profits. What will profits be?
d. Graph the market demand curve, the MR curve, and the three marginal
cost curves from parts a), b) and c). Notice that the monopolist’s
profitability is constrained by 1) the market demand curve and 2) the
cost structure underlying production.

6. (13.7) Suppose a monopoly can produce any level of output it wishes at a

constant marginal and average cost of $5 per unit. Assume the monopoly sells
its goods in two different markets separated by some distance. The demand
curve in the first market is given by
Q1 = 55 – P1,
And the demand curve in the second market is given by
Q2 = 70 – 2P2.
a. If the monopolist can maintain the separation between the two
markets, what level of output should be produced in each market, and

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 what price will prevail in each market? What are total profits in this
situation?
b. How would your answer change if it only cost demanders $5 to
transport goods between the two markets? What would be the
monopolist’s new profit level in this situation?
c. How would your answer change if transportation costs were zero?

7. (14.1) Assume for simplicity that a monopolist has no costs of production and
faces a demand curve given by Q = 150 –P.
a. Calculate the profit-maximizing price-quantity combination for this
monopolist. Also calculate the monopolist’s profits.
b. Suppose a second firm enters the market. Let q1 be the output for the
first firm and q2 the output of the second. Assuming this second firm
also has no costs of production, use the Cournot model to determine
the profit-maximizing level of production for each firm as well as the
market price. Also calculate each firm’s profits.
c. How do the results from a) and b) compare to the price and quantity
that would prevail in a perfectly competitive market? Graph the
demand and marginal revenue curves and indicate the three different
price-quantity combinations on the demand curve.

8. (15.7) Suppose firms A and B operate under conditions of constant average

and marginal cost but MCa = 10 and MCb = 8. The demand for the firms’ output
is given by
QD = 500 – 20P.
a. If the firms practice Bertrand competition, what will be the market
price under a Nash equilibrium?
b. What will the profits be for each firm?
c. Will this equilibrium be efficient?