XLRI - Xavier School of Management

Quiz 2
Managerial Economics (MGEH22-1)
Maximum Marks: 15 Duration: 60 Minutes Date: 31/08/2022

Instructions:

ˆ Answer all the questions.

ˆ This is a closed book quiz.

ˆ Usage of calculator is allowed.

√
1. Suppose that a firm’s production function is q = 10 LK. The cost of a unit
p of labor
is Rs. 20,pand the cost of a unit of capital is Rs. 80. (Hint: M PL = 5 K/L and
M PK = 5 L/K).

(a) What is the minimum cost to produce 100 units of output? (2)
Solution:
The tangency point of the isocost and isoquant curves implies that
M PL 20
= =⇒ L = 4K.
M PK 80

Substituting this into the production function we obtain

(b) Now, the firm wants to increase its production to 140 in the short-run and keep
its capital level fixed as derived in (a). What is the average cost to produce 140
units of output?
Solution: Since K = 5, therefore
√ 2 Q2
Q = 10 5L =⇒ Q = 500L =⇒ L = = 39.2
500
The total cost is
1184
T C = 20L∗ = 5 × 80 = 20 × 39.2 + 400 = 1184, AC = = 8.5
140

1
 (c) Now, suppose the firm has enough time to use both its capital and labour opti-
mally. What is the minimum cost required to produce 140 units of output?
Solution:
The total cost is
T C = 20L∗ + 80K ∗ = 8Q = 8 × 140 = 1120.

2. Consider a competitive industry with the demand curve Qd (p) = A − p. There are
many identical firms in the industry, and each has the following cost function
(
q + q 2 + 9 if q > 0
c(q) =
0 if q = 0.
(Hint: M C = 1 + 2q).

(a) For A = 28, find the price, the market output, output per operating firm, and the
number of operating firms in the long-run competitive equilibrium.
Solution: Since the firm is in the long run, we have
p = M C = 1 + 2q
q
p = AC = 1 + q +
9
We have
q
AC = M C =⇒ 1 + 2q = 1 + q + =⇒ q = 3
9
We obtain p∗ = 7 and each firm supplies q ∗ = 3. The market demand is Qd =
28 − 7 = 21 and the number of firms is
Qd
n∗ = = 7.
q∗
(b) Now, the demand curve shifts up in the sense that A increases to 67. In the short
run, the number of firms is fixed at the number you found in part (a) above. Find
the new short-run equilibrium price and per-firm output. (1.5)
Solution: First, find the supply curve in the short run
p−1
p = 1 + 2q =⇒ q s = for p ≥ 1.
2
The market supply curve is Qs = 7(p−1)
2
. The intersection of market supply and
market demand yield the equilibrium price
7(p − 1) 47
Qd = Qs =⇒ 67 − p = =⇒ p∗ =
2 3
Each firm’s equilibrium supply is q ∗ = 22
3
.

2
 (c) Now find the new long-run equilibrium for A = 67.
Solution: We have the same q ∗ = 3 and p∗ = 7. The market demand at p∗ = 7 is
Qd = 67 − 7 = 60 and the number of firms is
60
n∗ = = 20.
3

3. Suppose a monopolist named Jamshed Factory (JF) has a contract to make t-shirts
with the XLRI logo. JF’s cost of making t-shirts with XLRI logo is c(q) = 100−6q +q 2 ,
and the demand is q = 30 − 0.5p. (Hint: M C = −6 + 2q).

(a) What price should JF set to maximize profit? What output does the firm produce?
How much profit and consumer surplus does JF generate? (2)
Solution: M R = M C implies that

60 − 4q = −6 + 2q =⇒ q m = 11 and pm = 38

π m = 38 × 11 − (100 − 6 × 11 + 112 ) = 263

1
CS m = (60 − 38) × 11 = 121
2
(b) What would output be if JF acted like a perfect competitor? What profit and
consumer surplus would then be generated? (1)
Solution: p = M C implies that
33
60 − 2q = −6 + 2q =⇒ q ∗ =and p∗ = 27
2
  2 
∗ 33 33 33
π = 27 × − 100 − 6 × + = 172.25
2 2 2

1 33
CS ∗ = (60 − 27) × = 272.25
2 2
(c) What is the deadweight loss from monopoly power in part (a)? (1)
Solution:

3
 p

38

27
16

q
11 33
2
 
1 33
DW L = (38 − 16) × − 11 = 60.50
2 2
(d) Suppose XLRI, concerned about the high price of t-shirts with the XLRI logo,
sets a maximum price at Rs. 30. How does this affect price, quantity, consumer
surplus, and JF’s profit? What is the resulting deadweight loss?
Solution: Equate the demand with the maximum price

30 = 60 − 2q =⇒ q = 15

 
2
π = 30 × 15 − 100 − 6 × 15 + (15) = 215

1
CS = (60 − 30) × 15 = 225
2
 
1 33
DW L = (30 − 24) × − 15 = 4.5
2 2