Principles of Economics

Problem Set 5
Universidad Carlos III de Madrid – Department of Economics

WARMING-UP PROBLEMS

1. The isoprofit curves for Cheerios are downward sloping, but for Beautiful Cars, they
slope downward when Q is low and upward when Q is high. In both cases, the higher
isoprofit curves get closer to the average cost curve as quantity increases. Why?

2. What is the reason for the difference in the shape of the isoprofit curves between
Cheerios and Beautiful Cars?

Figure 7.4

Figure 7.10

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3. i) Suppose that Beautiful Cars had sufficient information and so much bargaining
power that it could charge each consumer separately the maximum they would be
willing to pay. Draw the demand and marginal cost curves (as in Figure 7.20) and
indicate on your diagram:
a) the number of cars sold
b) the highest price paid by any consumer
c) the lowest price paid
d) the consumer and producer surplus

ii) Can you think of any examples of goods that are sold in this way?
iii) Why is this type of pricing not common practice?
iv)Some firms charge different prices to different groups of consumers—for
example, airlines may charge higher fares for last-minute travelers. Why would
they do this and what effect would it have on the consumer and producer surpluses?
What can/cannot we say about the effect on overall welfare in the market?
v) Suppose a competition policy is implemented that prevents firms from charging
different prices to different groups of consumers. How could this change give
consumers more bargaining power?
vi) Under these rules, how many cars would be sold?
vii) Under these rules, what would the producer and consumer surpluses be?

Figure 7.20

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4. Below you can see the average and marginal costs per student for the year 1990-1 that
Koshal and Koshal calculated from their research.

a. How do average costs change as the numbers of students rise?

b. Using the data for average costs, fill in the missing figures in the total cost
column.
c. Plot the marginal and average cost curves for undergraduate education on a
graph, with costs on the vertical axis and the number of students on the
horizontal axis. On a separate diagram, plot the equivalent graphs for
graduates.
d. What are the shapes of the total cost functions for undergraduates and
graduates? (You could sketch them using what you know about marginal
and average costs.) Plot them on a single chart using the numbers in the
Total cost column.
e. What are the main differences between the universities’ cost structures for
undergraduates and graduates?
f. Can you think of any explanations for the shapes of the graphs you have
drawn?

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MULTIPLE CHOICE QUESTIONS

5. Which of the following events would contribute to economies of scale?

a. Large supermarkets being able to drive down the cost of purchasing milk as
it increases its scale of business.
b. The expansion of the workforce requiring extra layers of management for
better performance monitoring.
c. A merger of two firms leading to large increases in the costs of HR, IT, and
legal departments.
d. The higher the number of users of Windows 10, the less likely it is that
Microsoft will be able to achieve a higher sale of its operating system.

6. 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?

a. The average cost at Q = 40 is £7.

b. The marginal cost at Q = 80 is £9.50.
c. The marginal cost is higher than the average cost at Q = 50.
d. The marginal cost curve intersects the average cost curve at Q = 60.

7. 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?
a. The total cost curve is an upward-sloping straight line through the origin.
b. The average cost curve is U-shaped.
c. The marginal cost curve is a horizontal straight line.
d. The marginal cost curve intersects the average cost curve at its minimum point.

NUMERICAL PROBLEMS

8. A firm’s cost of production is £12 per unit of output. P is the price of the output good,
and Q is the number of units produced. Using this information, read the following
statements and choose the correct option(s).
a) Point (Q, P) = (2,000, 20) is on the isoprofit curve representing the profit level
£20,000.
b) Point (Q, P) = (2,000, 20) is on a lower isoprofit curve than point (Q, P) =
(1,200, 24).
c) Points (Q, P) = (2,000, 20) and (4,000, 16) are on the same isoprofit curve.
d) Point (Q, P) = (5,000, 12) is not on any isoprofit curve.

Hint: [Profit = (𝑃−unit cost)×𝑄; in this problem the unit cost =£12]

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9. 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. Additionally, we know that the demand curve
intersects the price and marginal cost axes at $7920. Based on this information, which
of the following statements is correct?

a. The consumer surplus at E is $41,000.

b. The producer surplus at E is $126,720.
c. The deadweight loss at E is $19,840.
d. The gains from trade at E are $120,320.

10. Figure 7.19 shows the spending per week in each category of a US consumer whose
total expenditure on food is $80, with typical spending patterns across food categories.

Suppose that the price of category 30, high-calorie milk products, increased by 10%:

a. By what percentage would his demand for high-calorie milk products fall?
b. Calculate the quantity he consumes, in grams, before and after the price change.

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 c. Calculate his total expenditure on high-calorie milk products before and after
the price change. You should find that expenditure falls.
d. Now choose a category for which the price elasticity is less than 1 and repeat
the calculations. In this case you should find that expenditure rises.

CONCEPTUAL QUESTIONS

Write down a short and concise answer. When you are asked to solve the question in class,
explain the concept clearly and give examples or pieces of evidence.

11. Food taxes intended to shift consumption towards a healthier diet are controversial.
Some people think that individuals should make their own choices, and if they prefer
unhealthy products, the government should not interfere. In view of the fact that those
who become ill will be cared for at some public expense, others argue that the
government has a role in keeping people healthy. In your own words, provide arguments
for or against food taxes designed to encourage healthy eating.

12. Imagine that you are a politician in a town where a multinational retailer is planning to
build a new superstore. A local campaign is protesting that it will drive small
independent retailers out of business, and thereby reduce consumer choice and change
the character of the area. Supporters of the plan argue in turn that this will only happen
if consumers prefer the supermarket. Which side are you on?