# Problems Of Economics

Problem 1:

A firm in a purely competitive industry has a typical cost structure. The normal rate of profit in the economy is 5 percent. This firm is earning $5.50 on every $50 invested by its founders. What is its percentage rate of return? Is the firm earning an economic profit? If so, how large? Will this industry see entry or exit? What will be the rate of return earned by firms in this industry once the industry reaches long-run equilibrium?

Problem 2:

There are 300 purely competitive farms in the local dairy market. Of the 300 dairy farms, 298 have a cost structure that generates profits of $24 for every $300 invested. What is their percentage rate of return? The other two dairies have a cost structure that generates profits of $22 for every $200 invested. What is their percentage rate of return? Assuming that the normal rate of profit in the economy is 10 percent, will there be entry or exit? Will the change in the number of firms affect the two that earn $22 for every $200 invested? What will be the rate of return earned by most firms in the industry in long‐run equilibrium? If firms can copy each other’s technology, what will be the rate of return eventually earned by all firms?

Problem 3:

A new production technology for making vitamins is invented by a college professor who decides not to patent it. Thus, it is available for anybody to copy and put into use. The TC per bottle for production up to 100,000 bottles per day is given in the following table.Output

TC

25,000

$50,000

50,000

70,000

75,000

75,000

100,000

80,000

a. What is ATC for each level of output listed in the table? b. Suppose that for each 25,000‐bottle per day increase in production above 100,000 bottles per day, TC increases by $5000 (so that, for instance, 125,000 bottles per day would generate total costs of $85,000 and 150,000 bottles per day would generate total costs of $90,000). Is this a decreasing‐cost industry? c. Suppose that the price of a bottle of vitamins is $1.33 and that at that price the total quantity demanded by consumers is 75,000,000 bottles. How many firms will there be in this industry? d. Suppose that instead the market quantity demanded at a price of $1.33 is only 75,000. How many firms do you expect there to be in this industry? e. Review your answers to parts b, c, and d. Does the level of demand determine this industry’s market structure?

Question 11.1:

How does monopolistic competition differ from pure competition in its basic characteristics? From pure monopoly? Explain fully what product differentiation may involve. Explain how the entry of firms into its industry affects the demand curve facing a monopolistic competitor and how that, in turn, affects its economic profit.

OTC

25,000

$50,000

50,000

70,000

75,000

75,000

100,000

80,000

a. What is ATC for each level of output listed in the table? b. Suppose that for each 25,000‐bottle per day increase in production above 100,000 bottles per day, TC increases by $5000 (so that, for instance, 125,000 bottles per day would generate total costs of $85,000 and 150,000 bottles per day would generate total costs of $90,000). Is this a decreasing‐cost industry? c. Suppose that the price of a bottle of vitamins is $1.33 and that at that price the total quantity demanded by consumers is 75,000,000 bottles. How many firms will there be in this industry? d. Suppose that instead the market quantity demanded at a price of $1.33 is only 75,000. How many firms do you expect there to be in this industry? e. Review your answers to parts b, c, and d. Does the level of demand determine this industry’s market structure? f. Compare your answer to part d of this question with your answer to part d of problem 3. Do both production technologies show constant returns to scale?

Problem 4(a):

How does monopolistic competition differ from pure competition in its basic characteristics? From pure monopoly? Explain fully what product differentiation may involve. Explain how the entry of firms into its industry affects the demand curve facing a monopolistic competitor and how that, in turn, affects its economic profit.

Problem 4(b):

Suppose that a small town has seven burger shops whose respective shares of the local hamburger market are (as percentages of all hamburgers sold): 23%, 22%, 18%, 12%, 11%, 8%, and 6%. What is the four‐ firm concentration ratio of the hamburger industry in this town? What is the Herfindahl index for thehamburger industry in this town? If the top three sellers combined to form a single firm, what would happen to the four‐firm concentration ratio and to the Herfindahl index?

ually profitable. Why might there be a temptation to cheat on the collusive agreement?

Problem 5. ADVANCED ANALYSIS:

Suppose the equation for the demand curve for some product X is P = 8 ‐ .6Q and the supply curve is P = 2 + .4Q. What are the equilibrium price and quantity? Now suppose an excise tax is imposed on X such that the new supply equation is P = 4 + .4Q. How much tax revenue will this excise tax yield the government? Graph the curves, and label the area of the graph that represents the tax collection “TC” and the area that represents the efficiency loss of the tax “EL.” Briefly explain why area EL is the efficiency loss of the tax but TC is not. LO3

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