ECN 303 Practice Problems for Ch.

8. a. Setting MR = MC implies 96 - .8Q = 16 + .2Q, or Q* = 80. In turn,

P = 64 and  = 5,120 - 2,080 = 3,040.

b. She is correct that Qmin = 40. At this output, AC = 960/40 = 24 and this exactly matches
MC = 16 + (.2)(40) = 24. Her second claim is incorrect. Optimal output is Q* = 80 where
MR = MC.

c. Yes, it is cheaper to produce 80 units in two plants (each producing at Qmin = 40). Total
cost is AC.Q = 24.80 = 1,920. This is cheaper than the single-plant cost (2,080) of part a.

9. a. Setting MR = 30,000 - .2Q = MC = 20,000 implies Q* = 50,000, and P* = 30,000 – .

1*50,000 = $25,000, confirming that GM’s current production level and price are profit
maximizing.

b. Fixed costs should not be mixed with variable costs in determining output and price
decisions. Removing the allocated fixed cost means taking out 160,000,000/40,000 =
$4,000 per unit. Thus, the true marginal cost per unit is $22,000 -$4,000 = $18,000. Note
that the actual MC in the West Coast factory is lower than the MC in the Michigan plants.
Thus, GM should expand its West Coast output (to 60,000 units to be exact).

11. a. We have: MCE = 1,000 + 10Q and MC = 3000 + 10Q. Setting MR = MC implies: 10,000 ­ 
60Q = 3,000 + 10Q. Thus, Q = 100 cycles and P = $7,000.

b.  The firm should continue to produce some engines itself (up to the point where MCE = 
1,400). Setting 1,000 + 10QE = 1,400 implies QE= 40 engines. The firm should produce 40 
engines and buy the remaining engines.

Purchasing engines implies a marginal cost of 2,000 + 1,400 = $3,400 (compared to the 
MC in part a of $4,000). 

Denote the number of engines bought as QB. The number of cycles produced is Q = QB + 
QE.

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 Again setting MR = MC implies: 10,000 – 60(QB + QE) = 3,400. Thus, Q = 110, QB = 110 –
40 = 70, P = $6,700. 

12 a. MPL = 120,000 watches/60,000 labor hours = 2 watches/hour. The marginal labor cost is:
($8/hour)/(2 watches/hour) = $4/watch. Total MC is: $6 + $4 = $10/watch. To maximize
profit, the firm sets MR = MC. Therefore, 28 - Q/10,000 = 10, or Q* = 180,000. However,
the firm’s capacity makes this output impossible. The best the firm can do is to produce up
to its capacity, Q* = 120,000. To sell this quantity, the firm sets P* = 28 - 120,000/20,000
= $22. The firm’s contribution is: (22-10)(120,000) = $1,440,000.

c. MR = MC = 10. It follows that 20 - Q/10,000 = 10 or Q* = 100,000. In turn, P* = 20 -

100,000/20,000 = $15. Contribution is now $500,000. In the short run (when its $600,000
in costs are fixed), the firm minimizes its losses by producing 100,000 units. If these losses
continue, the firm should shut down in the long run, i.e., when its lease is up.

The problem with goods A and B

A firm produces goods A and B. For good A, PA=$2, AVCA=$1.40, and QA=50,000 units. For good
B, PB=$3, AVCB=$2.20, and QB=75,000 units. The firm’s total fixed costs come to $100,000.

a. The profit contribution of A is $0.6 per unit, RA – VCA=(0.6)(50,000)=$30,000; the

contribution of B is $0.8 per unit, RB– VCB=(0.8)(75,000)=$60,000.

b. In the short run, the firm should continue to produce both goods because both goods
make positive contributions toward fixed costs. In the long run, since π=(0.60)
(50,000)+(0.80)(75,000) – 100,000= - $10,000, the firm should shut down to avoid
continuing losses.

Cobb-Douglas Production Function Problem

Suppose Q=100L0.5K0.4 , K is fixed at 5 units. PL= $10 and PK=$20.

a. Q=190L0.5.
L=Q2/36100
C(Q)=100+10Q2/36100

b. AFC=100/Q
AVC=10Q/36100
SAC=C/Q=AFC+AVC=100/Q+10Q/36100
SMC=20Q/36100

c. Q=0.

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d. SAC=100/Q+10Q/36100
Take first derivative and set equal to zero
-100/Q2+10/36100=0
Q=601
SAC=0.33

e. Q=3,600 – 200P
P=18 – Q/200
MR=18 – Q/100=SMC=20Q/36100
Q=1705
P=$9.48
Π=$15,358.13

f. The least cost combination of (K, L) in the long run satisfies L=2.5K.
Q = 100(2.5K)0.5K0.4 = 158K0.9
Hence, K= (Q/158)10/9
C = 10L+20K = 10(2.5K) + 20K = 45K = 45(Q/158)10/9 = 0.16Q10/9

g. The LAC is rising because of the decreasing returns to scale.