Producer Theory Practice Questions: ANSWERS
1. The law of diminishing marginal productivity implies that, when one input is variable while
others are fixed:
a) The Marginal Product of the variable input will eventually decline.
2. Which of the following cost relationships hold in the short run?
a) For positive Fixed Cost, Average Cost approaches Average Variable Cost as output
3. In the Long Run, if the cost per unit increases as output increases then the production of this
good is exhibiting
c) Diseconomies of Scale
4. For the following table, fill in the missing information.
Output Fixed Variable Total Marginal
Cost Cost cost cost
0 10 0 10 ----------
1 10 27 37 ----------
10 62 ----------
2 52 28
10 80 ----------
4 10 116 126 ----------
Given the information in the table above, if the price of the output is $32 what is the profit
maximizing quantity of output? Profit Maximizing output = 3
5. A firm in a perfectly competitive industry is producing where short run marginal cost is equal
to price. Total revenue is $1000; total short run cost is $1600 and total variable cost is $500.
The firm’s best strategy in the short run is to;
d) Maintain output at its present level.
6. A firm in a perfectly competitive industry is producing where short run marginal cost is
greater than price. Total revenue is $1700; total short run cost is $1600 and total fixed cost is
$500. The firm’s best strategy in the short run is to;
c) Decrease its output. 7. A firm in a perfectly competitive industry is producing where short run marginal cost is equal
to price. Total revenue is $6000; total short run cost is $8000 and total fixed cost is $2500.
What is the firm’s best strategy in the short run?
(c) Maintain its current level of output.
8. The graphs below represent the perfectly competitive constant cost widget industry and
representative firm. If there are 200 identical firms in this industry, draw in the Short run
Supply curve. Label the original price, firm quantity, and industry quantity P , Q , Q0on t0e 0
Now suppose there is a shock: The Canadian Government imposes a per unit tax on widget
production of $20 per unit. (Variable costs increase)
Using carefully labelled diagrams, analyse the shock on the individual firm and the industry, in
the short run. Label the new short run price, firm quantity, and industry quantity P , q , Q1. 1 1
Illustrate on the diagram the firm’s short run profit or loss. What will happen to the number of
firms in the long run? What will be the price in the long run?
The original short run supply curve is S. The original price is $60, the industry quantity is 1200,
and each firm is producing 6 units.
With the increase in variable cost, AVC, ATC, MC and Short run Supply, S, All shift up by $20.
The new short run price is $70, industry quantity is 1000, and each firm is producing 5 units.
The ATC at 5 units is $82, so each firm is losing $12 per unit, for a loss equal to $12(5) = $60.
(The shaded area) MC’ATC’
0 2 4 q 8 q
800Q1 1Q00 1600
0 In the Long run, some firms will leave the industry due to the short run losses. As firms leave,
the Short run supply will shift farther to the left. As supply shifts left, the price increases and the
losses get smaller. Firms stop leaving the industry once profits return to zero. This occurs when
price equals the new minimum point of ATC, $80. Industry quantity is now lower, (Q =800),
and the remaining individual firms are producing 6 2nit0, (q = q ) There are now 800/6 = 133
Individual Firm S2 S’
$ $ Industry
2 80 80
P 060 60
0 2 4 6 8