AK8.4 - Answer Key for Problem Set 8 ECON 211, Fall 2009...

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Answer Key for Problem Set 8 ECON 211, Fall 2009 Due on Friday, October 30th Part 1: Graded Questions Problem 1: 45 points Andre produces DVD movies for sale, which requires a building and a machine that copies the original movie onto a DVD. Andre rents a building for $30,000 per month and rents a machine for $20,000 a month. Those are his fixed costs. His variable cost per month is given in the accompanying table. a. (8 pts) Calculate Andre’s average variable cost, average total cost, and marginal cost for each quantity of output. Andre’s average variable cost, average total cost, and marginal cost are shown in the accompanying table. b. (5 pts) What is Andre’s break-even price? What is his shut-down price? Andre’s break-even price is $13.83 because this is the minimum average total cost. His shut-down price is $3, the minimum average variable cost, because below that price his revenue does not even cover his variable costs. c. (5 pts) Suppose the price of a DVD is $2. What should Andre do in the short run?
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If the price of DVDs is $2, the price is below Andre’s shut-down price of $3. So Andre should shut down in the short run. d. (7 pts) Suppose the price of a DVD is $7. What is the profit-maximizing quantity of DVDs that Andre should produce? What will his total profit be? Will he produce or shut down in the short run? Will he stay in the industry or exit in the long run? If DVDs sell for $7, Andre should produce 5,000 DVDs because for any greater quantity his marginal cost exceeds his marginal revenue (the market price). There will be a loss of $35,000. In the short run, he will produce because his short-run loss if he were to shut down would be greater; it would equal his fixed costs of $50,000. In the long run, he will exit the industry because his profit is negative: the price of $7 per DVD is below his break-even price of $13.83. e. (5 pts) There is free entry into the industry, and anyone who enters will face the same costs as Andre. Suppose that currently the price of a DVD is $25. What will Andre’s profit be? When the price is $25, Andre will sell 8,000 DVDs per month and make a profit of $78,000. If there is free entry into the industry, this profit will attract new firms. f. (5 pts) Is this a long-run equilibrium? If not, what will the price of DVD movies be in the long run? As firms enter, the price of DVDs will eventually fall until it is equal to the minimum average total cost. Here, the average total cost reaches its minimum of $13.83 at 6,000 DVDs per month. So the long-run price of DVDs will be $13.83 g. (10 pts) Draw Andre’s marginal cost curve and Andre’s individual supply curve The individual supply curve is shown in the accompanying diagram. It is his MC curve above the minimum average variable cost Problem 2: 30 points Figure 1 shows the industry's demand curve and short-run supply curve. You are asked to predict the behavior of an industry given the following
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AK8.4 - Answer Key for Problem Set 8 ECON 211, Fall 2009...

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