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Chapter 2 -The Market System and Circular Flow

# Chapter 2 -The Market System and Circular Flow - Which...

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Chapter 2 – The Market System and Circular Flow Worked Problems Resource Price per Unit of Resource Technique 1 Technique 2 Technique 3 Units Units Units Land \$2 2 2 3 Labor \$4 3 2 1 Capital \$3 1 2 3 Entrepreneurial Ability \$5 1 1 1

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1. Suppose there are three techniques for producing 1 wool blanket, as shown in the table above. a. With the resource prices shown, which production technique will the firm use? Why? b. Suppose the firm can sell blankets for \$26 each. Will the firm be profitable? c. Assume a new technique is developed that economizes on the relatively expensive labor. It requires 2 units of land, one unit of labor, 3 units of capital, and 1 unit of entrepreneurial ability. Will the firm adopt this new technique? d. Suppose the firm's cost of capital rises to \$5, all other values being the same.
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Unformatted text preview: Which technique will the firm now choose? Answers: a. The firm will choose technique 2. Its land cost is \$2x2 = \$4, its labor cost is \$4x2 = \$8, its capital cost is \$3x2 = \$6, and the cost of its entrepreneurial ability is \$5x1 = \$5, for a total cost of \$4 + \$8 + \$6 + \$5 = \$23. By comparison, each of the other techniques has a total cost of \$24. b. Yes. If each blanket sells for \$26 and can be produced for \$23, the firm will make \$3 profit on each one. c. Yes. The cost of producing a blanket would fall to \$2x2 + \$4x1 + \$3x3 + \$5x1 = \$22. This is \$1 cheaper than its current production technique. d. Technique 1 is now cheapest, with a total cost of \$26. By contrast, techniques 2, 3 and 4 now cost \$27, \$30, and \$28, respectively....
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