Suggested Solutions for P-Set 4 ver 03 09 11

Suggested Solutions for P-Set 4 ver 03 09 11 - Spring 2011...

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1 Spring 2011 University of California at Berkeley Suggested Solutions for Problem Set #4 Econ 100A: Microeconomic Analysis 14.4 Suppose you are currently operating a hamburger restaurant that is part of a competitive industry in your city. A: Your restaurant is identical to others in its homothetic production technology which employs labor l and capital k and has decreasing returns to scale. (a) In addition to paying for labor and capital each week, each restaurant also has to pay recurring weekly fees F in order to operate. Illustrate the average weekly long run cost curve for your restaurant. Answer: This is illustrated below where the long run average cost curve for your restaurant is U- shaped because of the combination of a recurring fixed cost and decreasing returns to scale in production. (b) On a separate graph, illustrate the weekly demand curve for hamburgers in your city as well as the short run industry supply curve assuming that the industry is in long run equilibrium. How many hamburgers do you sell each week? Answer: This is illustrated in panel (b) where the market supply curve S M is simply all short run restaurant supply curves added together. This has to intersect demand at p which lies at the lowest point of the AC curve in panel (a).

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2 It is only at that price that long run profits for restaurants are zero and thus no incentives for entering or exiting the industry exist. At this price, you will sell hamburgers so long as p is greater than long run average cost — and we know that MC crosses the AC curve at its lowest point. Thus, you will produce x as indicated in panel (a). As you are happily producing burgers in this long run equilibrium, a representative from the national MacWendy’s chain comes to your restaurant and asks you to convert your restaurant to a MacWendy’s. It turns out, this would require no effort on your part — you would simply have to allow the MacWendy’s company to install a MacWendy’s sign, change some of the furniture and provide your employees with new uniforms—all of which the MacWendy’s parent company is happy to pay for. MacWendy’s would, however, charge you a weekly franchise fee of G for the privilege of being the only MacWendy’s restaurant in town. When you wonder why you would agree to this, the MacWendy’s representative pulls out his marketing research that convincingly documents that consumers are willing to pay \$y more per hamburger when it carries the MacWendy’s brand name. If you accept this deal, will the market price for hamburgers in your city change? (d) On your average cost curve graph, illustrate how many hamburgers you would produce if you accepted the MacWendy’s deal. Answer: You would produce where p
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This note was uploaded on 09/11/2011 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at University of California, Berkeley.

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Suggested Solutions for P-Set 4 ver 03 09 11 - Spring 2011...

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