C40-2011-Winter-Solutions-1 - ECM C40 – 2011 Winter...

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Unformatted text preview: ECM C40 – 2011 Winter Midterm: SOLUTIONS PART A: Do ALL of the following FOUR questions!!!! A1. (20 marks) A) Key points: • Learning economies (sometimes called dynamic scale economies ) refer to cost advantages that result from accumulating experience and know-how (over time). Imagine a diagram of a downward sloping learning curve • Scale economies refer to a cost advantage that results from the ability to perform an activity at a lower unit cost when the output level (or scale of production) is high(er) (at a moment in time). Note The relationship between scale economies and learning economies • Economies of scale may be substantial even when learning economies are minimal (e.g. in the case of simple capital-intensive activities whose operation do not require a lot of experience and skills, but the fixed costs are substantial here, thus economies of scale may be significant). • Similarly, learning economies may be substantial even when scale economies are minimal (e.g. the case of complex labor-intensive activities where more experience can substantially reduce the production cost but since it is labor intensive, the fixed costs are not high, thus economies of scale are not substantial). (10 marks) B) It is important for managers to distinguish between economies of scale and learning. For example,- If a large firm has lower unit cost because of economies of scale , then any cutback in production will raise AC (Recall: Q Q TC Q AC ) ( ) ( = ) & thus it will lower profits (for two reasons – lower q & lower profit margin (higher cost of manufacturing)- If it is learning economies that cause this firm’s costs to be lower (at a moment in time), then their AC only depends on experience accumulated over time. (E.g. The first year’s AC=4, but the second year’s AC=2 because of the experience gained through operation in the first year.) So now if the manager wants to cutback the level of production, such action won’t raise the AC since past experience has already been obtained. Therefore, profits for this sort of firm will fall, but by much less (smaller output will reduce profits but the profit margin will not fall which will work to help prop up the level of profit, all else the same).- Any misunderstanding as to why the firm has the cost structure they do, for example, management feels it is due to learning economies and it is due to (SR static) scale economies would see the firm’s estimates of the profit impact of this production reduction miss their targets significantly (thus exposing management’s lack of competence thereby bringing into question, by shareholders, why the senior managers have been hired and put in charge) (10 marks) A2. (10 marks) - Rent and quasi-rent A) If 4 $ , 8 $ , 000 , 000 , 3 = = = c p F Chrysler , YES firm X would build the plant since, if we assume the contract will be honoured, then their economic profit (rent) would be positive. (4 marks; YES 1 mark & 3 marks for why) RENT = Economic Profit = ( 29...
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This note was uploaded on 09/18/2011 for the course ECONOMICS ECMC40 taught by Professor Parkinson during the Winter '08 term at University of Toronto.

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C40-2011-Winter-Solutions-1 - ECM C40 – 2011 Winter...

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