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Unformatted text preview: Homework 5 solutions Question 1 (a) Within-Chapter Exercise 13A.2 Can you find similar rectangular areas that are equal to FE k=100 for other output levels? Given that these rectangular areas have to be equal to one another, can you see why the AVC and AE curves must be getting closer and closer as output rises? For any two points that are vertically aligned on AE and AVC, draw the rectangle between those two points and the vertical axis. The greater the output (X), the closer the AE and AVC curves becomehence such rectangles become wider and have less height as X increases. Intuitively, AE and AVC get closer together as X increases because you are distributing a fixed, one-time cost over an increasingly large number of output unitsso that the fixed cost relative to each output unit gets smaller as X gets larger. In the graph below, the black rectangle between points B and B is also an area of size FE K=100 . VC k=100 TE k=100 FE K=100 = 100 r Output $ Output $ FE k=100 MC k=100 AE k=100 AVC k=100 x A (a) A A FE k=100 (b) Graph 13.1: Short Run Expenditure and Cost Curves VC k=100 TE k=100 FE K=100 = 100 r Output $ Output $ FE k=100 MC k=100 AE k=100 AVC k=100 x A (a) A A FE k=100 (b) Graph 13.1: Short Run Expenditure and Cost Curves Output $ FE k=100 MC k=100 AE k=100 AVC k=100 x A A A FE k=100 B B Output $ FE k=100 MC k=100 AE k=100 AVC k=100 x A A A FE k=100 B B (b) Within-Chapter Exercise 13A.4 Can you illustrate that economic profits will be positive when price falls between the lowest point of the AVC and the AE curves even though total expenditures exceed total revenues? In the area indicated by the heavy black line between points B and C on the MC curve, economic profit will be positive while total expenditure will exceed total revenue. We know that, at point B, economic revenue (price x output) equals economic cost (average var. cost x output). However, total expenditure also includes the fixed expenditures that are not included in the AVC curve (and, hence, are not counted as an economic cost). not included in the AVC curve (and, hence, are not counted as an economic cost)....
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- Fall '07