Office Hours: Monday 3:00-4:00 – LUMS C85 ECON 101 Tutorial: Week 5 Shane Murphy s.murphy5@lancaster.ac.uk Office Hours: Monday 3:00-4:00 – LUMS C85

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Outline Roll Call Problems Discussion

Chapter 13: Exercise 1 Isoquants are drawn as convex to the origin. Referring to the marginal rate of technical substitution, why do you think that isoquants are convex to the origin? The marginal rate of substitution is the rate at which one factor input can be substituted for another at a given level of output. The slope of the isoquant represents this. Isoquants are convex to the origin because when a firm reduces one unit of a factor and substitutes it for another it is likely that the addition to total output of each successive unit of the factor employed will diminish according to the law of diminishing marginal productivity. At the same time as less of the other factor is used its marginal product will be higher.

Chapter 13: Exercise 4 Look at the sketch of three production isoquants in the figure below. What do these isoquants tell you about the relationship between capital and labor in this particular instance? Capital and labor are perfect substitutes

Chapter 13: Exercise 7 If a firm faced a situation: 𝑀𝑃 𝐿 𝑃 𝐾 > 𝑀𝑃 𝐾 𝑃 𝐿 What would be the incentives for the firm to change its production decisions? At what point would the firm stop changing its production decisions? The point of least-cost input occurs where the marginal rate of technical substitution is equal to the ratio of the prices of factors. If one ratio is larger than the other then the budget constraint line is not tangential to the production isoquant. By changing the combination of the factors the firm can find itself on a higher isoquant line for the same costs.

Chapter 6: Exercise 1 Manton Baker is a company that bakes bread. Here is the relationship between the number of workers at the bakery and Manton’s output in a given day. A skilled baker costs 100 a day and the fixed cost is 200. Fill in the table:

Chapter 6: Exercise 1 What are the patters for MP, ATC, and MC? Marginal product rises at first, then declines because of diminishing marginal product. Average total cost is U-shaped. Marginal cost is also U-shaped, but rises steeply as output increases. What is the relationship between MP and MC? When MP is rising, MC is falling and vice versa. What is the relationship between ATC and MC? When marginal cost is less than average total cost, average total cost is falling; the cost of the last unit produced pulls the average down. When marginal cost is greater than average total cost, average total cost is rising; the cost of the last unit produced pushes the average up.

Chapter 6: Exercise 2 Your aunt announces that she is thinking about opening a restaurant. Rent is 500,000 per year. In addition she would have to leave her 50,000 per year job. Define opportunity cost What is your aunt’s opportunity cost of running the restaurant for a year? If she thinks she can sell 510,000 worth of food in a year, should she open the restaurant? The opportunity cost of running the restaurant is €550,000, consisting of €500,000 to rent the premises and buy the license and to buy in food and drink, and a €50,000 opportunity cost, since your aunt would quit her job as an accountant to run the restaurant. Since the total opportunity cost of $550,000 exceeds revenue of $510,000, your aunt should not open the restaurant, as her profit would be negative; she would lose money

Chapter 6: Exercise 7 Alejandro’s lawn-mowing services is a profit-maximizing competitive firm. Alejandro mows lawns for 27 each. His total cost each day is 280, of which 30 is fixed. He mows 10 lawns a day. What can you say about Alejandro’s short-run decision regarding shutdown and his long-run decision regarding exit? Since Alejandro’s average total cost is €280/10 = €28, which is greater than the price, he will exit the industry in the long run. Since fixed cost is €30, average variable cost is (€280 - €30)/10 = €25, which is less than price, so Alejandro won’t shut down in the short run.

Discussion