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Producer Behavior and Costs

Producer Behavior and Costs

1. Town workers occasionally use their own automobiles on official business. The currentreimbursement rate is $.25 per mile. The employees' union complains to the town manager thatnumerous studies show that the cost of operating an automobile is really $.50 per mile, so that the current rate is too low. The manager notes that workers seem delighted when they have an excuse to
use their own cars and get reimbursed at a "measly" $.25 per mile. Assuming that both the union and the management are factually correct, explain this situation.

2. Farmers currently use 50 units of capital and 25 hours of labor to harvest an acre of tomatoes. Capital costs $2.00 per unit and labor costs $5.00 per hour, so the total cost is 50(2) + 25(5.00) = $225.00 per acre. The minimum wage is increased to $5.75 per hour. The Labor Department estimates that costs will rise by 25(5.75 - 5.00) = $18.75, to $243.75 per acre. Is that likely to be an
over or underestimate? Are there conditions when it will be exactly right?

3. A firm has two plants, each with different marginal cost curves. Suppose plant 1 has MC = .1Q and plant 2 has MC = 1 + .05Q. Imagine that they want to produce Q = 100. How much would it produce at each plant?

4. On your last vacation to sunny Elko, Nevada you noticed that the casinos had $1.00 and $0.05 slot machines. You ask the casino owner which machine is more profitable and he assures you that on average they make more off the $1.00 machines than the $0.05. Why does the casino keep the $0.05
machines around? Would they be better off to replace the $0.05 machines with $1.00 machines? Assume that the $1.00 slot machine costs as much as the $0.05 slot machine for the casino owner to
purchase. (Hint: is the average revenue the relevant measure?)

5. Suppose that a firm has $100 in fixed costs and has constant marginal costs of $10.

a) Graph this firm's MC, AC, AFC, and AVC curves.
b) What is the minimum efficient scale of production for this firm?
c) How many firms will operate in this industry?

Solution Preview

1. Town workers occasionally use their own automobiles on official business. The current reimbursement rate is $.25 per mile. The employees' union complains to the town manager that numerous studies show that the cost of operating an automobile is really $.50 per mile, so that the current rate is too low. The manager notes that workers seem delighted when they have an excuse to use their own cars and get reimbursed at a "measly" $.25 per mile. Assuming that both the union and the management are factually correct, explain this situation.

This is a question about preference. The assumption is that workers prefer their own cars to the company's cars. Then the workers get utility = u by driving their own cars. When they get reimbursement, the total utility gained will be u+0.25. As soon as the total utility is higher than the total cost of driving their own cars, which is 0.50, the workers would be happy to do that. (i.e., u+0.25 > 0.50, workers are willing to drive their own cars.)

2. Farmers currently use 50 units of capital and 25 hours of labor to harvest an acre of tomatoes. Capital costs $2.00 per unit and labor costs $5.00 per hour, so the ...

Solution Summary

Producer Behavior and Costs are assessed.

$2.19