ECON 203 – Suppose you decide to leave your current job

| November 9, 2016

Economics 203
Spring (ii) 2017
Exercise Set 5 (due: April 18)
—————————————————————————————————————————————————————–Exercise Set 5 (25 points; 5 points individual, 10 points group, 10 points class)
Please note that you must complete your answers on this sheet. And that your sheets must be stapled or clipped.
1. Suppose you decide to leave your current job that pays $50,000 per year to open up an auto repair shop in
your home town. To open the shop, you decide to withdraw $100,000 from your retirement fund that was
earning 5% per year. If at the end of the first year, you earn $80,000 of accounting profit from your new
establishment, what is your economic profit? 2. Investors put up $520,000 to construct a building and purchase all equipment for a new restaurant. The
investors expect to earn a minimum return of 10% on their investment. The restaurant is open 52 weeks per
year and serves 900 meals per week. The fixed costs are spread over the 52 weeks. Included in the fixed
costs is the 10% return to the investors (the interest paid to the investors are paid out in equal weekly
installments) and $1000 per week in other fixed costs. Variable costs include $1000 in weekly wages and
$600 per week for materials, electricity, etc. The restaurant charges $5 on average per meal. (a) Calculate total fixed costs per week for the restaurant (b) Calculate total variable costs per week for the restaurant (c) Calculate total costs per week for the restaurant (d) Calculate total revenue per week for the restaurant (e) Calculate the economic profit per week for the restaurant 3. The Wall Street Journal published an article on May, 22, 2009, titled “Recession Turns Malls into Ghost
Towns,” in which it was documented that some of the mall establishments were considering not “sticking
around” once their lease expired. So why wouldn’t the owners of these stores simply shut down now and
not wait until the lease expires? 4. Refer to the graphs below to answer each of the questions that follow. Assume the market for Spanish cured
ham (jamón serrano) is in equilibrium where D = S . Further, for simplicity, assume that the AC cost for the typical
firm represents the appropriate short-run curve consistent with the optimal scale of output at its mínimum point.
Assume further that we begin in long-run equilibrium (i.e., the equilibrium market price in the market,
identifiable in the left-hand graph, equals minimum long-run average cost, identifiable in the right-hand graph);
that all firms have similar cost curves; and that this is a constant-cost industry, which means that as firms enter or
exit the market, input prices remain the same. Market Typical Firm P AC MC P
S P1
P1
D Q1 Q q1 (a) Referring to the market diagram above, show and explain what happens to the equilibrium market price and
quantity sold in the European market for Spanish cured ham (jamón serrano) if European tastes change in favor of
Italian proscuitto and away from Spanish cured ham. (Of course, we’re assuming that Spanish cured ham is
produced only in Spain, but consumed throughout Europe.) (b) Refer to the typical firm diagram above to show and explain what the new profit maximizing level of output
would be at this new market-equilibrium price. (c) Referring to the typical firm diagram above, identify whether the firm at the new profit-maximizing level of
output is earning a profit or a loss. (d) Refer again to the market diagram (on the left) above. Given your answer to (c), show and explain what will
happen in the market, i.e., what curve will shift and why? (e) Review your answers in (a) through (d) to summarize how a competitive market return to its long-run equilibrium. q 5. Suppose that the laptop computer industry is perfeclty competitive and that the firms that assemble laptops
do not also make the displays, or screens, for them. Suppose that the laptop display industry is also perfectly
competitive. Finally, suppose that because the demand for laptop displays is currently relatively small, firms
in the laptop display industry have not been able to take advantage of all the economies of scale in laptop
display production. (a) Choose a point of level in the diagram below of a typical firm in the laptop display industry consistent
with the narrative above and explain why you chose that level.
$ AC q = output (typical firm in laptop display industry) (b) Now suppose that every state university in the U.S. decides to issue laptop computers to all incoming
first-year students. Show in the diagram below what happens to P and Q in the laptop computer
market. P
D S P0 Q0 Q(laptop computers) (c) Show and explain in the graph below what happens to the production decision of a typical firm in the
laptop computer industry (not the display screen industry), producing initiatlly at P = P0 and q = q0,
given what you predict happens to the Price in (b). (So before the Price change, given that industry
produces Q0, we asume that each firm produces an equal amount , q 0, of that total ouput, so that q 0 x (no.
of firms) = Q0, as shown below.) MC AC P (laptop computers) P1 Q1 Q (laptap computers) (d) So given your answer to (c), is the typical firm making profits or
losses? Why? (e) Which way will the computer industry supply curve shift, given your answer to (d)? (f) Given your answer to (a), is this most likely a decreasing, constant, or increasing cost industry?
Explain.

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