UNIVERSITY OF GHANA BUSINESS SCHOOL

UGBS 201: MICROECONOMICS AND BUSINESS

TUTORIAL SET FOUR

Production, Cost and Market Structures

PART 1: TRUE/FALSE
1. If marginal product is decreasing, then average product must also be decreasing.
2. The short run is that period of time during which some inputs cannot be varied
3. To minimize the cost of producing a given amount of output, the marginal products of all
inputs must be equal.
4. If a production technology exhibits IRTS, then a 10% increase in output will result in less
than 10% increase in the total long-run costs of production.
5. If an equal percentage increase in the use of all inputs results in a smaller percentage
increase in the quantity produced, a firm’s production function is said to exhibit decreasing
returns to scale.

PART 2
Question 1
a. The following table summarizes the short-run production functions for “All Needs Firms”.
The product of “All Needs Firm” sells for 5 GH₵ per unit, the cost of input X1 is 8 GH₵ per
unit, and the price of input X2 is 25 GH₵ per unit. Complete the following table, and then
answer the associated questions. Please show how you arrive at your answers.

𝑋1 𝑋2 Q 𝑀𝑃𝑥1 𝐴𝑃𝑥1 𝐴𝑃𝑥2

0 5 0
1 5 10
2 5 30
3 5 60
4 5 80
5 5 90
6 5 95
7 5 95
8 5 90
 9 5 80
10 5 60
11 5 30
Answer the following questions using information from the above table.
1. Which input is the fixed input? Which is the variable input?
2. How much is the fixed costs?
3. What is the variable cost of producing 30 units of output?
4. Over what range of variable input usage does increasing marginal returns exist?
5. Over what range of variable input usage does decreasing marginal returns exist?
6. Over what range of variable input usage does negative marginal returns exists?

b. You are the manager of a firm that sells output at a price of 40ghc per unit. You are interested
in hiring a new worker who will increase your firm’s output by 2,000 units per year. Several
other firms also are interested in hiring the worker.
1. what is the highest annual salary you should be willing to pay this worker to come to
your firm?
2. What will determine whether or not you actually have to offer this much to the worker
to induce him to join your firm?

Question 2
Output Fixed Variable Total Marginal Average Average Average
Cost Cost Cost Cost Fixed Variable Total
(FC) (VC) (TC) (MC) Cost Cost Cost
0 50 50
1 100
2 128
3 148
4 162
5 180
6 200
7 225
8 254
9 292
 10 350
11 435

a. Use the table above to answer the following questions.

i. Calculate the fixed costs, Variable Costs, Marginal Costs, Average Fixed Costs, Average
Variable Costs and Average Total Costs.
ii. At what level of output does diminishing returns set in?
iii. What shape will the Marginal Cost curve assume? Why will it assume that shape?

b. Sompa owns a painting company with the following schedule for total costs:
Quantity 1 2 3 4 5 6 7
of houses
painted
per
month
Total 2000 4000 8000 1600 320000 6400 128000
Costs
(GHC)

i) What is the efficient scale of the painting company?

Question 3
Labour Capital TP MP AP TFC TVC TC MC ATC AVC
0 15 -
1 15 60
2 15 90
3 15 110
4 15 70
5 15 60
6 15 50
7 15 40
 a) Compute the Total product (TP) and Average product (AP) for all units of the labour
input.
b) Show all formulae and calculations.
c) In ordinary language explain the law of diminishing returns.
d) Does the production technology described in the table above exhibit the law of
diminishing returns? If yes, after what level of the labour input does diminishing returns
set in?
e) In ordinary language explain the concept of economies of scale and diseconomies of
scale
f) Assume that each unit of capital costs GHC 10 and each unit of labour costs GHC 50.
Compute that Total Fixed Cost (TFC), Total Variable Cost (TVC) and Total Cost (TC)
for each unit of the labour input.
g) Compute the Marginal cost (MC), Average Fixed cost (AFC), Average Variable Cost
(AVC) and Average Total Cost (AC) for each unit of the labour input.
h) In no more than two sentences, explain why short-run Average Cost curves are U-
shaped.
i) In no more than two sentences, explain why long-run Average Cost curves are U-
shaped.

Question 4
Sompa’s catering provides catered meals, and the catered meals industry is perfectly
competitive. Sompa’s machinery costs $100 per day and is the only fixed input. Her variable
cost consists of the wages paid to the cooks and the food ingredients. The variable cost per day
associated with each level of output is given in the accompanying table

Quantity of meals VC

0 $0

10 $150

20 $200

30 $480

40 $700
50 $1,000

a. Calculate the total cost, the average variable cost, the average total cost, and the marginal
cost for each quantity of output.

b. What is the break-even price? What is the shut-down price?

c. Suppose that the price at which Sompa can sell catered meals is $21 per meal. In the short
run, will Sompa earn a profit? In the short run, should she produce or shut down?

d. Suppose that the price at which Sompa can sell catered meals is $17 per meal. In the short
run, will Sompa earn a profit? In the short run, should she produce or shut down?

e. Suppose that the price at which Sompa can sell catered meals is $13 per meal. In the short
run, will Sompa earn a profit? In the short run, should she produce or shut down?

f. Suppose that the price at which Sompa can sell catered meals is $9 per meal. In the short run,
will Sompa earn a profit? In the short run, should she produce or shut down?

Question 5
a) Firms like Papa’s Pizza and Pizza Hut sell pizza and other products that are differentiated in
nature. While numerous pizza chains exist in most locations, the differentiated nature of these
firms’ products permits them to charge prices above the marginal cost. Given these above
observations, is the pizza industry most likely a monopoly, perfectly competitive
monopolistically competitive or an oligopoly industry? How will your answer change if
“numerous” is interpreted to mean 10?

b) “A firm in perfect competition makes no economic profit in the long run”. Discuss in no
more than half a page.

c) Compare and contrast the short-run and long-run equilibrium facing a firm under conditions
of monopolistic competition.
d) State and explain five factors that give rise to firm’s market power?
Problem 6
Explain whether each of the following statements is true, false, or could go either way,
depending on the circumstances. If a question has more than one part, please explain why each
part is true, false, or uncertain. Use the analytical tools learned in this course to back up your
answers. EXPLANATION DETERMINES MARKS.

a) The long run average cost is U-shaped because of the law of diminishing returns

b) Since a monopolist faces a downward sloping-demand curve, it controls both

the price and the quantity demand.

c) When average total cost is rising, it is high below the marginal cost.

d) The vertical distance between the average total cost and the average variable cost falls as
output decreases because the average fixed cost declines when output decreases

e) A monopolist can never make a loss because it is the only firm in the market.

f) In a perfectly competitive market, if firms are making profits in the short-run, there will be
fewer firms in the market in the short run than in the long-run.