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UniversityofToronto,DepartmentofEconomics,ECO20420102011AjazHussain
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Page1of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Question1[60Points.Allpartsworth10pointseach]
ThisquestionisbasedontheHBScase:ThePrestigeTelephoneCompany.Foryourconveniencehereis
exhibit1fromthecase(figuresbelowareforthePrestigeDataservicescompanyJanuaryMarch2003)
Exhibit1:PrestigeTelephoneCompany
January2003
February2003
IntercompanyHours
206
181
CommercialHours
123
135
TotalRevenueHours
329
316
ServiceHours
32
32
AvailableHours
223
164
TotalHours
584
512
Inthecase,thecommercialpriceis
$800/hourandtheintercompanypriceis
March2003
223
138
361
40
143
544
$400/hour:
PrestigeTelephone
Company
D
Intercompany a Pi =$400/hr.
t
a
Other
Services
PrestigeData
Services
Commercial
Commercial
Customers
Data
PC =$800/hr
ThePrestigeDataServicescostfunctionwasestimatedtobe(here ishoursofdataservices):
223,436
28
ThePrestigeDataServicescommercialinversedemandfunctioninMarch2003wasestimatedtobe:
1,466
4.83
Page2of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
(a)UnderthetermsofaregulationrulingPDSsintercompanybillingarecappedatanaverageof
$82,000/month.Whatdoesthisimplyfortheaverageintercompanyhoursthatcanbebilledper
month?IsPrestigeDataServicesabidingbyorviolatingthetermsoftheruling?Giveabriefexplanation.
Answer:
Ifintercompanyrevenuesarecappedat$82,000/monthandpricesare$400/hrthen:
400
82,000
205
Thisimpliesthatintercompanyhoursshouldbe205hours/monthonaverage.IsPDSbilling205hours
onaverageeachmonth?Lookat:
Exhibit1:PrestigeTelephoneCompany
January2003
February2003
IntercompanyHours
206
181
CommercialHours
123
135
TotalRevenueHours
329
316
ServiceHours
32
32
AvailableHours
223
164
TotalHours
584
512
March2003
223
138
361
40
143
544
NoticethataverageintercompanyhoursfromJanMar2003were:
206
181
3
223
610
3
203.33
Thus,PDSisabidingbythetermsoftheagreement.
(b)WhatkindofreturnsdoesPDShaveforitsvariableinputs?Giveabriefexplanationbasedonthe
figuresabove(notbelow).
Answer:
ThePrestigeDataServicescostfunctionwasestimatedtobe(here ishoursofdataservices):
223,436
28
SincethisisalinearcostfunctionPDSmusthaveconstantreturns.Inparticular,noticethat:
28
28
Page3of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Since
isconstant,PDShasconstantreturns.
(c)RecallthatPDShasneverearnedprofits.Calculatethebreakevennumberofcommercialhoursand
theequationofthedemandcurveinthemonthwhenPDSbreakseven.Showallcalculations.
Answer
PDSsellsdataservicestointercompanyandcommercialcustomers.Nowprofitsare:
Breakevencommercialoutputiswhen:
Breakeven
Breakeven
Breakeven
Assuming
28 and
Breakeven
205 wehave:
223,436
400 28 205
800 28
191
WecannowcomputethedemandcurveinthemonthwhenPDSbreakseven.Assumingtheother
factorsbesidespricearepushingthedemandcurverightweseethatinthebreakevenmonth,the
demandcurvehasthesameslopeastheMarch2003demandcurve:
Page4of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
PDSCommercialDemandCurveinMarch2003
P=1,466 4.83Q
CommercialPrice
$1,466
$800
123
135
138
Breakeven
=192
Commercial
Hours
Thus,inthebreakevenmonth:
Since
$800 and
4.83
4.83
192 wehave:
800
800
4.83 192
4.83 192
1,727.36
Thecommercialdemandcurveinthebreakevenmonthis:
1,727.36
4.83
(d)Ingeneral,isiteasierforthecommercialdivisiontobreakevenifPDScomprisesofcommercial
andintercompanydivisionsversusifPDScomprisesofjustacommercialdivision?Assumethetwo
scenarioshavethesametotalfixedcost.
Answer
Withtwodivisionswehad:
Page5of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Breakeven
Letscomparethisexpressionwiththecaseofasinglecommercialdivision:
Breakeven
(i.e.theother,intercompany,divisionhaspositivecontribution
Noticethatsolongas
margin),thenthecommercialbreakevenquantitywithanotherprofitabledivisionissmallerthanthe
breakevenquantityifthecommercialdivisionwasbyitself.
(e)[Thispartisindependentofallotherparts]SupposethatinMarch2003,thegovernmentimposesa
10%excisetaxoncommercialdataservices.Assumingallcommercialcustomerscanbemodeledbya
singlerepresentativeconsumerwithincome$ andutilityfunction
,
(wheregood1is
commercialdataservicesandgood2iseverythingelse)whatisthemarginalutilityduetotheexcise
taxoncommercialdataservices?Pleaseshowallcalculationsandspecificallystateallassumptions.
Answer:
Beforetheexcisehasbeenimposed,therepresentativeconsumer,withanunknownincome$ ,
consumes138hoursofcommercialdataservicesandsomeunknownquantityofothergoods.Let
everythingelsebethebasegoodsothat
1 andassumetheconsumerhasaquasilinearutility
functionofthetype:
,
Here
isanyfunctionofgood1suchthat 0
theincomeistheconsumersurplusofgood1:
0.Inthiscase,thetotalutilityofabundleminus
Page6of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
1,466
Pc
U(Q1,Q2 ) Y
800
A
CommercialDemand
Q1
CommercialHours
138
Q2 (EverythingElse)
Y/1
U(Q1,Q2 ) Y
Q2
138
Y/800
Q1
CommercialHours
ThatisatbundleA:
,
138,
1
1,466
2
800 138
$45,954
Page7of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
1,466
Pc
U(Q1,Q2 ) Y=$45,954
800
A
CommercialDemand
Q1
CommercialHours
138
Q2 (EverythingElse)
Y/1
U(Q1,Q2 ) Y=$45,954
Q2
138
Y/800
Q1
CommercialHours
A10%excisetaxraisesthepriceofcommercialservicesto$880andreducesdemandto:
1,466
880
4.83
4.83
1,466
1,466
1,466 880
4.83
4.83
880
121.33
Thus,atbundleB:
,
121.33,
1
1,466
2
880 121.33
$35,550
Page8of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
1,466
880
800
Pc
U(Q1,Q2 ) Y =$35,550
B
A
CommercialDemand
Q1
CommercialHours
121.33 138
Q2 (EverythingElse)
U(Q1,Q2 ) Y =$35,550
Y/1
Q2
Q2
U(Q1,Q2 ) Y=$45,954
121.33 138
Y/880
Y/800
Q1
CommercialHours
Therefore,thechangeinutilityduetoa10%excisetaxoncommercialdataservicesis:
of a 10% excise tax on
of a 10% excise tax on
,
,
$35,550
$45,954
$10,404
Noticethiscalculationdoesnotrequireknowledgeoftheactuallevelofincome,theexactutility
function,ortheamountofgood2beingconsumed.
Page9of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
(f)RecallthatthePDSsvariableinputswerequasivariablepower(denoteby )andquasivariable
labor(denoteby whileitsfixedinputswerequasifixedpower,quasifixedlaborandallother
inputs.Denoteallfixedinputsascapital .SupposePDSsproductionfunctionis:
Assume
1 and
0.Supposethepriceofpoweris$ /hour,thepriceofquasivariablelabor
is
$30.25/hourandthepriceofcapitalis .Giventhat
$4/hourand
$24/hour
whatisthepriceofquasivariablepower ?Hint:SolvetheCMP
max
s. t.
$4/hourand
andusethefactthat
$24/hour.Showallcalculationsbelow.
Answer:
Wearetoldthat:
4
Thismeansthat:
Thetotalcostof hoursofdataservicesis:
Wecouldsubstitutevaluesforsomeparametersnoworwecouldworkaslongaspossibleinparametric
formandthensubstitutenumbers.Welldothelattersothatyoucanseethealgebra.
TheCostMinimizationProblem(CMP)is:
min
s. t.
Now:
, ,
1sothat:
min
,
s. t.
, ,
Page10of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
SincetheproductionfunctionisoftheCobbDouglasformweknowthatfor
0 wemustusesome
powerandlaborsothat ,
0.Assuch,wecandropthenonnegativityconstraints:
s. t.
min
,
Now:
max
s. t.
max
s. t.
SetuptheLagrangian:
max
s. t.
max L
TheFOCsare:
L
6
7
The1stFOCimplies:
The2ndFOCimplies:
Page11of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
6
7
6
7
7
6
Equatingthe syieldsthefamiliartheoptimalinputbundleiswheretheisoquantistangenttothe
isocostresult:
7
7
1
6
Thisallowsustoisolatepower(orforthatmatterlabor)intermsoflabor(power).Forinstance:
Wecansubstitutethisinthe3rdFOC:
Page12of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Now,wearetoldthat
$4 whichmeansthat:
4
Substitutetheexpressionfor toget:
4
6
4
1
1
6
4 6
Page13of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Substitute
$30.25 toget:
4
30.25
0.9976
$1
Page14of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Question2[40Points.Parts(d)&(e)worth5pointseach,allotherpartsworth10pointseach]
ThisquestionisbasedontheHBScaseTheAluminumIndustryin1994.Thefollowingtablecontainsthe
coststructureoftheaverageCISprimaryaluminumsmelter,theaveragestateprimaryaluminum
smelter,andtheaveragerationalprimaryaluminumsmelter(pleasenotethatcumulativecapacity
belowisthetotalcapacityofallsmelterswithinacategory(forexample,thetotalcumulativecapacityof
allCISsmeltersis1.788milliontonsperyear):
Allcostfiguresare$/t
VariablecostsareinBOLD
AverageCIS AverageState
Smelter
Smelter
Smelter
Country
Company
AverageCapacity(000stpy)
Totalelectricitycost
Totalaluminacost
Otherrawmaterials
Plantpowerandfuel
Consumables
Maintenance
Labor
Freight
Generalandadministrative
Cumulativecapacity(000softons/year)
(allsmeltersinacategory)
Totalvariablecostsperton($/ton)=
Average
Rational
Smelter
CIS
Allover
Allover
CIS
State
Rational
243.73
120.74
121.53
148.62
454.49
292.29
382.13
407.27
348.49
63.69
163.57
120.62
4.51
11.81
10.34
76.92
56.72
73.91
39.57
46.45
53.84
17.80
62.73
194.19
68.76
53.17
37.82
67.11
52.48
86.58
1,788.07
(AllCIS)
2,826.95
(Allstate)
16,962.17
(Allrational)
740.14
1,135.25
873.15
Page15of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
(a)Solvetheprofitmaximizingproblemfortheaveragerationalprimaryaluminumsmelter:
max
s. t.
0,
Here
priceofaluminum/ton,
TotalfixedCost,
=Totalvariablecostand
capacity.Assume
0. Showallcalculations.
Answer
Sincethecasereportscostfiguresin$pertonweassumethatallsmeltershaveconstantreturnsso
that:
constant
constant
Thiswillbeusefulbelow.Now,asmeltersprofitmaximizationproblem(PMP)is:
max
s. t.
0,
Notethatsmeltersarepricetakerssothat isaconstant.Recallthatallinequalityconstraintsmustbe
expressedintheform
.Therefore:
max
s. t.
0,
max
s. t.
Havingexpressedallconstraintsintermsof
max L
,
0,
,formtheLagrangian:
0
max L
,
TheFOCis:
TheKuhnTuckerconditionsare:
0,
0
Page16of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
0,
0,
Noticethereare4possiblecasesthatmustbechecked:
q=0
2 =0
(Checkwhen2 0)
(Checkwhenq0)
q=qc
1 =0
q=qc
1 =0
(Checkwhen1 0 )
(Checkwhenqqc)
(Checkwhen1 0 )
(Checkwhenqqc)
CaseA
CaseB
CaseC
CaseD
Thisrequiresthat
0 and
Since
0 theKTcondition
withtheFOC:
CaseA
0,
0,
0.
Needtocheckif
>0.ThuscaseAisimpossible.
CaseB
0,
0
0,
.
Needtocheckif
isautomaticallysatisfied.Thusweneedtocheckif
0. Start
Page17of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Substitute
0:
0and
Thus,for
0 weneed:
0
CaseBisthesolutionwhenthepriceofaluminumislowerthan
0 .Thisisbecausethemarginal
st
costofproducingthe1 unitisgreaterthanorequaltotheprice,orthe
,ofthe1stunit.
ConstantReturnsTechnology
$
MC
MR
P
B
Thus,anytime
curve):
qc
Qty
0 thecompetitivefirmssupplycurveis
0(thatsnotthesameastheMC
Page18of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
ConstantReturnsTechnology
$
MC
MR
P
qc
CaseBwhen
Qty
Since
CaseC
,
0
Needtocheckif
0,
0
0 theKTcondition
0 isautomaticallysatisfied.Thusweneedtocheckif
0:
Substitute
0:
and
Thus,for
0 weneed:
Page19of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
CaseCwillbethesolutionifthealuminumprice,the
atfullcapacity:
,isgreaterthan
themarginalcost
ConstantReturnsTechnology
$
MC
MR
qc
thecompetitivefirmssupplycurveis
Thus,anytime
competitivefirmsMCcurveisnotthesupplycurve:
Qty
.Againnoticethatthe
Page20of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
ConstantReturnsTechnology
$
MC
MR
P
qc
Qty
CaseCwhen
CaseD
1,
0
Needtocheckif
0,
StartwiththeFOC:
Substitute
0
0
Page21of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
ThisisthefamiliarECO100resultthatacompetitivefirmproduceswherepriceequalsmarginalcost.
TheonlyproblemisthatwedontknowwhencaseDwillbeasolutionforsure.Forthatweneedtothe
conditionsunderwhich
0 and
.From:
Wehave:
Thus:
ThisgivesusaconditionforcaseDtobeasolutionandfortheoutputsuppliedtobebetween0andfull
capacity.
Intuitively,caseDsaysthatifthepriceoftheproductisbetween
0 and
thefirmwill
produceanoutputbetweenzeroandfullcapacity:
ConstantReturnsTechnology
$
MC
MR
qc
Qty
Optimaloutput
anywherebetween
0andfullcapacity
Page22of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Thus,anytime
thecompetitivefirmssupplycurveisalsoitsMCcurve:
ConstantReturnsTechnology
$
MC
MR
qc
CaseDwhen
Qty
Puttingallcasestogetherwehaveacompetitivesmelterssupplycurve:
Page23of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
ConstantReturnsTechnology
$
Supply
Curve
qc
Qty
Putanotherway,thequantitysuppliedis:
0,
0
,
(b)Basedonyouranswertopart(a)whatistheimpactontheaveragerationalsmeltersoptimalprofits
from,holdingallelseconstant,a1%increasein:
Thepriceofaluminum?
Capacity?
Theminimumoutput?
Fixedcost?
Assumethat
$1,100/ton.Showallcalculations.
Answer:
Wearebeingaskedtoinvestigatetheimpactontheaveragerationalsmeltersprofitsduetoachange
inaparametertheeasiestwaytosolvethisisbytheenvelopetheorem.Todothis,wemustfirstfind
outtheaveragerationalsmeltersoutput.Recallthat:
Page24of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Allcostfiguresare$/t
VariablecostsareinBOLD
AverageCIS AverageState
Smelter
Smelter
Smelter
Country
Company
AverageCapacity(000stpy)
Totalelectricitycost
Totalaluminacost
Otherrawmaterials
Plantpowerandfuel
Consumables
Maintenance
Labor
Freight
Generalandadministrative
Cumulativecapacity(000softons/year)
(allsmeltersinacategory)
Totalvariablecostsperton($/ton)=
Average
Rational
Smelter
CIS
Allover
Allover
CIS
State
Rational
243.73
120.74
121.53
148.62
454.49
292.29
382.13
407.27
348.49
63.69
163.57
120.62
4.51
11.81
10.34
76.92
56.72
73.91
39.57
46.45
53.84
17.80
62.73
194.19
68.76
53.17
37.82
67.11
52.48
86.58
1,788.07
(AllCIS)
2,826.95
(Allstate)
16,962.17
(Allrational)
740.14
1,135.25
873.15
Sinceweassumedallsmeltershaveconstantreturns,theaveragerationalsmelters
0, 121.53]:
for
0,
$873.15
Page25of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
AverageRationalSmelter
Supply
Curve
MC=873.25
Qty
qc =121.53
Currently,thepriceofaluminumis$1,100/tonandsince:
$1,100
$873.15
Theaveragerationalsmelterwillproduceatfullcapacity(i.e.caseC):
AverageRationalSmelter
P=$1,100
Supply
Curve
MR
MC=$873.25
Qty
qc =121.53
Page26of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
CaseCwhen
Thus:
121.53and:
1,100
873.25
226.75
Since
873.25 then
873.25
873.25 121.52
$106,117 .Moreover,adding
upallaveragefixedcostitemswehave:
$345
345 121.53
$41,928
Therefore:
1,100 121.52
41,928 106,117
Noticethatproducingatfullcapacitymaximizesprofitsinthesensethatitminimizesloss.(Asastudy
question,youshouldcheckthatoperatingatfullcapacityisbetterthanshuttingdown,confirmingthe
rulethatarationalcompanyincurringlossesshouldshutdownwhen
).
Now,whatistheimpactontheaveragerationalsmeltersoptimalprofitsfrom,holdingallelseconstant,
a1%increasein:
Thepriceofaluminum?
Capacity?
Theminimumoutput?
Fixedcost?
Bytheenvelopetheorem,thechangeintheobjective(inthiscaseprofits)fromasmallchangeina
parameterisgottenbydifferentiatingtheLagrangianwithrespecttotheparameter,evaluatedatthe
initialsolution.
_____________________________________________________________________________________
Optionalnote:RecalltheLagrangianwas:
Page27of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
max L
,
AnysolutiontothisproblemmustsatisfytheKTconditions:
0,
,
0
0,
0,
0
TheproducttermsintheKTconditionsimplythatattheoptimumthefollowingtermsarezero:
max L
0
,
ThisiswhydifferentiatingtheoptimalLagrangianisequivalenttodifferentiatingoptimalprofitswith
respecttotheparameter.
____________________________________________________________________________________
EnvelopeTheorem:themarginalprofitduetoa1%increaseinaluminumprice
TheLagrangianwas:
max L
,
DifferentiatingtheLagrangianwithrespecttoaluminumprice:
Thisistheimpactonprofitsfroma$1increaseinaluminumprice.Tofindtheimpactduetoa1%
increaseinaluminumpricewehave:
%
%P
Evaluateatoptimalsolution:
%
%P
%
%P
121.52 1,100
14,373
9.3%
9.3% % P
9.3%
1%
Page28of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
9.3%
New Initial
100
Initial
9.3%
New Initial
Initial
New
New
Initial
0.093
0.093 Initial
Initial
0.093 Initial
14,373
0.093
New
New
14,373
$13,036
A1%increaseinaluminumpricesreducestheaveragerationalsmelterslossby9.3%orfromalossof
($14,373)toalossof($13,036).
EnvelopeTheorem:themarginalprofitduetoexpandingcapacityby1%
TheLagrangianwas:
max L
,
DifferentiatingtheLagrangianwithrespecttocapacity:
L
Thisistheimpactonprofitsfroma1unitincreaseincapacity.Tofindtheimpactduetoa1%increasein
capacitywehave:
%
%
Evaluateatoptimalsolution:
%
%
%
%
344.95
%
%
121.52
14,373
2.92%
2.92%
1%
2.92%
Page29of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
New Initial
100
Initial
New Initial
Initial
New
Initial
New
0.0292
0.0292 Initial
Initial
New
2.92%
14,373
New
0.0292 Initial
0.0292
14,373
$13,953.31
A1%increaseincapacityreducestheaveragerationalsmelterslossby2.92%orfromalossof
($14,373)toalossof($13,953.31).
EnvelopeTheorem:themarginalprofitduetoraisingtheminimumoutputby1%
TheLagrangianwas:
max L
,
Wehadrequiredthat
0.Rewritingthisconstraintas
max L
,
wehave:
DifferentiatingtheLagrangianwithrespectto
Thisistheimpactonprofitsfroma1unitincreaseinminimumoutput.Tofindtheimpactduetoa1%
increaseinminimumoutputwehave:
%
%
L
L
Thereisnoimpactonoptimalprofitsfromraisingtheminimumoutputrequirementby1%.Why?
Becausetheoptimalsolutionisforthesmeltertoproducewellabovezero,sothattheminimumoutput
constraintdoesnotbindassuch,thereisnovalueinrelaxingtheconstraint.
EnvelopeTheorem:themarginalprofitof1%higherfixedcost
TheLagrangianwas:
Page30of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
max L
,
DifferentiatingtheLagrangianwithrespectto
Thisistheimpactonprofitsfroma$1increaseinTFC.Tofindtheimpactduetoa1%increaseinTFCwe
have:
%
%
Evaluateatoptimalsolution:
%
%
%
%
41,928
14,373
2.92%
2.92%
1%
2.92%
New Initial
100
Initial
New Initial
Initial
New
New
New
Initial
Initial
14,373
New
2.92%
0.0292
0.0292 Initial
0.0292 Initial
0.0292
14,373
$14,793
A1%increaseinTFCraisestheaveragerationalsmelterslossby2.92%orfromalossof($14,373)toa
lossof($14,793).
Page31of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
(c)GraphtheprimaryaluminumindustrysupplycurveasifallCISsmeltersbehaveliketheaverageCIS
smelter,allstateownedsmeltersbehaveliketheaveragestatesmelter,andallrationalsmeltersbehave
liketheaveragerationalsmelter.
Answer:
FromthecaseweknowthatCISandstateownedsmeltersmostlikelybehaveasirrationalsmelters,i.e.
theyproducealuminumevenifthepricefallsbelow
.Putanotherway,irrationalsmeltersproduce
aluminumregardlessoftheprice.Recallthat:
Allcostfiguresare$/t
VariablecostsareinBOLD
AverageCIS AverageState
Smelter
Smelter
Smelter
Country
Company
AverageCapacity(000stpy)
Totalelectricitycost
Totalaluminacost
Otherrawmaterials
Plantpowerandfuel
Consumables
Maintenance
Labor
Freight
Generalandadministrative
Cumulativecapacity(000softons/year)
(allsmeltersinacategory)
Totalvariablecostsperton($/ton)=
Average
Rational
Smelter
CIS
Allover
Allover
CIS
State
Rational
243.73
120.74
121.53
148.62
454.49
292.29
382.13
407.27
348.49
63.69
163.57
120.62
4.51
11.81
10.34
76.92
56.72
73.91
39.57
46.45
53.84
17.80
62.73
194.19
68.76
53.17
37.82
67.11
52.48
86.58
1,788.07
(AllCIS)
2,826.95
(Allstate)
16,962.17
(Allrational)
740.14
1,135.25
873.15
Page32of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Assumingconstantreturnsandthatsmeltersproduceatfullcapacity(forcasesCandD)weseethat
together,thestateandCISsmelterswillproduceacumulativeoutputof1,788.07+2,826.95=4,615.02
000stonsatanypricewhiletherationalsmelterswillproduce16,962.17000softonssolongas
873.15:
PrimaryAluminumIndustry
$
Supply
Curve
Rational
smelters
873.25
CIS&Statesmelters
4.61m 21.588m
Qty
(mtons)
(d)[Thispartisindependentofallpartsbelow]Graphtheprimaryaluminumindustrysupplycurvefrom
part(c)belowandthenshowtheimpactofallrationalsmeltersexperiencinglearningbydoing
(assumelearningbydoinghasasmalleffect).
Answer
Withlearningbydoingtherewillbeadecreaseineverysmelters
. However,sincethestateandCIS
smeltersproduceatanyprice,therewillbenochangeinthetheirsupplycurvewhilstlearningby
doingpushestherationalsmelterssupplycurvedown:
Page33of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
PrimaryAluminumIndustry
$
Supply
Curve
Rational
smelters
873.25
CIS&Statesmelters
4.61m 21.588m
Qty
(mtons)
(e)Usetheprimaryaluminumsupplymodelinpart(c)topredictthedemandforprimaryaluminumfor
thecaseforthecaseswhen(i)
$800/ton,(ii)
$1,100/ton.Pleaseshowallgraphsbelowand
explainyourreasoning.
Answer:
Case(i):
$800/
.Inthiscase:
Page34of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
PrimaryAluminumIndustry
$
Supply
Curve
Rational
smelters
873.25
P=800
CIS&Statesmelters
4.61m 21.588m
Qty
(mtons)
NoticethatallCISandstatesmelterswillproducealuminumwhileallrationalsmelterswillshutdown.
Thetotaloutputwillbe4.61mtons.Assumingnoinventorybuildupsorrundowns,demandforprimary
aluminumwillbe4.61mtons.
Case(ii):
$1,100/
.Inthiscase:
PrimaryAluminumIndustry
$
Supply
Curve
P=1,100
Rational
smelters
873.25
CIS&Statesmelters
4.61m 21.588m
Qty
(mtons)
Page35of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Noticethatallsmelterswillproducealuminum.Thetotaloutputwillbe21.588mtons.Assumingno
inventorybuildupsorrundowns,demandforprimaryaluminumwillbe21.588mtons..
TheEnd
WORKSHEETS
Page36of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto
Page37of37
S.AjazHussain,Dept.ofEconomics,UniversityofToronto