EKN 110 Practical 4 Memorandum

Question 1 The following table shows the total utility for a student for two goods, pizza and beer. The student gets a monthly allowance of R40 from his parents, which he spends only on pizza and beer. The price of pizza is R8 per unit and the price of beer is R12 per unit.
Pizza Total utility (TUP) 120 200 256 296 320 Beer Total utility (TUB) 156 276 372 456 516

Units 1 2 3 4 5

1.1

Determine the quantities of pizza and beer that the student should buy. Hint: Calculate the marginal utilities and weighted marginal utilities for each of the products. Use this information to find the equilibrium position. Consumer equilibrium where MUP/PP = MUB/PB: Two pizzas and two beers. (Is it affordable? Yes, cost = 2 R8 + 2 R12 = 16 +24 = R40.)
Pizza MUP 120 80 56 40 24 Beer MUB 156 120 96 84 60

Answer:

Units 1 2 3 4 5

TUP 120 200 256 296 320

MUP/PP 15 10 7 5 3

TUB 156 276 372 456 516

MUB/PB 13 10 8 7 5

1.2

Now suppose that the price of pizza falls to R4 per unit. Derive the new quantity demanded for pizza and beer. Consumer equilibrium where MUP/PP = MUB/PB: Four pizzas and two beers. (Is it affordable? Yes, cost = 4 R4 + 2 R12 = 16 +24 = R40.)
Pizza MUP 120 80 56 40 24 Beer MUB 156 120 96 84 60

Answer:

Units 1 2 3 4 5

TUP 120 200 256 296 320

MUP/PP 30 20 14 10 6

TUB 156 276 372 456 516

MUB/PB 13 10 8 7 5

1.3

Plot the demand curve for pizza.

Answer:

Price of pizza (P) 8

4 Units of pizza (Q)

Question 2 The indifference map for a consumer is indicated below. QC

12

2.1

10 8 6

The consumer spends her income on two goods, chocolates (C) and ice cream (I). The price of a chocolate bar is R8, the price of an ice cream is R12 and the consumer earns R96 per month. Draw the budget line for the consumer on the graph illustrated above. Budget line: BB

Answer: 4 QC
2 12 0 B 10 8

10

QI
A

6 4 2 B 0 2 4 6 8 10

QI

2.2

What is the consumers equilibrium position? At point A: Six chocolate bars and four ice creams.

Answer:

Question 3 Complete the following table Answer:

Output (Q) Total cost (TC) 500 700 860 1000 1200 1500 2300 Total fixed cost (TFC) 500 500 500 500 500 500 500 Total variable cost (TVC) 0 200 360 500 700 1000 1800 Average cost (AC) Average fixed cost (AFC) 50.0 25.0 16.7 12.5 10.0 8.3 Average variable cost (AVC) 20.0 18.0 16.7 17.5 20.0 30.0 Marginal cost (MC)

0 10 20 30 40 50 60

70.0 43.0 33.3 30.0 30.0 38.3

20 16 14 20 30 80

Question 4 The table below represents the total cost structure of an energy drink manufacturer.
Output (Q) Energy drinks 0 1 2 3 4 5 6 Total cost (TC) Rand 16 24 30 34 40 50 66 Total variable cost (TVC) Rand 0 8 14 18 24 34 50

4.1

Calculate the total fixed cost (TFC) for the firm. TFC = TC TVC = 16

Answer: 4.2

Extend the above table to include the unit cost schedules of the firm.
Total cost (TC) Rand 16 24 30 34 Total variable cost (TVC) Rand 0 8 14 18 Total fixed cost (TFC) Rand 16 16 16 16 Average cost (AC) Rand 24 15 11.3 (=34/3) Average variable cost (AVC) Rand 8 7 6 Average fixed cost (AFC) Rand 16 8 5.3 (=16/3) Marginal cost (MC) Rand 8 6 4

Answer:
Output (Q) Energy drinks 0 1 2 3

4 5 6

40 50 66

24 34 50

16 16 16

10 10 11

6 6.8 (=34/5) 8.3 (=50/6)

4 3.2 (=16/5) 2.7 (=16/6)

6 10 16

4.3

Suppose the firm is a price taker and the market price of an energy drink is R5. If the firm produces six energy drinks, which are sold at the market price, what is the firms profit? Profit = TR TC = R30 R66 = - R36 ( Loss = R36) (TR = P Q = R5 6 = R30)

Answer: 4.4

Suppose that the market price of an energy drink increase to R15. If the firm still produces six energy drinks, which are sold at the market price, what is the firms profit? Profit = TR TC = R90 R66 = R24 ( Profit = R24) (TR = P Q = R15 6 = R90)

Answer: Question 5

Consider a firm facing the following demand and cost curves:

MC

Price

ATC

Quantity

P 5.1 Is the firm making an economic profit, economic loss or normal profit and why? Answer: Economic profit, because AR (=P) > ATC the firm is more than covering its costs 5.2 q1 q2 q3 Describe in words and using diagrams the process by which a movement towards long-run equilibrium would take place. Show these effects on the individual firm and the industry as a whole.

Answer: If the firm is making an economic profit, other firms will notice this and join the industry. Therefore industry supply will increase (rightward shift of supply curve), thereby decreasing the market price. This will serve to decrease the firms demand curve (and AR and MR) (which is possible

since the firm is now operating in the long-run all inputs are variable) until such point that no economic profit is being made, i.e. until AR = AC. At this point only normal profits are made. Firm
P

Industry P
MC

S S
AC

P1 P2

MR1 = AR1 MR2 = AR2

P1 P2

D
Q