Universidad Carlos III de Madrid – Department of Economics
Principles of Economics - Course 2020-2021 - Problem Set 5
Conceptual Questions
Write down a short and concise answer. When you are asked to solve the question in class, explain
the concept clearly and give examples or pieces of evidence.
1. The isoprofit curves for Cheerios are downward-sloping, but for Beautiful Cars they slope
downward when Q is low and upward when Q is high. In both cases the higher isoprofit curves
get closer to the average cost curve as quantity increases. Why?
2. What is the reason for the difference in the shape of the isoprofit curves between Cheerios and
Beautiful Cars?
3. Food taxes intended to shift consumption towards a healthier diet are controversial. Some
people think that individuals should make their own choices, and if they prefer unhealthy
products, the government should not interfere. In view of the fact that those who become ill
will be cared for at some public expense, others argue that the government has a role in
keeping people healthy. In your own words, provide arguments for or against food taxes
designed to encourage healthy eating.
4. Imagine that you are a politician in a town where a multinational retailer is planning to build a
new superstore. A local campaign is protesting that it will drive small independent retailers out
of business, and thereby reduce consumer choice and change the character of the area.
Supporters of the plan argue in turn that this will only happen if consumers prefer the
supermarket. Which side are you on?
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Problems
1. Below you can see the average and marginal costs per student for the year 1990-1
that Koshal and Koshal calculated from their research.
a. How do average costs change as the numbers of students rise? lowers
b. Using the data for average costs, fill in the missing figures in the total cost column.
58 063 500 and 14 308 800
c. Plot the marginal and average cost curves for undergraduate education on a graph,
with costs on the vertical axis and the number of students on the horizontal axis. On a
separate diagram, plot the equivalent graphs for graduates. (Upload photos)
d. What are the shapes of the total cost functions for undergraduates and graduates?
(You could sketch them using what you know about marginal and average costs.) Plot
them on a single chart using the numbers in the Total cost column. (photo)
e. What are the main differences between the universities’ cost structures for
undergraduates and graduates?
f. Can you think of any explanations for the shapes of the graphs you have drawn?
2. Figure 7.19 shows the spending per week in each category of a US consumer whose
total expenditure on food is $80, with typical spending patterns across food categories.
Suppose that the price of category 30, high-calorie milk products, increased by 10%:
a. By what percentage would his demand for high-calorie milk products fall?
b. Calculate the quantity he consumes, in grams, before and after the price change.
c. Calculate his total expenditure on high-calorie milk products before and after the
price change. You should find that expenditure falls.
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d. Now choose a category for which the price elasticity is less than 1, and repeat the
calculations. In this case you should find that expenditure rises.
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Other Questions
1. Which of the following events would contribute to economies of scale? (Economies
of scale a bigger firm produces at a lower cost; e.g.: when we live by ourselves, we’ll
have many fixed costs which we have to pay on our own; however, when a family lives
together. The cost of a house per person is less; this makes us think why bigger firms are
sometimes more useful);
a. Large supermarkets being able to drive down the cost of purchasing milk as it
increases its scale of business. (The producer prefers to produce a lot for a fixed price
discounts on large quantities; supermarkets buy a lot and with discounts)
b. The expansion of the workforce requiring extra layers of management for better
performance monitoring. (A firm which requires extra workforce, we’re not told it
produces more same production, higher cost)
c. A merger of two firms leading to large increases in the costs of HR, IT, and legal
departments. (It may be the case that there are some economies of scale, but we’re not told
about increasing production, which means we cannot say anything about economies of
scale)
d. The higher the number of users of Windows 10, the less likely it is that Microsoft
will be able to achieve a higher sale of its operating system. (It’s the opposite if a lot of
people are using Windows, more people will be taught how to use it there will be even
more purchases)
2. The following is a table of the total cost (TC) of producing output Q for a particular
firm. Based on this information, which of the following statements is correct?
a. The average cost at Q = 40 is £7.
b. The marginal cost at Q = 80 is £9.50.
c. The marginal cost is higher than the average cost at Q = 50.
d. The marginal cost curve intersects the average cost curve at Q = 60.
3. Suppose that the marginal cost of producing a pound of cereal is $2, irrespective of
the level of output, but there are also some fixed costs of production. Which of the
following statements is correct?
a. The total cost curve is an upward-sloping straight line through the origin. (We have
a fixed cost, so we always pay it no matter how many units we produce)
b. The average cost curve is U-shaped. (No, it’s decreasing; we divide the fixed cost
by more and more units, which leads us to conclude that it’s always better to produce
more);
c. The marginal cost curve is a horizontal straight line.
d. The marginal cost curve intersects the average cost curve at its minimum point.
(The average cost line doesn’t have a minimum in this case; the average cost is always
above the marginal cost they never intersect, as the AC can never reach 2 no matter the
quantities it’s always, always strictly higher than 2)
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4. The following figure depicts a firm’s profit-maximising choice at point E, given the
market demand curve and the firm’s marginal cost curve. You are given that the firm’s
marginal costs are $400, $2,960 and $4,200 at output levels Q = 0, Q* = 32 (point E) and
Q0 = 48 (point F), respectively. Based on this information, which of the following
statements is correct?
a. The consumer surplus at E is $41,000.
b. The producer surplus at E is $126,720.
c. The deadweight loss at E is $19,840.
d. The gains from trade at E are $120,320.
