ECO 550 Check Your Understanding – Week 5

Week 5 – Check Your Understanding:

Chapter 9 Exercise 3, 4, and 5

3.  A study of the costs of electricity generation for a sample of 56 British firms in 1946-1947 yielded the following long-run cost function: 16

AVC = 1.24 + .0033Q + .0000029Q2 – .00046QZ – .026Z + .00018Z2

Where AVC = average variable cost (i.e., working costs of generation), measured in pence per kilowatt-hour (kWh).  (A pence was a British monetary unit equal, at the time, to 2 cents U.S.)

Q = output, measured in millions of kWh per year

Z = plant size, measured in thousands of kilowatts

a)      Determine the long-run variable cost function for electricity generation.

b)     Determine the long-run marginal cost function for electricity generation.

c)      Holding plant size constant at 150,000 kilowatts, determine the short-run average variable cost and marginal cost functions for electricity generation.

d)     For a plant size equal to 150,000 kilowatts, determine the output level that minimizes short-run average variable costs.

e)      Determine the short-run average variable cost and marginal cost at the out-put level obtained in Part (d).


4. Assuming that all other factors remain unchanged, determine how a firm’s break-even point is affected by each of the following:

a)      The firm finds it necessary to reduce the price per unit because of increased foreign competition.

b)     The firm’s direct labor costs are increased as the results of a new labor contract.

c)      The Occupational Safety and Health Administration (OSHA) require the firm to install new ventilating equipment in its plant.  (Assume that this action has no effect on worker productivity.)


5.  Cool-Aire Corporation manufactures a line of room air conditioners.  Its break-even sales level is 33,000 units.  Sales are approximately normally distributed.  Expected sales next year are 40,000 units with a standard deviation of 4,000 units.

a)      Determine the probability that Cool-Aire will incur an operating loss.

b)     Determine the probability that Cool-Aire will operate above its break-even point.


Chapter 10 Exercise 2, 6, and 10

2.  Television channel operating profits vary from as high as 45 to 55 percent at MTV and Nickelodeon down to 12 to 18 percent at NBC and ABC.  Provide a Porter Five Forces analysis of each type of network.  Why is MTV so profitable relative to the major networks?

6.  Assume that a firm in a perfectly competitive industry has the following total cost schedule:

















a)      Calculate a marginal cost and an average cost schedule for the firm.

b)     If the prevailing market price is $17 per unit, how many units will be produced and sold?  What are total profits?

c)      Is the industry in long-run equilibrium at this price?

10.  Which of the following products and services are likely to encounter adverse selection problems:  golf shirts at traveling pro tournaments, certified gemstones from Tiffany’s, graduation gift travel packages, or mail-order auto parts?  Why or why not?


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