ECONOMICS 110/111* Assignment #3

ECONOMICS 110/111*Assignment #32015/2016Due Dates and Notes:DUE: By Friday November 20, 2:00 PM. Completed assignments should be placed in the slot markedfor your section in the white assignment collection box on the 2nd floor of Dunning Hall. Lateassignments will not be accepted.Use the Cover Page (download from the Assignments page on moodle) when submitting assignments.Place diagrams for particular questions with your answers to those questions (not all at the end).Group Work: Maximum four per group, all students must be registered in the same class. Names (asthey appear on moodle) must be in alphabetical order on the cover page (last names first).Graded work will be available for pick-up beginning on the afternoon of Friday December 4 in the EconDistribution Center, Dunning Hall Room 334. You will require your student card.This assignment covers material from the Supplement Chapter “Other Household Decisions” (availableon the Reading List page on the moodle site) and from Chapters 7-9 of the text.True, False, or Uncertain[48 marks – 6 marks each]Explain why each of the following statements is True, False, or Uncertain according to economicprinciples. Use diagrams where appropriate. Unsupported answers will receive no marks. It is theexplanation that is important.A3-1. A household would prefer a reduction in the tax on interest income and an increase in the tax on currentlabour income that would leave it able to afford the original consumption in the present and consumptionin the future (Cp, Cf) bundle. [Hint: Assume all labour income is earned in the present and that saving isthe only source of future consumption.]A3-2. If the government increases Canada Pension Plan (CPP) mandatory contributions to finance an increasedretirement benefit equal to the future value of the contributions, household saving will be unaffected.[Hint: Assume that the household has private retirement saving before the change.]A3-3. Suppose 3 Econ profs quit their jobs to launch (an ethically dubiousstartup). Assume they borrow all of the money needed to start the business. Revenue is $250,000/year,and the interest on the loan is $100,000/year. The venture earns positive accounting and economic profit.A3-4. Suppose the total product (output) of a firm is given by TP = 4 + 2L (for L > 0). The firm experiencesdecreasing then constant marginal product (MP) as it increases labour.A3-5. If some technological advance increases the marginal product of labour in a firm, the firm’s marginal costcurve will shift down.A3-6. If a firm decides to increase its production level, average costs are lower in the long-run than they are in theshort-run.A3-7. In the long-run, if economic profits are zero for a firm operating in a perfectly competitive industry, thefirm has no incentive to produce and will exit the industry.A3-8. Consider a perfectly competitive industry where the firms are identical, each with U-shaped short-run andlong-run average cost curves. In the short-run, consumers bear part of the burden of a per unit tax, whilein the long-run, consumers bear the entire burden.Problems[52 marks – marks for each part as shown]A3-9. Suppose Lorne has 20 hours per day that can be spent either working or at “leisure”. Assume (at leastinitially) that Lorne earns all income from working at the after-tax wage rate of $10/hour.(a) Using an indifference curve, illustrate Lorne’s decision if he decides to work 10 hours per day.Calculate, and in your diagram, identify, Lorne’s quantity of leisure, supply of labour, andconsumption. What is the price of leisure? [5](b) If the wage fell to $5/hour and Lorne continued to work 10 hours per day, what would his decisiontell us about whether leisure is normal or inferior for Lorne? What would it tell us about the relativestrength of the substitution and income effects of the wage decrease? [5](c) Suppose the government institutes a program that will pay Lorne $100/day. However, if he works,he will have to pay back the government benefit with any labour income he earns until the full $100is paid back. Only after that will he be able keep any further labour income. Illustrate the newbudget line in your diagram. How much labour will he supply? How much consumption will hehave? Is he better off or worse off than he was in part (a)? [5](d) Now suppose the government changes the program. It will still pay $100/day, but now if he works,Lorne will have to pay only half of his labour income to the government until the full $100 is paidback. Illustrate the new budget line in your diagram. If he chooses to work 4 hours under the newscheme, how much consumption will he have? Is he better off or worse off than he was in part (b)?Which version of the program costs the government more? [5]A3-10. Fixed cost for a firm is given by FC = 400 and variable cost is given by VC = 5q + ¼q2, where q is theoutput level of the firm in a given period. Therefore marginal cost for the firm is given by MC = 5 + ½q(those of you who know calculus can confirm this – MC is the first derivative of VC with respect to q).(a) Derive an expression for average variable cost (AVC). Graph MC and AVC up to q = 80. Assumingthat the firm is a price-taker operating in a competitive market, derive an expression for the firm’ssupply curve, (ie. the profit maximizing output for the firm as a function of the market price). Whatis the shut-down price for this firm (ie. what is the price at or below which the firm chooses toproduce zero)? [6](b) What does the MC curve tell us about the marginal product (MP) of the firm’s variable factor ofproduction (presumably labour)? [4](c) Derive an expression for average total cost (ATC). At what quantity is ATC at its minimum (at whatATC level)? In your diagram, sketch ATC and confirm that it is U-shaped. [Hint: Calculate ATCwhen q = 20 and q = 80. [6](d) Assuming that there are 150 identical firms operating in this competitive industry, what is theequation of the industry supply curve? If the demand curve is given by Q = 4500 – 100P, what isthe equilibrium price, market quantity? [5](e) Given your answers from the previous part, what is the output level of each firm? Calculate andillustrate in your diagram the profit level for the firm? Is this a long run equilibrium? Explain. [5](f) Assuming that the minimum point of the short run ATC curve for all firms is also the minimum pointof the long rung average cost curve (LRAC) what is the long run equilibrium price? What is the longrun equilibrium market quantity and quantity per firm? How many firms are there in the long runequilibrium? [6]The material in this assignment is copyrighted and is for the sole use of students registered in Economics110, 111 and 112. The material in this assignment may be downloaded for a registered student’s personaluse, but shall not be distributed or disseminated to anyone other than students registered in Economics 110,111 and 112. Failure to abide by these conditions is a breach of copyright, and may also constitute a breachof academic integrity under the University Senate’s Academic Integrity Policy Statement.



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