EXERCISE 13: Theory of the Firm, Cost Curves, Competition, Returns to Scale
J Wahl – Micro Principles
1. Suppose you have 10 grades in your micro principles course, all of which count equally. You start
out well, then you slack off, then you really work hard to get your grades back up again. Suppose you have
the following scores over the term: 100, 90, 80, 75, 60, 70, 75, 78.57, 79.82, 85. Suppose also that I allot
you 10 points as a gift at the beginning of the course. You could forfeit this 10 points (by not showing up
to class, refusing to lend me money – just kidding!). As a result, you keep track of your average grade with
and without the 10 points. You can think of your scores as “variable” elements in your final grade and the
10 points as “fixed”. Please fill in the following chart:
Marginal points
Fixed points
Total points
average points
average variable points
Also, please graph the marginal, average, and average variable points (y axis) against number of scores (x
axis). What general relationships do you see among these curves?
2. 2. Economists typically draw the short-run marginal cost curve as U-shaped (like your point scores in the
previous problem). Please explain why, in layperson's terms.
3. 3. Suppose you are deciding how many bottles of soda to produce per minute in your factory. Your
industry consists of many identical small producers, so you have no control over prices. Your fixed costs
per minute equal 1. Your variable costs depend on the number of bottles produced, according to the
following schedule:
bottles/minute TVC
0 0
1 .8
2 .93
3 1.13
4 1.4
5 1.7
6 2.04
7 2.44
8 2.93
9 3.73
10 4.73
Please figure out the MC, AVC, and AC per bottle at each possible production point listed. If a
firm chooses the number of bottles by seeking to maximize profit, how many bottles of soda will you
produce if the price is 80 cents per bottle? 49 cents? 34 cents? 20 cents? (If you come up with two
possible quantities, choose the larger one.) What have you discovered about the short-run supply curve of a
competitive firm and its relation to cost curves?
4. Please graph the relationship between long-run average cost and short-run average cost for a given
firm.
5. Suppose that your industry operates at constant returns to scale -- that is, when you double all
inputs, you also double your output. What do your cost curves look like? What would cost curves look
like if you operated at increasing returns to scale? Decreasing returns to scale? If returns to scale depend
upon the scale of your operation, how would you decide how much output to produce?
