1.    The relationship between thefirm and the customer – the demand curve (sec. 7.1).

What is meant by a demand curve?

Consider the demand curve for Honey Weeties produced by Kelloggs in the diagram below. Please note that the demand curve is linear (a straight line). How many boxes of cereal can  Kelloggs’ expect to sell if the price is $8? What if the price is $4? What if the price is $2 per box? How much profit will Kellogg’s make if the cost of making a box of cereal is $1.00 at each of these prices?

What does this tell you about the trade-off Kellogg’s must make when deciding how much cereal to make and sell to maximise profit?

Price ($)

8.00

4.00

2.00

2000

6000

8000

Quantity (Q)

2.    The relationship between thefirm and the customer – isoprofit curves (sec. 7.1).

What is meant by the firm’s isoprofit curve? In the diagram from question 1, draw a series of isoprofit curves including a zero isoprofit curve.

Why are slopes of the isoprofit curve and the demand curve referred to as the marginal rate of substitution and marginal rate of transformation respectively?

Why is the firm’s problem of choosing the best price to maximise profit referred to as a constrained optimization?

3.    Why does the demand curve define the feasible set for a producer such as the one depicted in questions 1 and 2?

4.    Understanding Costs (sec. 7.2)

Describe what is meant by economies of scale and diseconomies of scale.

5.    Average cost and marginal cost (sec. 7.4 – 7. 7)

When we considered the cost of producing Honey Weeties, (question 1), we argued that the cost of each box was constant and equal to $1. In fact, costs are not usually constant.

Consider Figure 7.8 from the text which presents the average and marginal cost curves for Beautiful cars.

What is meant by average cost (AC)?

What is meant by marginal cost (MC)?

Why does the MC curve go through the minimum of the AC curve?

6.    Consumer surplus, producer surplus and total surplus (sec. 7.4 – 7. 7)

Consider the following diagram that shows the demand curve, the marginal cost curve, the     profit maximising isoprofit curve and the equilibrium outcome for Beautiful cars from figures 7.13 in the textbook.

Price ($)

7000

P*=5440

Q=20    Q*=32

Describe why some buyers receive a net benefit when they purchase from BCInc at the profit maximising price of $5440. Show the value of the consumer surplus in the diagram. Explain why the demand curve is a willingness to pay curve.

Show how BCInc benefits from participating in the market and generates producer surplus. Show the producer surplus in the diagram.

What is the loss of surplus called?

7.    Another way to think aboutprofit maximisation (sec. 7.6)

Consider the following table which describes the marginal revenue and marginal cost for WidgetInc, a manufacturer of small passenger cars.

What will happen to WidgetInc ’s profits if they are initially producing 122 cars and increase the number of cars produced by one? Why?

What will happen to WidgetInc ’s profits if they are initially producing 128 cars and decrease the number of cars produced by one? Why?

What does this imply about the profit maximisation decision?

8.    Elasticity.

What is meant by the term price elasticity of demand? Are the following goods likely to have elastic or inelastic demand? Why?

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Cigarettes

Bananas sold at Coles supermarket