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Chapter 11

1. The MidNight Hour, a local nightclub, earned $100,000 in accounting profit last year. This year the owner, who had invested $1 million in the club, decided to close the club. What can you say about economic profit (and the rate of return)in the nightclub business?

2. Redstone Clayworks, Inc., a small firm located in Sedona, manufactures clay fire pits
that homeowners place on their patios for decoration and light-duty heating. Red-
stone is one of 53 firms worldwide supplying clay fire pits to retailers such as Home
Depot, Lowe’s, Front Gate, and other upscale home product chains. Despite the best
marketing efforts of these retailers to differentiate their individual brands of fire pits,
consumers don’t care much about brands: A clay fire pit is a clay fire pit, regardless of who sells it. The following spreadsheet below provides data on Redstone’s costs of production.
(1) (2) (3) (4)
0 5,000 5,000 0
100 10,000 5,000 5,000
200 19,000 5,000 14,000
300 27,000 5,000 22,000
400 38,000 5,000 33,000
500 50,000 5,000 45,000
600 66,000 5,000 61,000
700 84,000 5,000 79,000
800 104,000 5,000 99,000
900 126,000 5,000 121,000
1,000 150,000 5,000 145,000

a. Create a spreadsheet that matches the one above by entering the output and cost data given above. Then use the appropriate formulas to create four new columns in your spreadsheet for average fixed cost ( AFC ), average variable cost ( AVC ), average total cost ( ATC ), and short-run marginal cost ( SMC ). [Computation check: At Q 5 400, SMC 5 $110].
The world demand and supply curves for clay fire pits intersect at $190 per unit.

b. Use the appropriate formulas to create two more columns in your spreadsheet for
total revenue ( TR ) and marginal revenue ( MR ). [Computation check: At Q 5 400:
MR 5 $190].
c. Use the appropriate formulas to create three more columns in your spreadsheet for
profit ( PROF ), average profit ( AVGPROF ), and profit margin ( PROFMARG ). [Com-
putation check: At Q 5 400: AVGPROF 5 $95].
d. If Redstone’s manager wishes to minimize average total cost, how many clay fire
pits should be produced? How many to maximize profit margin?
e. Redstone’s manager is fired, and you are now the manager of Redstone Clayworks.
How many fire pits would you choose to produce? Why?
f. Now triple the total fixed costs to $15,000 in your spreadsheet. How does this
change your production decision in part e ? Explain briefly.
g. Suppose a congressional environmental panel announces that greenhouse gases
from clay fire pits are contributing significantly to global warming. The announce-
ment causes worldwide demand for fire pits to shrink substantially, and clay fire pit
prices fall to $65 per unit. How does this change your production decision in part e ?
Explain briefly. [Note: Return total fixed cost to the original level of $5,000.]

7. At a recent board meeting, the president and CEO got into a heated argument about whether to shut down the firm’s plant in Miami. The Miami plant currently loses $60,000 monthly. The president of the firm argued that the Miami plant should continue to operate, at least until a buyer is found for the production facility. The president’s argument was based on the fact that the Miami plant’s fixed costs are $68,000 per month. The CEO exploded over this point, castigating the president for considering fixed costs in making the shutdown decision. According to the CEO, “Everyone knows fixed cost don’t matter!”
a) Should the Miami plant be closed or continue to operate at a loss in short run?
b) How would you explain to the incorrect party that he or she is wrong?

Chapter 12
3. The El Dorado Star is the only newspaper in El Dorado, New Mexico. Certainly, the Star competes with The Wall Street Journal, USA Today, and the New York Times, for nation news reporting, but the Star offer readers stories of local interest, such as local new, and cost schedules shown in the spreadsheet that follows:
Number of
news papers Total cost per day
per day (Q) Price(P) (TC)
0 0 $ 2,000
1,000 $1.50 2,100
2,000 1.25 2,200
3,000 1.00 2,360
4,000 .85 2,520
5,000 .75 2,700
6,000 .65 2,890
7,000 .50 3,090
8,000 .35 3,310
9,000 .10 3,550

a. Create a spreadsheet that matches the one above by entering the output, price, and cost data given?
b. Use the appropriate formulas to create three new columns (4,5,and 6) in your spreadsheet for total revenue, marginal revenue (MR), and marginal cost (MC), respectively. [Computation check: at Q = 3,000, MR = $0.50 and MC = $0.16]. What price should the manager of the El Dorando Star charge? How many papers should be sold daily to maximize profit?
c. At the price and output level output you answered in part b, is the El Dorado Star making the greatest possible amount of total revenue? Is this what you expected? Explain why or why not.
d. Use the appropriate formulas to create two new columns (7 and 8) for total profit and profit margin, respectively. What is the maximum profit the El Dorado Star can earn? What is the maximum possible profit margin? Are profit and profit margin maximized at the same point on demand?
e. What is the total fixed cost for the El Dorado Star? Create a new spreadsheet in which total fixed cost increases to $5,000. What price should the manager charge? How many papers should be sold in the short run? What should the owners of the Star do n the long run?
10. The Ali Baba Co. is the only supplier of a partucalr type of Oriental carpet. The estimated demand for its carpet is
where Q= number of carpets, P= price of carpets (dollars per unit), and M=consumers income per capita. The estimated average variable cost function for Ali Babas carpet is
AVC+200-0.012Q+0.000002Q2 (squared)
Consumers income per capita is expected to be 20,000 and total fixed cost is 100,000.
a. How many capers should the firm produce in order to maximize profit?
b. What is the profit maximizing price of carpets?
c. What is the maximum amount of profit that the firm can earn selling carpets?
d. answer parts a-c if the consumers income per captia is expiated to be 30,000 instead.

11. Dr. Leona Williams, a well-known plastic surgeon, has a reputation for being one of the best surgeons for reconstructive nose surgery. Dr. Williams enjoys a rather substantial degree of market power in this market. She has estimated demand for her work to be Q=480-0.2P, where Q is the number of nose operations performed monthly and P is the price of a nose operation.

a. What is the inverse demand function for Dr. William’s services?
b. What is the marginal revenue function?

The average variable cost function for reconstructive nose surgery is estimated to be

AVC=2Q (squared) – 15Q + 400, where AVC is average variable cost (measured in dollars), and Q is the number of operations per month. The doctor’s fixed costs each month at $8,000.

c. If the doctor wishes to maximize her profit, how many nose operations should she perform each month.

d. what price should she charge to perform a nose operation?
e. how much profit does she earn each month?


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