EC1002 Introduction to economics
5 55
6 65
7 78
8 93
9 110
10 130
► BVFD: read the summary and work through the review questions.
Overview
As well as providing an introduction to the basic unit of production – the
firm – this block has demonstrated what lies behind the firm’s production
decisions. Using isoquants and isocost curves, the firm can determine the
least-cost combination of inputs to produce a given quantity of output. From
there, the firm’s total cost curve can be derived. It is assumed that firms
pursue a goal of profit maximisation, and one key point from this block is
that Profit = Revenue – Cost. Knowing the demand curve it faces, the firm
can derive its revenue curve, and since it knows both revenue and cost, the
profit-maximising level of output can easily be found. At this level of output,
we have also seen in this block that marginal cost and marginal revenue
are equal. Marginal analysis is a very useful tool in economic analysis, as
we have seen here in the case of the firm. As the textbook also clarifies, the
economic analysis of the firm provides a useful model for understanding
firms’ behaviour – it is not meant to be a practical system for real world
firms to follow, rather, it provides an analytical framework which helps
explain the behaviour of individual firms and the market as a whole.
Reminder of learning outcomes
Now go back to the list of learning outcomes at the start of the block and
be sure that they have been achieved.
Sample examination questions
Multiple choice questions
For each question, choose the correct response:
1. Labour Productivity at Shakespeare’s Pies:
Number of workers 0 1 2 3 4 5 6
Output of pies 0 10 26 36 44 49 52
Note: Pies are sold competitively at £3 each. Labour is the only
variable input and costs £14 per worker. Capital costs are £80. These
are short-run and long-run costs and productivities (i.e. there is no
possibility of using different production techniques or combinations in
the long run).
Using the information above, which describes the number of pies
produced as a function of the number of workers at Shakespeare’s
Pies, and focusing just on the decision to hire workers (ignoring
the shut-down condition and just trying to pick the best number of
workers), Shakespeare’s Pies maximises its profit if it hires:
a. 1 worker
b. 3 workers
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Block 5: The Firm I
c. 5 workers
d. 6 workers.
2. Anita owns a grocery shop. These are her annual revenues and costs:
Revenues £250,000
Supplies £25,000
Electricity and heating £6,000
Employees’ salaries £75,000
In addition to the above, Anita pays herself a salary of £80,000. If she
closed her shop she could rent out the land and building for £100,000.
Due to her experience at running her own shop the local supermarket
would offer her a job and pay her £95,000.
a. Anita’s revenue exceeds her economic costs so she should continue
running her business.
b. Anita’s economic costs exceed her accounting costs so she should
shut down her business.
c. Anita’s economic costs exceed her revenue so she should shut
down her business.
d. Anita’s salary is less than what the supermarket would pay so she
should shut down her business.
3. Choose the statement which is false:
When long-run costs for a firm are at a minimum
a. The ratio MPL/MPK = wage / rental.
b. MPL = MPK .
c. The extra output we get from the last dollar spent on an input
must be the same for all inputs.
d. The firm’s production is economically efficient.
Long response question
1. a. What is an isoquant?
b. Why does an isoquant get flatter as you move towards the right? Draw an isoquant and an
c. isocost line which have a point of
tangency and indicate the productive efficient level of output. How will this change if there is
an increase in the wage level? Clearly indicate output and substitution effects.
d. Use the following information to derive the total cost curve for Ice
Cream Inc. (indicating three points on the curve will be sufficient):
Production function: Q(K, L) = K*L
Rental rate of capital = £15 per hour
Wage = £15 per hour
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EC1002 Introduction to economics
2. a. Fill in the blanks in the table below
Q P TC TR MR MC π
0 5 5
1 5 10
2 5 13
3 5 14
4 5 16
5 5 19
6 5 23
7 5 28
8 5 34
Explain the difference between economists and accountants
definitions of profit. What assumption is required such that the
profit levels you calculated in the table above represent economic
profit?
b. What is the profit maximising level of output? What can you
say about the relationship between marginal cost and marginal
revenue at this point?
c. Draw a graph of a generic marginal cost schedule and a generic
marginal revenue schedule (not based on the figures above) and
indicate the profit maximising level of output.
d. Demonstrate graphically how a fall in the price of the raw
materials will affect the profit maximising level of output.
e. Demonstrate graphically how a fall in demand will affect the profit
maximising level of output.
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