Problem set 9 - Supply

Multiple choice questions

1. A profit-maximizing dairy farm is currently producing 10,000 gallons of milk per day. The government
is considering two alternative policies. One is to give the farm a lump sum subsidy of $500 per month. The
other policy is to give the farm a subsidy of $.05 per gallon of output.
a. Both kinds of subsidy will increase production at this farm.
b. Neither subsidy will affect production at this farm, since output is determined by profit
maximization.
c. Production at this farm will be increased if the per-unit subsidy is adopted but not if the lump
sum subsidy is adopted.
d. Which subsidy has the greater effect on production at this farm depends on whether fixed
costs are greater than variable costs.
e. Production will be increased by either kind of subsidy if and only if there are not decreasing
returns to scale.

2. A competitive firm uses two variable factors to produce its output, with a production function q 

min x 1, x 2. The price of factor 1 is $8 and the price of factor 2 is $5. Due to a lack of warehouse space,
the company cannot use more than 10 units of x 1. The firm must pay a fixed cost of $80 if it produces any
positive amount but doesn’t have to pay this cost if it produces no output. What is the smallest integer price
that would make a firm willing to produce a positive amount?
a. $44
b. $41
c. $29
d. $13
e. $21

3. A competitive firm has a single factory with the cost function c(y)  4 y 2  89 and produces 28 units
in order to maximize profits. Although the price of output does not change, the firm decides to build a

second factory with the cost function c(y)  8 y 2  39. To maximize its profits, how many units should it
produce in the second factory?
a. 14
b. 21
c. 9
d. 13
e. None of the above.
Problems

1. A competitive firm has the following short-run cost function: c(y) = y 3− 8 y 2 + 30y + 5.
(a) The firm’s marginal cost function is ___________.
(b) The firm’s average variable cost function is _________ .
(c) On the axes, sketch and label a graph of the marginal cost function and of the average variable cost
function.
(d) Average variable cost is falling as output rises if output is less than ____ and rising as output
rises if output is greater than _____.
(e) Marginal cost equals average variable cost when output is ______.
(f ) The firm will supply zero output if the price is less than _______.
(g) The smallest positive amount that the firm will ever supply at any price is _____. At what price
would the firm supply exactly 6 units of output?.

2. Severin, the herbalist, is famous for his hepatica. His total cost function is c(y) = y 2 +10 for y > 0
and c(0) = 0. (That is, his cost of producing zero units of output is zero.)
(a) What is his marginal cost function?
(b) What is his average cost function?
(c) At what quantity is his marginal cost equal to his average cost?
(d) At what quantity is his average cost minimized?
(e) In a competitive market, what is the lowest price at which he will supply a positive quantity in
long-run equilibrium?
(f) How much would he supply at that price?