ECON 221_2. Assignment II (out of 16 marks). Due April 02, 2021.

Name: …………….………………………………ID: ……………

Course Learning Outcomes PLO

CLO2: Explain the managerial problems by making use of cost theory 1
CLO4: Formulate Consumer Choices using Utility Theory 4

Answer All Questions. Submit online on Moodle. DO NOT email attachments.

Show your workings.
QN 1. Mary has an income of 600 dollars per week, which she can split between
consumption of pizza and coke (Figure 1). The price of pizza is currently $12, while coke
costs $8. At these prices, she divides her income between the two goods such that her
optimal consumption point is at point K (with 28 pizza) shown on original budget line B 0.
Suppose that the price of pizza decreases to $10, so that the new budget line is B 1. Mary’s
optimal point now becomes point M (with 35 Coke).
Figure 1

Pizza

X1
B1

X2 B0

M
X3

K IC1
28
IC0

Coke
X40 35 X5

(a): Compute the missing values in the diagram (x1, x2, x3, x4 and x5) (2.5 marks).

x1 = 60
x2 = 50
x3 = 32
x4 = 33
x5 = 75

calculation:
X1 is the quantity of pizza when price of pizza = $10. With $600 income, Mary can purchase 600/10
= 60 pizzas.

x2 is the quantity of pizza when price of pizza = $12. With $600 income, Mary can purchase 600/12
= 50 pizzas.

x3 is the quantity of pizza (price of pizza = $10) Mary can buy when she buys 35 units of coke.
600 = 35*8 + 10P So, P =  (600-280)/10 = 32

x4 is the quantity of coke when Mary buys 28 pizzas (price of pizza = $12).
600 = 28*12 + 8C So, C = (600 - 336)/8 = 33

x5 is the amount of coke Mary can buy with income $600. 600/8 = 75

2. Price/ quantity pair:

(b): The price __12_____ and Quantity ___28_____ pair, AND price __10______ and quantity
__32______ pair belong on Mary’s demand curve for pizza. Fill in the missing Price and
Quantity pairs that are on Mary’s demand curve for pizza (2 marks).

As seen above, when price of pizza is $12, Mary can buy 28 pizzas.
600 = 12*28 P + 8*33 C

Similarly, when price of pizza = $10, Mary can buy 32 pizzas.

600 = 10*32 P + 8*35 C

P = pizza; C = coke
Question 2: A small coffee shop operating in a perfectly competitive environment has the costs shown.
(a): Compute the missing costs and complete the table up to quantity =60 (use at least 2 decimal places) (4.5 marks)

Quantity of Variable Costs Total Cost (TC) Average Average Fixed Average Total Marginal Cost
coffee (in kgs) (VC) Variable Cost Cost (AFC) Cost (ATC) (MC)
(AVC)
0 0 50 N/A N/A N/A NA

10 25 75 2.5 5 7.5 2.5

20 48 98 2.4 2.5 4.9 2.3

30 75 125 2.5 1.67 4.17 2.7

40 108 158 2.7 1.25 3.95 3.3

50 150 200 3 1 4 4.2

60 204 254 3.4 0.83 4.23 5.4

(b). Compute the profit (or loss) the business would make if the current market price is 5.4 and explain if the business should
continue operating, shut down, or exit in the short run. Briefly explain your choice [2.5 marks].
Answer: When the market price is $5.4, the firm is making profit. The total revenue at market price $5.4 is $324 (5.4*60) and total cost is
$253.8 The profit is $70.2 So the business should continue operating.

(c). Compute the profit (or loss) the business would make if the current market price is 3.3 and explain if the business should
continue operating, shut down or exit in the short run. Briefly explain your choice [2.5 marks].
Answer: At market price $3.3, the firm is making loss. The total revenue at market price $3.3 is $132 (3.3*40) and total cost is $158. The
loss is $26. But since price ($3.3) is more than average variable cost ($2.7), it should continue operating.

(d). At what quantity does the business achieve the “efficient scale” of operation? Briefly explain [2 marks]
Efficient scale is when average total cost is minimum. At quantity 40, the average cost is minimum ($3.95), so it is efficient scale of
operation.