ECON HW # 5

Ilana Berger, Jessica Gonsalves, Sankalp Khare, James Lee, Cesar Valiente Professor Kirsten Daniel Microeconomics for Management Group Homework # 5 Problem #1 The long-run average cost curve is estimated by the equation: LAC = 1000 - 2.5Q + 0.005Q 2 a) Compute the minimum efficient scale of production. d LAC / d Q = 0 -2.5 + 0.01 Q = 0 Q = 250 b) Distinguish between economies of scale and the learning curve in general. What is the minimum efficient scale and which concept does it relate to? Economies of Scale: This refers to average long term cost being reduced, or even per unit cost being reduced as the output of an organization increases. It refers to the advantages that a company can have by producing on a large scale to reduce its costs. A higher profit is produced for each extra unit we produce. Learning Curve: The learning curve contrasts the economies of scale because it refers to average cost being reduced in the long run due to an increase in cumulative output. This leads to an increasing production experience and if a worker is more productive and efficient, it reduces costs for producing each additional unit. Minimum Efficient Scale: It is the minimum output for an organization where the firm will meet the minimum for the average long term cost at first and is related to economies of scale. It is the point when the unit cost is at its lowest point of the curve. The company produces its units effectively at the minimum cost per unit.

Problem # 2 In the late 1990s a study sponsored by the California Agriculture Board found that moderate daily consumption of red wine reduced the incidence of heart disease in laboratory rats. As a result of national press coverage of the report, the demand for red wine increased dramatically. Assume that the wine market satisfies all of the attributes of a competitive market. Further assume that red grapes are the most expensive input into the red wine production process. a) Use a graph of the market for wine to demonstrate the effect of the report on market equilibrium. We can observe that the demand will increase, shifting the demand curve upwards. Thus, both the price and quantity in the market will increase from P 0 to P 1 and Q 0 to Q 1 .

ATC will increase due to the rise of red grapes price resulting from the increase in production of red wine. This will lead to upward sloping industry supply. Problem # 3 In each of the following scenarios, explain why the dollar will appreciate or depreciate in a system of floating exchange rates. a) Some major European countries experience a much faster growth rate than the US. Exports are increasing more rapidly than imports, which causes the dollar's demand to increase faster than its supply. The result will be an appreciation of the dollar in a system of floating exchange rates . b) Interest rates on government bonds rise in the US but remain stable in Germany. As a result, both domestic and international investors will have a greater desire for American financial assets. As a result, there will be a decline in production while the desire for the dollar rises. The result will be an appreciation of the dollar in a system of floating exchange rates. c) Inflation rates are higher in the US compared to its major European trading partners. As a result, there will be fewer exports and more imports, which will result in less demand for dollars and more availability. The result will be depreciation of the dollar in a system of floating exchange rates. Problem # 4 CPFE is a producer of watches located in the US. Its production is either sold in the internal market or it is exported and sold in Europe. The demand for watches in the US is QUS = 500- 20PUS(dollars) and in Europe, QEurope = 750 - 5PEurope(euros). Assuming that the exchange rate US Dollar/Euro is e = 1.2, i.e., you need 1.2 dollars to buy 1 euro, the transportation costs are equal to $1 per watch, the cost of production is C (Q) = 10 + 15Q, C (Q) and PUS are measured in US dollars and PEurope is measured in euros, determine the following: a) The optimal local prices and quantities in the US and the European markets. US Q us = 500 - 20P

P = 25 - 0.05Q us MR = 25 - 0.1Q us MR = MC 25 - 0.1Q us = 15 Q us = 100 P us = 20 Europe P Europe = 150 - 0.2Q Europe MR = 150 - 0.4Q Europe MR = MC 150 - 0.4Q Europe = 15 + 1 *to convert Euros to dollars 150 x 1.2 - (1.2 x 0.4Q Europe ) = 15 + 1 180 - 0.48Q Europe = 16 Q Europe = 342 P Europe($) = 97.92 P Europe(euro) = 97.92/1.2 = 81.60 b) Recently, the interest rates in the US were raised which made the US dollar appreciate, in this case it went from e = 1.2 to e = 1.1. Under this new exchange rate, what happens to the optimal prices and quantities in the US and what happens to the optimal prices and quantities in Europe? P Europe = 150 - 0.2Q Europe MR = 150 - 0.4Q Europe MR = MC 150 - 0.4Q Europe = 15 + 1 *to convert Euros to dollars 150 x 1.1 - (1.1 x 0.4Q Europe ) = 15 + 1 165 - 0.44Q Europe = 16 Q Europe = 339 P Europe($) = 165 - (1.1x 0.2 x 339)= 90.42 P Europe(euro) = 90.42/1.1 = 82.20 c) Based on this example, what can you say about the effect of an exchange rate appreciation on the exports of a firm? This example shows us that after the increase in value of the exchange rate, exports will go down in both the quantity and the value.