Cost Theory and Profit Maximization

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Cost Theory and Profit MaximizationWeek 04 Assignment 011.Why must marginal cost intersect average cost at minimum average cost? Use your own words, notthe words in the text. (5 points)Marginal cost (MC) intersects average cost (AC) at theminimum point of average cost because of therelationship between these two costs. When marginal cost is below average cost, it pulls the average costdown, causing the average cost to decrease. Conversely, when marginal cost is above average cost, itpushes the average cost up, making the average cost increase. The point where the marginal cost curveintersects the average cost curve represents the minimum point of the average cost curve, as this iswhere the two forces balance each other out, and the average cost stops decreasing and startsincreasing.2.a) Say a wheat farmer from the Midwest wants to increase his total revenue. In this perfectlycompetitive market where there are many farmers selling wheat, the going price for wheat is $10 abushel. Do you think this farmer can increase his total revenue by raising the price he charges forwheat? Why or why not? (5 points)In a perfectly competitive market, the price is determined by the overall market supply and demand,not by individual farmers. Since the farmer is just one of many in the market, if he raises the price ofhis wheat above the market price of $10, consumers will simply buy from other farmers who areselling at the market price. Therefore, the farmer cannot increase his total revenue by raising theprice because he has no control over the market price. To increase his total revenue, the farmerwould need to increase the quantity of wheat he sells, but even then, his revenue is still determinedby the market price.b) If that farmer lived in a community where he was the only supplier of wheat and if wheat was theprimary food source for the community, do you think he could increase his total revenue by raising theprice he charges for wheat? Why or why not? (5 points)In this case, the farmer is a monopolist in the community, as he is the only supplier of wheat. If he raisesthe price of wheat, consumers will have no choice but to pay the higher price, assuming that wheat is anessential good. By raising the price, the farmer can increase his total revenue, as long as the higher pricedoes not lead to a large enough decrease in quantity demanded. Since wheat is the primary food source,demand may be relatively inelastic, meaning that consumers will not reduce their consumptionsignificantly in response to higher prices. Therefore, the farmer can likely increase his total revenue byraising the price, especially if the demand for wheat is inelastic.3.a) Using both market and firm graphs for a perfectly competitive industry, show the effect of anincrease in consumers’ income taxes. Assume the representative firm and market begin in long runequilibrium. Illustrate the short run effect on price, output, and profits, assuming this firm does notshut down. Label your graphs and explain your answer. (5 points)In the short run, an increase in consumers’ income taxes reduces consumers' disposable income,which leads to a decrease in demand for goods, including the good produced by the perfectlycompetitive firm. In the market graph, this decrease in demand shifts the demand curve leftward. Theprice in the market decreases due to the reduced demand.

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