1. You are a jewler so you can buy and sell gold at market price. Last month you bought 1 ounce for $1,600. The current market price is $1,700. If you are asked to make the gold into a ring, what is the opportunity cost of using the gold? What if it is now $1,500 an ounce? Explain. In both parts a and b the opportunity cost of the ounce of gold is the market price. The opportunity cost is the best alternative use for the gold. Because you buy and sell gold, you always have the option of selling the ounce of gold. In part a, you can sell the ounce of gold for $1,700, so if you use it for a ring, you have foregone the opportunity to sell it for $1,700. Hence $1,700 is the opportunity cost ofthe gold in part a. In part b, you can sell the gold for $1,500, so if you use it for the ring, you have foregone the opportunity to sell it for $1,500. Yes, you initially paid $1,600 but that payment is a sunk cost—it has been made and nothing can change it. So the opportunity cost of the ounce of gold in part b is $1,500. The main point here is that what you initially paid for the gold does not affect the opportunity cost of using it. That opportunity cost will be influenced by the current price of the gold not its historical price.
2. You have a store selling cookies in the local mall. You have 6 months left on a 12 month lease. Your rent is $3,000 per month plus 1% of your sales. If you remain open, you would maximize your profit by selling 5,000 cookies per month at a price of $2 per cookie. Tomake 5,000 cookies, the cost of the ingredients is $2,500. You have four workers and you pay each$1,500 per month. The normal profit from running a mall‐based cookie store is $2,000 per month. You forecast that your costs and revenues will never change. Shouldyou close or stay open? Why? What is your economic profit or loss?Let’s first see what sort of profit or loss you are facing. After all, if your cookie store is making aneconomic profit or a normal profit, then answering the question is easy: You will stay open. To thisend, the revenue is $10,000 (5,000 cookies x $2 per cookie). Your costs are the rent, $3,000, 1% of your sales, $100 ($10,000 x 0.01), ingredients, $2,500, workers, $6,000 (4 workers x $1,500), and normal profit, $2,000, for a total cost of $13,600. Sadly you have a loss of $3,600 ($10,000 of revenue minus $13,600 of costs). Hence the question of staying open or closing is of relevance. You will stay open if your loss when open is less than your loss when closed. What is your loss if you close? It is equal to your fixed cost. And so what is the fixed cost? Well, the $3,000 of rent is a fixed cost—you must pay that for the next 6 months, open or closed. The 1% of your sales is precisely $0 if you are closed. If you are closed, you will not buy ingredients ($2,500), hire workers ($6,000), or use your entrepreneurial ability to run your store ($2,000), so these are all variable costs. Hence your los if closed is only $3,000, which is less than your loss if open. You should close.
3. Corn is primarily purchased by two groups: Those who use it to make ethanol and those who useit as animal food. Suppose the elasticity of demand differs between these two groups. Is a perfectlycompetitive corn farmer able to price discriminate? Why or why not? Looked at correctly, this question is quick to answer: To be able to price discriminate, a producer musthave some market power. That is, the producer must be able to determine what price he or she willset. A perfectly competitive firm must take the price that the market determines and cannot set itsprice. So a perfectly competitive corn grower cannot price discriminate.The “problem” for the corn farmer is that while there are two classes of customers, it is such a smallpart of the market that it cannot affect the price it charges. If any particular farmer tried to set ahigher price to those buyers with the smaller elasticity, those buyers would simply switch to thehundreds of thousands of
