S. Klepper, Economics 73-100, Fall 2009

Solution to Quiz 4

A subsidy of variable costs of 10% means that total variable costs at every level of output fall by 10%, which in turn implies a decline of 10% in marginal and average variable costs at every level of output. A subsidy of fixed costs of 20% implies that average fixed costs decline by 20% at every level of output. With average variable costs falling by 10% at every level of output and average fixed costs falling by 20% at every level of output, average total costs will fall between 10% and 20% at every level of output. The minimum price required to get a firm to produce a positive level of output in the short run equals the minimum value of average variable cost across all output levels. With average variable cost falling by 10% at every level of output, the minimum price needed to get a positive level of output supplied in the short run would then fall by 10%. Finally, each firm’s short-run supply curve is the firm’s marginal cost curve above its average variable cost curve. Since marginal cost falls by 10% at every level of output, the marginal cost curve shifts down and to the right, which means the firm supply curve shifts to the right. Consequently, the market supply curve must shift to the right. Nothing happens to the market demand curve for automobiles since the subsidy is directed entirely to producers and thus has no direct effect on demanders.

Based on this description, the answers to the individual questions are:

_____1. True

_____2. True

_____3. False

_____4. True

_____5. False