S. Klepper, Economics 73-100, Fall 2011

Solution to Quiz 7

If total variable costs increase by 10% at every level of output then the marginal cost curve of hospitals must increase by 10% at every level of output. The cost increase has no direct effect on demanders, hence the market demand curve is not affected. The effect of the cost increase on the price and output of hospital services is pictured below. Before the increase in marginal cost, the output of hospital services was q₀, which is where marginal cost equaled marginal revenue. The original price, p₀, is the price at which the quantity demanded equaled q₀. After the increase in marginal cost, marginal revenue equals marginal cost at the lower output of q₁, and price rises to p₁. As the graph illustrates, the price does not necessarily rise by the 10% increase in marginal costs at every level of output. Furthermore, the extent of the fall in quantity depends on the marginal cost and marginal revenue curves and will not generally be 10%. With quantity declining and price not necessarily rising by 10%, total expenditures on hospital services will not generally rise by 10%.

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

_____1. False

_____2. True

_____3. True

_____4. False

_____5. False