1. Explain the difference between the short run and the long run. Assume a firm sees a sudden rise in demand for their production. What resources can the firm vary to increase production in the short run? What is fixed in the short run? Suppose a restaurant decides to build a bigger kitchen. Is this a short run or a long run decision?

2. Capital (tool or factory) is considered a fixed cost. Firms make interest payments of fixed amounts to those from whom they borrowed money. What happens to the average cost of capital as the total product sold increase? (Hint: look at AFC in the graphs and tables.) Then explain the following statement "If a market is sufficiently large, capital pays for itself."

3. Use a restaurant kitchen to demonstrate the law of diminishing marginal returns. Assume that the oven is the fixed resource. (In other words, you have only one oven.) The variable resource is cooks (you may add as many cooks as desired to the kitchen staff.) According to the law of diminishing marginal returns, how does the return of the first cook compare to the return of the fourth cook? Why? And why don't we add as many cooks as possible?

4. What are economies of scale? Why does mass production lead to lower average costs of production in the long run? Explain how large economies of scale for one firm might drive out competition in an industry. What do we call a firm, which is a monopoly because of economies of scale?

5. Fill in the following table Q FC VC TC AFC AVC ATC MC

0 60

1 100

2 140

3 170

6. Draw the following graph and label each curve: Draw average total cost curve above an average variable cost curve with marginal cost passing through their minimum (lowest point). Draw a flat perfectly elastic demand line anywhere on the graph. Label the demand curve equal to marginal revenue. Identify the profit maximizing price and quantity (profit maximizing rule). Going up from the quantity, identify whether there is a profit or loss box on your graph and label the box.