5. (Similar to class activity 1 on 11/7): Consider the following information for
ID: 1105838 • Letter: 5
Question
5. (Similar to class activity 1 on 11/7): Consider the following information for a firm that is currently producing 500,000 gadgets: Workers Wage per worker Cost of Raw Materials Rent of Factory and Machine Cost of Ener TOTAL COST 20 $60,000 $2,000,000 $700,000 S300,000 S4,200,000 a) If the price is $10 per gadget, would the firm be willing to stay in the market in the long-run? [10%] b) Imagine that all prices in the economy are suddenly cut by half, what would the firm do in the long- run? Why? [ 10%] c) Repeat part (b) but assume that wages are "sticky". That is, assume wages remain at $60,000 while all other prices are cut by half what would the firm do in the long-run? Why? [15%] d) In class (Lecture 18) we learned that when all prices (including wages) are flexible the aggregate supply is vertical. Use your previous answers to determine how is the aggregate supply when wages are "sticky." [2596]Explanation / Answer
As per the data are given above the firm is producing 500,000 gadgets at a total cost of $42,00,000. So the cost per gadget for the firm is 42,00,000 / 500,000 = $8.4.
a) If the price of the gadget is $10 the firm will happily remain in the market in the long term because the price which the firm is getting for their gadget is above the production cost and the firm is making a profit.
b) As per the question all the prices that are wages, cost of raw material, cost of energy, and rent are reduced by half. In that situation, the firm will experience a supernormal profit in the short run and that will attract many other firms in the same business because of that the firm will have to reduce the price of their gadget and they will only make normal profits in the long run.
If the reduction in price also includes the price of gadgets then the firm will only be earning a normal profit in the short as well as the long run. The new price of the gadget will be $4.2. They will work at the same condition but half the cost.
) Wages are sticky and all other prices are reduced by half in that situation the firm will have to bear a total cost of $27,00,000 for producing 500,000 units of gadgets. The cost per gadget for the firm will be $5.4. If the price of Gadgets is also reduced by half that is $4.2 then the firm is facing a loss. In the long run, the firm has to increase the price of the gadget if they want to continue operating or they have to lay off several employees to cover their cost.
d) Aggregate supply is positively sloped when wages are sticky i.e. if the firm has to increase the supply they have to hire more labor and that will increase the price of the goods, but if the price can't be increased the firm has to lay off some labor to cover the cost of production this will reduce the output and the price of the good as well.
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