Question

Katy runs her family's donut shop. The capital stock of the firm consists of three machines of various vintages, each of which can make the donuts equally well. All of the machines are in excellent condition, and all machines can be running at the same time. The table below gives some production details for the donut shop:

	COST OF PROCESSING PER DONUT	MAXIMUM TOTAL CAPACI TY (DONUTS) PER DAY
MACHINE 1	$0.10	250
MACHINE 2	$0.25	400
MACHINE 3	$0.50	500

Assume that “cost of processing” includes all labor and materials, including the owner’s wages. Assume further that Katy’s family signed a long - term contract (20 years) with a service company to keep the machines in good repair for a fixed fee of $1,825 per year, or $5 per day.

a. Derive and illustrate the firm’s marginal cost curve. (1 point)

b. Derive and illustrate the firm’s total cost curve. (1 .5 point s )

c. At a price of $0.40 per donut, how many donuts would the shop produce? Explain your reasoning. What would total revenues, total costs, and total profits be? (2 point s )

d. How much does donut price have to be (at a minimum) for Katy to consider investing in a 4 th machine that can double their current maximum donut output per day ? [Hint: T here are many ways to answer this question, think about what assumptions you need to make or what information you will need to make this decision.] (0.5 point)   

Answer 1