Question

1. Optimal choice of capital Valerie makes sweaters in her home. Starting with just some knitting needles and yarn, she was able to knit 50 sweaters per year. Now some local stores have expressed interest in her designs and offered to buy her sweaters for $20 each. This makes it worthwhile for her to invest in some capital in particular, she could produce many more sweaters if she invested in one or more looms, as shown in the following table. Assume that Valerie's sweater business is a perfectly competitive firm. Complete the following table by calculating the marginal physical product (MPP) of each loom and the marginal revenue product (MRP) of each loom. Quantity of Input (Looms) MPP of Each Loom MRP of Each Loom Output (Sweaters per year) (Sweaters) (Dollars) 50 1 90 2 121 144 4 161 5 176 If the rental price of a loom is $540 per year, Valerie should use Suppose the demand for sweaters is very elastic, while the demand for cigarettes is very inelastic. Suppose that looms are used exclusively in the production of sweaters and that tobacco is used exclusively in the production of cigarettes. Which of the following might we expect? The supply of tobacco would be more elastic than the supply of looms The demand for tobacco would be less elastic than the demand for looms The supply of tobacco would be less elastic than the supply of looms. The demand for tobacco would be more elastic than the demand for looms.

Answer 1

First find the marginal physical product as change in TPP / change in input

Next find MRP by multiplying MPP with the price, price here is fixed at $20

This gives us the following table

Input	TPP	MPP	MRP
0	50
1	90	40	800
2	121	31	620
3	144	23	460
4	161	17	340
5	176	15	300

If price of loom is 540 firm should use 2 looms. This is because its MRP is 620 and is greater than 540, while hiring the 3rd loom will reduce MRP to a lower level at 460

Since demand for sweaters is very elastic demand for input used in sweaters which is the loom, is also very elastic. Hence the second option is correct.