1 Optimal choice of capital Caroline makes sweaters in her h

1. Optimal choice of capital Caroline 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 Caroline\'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 (Sweaters per year) 50 90 120 142 159 174 (Sweaters) (Dollars) 4 If the rental price of a loom is $520 per year, Caroline 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

Solution

If the rental price of a loom is $520, it should use loom such as input price<=MRP. So Caroline should use 3 looms.

Demand for sweater is very elastic, that is consumers response highly when price changes. A small increase in price would decresae the demand of sweater near to 0. In this case supply of loom should not response highly with price change for maximization of profit. So supply of loom should be inelastic. Demand for ciggerate is very inelastic, that is customers respond a little with price change. If in this case supply of tobacco is highly price sensitive firms can increase their revenue. So supply of tobacco should be elastic. Therefore the third option is correct.

Quantity of inputs(looms)	Outputs(sweaters per year)	MPP of each loom( sweaters)	MRP of each loom (dollars) =MPP*20
0	50	50	1000
1	90	40	800
2	120	30	600
3	142	22	440
4	159	17	340
5	174	15	300