Stanley Ford makes mountains out of molehills. He can do this with almost no effort, so for the purposes of this problem, let us assume that molehills are the only input used in the production of mountains. Suppose mountains are produced at constant returns to scale and that it takes 100 molehills to make 1 mountain. The current market price of molehills is $20 each. A few years ago, Stan bought an “option” that permits him to buy up to 2,000 molehills at $10 each. His option contract explicitly says that he can buy fewer than 2,000 molehills if he wishes, but he can not resell the molehills that he buys under this contract. In order to get governmental permission to produce mountains from molehills, Stanley would have to pay $10,000 for a molehill-masher’s license.
(a) The marginal cost of producing a mountain for Stanley is ________ if he produces fewer than 20 mountains. The marginal cost of producing a mountain is ________ if he produces more than 20 mountains.
(b) On the graph below, show Stanley Ford’s marginal cost curve (in blue ink) and his average cost curve (in red ink).
(c) If the price of mountains is $1,600, how many mountains will Stanley produce? __________.
(d) The government is considering raising the price of a molehill-masher’s license to $11,000. Stanley claims that if it does so he will have to go out of business. Is Stanley telling the truth? No. What is the highest fee for a license that the government could charge without driving him out of business?
(e) Stanley’s lawyer, Eliot Sleaze, has discovered a clause in Stanley’s option contract that allows him to resell the molehills that he purchased under the option contract at the market price. On the graph above, use a pencil to draw Stanley’s new marginal cost curve. If the price of mountains remains $1,600, how many mountains will Stanley produce now?