Midterm Exam Managerial Economics Dr. John B. Horowitz Fall 2004

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1 Midterm Exam Managerial Economics Dr. John B. Horowitz Fall 2004 Choose the best answer: (right answers are shown by *) 1. If the price of gasoline is $2.00 and the price elasticity of demand is 0.5, how much will a 10 percent reduction in the quantity placed on the market increase the price? A. There will be 20% increase in the price. Milk will be $2.20. B. There will be a 5% increase in the price. Milk will be $2.10. C. There will be a 5% increase in the price. Milk will be $2.20. D.* There will be a 20% increase in the price. Milk will be $2.40. E. None of the above 0.1/x = 0.5. x= % increase in price. 2. Consumers understandably like lower prices, but they should understand there is a great difference between a lower price produced by a government price ceiling and a lower price that comes about through normal market channels; one benefits the consumer, the other may not. A. This statement is not true. Consumers are benefitted when the government lowers the price and consumers are benefitted if businesses lowers the price. B.* This is because when the government forces prices down, there is a shortage and reduction in total surplus. Lower prices through markets don t create shortages but they do benefit consumers. C. This is because when the government forces prices down, there is a surplus and reduction in total surplus. Lower prices through markets don t create surpluses but they do benefit consumers. D. This is because when markets force the price down, there is a shortage and a reduction in total surplus. Lower prices through government action don t create shortages but they do benefit consumers. 3. For a demand curve, certain things are held constant. What are they? A. Price of the good, prices of substitutes and complements for the good, income, tastes and preferences, buyers expectations, technology, and the costs of production. B. Prices of substitutes and complements for the good, income, tastes and preferences, buyers expectations, technology, and costs of production. C. Technology and costs of production. D. * Prices of substitutes and complements for the good, income, tastes and preferences, and buyers expectations. D is the only one that only lists determinates that shift the demand curve. Each of the others also lists determinates that shift the supply curve but not the demand curve. 4. The height of the demand curve shows the marginal benefit for each level of consumption. A. * True B. False 5. Does a consumers well being vary along a demand curve? A. * Yes. When price increases, consumers move to a lower indifference curve. B. Yes. When price increases, consumers move to a higher indifference curve. C. No. When price increases, consumers stay on the same indifference curve. D. No. When price increases, the higher price has no effect on budget constraints or indifference curves.

2 6. The Hilton Hotel in the central business district of Hong Kong is being torn down so that the land it sits on can be converted to an office tower. Suppose that: the office tower is projected to generate net revenues of $2 billion over the course of its lifetime; the Hilton Hotel is projected to generate net revenues of $1 billion over the course of its lifetime were it not torn down; and the cost of tearing down the hotel and building the office tower is expected to be $100 million. The opportunity cost of replacing the hotel with an office tower is thus A. $1 billion B.* $1.1 billion C. $100 million D. $900 million E. $3.1 billion The next best alternative includes giving up the $1billion net revenues over the life span of the hotel and the explicit cost of having to tear down the hotel for $100 million. 7. Which of the following will always cause the demand curve for a product to shift to the right? A. An increase in income whether the good is a complement or a substitute B. An increase in the price of a complement C.* An increase in the price of a substitute D. An increase in technology. E. A decrease in the price of the good. 8. Suppose that there was a simultaneous 1) increase in the price of a substitute product for buyers and 2) an increase in the cost of resources used in producing wheat. The likely results in the wheat market would be: A. a decrease in the equilibrium price, but the effect on output cannot be determined. B. a decrease in equilibrium output, but the effect on price cannot be determined. C.* an increase in the equilibrium price, but the effect on output can not be determined. D. an increase in both the equilibrium price and output. 9. For which of these goods would the price elasticity of demand ordinarily be greatest? A. Food from fast food restaurants. B.* Pizza Hut pizza from the restaurant located on Wheeling. C. Food. D. Pizza. E. Pizza Hut pizza. 10. According to economics, effective minimum wage laws A. are at the equilibrium. B.* are price floors and create more unemployment. C. are price floors and create less unemployment. D. are price ceilings and create more unemployment. E. are price ceilings and create less unemployment. Price floors such as minimum wages that are effective, push prices above equilibrium. Employers want to higher fewer employees and more employees want to work at minimum wage jobs. This creases a surplus of labor which is usually called unemployment. 11. The consumer s budget line A.* identifies the options from which the consumer can choose. B. identifies the optimal basket of goods for the consumer. C. identifies the tastes of the consumer. D. ranks the baskets of goods in the order the consumer prefers them. E. shows that the consumer prefers more better than less. 12. If a consumer values one good but has no interest in the other good, then the optimal choice for the consumer will be A. only a short-run optimal choice. B. one that does not make the consumer as well off as possible. C. found by a tangency between an indifference curve and the budget line. D.* a corner solution with the consumer buying zero units of the second good.

3 13. Suppose that the price of X is $5, the price of Y is $10, and the consumer s income is $100. If Y is measured on the vertical axis and X is measured on the horizontal axis, and if the price of Y increases to $20, a. the entire budget line shifts toward the origin with its slope changing from ½ to 1/4. b. the budget line pivots inward toward the origin along the X axis with its slope changing from ½ to 1/4. c.* the budget line pivots inward toward the origin along the Y axis with its slope changing form ½ to 1/4. d. the budget line pivots inward toward the origin along the Y axis with its slope changing from 1/4 to ½. 14. A set of indifference curves showing that the consumer places no value on the good on the horizontal axis must be a.* horizontal. b. positively sloped. c. parallel lines. d. intersecting. 15. If the vertical axis measures movie passes which cost $5 apiece and the horizontal axis measures compact discs which cost $15 each, the slope of the budget line is a.* 3. b. 1/3. c d e. None of the above. Px/Py 16. At the optimal point, the consumer a. is consuming the largest market basket possible. b.* is consuming the most desired market basket, given his or her income and the prices of the goods. c. is maximizing his or her income. d. is consuming where the marginal rate of technical substitution between the two goods equals the price ratio. 17. The relative price of two goods is shown by a. the slope of an indifference curve. b.* the slope of the budget line. c. the diminishing marginal rate of substitution. d. the slope of the income-consumption curve. Relative price is the ratio of the prices. 18. Sue s marginal rate of substitution is four compact discs per movie pass, given the endowment of movie passes and compact discs she has. If she trades four compact discs for one movie pass, her new marginal rate of substitution will be a. greater than four. b.* less than four. c. equal to four. d. can t tell without more information. She is willing to trade 4 CDs for 1 Movie pass. With normal indifference curves, when she has more movie passes she will trade fewer CDs for a movie pass such as 3CDs for 1 Movie pass. To remain at 4CDs for 1 Movie pass would require straight line indifference curves. 19. If the marginal cost exceeds the average cost then the cost must as output increases. A. marginal; increase. B. marginal; decrease. C.* average; increase. D. average; decrease. E. average; stay the same. When the marginal is above the average, the average increases. When the marginal is less than the average the average decreases. And when the marginal is equal to the average, the average remains the same.

4 20. In the short run, diminishing marginal returns are implied by A.* rising marginal cost. B. rising average cost. C. rising average variable cost. D. falling marginal cost. E. falling average cost. 21. Increasing returns to scale imply that the short run average costs are as the firm gets larger. A. constant. B.* decreasing. C. increasing. D. negative. E. positive. 22. Capital and labor are used to produce a product. On an isoquant map capital is represented on the vertical axis and labor is represented on the horizontal axis. At point B on isoquant Q2, the slope of the isoquant is The -2.0 slope means that A. * two units of capital replace one unit of labor without reducing output. B. two units of labor can replace one unit of labor without reducing output. C. output will be reduced by two units when labor and capital are reduced by one unit each. D. the isoquant must be a straight line. E. the isoquant must be a curved. 23. If a competitive firm s sets her output such that marginal revenue, marginal cost and average total cost are equal, economic profit must be: A. Negative. B. Positive. C.* Zero. D. Indeterminate from the given information. 24. An decrease in the wage rate will induce a competitive firm to a. raise its price. b. reduce its rate of output. c.* increase its rate of output. d. lower its price. e. lower its price and raise its output. For a competitive firm, the Demand is horizontal at the market wage rate. When the MC shifts to the right because the wage rate fell, the firm produces more at the same price. If all firms have their MC shift to the right, this cause the Supply curve to shift to the right. Which causes lower price and higher output. (I lowered the curve by a point for the benefit of those of you who answered e) 25. According to Dr. Horowitz, if one firm in a competitive industry employs unusually productive inputs, then A. its long-run average cost curve lies below the long-run average cost curves of other firms. B. the firm makes economic profits even in the long run. C.* the prices of the inputs get bid up so the firm s minimum long-run average cost is the same as the other firms. D. it depends on how other firms respond to the competitive threat. I gave a point to those of you who answered A, though in the long run if people are aware, then the price will be bid up so that there are zero economic profits. 26. How does an increase in the price of a variable input affect the AC and the MC curves? A. MC shifts to the right and AC increases. B.* MC shifts to the left and AC increases. C. MC shifts to the right and AC does not change. D. MC does not change but AC increases. If costs increase, the MC shifts to the left since each unit is more costly to produce and TC increases so AC increases. Many of you said A which implies a lower cost of producing each additional product but costs increase.

5 27. How does an increase in the price of a fixed input affect the AC and the MC curves? A. MC shifts to the right and AC increases. B. MC shifts to the left and AC increases. C. MC shifts to the left and AC does not change. D.* MC does not change but AC increases. 28. IBM should not sell its product for less than it costs to produce. This is true if cost is interpreted to mean A. MC, AC, and AVC. B.* AVC and MC C. Only AVC. D. Total cost Shutdown your business if the price is less than AVC since that is cheaper than staying open. Also, firms shouldn t produce where MR is less than the MC (reduce output). If the price is less than AC, the firm makes an economic loss but still produces (likewise for TC). 29. Because agricultural demand is inelastic, a technological advance that lowers production costs will reduce total revenue. Thus, farmers have no incentive to introduce such a technique. A.* False, If you are one of the first to adopt the technology you can make economic profits. B. True, lower prices reduce total revenue when the elasticity of demand is inelastic. C. False, lower prices increase total revenue when the elasticity of demand is inelastic. D. False, there would be no change in total revenue. This question is true about Agriculture markets over at least the last 100 years. Farmers have an incentive to be the first to introduce new technologies that lower costs and shift the MC to the right. This is because Individual firms who are the first to implement the technologies make economic profits. Later firms copy them and soon everyone is making zero economic profits. However, price is pushed down as other firms copy the cost saving technologies (supply shifts to the right), TR to the industry falls. Some firms leave the industry. (I lowered the grading curve by a point for those who answered b even though it is incorrect) Assume SeatComfy Inc. produces table and chairs with the following total cost function, TC=10,000+10Q+0.1Q, where Q=quantity of chairs produced. If SeatComfy can sell as many chairs it wishes at the current market price of $45, how many chairs should it produce to maximize its short-run profits? A. 350 B. 700 C.* 175 D. None of the above. 31. FarAwayDrive Inc. has recently increased the price of its golf balls from $4.00 to $6.00. In response to this increase in price, sales decreased from 2,200 to 1,800 units. If no other information concerning the demand is available, which of the following is true about the sensitivity of demand (using the ARC or mid-points formula) for FarAwayDrive s golf balls? A. The ARC-elasticity (midpoints formula) of demand is 2.0. B. * The ARC-elasticity (midpoints formula) of demand is ½ or.50. C. The ARC-elasticity (midpoints formula) of demand is 2/3 or.667. D. The ARC-elasticity (midpoints formula) of demand is 4/11 or.364.