(per day) Pizzas. Figure 1

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1 ECONOMICS Dr. John Stewart Sept. 25, 2001 Exam 1 Detailed solution for one Form of the Midterm: The general question are the same for all forms but some questions differ in details so correct answer may vary from form to form, and the order of questions will also vary from form to form. Instructions: Mark the letter for your chosen answer for each question on the computer readable answer sheet using a No.2 pencil. Note a)=1, b)=2 and so forth. Please note that some questions have four choices, others have five choices. On the answer sheet make sure that you have written and coded your name, your student ID number and the number of the recitation section you attend (A list of recitations shown on the screen will help you identify your section number). Each failure to follow directions will result in a one question deduction. All questions are weighted equally. Information for Questions 1-4 : Larry and Curly live on a desert island. The raw materials are suitable only for making beer and pizza, but these quantities are unlimited. What is scarce is labor. Curly and Larry can only work 10 hours a day. Curly can make 1 bottle of beer per hour or.2 pizzas per hour. Larry can make.5 bottles of beer an hour or 1.5 pizzas per hour. Hint: before answering the following questions, draw the production possibilities curve for Larry and Curly working together for a 10-hour workday. You may use the accompanying grid in Figure 1. Pizzas (per day) The PPF 1. The opportunity cost for Larry to produce 1 bottle of beer is a) 1/5 pizza b) 5 pizzas c) 3 pizzas If Larry devotes all of his 10 hours to beer production he can produce 5 bottles; if he devotes the full 10 hours to pizza production he can produce 15 pizzas. For each bottle of beer he produces three pizzas must be sacrificed d) 1/3 pizza Figure Beer (bottle per day) 2. If both Curly and Larry completely specialize in producing only what they can produce at the lowest opportunity cost, they will produce a) 17 pizzas and no beer b) 15 bottles of beer and no pizzas c) 10 pizzas and 15 bottles of beer d) 10 bottles of beer and 15 pizzas The green point on the PPF. If we want more than 10 bottles of beer, we have to use so of Curly s time and he is the least efficient beer producer. If we want more than 15 pizza we have to use some of Larry s time and he is the least efficient producer of pizza. Econ , Exam1 Page 1 of 11

2 3. If Curly and Larry jointly decide to consume together a total of 3 pizzas and 14 bottles of beer, the efficient way to do this would be a) Curly produces 3 pizzas and Larry produces 14 bottles of beer b) Curly produces 14 bottles of beer and Larry produces 3 pizzas c) Curly produces 3 pizzas and 4 bottles of beer while Larry produces 10 bottles of beer d) Larry produces 3 pizzas and 4 bottles of beer while Curly produces 10 bottles of beer. The blue point on the PPF Curly, being the most efficient beer producer will devote full effort to beer production. Larry being the most efficient pizza producer will make the 3 pizzas and the remainder of the beer. 4. In this economy, the production of 12 bottles of beer and 14 pizzas is a) feasible but not efficient b) feasible and efficient c) not feasible See the purple point on the PPF. d) it is impossible to tell Non-students Non-Student Demand Students Total Market Demand curve will shift to the left if the price of a complement increases Market Supply P r i 200 Market demand Information for Questions Student Demand 5-9: Consider the market for bicycles in the Chapel 100 Hill & Carrboro area. There are two groups of consumers: UNC-Chapel Hill students and nonstudents. Assume that Qbycycles(measured in 1000's) these two groups cannot trade bicycles between Figure 2 them. Anybody who rides bicycles are required to wear safety helmets by law. Here are the demand curves for bicycles for both groups and the supply curve. The QNS 5 10 QS 5+12= quantities are in thousands of bicycles demanded per year. It may help if you draw the demand curve for the whole market on the same graph as the supply curve. QM 5. What is the equilibrium price (P) and quantity (Q) in this market? a) P=$100, Q=17,000 at this price, total quantity demanded = total quantity supplied b) P is between $100 and $200, Q is between 17,000 and 22,000 c) P=$200, Q=22,000 d) P is between $200 and $300, Q is between 22,000 and 27,000 e) P=$300, Q=27,000 c 6. Bicycle safety helmets a) and bicycles are substitute goods b) and bicycles are complementary goods two good that must be purchased together, in this case be law c) necessarily have elastic demand curve d) necessarily have inelastic demand curve e 7. The towns of Chapel Hill and Carrboro jointly enact a resolution increasing the standards for safety helmets that are required to be worn while riding bicycles. Cheap helmets will be less likely to reach the new standards. What would you expect to happen to the market equilibrium price (P) and quantity (Q) of bicycles? Econ , Exam1 Page 2 of 11

3 a) P and Q go up b) P and Q go down the new standards will raise the price of helmets, increasing the price of a complement will shift the demand curve for bicycles left causing price and quantity to fall. c) P goes up while Q goes down d) P goes down while Q goes up e) we cannot tell 8. Calculate the arc-price elasticity of non-students' demand curve for a price drop from $300 to $100. Which of the following is true? a) Non-students' demand curve for bicycles is unitary elastic b) Non-students' demand curve for bicycles is inelastic c) Non-students' demand curve for bicycles is elastic d) We cannot tell arc elasticity & Ä Q Q 1 % Q 2 2 Ä P P 1 % Q P 2 & 8 4% 12 2 & % The point elasticity of demand for non-students at a price of $100 is a) 1 b) c).333 d).25 point elasticity & ( ÄQ Ä P ) ( P Q ) & 1 slope of the demand curve ( P Q ) ( ) ( ) If a good is an inferior good then as income decreases, the demand curve for that good will a) stay the same b) shift left c) have positive slope d) shift right 11. A demand curve with infinite price elasticity everywhere: a) is horizontal. b) is vertical. c) has a negative slope. d) has a very steep slope. Econ , Exam1 Page 3 of 11

4 Information for questions : While studying late one night, Andy decides to have a midnight snack consisting of pizza slices and breadsticks. The following table illustrates various values of total utility and marginal utility for different quantities of both snacks. (Before answering any of the questions, complete the table with missing values) Pizza Slices (number) Total Utility Marginal Utility Breadsticks (number Total Utility Marginal Utility If Andy is a rational consumer and attempts to purchase optimal quantities of both pizza slices and breadsticks, he will maximize his: a) consumer surplus b) total utility c) marginal utility d) total quantity (# pizza slices + # breadsticks) consumed 13. If slices of pizza coast $5/slice and breadsticks cost $2/breadstick, what is the optimal quantity of each Andy should purchase? (Assume that you can t purchase fractional amounts of either good) a) pizza slices = 4; breadsticks = 3 b) pizza slices = 3; breadsticks = 4 find the last unit of each good where MU > (or equal to) P c) pizza slices = 4; breadsticks = 5 d) pizza slices = 3; breadsticks = Calculate the consumer surplus Andy enjoys from purchasing optimal quantities of both pizza slices and breadsticks. a) $2.50 b) $0.50 c) $6.50 d) $8.50 Consumer surplus = total utility - expenditure. For pizza, the total utility of 3 slices is $18.5, total expenditure is $15; surplus is $3.50 for breadsticks total utility of 4 is $13, total expenditure is $8; consumer surplus is $5 $5 + $3.50 = $ If the cross price elasticity of the demand for oranges with respect to price of lemons is found to be -0.5, which statement below is true. a) oranges and lemons are substitute goods b) oranges and lemons are complementary goods c) oranges are inferior goods d) lemons are inferior goods. Econ , Exam1 Page 4 of 11

5 16. If the pizza and beer are complements and the price for pizza falls, we expect the equilibrium price for beer to and the quantity to a) raise, raise b) raise, fall c) fall, raise d) fall, fall For complementary goods, if the price of one decreases, the demand for the other (its complement) will shift to the right so both price and quantity of the other good will increase. P S 17. A business facing an inelastic demand curve increases its price from $7 to $8. From this information you can correctly conclude that a) total revenue for the firm will decrease. b) total revenue for the firm will increase Inelastic demand means that a 1% increase will result in a less than 1% decrease in the quantity demanded thus causing revenue to increase c) total revenues for the firm will be unchanged d) nothing about the way total revenues would change Question 16 D1 D2 Q Information for Questions 18-19: Figure 3 shows Jane s demand for minutes of local telephone calls per month as a function of the price of phone calls per minute. $1.00 Price ($ per minute) Jane's demand curve 18. If the price of phone calls is $.50 per minute, how much consumer surplus will Jane receive per month? a) $50.00 b) $25.00 c) $12.50 At a price of $.50 per minute, Jane will choose to purchase 50 minutes (point where P=MU) total surplus is $.50 Figure 3 50 Consumer surplus = 1/2 x.$.50 x 50 = $ Quantity (minutes per month) the area above the above the price but below the demand curve a triangle with area ½ $.50 x 50 = $12.50 d) $ The phone company offers Jane the option of keeping her current plan (paying $.50 a minute for her phone usage) or a plan where she pays a fixed monthly fee and then can make all the phone calls she wishes at no additional charge. What is the HIGHEST monthly fee the phone company could charge and still get Jane to switch to the new plan? a) $50.00 per month b) $40.00 per month c) $37.50 per month If phone call were free ($0 per minute), Jane would consume 100 minutes (point where P=MU. At that level of consumption, her consumer surplus would be (½ 100 x $1)=$50. She would choose the fixed fee plan so long as here consumer surplus ($50 - fee) is larger than she would receive paying the per minute rates ($12.50) from the previous part. This would be true for any monthly fee less than $ d) $25.00 per month Econ , Exam1 Page 5 of 11

6 20. To economists the main difference between "the short run" and "the long run" production is that a) the law of diminishing returns applies in the long run, but not in the short run b) in the long run all input quantities are variable, while in the short run the quantities of some inputs cannot changed c) fixed costs are more important to decision making in the long run than they are in the short run d) in the short run all resources are fixed, while in the long run all resources are variable 21. Marginal cost necessarily intersects which of the curves at its minimum? a) AFC b) ATC c) AVC d) TC e) both b and c Information for Questions 22-24: Constant Cravings produce gourmet chocolates. Figure 4 below the costs of producing chocolate bars are plotted on the vertical axis and the number of bars of chocolate produced on the horizontal axis. 22. In Figure 4 the marginal cost of producing the 101st unit of output is a) $100 b) $110 Total cost increases form 1900 too 2010 when output increases from 100 to 101 c) $1900 d) $ The average total cost of producing 100 units of output is a) $17 b) $18 c) $19 = 1900/100 d) $ The Average fixed cost of 100 units of output is $ Figure 4 Total Cost Q (units of chocolates) a) $10 = 1000/100 b) $100 c) $1000 d) $ If a firm s long-run average curve is a horizontal line, then the firm is subject to a) constant returns to scale b) decreasing returns to scale c) increasing returns to scale d) decreasing marginal returns Econ , Exam1 Page 6 of 11

7 Information for Questions 26-29: In the following table output is produced using capital and labor. Capital is fixed at 5 units. The price of capital is $4 per unit and the price of labor is $4.00 per unit Number of units of labor Total Product Marginal Physical Product Average Physical Product B= In the table the value of B is a) 7 b) 12 c) 21 d) The total cost of producing 22 units of output is a) $12 b) $21 c) $21.33 d) $28 Total cost = fixed cost + variable cost. Fixed cost = 4 * $4.00 = $20. To produce 22 units requires 2 units of labor so variable cost = $4.00 * 2 = $8 28. If we assume that the firm is in a perfectly competitive market and that the current market price of its output is $0.50 per unit, then the firm s optimal use of labor will be a) 2 units b) 3 units c) 4 units d) 5units Firms will produce an output level where P>MC so long as P>AVC. Remembering that MC= P V /MPP V where P V and MMP V are the price of the variable input and the marginal physical product of the input respectively, the were will choose to produce 60 unit of output requiring 5 units of labor. Note also that at this point AVC =4/12 which is less than the output price. 29. Again assuming that the market price is $0.50 per unit and that the firm is a profit maximizing competitive firm, at it chosen level of output the firm will be making a a) profit of zero b) profit of $7.50 c) loss of $10.00 d) loss of $20.00 At 60 units of output, the total cost is $20 + $4 x 5 = $40. The firs total reven is 60 x $.50 or $30 so the firm is making a loss of $ A corn farmer is currently producing 20,000 bushels of corn using 1,000 hours of labor and 100 hours of machinery time. The marginal physical product of labor is 100 bushels of corn per hour of labor and the marginal physical product of machinery is 500 bushels of corn per hour. Labor costs the farmer $10 per hour and machinery costs the farmer $50 per hour. In order for the farmer to minimize the cost of producing 20,000 bushels of corn he should: a) do nothing, he is already minimizing his cost The condition for optimally choosing the quantity of two inputs to minimize cost is P 1 /MMP 1 =P 2 /MPP 2 and in this case 10/100 does equal 50/500. b) decrease the amount of labor and increase the amount of capital Econ , Exam1 Page 7 of 11

8 c) increase the amount of labor and decrease the amount of capital d) not enough information to determine this 31. You are the manager of a perfectly competitive firm and are faced with the following situation. The market price for your product is $2.50 and you are currently selling 1,000 units. Your total fixed costs are $9,000 while your total variable costs are $3,000. Your short run marginal cost is $2.50 per unit. Given this information, to maximize profit in the short run you should decide to: a) immediately stop all production. Conditions for short run profit maximization are P = MC and P> AVC. Though the firm has chosen the quantity where P=MC, it is the case that P<AVC so the firm should shut down. b) continue to produce 1,000 units. c) expand output to cover more of fixed costs. d) decrease output so that you can cut down on variable costs. e) uncertain, there is not enough information in the problem deduce an answer. 32. Opportunity cost can best be defined as the a) money cost of a good or service. b) money cost plus interest on money borrowed to buy a good or service. c) cost of the resources used to produce a good or service. d) value of the best alternative forgone when the alternative at hand is chosen. 33. Bill s Sandwich shop is currently charging a price of $3.00 per sandwich. At this price Bill is selling 100 sandwiches a day. The marginal cost of producing another sandwich is $1.00. An economist estimates that the price elasticity of the demand curve for Bill s sandwiches at his current output is 2.0. Bill comes to you with this information and asks for your advice. You should tell Bill a) to keep charging $3.00 per sandwich. b) that he can increase profits if he lowers his price a little. Marginal Revenue = P(1-1/h) this case since marginal revenue = $1.50 and MC = $1.00, Bill could increase profits by selling more sandwiches. The only way he can sell more is to lower price. c) that he can increase profits if he raises his price a little. d) that he hasn t given you enough information for you to make a recommendation. Econ , Exam1 Page 8 of 11

9 Information for Questions 34-37: Figure 5 shows market demand and supply for computers. The market for computers is perfectly competitive. Quantities are measured in number of computers per week. There are currently 200 identical firms supplying the market. Also shown in the diagram are the average and marginal cost curves of a typical computer firm. Assume that all firms in the market face identical cost conditions and that there are no fixed inputs in computer manufacturing. (Thus there is no difference between long run and short run cost curves) $ 600 Profits Typical Firm MC AC $ Market Supply 200 Demand q firm Qmarket 34. Given that there are currently 200 Figure 5 firms operating in the market in the short run a) the equilibrium price will be $100 and the equilibrium market quantity will be 4000 computers per week. b) the equilibrium price will be $400 and the equilibrium market quantity will be 10,000 computers per week. c) the equilibrium price will be $600 and the equilibrium market quantity will be 8000 computers per week. d) the equilibrium price will be $600 and the equilibrium market quantity will be 10,000 computers per week. Short run market equilibrium Firms: P=MC market Q S =QD 35. How much profit will each firm be making at the equilibrium described in Question 34 a) $0 per week b) about $2,000 per week c) about $7,500 per week Typical firm is producing 50 units of output. Price is $600 per unit average cost is a little above $400 (say $450) that s $150 per unit profit on 50 units or $7500. (Clearly the closest answer). d) about $10,000 per week e) the firms are not making a profit. They are losing money. 36. In the long run, what do you expect to happen in this market? a) Nothing will change; it is in long run equilibrium. b) New firms will enter because there are profits. This will cause the market supply curve to shift to the right. See the red lines in the diagram. c) New firms will enter because there are profits. This will cause the market demand curve to shift to the left d) Existing firms will leave the market because they are losing money. This will cause the supply curve to shift to the left. e) Existing firms will leave the market because they are losing money. This will cause the demand curve to shift to the right. Econ , Exam1 Page 9 of 11

10 37. In the final long run market equilibrium, price (P) will be and the market quantity (Q) will be a) P= $100, Q = 14,000 b) P= $400, Q = 12,000 supply shifts till P=AC (and =MC) for firms; Q S =Q D for market c) P= $600, Q = 12,000 d) P= $600, Q = 10,000 Econ , Exam1 Page 10 of 11

11 When you have completed your exam: Print your Name Write your Student ID number (PID) Print your recitation section number (A list of recitation will be on the screen) Section Sign the honor Pledge affirming that you have neither given nor received aid on this exam and have complied with all of the rules of this exam. Signature Tear this form off the back of you exam and turn it in with your answer sheet. You may keep the rest of the exam. Econ , Exam1 Page 11 of 11