Economics 53 Introductory Microeconomics Practice Final Exam

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1 NAME: Economics 53 Introductory Microeconomics Practice Final Exam Answer all the questions. Allocate your time according to the points that each question is worth. There are 180 points in the exam. You should plan on spending 180 minutes to complete the exam. Part I Multiple Choice (48 Points, 1.5 Points each question) Please write the letter corresponding to the correct answer in the box below Private markets do not account for externalities because A) externalities don t occur in private markets. B) buyers and sellers in private markets are only interested in social benefit. C) buyers and sellers in private markets are only interested in social cost. D) buyers and sellers have no incentive to consider the effects of their behavior on others. 2. The attainable points in a production possibilities (PPF) graph are A) the points within the production possibilities frontier. B) the points along the production possibilities frontier. C) the points of the horizontal and vertical intercepts. D) All of the above 3. Comparative advantage means A) the ability to produce more of a product with the same amount of resources than any other producer. B) the ability to produce a good or service at a lower opportunity cost than any other producer. C) the ability to produce a good or service at a higher opportunity cost than any other producer. D) compared to others you are better at producing a product. 4. Which of the following will not shift the demand curve for a good? A) An increase in the number of buyers. B) An increase in the price of the good. C) A decrease in the price of a substitute good. D) An increase in household incomes

2 5. Suppose that when the price of hamburgers decreases, the Ruiz family increase their purchases of ketchup. A) hamburgers and ketchup are complements. B) hamburgers and ketchup and substitutes. C) hamburgers and ketchup are normal goods. D) hamburgers are normal goods and hot dogs are inferior goods. 6. Red Stone Creamery currently hires 5 workers. When it added a 6th worker, its output actually fell. Which of the following statements is true? A) The marginal product of the sixth worker must be negative. B) The average product of the sixth worker is negative. C) The sixth worker is not as skilled as the fifth worker. D) The total product becomes negative. 7. Refer to Table Marginal revenue product of the worker is $250. A) second B) third C) fourth D) fifth 8. Refer to Table If workers are paid $150 per day, then the firm will hire workers. A) two B) three C) four D) five 9. Jane has $500 a week to spend on clothing and food. The price of clothing is $25 and the price of food is $10. Jane spends her entire income when she purchases units of clothing and units of food. A) 10; 10 B) 25; 5 C) 12; 20 D) 16; Assume leisure is a normal good. The substitution effect of a wage decrease implies a demand for leisure and a labor supply. A) lower; higher B) higher; lower C) higher; higher D) lower; lower

3 11. Peet's Coffee and Teas produces some flavorful varieties of Peet's brand coffee. Is Peet's a monopoly? A) Yes, there are no substitutes to Peet's coffee. B) Yes, Peet's is the only supplier of Peet's coffee in a market where there are high barriers to entry. C) No, although Peet's coffee is a unique product, there are many different brands of coffee that are very close substitutes. D) No, Peet's is not a monopoly because there are many branches of Peet's 12. A local electricity-generating company has a monopoly that is protected by an entry barrier that takes the form of A) perfectly inelastic demand curve. B) network externalities. C) economies of scale. D) control of a key raw material. Two discount superstores (Ultimate Saver and SuperDuper Saver) in a growing urban area are interested in expanding their market share. Both are interested in expanding the size of their store and parking lot to accommodate potential growth in their customer base. The following game depicts the strategic outcomes that result from the game. The profits (in millions of dollars) of the two discount superstores are shown in the table below. Figure Refer to Figure 1. Is there a dominant strategy for Ultimate Saver and if so, what is it? A) The dominant strategy is to increase the size of the store and parking lot B) The dominant strategy is to not increase the size of the store and parking lot C) The dominant strategy is to collude with SuperDuper Saver D) There is no dominant strategy. 14. Refer to Figure 1. Is there a dominant strategy for SuperDuper Saver and if so, what is it? A) The dominant strategy is to collude with Ultimate Saver. B) The dominant strategy is to increase the size of the store and parking lot C) The dominant strategy is to not increase the size of the store and parking lot D) There is no dominant strategy.

4 15. Refer to Figure 1. What is the Nash equilibrium in this game? A) There is no Nash equilibrium in this game. B) SuperDuper Saver increases size and Ultimate Saver does not increase size C) Each firm does not increase in size D) Each firm increases in size 16. Refer to Figure 1. If Ultimate Saver and SuperDuper Saver could collude, what would they do? A) SuperDuper Saver does not increase in size while Ultimate Saver increases in size B) Both will not increase in size C) Ultimate Saver does not increase in size while SuperDuper Saver increases in size D) Both will increase in size 17. A key difficulty facing insurance companies is that individuals know more about their health than do insurance companies. What is this phenomenon called? A) moral hazard. B) adverse selection. C) asymmetric information. D) market signaling 18. Colleges and universities grant tenure to professors, making it virtually impossible to fire them after they have worked there for six or seven years. How can the tenure system lead to moral hazard? A) Because of the job security the tenure system provides, it tends to attract primarily those people who want to adopt controversial teaching methods and research topics B) Because of the job security the tenure system provides, academic institutions can attract highly talented people and pay lower salaries compared to the amount that faculty could earn in other occupations. C) The system encourages people who value job security the most to apply for these jobs, even they may not necessarily enjoy teaching as a career. D) Once a faculty member gets tenure they can reduce their productivity considerably without being fired. 19. Which of the following activities is a negative consumption externality? A) cleaning up the sidewalk on your block B) graduating from college C) repainting the house you live in to improve its appearance D) keeping a junked car parked on your front lawn 20. Which of the following characteristic is common to monopolistic competition and perfect competition? A) Barriers into the industry are low or non-existent. B) Firms produce identical products. C) Firms take market prices as given. D) Each firm faces a downward -sloping demand curve.

5 21. If 20 units are sold at a price of $50 and 30 units are sold at a price of $40, what is the value of the price elasticity of demand? Use the midpoint formula. A) B) C) -1. D) None of the above Figure Refer to Figure 2. A perfectly inelastic demand curve is shown in A) Panel A. B) Panel B. C) Panel C. D) Panel D

6 23. What is the voting paradox? A) the idea that wealthy corporations are able to sway politicians to act in ways contrary to the desires of the majority B) people are aware that their votes will not change the political outcome since these outcomes are predetermined by a group of influential politicians C) the observation that less than 60 percent of those eligible to vote actually vote D) the observation that majority voting may not always result in consistent choices 24. The largest source of federal tax revenue in the United States comes from A) corporate taxes. B) individual income taxes. C) social insurance taxes. D) excise taxes 25. Billy-Bob who lives in Tennessee is thinking about buying a trailer home. The current price is $20,000, and next year he estimates that it will be $24,000. If the market interest rate is 10% he should A) not buy either this year or next B) buy now C) buy next year D) be indifferent between buying now or buying next year 26. Def Jam Corp is employing 100 units of labor and 50 units of capital to produce 2,000 CDs. Labor costs $10 per worker and capital costs $30 per unit. The marginal product of labor (MPL) is 3 and marginal product of capital (MPK) is 10. A) Def Jam is maximizing profits B) Def Jam could increase its profits by using more labor and less capital C) Def Jam could increase its profits by using more capital and less labor D) Def Jam could increase its profits by using less capital and less labor 27. If a firm is not able to expand its plant capacity immediately, it is A) bankrupt. B) operating in the long run. C) operating in the short run. D) losing money. 28. If the market price is $25 in a perfectly competitive market, the marginal revenue from selling the fifth unit is A) $25. B) $5. C) $125. D) Not enough information is given 29. The deadweight loss to society associated with a tax on a good A) will be greater if the demand price elasticity of the good is elastic B) will be greater if the demand price elasticity of the good is inelastic C) will be smaller if the tax incidence is mainly on the firms D) will be smaller if the tax incidence is mainly on the consumers

7 30. When the marginal social cost curve is below the marginal private cost curve A) the government should impose a tax B) a negative production externality exist C) a positive production externality exist D) society is producing at the optimal level 31. If the cross-price elasticity of two goods is negative, then those two goods are A) necessities B) inferior goods C) complements D) substitutes 32. Which of the following properties about costs is correct? A) When marginal cost is below average total cost, average total cost is rising B) The average fixed cost curve is U-shaped C) As the quantity of output increases, marginal cost eventually rises D) All of the above are correct

8 Section II: Short Essay Questions (40 Points Total) Answer four (4) questions from Questions (1) through (6). You must answer Question (7). Question #1: A survey conducted at a local community college shows an increase in drug use by the students. Two competing explanations have been proposed: (1) Reduced police efforts have increased the availability of drugs on the streets (2) Cutbacks in drug awareness programs in high schools have decreased the awareness of the dangers of drug addiction. Local news reports also have noted that the price of drugs have increased. Can you determine which explanation is correct? You may use supply and demand graphs to answer this question. (7 Points) Question #2: Batman is thinking about setting a private firm to provide police protection to Gotham City. Explain why Batman may find it difficult to provide police protection profitably. (7 Points)

9 Question #3: Define the following terms: (1) Proportional Tax, (2) Progressive Tax, and (3) Regressive Tax. The U.S. tax system would fall under which category? (7 Points) Question #4: Define moral hazard. Give an example of moral hazard. What is a possible solution to the moral hazard problem? (7 Points)

10 Question #5: Describe how output and price is determined in the Price-Leadership Model. (7 Points) Question #6: Do you agree or disagree with the following statement: A firm that is suffering losses in the short-run will always be better off if they shut down immediately. Explain your answer. (7 Points)

11 Question #7 (REQUIRED) (12 Points) In the class we have covered several examples of market failure. Market failures occur when resources are misallocated and the economy produces too much or too little of a good at market equilibrium. (a) Provide three examples of market failures. (b) Some have argued that one of government s main roles in the economy is to correct market failure when they occur. Discuss how the government can address the market failure problem in each of the examples that you listed in Part (a).

12 Part III Quantitative and Graphical Section (92 Points Total) You must show your work to receive full or partial credit. Question #8: Taxes (20 Points) The graph (Figure 3) below represents the market for pizza. (a) Suppose the government imposes a $3 per unit tax on the suppliers of pizza. Illustrate how this tax will affect Figure 3 above. (2 Points)

13 (b) Find the initial (before the tax) equilibrium price and quantity. Calculate the consumer surplus, producer surplus and total surplus before the tax. (3 Points) (c) Find the equilibrium price and quantity after the tax is imposed. What is the price that consumers pay? What is the price that suppliers receive? (3 Points) (d) Who bears the burden of the tax? Explain (3 Points) (e) Calculate the consumer surplus, producer surplus, government revenue and total surplus after the tax has been imposed. (3 Points) (f) Calculate the deadweight loss associated with the tax. (3 Points)

14 (g) Suppose that the demand curve for pizza was more inelastic than was drawn on the diagram. Would you expect that suppliers would be able to shift more or less of the tax burden onto consumers? Explain your answer (3 Points) Question #9: Economics of Uncertainty (12 Points) (a) Does the above graph show diminishing marginal utility? Explain your answer. (3 Points) Wayne is a high-roller gambler in Las Vegas. After a very successful night of blackjack, Wayne is up $40,000. The casino manager comes over to Wayne and offers him the following high stakes game. Wayne can keep his $40,000 winnings or he can take one roll of the die. If the die turns up 5 or 6 then Wayne will win an additional $40,000 ($80,000 total). If the die turns up 3 or 4, then Wayne will not win any additional money and will thus have $40,000. If the die rolls a 1 or a 2, then Wayne will lose $40,000 and end up with nothing.

15 (b) Calculate the expected value of Wayne s winnings if he chooses not to play the casino manager s game. Calculate the expected value of Wayne s winnings if he does choose to play the casino manager s game. (2 Points) (c) Calculate the expected utility of Wayne s winnings if he chooses not to play the casino manager s game. Calculate the expected utility of Wayne s winnings if he does choose to play the casino manager s game. (3 Points) (d) If Wayne prefers not to play the casino manager s game does that imply that he is risk adverse, risk neutral or risk loving. Explain your reasoning. (4 Points) Question #10: Monopoly (10 Points) Shaggy is the only seller of Scooby Snacks and thus has a monopoly in the production of that good. Figure 2 below shows Shaggy s demand, marginal revenue and cost curves. (a) If Shaggy is a profit-maximizing monopolist, what is the quantity of Scooby Snacks he will produce? What price will he charge for each bag of Scooby Snacks? (2 Points)

16 (b) What is the profit/loss for Shaggy at the profit maximizing output? (2 Points) (c) If the production of Scooby Snacks was done under perfect competition industry, what would be the quantity produced? What would be the price charged under perfect competition. Compare the quantity produced and priced charged under perfect competition with that under a monopoly. Under which situation is the quantity greater? Under which situation is the price greater? (4 Points) (d) What will happen to Shaggy the monopolist in the long-run? (2 Points)

17 Question 11: Total Costs and Perfect Competition (14 Points) Mercy Hospital is a small community hospital in Trinity County, CA. Assume that small community hospitals are a perfectly competitive industry. Quantity of Hospital Beds (Q) Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) Average Fixed Costs (AFC) Average Variable Costs (AVC) Average Total Costs (ATC) Marginal Cost (MC) N/A N/A N/A N/A (a) Complete the table above (7 Points) (b) If the price of medical hospitalization is $520 per night, how many hospital beds will Mercy Hospital offer? Explain your answer. (3 Points) (c) Calculate the profit level of Mercy Hospital (2 Points)

18 (d) Will Mercy Hospital continue to operate in the short-run? Explain your answer. What will happen to Mercy Hospital in the long-run? (2 Points) Question #12 Demand and Supply (8 Points; 2 Points each) Suppose we are analyzing the market for hot chocolate. Graphically illustrated the impact each of the following would have on demand and/or supply. Clearly show how equilibrium price and quantity have changed. Make sure your axes and curves are clearly labeled. (a) Winter starts and the weather turns sharply colder (b) A better method of harvesting cocoa beans is introduced

19 (c) Producers expect the price of hot chocolate to increase next month (d) The price of whipped cream falls Question #13: Oligopoly (Cournot Model) 10 Points Two firms (Ryanair and EasyJet) are the only air carriers that fly out of London s Gatwick Airport. The two airlines are very similar in terms of their costs, strategic approach, and market outlook. Moreover, the firms have nearly identical individual demand curves. The number of flights by Ryanair depends on the number of flights by EasyJet and vice-versa. The reaction functions are as follows: QR = QE (Reaction function for Ryanair) QE = QR (Reaction function for EasyJet) Where Q = number of flights out of Gatwick Airport (a) Graph the reaction functions for EasyJet and Ryanair on the same graph. Put the number of flights by Ryanair on the y-axis, and the quantity of flights flown by EasyJet on the x-axis. (5 Points)

20 (b) Solve for the best response equilibrium. At the best response equilibrium, how many flights will Ryanair fly? At the best response equilibrium, how many flights will EasyJet fly? What will be the total number of flights (Q = QR + QE) flying out of Gatwick Airport? (3 Points) (c) If EasyJet were to become a monopolist at Gatwick airport, what would the total number of flights that would fly out of Gatwick Airport (2 Points) Question #14: Externalities (8 Points) A fertilizer plant near Coalinga produces bags of cow manure. The fertilizer plant produces a noxious odor that produces an external cost for households living near the plant. Let Q = number of bags of fertilizers produced per week Let MPC = marginal private cost = Q Let MSC = marginal social cost = Q Let MPB = marginal private benefit = P = Q (a) What type of externality is described in the scenario above? (2 Points) (b) Determine the output and price that would be established by market equilibrium. (For quantity round your answer to the nearest whole number; for price round your answer to the nearest penny) (2 Points)

21 (c) Determine the socially efficient output and price. (For quantity round your answer to the nearest whole number; for price round your answer to the nearest penny) (4 Points) Question #15: Present Value (10 Points) This year the St. Louis Rams football team signed Sam Bradford to a $50,000,000 guaranteed contract. The contract states that Bradford will be paid $10 million per year over the next 5 years beginning next year. Sports Illustrated states that this $50,000,000 contract is the biggest contract ever awarded to a rookie quarterback. (a) Calculate the present value of Bradford s contract. Assume that the interest rate is 10%. Is Bradford s contract worth $50,000,000? (7 Points) (b) If interest rates were to increase what would happen to the present value of Bradford s contract? Explain your answer. (3 Points)