# Multiple Choice: (circle the letter of the best response; 4 points each)

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1 ECON 5 Spring 7 Exam Name: _A. Key ultiple Choice: (circle the letter of the best response; 4 points each). In a Perfectly Competitive arket d. All of the above answers are correct.. Evan s preferences are transitive. Comparing the consumption bundles A = (,4), B = (,), C = (8,6), and D = (6,8) he states: A f D, C f A, and B f C. It follows that d. All of the above answers are correct. 3. The observation that all ( non-express ) checkout lines in a grocery store tend to be of roughly the same length is an illustration of b. Adam Smith s Invisible Hand in action. 4. arginal Utility of good one a. provides a measure of how total utility changes as consumption good one is increased, with consumption of all other goods fixed. 5. Brady sells footballs. His revenue per year is \$5,, his explicit costs are \$4,, and his implicit costs are \$,75. rom this information, his Accounting Profit c. is \$,. 6. Suppose the market for lemons is perfectly competitive. In the Short Run, Lee currently sells, pounds of lemons at a price of \$.3 per pound, while incurring Average Total Costs of production eual to \$.8 per pound. In the Long Run, Lee should expect d. new firms to enter the industry. 7. serves to distribute scarce goods to those consumers who value them most highly. b. The Rationing unction of Price 8. A firm with arket Power c. can typically increase it s price slightly without losing all customers. 9. Explicit Costs a. refer to the actual payments a firm makes to its factors of production and other suppliers.. Which of the following is an example of Third Degree Price Discriation? a. A ticket to see Kickin It Old Skool at the Regal Town Center Cinema in Kennesaw, GA costs Adults \$9.75, but costs Seniors only \$7.5.. A firm operating in the Short Run c. is not able to vary the amount hired of at least one factor of production.

2 . Price Discriation a. refers to the practice of a firm charging different prices for different units of a good. 3. A situation is efficient if a. no change is possible that will help some people without harg others. 4. In comparison to the outcome that would result with no intervention in this market, imposing a price floor of \$6. would decrease Consumers Surplus by b. areas (c)+(d). 5. If, units are traded in the market d. the resulting Deadweight Loss is eual to areas (a)+(c). Short Answer Questions:. o likes to consume x =(ice cream) and x =(broccoli). Each unit of ice cream costs p =, each unit of broccoli costs p = 4, and he has income of I =. His preferences can be summarized by the utility function U ( x, x ) = xx. It follows that U = x and U = x. a. Which of the following two consumption bundles does o like more: units of ice cream and 5 units of broccoli or 4 units of ice cream and units of broccoli? Clearly explain. (3 points) Since U (,5) = ()(5) = 6 is less than U ( 4,) = (4)() = 8, it follows that of these two bundles o prefers 4 units of ice cream and units of broccoli. b. Is o able to afford 35 units of ice cream and units of broccoli? Clearly explain why or why not. (3 points) This bundle is affordable, since it would cost him only p x + px = ()(35) + (4)() =, which is less than his income of I =. c. State an expression for o s arginal Rate of Substitution (as a function of x and x ). (3 points) U RS, = = U x x d. Is the consumption bundle units of ice cream and units of broccoli the optimal consumption bundle (i.e., the utility maximizing consumption bundle ) for o? Clearly explain why or why not. (3 points)

3 x At this consumption bundle RS, = = =. But with x p = and p = 4, it follows that p p = = p 4. Since RS,, the proposed p consumption bundle cannot be optimal.. Consider a perfectly competitive firm operating in the Short Run. arginal Costs, Average Variable Costs, and Average Total Costs are illustrated below. \$.5 ATC C AVC ATC = 6..5 AVC = a. Detere the numerical value of ixed Costs of Production for this firm. (3 points) Recall that by definition AC = ATC AVC and AC =. rom the graph above we see that at = AC = ATC AVC =.5.5 = 8. Thus, by AC = it follows that 8 =, implying = 8. b. If the per unit price of output in this market were p =. 5, how much output would this firm produce? Explain. (3 points) The given price of p =. 5 is above AVC =. 8. Therefore, the firm will maximize profit by producing the positive level of output for which p = C(). rom the graph above this level of output is = 8. c. If the per unit price of output in this market were p = 6. 3, how much output would this firm produce? Explain. (3 points) The given price of p = 6. 3 is below AVC =. 8. Therefore, the firm will want to shutdown in the short run and produce = units of output.

4 d. If the per unit price of output in this market were p =. 5, is this firm able to earn a positive profit? Explain. (3 points) The given price of p =. 5 is below ATC =6.. Since profit can be expressed as π = [ p ATC() ], this insight implies that profit will be negative for all values of. That is, the firm is not able to earn a positive profit. 3. Consider a monopolist facing Demand as illustrated by the linear function below. Also illustrated is the arginal Cost curve and Average Total Cost curve for this monopolist. Suppose throughout that this firm is not able to engage in price discriation. p C () ATC () () P D,4 4, R () 8, a. In order to maximize profit, what price should this monopolist charge? Explain. (4 points) To maximize profit, this monopolist should produce the level of output for which R ( ) = C( ). The graph above indicates that this level is =, 4 units of output. or consumers to be willing and able to purchase exactly this p P =. = D uantity, the firm should charge a per unit price of ( ) 8 b. Is this monopolist able to earn a positive profit? Explain. ( points) No, this monopolist is not able to earn a positive profit. Recall that profit can be expressed as π = [ p ATC() ]. rom this expression (along with the profit maximizing values identified in the answer to part (a) above), we see that the maximum profit of this firm is π = (,4)[ 8 38] = 4, <.

5 c. Does this monopolist produce the socially efficient level of output (that is, the level of output which maximizes total social welfare)? Explain. ( points) The socially efficient level of output is the uantity at which P D ( ) = C( ) : E = 4,. Therefore, when this monopolist produces only =, 4 units, less than the socially efficient level of output is being produced. 4. Consider a market with Supply and Demand as illustrated below:.5 \$ Supply Demand , a. If a per unit tax of \$3. is imposed on sellers in this market, by how much will the per unit price paid by buyers increase? Explain. (4 points) Without any intervention in this market, = 65 units will be traded, each at a price of p = When a per unit tax of T = 3. is imposed on sellers in this market, the level of trade will be the uniue level for which P ( ) P ( ) T. rom the graph above, we see that this level of trade is D S = T = 5. The price that buyers pay per unit is eual to the height of the T demand curve at this uantity of trade: p B = PD ( T ) = Thus, the imposition of this tax increase the price that buyers pay by p T B p = =.5. b. If a per unit tax of \$3. is imposed on buyers in this market, how much tax revenue would be generated? Explain. (4 points) If this tax is instead imposed on buyers, the same level of trade as above ( T = 5 ) will result. Therefore, this tax would generate tax revenue of T = 3 (5) =,. ( ) 5 T

6 Extra Credit! (4 points) Consider a monopolist facing inverse demand of P D ( ) =,. Suppose this firm has costs of production eual to TC ( ) = + +, so that C( ) = +., 5 Demand and arginal Costs are illustrated below. p C () () P D = 7, 4, If this firm cannot price discriate, profit is maximized by producing = 6, units of output and charging a price of p = 7. This choice leads to a maximum profit of π = 54,. Thus, such a firm is only able to earn a positive profit if < 54,. Suppose this firm is able to engage in irst Degree Price Discriation (i.e., Perfect Price Discriation ). or what range of is the firm able to earn a positive profit? Explain. If this firm were able to engage in irst Degree Price Discriation, they would sell all units for which P D ( ) =, C( ) = + 5. That is, they would choose to sell = 7, units of output, as illustrated above. By charging each consumer a price exactly eual to reservation price, the firm would be able to capture the entire area below the demand curve (up to this level of output) as Revenue. Since Variable Costs can be illustrated as the area below the arginal Cost curve, it follows that the maximum value of Producer s Surplus PS = REV VC( ) for this firm is eual to the area of the red triangle shaded in the graph above. The area of this triangle is: PS = ( 7,)( ) = (9)(7,) = 64,8 Since π = PS, it follows that the maximum profit of this firm is π = PS = 64, 8. Thus, the firm is able to earn a positive profit if and only if 64, 8.