Exam 1. Pizzas. (per day) Figure 1

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1 ECONOMICS Dr. John Stewart Sept. 30, 2003 Exam 1 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 each work only 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 showing the combined output for Larry and Curly when the each work 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 Figure Beer (bottle per day) 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 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. 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 Econ , Exam1 Page 1 of 9

2 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 Information for Questions Assume that there are only two types of houses that can be built: small affordable houses and large luxury houses. Both housing markets are assumed to be competitive. Figure 2 shows the supply and demand curves for new affordable housing in Chapel Hill. 5. In market equilibrium, there will be new affordable houses built each year and they will sell at a price of. House price Thousands Supply and Demand of Affordable Housing $320 $280 $240 $200 $160 $120 Demand Shift of demand Supply a) 100, $160,000 b) 100, $100,000 c) 120, $120,000 d) 140, $140,000 (Supply=Demand; red lines) e) 160, $160,000 $80 $40 $ Affordable Houses built per year 6. If the Chapel Hill city council passes an Figure 2 ordinance that the maximum price that can be charged for an affordable house is $120,000 then a) 140 new affordable homes will be built each year selling for $120,000 each. b) 120 new affordable homes will be built each year but there will be an excess demand of 20. c) 120 new affordable homes will be built each year but there will be an excess demand of 60. At a price of $120, will be supplies but 180 will be demanded (purple lines) d) 180 new affordable homes will be built each year but there will be an excess supply of 60. e) the ordinance will have no effect on the price or quantity of new affordable home. 7. If the affordable home and luxury homes are substitutes and the price for luxury homes increases, we expect the equilibrium price for affordable homes to and the quantity to a) raise, raise b) raise, fall c) fall, raise d) fall, fall If the price of a substitute for a good increases, the demand for the good shifts out. 8. If we consider a price change from $160,000 per house to $140,000 per house, the arc price elasticity for the demand curve shown in Figure 2 is a).002 b) 2.0 c) 2.5 d) 3.0 e) 4.0 Econ , Exam1 Page 2 of 9

3 9. If the price is $140,000, then the point price elasticity for the demand curve shown in Figure 2 is. a).002 b) 2.0 c) 2.5 d) 3.0 e) If Chapel hill passes a new law requiring that construction workers be paid a living wage which is higher than the current market wage then the supply curve will and the market equilibrium price for affordable houses will. a) shift down; decrease b) shift up; increase c) shift up; decrease d) not shift, remain the same The living wage increases the price of one of the inputs used in construction so the supply curve will be shifted up so the equilibrium price of houses will increase. 11. If a good is an inferior good then as income decreases, the demand curve for that good will e) not shift, increase a) stay the same b) shift left c) have positive slope d) shift right 12. 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. Information for Questions : Professor Stewart does a lot of traveling. When he is on the road he uses a calling card from TeleRipOff to keep in touch. Figure 3 shows Professor Stewart s demand curve. Price is measured in dollars per minute of long distance calls and quantity is measured in the number of minutes of long distance calls per month. (Note: You can purchase calls in less than 1 minute increments) Price $ per minute $.55 Prof. Stewarts demand calling card calls $.30 $ If the price for long distance calls is $.25 per minute, how many minutes of long distance calls will Professor Stewart purchase? $.05 Figure Minutes per month a) 4 b) 5 c) 6 d) 11 e) none Econ , Exam1 Page 3 of 9

4 14. If the price of long distance calls is $.25 per minute, how much consumer surplus will Professor Stewart receive? (Hint: in case you forgot, the area of triangle is ½ base x height) Q P η = = = P Q. 3 6 b) 2.75 c).90 = ½.30 x 6 d) 1.80 e) a) At a price of $.25 per minute, what is Professor Stewart s point price elasticity of demand? a) 0 b).5 c).05 d).833 e) If the current price is $.25 per minute and TeleRipOff increases the price slightly (1%) Professor Stewart would end up a) spending more on long distance calls b) spending less on long distance calls We can calculate Marginal Revenue from price ($.25) and elasticity (.833) MR = P 1 1 = η 1 = c) spending the same amount on long distance calls since Marginal Revenue is negative, decreasing output (caused by raising price) will increase revenue. d) uncertain, cannot know if more or less would be spent 17. TeleRipOff announces a new pricing policy. You can either keep you old calling card and continue to pay $.25 per minute of calls or you can get the new TeleRipOff Platinum Card which will cost you $1.50 per month but allow you to make calls for $.05 per minute. Given that professor Stewart has a Ph.D. in economics he will a) not buy the Platinum Card and make 6 minutes of calls per month. b) not buy the Platinum Card and make 11 minutes of calls per month. c) buy the Platinum Card and make 10 minutes of calls per month.. Keeping the old plan you get $.90 of consumer surplus. If calls were $.05 you would make 10 minutes of call (the marginal price is $.05) and get $2.50 of surplus - the $1.50 cost of the plan = $1.00 of net consumer surplus. Because you get more surplus with the Platinum Card, that would be the plan you would choose. d) buy the Platinum Card and make 11 minutes of calls per month. e)buy the Platinum Card and make 6 minutes of calls per month. 18. Professor Stewart would buy the card so long as the monthly fee for the card was less than a) $2.50 b) $2.00 c) $1.75 d) $1.60 at this price the two plans produce the same surplus. e) Professor Stewart would only take the Platinum Card if it were free. 19. 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 Econ , Exam1 Page 4 of 9

5 c) oranges are inferior goods d) lemons are inferior goods. 20. If the pizza and beer are substitutes and the price for pizza falls, we expect the equilibrium price for beer to and the quantity to a) rise, rise b) rise, fall c) fall, rise d) fall, fall Information for Questions 21-24: 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. 21. 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) $20.10 $ Figure 5 Total Cost Q (units of chocolates) 23. The average variable cost of 100 units of output is a) $9 b) $10 c) $19 d) $900 Since the total cost of zero (0) units of output on the graph is $1000, fixed cost must be $1000. Thus the variable cost at 100 units of output is =$900. AVC = TVC/Q = 900/100 = $9 24. The shape of the total cost curve in Figure 4 is the result of a) the production function having increasing returns to scale. b) the production function having decreasing returns to scale. c) the production function having constant returns to scale. d) diminishing marginal returns to variable inputs. This short run. Returns to scale are long run. MC is increasing (the slope of the total cost function is getting steeper. This is because of the diminishing marginal product of the variable input. I.e., diminishing marginal returns. Econ , Exam1 Page 5 of 9

6 Information for Questions 25-28: 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 SRMC = P L /MP L 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) $28 Total cost = P K K+P L L = (4 x 5) + (4 x 2) =$ 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) 5 units The firm will maximize profits by producing output up to the point where P=MC this occures at 60 units of output and 60 units of output takes 5 units of labor to produce. 28. Again assuming that the market price is $0.50 per unit and that the firm is a profit maximizing competitive firm, at its 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 The firm will choose to produce 60 (output where P=MC and if P > AVC(60) which it is AVC(60) =.33 At that point total revenue is 60 x.5 = $30 and total cost is (4 x 5) + (4 x 5) = $40. Profits are TR-TC= 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 30. Marginal cost necessarily intersects which of the curves at its minimum? Econ , Exam1 Page 6 of 9

7 a) AFC b) ATC c) AVC d) TC e) both b and c 31. 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 400 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 b) decrease the amount of labor and increase the amount of capital c) increase the amount of labor and decrease the amount of capital If the farmer has chosen the mix of inputs such that cost is minimized then P L /MP L = P M /MP M 10/100=.1< 50/400 =.125 Since it costs less to expand output with labor than machinery, the use of labor should be increased and the use of machinery decreased d) not enough information to determine this Information for Questions 32-35: 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. (Assume that there are no fixed cost. Thus there is no difference between long run and short run cost curves.) $ 600 Profit Figure 6 Typical Firm MC AC $ Market Supply 200 Demand q firm Q market 32. Given that there are currently 200 firms operating in the market in the short run a) the equilibrium price will be $100 and the equilibrium market quantity will be 400 computers per week. b) the equilibrium price will be $400 and the equilibrium market quantity will be 1,000 computers per week. c) the equilibrium price will be $600 and the equilibrium market quantity will be 800 computers per week. d) the equilibrium price will be $600 and the equilibrium market quantity will be 10,000 computers per week. Red lines 33. How much profit will each firm be making at the equilibrium described in question 33 a) $0 per week b) about $2,000 per week c) about $7,500 per week 50 x 150 (note can t get an exact number for P-AC but it is clearly less than 200 and more than 100 d) about $11,000 per week e) the firms are not making a profit. They are losing money. Econ , Exam1 Page 7 of 9

8 34. 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. 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. 35. 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 blue lines c) P= $600, Q = 12,000 d) P= $600, Q = 10,000 Econ , Exam1 Page 8 of 9

9 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 9 of 9