ECONOMICS 53 Problem Set 5 Due before lecture on March 25

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1 Department of Economics Spring Semester 2010 University of Pacific ECONOMICS 53 Problem Set 5 Due before lecture on March 25 Part 1: Multiple Choice (25 Questions, 1 Point Each) 1. The demand for inputs is a derived demand because A) it does not come from competitive markets. B) it depends on the demand for outputs. C) it is derived from nature. D) it is derived from production. 2. The marginal revenue product of labor is A) the additional revenue a firm earns by employing one additional unit of labor. B) the additional profit a firm earns by employing one additional unit of labor. C) the marginal product of capital times the price of labor. D) the additional revenue the firm makes by selling one unit of labor. 3. The Package Store hires workers to wrap packages. The store sells this service for $5. The marginal revenue product of this storeʹs fifth worker is $50. The marginal product of the fifth worker is A) 0.01 package. B) 1 package. C) 10 packages. D) indeterminate from this information. 4. Louʹs Potato Chips is a perfectly competitive firm currently employing 30 workers. The marginal revenue product of the 30th worker is $7.00 per hour. The wage rate is $8.00 per hour. To increase profits, this firm should A) decrease employment until the MRP of labor equals $8.00. B) increase employment until the MRP of labor equals $8.00. C) continue hiring 30 workers because the firm earns a surplus of $1.00 on each worker hired. D) increase the price of potato chips so that the marginal revenue product increases to $8.00 per hour. 1

2 Refer to the information provided in Figure 10.1 below to answer the questions that follow. 5. Refer to Figure This firm is currently hiring 16 workers and paying a wage of $10. This firm should A) do nothing because it is maximizing profits. B) reduce employment to 15 workers to increase profits. C) reduce employment to 14 workers to increase profits. D) increase employment to 17 workers to increase profits. 6. When a firm substitutes away from a factor whose price has risen and toward a factor whose price has fallen, it is an example of the A) output effect of a factor price decrease. B) factor substitution effect. C) factor complementary effect. D) output substitution effect. 7. If the price of labor falls, A) we can conclude that the demand for capital will always decrease because only the factor substitution effect is relevant. B) we can conclude that the demand for capital will always increase because only the output effect is relevant. C) the change in the demand for capital cannot be predicted because the factor substitution effect and output effect work in opposite directions. D) the demand for capital will be unaffected, because only a change in the price of capital would change the demand for capital 8. Assume the Backwoods Shoe Company hires three inputs: labor ( L), capital (K), and land (A) to produce shoes (X). Which of the following conditions must be met so that the firm is using the optimal, or least costly, combination of inputs? A) MPL = MPK = MPA B) PL = PK = PA C) MPL/PL = MPK/PK = MPA/PA D) MPL = MPK = MPA = 1/PX 2

3 9. A firm hires labor, capital, and land to produce tomatoes. Currently the marginal product of the last unit of labor input is 20, the marginal product of the last unit of capital input is 30, and the marginal product of the last unit of land input is 100. The market wage is $10 and the market price for capital is $15. If the firm is using the optimal combination of inputs, then the price of land is A) $2. B) $20. C) $50. D) indeterminate from the given information. 10. An example of intangible capital is A) a vacation house. B) a flower garden. C) a book. D) a trained apprenticeship program. 11. A capital asset will depreciate because A) it wears out physically. B) a similar product becomes available. C) of an increase in the tax on profits. D) All of the above are correct. 12. When a household lends money directly to a firm, the firm gives the household A) interest on the savings account B) a certificate of investment. C) a bond. D) dividends. 13. The two most important forms of capital income are A) rents and profits. B) investments and rents. C) dividends and depreciation. D) interest and profits. 14. You are asked to lend a friend $20,000 for a year. At the end of the year your friend agrees to pay you $21,000. The interest rate on this loan is A) 4.50% B) 5.00%. C) 5.50%. D) indeterminate from this information. 15. As a holder of a share of common stock, you are A) entitled to a portion of the firmʹs revenues. B) entitled to a portion of the firmʹs profits. C) entitled to a standard percentage return on your investment. D) responsible for the liabilities of the corporation. 16. A fund that takes household savings and puts them into high -risk ventures in exchange for a share of the profits if the new business succeeds is a A) business capital fund. B) innovation capital fund. C) risk capital fund. D) venture capital fund. 3

4 17. Polar Water, a company that delivers bottled water, is considering three investment opportunities. The expected returns for each of the projects are as follows: buying a new delivery van, 20%; computer training for its office staff, 15%; and defensive driving training for its drivers, 8%. If the current interest rate is 10%, the firm should invest in A) only the purchase of a new delivery van. B) the purchase of a new delivery van and computer training for its office staff. C) all of the projects because the average of the returns is greater than 10%. D) only the office staff training project. 18. An investment should be undertaken A) if the present value of the expected income stream associated with the investment is greater than the full cost of the investment project. B) if the present value of the expected income stream associated with the investment is less than the full cost of the investment project. C) any time the present value of the expected income stream associated with the investment is positive. D) if the present value of the costs of the investment project exceed the present value of the expected returns from the investment project. 19. The quantity of investment demanded by firms A) is inversely related to the interest rate. B) is directly related to the interest rate. C) is unrelated to the interest rate. D) is positively related to the level of uncertainty. 20. An economist investigates the impact that implementing an energy tax has on all industries and input markets. She does a(n) equilibrium analysis. A) interrelated B) general C) interconnected D) partial 21. If some gain and some lose as the result of a change, and it can be demonstrated that the value of the gains exceeds the value of the losses, then the change is said to be A) potentially efficient. B) inefficient. C) unequivocally Pareto optimal. D) technically efficient. 4

5 Refer to the information provided in the Figure 12.2 below to answer the questions that follow. Figure Refer to Figure A technological advance causes the supply of personal computers to increase. The graph of this situation represents a A) general equilibrium analysis because it identifies what happens to both equilibrium price and quantity of personal computers. B) partial equilibrium analysis because it considers only this one industry. C) firm-specific analysis because only one firm would be affected by the technological advance. D) technological analysis because the change resulted from a technological advance. 23. reflects household willingness to pay and reflects the opportunity cost of the resources needed to produce a good. A) Marginal utility; price B) Price; marginal cost C) Price; average total cost D) Demand; price 24. If society will gain by producing more X, then it must be the case that currently A) PX = MCX. B) PX > MCX. C) PX < MCX. D) either PX > MCX or PX < MCX. 25. Which one of the following is NOT a source of market failure? A) externalities. B) public goods. C) imperfect information. D) price ceilings. 5

6 Part II: Short Answers (75 Points) Question 1: Labor Demand for a Firm (20 Points) Consider the following information for a T-shirt manufacturing firm that can sell as many T-shirts as it wants for $3 per shirt. Number of Workers Number of Shirts Produced per Day Marginal Product of Labor Total Revenue (TR) Marginal Revenue Product of Labor (MRP L ) 0 0 N/A $30 8 $15 (a) Fill in all the blanks in the table (6 Points) (b) If the market price of labor is $40 per worker per day, how many workers should the firm hire? Briefly explain why. (3 Points) (c) Suppose the wage rate rises to $50 per worker per day. How many workers should be hired now? Why? (3 Points) (d) Suppose that there is a breakthrough technology in the T-shirt industry that doubles output at each level of employment (i.e. Worker 1 produces 60 shirts, Worker 2 produces 160 shirts, etc ). Redo the table in (a) reflecting this new technology. What effect has this new technology had on marginal product of labor and on the marginal revenue product of labor? At the wage rate of $50 per worker per day, how many workers will the firm hire now? (8 Points) Number of Workers Number of Shirts Produced per Day Marginal Product of Labor Total Revenue (TR) Marginal Revenue Product of Labor (MRP L ) 0 N/A N/A

7 Question 2: Input Demand for a Firm: Using Algebra (15 Points) You own farm producing corn. Assume that the only variable input that determines how much corn you produce is acres of land devoted to corn. Your production function is Q = 500A 20A 2 Your marginal product of land function is MP A = A Where Q = Number of corn produced (output) A = acre of land devoted to corn (input) Assume that the market for corn is perfectly competitive. The price of each ear of corn is $2 The price of an acre of land is $40 an acre. (a) How many acres of land should you purchase to grow corn based on the above information? (4 Points) (b) What if the price of corn increases to $3 an ear, while the price of land skyrockets to $180 per acre. How many acres of land will you purchase? Based on your answer how many ears of corn will you now grow? (6 Points) (c) Given your answer to Part (b), calculate the profit of your farm. (5 Points) Question 3: Firm s Profit Maximizing Condition in the Input Market (5 Points) For a given firm, MRPL = $50, MRPK = $100, PL = $10, PK = 20. Assume that the price of the output be $5 (P = $5) Is the firm maximizing profits? Explain your answer. Question 4: Defining Capital (7Points; 1 Point Each) For the following (1) identify whether or not it is capital and (2) if they are capital which category of capital do they belong: tangible capital, social capital, or intangible capital (a) A video poker game machine at the local Indian casino (b) A $100 bill (c) A college education (d) The Golden Gate Bridge (e) The shirts in the stockroom at Sears (f) A savings account (g) A Honda plant in Marysville Ohio 7

8 Question 5: Present Value (15 Points) Congratulations! You just won the MegaMillions jackpot. Before you can claim the money, you have to decide on how you would want to be paid out. The Lottery Commission has given you three choices on how you can receive your after-tax winnings. Choice A: Take a lump sum of $75 million today Choice B: Starting next year, you can receive annual payments of $30 million for 3 years. Choice C: Receive a lump sum of $125 million 5 years from now The interest rate is constant at 10%. Which payout should you choose? Explain your answer. Question #6: General Equilibrium Theory (13 Points) Suppose that we have two goods X and Y that are both in perfectly competitive industries. Both X and Y are in their long-run equilibrium where P=MR=MC=ATC such that there are both earning zero economic profits. (a) Draw this long-run equilibrium situation for both goods X and Y. For both goods you will want to draw two graphs side-by-side. The left hand side graph should represent the market or industry while the right hand graph should represent a representative firm. (1 Point) (b) Suppose that there is a change in consumer preferences that causes the demand for Good X to suddenly increase. What effect will this have on profits for the representative firm that produces Good X? What will happen in the long-run in the industry that produces Good X. Show the above effects on the industry that produces Good X on your graph in Part (a) above. (5 Points) (c) Assume that income for a typical household is fixed. That is the only way consumers will able to purchase more of Good X is to decrease their consumption of every other good (including Good Y). Thus the demand for Good Y decreases. What effect will this have on the profits for a representative firm producing Good Y? What will happen in the long-run in the industry that produces Good Y. Show the above effects on the industry that produces Good Y on your graph in Part (a) above. (5 Points) (d) Give an example on how the change in consumer preference for Good X will affect other markets. (2 Points) 8

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