ECON 4550 (Fall 2011) Exam 1

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1 ECON 455 (Fall 211) Exam 1 Name Multiple Choice Questions: (4 points each) 1. Jimmy is risk neutral. He is faced with a random payoff with expected value of $2,. Further, for this payoff the highest possible realization of wealth is $32,5, while the lowest possible realization of wealth is $7,25. It follows that his Certainty Equivalent for this random payoff must be A. exactly equal to $7,25. B. greater than $7,25 and less than $2,. C. exactly equal to $2,. D. greater than $2, and less than $32,5. E. exactly equal to $32,5. 2. Since December 21, there has been a decrease in both the price and quantity traded of Good X. Which of the following would have led to this observed change in the market outcome for this good? A. An increase in supply. B. A decrease in supply. C. An increase in demand. D. A decrease in demand. E. None of the above answers are correct. 3. Albert is considering purchasing a new MP3 player. His reservation price as a buyer of this item is r b 9. Walmart is selling MP3 players for p 6. If Albert were to buy this item from Walmart he would realize a Consumer s Surplus of: A. (9)/(6) = (1.5). B. (9) (6) = (3). C. (9). D. (9) + (6) = (15). E. (9)(6) = (5,4). 4. Bob promised to pay Jan $5 exactly five years from today. Supposing that an annual return of 4% could be earned in each year between now and this future date, Jan s present value for this payment is A. approximately equal to $ B. approximately equal to $ C. approximately equal to $ D. exactly equal to $52. E. approximately equal to $ At the market equilibrium outcome (within the model of Supply and Demand) A. both Total Consumers Surplus and Total Producers Surplus are typically equal to zero. B. both Total Consumers Surplus and Total Producers Surplus are typically positive. C. both Total Consumers Surplus and Total Producers Surplus are typically negative. D. Total Producers Surplus is typically positive, while Total Consumers Surplus is typically equal to zero. E. Total Consumers Surplus is typically positive, while Total Producers Surplus is typically equal to zero.

2 6. According to the Inverse Elasticity Pricing Rule, when maximizing profit a firm must be operating in a manner so that 1 is equal to p A. P. MC B. P MC. P C. P MC. D. F. E. AVC. For questions 7 through 9, consider a firm with costs of production as illustrated below. Observe that ATC(q) take on a minimum value of $152 (when 12 units of output are produced) and AVC(q) take on a minimum value of $1 (when 1 units of output are produced). $ ATC(q) ATC min 152 AVC(q) AVC min The Marginal Cost of producing the 11 th unit of output must be A. less than $1. B. exactly equal to $1. C. greater than $1, but less than $152. D. exactly equal to $152. E. greater than $152. quantity 8. The Efficient Scale of production is equal to units of output. A. B. 1 C. 12 D. 2 E. None of the above answers are correct. 9. If this firm were to produce 16 units of output, Average Variable Costs of Production would be equal to A. $14. B. $136. C. $148. D. $21,76. E. $27,52.

3 1. Suppose the Income Elasticity of Demand for Good X is (.489) and the Income Elasticity of Demand for Product Y is (1.237). These values would suggest that A. both Good X and Good Y are normal goods. B. both Good X and Good Y are inferior goods. C. Good X is an inferior good, while Good Y is a normal good. D. Good Y is an inferior good, while Good X is a normal good. E. demand for Good X satisfies the Law of Demand, while demand for Good Y violates the Law of Demand. 11. A seller s reservation price A. refers to the minimum dollar amount a seller is willing to accept in exchange for an item. B. refers to the maximum dollar amount a buyer is willing to pay for an item. C. is illustrated by the vertical distance between the supply curve and demand curve. D. must be equal to zero for all units sold at the equilibrium outcome. E. More than one (perhaps all) of the above answers is correct. For questions 12 and 13, consider a market in which demand is given by the linear function illustrated below: price At a price of p 6 demand is. A. perfectly elastic B. elastic C. unit elastic D. inelastic E. perfectly inelastic 12,5 quantity 13. If price were to decrease from p 3. 2 to p 2. 8, then the value of price elasticity of demand would A. increase (i.e., get closer to zero in value). B. decrease (i.e., get further from zero in value). C. remain unchanged at a value of (.64) both before and after the decrease in price. D. remain unchanged at a value of (.875) both before and after the decrease in price. E. None of the above answers are correct, since the graph does not convey enough information to be able to determine how the value of price elasticity will change as a result of this price decrease.

4 14. is a market structure in which firms sell differentiated products (and thus, each firm has some market power in the Short Run) and in which there are no substantial barriers to entry in the Long Run. A. Monopoly B. Monopolistic Competition C. Perfect Competition D. Oligopoly E. None of the above answers are correct. 15. Consider a firm in a perfectly competitive market with: output price of $16.85 per unit; AVC min $15.6; and ATC min $18.2. When maximizing profit in the short run, this firm A. will shut-down and earn a negative profit. B. will shut-down and earn zero profit. C. will produce a positive quantity and earn a negative profit. D. will produce a positive quantity and earn zero profit. E. will produce a positive quantity and earn a positive profit. For questions 16 and 17, consider a monopolist operating in the market illustrated below. Suppose throughout that the monopolist is restricted to charging a common price for every unit of output sold $ MC(q) b a 11. c d g f 8.5 e h Demand quantity MR(q) 2,275 3,9 4, 16. In order to maximize profit this monopolist should charge a price of per unit. A. $3.9 B. $6.3 C. $8.5 D. $11. E. $ When this monopolist maximizes profit, the resulting Total Consumers Surplus in this market is equal to A. zero. B. areas (a)+(b). C. areas (a)+(b)+(c)+(d). D. areas (a)+(b)+(c)+(d)+(e)+(f)+(g). E. areas (e)+(h).

5 Problem Solving/Short Answer Questions: 1. Consider the market for wrist watches. Between 24 and 211 the market shares of the five largest firms in this industry evolved as follows: largest 2 nd largest 3 rd largest 4 th largest 5 th largest firm firm firm firm firm 24 16% 14% 1% 8% 5% 211 2% 9% 7% 4% 3% 1A. Determine the value of C4 in both 24 and 211. (4 points) 1B. Based upon your answer to part (1A), is this industry more competitive or less competitive in 211 than it was in 24? Explain. (4 points)

6 2. Ty s preferences for wealth are summarized by the Bernoulli utility function u( x) 2 x. From here it follows that 1 MU ( x). Suppose that he must choose one of the two following random x payoffs: 9 11 Random Payoff A: $1 with probability p 2 and $25 with probability ( 1 ) Random Payoff B: $64 with probability q 1 and $4 with probability ( 1 q ) 1. 2A. Do his preferences satisfy the property of monotonicity? Explain. (2 points) p. 2B. Determine the value of Ty s Certainty Equivalent to Random Payoff A. (4 points) 2C. Supposing that Ty applies the Expected Utility Criterion for decision-making, which of these two random payoffs would he prefer? Explain. (4 points)

7 3. Consider a firm that can potentially produce up to four different products, Product A, Product B, Product C, and Product D. The Per-Unit Revenue, Per-Unit Variable Cost, and Annual Quantity Sold for each product is summarized in the table below (each of these values reported in the table below for each product does not depend on which other products are or are not produced). Product A Product B Product C Product D Per-Unit Revenue Per-Unit Variable Costs Annual Quantity Sold 8, 1, 1, 16, In addition to the variable costs of production described in the table above, the firm must incur an overhead cost of $6, if they produce at least one of the four products (this overhead is a quasi-fixed cost, which can be completely avoided by not producing any of the four products). 3A. Determine the value of the Contribution of each of the four different products for this firm. (4 points) 3B. What combination of these four products should the firm choose to produce? When producing this combination of products, how much profit is the firm able to earn? Explain. (4 points)

8 4. You are the manager of a firm that is considering bringing a new product to market. You anticipate that demand will either be high (with probability P ( h). 65 ) or low (with probability P ( l).35 ). You have hired a marketing firm to gauge future demand for this product. The marketing firm will provide a report specifying that they anticipate demand for the product being either High or Low. Based upon past experience, you believe: P (" H" h). 8, P (" L" h).2, P (" H" l). 25, and P (" L" l). 75. Apply Bayes Rule to determine P ( h " H"). (6 points)

9 Extra Credit: Consider a monopolist operating in the market illustrated below. Suppose throughout that the monopolist is restricted to charging a common price for every unit of output sold. $ MC(q) AVC(q) Demand quantity 3,41 3,85 4,475 5,69 MR(q) Determine the value of Price Elasticity of Demand at a price of $16.8. (4 points)

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