ECON 81 (Spring 214) Exam 1 Name A. Key Multiple Choice Questions: (4 points each) 1. The states that a rational decision maker should undertake an action if and only if the Marginal Benefit from taking the action is at least as great as the Marginal Cost of doing so. C. Cost-Benefit Principle 2. A decrease in demand is visually illustrated by a shift of the demand curve; a decrease in supply is visually illustrated by a shift of the supply curve. A. leftward; leftward. 3. Amanda is considering purchasing a new basketball. Her reservation price as a buyer of this item is r b 4. Target is selling basketballs for p 18. If Amanda buys a basketball from Target she would realize a Consumer s Surplus of: C. 4 18 = 22. 4. The Law of Supply C. implies that Supply Curves should be upward sloping. 5. At the market equilibrium outcome in the model of Supply and Demand C. both Total Consumers Surplus and Total Producers Surplus are typically positive. 6. Westley Industries (an Australian based pharmaceutical company) produces Iocaine Powder using three inputs, Input A, Input B, and Input C. During the next month they are able to hire any amount of Input A and Input B that they wish, but are restricted to using exactly 125 units of Input C. From this information, it appears as if Westley Industries is operating in the A. Short Run. 7. Which of the following would lead to a decrease in the supply of oranges? A. A severe frost in Florida. 8. In a perfectly competitive market, D. More than one (perhaps all) of the above answers is correct. [Both B and C are correct.] 9. Suppose that demand for sugar is unit elastic at all prices. If price were to decrease by 7%, then quantity demanded would C. increase by exactly 7%.
1. Wendy sells cotton candy in a perfectly competitive market. She hires a business consultant to analyze her company s financial records. The consultant recommends that she increase her production. The consultant must have concluded that at her current level of output Wendy s D. Marginal Cost is less than price. 11. Since October 213, there has been a 4% decrease in price and a 6% increase in quantity traded of Good Z. Which of the following would have led to this observed change in the market outcome for this good? A. An increase in supply. 12. The Efficient Scale of Production refers to the level of output at which C. Average Total Costs of Production are imized. 13. For a firm with market power Marginal Revenue is, while for a firm in a perfectly competitive market Marginal Revenue is. A. less than Price; equal to Price. 14. No buyer in this market has a Buyer s Reservation Price A. above $12.8. 15. In this market there would be at a price of $5.95. B. excess supply 16. At the market equilibrium, Total Consumers Surplus is equal to and Total Producers Surplus is equal to. C. areas (a)+(b)+(e) ; areas (c)+(d)+(f) 17. Economics is C. the social science that studies decision making in the face of scarcity, and the implications of such decisions on individuals and societies. 18. Consider a market in which demand is given by the function D( p) 8, 2p (for p 4). Demand is at a price of $9 and is at a price of $15. C. inelastic; inelastic. 19. If this firm were to produce 1,2 units of output, its Average Fixed Costs of Production would be equal to. B. $18.9 2. Suppose that each unit of output can be sold for $15.. In order to maximize profit in the Short Run, this firm should produce units of output. D. 1,2
Problem Solving/Short Answer Questions: 1. Consider the market for Good X. Suppose the following estimated values of elasticity have been detered: (Price Elasticity of Demand for Good X ) = (.6532) (Cross-Price Elasticity of Demand for Good X with respect to the price of Good Y ) = (.2214) (Cross-Price Elasticity of Demand for Good X with respect to the price of Good Z ) = (.382) (Income Elasticity of Demand for Good X ) = (.1853) Based upon these estimated values, answer the following questions. 1A. If the price of Good X were to increase slightly, would the total revenue received by sellers of Good X increase, decrease, or remain unchanged? Clearly explain, making specific reference to at least one of the numerical values above to support your answer. (4 points) The estimated value of Price Elasticity of Demand for Good X (of.6532) is between 1 and, implying that demand is inelastic. As a result, Marginal Revenue (a measure of the change in Total Revenue as more output is sold) is negative. Thus, an increase in price (which will lead to a decrease in quantity demanded, by the Law of Demand) would result in an increase in Total Revenue for sellers of Good X. 1B. Is Good X a normal good or an inferior good? Clearly explain, making specific reference to at least one of the numerical values above to support your answer. (3 points) A normal good refers to a good for which demand increases as a result of an increase in income; an inferior good refers to a good for which demand decreases as a result of an increase in income. The sign of Income Elasticity of Demand reveals whether a good is normal (in which case Income Elasticity is greater than zero) or inferior (in which case Income Elasticity is less than zero). The estimated value of Income Elasticity of Demand for Good X (of.1853) therefore implies that Good X is an inferior good. 1C. Suppose the price of Good Z decreased. Clearly explain whether the equilibrium price and equilibrium quantity of Good X would each either increase or decrease. Again, make specific reference to at least one of the numerical values above to support your answer. (3 points) To detere how demand for Good X changes in response to a change in the price of Good Z, we must exae the value of Cross-Price Elasticity of Demand for Good X with respect to the price of Good Z. Since the estimated value of this elasticity (.382) is positive, it follows that Good X is a substitute for Good Z. Thus, a decrease in the price of Good Z will lead to a decrease in demand for Good X. In general, a decrease in demand for a good
(which corresponds to a leftward shift of the demand curve) results in a decrease in equilibrium price and a decrease in equilibrium quantity (as illustrated below). price Supply New Demand Initial Demand quantity 2. Consider a firm operating in a Perfectly Competitive Market in the Short Run, with Marginal Costs, Average Variable Costs, and Average Total Costs as illustrated below. 3.6 $ MC(q) ATC(q) AVC(q) 3.1 ATC 2.8 2.15 AVC 1.65 MC 1.2 quantity 8,56 9, 9,45 11,62 2A. If this firm were to shutdown and produce zero output in the Short run, how much profit would it earn? Clearly explain. (3 points) If this firm were to shutdown and produce zero output in the Short Run, then it would realize zero Revenue and zero Variable Costs. As a result, profit would be equal to simply F (i.e., us Fixed Costs of Production). Recall, Average Total Costs can be decomposed into the sum of Average Variable Costs and Average Fixed Costs (ATC=AVC+AFC). This equality can be rearranged as AFC=ATC AVC (i.e., Average Fixed Costs are equal to the difference between Average Total Costs and Average Variable Costs). Also recall the definition of Average Fixed Costs: AFC=F/q. Focusing on 11,62 units of output, ATC=3.6 and AVC=3.1.
This implies that at q=11,62, AFC=.5. From here it follows that the value of Fixed Costs must satisfy.5=f/(11,62). Solving for F, we obtain F=(.5)(11,62)=5,81. So, if the firm were to shutdown and produce zero output it would realize a profit of 5,81. 2B. Suppose that the price of output in this market is $1.5. In order to maximize profit, would this firm want to shutdown or produce a positive quantity of output in the Short run? Is this firm able to earn a positive profit in the Short Run? Clearly explain. (3 points) If the price of output in this market were $1.5, then the firm would want to shutdown and produce zero output in the Short Run. This is the best choice by the firm since at such a low output price, there is no quantity of output that the firm could produce for which Revenue would cover even Variable Costs of production. As a consequence, the maximum profit of the firm is 5,81 (so, no, the firm is not able to earn a positive profit in the Short Run). 2C. Suppose that the price of output in this market is $3.1. What quantity of output would this firm have to produce in order to maximize profit (i.e., detere a numerical value)? How much profit is the firm able to earn when producing this quantity (i.e., detere a numerical value)? Clearly explain. (4 points) If instead the price of output in this market were $3.1, then the firm would want to produce q=9, unit of output (since this is the level of output that equates price to Marginal Costs of production). Producing a positive quantity of output is better than shutting down since price is above the imum value of Average Variable Costs of production. From the graph, we can see that the Average Variable Costs of producing q=9, units of output are $2.15. This implies that the Variable Costs of producing these units are (9,)x($2.15)=$19,35. By selling q=9, units at a per unit price of $3.1 the firm earns Revenue of $28,35. Consequently the profit of the firm is: Profit = (Revenue) (Variable Costs) (Fixed Costs) = $28,35 $19,35 $5,81 = $3,19