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Principles of Microeconomics (Econ 2) Signature: Drake University, Spring 2005 William M. Boal Printed name:
MIDTERM EXAMINATION #3 VERSION B
“Choices Underlying Supply and Demand”
April 11, 2005
INSTRUCTIONS: This exam is closed-book, closed-notes. Simple calculators are permitted, but graphing calculators or calculators with alphabetical keyboards are NOT permitted. Numerical answers, if rounded, must be correct to at least 3 significant digits. Point values for each question are noted in brackets. Maximum total points are 100. I. Multiple choice: Circle the one best answer to each question. [1 pts each: 12 pts total] (1) Suppose a music CD costs $12 and a tee-shirt costs $4. The consumer’s opportunity cost of a tee-shirt is a. 1/3 of a music CD. b. 3 music CDs. c. 4 music CDs. d. 12 music CDs. (2) Suppose Arnold buys food and other goods. If Arnold's income rises, then Arnold's budget line a. does not change position. b. shifts but does not change slope. c. changes slope. d. cannot be determined from information given. (3) Suppose Brigit buys energy and other goods. If Brigit's income, the price of energy, and the price of other goods all fall by 50%, then the consumer's budget line a. does not change position. b. shifts but does not change slope. c. changes slope. d. cannot be determined from information given. (4) Carl’s indifference-curve diagram is shown below. The straight line represents Carl’s budget line and the curved lines represent his indifference curves. If Carl is currently choosing the bundle of goods represented by point A, he could be made better off without exceeding his budget by a. buying more health care and fewer other goods. b. buying more other goods and less health care. c. either (a) or (b). d. Carl cannot be made better off by changing his purchases. (5) Derek consumes sodapop and other goods. The price of a can of sodapop is approximately equal to a. zero. b. the average value to Derek of all cans of sodapop that he consumes. c. the value to Derek of the first can of sodapop that he consumes. d. the value to Derek of the last can of sodapop that he consumes. (6) Accounting costs do not usually include such economic costs as a. money paid for electricity, raw materials, and supplies. b. lease payments for factories or offices. c. wages paid to workers. d. the value of the business owner’s time spent running the business. (7) Suppose at 300 units of output, marginal cost is less than average cost. It follows that at this level of output, the average cost curve must be a. sloping upward. b. sloping downward. Health care Other goods
A
Drake University, Spring 2005 Page 2 of 8 c. at its minimum point. d. vertical. (8) If a firm is currently producing at a level of output where marginal cost is greater than marginal revenue, it can increase its profit by a. producing less output. b. producing more output. c. It cannot increase its profit by making small changes in output. d. cannot be determined from information given. (9) If a firm takes the market price as given in choosing its level of output, then what is the shape of its marginal revenue curve, graphed against output on the horizontal axis? a. A horizontal line. b. A downward-sloping line. c. An upward-sloping line through the origin. d. A U-shaped curve. (10) Suppose milk is produced in a competitive market. Then the price of a gallon of milk is approximately equal to the a. zero. b. marginal cost to milk producers of the first gallon produced. c. marginal cost to milk producers of the last gallon produced. d. average variable cost of all milk produced. (11) The present discounted value of a given payment to be received in the future is smaller a. the lower the interest rate (or discount rate). b. the later the payment is received. c. both (a) and (b). d. neither (a) nor (b). (12) A firm has daily revenue of $1000, short-run variable cost of $700, and short-run fixed cost of $400. Its short-run producer surplus is a. negative $100. b. $300. c. $600. d. $1000.
Drake University, Spring 2005 Page 4 of 8 (1) [Consumer choice and demand: 16 pts] The indifference curves in the graph below represent Ellen’s preferences for other goods and health care. 0
Health care Other goods a. Would Ellen rather have 5 units of health care and 4 units of other goods, or 2 units of health care and 9 units of other goods? other health care goods b. Would Ellen rather have 2 units of health care and 5 units of other goods, or 6 units of health care and 1 unit of other goods? other health care goods Suppose Ellen has a budget of $40 to spend on health care and other goods. The price of other goods is $4. c. Using a straightedge , carefully draw Ellen’s budget line when the price of health care is $5. Label this budget line “A”. d. How many units of health care will Ellen buy if the price of health care is $5? units of health care e. Using a straightedge , carefully draw Ellen’s budget line when the price of health care is $10. Label this budget line “B”. f. How many units of health care will Ellen buy if the price of health care is $10? units of health care g. [4 pts] Plot two points on Ellen’s demand curve for health care, and sketch his demand curve at right. $ $ $ $ 0 1 2 3 4 5 6 7 8 9 10 11 Units of health care Price of health care
Drake University, Spring 2005 Page 5 of 8 (2) [Short-run cost curves and supply: 22 pts] Acme Computer Chip Company is a small firm in a big market, and therefore takes its output price as given. In the short run, Acme faces daily cost curves as shown in the following diagram. Here, SMC denotes short-run marginal cost, SAVC denotes short-run average variable cost, and SATC denotes short-run average total cost.
0 100 200 300 400 500 600 700 800 900 1000 1100 1200
Quantity of output
Average and marginal cost
SMC
SAVC
SATC
a. Suppose Acme were currently producing 900 chips. What would Acme's total cost be, to the nearest thousand dollars?
$ thousand
b. Suppose Acme were currently producing 1000 chips. If Acme produced one more chip, by how much would its total cost increase? That is, what would be the change in cost as Acme increased output from 1000 to 1001 chips?
c. What is Acme’s fixed cost, to the nearest thousand dollars? $ thousand
d. What is Acme's break-even pricethat is, the lowest price at which the company can avoid losses?
e. What is Acme's shut-down pricethat is, the lowest price at which it will remain in operation in the short run?
f. Suppose the price of chips is $3. How many chips will Acme produce? (Give an answer to the nearest hundred.)
chips
g. Will Acme experience profits or losses at a price of $3? h. Suppose the price of chips is $8. How many chips will Acme produce? (Give an answer to the nearest hundred.)
chips
i. Will Acme experience profits or losses at a price of $8? j. Suppose the price of chips is $15. How many chips will Acme produce? (Give an answer to the nearest hundred.)
chips
k. Will Acme experience profits or losses at a price of $15?
Drake University, Spring 2005 Page 7 of 8 (5) [Discounting: 4 pts] Answer the following questions, assuming the interest rate is 2%. Round to the nearest whole dollar. a. Suppose $2000 is to be received one year from today and $3000 is to be received two years from today. Compute the present discounted value of this stream of payments, to the nearest whole dollar.
b. Suppose a firm is expected to enjoy $20 million in profits every year, perpetually, beginning a year from today. Compute the value of the firm.
$ million
(6) [Welfare effects of international trade: 16 pts] Domestic supply and demand for ink cartridges are given by the following diagram. At first, international trade in ink cartridges is not permitted. Then this industry is opened to international trade and the international price of ink cartridges turns out to be $6. $
Quantity (millions) Price Demand Supply a. Will this country now export or import ink cartridges?
b. How many? million
c. Does consumer surplus in this country increase or decrease from international trade in ink cartridges?
d. By how much? $ million
e. Does producer surplus in this country increase or decrease from international trade in ink cartridges?
f. By how much? $ million
g. Does net social welfare in this country increase or decrease from international trade in ink cartridges?
h. By how much? $ million
Drake University, Spring 2005 Page 8 of 8 III. Critical thinking: Write a one-paragraph essay answering one question below (your choice). Full credit requires correct economic reasoning, legible writing, good grammar including complete sentences, and accurate spelling. [4 pts] (1) Consider the following statement. "International trade must be fair trade. The U.S. should only trade with countries whose prices are the same as ours." Do you agree or disagree? Why or why not? Illustrate your answer with a supply-and-demand diagram. (2) Consider the following statement. "To maximize profit, a firm should set its level of output at the point corresponding to the lowest point on its average cost curve. For example, suppose the price of a good is $5 and the minimum point on the average cost curve is $3 where output is 300 units. Then the firm should produce 300 units of output and enjoy profit of $600." Do you agree or disagree? Why or why not? Illustrate your answer with a cost-curve diagram. Which question are you answering, (1) or (2)? _________. Please write your answer below, continuing on the back if necessary. [end of exam]
