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Principles of Microeconomics (Econ 002) Signature: Drake University, Summer 2003 William M. Boal Printed name:
FINAL EXAMINATION VERSION B
INSTRUCTIONS: This quiz is closed-book, closed-notes, but calculators are 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 200. I. Multiple choice: Circle the one best answer to each question. [2 pts each: 52 pts total] (1) Rational behavior implies doing something up to the point where the benefit of the last unit done a. is much less than its opportunity cost. b. is much more than its opportunity cost. c. begins to fall below its opportunity cost. d. begins to exceed its opportunity cost. (2) In an efficient, well-functioning market a. the law of one price holds. b. every potential seller will sell something. c. gains from trade (or earnings) are divided equally between buyers and sellers. d. every trade will take place at a different price. (3) Markets tend to automatically eliminate excess demand through a. a rise in price. b. a fall in price. c. a fall in the quantity actually sold. d. a leftward shift in demand. (4) In April, the price of bathing suits rose and the quantity sold increased. This could have been caused by a. a leftward shift in the demand. b. a leftward shift in the supply. c. a rightward shift in the demand. d. a rightward shift in the supply. (5) If a very good substitute is available for a particular product, that product’s demand will be a. more elastic. b. less elastic. c. perfectly inelastic. d. Substitution possibilities do not affect elasticity. (6) If buyers or consumers have more time to anticipate and adjust to a price change, their demand is a. more elastic. b. less elastic. c. upward-sloping. d. Time for adjustment does not affect elasticity. (7) The supply curve in the graph below is a. perfectly elastic. b. perfectly inelastic. c. unitary elastic. d. Cannot be determined from information given. (8) Suppose new security regulations add hours to the time airline passengers must spend in airports. By itself, this will shift a. the demand for air travel up. b. the demand for air travel down. c. the supply of air travel up. d. the supply of air travel down. (9) Suppose the price of peaches in Atlanta is $1 per pound and that the cost of shipping peaches between Atlanta and Des Moines is $0.40 per pound. There are no potential gains from arbitrage if the price of peaches in Des Moines is a. $0.50 per pound. b. $0.70 per pound. c. $1.50 per pound. d. $2.00 per pound. (10) Suppose the price of a share of stock in Mega Corporation today is $50. We know that speculators are active in the stock market. Assume that the stock market is in equilibrium. Then speculators must believe that the price of a share of stock in Mega Corporation tomorrow will be a. less than $50. b. greater than $50. c. about $50. d. cannot be determined from information given.
P
Q
Supply
Drake University, Summer 2003 Page 2 of 11 (11) Who loses if a price floor (or legal minimum price) is imposed on housecleaning services? a. All buyers of housecleaning services. b. All sellers of housecleaning services. c. All buyers and all sellers of housecleaning services. d. No one loses—everyone gains. (12) A quota on buyers of gasoline, if binding, will cause the price of gasoline to a. rise. b. fall. c. remain constant. d. rise or fall, depending on the shapes of the demand and supply curves for gasoline. (13) If the tax rate on cigarettes were steadily increased, the tax revenues collected by the government would likely a. decrease steadily. b. first decrease and then increase. c. increase steadily. d. first increase and then decrease. (14) Suppose the price elasticity of demand for donuts is -0.5 and the price elasticity of supply of donuts is 3.0. If a tax is imposed on donuts, which side of the market effectively pays most of the tax? a. Sellers. b. Buyers. c. Sellers and buyers each pay half of the tax. d. Answer depends on which side is legally required to remit the tax to the government. (15) If the price of only one good increases, then a. the slope of the budget line changes. b. the slope of the budget line does not change but the intercepts do. c. neither the slope of the budget line nor its intercepts change. d. cannot be determined from information given. (16) The graph below shows Anita’s indifference curves and two possible combinations (or bundles) of goods. According to this graph, combination A is a. more valuable to Anita than combination B. b. less valuable to Anita than combination B. c. just as valuable to Anita as combination B. d. cannot be determined from the information given. (17) If a firm is currently producing at a level of output where marginal cost is less 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. (18) If a firm takes the market price as given, its total revenue curve is a a. horizontal line. b. an upward-sloping line through the origin. c. downward-sloping line. d. curve with increasing slope. (19) As output rises, short-run average fixed cost a. rises. b. falls. c. remains constant. d. cannot be determined from the information given. (20) In the short run, if a firm shuts down, its loss will equal a. zero. b. its fixed cost. c. its variable cost. d. its marginal cost. (21) A perfectly competitive firm expects that if it increases its output, the price will a. increase. b. stay the same. c. decrease. d. fall to zero. (22) Suppose price is currently greater than long-run average cost in a particular industry. In this industry, we should expect a. entry of new firms. b. some existing firms to leave the industry. c. existing firms to increase the size of their plant and equipment. d. the short-run supply curve to shift to the right.
B
A
Other goods Health care
Drake University, Summer 2003 Page 4 of 11 (2) [Production possibility curves, opportunity costs, comparative advantage: 18 pts] Kelly and Leslie each grow corn and tomatoes. They each face a tradeoff between these two kinds of crops because their land is limited. Their production possibility curves are shown below.
Bushels of tomatoes
Bushels of corn
Kelly
Leslie
a. [2 pts] Kelly's opportunity cost of growing a bushel of tomatoes is how many bushels of corn? bushels of corn b. [2 pts] Leslie’s opportunity cost of growing a bushel of tomatoes is how many bushels of corn? bushels of corn c. [2 pts] Kelly's opportunity cost of growing a bushel of corn is how many bushels of tomatoes? bushels of tomatoes d. [2 pts] Leslie’s opportunity cost of growing a bushel of corn is how many bushels of tomatoes? bushels of tomatoes e. [2 pts] Which person has a comparative advantage in growing tomatoes? f. [2 pts] Which person has a comparative advantage in growing corn? g. [6 pts] Fill in the blanks: Both people can consume combinations of corn and tomatoes outside their individual production possibility curves if ___________________________ produces and gives one bushel of corn to ___________________________, who produces and gives back ______________ bushel(s) of tomatoes in return. (3) [8 pts] Suppose Erudite College raises its tuition by 4%. The long-run elasticity of demand for enrollment at Erudite College is known to be -1.5. Assume everything else affecting enrollment remains constant. a. Will the number of students enrolled at Erudite College increase or decrease? b. ... by about how much, in the long run?
c. Will tuition revenue received by the college increase or decrease? d. ... by approximately how much, in the long run?
Drake University, Summer 2003 Page 5 of 11 (4) [Government farm policies: 8 pts] The following graph shows the market for grain. $
Quantity (millions of tons) Price per ton Demand Supply First consider the market without government intervention.
a. Find the equilibrium price. $ per ton
b. Find the equilibrium quantity. million tons
Now suppose the government sets a target price of $6 per ton. c. How many tons of grain will the government have to purchase to raise the price to this level?
million tons
d. What will be the direct cost of this program to the government--that is, how much money should the government budget for purchasing grain?
$ million
(5) [Illegal activities: 8 pts] The graph below shows the market for a kind of weapon in the absence of any government intervention. Suppose it now becomes illegal to sell (but not to buy) this weapon. Enforcement efforts are such that each time a seller sells a weapon of this kind, she or he faces a 10% chance of being caught and having to pay a $3000 fine. $ $ $ $ $ $ $ $ $ $ $1, 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity (thousands) Price Demand Supply
a. Compute the seller’s expected punishment price for selling this weapon. $
b. Compute the new equilibrium money price for the weapon. $
c. Compute the new equilibrium quantity of this weapon. thousand
d. How much money can the government expect to collect in total fines, on average? $ thousand
Drake University, Summer 2003 Page 7 of 11 (7) [Consumer choice: 8 pts] Consider the graph below of Corinne's preferences for pink lemonade and regular lemonade. Her indifference curves are shown below as heavy lines. 0
Cans of regular lemonade Cans of pink lemonade a. According to these indifference curves, does Corinne view pink lemonade and regular lemonade as perfect substitutes, perfect complements , or neither? Suppose cans of pink lemonade costs $2, cans of regular lemonade costs $1, and Corinne has a budget of $8 to spend on these two items. b. Using a straightedge, carefully draw Corinne’s budget line on the graph above.
c. How many cans of pink lemonade will Corinne purchase? cans
d. How many cans of regular lemonade will Corinne purchase? cans
Drake University, Summer 2003 Page 8 of 11 (8) [Short-run cost curves and supply: 20 pts] Acme Manufacturing Company is a small firm in a big market, and therefore takes the price of its product as given. In the short run, Acme faces 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. $
Quantity of output Avg. and marginal cost SMC = short-run marginal cost SAVC = short-run average variable cost SATC = short-run average total cost a. What is Acme's break-even pricethat is, the lowest price at which the company can avoid losses? (Give an answer to the nearest dollar.)
b. What is Acme's shut-down pricethat is, the lowest price at which it will remain in operation? (Give an answer to the nearest dollar.)
c. Suppose the price of Acme's output is $7. How many units will Acme produce, to the nearest ten? d. Will Acme make a profit or a loss at a price of $7? e. Suppose the price is $5. How many units will Acme produce, to the nearest ten? f. Will Acme make a profit or a loss at a price of $5? g. Suppose the price is $2. How many units will Acme produce, to the nearest ten? h. Will Acme make a profit or a loss at a price of $2? i. What is the smallest positive level of output that Acme will ever produce, to the nearest ten? j. Estimate Acme’s fixed cost, to the nearest hundred dollars. [Hint: Recall that average fixed cost = average total cost minus average variable cost, and that average fixed cost = fixed cost divided by output.]
Drake University, Summer 2003 Page 10 of 11 (10) [Monopoly and price discrimination: 22 pts] Suppose one firm holds a patent for a special industrial part. Cost and demand for the part are shown below.
Quantity (thousands)
Price
Demand
Marginal revenue
Marginal cost and
average cost
First, assume the monopolist must charge the same price to all its customers.
a. What quantity should it produce to maximize profits? thousand
b. What price should it charge? $
c. Compute the monopolist’s profit. $ thousand
d. Compute consumer surplus. $ thousand
e. Compute the deadweight loss from monopoly. $ thousand
Now assume that the monopolist can charge a different price to each customer for each unit, based on what that customer is willing to pay. f. What is the highest price the monopolist will charge any customer, to the nearest dollar?
g. What is the lowest price the monopolist will charge any customer, to the nearest dollar?
h. What quantity should it produce to maximize profit? thousand
i. Compute the monopolist’s profit. $ thousand
j. Compute consumer surplus. $ thousand
k. Compute the deadweight loss from monopoly. $ thousand
Drake University, Summer 2003 Page 11 of 11 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. [6 pts] (1) Consider the following statement. "Competition is the law of the jungle; cooperation is the law of civilization. Everyone is better off when businesses cooperate on setting prices than when they constantly try to undercut each other and steal each others' customers." Do you agree or disagree? Explain your reasoning. (2) Consider the following statement. "If one farmer is better than another farmer at growing everything, then the first farmer cannot possibly benefit from trading with the second farmer." Do you agree or disagree? Explain your reasoning. Which question are you answering? _________. Please write your answer below. [end of final exam]
