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Principles of Microeconomics (Econ 2) Signature: Drake University, Summer 2007 William M. Boal Printed name:
FINAL EXAMINATION VERSION B
July 5, 2007
INSTRUCTIONS: This quiz 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 200. I. Multiple choice: Circle the one best answer to each question. [2 pts each: 44 pts total] (1) Rational choice implies pursuing an activity up to the point where the benefit of the last unit is a. about to fall below its opportunity cost. b. about to exceed its opportunity cost. c. much less than its opportunity cost. d. much more than its opportunity cost. (2) Which of the following is a positive statement? a. “The state government should cut property taxes.” b. “The federal government needs to do more about global warming.” c. "An increase in the gasoline tax would reduce gasoline consumption." d. “The government ought to pay for health insurance for people who cannot afford it.” (3) A shift in the demand curve for gasoline caused by a rise in consumers’ incomes is called a a. change in demand for gasoline. b. change in quantity demanded of gasoline. c. change in preferences. d. all of the above. (4) A decrease in the price of internet access is likely to increase purchases of computers, because internet access and computers are a. substitute goods. b. normal goods. c. inferior goods. d. complementary goods. (5) The rise in people’s incomes in East Asia is causing consumers there to buy more meat because meat is a. a substitute good. b. a normal good. c. an inferior good. d. a complementary good. (6) Which demand curve below is more elastic? a. Demand curve A. b. Demand curve B. c. Both have the same elasticity because they pass through the same point. d. Cannot be determined from the information given. (7) IPod music players and iTunes downloaded music are complements. Therefore, the cross-price elasticity of demand for iTunes, with respect to the price of iPods, is surely a. positive. b. zero. c. negative. d. cannot be determined from information given. (8) Suppose the income elasticity of demand for new cars is about 1.2. If a consumers' income increases, the share of the consumers' income devoted to spending on new cars will a. decrease. b. remain constant. c. increase. Demand curve A Demand curve B Price Quantity
Drake University, Summer 2007 Page 2 of 14 d. fluctuate randomly. (9) Suppose the price of tomatoes in Des Moines is $1. per pound and that the cost of shipping tomatoes between Minneapolis and Des Moines is $0.50 per pound. The market is out of equilibrium if the price of tomatoes in Minneapolis is a. $0.90 per pound. b. $1.10 per pound. c. $1.30 per pound. d. $1.75 per pound. (10) Suppose for some reason the futures price of corn for delivery next December were $6, but you believed that the spot price would be $4 next December. You could make money by a. selling corn futures now and selling corn on the spot market in December. b. buying corn futures now and selling corn on the spot market in December. c. selling corn futures now and buying corn on the spot market in December. d. buying corn futures now and buying corn on the spot market in December. (11) A quota on buying coal would cause the price of coal to a. rise. b. fall. c. remain constant. d. rise or fall, depending on the shapes of the demand and supply curves for coal. (12) Suppose the price elasticity of demand for books sold over the internet is -0.2 and the price elasticity of supply of books sold over the internet is 8.0. If a tax is imposed on books sold over the internet, 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. (13) In the graph below, the shift in the budget line could be caused by a. an increase in income. b. a decrease in income. c. an increase in the price of housing. d. a decrease in the price of housing. e. an increase in the price of other goods. f. a decrease in the price of other goods.
Drake University, Summer 2007 Page 4 of 14 (21) Suppose market segment A has an elasticity of -8, while market segment B has an elasticity of -2. Costs are the same for both markets segments, but the monopolist can prevent arbitrage between the two market segments. To maximize profit, the monopolist should set a. a price of zero in both market segments. b. a price as high as possible in both market segments. c. a price equal to marginal cost in both market segments. d. a lower price in market segment A. e. a lower price in market segment B. f. the same price, greater than marginal cost, in both market segments, since they have the same marginal cost. (22) Cartels are organizations of firms that try to increase their members' profits by a. sharing technology. b. boosting output. c. increasing advertising. d. offering discounts and promotional pricing. e. reducing output.
Drake University, Summer 2007 Page 5 of 14 II. Problems: Insert your answer to each question below in the box provided. Feel free to use the margins and graphs for scratch workonly the answers in the boxes will be graded. Work carefullypartial credit is not normally given for questions in this section. (1) [Production possibility curves, opportunity costs, comparative advantage: 18 pts] Ryan and Jennifer each grow both tomatoes and zucchini. They each face a tradeoff between these two kinds of vegetables because their gardens are of limited size. Their production possibility curves are shown below. (Units are bushels.)
Tomatoes
Zucchini
Ryan
Jennifer
a. [2 pts] What is Ryan's opportunity cost of growing a bushel of tomatoes? bushels of zucchini b. [2 pts] What is Jennifer’s opportunity cost of growing a bushel of tomatoes? bushels of zucchini c. [2 pts] What is Ryan's opportunity cost of growing a bushel of zucchini? bushels of tomatoes d. [2 pts] What is Jennifer’s opportunity cost of growing a bushel of zucchini? 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 zucchini? g. [6 pts] Fill in the blanks: Both persons can consume combinations of tomatoes and zucchini outside their individual production possibility curves if ___________________________ produces one bushel of tomatoes for ___________________________, who produces ______________ bushel(s) of zucchini in return.
Drake University, Summer 2007 Page 7 of 14 (4) [8 pts] Suppose the natural gas company raises its price by 5%. Suppose the price elasticity of demand for natural gas service is -0.6. Assume everything else affecting demand for natural gas service remains constant. a. Will the quantity demanded of natural gas increase or decrease?
b. ... by about how much? %
c. Will revenue received by natural gas company increase or decrease? d. ... by about how much?
(5) [Government farm policies: 8 pts] The following graph shows the market for peppercorns.
Thousands of kilograms
Price per kilogram
Demand
Supply
First consider the market without government intervention.
a. Find the equilibrium price. $ per kilogram
b. Find the equilibrium quantity. thousand kilograms
Now suppose the government sets a target price of $9 per kilogram. c. How many kilograms will the government have to purchase to raise the price to this level?
thousand kilograms
d. What will be the direct cost of this program to the government-- that is, how much money should the government budget for purchasing peppercorns?
$ thousand
Drake University, Summer 2007 Page 8 of 14
(6) [Effects of trade: 18 pts] Country A and Country B both have markets for grain. Supply and
demand schedules for the two countries are given below in millions.
Country A Country B Price Quantity demanded Quantity supplied Quantity demanded Quantity supplied $1 50 2 11 9 $2 44 4 10 10 $3 38 6 9 11 $4 32 8 8 12 $5 26 10 7 13 $6 20 12 6 14 $7 14 14 5 15 $8 6 16 4 16 First consider the outcomes under autarky (that is, no international trade). a. Compute the equilibrium price in Country A. (^) $ b. Compute the equilibrium price in Country B. (^) $ Now consider the outcomes with free international trade between Country A and Country B. c. Compute the equilibrium price with trade. (^) $ d. Which country exports grain? e. How much grain does that country export? (^) million Indicate whether each of the following groups are better off, worse off, or just as well off as before , as a result of free international trade. f. Grain consumers in Country A g. Grain producers in Country A. h. Grain consumers in Country B. i. Grain producers in Country B.
Drake University, Summer 2007 Page 10 of 14 i. [6 pts] Using your answers above, plot three points on Ryan’s demand curve for corn dogs, and sketch his demand curve below.
Bottles of sodapop
Price per bottle
Drake University, Summer 2007 Page 11 of 14 (8) [Short-run cost curves and supply: 24 pts] Acme Hardware Company makes plumbing parts. It 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.
Quantity
Marginal & average cost
SMC
SAVC
SATC
a. Suppose Acme were currently producing 2000 parts. What would Acme's total cost be, to the nearest thousand dollars? $ thousand b. Suppose Acme were currently producing 1500 parts. If Acme produced one more part, by how much would its total cost increase? That is, what would be the change in total cost as Acme increased output from 1500 to 1501 parts? Give an answer to the nearest dollar. $ c. What is Acme’s fixed cost, to the nearest thousand dollars? [Hint: Use the fact that short-run average fixed cost = SATC – SAVC.] $ thousand d. 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. $ e. What is Acme's shut-down pricethat is, the lowest price at which it will remain in operation in the short run? Give an answer to the nearest dollar. $ f. What is the smallest positive number of parts that Acme will ever produce? Give an answer to the nearest hundred. parts g. Suppose the price of parts is $4. How many parts will Acme produce? Give an answer to the nearest hundred. parts h. Will Acme experience profits or losses at a price of $4? i. Suppose the price of parts is $6. How many parts will Acme produce? Give an answer to the nearest hundred. parts j. Will Acme experience profits or losses at a price of $6? k. Suppose the price of parts is $8. How many parts will Acme produce? Give an answer to the nearest hundred. parts l. Will Acme experience profits or losses at a price of $8?
Drake University, Summer 2007 Page 13 of 14 (10) [Monopoly: 12 pts] Suppose Acme Game Company has a monopoly in the market for a particular copyrighted video game. Its demand, marginal revenue, and marginal cost curves are shown below. Assume for simplicity that marginal cost equals average cost.
Quantity (thousands)
Demand
Marginal revenue
Marginal cost and
average cost
Assume Acme must charge the same price to all its customers.
a. Suppose Acme were (for some reason) producing 3000 copies of the game. If Acme produced one more copy, by how much would its total cost increase? That is, what would be the change in total cost as Acme increased output from 3000 to 3001 copies? (Give an answer to the nearest whole dollar.) $ b. Again suppose Acme were (for some reason) producing 3000 copies of the game. If Acme produced one more copy, by how much would its total revenue increase? That is, what would be the change in total revenue as Acme increased output from 3000 to 3001 copies? (Give an answer to the nearest whole dollar.) $ c. What quantity should Acme produce to maximize profits? (^) thousand d. What price should it charge? (^) $ e. Compute Acme's profit. (^) $ thousand f. Compute the deadweight loss from monopoly. (^) $ thousand
Drake University, Summer 2007 Page 14 of 14 III. Critical thinking: Write a one-paragraph essay answering one question below (your choice). [4 pts] (1) Consider the following statement. "If Farmer A is better than Farmer B at growing everything, then Farmer A cannot possibly benefit from trading with Farmer B." Do you agree or disagree? Explain your reasoning. (2) Consider the following statement. "Cartels replace cutthroat competition with stable prices that everyone can live with. But they need government support—otherwise the law of the jungle takes over and companies undercut each other in a race to the bottom. Congress should repeal laws against cartels so businesses can cooperate for the benefit of everyone." Do you agree or disagree? Justify your answer with a graph. Which question are you answering, (1) or (2)? _________. Please write your answer below. Full credit requires correct economic reasoning, legible writing, good grammar including complete sentences, and accurate spelling. [end of quiz]
