Exam 1. Corn (bushels)

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1 ECONOMICS Dr. John Stewart Feb. 13, 2001 Exam 1 Instructions: Mark the letter for your chosen answer for each question on the computer readable answer sheet using a No.2 pencil. Please note that some questions have four choices, others have five choices. On the answer sheet make sure that you have written and coded your name, your student ID number and the number of the recitation section you attend (A list of recitations shown on the screen will help you identify your section number). Each failure to follow directions will result in a one question deduction. All questions are weighted equally. 1. Consider a farmer that can grow either peanuts or corn on his farm. The following table shows the farmers production possibilities frontier, the various combinations of crops the farmer can grow. Peanuts (bushels) Corn (bushels) Suppose a farmer produces 50 bushels of corn and 10 bushels of peanuts. According to the table, the opportunity cost of 10 more bushels of peanuts is a) 8 bushels of corn. When the farmer is producing 50 bushels of corn he can produce 10 bushels of peanuts; to get 20 bushels of peanuts he must reduce his corn output by 8 bushels b) 42 bushels of corn. c) 50 bushels of corn. d) impossible to determine from the information given. Information for Questions 2-3. Figure 1 represents a production possibility frontier for a farm producing wheat and barley 2. According to Figure 1, the opportunity cost of one more bushel of wheat is a) higher at B than at D. b) lower at B than at D. Opportunity cost is the slope of the PPF the slope is lower at point B c) equal at B and D. d) impossible to determine from the information given. Figure 1 3. The shape of the production possibilities frontier in Figure 1 implies that a) some resources are better suited for producing wheat than for producing barley. b) the opportunity cost of producing more wheat falls as wheat production rises. c) the farmer s technology is not subject to the principle of increasing costs. d) the financial cost of producing wheat is higher than the financial cost of producing barley. 4. If the quantity of ice cream demanded increases as the price of chocolate decreases then we may deduce that a) Ice cream and chocolate are complements Definition of complement goods b) Ice cream is a normal good c) Chocolate is an inferior good d) Ice cream and chocolate are substitutes 5. If a good is an inferior good then as income increases, the demand curve for that good will Econ , Exam1a Page 1 of 8

2 a) stay the same b) shift left definition of inferior good c) have positive slope d) shift right Information for Questions 6-9: The Graph in Figure 2 shows the Short run marginal (SRMC) average variable (SRAVC) and average total (SRATC) cost curves for a firm in a perfectly competitive market. 6. If the market price in a perfectly competitive market is $10 in the short-run, the quantity the firm will produce is approximately a) 7 b) 23 Q where P=MC c) 30 d) If the market price in a perfectly competitive market is $8, the firm a) earns a positive profit in the short-run b) earns a negative profit in the short-run c) earns zero profit in the short-run If price is $8 firm will produce 20 (P=MC) at Q=20 P=ATC so profits are zero d) will exit the market in the long-run Cost ($) Figure 2 SRATC SRMC SRAVC Quantity 8. Again consider the short run with the market price equal to $8 per unit. If all firms in the market look exactly like the firm in Figure 2, we can expect that the long run competitive equilibrium price in this market will be a) exactly $8 b) more than $8 c) less than or equal to $8 Look at the discussion of average cost in the long run and short run on page 149 of the text. LRAC is less than or equal to SRAC since entry will drive profits to zero in th LR, price will equal the minimum of the LRAC curve. That could be $8 but it could be lower. d) uncertain. Can t tell if the LR equilibrium price will be higher or lower than $8. 9. If the market price in a perfectly competitive market is less than $4 in the short-run, the firm a) earns zero profit b) should increase production c) should exit the market d) should shut down production 10. The firm s supply curve is based on a) the short-run marginal cost curve b) the short-run average total cost curve c) the short-run average fixed cost curve d) the short-run average variable cost curve 11. If the industry s long-run average costs fall with increased output, the industry shows a) constant marginal returns b) decreasing returns to scale c) increasing returns to scale d) decreasing marginal returns 12. If the percentage change in the price of a car is 10% and the resulting percentage change in quantity demanded for cars is 5%, then the price elasticity of demand for cars is: Econ , Exam1a Page 2 of 8

3 a) unitary elastic. b) inelastic. c) unchanged. d) elastic. 13. A demand curve with zero price elasticity everywhere: a) is horizontal. b) is vertical. c) has a negative slope. d) has a very steep slope. Use Figure 3 in answering questions 14 and 18. Figure 3 shows a market demand curve (D) and a market supply curve (S). P denotes price and Q denotes quantities. P D 10 S 14. Equilibrium price and quantity are a) P=10 and Q=25 b) P=8 and Q=20 c) P=6 and Q=25 d) P=10 and Q= If the price was $10, the market will a) be in equilibrium. b) have an excess supply of 10. c) have an excess demand of 10. d) have an excess demand of 5. Figure Q 16. If we consider a price change form $8 per unit to $6 per unit, the arc price elasticity for the demand curve shown in Figure 3 is a).777 b) c) 1.0 d) If we consider a price of $8 per unit, then the point price elasticity for the demand curve shown in Figure 3 is a).933 b) 1.0 c) d) 1.2 P/Q is 8/20; DQ/DP is the inverse of the slope of the demand curve (-5/2); so the using the formula, the point elasticity is If this is a normal good and the income of consumers increases what will happen a) Price and Quantity will increase b) Price will increase and Quantity will decrease c) Price and Quantity will decrease d) Price will decrease and Quantity will increase Information for Questions The table below is showing John s total utility while consuming different Econ , Exam1a Page 3 of 8

4 numbers of donuts per day. The total and marginal utility is measured in dollars. You can use the information provided to fill in any blanks in the table. (Hint: complete the table before you start the questions) Number of donuts consumed Total Utility (dollars) Marginal Utility (dollars) At what quantity does John first experience diminishing marginal utility? a) 0 b) 2 c) 3 d) 5 e) If the donuts are free of charge, how many donuts per day is John going to consume? a) 0 b) 3 c) 4 d) 7 last donut with positive MU e) If donuts cost $2.50 a piece, how many donuts will John choose to consume per day? a) 4 b) 5 6 th donut has MU less than $2.50 so will stop at 5 c) 6 d) 7 e) If donuts cost $2.50 a piece, how much consumer surplus will John receive at his chosen consumption level. a) $1.50 b) $2.50 c) $3.50 Total Utility - Total payment; $18- $12.50 d) $4.00 e) $ John is given the opportunity to join the Columbia Donut Club. For just $10 a day membership fee he can buy donuts for $.50 a piece. Should he join and if he does, how many donuts should he purchase each day? a) no, should not join b) yes, should join and buy 5 donuts per day c) yes, should join and buy 7 donuts per day If he joins the club he will consume 7 donuts (quantity where MU is still greater than P (1! >$.50) will pay $10 + $.5 x 7 = $ Consumer surplus is $19 -$13.50=$5.50 which is greater than what he would receive if he doesn t joint the club ($3.50) d) uncertain, from the information given it is not possible to tell whether he should join or not. Information for Questions 24-29: The following two tables give you information about the physical productivity of labor and about the short run costs of a perfectly competitive firm manufacturing bicycles. This firm uses two inputs: Capital (fixed input), and labor (variable input). Capital is fixed at 4 units, and the cost of capital per unit is $2.5. Please answer the questions by using these tables. Quantity of labor Total product of labor (number of bicycles per day) Average physical product of labor (number of bicycles day) Marginal physical product of labor (number of bicycles per day) 1 A= /3 B=2 11/5 16/6 16/7 17/ Econ , Exam1a Page 4 of 8

5 Number of bicycles produced per day Total Cost C= Total Variable Cost Average Variable Cost Average Total Cost Marginal Cost In the table above, what must the value of A be? a) 1 b) 2 APP L =1 TPP L =APP L x Q c) 3 d) In the table above, what must the value of B be? a) 2 b) 4 c) 6 d) In the table above, what must the value of C be? a) $1 b) $5 c)$10 total cost of 0 units of output is fixed cost = $2.50 x 4 d) $ What is the Average Variable Cost when the firm produces 4 bicycles? a) $10 b) $20 c) $22.5 =TVC/Q=90/4 d) $ What is the price of labor per unit of labor (assume the firm is producing 4 bicycles per day)? a) $1 b) $20 c) $27 d) $30 We know that AVC=P L /APP L at 4 bicycles AVC=22.5 and it takes 3 laborer to produce 4 bicycles. APP L (3 laborers)=4/3 so P L must equal 4/3 x 22.5 = Assume that the market price for a bicycle is $20 and the firm is currently producing 4 bicycles per day, then what should the firm do in order to maximize profits? a) Produce more than 9 bicycles per day b) Continue producing 4 bicycles a day c) Shut down the plant d) Produce 1 less bicycle per day Note that AVC is still declining when we reach 9 bicycles and that MC is still less than AC. At 9 bicycles P >ATC so the firm would be making a profit at 9 bicycles but P is still greater than MC so the firm could make even more profit by expanding output beyond 9 bicycles. See diagram to the right. $ AVC ATC MC Bicycles Econ , Exam1a Page 5 of 8

6 30. Consider the demand curves of two individual shown in Figure 4. Consumer A and B each demand 5 units of the good when the price is $3 per unit. Which consumer has the more elastic demand curve at the price of $3.00. a) A s demand curve is more elastic than B s demand curve b) B s demand curve is more elastic than A s demand curve. c) A s and B s demand curves have the same elasticity. d) Uncertain, it is impossible to tell which of the demand curves is more elastic at a price of $3. P 3 5 Figure 5 Consumer A Q P 3 Consumer B Though as a general rule we know that elasticity and slope are not the same thing, here we have two demand curve where we are looking at identical P s and Q s since elasticity is DQ/DP x P/Q and P/G is the same for both demand curves the only question is which demand curve has the greater DQ/DP. There is a bigger change in Q for a change in P along demand curve B, so it is more elastic. 31. Given that the cross price elasticity of the demand for oranges with respect to price of lemons is found to be 1.0, which statement below is true. a) oranges and lemons are substitute goods b) oranges and lemons are complementary goods c) oranges are inferior goods d) lemons are inferior goods. 32. A corn farmer is currently producing 20,000 bushels of corn using 1,000 units of labor and 10 units of capital. The marginal physical product of labor is 100 bushels of corn per hour and the marginal physical product of capital is 120 bushels of corn per hour. Labor costs the farmer $10 per hour and capital costs the farmer $20 per hour. In order for the farmer to minimize the cost of producing 20,000 bushels of corn he should: a) do nothing, he is already minimizing his cost b) decrease the amount of labor and increase the amount of capital c) increase the amount of labor and decrease the amount of capital d) not enough information to determine this If the farmer had chosen capital and labor to minimize the cost of producing 20,000 bushels then it would be true than P L /MPP L = P K /MPP K Check the numbers we find P L /MPP L = 10/100 =$.10 per bushel, P K /MPP K = 20/120 = $.17 per bushel. Because an additional bushel of corn cost more when one hires enough capital to do it than it does when one hires enough labor to do it, one should add labor and reduce capital. 33. You are the manager of a perfectly competitive firm and are faced with the following situation. The market price for your product is $10 and you are currently selling 1,000 units. Your total fixed costs are $9,000 while your total variable costs are $3,000. Your short run marginal cost is $8 per unit. Given this information, to maximize profit in the short run you should decide to: a) immediately stop all production. b) continue to produce 1,000 units. c) expand output to cover more of fixed costs. d) decrease output so that you can cut down on variable costs. e) uncertain, there is not enough information in the problem deduce an answer. For the firm to be maximizing profit, it must have chosen a quantity of output where P=MC and P>AVC, (if such a point doesn t exist, the firm should produce zero). In the present case P >MC and P>AVC. 5 Q Econ , Exam1a Page 6 of 8

7 34. Opportunity cost can best be defined as the a) money cost of a good or service. b) money cost plus interest on money borrowed to buy a good or service. c) cost of the resources used to produce a good or service. d) value of the best alternative forgone when the alternative at hand is chosen. Information for questions Figure 5 shows the market demand and supply for frisbees. The market for frisbees is perfectly competitive. Quantities are measured in number of frisbees per week. There are currently 500 identical firms supplying the market. Also shown $ MC $ $3 $2 $1 Typical Firm Figure 6 AC q firm $3 $2 $1 Market Supply 500 Demand 500 5,000 7,500 10,000 15,000 in the diagram are the average and marginal cost curves of a typical frisbee firm. Assume that all firms in the market face identical cost conditions and that there are no fixed inputs in frisbee manufacturing. (Thus there is no difference between long run and short run cost curves) 35. Given that there are currently 500 firms operating in the market in the short run a) the equilibrium price will be $1 and the equilibrium market quantity will be 5,000 frisbees per week. b) the equilibrium price will be $2 and the equilibrium market quantity will be 7,500 frisbees per week. c) the equilibrium price will be $3 and the equilibrium market quantity will be 5,000 frisbees per week. d) the equilibrium price will be $3 and the equilibrium market quantity will be 7,500 frisbees per week. 36. How much profit will each firm be making at the equilibrium described in question 35 a) $0 per week b) about $5 per week c) about $13 per week P=$3, AC is slightly more than $2 so firm is making a little less than $1 per unit profit on 15 units. d) about $20 per week e) the firms are not making a profit. They are losing money. 37. In the long run, what do you expect to happen in this market? a) Nothing will change; it is in long run equilibrium. b) New firms will enter because there are profits. This will cause the market supply curve to shift to the right. c) New firms will enter because there are profits. This will cause the market demand curve to shift to the left d) Existing firms will leave the market because they are losing money. This will cause the supply curve to shift to the left. e) Existing firms will leave the market because they are losing money. This will cause the demand curve to shift to the right. Q market Econ , Exam1a Page 7 of 8

8 38. In the final long run market equilibrium, price (P) will be and the market quantity (Q) will be a) P= $1, Q = 15,000 b) P= $2, Q = 10,000 c) P= $3, Q = 7,500 d) P= $3, Q = 10, Bill s Sandwich shop is currently charging a price of $3.00 per sandwich. At this price Bill is selling 100 sandwiches a day. The marginal cost of producing another sandwich is $2.00. An economist estimates that the price elasticity of the demand curve for Bill s sandwiches at his current output is 4.0. Bill comes to you with this information and asks for your advice. You should tell Bill a) to keep charging $3.00 per sandwich. b) that he can increase profits if he lowers his price a little. c) that he can increase profits if he raises his price a little. d) that he hasn t given you enough information for you to make a recommendation. You have just completed FORM A of the exam. Make sure you print Form A in the upper corner of your scan sheet and put your exam in the FORM A pile for your recitation section. Econ , Exam1a Page 8 of 8