ECON 8010 (Spring 2012) Exam 1

Transcription

1 ECON 81 (Spring 212) Exam 1 Name A. Key Multiple Choice Questions: (4 points each) 1. Since August 211, there has been a 5% decrease in price and a 8% increase in quantity traded of Good X. Which of the following would have led to this observed change in the market outcome for this good? A. An increase in supply. 2. Economics is B. the social science that studies decision making in the face of scarcity, and the implications of such decisions on individuals and societies. 3. Bruce manages a firm that is the only producer and seller of widgets. He has determined that if his company were to decrease price from $4 to $3, total revenue for his firm would decrease from $8, to $69,. From this information we can infer that A. over this price range demand is Inelastic. 4. In a perfectly competitive market, D. More than one (perhaps all) of the above answers is correct. [B and C] 5. The refers to a period of time during which the amount hired of at least one input cannot be altered, but rather is equal to some predetermined level (based upon a previous decision). A. Short Run 6. Amy is considering purchasing a new MP3 player. Her reservation price as a buyer of this item is r b 75. Target is selling MP3 players for p 5. If Amy were to buy this item from Target she would realize a Consumer s Surplus of: B. (75) (5) = (25). 7. For a firm with market power, while for a firm in a perfectly competitive market. B. Marginal Revenue is less than Price; Marginal Revenue is equal to Price. 8. At a price of p 6 demand is. B. Unit Elastic 9. If price were to decrease from p to p 8. 5, then the value of price elasticity of demand would A. increase (i.e., get closer to zero in value). 1. The Law of Demand A. states that all other factors fixed, the quantity demanded of a good will be greater when its price is lower.

2 11. In this market there is at a price of $6.. B. excess supply 12. At the market equilibrium, units are traded, each at a price of. C. 375; $ At the equilibrium outcome, Total Consumers Surplus is equal to B. areas (a)+(b)+(c). 14. 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. D. Cost-Benefit Principle 15. Based upon the graph above, this firm is currently operating in the A. Short Run, since Average Fixed Costs of Production (and therefore Fixed Costs of Production) are clearly positive. 16. The Marginal Cost of producing the 5 th unit of output must be C. exactly equal to $ An increase in demand is visually illustrated by a shift of the demand curve; an increase in supply is visually illustrated by a shift of the supply curve. B. rightward; rightward. 18. A buyer s reservation price D. More than one (perhaps all) of the above answers is correct. 19. The Short Run Supply Curve of a firm operating in a Perfectly Competitive Market can be described as A. the portion of the Marginal Cost Curve which lies above the Average Variable Cost Curve. 2. The Efficient Scale of Production refers to the level of output at which B. Average Total Costs of Production are minimized.

3 Problem Solving/Short Answer Questions: 1. Consider the market for peanut butter. Suppose the following estimated values of elasticity have been determined: (Price Elasticity of Demand for peanut butter) = (.6894) (Cross-Price Elasticity of Demand for peanut butter with respect to the price of grape jelly) = (.2679) (Cross-Price Elasticity of Demand for peanut butter with respect to the price of American cheese) = (.1839) (Income Elasticity of Demand for peanut butter) = (.3148) Based upon these estimated values, answer the following questions. 1A. If the price of peanut butter were to increase slightly, would the total revenue of peanut butter sellers 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 (of.6894) 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 peanut butter sellers. 1B. Is peanut butter 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 in value) or inferior (in which case Income Elasticity is less than zero in value). The estimated value of Income Elasticity of Demand (of.3148) therefore implies that peanut butter is an inferior good. 1C. Suppose the price of American cheese decreased. Clearly explain whether the equilibrium price and equilibrium quantity of peanut butter 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 determine how demand for peanut butter changes in response to a change in the price of American cheese, we must start by examining the value of Cross- Price Elasticity of Demand for peanut butter with respect to the price of American cheese. Since the estimated value of this elasticity (.1839) is positive, it follows that peanut butter is a substitute for American cheese (i.e., an increase in the price of American cheese would lead to an increase in demand for peanut butter,

4 whereas a decrease in the price of American cheese would lead to a decrease in demand for peanut butter). So, when the price of American cheese decreases, demand for peanut butter decreases. 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 Average Variable Costs and Average Total costs as illustrated below. $ MC(q) ATC(q) 23. AVC(q) ATC min AVC min 8.75 quantity 2,195 3,975 5,95 7, 8,5 2A. Determine the numerical value of Fixed Costs of Production for this firm. (2 points) 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. From the graph above, there

5 are multiple levels of output where enough information is provided to be able to determine the numerical value of Average Fixed Costs, and therefore Fixed Costs. For example, at 7, units of output, AFC=ATC AVC= =4.25. From here it follows that the value of Fixed Costs must satisfy 4.25=F/(7,). Solving for F, we obtain F=(4.25)(7,)=29,75. 2B. Suppose that the price in this market is $23.. What quantity of output would this firm have to produce in order to maximize profit? How much profit is the firm able to earn when producing this quantity? Clearly explain. (4 points) Recall that a firm operating in a perfectly competitive market has no market power (i.e., no control over price ). As a consequence, at every level of output, Marginal Revenue is simply equal to market price (in this case, $23.). Applying the Cost-Benefit Principle, the positive level of output which maximizes profit is 7, units (Marginal Benefit is greater than Marginal Cost for every unit produced up to this level, whereas the reverse is true for every unit beyond this level). Further, since the price of $23. is greater than the minimum value of Average Variable Costs (of $8.75), the firm does not want to shut-down. Thus, 7, units of output doers indeed maximize profit. When producing and selling this quantity, the firm earns a profit of: (Profit)= (quantity)[price Average Total Costs] = (7,)[ ] = (7,)[5.75] = 4,25 2C. Suppose that the price in this market is $7.5. What quantity of output would this firm have to produce in order to maximize profit? How much profit is the firm able to earn when producing this quantity? Clearly explain. (4 points) If the per unit price of output were instead only $7.5 (a price below the minimum value of Average Variable Costs of Production of $8.75), then the firm would want to shut-down and produce zero units of output in the Short Run. This is the best thing for the firm to do since there is no level of output that could be produced for which Total Revenue would cover even Variable Costs of Production. As a result of shutting-down, the firm earns zero Revenue and incurs zero Variable Costs of Production, but still incurs the Fixed Costs of Production equal to $29,75 (as determined in part (2A) of this question). Thus, the profit of the firm is $( 29,75).