Econ 1110 Prelim 2 Spring 2016 Wissink - ANSWERS

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1 Econ 1110 Prelim 2 Spring 2016 Wissink - ANSWERS 1 C Since the price that you are currently charging lands on the inelastic portion of the demand curve, this implies you are charging a price that is on the lower part of the demand curve. In order to maximize revenue, you would want to get to the point on the demand curve where it is unit elastic (which is at the midpoint of the demand curve). At the unit elastic point on the demand curve total revenue is maximized. Therefore, in order to get to the point of unit elasticity you would need to raise the price and simultaneously sell fewer jet packs. 2 D Perfectly inelastic means that quantity supplied is extremely insensitive to any price change. This means that the price elasticity of supply is zero. This is graphically represented by a vertical supply curve. 3 D McDonald s is an inferior good because demand rose after incomes fell. Thai food is not a luxury because demand fell by less than what income did over the period. 4 C We can calculate the elasticity of demand for pizza by using observations (week 1)&(week 2). We also can calculate cross price elasticity of demand for pizza with respect to the price of pizza by using observations (week 1)&(week 3). 5 B Linear indifference curves with slope -1 mean that the two goods are perfect substitutes (in fact they are identical in the consumers eyes). Bismark s initial behavior is utility maximizing because he buys the cheapest good only. After the price change pretzels become cheaper than beer so he should shift all his consumption to pretzels. (note: His income is $2 per beer * 20 beers= $40. This income stays the same when the price is changing) 6 C Looking at the movement from bundle B to C we can see that as income rises demand for popcorn falls, while that of steak rises. This means that steak is a normal good and popcorn is an inferior good. Comparing bundle A to C we see that as the price of popcorn falls, demand for popcorn rises so although popcorn is an inferior good, it is not a Giffen good. Also, since the final demand for steak rises as the price of popcorn falls, steak and popcorn are complements. A and B are textbook descriptions of a Slutsky decomposition. 7 A The ratio of MU/P for apples is 20 and for oranges is 16. To increase utility (satisfaction), Melissa should increase her consumption of apples (which will lower its MU and leave the price unchanged) and at the same time to stay within her budget constraint she must also reduce her consumption of oranges (which will raise its MU and leave the price unchanged. Melissa should continue doing this until the ratio MU/P is the same for both goods. 8 A First you have to invert to get Q = 50 1/3P and Q = 100 2/3P and now add to get Q = 150 P. Inverting back yields P = 150 Q. 9 A If the producer is maximizing he must be producing where marginal revenue = marginal costs. If the producer has no impact on price, then marginal revenue = price. Since the producer is making a profit price > average costs, which means marginal costs > average costs. 10 B As the cost of a variable factor of production increases, the variable cost (VC) curve shifts up in the vertical direction. Consequently, so does the marginal cost curve which is just the change in VC for a unit change in quantity. Note that part E is wrong since a competitive firm s short run supply curve is only the part of its marginal cost curve that is above the firm s average variable cost curve due to the short run shut down rule. Part B is the correct answer. 11 D In the short run, she is better off producing as long as the price is above the minimum of the Average Variable Cost curve. This is the same as saying that as long as the firm s revenue exceeds its variable costs, it is assured of a smaller loss than if it shut down.

2 12 A Janet s total revenue is 4,500 * $2.50 = $11,250. Total costs are $3,000 + (0.02*$25,000) + (20*40*$8) = $3,000+$500+$6,400. Economic Profit = TR TC = $11,250 $9,900 = $1, D Pablo s rent is an explicit cost. The money Vincent forgoes by not renting out his house is an implicit cost. Hence, given all the other costs are identical, the accounting costs would be higher for Pablo, and hence he earns a lower accounting profit as compared to Vincent (since his explicit costs are higher). However, their economic profits are the same, since the opportunity cost of rent would feature in Vincent s economic costs (which now includes his implicit costs). 14 B MC cuts AVC and ATC at their minimum. Thus, if MC<ATC, ATC is falling, but not sure about AVC because AVC lies below ATC. TC always increases, and FC is always the same. 15 E Labor cost is counted as variable costs. The cost of an extra labor is part of the marginal cost. So AVC, ATC, VC, TC, MC will all increase. However, labor cost is not part of the fixed cost, so FC and AFC won t change.

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