Economics 501.01 Final Examination Manisha Goel Tuesday, March 15, 2011 9:30 AM 11:18 AM General Instructions Please write your name above and on your exam booklet. This exam has 10 multiple choice questions (each worth 2 points), three short questions (each worth 10 points) and two long questions (each worth 25 points). The exam covers 5 sides on 3 pages. Please make sure that your copy is complete now. Notes, books, programmable calculators, and cellular telephones are NOT allowed. You may write on the exam sheet but this material will not be graded. Additional exam booklets are available. Each question in this section is worth 2 points. Multiple Choice Questions 1. The price elasticity of demand for a demand curve that has a zero slope is a) zero. b) one. c) negative but approaches zero as consumption increases. d) infinity. 2. Jane is trying to decide which courses to take next semester. She has narrowed down her choice to two courses, Econ 1 and Econ 2. Now she is having trouble and cannot decide which of the two courses to take. It s not that she is indifferent between the two courses, she just cannot decide. An economist would say that this is an example of preferences that a) are not transitive b) are incomplete. c) violate the assumption that more is preferred to less. d) all of the above 3. Consider the following graph.
Cost per unit ATC MC Q a) The cost curves are for a firm with diseconomies of scale. b) The cost curves are for a firm with neither economies nor diseconomies of scale. c) The cost curves are for a firm with economies of scale. d) The cost curves are for a firm with economies of scale at low levels of output and diseconomies of scale at higher levels of output. 4. Which of the following conditions for profit maximization is correct: a) MC=MR gives the condition for profit maximization for all firms; under competition MR=P, which implies that for a competitive firm optimal output is where MC=P. b) MC=MR gives the condition for profit maximization for all firms; under monopoly MR=P, which implies that for a monopolist optimal output is where MC=P. c) MC=MR gives the condition for profit maximization, it is impossible to say whether MR will be greater than, less than, or equal to P for any type of firm. d) MR=P gives the condition for profit maximization for all firms. 5. Assuming that the government does not own or subsidize a natural monopolist, the optimal regulation of a monopoly is where: a) the price is at the competitive price. b) P=ATC c) P=MC d) P=ATC if MC is below ATC and P=MC if MC is above ATC. 6. Which of the following best describes the distinction between the short run and long run? a) In the short run both capital and labor are fixed. New firms do not have time to open in the short run. b) In the short run capital is fixed but labor can be varied. New firms do not have time to open in the short run. c) In the short run capital is fixed but labor can be varied. New firms do have time to open in the short run. d) Both capital and labor can be varied in the short run but new firms do not have time to open in the short run.
7. The difference between what a consumer is willing to pay for a unit of a good and what must be paid when actually buying it is called a) producer surplus. b) consumer surplus. c) cost benefit analysis. d) net utility. 8. If an Engel curve has a negative slope, a) the good is inferior. b) the good is normal. c) the good has no substitutes. d) the good has no complements. 9. For which of the following market structures is it assumed that there are barriers to entry? a) Perfect competition b) Monopolistic competition c) Monopoly d) b and c only 10. The optimum level of pollution emissions a) is zero. b) occurs where no damage to the environment is being done. c) occurs where the marginal external benefit equals the marginal external cost. d) occurs where the marginal external cost equals the marginal cost of abatement. Each question in this section is worth 10 points. Question 1. (10 points) Short Questions Consider two firms, X and Y, which produce super computers. Each can produce the next generation super computer for the military (M) or for civilian research (C). However, only one can successfully produce for both markets simultaneously. Also, if one produces M, the other might not be able to successfully produce M, because of the limited market. The following payoff matrix illustrates the problem. Firm X Firm Y Military Civilian Research Military 2, 1 2, 2 Civilian Research 1, 1 3, 2 a. Does firm X have a dominant strategy? Explain. (3 points) b. Does firm Y have a dominant strategy? Explain. (3 points)
c. Find the Nash equilibrium. What are the Nash equilibrium payoffs? (4 points) Question 2. (10 points) For a typical perfectly competitive firm, draw the total variable cost, total fixed cost and total cost curves on one graph. Draw the average variable cost, average fixed cost, average total cost and marginal cost curves on another graph showing how each of these cost curves corresponds to the curves in the other graph. Explain why you drew the cost curves the way you did. Question 3. (10 points) Bud Owen operates Bud s Package Store in a small college town. Bud sells six packs of beer for off-premises consumption. Bud has very limited store space and has decided to limit his product line to one brand of beer, choosing to forego the snack food lines that normally accompany his business. Bud s is the only beer retailer physically located within the town limits. He faces considerable competition, however, from sellers located outside of town. Bud regards the market as highly competitive and considers the current $2.50 per six pack selling price to be beyond his control. Bud s total and marginal cost functions are: TC = 2000 + 0.0005Q 2 MC = 0.001Q, where Q refers to six packs per week. Included in the fixed cost figure is a $750 per week salary for Bud, which he considers to be his opportunity cost. a. Calculate the profit maximizing output for Bud. What is his profit? Is this an economic profit or an accounting profit? (4 points) b. The town council has voted to impose a tax of $.50 per six pack sold in the town, hoping to discourage beer consumption. What impact will the tax have on Bud s optimal output and profit? Should Bud continue to operate? (6 points) Each question in this section is worth 25 points. Question 4. (25 points) Long Questions The Tire Shed is a regional chain that sells tires and other automobile parts. The company sells its own brand of tires under a block pricing scheme that charges $100 per tire if the customer buys one or two tires and $75 per tire if the customer buys three or four tires. The monthly
demand curve facing the typical store is Q = 1000-4P, and the marginal cost of the tires is constant at $40 per tire. a. What are the monthly profits for the typical store under the block pricing scheme? What is the consumer surplus enjoyed by customers of the typical store? (17 points) b. Suppose the firm is considering a uniform pricing scheme with P = $90 per tire. How does the firm profit and consumer surplus under uniform pricing compare to the profit and consumer surplus outcomes under block pricing? (8 points) Question 5. (25 points) The food processing industry involves the canning of fruit products, among other things, and the canning process produces canned goods and waste products. The manufacturer of one kind of fruit product produces an external cost for third parties. This external cost is expressed as: MEC = 0.00005Q, where MEC represents marginal external cost (dollars/unit), and Q represents cases produced per week. The marginal cost of production (supply), ignoring MEC, at the industry level is: MC = 2 + 0.000175Q. The industry demand for the product is: P = 10-0.00025Q, where price P is in dollars per unit. a. Determine the output rate and price that would be established by profit maximizing firms. (6 points) b. Determine the efficient output rate and price. (9 points) c. How do the prices and quantities compare between the two situations? Calculate the deadweight losses in the two situations. (10 points)