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ECON 8010 (Spring 2014) – Exam 1
Name __A. Key_____________________________
Multiple Choice Questions: (4 points each)
1.
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.
C.
Cost-Benefit Principle
2.
A decrease in demand is visually illustrated by a _______________ shift of the demand
curve; a decrease in supply is visually illustrated by a _______________ shift of the
supply curve.
A.
leftward; leftward.
3.
Amanda is considering purchasing a new basketball. Her reservation price as a buyer of
this item is rb  40 . Target is selling basketballs for p  18 . If Amanda buys a
basketball from Target she would realize a Consumer’s Surplus of:
C.
40 – 18 = 22.
4.
The “Law of Supply”
C.
implies that Supply Curves should be upward sloping.
5.
At the market equilibrium outcome in the model of Supply and Demand
C.
both Total Consumers’ Surplus and Total Producers’ Surplus are typically
positive.
6.
“Westley Industries” (an Australian based pharmaceutical company) produces Iocaine
Powder using three inputs, “Input A,” “Input B,” and “Input C.” During the next month
they are able to hire any amount of “Input A” and “Input B” that they wish, but are
restricted to using exactly 125 units of “Input C.” From this information, it appears as if
“Westley Industries” is operating in the
A.
Short Run.
7.
Which of the following would lead to a decrease in the supply of oranges?
A.
A severe frost in Florida.
8.
In a “perfectly competitive market,”
D.
More than one (perhaps all) of the above answers is correct. [Both “B” and “C”
are correct.]
9.
Suppose that demand for sugar is unit elastic at all prices. If price were to decrease by
7%, then quantity demanded would
C.
increase by exactly 7%.
10.
Wendy sells cotton candy in a perfectly competitive market. She hires a business
consultant to analyze her company’s financial records. The consultant recommends that
she increase her production. The consultant must have concluded that at her current level
of output Wendy’s
D.
Marginal Cost is less than price.
11.
Since October 2013, there has been a 4% decrease in price and a 6% increase in quantity
traded of “Good Z.” Which of the following would have led to this observed change in
the market outcome for this good?
A.
An increase in supply.
12.
The “Efficient Scale of Production” refers to the level of output at which
C.
Average Total Costs of Production are minimized.
13.
For a firm with “market power” Marginal Revenue is _________________, while for a
firm in a “perfectly competitive market” Marginal Revenue is _________________.
A.
less than Price; equal to Price.
14.
No buyer in this market has a “Buyer’s Reservation Price”
A.
above $12.80.
15.
In this market there would be___________________ at a price of $5.95.
B.
excess supply
16.
At the market equilibrium, Total Consumers’ Surplus is equal to____________ and Total
Producers’ Surplus is equal to ____________.
C.
“areas (a)+(b)+(e)”; “areas (c)+(d)+(f)”
17.
Economics is
C.
the social science that studies decision making in the face of scarcity, and the
implications of such decisions on individuals and societies.
18.
Consider a market in which demand is given by the function D( p)  8,000  200 p (for
0  p  40 ). Demand is ________ at a price of $9 and is ________ at a price of $15.
C.
inelastic; inelastic.
19.
If this firm were to produce 1,200 units of output, its Average Fixed Costs of Production
would be equal to ________.
B.
$18.90
20.
Suppose that each unit of output can be sold for $15.00. In order to maximize profit in
the Short Run, this firm should produce __________ units of output.
D.
1,200
Problem Solving/Short Answer Questions:
1.
Consider the market for “Good X.” Suppose the following estimated values of elasticity
have been determined:
 (Price Elasticity of Demand for “Good X”) = (–0.6532)
 (Cross-Price Elasticity of Demand for “Good X” with respect to the price of
“Good Y”) = (–0.2214)
 (Cross-Price Elasticity of Demand for “Good X” with respect to the price of
“Good Z”) = (0.3802)
 (Income Elasticity of Demand for “Good X”) = (–0.1853)
Based upon these estimated values, answer the following questions.
1A.
If the price of “Good X” were to increase slightly, would the total revenue
received by sellers of “Good X” 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 for “Good X” (of –0.6532) is
between –1 and 0, 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 sellers of “Good X.”
1B.
Is “Good X” 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) or inferior (in which case Income Elasticity is less than zero). The
estimated value of Income Elasticity of Demand for “Good X” (of –0.1853)
therefore implies that “Good X” is an inferior good.
1C.
Suppose the price of “Good Z” decreased. Clearly explain whether the
equilibrium price and equilibrium quantity of “Good X” 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 “Good X” changes in response to a change in the
price of “Good Z,” we must examine the value of Cross-Price Elasticity of
Demand for “Good X” with respect to the price of “Good Z.” Since the
estimated value of this elasticity (0.3802) is positive, it follows that “Good X” is a
substitute for “Good Z.” Thus, a decrease in the price of “Good Z” will lead to a
decrease in demand for “Good X.” 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 Initial Demand New Demand quantity 0 0 2.
Consider a firm operating in a Perfectly Competitive Market in the Short Run, with
Marginal Costs, Average Variable Costs, and Average Total Costs as illustrated below.
$
MC(q)
3.60
ATC(q)
AVC(q)
3.10
ATC min  2.80 2.15 AVC min  1.65 MC min  1.20 quantity
0
0
2A.
8,560
9,000
11,620
9,450
If this firm were to “shutdown” and produce zero output in the Short run, how
much profit would it earn? Clearly explain. (3 points)
If this firm were to “shutdown” and produce zero output in the Short Run, then it
would realize zero Revenue and zero Variable Costs. As a result, profit would be
equal to simply –F (i.e., minus Fixed Costs of Production). 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. Focusing on 11,620 units of output, ATC=3.60 and AVC=3.10.
This implies that at q=11,620, AFC=.50. From here it follows that the value of
Fixed Costs must satisfy .50=F/(11,620).
Solving for F, we obtain
F=(.50)(11,620)=5,810. So, if the firm were to “shutdown” and produce zero
output it would realize a profit of –5,810.
2B.
Suppose that the price of output in this market is $1.50. In order to maximize
profit, would this firm want to “shutdown” or produce a positive quantity of
output in the Short run? Is this firm able to earn a positive profit in the Short
Run? Clearly explain. (3 points)
If the price of output in this market were $1.50, then the firm would want to
“shutdown” and produce zero output in the Short Run. This is the best choice by
the firm since at such a low output price, there is no quantity of output that the
firm could produce for which Revenue would cover even Variable Costs of
production. As a consequence, the maximum profit of the firm is –5,810 (so, no,
the firm is not able to earn a positive profit in the Short Run).
2C.
Suppose that the price of output in this market is $3.10. What quantity of output
would this firm have to produce in order to maximize profit (i.e., determine a
numerical value)? How much profit is the firm able to earn when producing this
quantity (i.e., determine a numerical value)? Clearly explain. (4 points)
If instead the price of output in this market were $3.10, then the firm would want
to produce q=9,000 unit of output (since this is the level of output that equates
price to Marginal Costs of production). Producing a positive quantity of output is
better than “shutting down” since price is above the minimum value of Average
Variable Costs of production. From the graph, we can see that the Average
Variable Costs of producing q=9,000 units of output are $2.15. This implies that
the Variable Costs of producing these units are (9,000)x($2.15)=$19,350. By
selling q=9,000 units at a per unit price of $3.10 the firm earns Revenue of
$28,350. Consequently the profit of the firm is:
Profit = (Revenue) – (Variable Costs) – (Fixed Costs)
= $28,350 – $19,350 – $5,810
= $3,190