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ECON 300 Practice Problems for Test 2 Please circle one answer for the following questions. 1. Efficient production occurs if a firm A) cannot produce its current level of output with fewer inputs. B) given the quantity of inputs, cannot produce more output. C) maximizes profit. D) All of the above. For questions 2‐ 6, refer to the table below 2. The above figure depicts a short‐run production function for Albert’s Pretzels. The marginal productivity of labor A) rises then falls as the amount of capital increases. B) falls then rises as the amount of labor increases. C) is greater than or equal to the average productivity of labor for all amounts of labor. D) is less than or equal to the average productivity of labor for all amounts of labor. 3. The above figure shows the short‐run production function for Albert’s Pretzels. The marginal productivity of labor for the third worker is A) 6. B) 8. C) 24. D) not known from the information provided. 4. The above figure shows the short‐run production function for Albert’s Pretzels. The marginal productivity of labor equals the average productivity of labor A) for all levels of labor. B) at none of the levels of labor. C) only for the first worker. D) only for the fifth worker. 5. The above figure shows the short‐run production function for Albert’s Pretzels. The law of diminishing marginal productivity A) appears with the second worker. B) has not yet appeared for any of the levels of labor. C) first appears with the fifth worker. D) is refuted by this evidence. 6. The above figure shows the short‐run production function for Albert’s Pretzels. The average product of labor A) increases first and then decreases. B) decreases first and then increases. C) decreases throughout. D) increases throughout. 7. If the average productivity of labor equals the marginal productivity of labor, then A) the average productivity of labor is at a maximum. B) the marginal productivity of labor is at a maximum. C) Both A and B above. D) Neither A nor B above. 8. Joey cuts lawns during the summer. Let q equal the number of acres mowed per day, and let L equal the number of hours worked per day. Joey never works more than eight hours per day, and during that time his short‐run production function is q = 0.2 ∗ L. Which of the following statements is FALSE? A) Joey’s marginal productivity equals his average productivity. B) Joey’s marginal productivity diminishes by 0.2 for each additional hour worked. C) Joey’s average productivity is constant. D) Joey’s marginal productivity is constant. 9. At any given point on the curve, the slope of the total product curve always equals A) the ratio of the marginal product and the average product. B) the change in input divided by the change in output. C) the average product of the input. D) the marginal product of the input. 10. The slope of an isoquant tells us A) how much output increases when both inputs are increased. B) the increase in MPL when capital increases. C) the decrease in capital necessary to keep output constant when labor increases by one unit. D) the decrease in capital necessary to keep MPL constant when labor increases by one unit. 11. The steeper an isoquant is A)the greater is the marginal productivity of labor relative to that of capital. B) the greater is the substitutability between capital and labor. C) the greater is the need to keep capital and labor in fixed proportions. D) the greater is the level of output. 12. Suppose the production of VCRs can be represented by the following production function: 𝑞 = 𝐿&.( 𝐾 &.(. Which of the following statements is (are) TRUE? A) The production function has decreasing returns to scale. B) The marginal productivity of labor falls as labor increases in the short run. C) Capital and labor can be substituted for one another. D) All of the above. 13. Joey’s lawn‐cutting service recently traded in its push mowers for gasoline‐powered mowers. Joey still requires one worker per lawnmower; however, more grass is now cut in the same amount of time as before. This is an example of A) labor‐saving technical change. B) non‐neutral technical change. C) neutral technical change. D) organizational change. 14. The Nifty Gum Co. has purchased a large parcel of land for $1 million. The company recently discovered that the land is contaminated and is worthless to all possible buyers. The opportunity cost of the land is A) $0. B) $1 million. C) some amount greater than $0 but less than $1 million. D) equal to the cost of the factory that was planned to be built there. 15. If a firm buys a building so as to have office space for its workers, the monthly opportunity cost of the building is best measured as A) the monthly mortgage payment the firm must pay. B) the price the firm paid divided by twelve. C) zero. D) the rent the firm could earn if it rented the building to another firm 16. Which of the following statements is NOT true? A) AC = AFC + AVC B) C = F + VC C) AVC = wage/MPL D) AFC = AC – AVC 17. If average cost is decreasing A) marginal cost equals average cost. B) marginal cost exceeds average cost. C) marginal cost is less average cost. D) Not enough information 18. Suppose the short‐run production function is q = 10 ∗ L. If the wage rate is $10 per unit of labor, then AVC equals A) q. B) q/10. C) 10/q. D) 1. 19. In the short run, the point at which diminishing marginal returns to labor begin is the point at which the marginal cost curve A) peaks. B) bottoms out. C) is upward sloping. D) is downward sloping. 20. Which of the following will cause the average cost curve of making cigarettes to shift? A) A $5 million penalty charged to each cigarette maker. B) A $1 per pack tax on cigarettes. C) A $1 an hour wage increase paid to all cigarette production workers. D) All of the above. 21. Suppose MPL = 0.5 ∗ (q/L) and MPK = 0.5 ∗ (q/K). In the long run, the firm will hire equal amounts of capital and labor A) all of the time. B) only when w = r. C) only when w = 0.5 ∗ r. D) at no point in time. 22. Suppose that each worker must use only one shovel to dig a trench, and shovels are useless by themselves. In the long run, an increase in the price of shovels will result in A) fewer shovels being purchased to produce the same number of trenches. B) more workers being hired to produce the same number of trenches. C) the firm wishing to produce more trenches. D) no change in the firm’s input mix. 23. Suppose that each worker must use only one shovel to dig a trench, and shovels are useless by themselves. In the long run, the firm’s cost function is A) TC = (w/r) ∗ q. B) TC = (w + r)/q. C) TC = (w + r). D) TC = (w + r) ∗ q 24. The long run average cost curve may initially slope downward due to A) decreasing average fixed costs. B) increasing marginal returns. C) economies of scale. D) All of the above. 25. Which of the following statements best explains why long‐run average cost is never greater than short‐run average cost? A) In the long run, tangency of the isocost and isoquant is attainable. This is not necessarily true in the short run. B) In the long run, diseconomies of scale might not occur, but in the short run diminishing marginal returns do. C) In the long run, the cost of capital declines because the firm is able to pay down some of its debts. D) In the long run, the average cost curve need not be U‐shaped, but in the short run it is. 26. A horizontal demand curve for a firm implies that A) the firm is a monopoly. B) the market the firm is operating in is not competitive. C) the firm is selling in a competitive market. D) the products of that firm are very different from other firms’ products. 27. In a competitive market, if buyers did not know all the prices charged by the many firms, A) all firms still face horizontal demand curves. B) firms sell a differentiated product. C) demand curves can be downward sloping for some or all firms. D) the number of firms will most likely decrease. 28. How can the market demand for a product be inelastic but the demand for a particular firm is elastic? A) There is no advertising. B) There is a sufficiently large number of sellers. C) There is only one or two sellers. D) Buyers do not have complete information. 29.Which of the following characteristics of a competitive market make auction sites such as eBay so popular? A) There is freedom of entry and exit. B) There are very low transaction costs. C) There are only one or two sellers. D) Buyers and sellers have complete information. 30.Many auction sites, such as eBay, provide a reputation score by which previous customers can rate a seller. Which of the following characteristics of a competitive market is this policy trying to emulate? A) There is freedom of entry and exit. B) There are very low transaction costs. C) There are only one or two sellers. D) Buyers have more complete information. 31. In a competitive market, one would expect to see A) no advertising. B) false advertising. C) advertising only in the Sunday papers. D) minimal advertising. 32. If a firm makes zero economic profit, then the firm A) has no incentive to stay in the industry. B) is better of exiting the industry. C) it is indifferent between staying and exiting the industry. D) it will shut down. 33. If a firm makes zero economic profit, then the firm A) has total revenues greater than its economic costs. B) must shut down. C) can be earning positive business profit. D) must have no fixed costs. 34. A small business owner earns $50,000 in revenue annually. The explicit annual costs equal $30,000. The owner could work for someone else and earn $25,000 annually. The owner’s business profit is ________ and the economic profit is ________. A) $20,000, $5,000 B) $20,000, ‐$5,000 C) $25,000, ‐$5,000 D) $45,000, ‐$5,000 35. If a profit‐maximizing firm finds that, at its current level of production, MR > MC, it will A) earn greater profits than if MR = MC. B) increase output. C) decrease output. D) shut down. 36. If a firm traded on the New York Stock Exchange posts an accounting profit of $10 million, then the firm is making a positive economic profit. A) Only if the Securities and Exchange Commission (SEC) approves the accounting report. B) Only if the firm’s opportunity cost is less than $10 million. C) Only if the firm’s opportunity benefit is more than $10 million. D) Only if the firm’s management receives stock compensation. 37. If a competitive firm finds that it maximizes short‐run profits by shutting down, which of the following must be true? A) p < AVC for all levels of output. B) p < AVC only for the level of output at which p = MC. C) p < AVC only if the firm has no fixed costs. D) The firm will earn zero profit. 38. Suppose TC = 10 + (0.1 ∗ q2). If p = 10, the firm’s profits will be A) 240. B) 250. C) 260. D) ‐10 because the firm will shut down. 39. If firms in a competitive market are not identical, then the long‐run market supply curve will be A) horizontal. B) upward sloping. C) downward sloping. D) undetermined. 40. Suppose that for each firm in the competitive market for potatoes, long‐run average cost is minimized at $0.20 per pound when 500 pounds are grown. If the long‐run supply curve is horizontal, then A) some firms will enjoy long‐run profits because they operate at minimum average cost. B) the long‐run price will be $0.20 per pound. C) each consumer will purchase $100 worth of potatoes. D) the long‐run price will be set just above $0.20 per pound. 41. Suppose that for each firm in the competitive market for potatoes, long‐run average cost is minimized at $0.20 per pound when 500 pounds are grown. The demand for potatoes is Q = 10,000/p. If the long‐run supply curve is horizontal, then how many firms will this industry sustain in the long run? A) 0 B) 100 C) 50,000 D) There is not enough information to answer. 42. Which of the following characterizes long‐run equilibrium in perfect competition? A) P=MC=ATC B) P=MC<ATC C) P>MC=ATC D) P=MC>ATC Answers 1. D 2. D 3. A 4. C 5. A 6. C 7. A 8. B 9. D 10. C 11. A 12. D 13. C 14. A 15. D 16. C 17. C 18. D 19. B 20. D 21. B 22. D 23. D 24. C 25. A 26. C 27.
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C B B D D C C B B B A A B B B A Problems 1. A local non‐profit group prints a weekly newsletter. Professional typists earn $10 per hour and can type 2 pages per hour. Unpaid volunteers can type only 1 page per hour. Measuring hours of professional typist services on the vertical axis and hours of unpaid volunteer typist services on the horizontal axis, draw the relevant isoquant and isocost curves if the newsletter is 10 pages long. What input mix is chosen by the non‐profit group if they wish to minimize the cost of the newsletter? If the group will reimburse volunteers for expenses (lunch, driving), how much must the reimbursement be for your answer to change? 2. Suppose a firm has the following total cost function: 𝑇𝐶 = 100 + 4𝑞 0. What is the minimum price necessary for the firm to earn profit? Below what price will the firm shut down in the short run? 3. Suppose there are 1000 identical wheat farmers. For each, 𝑇𝐶 = 10 + 𝑞 0 . Derive the market supply curve. 4. Suppose there are 1000 identical wheat farmers. For each, 𝑇𝐶 = 10 + 𝑞 0 . Market demand is 𝑄 = 600,000 − 100𝑝. Derive the short‐run equilibrium Q, q, and p. Does the typical firm earn a short‐run profit? 5. Suppose all firms in a competitive market are currently in both short‐run and long‐run equilibrium. What impact will a lump sum tax have on each firm in the short run? in the long run? 6. Suppose market demand is Q = 1000 ‐ 4p. If all firms have 𝐿𝑅𝐴𝐶 = 50 − 5𝑞 + 𝑞 0 , how many identical firms will there be when this industry is in long‐run equilibrium? Answers 1. The isoquant is a straight line with a slope of 1/2. The group can use either 5 pros, 10 volunteers, or some combination of the two. The isocost curves are horizontal since volunteers are free. As a result, the lowest isocost curve is achieved by hiring all volunteers. If the group reimbursed volunteers for expenses (lunch, driving, etc.) then the group will still hire all volunteers as long as they do not cost more than $5 per hour. 2. AC = 100/q + 4q. This is minimized when 𝑑𝐴𝐶/𝑑𝑞 = 0, 𝑜𝑟 − 100/𝑞0 + 4 = 0. Solving yields q = 5 and AC = 40. Thus, a price greater than $40 is required for the firm to earn profit. AVC = 4q and MC = 8q. Since AVC is below MC for all levels of output, AVC will be less than price for all levels of output. The firm will not shut down in the short run. 3. For each MC = 2q and AVC = q. Thus MC > AVC for all levels of output. The firm sets p = 2q or q = 0.5p. Since there are 1000 firms each producing q, market supply equals Q = 500p. 4. The firm’s supply is q = 0.5p; market supply is Q = 500p. Market equilibrium can be found as 500p = 600,000 ‐ 100p, or 600p = 600,000, so p = 1,000 and Q = 500,000. q = 0.5p = 500. Profit = (500 ∗ 1,000) ‐ (10 + 250,000) = 249,990. Each firm earns a profit. 5. In the short run, the lump sum tax represents a fixed cost. The firm’s output decision is unchanged, but its profits decrease. In the long run, the tax raises the LRAC of each firm, but not MC. Minimum AC is higher, so price is higher. With a higher price, each firm produces a greater quantity, but the higher price means less quantity is demanded in total; thus, the number of firms will decrease. 6. The long‐run market supply curve is horizontal at the minimum LRAC. LRAC is minimized when ‐5 + 2q = 0 or q = 2.5. At this level of output, LRMC = LRAC = 43.75. At this price, 825 units are demanded. If each firm produces 2.5 units in the long run, then 330 firms will be in this market.