Download Eco 201 Name______________________________

Eco 201
Final Exam
Name______________________________
2 July 2008
Please write answers in ink. You may use a pencil to draw graphs.
Allocate your time efficiently.
Good Luck.
1. State whether the following statements are true or false, and explain why.
a. In a perfectly competitive industry, the industry demand curve is horizontal, whereas for a
monopoly it is downward-sloping.
False. The industry demand curve is downward sloping in both cases, but from the individual
perfectly competitive firm’s point of view, the demand curve is horizontal. Because the
individual firm is too small to affect the market price, it can sell as many units as it wishes at that
price.
b. Perfectly competitive firms have no control over the price they charge for their product.
True. If they try to charge a higher price they will lose all their business; if they try to charge a
lower price, they will not be maximizing profit.
c. For a natural monopoly, average cost declines as the number of units produced increases
over the relevant output range.
True. This is the essential feature of natural monopoly.
2. True or False: Explain why the following statements are true or false:
a. The economic maxim "There's no cash on the table" means that there are never any
unexploited economic opportunities,
False: the maxim tells us that there are no unexploited economic opportunities when the market
is in long-run equilibrium.
b. Firms in competitive environments make no accounting profit when the market is in longrun equilibrium,
False: firms in long-run equilibrium have to make an accounting profit in order to cover the
opportunity cost of resources supplied by their owners.
c. Firms that can introduce cost-saving innovations can make an economic profit in the short
run.
True: These firms can earn economic profits until other firms adopt their innovations. As the
innovations spread, the industry supply curve will shift down, causing the market price of the
good to fall and eroding the short-term economic profit.
3. John Jones owns and manages a cafe in Collegetown whose annual revenue is $5,000.
Annual expenses are as follows:
Labor
Food and drink
Electricity
Vehicle lease
Rent
Interest on loan for equipment
$2,000
500
100
150
500
1,000
a. Calculate John's annual accounting profit.
John's accounting profit is his revenue minus his explicit costs, or $750 per week.
b. John could earn $1,000 per year as a recycler of aluminum cans. However, he prefers to run
the cafe. In fact, he would be willing to pay up to $275 per year to run the cafe rather than to
recycle. Is the cafe making an economic profit? Should John stay in the cafe business?
Explain.
Yes: his opportunity cost of his labor to run the café is $1,000 - $275, or $725 per week. Adding
this implicit cost to the explicit costs implies that the café is making an economic profit of $25
per week. And since $25>0, John should stay in business.
c. Suppose the cafe's revenues and expenses remain the same, but recyclers' earnings rise to
$1,100 per year. Is the cafe still making an economic profit? Explain.
John's opportunity cost rises by $100, to $825 per week. The café is thus now making an
economic loss of $75 per week.
d. Suppose John had not had to get a $10,000 loan at an annual interest rate of 10 percent to
buy equipment, but instead had invested $10,000 of his own money in equipment. How would
your answer to parts a and b change?
The accounting profit would now be $1,750/yr. The answer to part b. would not change. If John
had $10,000 of his own to invest in the café, he would forgo $1,000/yr in interest by not putting
the money in a savings account. That amount is an opportunity cost that must be included when
calculating economic profit.
e. If John can earn $1,000 a year as a recycler, and he likes recycling just as well as running
the cafe, how much additional revenue would the cafe have to collect each year to earn a
normal profit?
To earn a normal profit, the café would have to cover all its implicit and explicit costs. The
opportunity cost of John's time is $1,000/yr, whereas the café's accounting profit is only $750/yr.
Thus, the café would have to earn additional revenues of $250/yr to make a normal profit.
4. Suppose the weekly demand and supply curves for used DVDs in Lincoln, Nebraska, are as
shown in the diagram. Calculate
a. The weekly consumer surplus.
Consumer surplus is the triangular area between the demand curve and the price line. Its area is
equal to 0.5bh, where b is the base of the triangle and h is the height. The base is 6 units and the
height is 1.5 units, measured in dollars. Therefore, consumer surplus is 0.5($1.50/unit)(6
units/wk), or $4.50 per week.
b. The weekly producer surplus.
Producer surplus is the triangular area between the supply curve and the price line. Using the
base-height formula, it is (0.5)($4.50/unit)(6 units/wk), or $13.50 per week.
c. The maximum weekly amount that producers and consumers in Lincoln would be willing to
pay to be able to buy and sell used DVDs in any given week.
The maximum weekly amount that consumers and producers together would be willing to pay to
trade in used DVDs is the sum of gains from trading in used DVDs—namely, the total economic
surplus generated per week, which is $18 per week.
5. Unskilled workers in a poor cotton-growing region must choose between working in a
factory for $6,000 a year and being a tenant cotton farmer. One farmer can work a 120-acre
farm, which rents for $10,000 a year. Such farms yield $20,000 worth of cotton each year.
The total nonlabor cost of producing and marketing the cotton is $4,000 a year. A local
politician whose motto is "working people come first" has promised that if he is elected, his
administration will fund a fertilizer, irrigation, and marketing scheme that will triple cotton
yields on tenant farms at no charge to tenant farmers.
a. If the market price of cotton would be unaffected by this policy and no new jobs would be
created in the cotton-growing industry, how would the project affect the incomes of tenant
farmers in the short run? In the long run?
A cotton farmer would make a short-run economic profit of $60,000 revenue -$10,000 rent $4,000 marketing cost - $6,000 opportunity cost, or $40,000/yr. In the long run, factory workers
would want to move into cotton farming, and would thereby bid up the rent on cotton farms. The
rent would continue to rise until it reached $50,000 per farm. At that point the incentive to leave
a factory job would no longer exist, because cotton farmers would again be making zero
economic profit.
b. Who would reap the benefit of the scheme in the long run? How much would they gain
each year?
Landowners would reap the long-term benefits of the scheme. Their income would rise by
$40,000/yr. per 120-acre plot.
6. The Paducah Slugger Company makes baseball bats out of lumber supplied to it by Acme
Sporting Goods, which pays Paducah $10 for each finished bat. Paducah's only factors of
production are lathe operators and a small building with a lathe. The number of bats per day it
produces depends on the number of employee-hours per day, as shown in the table below.
Number of Bats per day
0
5
10
15
20
25
30
35
Number of employee hours per day
0
1
2
4
7
11
16
22
a. If the wage is $15 per hour and Paducah's daily fixed cost for the lathe and building is $60,
what is the profit-maximizing quantity of bats?
As indicated by the entries in the last column of the table below, the profit-maximizing quantity
of bats for Paducah is 20/day, which yields daily profit of $35.
b. What would be the profit-maximizing number of bats if the firm's fixed cost were not $60 per
day but only $30?
Same quantity as in part a, but now profit is $65, or $30 more than before.