Download November 5, 2004

Answers – Test #2 ECMA04H – November 5, 2004
Version #1 – (on front page: “Profs. Michael Krashinsky and Gordon Cleveland”)
1. The price of pears rises. Pears are a substitute in consumption for apples.
Therefore, the demand for apples shifts to the right. As a result, P* and Q* both
rise. The correct answer is (A).
2. Consumer incomes rise. Apples are a normal good, so the demand for apples
shifts to the right. At the same time, a technological innovation occurs which
lowers the cost of producing apples. Therefore, the supply curve for apples shifts
to the right as well. Q* must rise, but the effect on P* is uncertain (depends on
the relative size of the shifts in demand and in supply). The correct answer is (K).
3. The price of pears rises. Pears are a substitute in consumption for apples.
Therefore, the demand for apples shifts to the right. At the same time, the price of
cheese rises. Cheese is a complement in consumption to apples. Therefore, the
demand for apples shifts to the left. Since we do not know the magnitude of these
two shifts, we do not know what happens to P* and Q*. However, if the shift to
the right is larger, P* and Q* will rise; if the shift to the left is larger, P* and Q*
will fall. The correct answer is (N).
4. A newspaper story increases the demand for apples – the demand shifts to the
right. At the same time, wages in the apple industry rise; this will shift the supply
curve of apples to the left. As a result, P* will rise, but we cannot tell what
happens to Q* (without knowing the relative magnitude of the two shifts). The
correct answer is (G).
5. An increase in price in the textiles industry will increase the total expenditures on
textiles. This must mean that demand is inelastic (i.e., % change in Q is less than
% change in P). The correct answer is (C).
6. An excise tax is levied and the buyers share is larger than the sellers share. Since
ES/ED = BS/SS, this must mean that the elasticity of supply is greater than the
elasticity of demand. The correct answer is (F).
7. P = 40 - .03X and supply is horizontal at P = 16. A tax of $9 will put the S + T
curve at P = 25. At this price, consumers will want to purchase 500 units of the
good. The tax revenue raised would be 9 x 500 = $4,500. The correct answer is
(O).
8. The excess burden of the tax would be [9 x (800 – 500)]/2 = $1,350. The correct
answer is (F).
9. If q = 4L2/3, the marginal product of labour is dq/dL = 2/3 x 4L-1/3 = 8/3L-1/3. If L
= 27, the marginal product of labour is 8/9. The correct answer is (B).
10. Since TC = (PL x L) + (PK x K), we have TC = (12 x 27) + (9 x 20) = $504. At 36
units of output, the average cost is 504/36 = $14. The correct answer is (W).
11. There are a couple of ways to do this question. You could already know that MC
= PL/L, so MC = 12/(8/9) = 13.50. Or, you could take TC = FC + (PL x L) and
know that q = 4L2/3, so that q/4 =L2/3, or L = q3/2/8. Therefore TC = FC + 12 x
(q3/2/8) = FC + 3/2 q3/2. Therefore MC = dTC/dq = 9/4 q1/2. At q = 36, this is
13.50. The correct answer is (V).
12. TC = 450 + 6q + 2q2 and TVC = 242 + 6q + 2q2. Therefore, AVC = 242q-1 + 6 +
2q. dAVC/dq = -242q-2 + 2. Setting this equal to zero to find the minimum, we
find q = 11. The correct answer is (M).
13. TC = 450 + 6q + 2q2. Therefore, AC = 450q-1 + 6 + 2q. dAC/dq = -450q-2 + 2.
Setting this equal to zero to find the minimum, we find q = 15. The correct
answer is (Q).
14. Accountants do not take account of the use of resources for which there is no
explicit payment, whereas economists do consider the opportunity cost of all
inputs used, even if no explicit payment occurs. In this case, revenues are $6,000
per week. Explicit costs are $3,000 for raw materials and $3,000 for hiring
workers. Implicit opportunity costs include $600 for rent and $500 for the
owner’s salary. Therefore, accounting profits are zero, but the firm is making
economic losses (i.e., negative economic profits). The correct answer is (F).
15. TC = 1.5q2 - 4q + 96, so MC = 3q – 4. A competitive firm will produce where P
= MC (unless price is insufficient to cover AVC). P = MC implies 32 = 3q – 4, or
q = 12. Since AC reaches its minimum at $20, it is clear that P > AVC, so the
correct answer is (M).
16. Profit = TR – TC = (32 x 12) – (1.5[12 x 12] – [4 x 12] + 96) = $120. The correct
answer is (L).
17. The firm will shut down in the short run unless it covers its AVC. AVC = 1.5q – 4
+ 37.5q-1. dAVC/dq = 1.5 – 37.5q-2. Setting this equal to zero to find the level of
q at which AVC reaches its minimum, we have q2 = 37.5/1.5 = 25. Therefore, q =
5. When q = 5, AVC = (1.5 x 5) – 4 + (37.5/5) = $11. The correct answer is (D).
18. If there are 200 identical firms, Q = 200q, so q = .005Q. The individual firm’s
supply curve is P = 3q – 4, so industry supply is P = 3(.005Q) – 4 or P = .015Q –
4. The demand curve is P = 48 - .005Q. Setting 48 - .005Q = .015Q – 4, we
have .020Q = 52 or Q* = 2600. To find equilibrium price, substitute into the
demand curve, P* = 48 - .005(2600) = $35. The correct answer is (R).
19. In the long run, each firm will operate at the minimum point on its long run
average cost curve, and freedom of entry and exit will ensure that price is kept
down at this level. This is a constant cost industry so we have P = 20 as the long
run supply curve. Since demand is P = 48 - .005Q, we have 48 - .005Q = 20, or
.005Q = 28, or Q* = 5600. The correct answer is (K).
20. Since each firm in the long run is operating at the minimum point on its LRAC,
each firm produces q = 8. The total number of firms in the long run is 5600/8 =
700. The correct answer is (L).
21. In the short run in the above problem, there were 200 firms in the industry and the
equilibrium price was $35. There were positive profits in the short run, which
would attract new firms into the industry. As new firms entered, adding their
supply to the existing supply, the equilibrium price would have been driven down
until profits equal zero and each firm is operating at the ideal size in the long run.
This happens when there are 700 firms in the industry at a price of $20. The
correct answer is (A).
22. TC = q2 + 100, so MC = 2q. There are 400 identical firms in the industry, so Q =
400q or q = .0025Q. The short run supply curve in the industry is given by P = 2
x .0025Q = .005Q. With the tax, we have the new S + T curve at P = 6 + .005Q.
Demand is given by P = 30 - .0025Q, so 30 - .0025Q = 6 + .005Q or .0075Q = 24,
or Q* = 3200. At this output, P = 30 - .0025(3200) = $22. Since the equilibrium
price before the tax was $20, the buyers share of the tax is $2 or 1/3rd of the tax.
The correct answer is (E).
23. Since there are 400 firms in the short run and Q* = 3200, the output of each firm
is 8 units. Profit = TR – TC. However, TC now has to include the tax as an
obligation that the supplier must pay. The new TC function is TC’ = q2 + 6q +
100. Therefore profit of the firm = (22 x 8) – ([8 x 8] + [6 x 8] + 100) = -$36.
Since this loss is less than the amount of fixed costs, the firm will continue to
operate in the short run, so profit = -$36. The correct answer is (Q).
24. In a constant cost industry, the long run supply curve is perfectly elastic
(horizontal). As a result, the tax is entirely borne by buyers. The correct answer
is (M).
25. In the long run, the long run supply curve is given by P = $20. The S + T curve
will be given by P = $26. The demand curve is given by P = 30 - .0025Q.
Therefore, we have 30 - .0025Q = 26 or Q* = 1600. Since each firm must be the
ideal size (i.e., at the quantity of output which gives lowest possible costs), each
firm has q = 10. Therefore, in the long run there will be 1600/10 = 160 firms.
The correct answer is (E).