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Econ 1110 - INTRODUCTORY MICROECONOMICSPRELIM #2 – Wissink - S2018 – April 12

________________________________________ ____________________________________Your LAST (FAMILY) NAME Your First (given) name

Your NetId:_________________ Your Student Number:________________________________

Instructions and Exam Taking Policy:

There are two sections in this exam. Answer all questions.

Part I: 15 multiple choice @ 3 points eachPart II: 2 problems @ 27.5 points eachTotal Points = 100, Total Time = 90 minutes.

NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have, raise your hand and wait for the proctor to come to you. Only one person can be out of the examination room at a time, and the proctor will hold onto your exam papers while you are out at the restroom.

NO CELL PHONES, NO IPODS OR SIMILAR DEVICES WITH CALCULATOR “APPS”.NO GRAPHING CALCULATORS.NO BOOKS. NO NOTES. NO HELP SHEETS.NO TALKING TO EACH OTHER.

Check the TA’s name for the section you regularly attend (that is, where you will pick up your prelim):

One more time, please…

_____________________________________ _________________________________Your LAST (FAMILY) NAME Your First (given) name

Your NetId:_________________ Your Student Number:________________________________

Max Points Your ScorePart I 45 points

Part IIQ1 27.5 points

Q2 27.5 points

Total Score

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1. A recent study finds that after average annual income increased by 2% last year, the quantity demanded of Hershey’s chocolate increased by 1.5% and the quantity demanded of Belgian chocolate increased by 4%. Based on this information, we can conclude that

A. both Hershey’s and Belgian chocolate are inferior goods.B. Hershey’s chocolate is an inferior good and Belgian chocolate

is a luxury good.C. Hershey’s chocolate is a necessity and Belgian chocolate is a

luxury good.D. Hershey’s chocolate is a luxury good and Belgian chocolate is

an inferior good.E. Hershey’s chocolate is a necessity and Belgian chocolate is an

inferior good.

2. You run an amusement park. You keep track of your popcorn and soda sales over 3 years, along with the corresponding prices. You also collect information about the incomes of your average visitor over the period. Assume nothing else is changing in these markets aside from what you see in the chart. From this data only, what elasticities can be calculated using the (midpoint) arc formula?

Quantity DemandedFor Popcorn

Price of Popcorn

Price of Soda

Visitor Income

Year 1 200 bags $3/bag $2.00/cup $1000/month

Year 2 300 bags $3/bag $1.00/cup $1000/month

Year 3 250 bags $3/bag $2.00/cup $2000/month

A. Only the cross price elasticity of demand for popcorn with respect to the price of soda.

B. The own price elasticity of demand for popcorn and the cross price elasticity of demand for popcorn with respect to the price of soda.

C. The own price elasticity of demand for popcorn and the elasticity of demand for popcorn with respect to income.

D. The cross price elasticity of demand for popcorn with respect to the price of soda and the elasticity of demand for popcorn with respect to income.

E. None.

Part I: Multiple Choice/Fill In The Blank. Do them ALL.Circle the letter for your answer or fill in the answer in the blank provided.

3. Betty Crocker consumes only perfectly tasting ginger paste that she makes using vanilla and ginger. Both vanilla and ginger are measured in teaspoons. For her taste, she insists on always mixing 3 parts vanilla to 1 part ginger, no matter how much paste she consumes. In the graph sketch at least 2 indifference curves in Betty’s indifference curve map.

Make sure to label in some detail the values of numbers on both the vertical and horizontal axes on your graph!

4. A firm is a price taker if it is so small relative to the market that it can sell whatever it desires to produce (q) at the market price (P), but will sell nothing if it charges even slightly over the market price. What is the own price elasticity of demand as perceived by this particular firm for its own output (what we call δ)?

A. always greater than one but less than infinity.B. always one.C. always zero.D. always infinite.E. impossible to determine from the information given.

5. Assume that Andy spends his money on only two things: food and books. Assume that both are normal goods and that Andy has a very nicely behaved utility function. Andy is also a savvy consumer (who correctly maximizes his utility). When the price of books increases how will Andy react?

A. He will consume less books, however, his food consumption may increase, decrease or remain unchanged.

B. He will consume less food, however, his books consumption may increase, decrease or remain unchanged.

C. He will consume more food, however, his books consumption may increase, decrease or remain unchanged.

D. He will consume more food and more books.E. He will consume less food and more books.

6. Tony is a simple man. He consumes bread and butter. Bread costs $6 per loaf, while butter costs $3 per pound. Tony has an annual income of $70. Being a simple man, he tells you that, holding income and the price of butter constant, he chooses to consume 5 loaves of bread optimally, regardless of its price (within reason). Which one of the following statements is true?

A. For Tony, bread is a normal good.B. For Tony, bread is a luxury good.C. For Tony, bread is an inferior good.D. For Tony, bread is a Giffen good.E. For Tony, bread is an elastic good.

7. When the price of meat doubles, holding income and the price of vegetables constant, which one of the following moves of the budget line describes this change?

A. B1 moves to B2.B. B1 moves to B3.C. B3 moves to B2.D. B2 moves to B1.E. B3 moves to B1.

8. You work for a marketing firm and are told that a client, a cruise ship company, has two main groups of customers: pensioners and families. After looking at some data, you determine that demand from pensioners is: PD = 60 – 2Q, while demand from families is: PD = 150 – 5Q. What is aggregate demand for cruises (assuming P is less than 60)?

A. PD = 210 – 7QB. QD = 60 – 0.7PC. PD = 210 – 3QD. QD = 60 – 0.3PE. QD = 100 – 0.5P

9. Bobby consumes only beans and carrots. His indifference curves are all very nicely behaved and Bobby is a successful utility maximizer. His original optimal bundle on the original budget line is O. Suppose the price of beans increases, ceteris paribus.

Draw Bobby’s original and new indifference curves on the diagram so that it turns out that, for Bobby, beans are a Giffen good.

10. Assume all fixed costs are sunk fixed costs. If a profit maximizing firm does not produce any output in the short run, then it must be true that its

A. total costs are zero.B. economic profit is positive.C. accounting profit is negative.D. total fixed costs are zero.E. total revenue from operating (that is with q>0) would be less

than its variable costs from operating.

11. Marta grows tulips on land which costs $1,000/year to rent from VanGo Properties on a 10-year lease (rent payments must be made for the next 10 years, at least). Marta must pay part-time workers $6.00/hour. Last year, Marta hired 2 workers, who each worked 500 hours, and she bought $200 worth of tulip bulbs based on wanting to make 20,000 tulips. These are her only explicit costs. She produced and sold 20,000 tulips at $1.00 per tulip last year. Marta could have worked full-time at Nick's Greenhouse growing tulips for $8,000/year but only if she permanently closed her own tulip farm. Which one of the following statements is false?

A. Marta's accounting costs are less than her economic costs.B. Marta's fixed costs totaled $9,000 last year.C. At last year's level of production, Marta's average variable cost

was $0.31.D. Marta's economic profit last year was $12,800.E. Marta's total revenue was $20,000.

12. The table shows part of the total cost and marginal cost (calculated using the smaller delta approach) for Harry to produce pumpkins in a small patch of land. Some of the data numbers are missing, but you can fill it in and figure out what you need. If the price of pumpkins are $8 each in the perfectly competitive pumpkin market and Harry’s choice of pumpkin production is discrete, how many pumpkins should Harry produce to profit maximize and what is his profit and producer’s surplus?

Number of Pumpkins

$Total Costs

$Marginal Costs

0 5 na1 6 12 33 54 75 30 96 41

A. He should produce 3 pumpkins, earns $10 of profit, and $15 of producer’s surplus.

B. He should produce 1 pumpkin, earns $2 of profit and $7 of producer’s surplus.

C. He should produce 4 pumpkins, earns $11 of profit and $16 of producer’s surplus.

D. He should produce 4 pumpkins, earns $8 of profit and $8 of producer’s surplus.

E. He should produce 2 pumpkins, earns $3 of profit and $8 of producer’s surplus.

13. John is a computer code writer. He currently makes 600 lines of code a month using 100 units of kapital and 300 hours of labor. With his current input choices the marginal product of kapital is 8 lines and the marginal product of labor is 3. The price of labor is $12 per hour and the price of kapital is $24 per unit. To either produce more code with the same total cost or produce the same amount of code at a lower total cost, John should

A. use less labor and more kapital.B. 1use less labor only, since it is not very productive.C. use more labor and less kapital.1D. use more kapital only, since it is more productive.1E. do nothing.1

14. Steve and Bill are computer software developers and have the exact same cost structures except that Steve buys power for his

computers from a power company for 12 cents per kilowatt-hour while Bill powers his computers using solar panels that he has installed on his house. The solar panels cost Bill $4,000 of his own savings which had been earning 0% interest per year in the bank. The panels don’t depreciate when used. If Bill does not use the energy created by his solar panels, the local energy utility buys it from him at 12 cents per kilowatt-hour. Both Steve and Bill would become baristas and earn salaries of $30,000/year if they quit developing software. Assume that the computer software business is a perfectly competitive industry. Which one of the following is true?

A. Steve earns less accounting profit and less economic profit as compared to Bill.

B. Steve earns the same accounting profit and less economic profit as compared to Bill.

C. Steve earns more accounting profit and the same economic profit as compared to Bill.

D. Steve earns same accounting profit and the same economic profit as compared to Bill.

E. Steve earns less accounting profit and the same economic profit as compared to Bill.

15. Assume marginal costs are rising. If a profit-maximizing competitive firm discovers that its marginal cost of production exceeds its marginal revenue, the firm should

A. produce the same amount.B. decrease production.C. increase production.D. decrease production if demand is elastic and increase

production if demand is inelastic.E. increase production if demand is elastic and decrease

production if demand is inelastic

Keep going!

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1. Suppose the status quo for the Slutsky family is that they have an income of $100,000 per year. This income is spent on only two goods: A, which stands for "dollars of all-other-goods" and E, which stands for units of education. The price of A equals $1 per unit, and the price of E is $200 per unit. The Slutsky family currently chooses to consume $70,000 of all-other-goods.

a) Assume that the Slutsky family is a very nicely behaved utility maximizer. Putting units of E on the HORIZONTAL and A on the VERTICAL, graph and carefully label the Slutsky family's budget-line/indifference-curve diagram representing the equilibrium status quo. Label the equilibrium bundle O, and on the axes label EO and AO.

b) How many units of education (EO) do the Slutskys consume at their equilibrium bundle?

c) What is the Slutsky family's MRS at their equilibrium bundle?

Suppose that the government wishes the Slutskys would buy more education. So the government decides to support education for the Slutskys in the following way. The government will pay for half the cost for any units of education consumed by the Slutskys beyond EO.

d) On your graph in part (a) indicate how the Slutsky family's budget-line is altered by this policy. Make sure to include values on the axes for their new budget line’s endpoints.

e) What can you say about the new Slutsky family’s optimal bundle? Where can it plausibly be located? With this policy will the Slutskys be better off, as compared to the original status quo? Will this policy NECESSARILY get the Slutskys to consume more education? Explain your position.

f) After the policy goes into effect and the Slutskys react to the policy and re-optimize, what is the Slutsky family's MRS at their NEW optimal bundle?

g) After the policy goes into effect and the Slutskys react to the policy and re-optimize, what is the Slutsky family's MRS at their ORIGINAL optimal bundle?

h) Choose a plausible point for the new Slutsky optimal bundle and label it N. Based on your choice of N, either graphically indicate OR calculate how much money the government will spend on the Slutsky family’s education. (No need to do both.)

Please start your answers on the next page.

Part II: Make sure you read and do ALL parts of each question. Show as much work as possible. TRY to get started on every question. Show us something. Write legibly and remember to label all graphs and axes in diagrams.

Answers

Answers

2. K-2SO is an entrepreneur. He has a talent for repairing droids and decides to open a droid repair stand at Mos Eisley market.

K-2SO rents a stand for 6,000 credits a week but he is contractually not allowed to sublet his stand to any other businesses if he does not use it.

He will also have to purchase 50,000 credits worth of welding equipment that fortunately does not depreciate. He borrows the money from an amicable local financier named Jabba at an interest rate of 10% a week – interest due each week. Jabba also offers K-2SO a job in one of his "persuasion businesses" for 1,000 credits a week. He would not be able to run his repair business, however, if he takes the job.

In addition, drone repair requires hired labor, spare parts and motor oil as indicated in the table below. The going wage of hired labor is 20 credits per hour and motor oil costs 10 credits per pint (purchased from Wags). Luckily, although spare parts are not locally available, K-2SO happens to have a cargo bay full of spare parts (more than he will ever need for his business). K-2SO can sell this stuff at 200 credits per ton as “junk-yard art” if he does not use it himself.

The table shows information for a typical week.

a) Fill in the missing cells in the production and cost table using the information above (use the “smaller delta” method for the marginal cost). The revenue and economic profit columns will be filled out in question (c). Use the workspace columns as you wish to organize your calculations.

b) Which of K-2SO's costs are implicit costs (simply name the item(s))? Which are explicit costs (simply name the item(s))?

Assume that droid repair is a perfectly competitive industry where K-2SO can charge 550 credits for each droid repaired.

c) What is the economic profit maximizing number of droids to repair in a week? What are his economic profits per week?

d) Sketch K-2SO’s profit maximizing position using The Cost Graph introduced in lecture. Make sure to label each of the cost curves you draw as well as K-2SO’s marginal revenue. Numbers on the axes do not have to be “to scale” or exact – but your sketch must be reasonable enough so we know you “get the picture”.

e) How will your answers to (c) change, if at all, if the government suddenly announces that effective immediately all droid repair shops must pay a weekly license fee of 20,000 credits to the government?

Please start your answers on the next page.

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Production Information

q=# of droids

repaired

Hours of hired

labor

Workspace use as you

wish

Tons of Spare Parts

Workspaceuse as you

wishPints of

motor oilWorkspace use as you

wish

Workspace use as you

wish

0 0   0   0    

20 50   20   100    

40 100   40   200    

60 200   60   300    

80 400   80   400    100 800   100   500    

120 1,600   120   600    

Cost, Revenue and Profit Information

q=# of droids

repairedFixed Cost Variable Cost Total Cost Marginal

CostMarginal Revenue

Total Revenue

EconomicProfit

0       xxxx       

20              

40              

60              

80              

100              

120

Answers

Answers

1ANSWERS Econ 1110 - INTRODUCTORY MICROECONOMICSPRELIM #2 – Wissink - S2018 – April 12

. CConsumption of both have increased after a rise in income so both are normal goods. Quantity demanded for Belgian chocolate increased (in per cent terms) more than income did - so it is a luxury. Quantity demanded (in per cent terms) for Hershey’s chocolate increased less than income did so it is a necessity.

2 DWe can calculate the cross price elasticity of demand for popcorn with respect to the price of soda by using observations (year 1) & (year 2). We also can calculate the elasticity of demand for popcorn with respect to income by using observations (year 1) & (year 3).

3 They are perfect complements so “L” shaped with the corners on a helping line with slope = 3.

4 DThe perceived demand curve for a perfectly competitive firm’s output is horizontal at the prevailing market price, so has an infinite elasticity.

5 AWhen the price of books increases there are two effects. From the substitution effect, he will consume more food and less books. From the income effect, he will consume less books and less food. Combining these two effects together, books consumption will definitely decrease and food consumption may increase decrease or remain unchanged.

6 CIf the total effect of the own price change is zero, then the income and substitution effects are equal and opposite, and so we must have an inferior good.7 DWhen the price of meat doubles, the consumer will be able to consume half as much meat as before if she spends her entire income on meat. Whereas if she were to spend her entire income on vegetables, the change in the price of meat will not affect how many vegetables she can afford. This means that the rise in the price of meat lead to a rotation of the budget line towards the origin. So from BL2 to BL1.

8 BRearranging the demand curves in terms of Q we get Q = 30-0.5P and Q= 30-0.2P. Adding these curves up (so that we are horizontally summing demand), we get Q = 60-0.7Q.

9The original indifference curve needs to be tangent at O. The new one is tangent on the steeper budget line and at a point where more beans will be consumed relative to how many were originally consumed.

10 E.A firm that does not produce any output is not incurring any variable costs in the production of output. The answer is not (A) or (D) because fixed costs exist even when the firm’s output is 0. It is not (B) since profit would be 0-fc, that is negative. It is not (C) because we require more information to determine the truthfulness of that statement. If the firm has shut down in the short run it’s because it determines it is better off incurring losses equal to –fc than operating at an even greater loss.11 DMarta’s economic profits are $4,800. Her accounting profits are $12,800. Marta's total revenue was $20,000 = 20,000 tulips at $1.00/tulip. Marta's accounting costs are $7,200, which is less than her economic costs of $15,000. Marta's fixed costs totaled $9,000 = land costs of $1,000 + her time opportunity cost of $8,000.

12 CThe profit is maximized at 4 pumpkins and gets $11 (=total revenue – total cost =8*4 – 21) profit. The producer surplus is $16, $7 from the first pumpkin, $5 from second pumpkin, $3 from the third pumpkin and $1 from the fourth pumpkin.

13 A

John should use inputs so that the marginal product of labor divided by the price of labor is equal to the marginal product of kapital divided by the price of kapital. Since the MP/P= 1/4 for labor, and the MP/P= 1/3 for kapital, John should simultaneously hire more kapital and less labor which will bring down the marginal product of kapital and increase the marginal product of labor.

14 ESteve’s electricity bill is an explicit cost. Bill’s is implicit. Hence, given all the other costs are identical, the accounting costs would be higher for Steve, and hence he earns a lower accounting profit as compared to Bill (since his explicit costs are higher). However, their economic profits are the same, since the opportunity cost of the energy would factor in Bill’s economic costs (which now includes his implicit costs).

15 BRegardless of the demand conditions the firm can increase profits by decreasing production because when MC > MR, it is losing money on at least the last unit and should not produce it. If the firm decreases production by 1 unit, it will recover the marginal cost, which exceeds the foregone marginal revenue. Therefore, profits will increase.