ECON 500 Examination 3 - Spring 2005 1) Does the production function 24),( LKLKF += exhibit Increasing, Decreasing, or Constant Returns to Scale? Clearly explain. (10 points) 2) David enjoys eating hotdogs. As the price of a package of hotdogs decreases from $3.75 to $3.25, his annual consumption changes as a result of two effects, a “substitution effect” and an “income effect.” The substitution effect alone causes consumption to increase by 15 units, while the income effect alone causes consumption to decrease by 6 units. Based upon this information: a) Are hotdogs an ordinary good or Giffen good for David? Clearly explain. (6 points) b) Are hotdogs a normal good or inferior good for David? Clearly explain. (6 points)3) Suppose demand is given by ppD000,2)( = . a) Graphically illustrate Consumers' Surplus in this market at a price of 16=p (being sure to label quantity demanded at this price). (6 points) b) Graphically identify the decrease in Consumers' Surplus resulting from an increase in price from 16=p to 25=p (being sure to label quantity demanded at each of these prices). (6 points) c) Noting that the “demand curve becomes flatter” as we move to “lower price, higher quantity pairs,” place both an upper and lower bound on the decrease in Consumers' Surplus resulting from an increase in price from 16=p to 25=p . (8 points)d) Is demand for this product “elastic,” inelastic,” or “unit elastic”? Explain. (6 points) 4) Consider the production function LKKLF 20),( = . For this function LKMPL10= and KLMPK10= . a) Determine the amount of output that can be produced with )2,18(),( =KL and with )18,2(),( =KL . (6 points) b) State an expression for KLMRTS,. Is the Marginal Rate of Technical Substitution “Diminishing”? Explain. (8 points)c) Based upon your answers to parts (a) and (b), explain why the input combination )10,10(),(=KL must produce more output than )2,18(),( =KL (NOTE: base your answer on parts (a) and (b), and NOT upon a direct evaluation of ),( KLF ). (8 points) d) Sketch the isoquant passing through the input combination )2,18(),( =KL . Illustrate the input combinations )18,2(),( =KL and )10,10(),( =KL in relation to this isoquant. (6 points)5) Consider a market in which demand is given by the linear function illustrated below. a) Is demand “elastic,” inelastic,” or “unit elastic” at a price of $8? Briefly explain. (6 points) b) Would decreasing price from $4 to $3 lead to an increase, decrease, or no change in total consumer expenditures in this market? Briefly explain. (6 points) qp12c) What price would have to be charged in order to maximize total consumer expenditures in this market? Briefly explain. (6 points) d) If income elasticity of demand for this good is equal to 73.=Iε, would a decrease in per capita income lead to an increase, decrease, or no change in demand? Briefly explain. (6 points)EXTRA CREDIT - 4 points! A firm produces output using two inputs, labor and capital. Is it possible for the production process to exhibit “Increasing Returns to Scale” even if the marginal product of each input is “diminishing”? Explain. (hint: consider the production function βαLAKLKF =),( with 0>α and 0>β, for which 1−=βαβLAKMPL and βααLAKMPK1−= .)Blank
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