ECON 500 – Spring 2007 Name: _A. Key______________________ Exam 2 Multiple Choice: (circle the letter of the best response; 4 points each) 1. In a “Perfectly Competitive Market” d. All of the above answers are correct. 2. Evan’s preferences are “transitive.” Comparing the consumption bundles )4,20(=A, )12,12(=B , )16,8(=C , and )18,6(=D he states: DA f , AC f , and CB f . It follows that d. All of the above answers are correct. 3. The observation that all (“non-express”) checkout lines in a grocery store tend to be of roughly the same length is an illustration of b. Adam Smith’s Invisible Hand in action. 4. “Marginal Utility of good one” a. provides a measure of how total utility changes as consumption good one is increased, with consumption of all other goods fixed. 5. Brady sells footballs. His revenue per year is $5,000, his explicit costs are $4,000, and his implicit costs are $1,750. From this information, his Accounting Profit c. is $1,000. 6. Suppose the market for lemons is perfectly competitive. In the Short Run, Lee currently sells 10,000 pounds of lemons at a price of $2.30 per pound, while incurring Average Total Costs of production equal to $1.80 per pound. In the Long Run, Lee should expect d. new firms to enter the industry. 7. _________________ serves to distribute scarce goods to those consumers who value them most highly. b. The Rationing Function of Price 8. A firm with “Market Power” c. can typically increase it’s price slightly without losing all customers. 9. Explicit Costs a. refer to the actual payments a firm makes to its factors of production and other suppliers. 10. Which of the following is an example of “Third Degree Price Discrimination”? a. “A ticket to see Kickin’ It Old Skool at the Regal Town Center Cinema in Kennesaw, GA costs “Adults” $9.75, but costs “Seniors” only $7.50.” 11. A firm operating in the Short Run c. is not able to vary the amount hired of at least one factor of production.12. “Price Discrimination” a. refers to the practice of a firm charging different prices for different units of a good. 13. A situation is efficient if a. no change is possible that will help some people without harming others. 14. In comparison to the outcome that would result with no intervention in this market, imposing a price floor of $16.00 would decrease Consumers’ Surplus by b. areas (c)+(d). 15. If 2,000 units are traded in the market d. the resulting Deadweight Loss is equal to areas (a)+(c). “Short Answer” Questions: 1. Mo likes to consume 1x =(ice cream) and 2x =(broccoli). Each unit of ice cream costs 21=p , each unit of broccoli costs 42=p , and he has income of 120=I . His preferences can be summarized by the utility function 2121),( xxxxU=. It follows that 21xMU = and 12xMU = . a. Which of the following two consumption bundles does Mo like more: “12 units of ice cream and 5 units of broccoli” or “4 units of ice cream and 20 units of broccoli”? Clearly explain. (3 points) Since 60)5)(12()5,12(==U is less than 80)20)(4()20,4( ==U , it follows that of these two bundles Mo prefers “4 units of ice cream and 20 units of broccoli.” b. Is Mo able to afford “35 units of ice cream and 10 units of broccoli”? Clearly explain why or why not. (3 points) This bundle is affordable, since it would cost him only 110)10)(4()35)(2(2211=+=+ xpxp, which is less than his income of 120=I . c. State an expression for Mo’s “Marginal Rate of Substitution” (as a function of 1x and 2x). (3 points) 12212,1xxMUMUMRS == d. Is the consumption bundle “20 units of ice cream and 20 units of broccoli” the “optimal consumption bundle” (i.e., the “utility maximizing consumption bundle”) for Mo? Clearly explain why or why not. (3 points)At this consumption bundle 12020122,1===xxMRS. But with 21=p and 42=p , it follows that 214221==pp. Since 212,1ppMRS ≠, the proposed consumption bundle cannot be optimal. 2. Consider a perfectly competitive firm operating in the Short Run. Marginal Costs, Average Variable Costs, and Average Total Costs are illustrated below. a. Determine the numerical value of Fixed Costs of Production for this firm. (3 points) Recall that by definition AVCATCAFC−= and qFAFC=. From the graph above we see that at 100=q 850.1250.20 =−=−=AVCATCAFC . Thus, by qFAFC = it follows that 1008F=, implying 800=F . b. If the per unit price of output in this market were 50.20=p , how much output would this firm produce? Explain. (3 points) The given price of 50.20=p is above 80.11min=AVC. Therefore, the firm will maximize profit by producing the positive level of output for which )(qMCp = . From the graph above this level of output is 180*=q . c. If the per unit price of output in this market were 30.6=p , how much output would this firm produce? Explain. (3 points) The given price of 30.6=p is below 80.11min=AVC . Therefore, the firm will want to shutdown in the short run and produce 0*=q units of output. $ q MC ATC AVC 250 180 160 142 100 0 0 12.50 =minATC16.00 20.50 275 =minAVC11.80 6.30d. If the per unit price of output in this market were 50.12=p , is this firm able to earn a positive profit? Explain. (3 points) The given price of 50.12=p is below 00.16min=ATC . Since profit can be expressed as [])(qATCpq−=π, this insight implies that profit will be negative for all values of 0≥q . That is, the firm is not able to earn a positive profit. 3. Consider a monopolist facing Demand as illustrated by the linear function below. Also illustrated is the Marginal Cost curve and Average Total Cost curve for this monopolist. Suppose throughout that this firm is not able to engage in price discrimination. a. In order to maximize profit, what price should this monopolist charge? Explain. (4 points) To maximize profit, this monopolist should produce the level of output for which )()( qMCqMR = . The graph above indicates that this level is 400,2*=Mq units of output. For consumers to be willing and able to purchase exactly this quantity, the firm should charge a per unit price of ()28**==MDMqPp . b. Is this monopolist able to earn a positive profit? Explain. (2 points) No, this monopolist is not able to earn a positive profit. Recall that profit can be expressed as