Economics 500 Examination 2 – Fall 2005 1. Consider a market with linear demand as illustrated below: a) Is demand elastic, inelastic, or unit elastic at a price of 5=p ? Explain. (6 points) b) Would an increase price from 7=p to 9=p result in an increase, decrease, or no change in total expenditures on this good? Explain. (6 points) c) Suppose price were to decrease from 8=p to 4=p. Determine the value of the resulting increase in Consumer’s Surplus. (6 points) $ Q Demand 12 0 0 1,500 8 4 500 1,0002. The following elasticities have been estimated for “Product X” and “Product Y” under current market conditions: Elasticity Product X Product Y Price Elasticity of Demand .92 1.37 Cross-Price Elasticity of Demand -.17 -.22 Income Elasticity of Demand -.15 .34 Based upon these estimates, answer the following questions. a) Would an increase in the price of “Product X” lead to an increase, decrease, or no change in total expenditures on “Product X”? Explain, making specific reference to one of the six values given above. (4 points) b) Would an increase in the price of “Product X” lead to an increase or a decrease in the demand for “Product Y”? Explain, making specific reference to one of the six values given above. (4 points) c) Would an increase in consumer income lead to an increase or a decrease in the demand for “Product X”? Explain, making specific reference to one of the six values given above. (4 points) d) Is “Product Y” a normal good or an inferior good? Explain, making specific reference to one of the six values given above. (4 points)3. Consider a perfectly competitive firm operating in the Short Run. The only factor of production that is variable is the amount of labor hired, denoted (L). The first two columns of the table below specify the relation between (L) and output produced (Q). MPL denotes the Marginal Product of Labor; MC denotes Marginal Costs of Production. Suppose that: the “Average Variable Costs” of producing 10 units of output are 4; the “Average Fixed Costs” of producing 22 units of output are 20; the price of the output of this firm is 30=p per unit. L Q MPL MC 0 0 1 10 2 15 3 19 4 21 5 22 a) Complete the table above (filling in ALL blank cells). (5 points) b) Determine the optimal amount of output for this firm to produce. Explain. (5 points) c) Determine the maximum profit that this firm is able to earn. Explain. (6 points)4. The budget line below represents all combinations of popcorn and pretzels that Rebecca can buy with a fixed amount of income. Suppose the per unit price of pretzels is 22=p . a) How much income does Rebecca have to spend on these two goods? Clearly explain. (4 points) b) What is the per unit price of popcorn? Clearly explain. (4 points) c) Suppose that Rebecca’s income were to double (with prices fixed). Illustrate her new budget line, clearly labeling the value of each intercept, as well as the slope of the line. (4 points) pretzels Budget Line 30 0 0 120 popcorn5. Consider a perfectly competitive firm operating in the Short Run. Marginal Costs, Average Variable Costs, and Average Total Costs are illustrated below. a) Suppose the price of the output of this firm is 32=p. Is this firm able to earn a positive profit at this price? Explain. (6 points) b) Suppose the price of the output of this firm is 20=p. What quantity of output should this firm produce in order to maximize profit? How much profit is this firm able to earn? Explain. (6 points) c) If the firm were to produce 12 units of output, what would be the realized value of Fixed Costs of production? Explain. (6 points) $ q MC ATC AVC 10 8 4 32 0 0 28 20 16 126. Gene’s preferences for 1x =(blue t-shirts) and 2x =(cigarettes) can be summarized by 2140)( xxXu = . As a result, his marginal utility functions are 12120xxMU = and 21220xxMU =. Suppose each unit of 1x costs 1p , each unit of 2x costs 2p , and Gene’s income is equal to I. a) Illustrate the indifference curve along which Gene realizes utility of 240=u . Identify three different consumption bundles along this curve. (6 points) b) Derive an expression for 2,1MRS . (6 points) c) Showing all work, determine Gene’s optimal levels of consumption as functions of 1p , 2p , and I. (8 points)EXTRA CREDIT - 3 Points! Consider a market in which demand is given by ppD 212)( −= (for 360 ≤≤ p). Price elasticity of demand is given by ppp212 −=ε. At what price are total expenditures in this market maximized? Explain.Blank
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