Final Exam. ECON 500 – Spring 2004. 1. Suppose that at "initial prices and income" of ),,(21Ipp , a consumer maximizes utility by choosing the bundle *X illustrated below. For each of the following scenarios, identify the entire area in ),(21xx -space where the "new optimal bundle" could be. a. both goods are "normal"; income increases with prices fixed. (4 points) b. good two is a "substitute for" good one; the price of commodity one increases, with income and the price of commodity two held fixed. (4 points) 1x2x*X1x2x*X2. Suppose the price of commodity one decreases, and consumption changes as illustrated below. Decompose the total change in consumption of commodity one into that resulting from an income effect and that resulting from a substitution effect. (8 points) 1x2x3. Ernie wears Fidra golf shirts; Adam wears Burberry golf shirts. They notice the following elasticities for these two products under current market conditions: Elasticity Burberry shirts Fidra shirts Price Elasticity of Demand -1.54 -.89 Cross-Price Elasticity of Demand .26 .34 Income Elasticity of Demand -.12 .27 Based upon these values, answer the following questions. a. Would an increase in the price of Fidra golf shirts result in an increase or decrease in total expenditure on the product? Clearly explain. (3 points) b. Under the current market conditions, are Burberry golf shirts and Fidra golf shirts complements to or substitutes for each other? Clearly explain. (3 points) c. Under the current market conditions, are Burberry golf shirts a normal or an inferior good? Clearly explain. (3 points) d. Under the current market conditions, are Fidra golf shirts a normal or an inferior good? Clearly explain. (3 points)4. Suppose that the demand for pizza is given by ppD 240)(−=. a. Does the “Law of Demand” appear to be satisfied? Explain. (3 points) b. Determine an expression for total expenditure on pizza as a function of price. (3 points) c. Is demand “elastic,: “inelastic,” or “unit elastic” at a price of 8=p ? Explain. (3 points) d. What price maximizes total expenditure on pizza? Explain. (3 points) 5. Consider the production function KLLKF 10),(=. For this function KMPL10= and LMPK10= . a. Suppose )5,4(),( =LK . How much output can the firm produce? (3 points) b. Determine KLMRTS,. Is KLMRTS, “Diminishing”? Explain. (4 points)c. Sketch the isoquant associated with 200=Q . (3 points) d. Identify an input combination that leads to more than 40 units of output being produced. Illustrate this input combination graphically, in relation to the isoquant associated with 200=Q . (3 points) 6. Consider a firm with the production function },min{),(31KLKLF=. Suppose the firm is operating in the long run, and wants to produce q units of output as inexpensively as possible. a. Graphically illustrate the solution to the long run cost minimization problem for this firm. (4 points)b. Determine the long run cost minimizing levels of labor and capital. (4 points) c. Determine the long run cost function of this firm, as well as the long run average cost function of this firm. (4 points) d. Based upon the functional form of average costs of production, does this technology appear to exhibit Increasing, Decreasing, or Constant Returns to Scale? Explain. (2 points)7. Consider the market for avocados. Suppose that between 2002 and 2004 supply decreases while demand increases. Clearly explain how the equilibrium price and quantity in 2004 compare to the equilibrium price and quantity in 2002. (10 points) 8. Gene and Emmanuel devote each workday to producing either “computers” or “pizza.” On any given day Gene can produce either 5 computers or 20 pizzas, while; Emmanuel can produce either 10 computers or 10 pizzas. As a result, the opportunity cost of pizza for Gene is 25.=GenePizzaOC , while the opportunity cost of pizza for Emmanuel is 1=EmmanuelPizzaOC . Suppose that trade can take place between these two workers. a. Determine the maximum number of computers that these two individuals can produce collectively. (2 points) b. Which of these two individuals has a comparative advantage in the production of computers? Explain. (2 points)c. Graph the daily Production Possibilities Frontier for this “two person economy.” Clearly label each intercept, as well as the slope of this curve at each point. (4 points) d. Argue that: “Without trading with one another, it is not possible for Gene to consume 6 computers and 12 pizzas and for Emmanuel to consume 4 computers and 8 pizzas. However, with trade these levels of consumption are possible.” (3 points)9. The company you manage has already invested $20,000 in developing a new product, but the development is not quite finished. At a recent meeting, your salesperson reports that the introduction of competing products has reduced the expected sales of your new product to $12,000. What is the largest dollar amount that you should be willing to pay to complete the development of the product? Clearly explain. (6 points)10. Imagine a society that produces two goods: “Tanks” (a “military good”) and “Cars” (a “consumer good”). The Production Possibilities Frontier for Tanks and Cars is illustrated below. a. In the figure above, identify a point which is impossible for this economy to achieve (label this point “U”). In the figure above, identify a point which can be achieved, but is inefficient (label this point “I”). (2 points) b. Suppose the society has two political parties, the Hawks (that want a strong military, but still some consumer goods) and the Doves (that want a smaller military, and more consumer goods). In the figure above: identify a point that the Hawks might argue in favor of (label this point “H”); identify a point that the Doves might argue in favor of (label this point “D”). (2 points) c. Suppose that an aggressive neighboring country reduces the size of its military. As a result, both Hawks and Doves reduce their desired level of Tanks by the same amount. Which party would realize a bigger “peace dividend,” measured by the resulting increase in Car production. Clearly Explain. (2
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