GM545 Quiz 1 Guidelines Recall that Keller courses are built around Terminal Course Objectives (TCOs).

At the conclusion of the course, you will even be asked to rate the extent to which the TCOs have been covered. There are 9 TCOs specified for GM545. Review the TCOs by clicking on Course Syllabus at the top of the course home page, and then clicking on the Terminal Course Objectives link. Also, please note that the TCO(s) to be covered during any given week are specified in the Objective section for that course week. Quiz 1 addresses material covered in Weeks 1 and 2 of the course. The TCOs at issue are:

Course Objective A

Description Given a demand function and a supply function, illustrate how the price mechanism, in response to changes in other demand or supply factors, leads to a new market equilibrium price and level of output. Given appropriate marketing data, including price elasticity coefficients, demonstrate how to use this information in product pricing in order to maximize revenues. Given knowledge of key cost and marginal revenue relationships, use marginal analysis to demonstrate shutdown, break-even and optimal output points, as well as the optimal amount of a resource to utilize.

You will note that the problems that have been assigned from the book focus on these TCOs. The problems address the basics while Discussion topics focus on broad applications. The quizzes (and the final exam) emphasize the basics. So, make sure you completely understand the assigned homework problems before attempting the quiz. The 2 hour quiz will consist of 10 short answer questions worth 10 points each (100 points total). Each question has several parts. These are short answer questions that require you to work through an issue and report your conclusion. You will have to make calculations, so be prepared for that. In all cases, to receive full credit, you must provide appropriate explanation and support for any conclusion that you make. If you are asked to make a calculation, the complete calculation must be shown. Formatting numerical calculations can be difficult in the online environment, so do not spend a lot of time arranging things in the neatest way. Just make sure that what you have done is clear to any informed reader. Here are some sample questions and representative answers: NOTE: Questions 1-3 refer to material from Chapter 3 of the text. In dealing with these questions, be absolutely sure you are clear on the distinctions between demand vs. quantity demanded, and between supply vs. quantity supplied. 1. Immigration policies have increased the number of kiwi consumers in the United States. a. In the short run, what happens to kiwi demand? ANS. Kiwi demand would increase due to the increased number of consumers in the market. Market demand is the horizontal summation of individual consumer demands. Thus, the more consumers there are, the greater is the demand. b. In the short run, what happens to kiwi supply?

ANS. There is no impact on supply. The number of consumers in the market is a demand factor, not a supply factor. 2. Beef and chicken are substitutes. The price of beef rises. a. In the short run, what happens to the demand for chicken? ANS. The demand for chicken would increase. As the price of beef rises, consumers would want to buy less beef and substitute chicken that becomes relatively cheaper. b. In the short run, what happens to the demand for beef? ANS. The demand for beef remains unchanged. An increase in the price of beef causes movement along the demand curve for beef (i.e., a change in the quantity demanded), but the demand curve itself would not be expected to shift. Be sure you understand this. 3. The price of fertilizer used in the production of wheat declines. a. In the short run, what happens to the supply of wheat? ANS. The supply of wheat would be expected to increase since it has become cheaper to produce, providing greater profit margins than before at alternative prices. b. In the short run, what happens to the demand for wheat? ANS. There would be no effect on the demand for wheat since a change in resource prices is a supply factor, not a demand factor. NOTE: Question 4 also refers to material from Chapter 3 of our text. In dealing with more than one change, consider them in any order--- your final conclusion does not depend on the particular sequence chosen for your analysis. And, please answer only the question being asked. For example, if you are asked to analyze a price change, I am not interested in the quantity sideand vice-versa. 4. A market is in equilibrium with quantity Q* and price P*. a. What happens to P* if there is an increase in demand? ANS. Price will rise due to shortages at the original price of P*. b. What happens to Q* if there is an increase in demand and an increase in supply? ANS. First notice that were talking about equilibrium quantity (Q*) here, not equilibrium price (P*). The increase in demand will force both equilibrium price and quantity up due to initial shortages. The increase in supply will then force price down, but quantity will again increase. The net effect on quantity is an increase in Q*. c. What happens to P* if there is an increase in supply followed by a decrease in demand followed by a decrease in supply? ANS. Focusing only on P*, we see that it decreases as supply increases, decreases again as demand decreases, but then increases as supply decreases. The net effect of these three changes is therefore indeterminate, as P* increases twice but then decreases there is no way to know what are the magnitude of opposing changes.

NOTE: Question 5 refers to material from Chapter 5 of the text . When computing elasticity, use the midpoint formula at all times. 5. The following table shows part of the demand for marshmallows: Price (P) 15 10 6 3 Quantity (Q) 80 100 150 350

a. Is demand elastic in the $3-$6 price range? ANS. Yes, demand is elastic in this range since Ed > 1. Ed = A/ B, where A = chg in Q / [sum Q/ 2], and B = chg in P / [sum P/ 2]. Thus, A = (350-150)/[(350+150)/2] = 200/250 = 0.8, and B = (6-3)/[(6+3)/2] = 3/ 4.5 = 0.67. So, Ed = 0.80 / 0.67 = 1.194 b. Ed = 0.55 in the $10 - $15 price range. (Take my word for it.) In this range of demand, by what percentage would quantity demanded change if price changes by 2 percent? ANS. Quantity would be expected to change by 1.1 percent. Since Ed = (% chg Q) / (% chg P), it must be the case that % chg Q = (Ed) x (% chg P). Thus, % chg Q = (0.55) x (2) = 1.1%.

c. Price falls from $6 to $3. Does total revenue (TR) increase, decrease, or remain the same? ANS. Total revenue rises by $150, from $900 to $1050. TR @ $6 = ($6) x (150 units) = $900, and TR @$3 = ($3) x (350 units) = $1050. SHORTCUT: You would not need to make a numerical calculation in order to answer 5c correctly. Why? Because you know that demand is elastic in this range. (From 5a.) As price falls over an elastic portion of demand, total revenue must rise. You could reason it out this way and receive full marks for such an answer.

NOTE: Question 6 also refers to material from Chapter 5 of the text. 6. Does price elasticity of supply play a role in determining the shortages that are entailed in a price ceiling policy? Invent some appropriate numbers to illustrate your conclusion. ANS. Yes. The more elastic is the supply, the larger is the shortage; the less elastic is the supply, the smaller is the shortage. Suppose, S = D at the equilibrium price of $1.20. Assume that Qo = 180 units. If the price ceiling of $0.90 is established, then there will be a shortage equal to Qd Qs. For example, if Qd = 200 and Qs = 140, then the shortage will be equal to 60 units per unit time. If supply is more elastic than what is shown in the diagram, then the quantity supplied would fall by a bigger percentage, and may be equal to, say, 120 units at the ceiling price. The shortage

would therefore be equal to 200 120 = 80 units--- greater than before. On the other hand, if supply is less elastic than what is shown in the diagram, the quantity supplied at the ceiling price might be 150, in which case the shortage would be 200 150 = 50 units---less than before. SHORTCUT: The analysis is simplified if one assumes a perfectly inelastic demand (vertical line). Then, one can say that a ceiling price will impact the quantity supplied but not the quantity demanded. So, if the price elasticity of supply is equal to, say, the value of 2, then the quantity supplied will fall by 2% for every 1% fall in the price away from equilibrium. But if the price elasticity of supply is greater than this, for example, equal to 3, then quantity supplied falls by 3% per each 1% fall in price. Since quantity demanded is unaffected by the change in price, the shortage would be larger in this second case for any ceiling price whatsoever. Conversely, if the price elasticity of supply was equal to, say, the value of 1, quantity supplied would fall by only 1% for each 1% drop in price, resulting in a smaller shortage than would be observed in either of the above cases. NOTE: Always remember that flatter demand and supply curves are more elastic than are steeper ones.

Quiz 1 Guidelines (continued)

C. Given knowledge of key cost and marginal revenue relationships, use marginal analysis to demonstrate shutdown, break-even and optimal output points, as well as the optimal amount of a resource to utilize.

Here is what to focus on in each chapter: Chapter 7 Production and Cost . Know the differences among Total Cost (TC), Total Fixed Cost (TFC), and Total Variable Cost (TVC). . Know the differences among Average Total Cost (ATC), Average Fixed Cost (AFC), and Average Variable Cost (AVC). If you know TC, TFC, and TVC data for a given quantity of output Q, then ATC, AFC, and AVC are easily determined. Why must AFC continually decrease as output increases? . Know (above all) what is meant by Marginal Cost (MC). Remember that MC applies only over intervals of production. Remember that MC eventually increases as output increases due to the law of diminishing marginal product.
NOTE: Question 7 (below) utilizes material from all of Chapter 7. If you understand how all of the answers are derived here, you have a solid understanding of marginal analysis.

7. (TCO C) You have been hired to manage a small manufacturing facility which has cost and production data given in the table below.

No. of workers Total Labor Cost 1 2 3 4 5 6 7 $100 200 300 400 500 600 700

Output 30 80 120 150 170 180 185

Total Revenue $300 450 540 610 660 690 700

a. What is the marginal product of the second worker? Marginal product of the second worker is calculated as follows: Total product (output) of 2 workers minus total product (output) of 1 worker = 80 30 = 50. The marginal product of the second worker is 50. b. What is the marginal revenue product of the fourth worker? Marginal Revenue Product of the fourth worker is the Total Revenue at 4 workers minus the Total Revenue at 3 workers = 610 540 = $70. c. What is the marginal cost of the first worker? The marginal cost of the first worker (or any worker in this case) is $100. d. Based on your knowledge of marginal analysis, how many workers should you hire? Explain you answer. To use marginal analysis on this problem you need to compare the Marginal Cost of each worker (Marginal Factor Cost) to the Marginal Revenue of each worker (Marginal Revenue Product). No. of workers Total Labor Cost MC Output Total Revenue 1 2 3 $100 200 300 100 100 100 30 80 120 $300 450 540 MR 300 150 90

4 5 6 7

400 500 600 700

100 100 100 100

150 170 180 185

610 660 690 700

70 50 30 10

So, as long as MC is less than or equal to MR we will continue to hire workers. When MC exceeds MR we will no longer hire workers. In this case, we want to hire 2 workers, because at 2 workers MC (100) is less than MR (150). At the 3rd worker and thereafter, MC is greater than MR.

Chapter 8: Competition . Know what is implied by saying that a pure competitor is confronted with perfectly elastic demand. Why is the pure competitors marginal revenue equal to the market price of its output? How is Total Revenue (TR) calculated? . Know why maximizing the difference between Total Revenue (TR) and Total Cost (TC) is the same as equating Marginal Revenue (MR) and Marginal Cost (MC). . Know why and when a firm would operate in the short run at a loss.
NOTE: Question 8 (below) utilizes material from all of Chapter 8. If you understand how all of the answers are derived here, you have a solid understanding of applying marginal analysis to profit maximization in any firm.

8. (TCO C) Answer the next question on the basis of the following cost data for a purely competitive seller: Total Product 0 1 2 3 4 5 TFC $30 30 30 30 30 30 TVC $0 10 20 50 120 300 6

30

590

Refer to the above data. If the product price is $25, at its optimal output will the firm realize an economic profit, break even, or incur an economic loss? How much will the profit or loss be? Show all calculations.

Solution We need to calculate Marginal Cost based on this data, and then compare to Marginal Revenue (which is the same as price for a perfectly competitive firm described in Chapter 8).

Total Product 0 1 2 3 4 5 6

TFC $30 30 30 30 30 30 30

TVC $0 10 20 50 120 300 590

MC Undefined 10 10 30 70 180 290

MR

25 25 25 25 25 25

So, comparing MR and MC again, we see that the firm should produce 2 units because MR is still greater than or equal to MC at this level of production. After 2 units MC becomes bigger than MR so we dont want to produce those units.

Notice if we calculate profits at each level of production: Total Product 0 1 2 TFC $30 30 30 TVC $0 10 20 MC Undefined 10 10 25 25 MR TR 0 25 50 TC 30 40 50 Profits/Losses -$30 -$15 0

3 4 5 6

30 30 30 30

50 120 300 590

30 70 180 290

25 25 25 25

75 100 125 150

80 150 330 620

-$5 -$50 -$205 -$470

So, the simpler MR greater than or equal to MC rule gets us the same best production level decision as we would get above ------------ produce 2 units. Notice that it not wise to shut down because were making zero profits. If we shut down, as shown in the first line above, we still have to pay our fixed costs, and will lose -$30.
Good luck. I want all of you to do well.