# ECON 203 Spring 2007 FINAL EXAMINATION Saturday April 14, 2007 You have 3 hours to answer the questions

on this examination. The exam contains 24 questions on 6 pages for a total of 90 points. You do not have the right to any aid or device other than pens, pencils and an eraser. Good luck! ANSWER QUESTIONS 1 TO 20 ON THE COMPUTER BUBBLE SHEET. Each is worth 2 points

1. When demand for a good is inelastic, consumer expenditures on the good a. increase when price increases. b. decrease when price increases. c. do not change when price increases. d. are not related to price elasticity of demand. 2. When a person consumes two goods (A and B), that person's utility is maximized when the budget is allocated such that: a. the marginal utility of A equals the marginal utility of B. b. the marginal utility of A times the price of A equals the marginal utility of B times the price of B. c. the ratio of total utility of A to the price of A equals the ratio of the marginal utility of B to the price of A. d. the ratio of the marginal utility of A to the price of A equals the ratio of the marginal utility of B to the price of B. 3. Which of the following is true at each point along a price consumption curve? a. Utility is maximized but income is not. b. All income is spent, but utility is not maximized. c. Utility is maximized, and all income is spent. d. The level of utility is constant. 4. When the income-consumption curve has a positive slope throughout its entire length, we can conclude that a. both goods are inferior. b. both goods are normal. c. the good on the vertical (y) axis is inferior. d. the good on the horizontal (x) axis is inferior. 5. The inverse demand for erasers (Q) is given by P=60–0.25Q, where P is the price of erasers. Suppose that P = 10. What is the price elasticity of demand? a. -5 b. -1/8 c. -1/5 d. -0.25 e. -80

6. Fill the blanks in the following sentence. Assume beer is an inferior good and the price of beer falls, then the substitution effect results in the person buying ______ of the good and the income effect results in the person buying ______ of the good. a. more, more b. more, less c. less, more d. less, less 7. In a production process, all inputs are increased by 10% and output increases by 7%. This means that the firm experiences a. decreasing returns to scale. b. decreasing marginal product of capital and labor. c. increasing returns to scale. d. constant returns to scale. e. both a) and b) 8. Which always increase(s) as output increases? a. Marginal costs only b. Fixed costs only c. Total costs only d. Variable costs only e. Total costs and variable costs 9. In a short-run production process, the marginal cost is rising and the average variable cost is falling as output is increased. Thus, a. average fixed cost is constant. b. marginal cost is above average variable cost. c. marginal cost is below average fixed cost. d. marginal cost is below average variable cost. 10. At the optimum combination of two inputs, a. the slopes of the isoquant and isocost curves are equal. b. costs are minimized for the production of a given output. c. the marginal rate of technical substitution equals the ratio of input prices. d. all of the above. e. a and c only. 11. Bette's Breakfast, a perfectly competitive eatery, sells its "Breakfast Special" (the only item on the menu) for \$5.00. The costs of waiters, cooks, power, food etc. average out to \$3.95 per meal; the costs of the lease, insurance and other such expenses average out to \$1.25 per meal. Bette should a. close her doors immediately. b. continue producing in the short and long run. c. continue producing in the short run, but plan to go out of business in the long run. d. raise her prices above the perfectly competitive level. e. lower her output.

12. Consider this diagram:

The LAC and LMC curves in the diagram are consistent with a production function that exhibits a. decreasing returns to scale. b. constant returns to scale. c. increasing returns to scale. d. increasing returns to scale for small levels of output, then constant returns to scale, and eventually decreasing returns to scale as output increases. e. decreasing returns to scale for small levels of output, then constant returns to scale, and eventually increasing returns to scale as output increases. 13. The demand curve for a product is given Q=100-P and the monopolist operating in this market has a total cost function TC = 10Q. The profit maximizing price is: a. \$70 b. \$65 c. \$60 d. \$55 e. \$50 14. If a monopolist sets her output such that marginal revenue, marginal cost and average total cost are equal, economic profit must be: a. negative. b. positive. c. zero. d. indeterminate from the given information. 15. The Cournot equilibrium can be found by treating _____ as a pair of simultaneous equations and by finding the combination of Q1 and Q2 that satisfies both equations. a. the contract curve and the market demand curve b. the contract curve and the market supply curve c. the reaction curves for firms 1 and 2 d. the market supply curve and the market demand curve e. the firm's supply curve and the firm's demand curve

16. McDonald's restaurant located near the high school offered a Tuesday special for high school students. If high school students showed their student ID cards, they would be given 50 cents off any special meal. This practice is an example of: a. collusion. b. price discrimination. c. two-part tariff. d. bundling. 17. When a monopolist engages in perfect price discrimination, a. the marginal revenue curve lies below the demand curve. b. the demand curve and the marginal revenue curve are identical. c. marginal cost becomes zero. d. the marginal revenue curve becomes horizontal. 18. You observe the following production relationship: F (aK , aL) > aF ( K , L) . From this, you can conclude that a. the total cost of production is falling b. the marginal product of L and K are increasing c. there are increasing returns to scale d. you should expand production e. c and d 19. A perfectly vertical demand curve is a. infinitely elastic b. unit elastic c. perfectly inelastic d. highly, but not infinitely elastic 20. At point C of the curve below a. the marginal product of labor is greater than the average product of labor. b. the average product of labor is greater than the marginal product of labor. c. the marginal product of labor and the average product of labor are equal. d. the marginal product of labor and the average product of labor are both increasing. e. both (c) and (d) are correct.

Answer the following questions in a booklet.
Q21. 15 points Adam has a utility function U ( X , Y ) = X 2Y and an endowment of X and Y in the quantities (1,4). Brenda has utility U ( X , Y ) = X + Y and endowment (5,4).
Draw an Edgeworth box of this economy. Indicate all pertinent information, including relevant indifference curves and initial utility levels. Adam and Brenda decide to trade. If they trade in such a way that all gains from trade go to Brenda, What will be the final allocation of goods? Draw the relevant indifference curves and indicate this final allocation on your graph with the letter W. Verify that the allocation ( X A , YA ) = (10 / 3, 5 / 3);( X B , YB ) = (8 / 3, 19 / 3) with competitive prices p X = 1, pY = 1 is an equilibrium. Compare Brenda’s utility level to her initial utility to help you place the competitive allocation in the phase diagram and indicate it with a C.

Draw the core of the economy.

Q22. 10 points. In your booklet, draw a diagram similar to this one. MAKE IT LARGE SO THAT YOU CAN EASILY ILLUSTRATE YOUR ANSWERS

Y

U0

X
The graph illustrates the position of a consumer who maximizes utility subject to its budget constraint. The government is considering the introduction of a tax on good Y. Graphically analyze the impact of the tax on the consumer if good Y is an INFERIOR GOOD. Clearly indicate the total, substitution and income effects of the policy on the consumer.

Q23. 10 points. A firm has a long run production function Q = 12( KL)1/ 2 . Input prices are respectively r=3 for K and w=2 for L.

a) Is the firm minimizing its cost of production if K=16 and L=25? Briefly explain. b) If the firm is employing 9 units of labor, - how many units of capital should it use to minimize costs? - What will be the average cost per unit? (you do not need to simplify the expression. just leave the fractions and exponents in the expression if need be) c) If the firm is free to modify its input quantities and it wants to double its production, would the average cost increase, decrease or remain unchanged.

Q24. 15 points. Consider the following graph representing a market.

P

a
P1

b d h k e f i q n
Q2 Q3 Q4

c
P2 P3 P4

MC P(Q)
Q5

g j L

m
Q1

r

Q

For questions 1 to 6, consider the graph to represent a monopoly market. 1) What quantity will the monopolist choose to produce? 2) What will be the prevailing market price 3) What area (e.g. a+b+c) give the monopolist's total revenue 4) What area gives the monopolist's total costs of production (assuming that there is no fixed costs) 5) What area gives the monopolist's total surplus 6) What area gives the consumer surplus For questions 7 to 10, consider the Marginal Cost and Demand Curves to represent the short run situation of a competitive market

7) What quantity will be produced in this market? 8) What will be the prevailing market price 9) What area (e.g. a+b+c) gives the firms' aggregate producer surplus? 10) When you compare the monopoly outcome to the competitive outcome, what area represents the deadweight loss associated with a monopoly market? 11) Briefly explain why this graph cannot represent the long run position of a competitive industry. What will be the long run price? Explain how it will come about.

Solution to Multiple Choices 1) a 2) d 3) c 4) b 5) c 6) a 7) a 8) e 9) d 10) d 11) c 12) d 13) d 14) d 15) c 16) b 17) b 18) c 19) c 20) b