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Answer Key

Econ 4351_ Midterm II


1) B
Section: 6.1

2) D
Section: 6.3

3) D
Section: 7.1

4) E
Section: 7.1

5) A
Section: 8.3

6) D
Section: 8.3

7) B
Section: 9.2

8) E
Section: 9.4

9) A
Section: 10.1

10) D
Section: 10.1

11) C
Section: 10.2

12) A
Section: 6.2

13) B
Section: 6.4

14) B
Section: 7.2

15) E
Section: 8.1

16) C
Section: 8.4

17) D
Section: 9.4

18) B
Section: 10.2

19) D
Section: 6.2

20) C
Section: 6.4

21)
(a) To determine which returns to scale a production exhibits, we can compare the output resulting from
doubling both inputs F 2K ,2L and doubled output 2q or 2F K , L .

F 2K ,2L

2K 2L 4KL 2 KL
2q 2F K , L 2 KL F 2K ,2L 2F K , L
So, this production function exhibits constant returns to scale (CRS).

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Answer Key
Econ 4351_ Midterm II
(b) Currently, with K 16 & L 16 , Marge can produce q F 16,16 16 16 16 units of output. If she increased

labor and capital (hair dryers) by 50%, she can use K 161 50% 161.5 24 and L 161 50% 161.5 24 . So
she can produce q F 24,24 24 24 24 units of output. The percentage change in her production would be:

24 16

100% 50%
16
which is exactly 50% because of the constant return to scale (CRS) nature of her production function.
Section: 6.4

22)
(a) Homer operates in a perfectly competitive market, so the profit-maximizing output level is where marginal
cost equals the market price P $1,200 . First, we need to find the marginal cost function from total cost function:

MC q

dTCq
75 3 75 3
4
q q
dq
128
32

Then, equate marginal cost function to the market price and solve for the optimal output level q :

75
q
32

1,200

512
q 8

(b) When Homer produces 8 units of output, his profit is:


q R q TC q

75 4

Pq
q 10,240
128

75 4

1,2008
8 10,240
128

9,600 12,640
$3,040
Therefore, Homer is losing $3,040 every year.
(c) In the short run, capital is fixed, which means fixed costs cannot be eliminated by shutting down. To
determine if Homer should operate or shut down, we should compare P $1,200 to average variable cost (AVC) at
the optimal output level q :

75 4
q

75 4
VC 128 75 3
VC
q AVC

q
128
q
q
128
75 3 75 3
8 300
AVC q
q
128
128
At the profit-maximizing output level, P AVC , so Homer should operate in the short run. He only loses $3,040
by producing 8 units but would lose $10,240 (fixed costs) if nothing is produced.

Section: 8.4

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Answer Key
Econ 4351_ Midterm II
23)
(a) To calculate the equilibrium price and quantity, set QD QS and solve for P :
200,000 4,000 P 20,000 2,000 P
180,000 6,000 P
P $30
Substitute P $30 into either the supply or demand function to solve for the equilibrium quantity Q :

Q QD 200,000 4,000(30) 80,000


(b) In the free competitive market, consumer surplus is the area below the demand curve and above the market
price ($30), as represented by area A+B in the diagram below.
CS A B 0.5 80,000 50 30 $800,000

50

30

C
Pceiling = 15

50,000

80,000

140,000

200,000

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(c) If the government imposes a price ceiling of $15 on the price of basic cable service, consumers would like to
buy QD P 15 200,000 4,00015 140,000 units, as shown in the diagram above. However, producers are only
willing to supply QS P 15 20,000 2,00015 50,000 units. Eventually the market will settle at the quantity
available (50,000) and there will be a shortage of 90,000 units.
With the policy, CS A C CS A C A B C B .
To determine the area of B, we need to determine the coordinate of point M, which can be found by substituting
Q 50,000 into the demand function. 50,000 200,000 4,000P P $37.5 , so the coordinate of point M is
(Q=50,000, P=$37.5).

CS C B
50,000 30 15 0.5 80,000 50,000 37.5 30
$637,500

Therefore, consumer surplus has risen by $637,500. However, not all consumers are better off as the price ceiling
brings about a shortage. That is, some consumers are willing to pay $15 for cable TV yet are unable to get it.
Section: 9.1

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Answer Key
Econ 4351_ Midterm II
24)
(a) To calculate the equilibrium price and quantity, set QD QS and solve for P :
25,000 1,500 P 2,500 P 15,000
40,000 4,000 P
P $10
(b) After the tax of $1 per pizza is in place, marking clearing requires four conditions:
QD QD Pb
QS QS Ps
Q D QS
Pb Ps 1
where Pb denotes the price (including the tax) paid by buyers and Ps denotes the price that sellers receive, less the
tax.
Combine the first three equations to get 25,000 1,500Pb 2,500Ps 15,000 .
Rewrite the last equation to get Pb Ps 1 .
Substitute Pb Ps 1 into 25,000 1,500Pb 2,500Ps 15,000 and solve for Ps :

25,000 1,500Ps 1 2,500 Ps 15,000


38,500 4,000 Ps
Ps $9.625

So

Pb Ps 1 9.625 1 $10.625
Therefore, after the tax is imposed, sellers receive $9.626 per pizza and buyers pay $10.625 for each pizza.
(c) Compare the price paid by buyers with the policy to the equilibrium price without the policy; buyers
pay Pb P $10.625 $10 $0.625 as tax per pizza.
Compare the equilibrium price without the policy to the price received by sellers with the policy; sellers pay
P Ps $10 $9.625 $0.375 as tax per pizza.
Therefore, the burden of the tax falls more on buyers.
Section: 9.6

25)
(a) To maximize profit, a monopolist should choose a quantity such that marginal revenue equals marginal cost.
First, find marginal revenue function from total revenue function. Since we are solving for quantity, we need to
express price as a function of output based on the demand curve: Q 160 4P P PQ 40 0.25Q .

RQ PQQ 40 0.25QQ 40Q 0.25Q 2


dRQ
MR Q
40 20.25Q 40 0.5Q
dQ
Second, find marginal cost function from total cost curve.
dTCQ
MC Q
4
dQ
Finally, set MR MC to find the optimal quantity Q :

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Answer Key
Econ 4351_ Midterm II

MR Q MC Q
40 0.5Q 4
Q 72

(b) When the monopolist produces 72 units of output, it should charge the optimal price P , which is determined
by the demand curve.

P P Q 40 0.25Q 40 0.2572 $22

So the monopolist should set its price at $22 per unit to maximize profit.
Section: 10.1

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