Microeconomic Theory Econ 230 D1 001 Version 1

First page just to get the numbering right - throwaway

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Microeconomic Theory Econ 230 D1 001 Version 1

Multiple Choice Questions

Make sure that the multiple choice card contains your name and student ID. You
also need to mark VERSION 1 on this card.

1. True, False, or Uncertain? Wal-Mart oers a discount if you buy a large box of paper

towels which will last you 2 years. The savings per roll of paper towels amount to

1$ each. Claim: a rational consumer should always purchase this large box instead of

paying a higher price for individual paper towel rolls.

(a) TRUE. It is cheaper to buy the larger quantity. It can't be rational to not take

advantage of the discount and pay a higher price instead.

(b) FALSE. When interest rates are suciently high, is it not optimal for a consumer

to incur a large upfront cost.

(c) UNCERTAIN. This depends on the elasticity of demand and the elasticity of

supply.

2. Which of the following production functions has constant return to scale?

(a) q = 2LK
√
(b) q = L+K
1
(c) q = (3L + 3K) 3
(d) All of the above.

(e) None of the above.

3. True, False, or Uncertain? If there are many rms competing in a market and there

is free entry, scarce inputs will not receive any economic rents from working in this

industry.

(a) True. In competitive markets with free entry prots will be competed away. There-

fore no inputs will be paid economic rents.

(b) False. In competitive markets with free entry, rms will compete for the scarce

inputs. Prots will be zero, but scarce inputs will receive economic rents.

(c) Uncertain. To answer this question we need to know more about the elasticity of

demand for the nal good and the elasticity of the supply of the scarce inputs.

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Microeconomic Theory Econ 230 D1 001 Version 1

4. Suppose you are the manager of rm A operating in a competitive market. Your cost

of production is given by C(q) = 200 + 2q 2 , where q is the level of output and C(q) is

total cost. The supply curve of your rm is ...

(a) q = 41 p
200
(b) p= q
+ 2q
0 p < 40
(c) q=
4p p ≥ 40
0 p < 40
(d) q= 1
4
p p ≥ 40
0 p < 10
(e) q= 1
4
p p ≥ 10

5. When we analyze price regulations and taxes, we refer to the Dead Weight Loss.

Which of the statements is false?

(a) For a price oor, the Dead Weight Loss is a measure of the minimum loss of total

gains from trade. Often the losses are greater because those consumer who value

the goods the most are not those who get the good.

(b) For taxes, the Dead Weight Loss is smaller if Demand and Supply are less elastic.

(c) For a price ceiling, the Dead Weight Loss is smaller if Demand is more elastic.

(d) For a price ceiling, the Dead Weight Loss is a measure of the minimum loss of

total gains from trade. Often the losses are greater because those consumers who

value the goods the most are not those who get the good.

(e) For a price oor, the Dead Weight Loss is smaller if Supply is more elastic.

√
3 I
6. True, False, Uncertain? The function x(I, px , py ) = √
px py
is a valid demand function.

(a) True. The function satises the law of demand since demand declines in px .
Therefore it is a valid demand function.

(b) False. This is not a valid demand function, since it implies that proportional

changes to all prices and income would change the demand for x.

(c) Uncertain. To determine whether this is a valid demand function, we need to

know more about preferences.

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Microeconomic Theory Econ 230 D1 001 Version 1

7. Assume the demand elasticity of X is −3 and the supply elasticity is +1. Assume

further that the demand for X shifts outward by 2%. How much does the equilibrium

quantity change?

(a) −0.5%
(b) 0%
(c) +0.5%
(d) +1.5%
(e) −1.5%

8. Consider a simple competitive economy with two goods (x1 , x2 ). The government levies

a tax on the price of x1 . Which of the following is False?

(a) With or without the tax, exchange eciency holds.

(b) With the tax, the price ratio changes so exchange eciency doesn't hold any more.

(c) Introducing a tax distorts the prices, and output eciency doesn't hold any more.

(d) The economy still produces along the Production Possibility Frontier (PPF) so

input eciency holds.

(e) All of the above statements are false.

9. A production isoquant is:

(a) a curve that shows all the possible combinations of inputs that yield the same

output.

(b) a curve that shows all the possible levels of output from a given combination of

inputs.

(c) a curve that shows all the possible baskets of goods that deliver the same utility.

(d) a curve that shows all the possible levels of utility from a given basket of goods.

(e) none of the above.

10. An isoquant is linear whenever:

(a) the inputs are perfect substitutes.

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Microeconomic Theory Econ 230 D1 001 Version 1

(b) the production function is Leontief.

(c) marginal products are declining.

(d) all of the above.

(e) none of the above.

11. When average costs are declining, then we know that:

(a) total costs are declining.

(b) marginal costs are declining.

(c) marginal costs are below average costs.

(d) all of the above.

(e) none of the above.

12. Which of the following statements about competitive markets with free entry is true?

(a) Firms make zero prots and therefore capital is not paid any return.

(b) All surplus in the economy goes to the rm.

(c) Supply functions are inelastic.

(d) Supply functions are innitely elastic

(e) None of the above.

13. The following statements describe behavior when there is heterogeneity across rms

and there is no free entry. Indicate the correct answer.

(a) The supply curve is upwards sloping in part because more and more rms enter

into the market as the price increases.

(b) The payments going to the owners of capital will always exceed the rental rate of

capital even if there is a competitive market for capital. This is because prots

are paid to capital owners.

(c) The elasticity of the supply curve is determined entirely by the elasticity of the

marginal cost curve of producers in the market.

(d) There will be no consumer surplus in this market.

(e) None of the above.

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Microeconomic Theory Econ 230 D1 001 Version 1

For questions 14-17 Consider a competitive market with a production function of

√
F (L) = 2 L where L is labor hours. Assume furthermore that wages are 5 and that

to produce a rm needs to rent one machine costing $500. Assume also that there is

free entry. Assume also that demand is unit elastic

14. What is the equilibrium price in this market?

(a) $20

(b) $25

(c) $40

(d) $50

(e) We don't know unless we know the market demand function.

15. How many workers does the rm hire?

(a) 100

(b) 200

(c) 225

(d) 400

(e) We don't know unless we know the market demand function.

16. Assume that the cost of the machine increases, what happens in this market?

(a) The size of rms operating in the market increases.

(b) The equilibrium price increases.

(c) Total output in this industry declines.

(d) Fewer rms will operate in this market.

(e) All of the above.

17. True or False? An allocation of income can be pareto ecient without maximizing

total utility.

(a) True. A pareto ecient allocation might not maximize total utility. For example,

if one individuals get all income, then this is pareto ecient even though it might

not maximize total utility.

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Microeconomic Theory Econ 230 D1 001 Version 1

(b) False. An allocation of income is pareto ecient if nobody can be made better

o without making somebody else worse o. This implies that total utility is

maximized.

18. True of False? An allocation of income that maximizes total utility is necessarily pareto

ecient.

(a) True. To maximize total utility means that it can not be possible to reallocate

income so as to make everybody (weakly) better o.

(b) False. Even though total utility is maximized, it might be possible to redistribute

income to increase utility of some agents without harming others.

19. Suppose that labour is the only variable input to the production process. If the marginal

cost of production increases with the quantity produced, what does this imply for the

marginal product of labour?

(a) The marginal product of labour is increasing

(b) The marginal product of labour is constant

(c) The marginal product of labour is decreasing

(d) All of the above.

(e) None of the above

20. A Prot Maximizing Firm in a Competitive Market will

(a) produce only if the price is above the minimum marginal cost.

(b) set production such that the price equals the average cost

(c) choose input levels such that the input price is below the value of the marginal

product.

(d) all of the above.

(e) none of the above.

Non Multiple Choice Questions

For the Non-Multiple Choice Questions, please use the paper provided here.
Make sure that you put your name and Student ID in the top left hand corner

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Microeconomic Theory Econ 230 D1 001 Version 1

of each page. Write legibly. Do not exceed provided word counts. Also, make
sure your graphs are clean, easily understandable, and contain all information
required.

NM- Question 1

(Cost Minimization Problem).

The good X is produced using capital K and labor L, according to the production
√
F(L,K) = 2L + 10K . Assume also that there is a xed cost of producing the good of

$625.
a.) Draw and appropriately label the isoquants for K and L associated with X = 100 and
X = 200.
b.) If capital costs r = $1000 per unit and labor costs w = $50 per unit, determine the

cost-minimizing levels of the two inputs if output is 200.

c.) Show an expression for the cost of producing the output q given these input prices.

d.) Please draw the supply curve for (i) a rm and (ii) the industry as a whole under free

entry. Label the graphs appropriately and take care that your graphs are clean and easily

understood.

e.) True, False, or Uncertain? In the short run, the incidence of a tax on this product

will fall partially on producers and on consumers in this market. In the long run, the tax

incidence will fall exclusively on consumers.

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Microeconomic Theory Econ 230 D1 001 Version 1

NM- Question 2

(Consumer Choice & Ination)

Suppose Sarah's utility function is given by U (F, C) = ( 35 ln F + 52 ln C)3 , where C is

clothing, and F is food. In 2013, the price of clothing is PC = $40 and the price of food is

PF = $5. Sarah's total expenditure on clothing and food is $600.

a.)What is Sarah's optimal consumption bundle in 2013?

b.) What is the income elasticity of the demand for clothing? What is the elasticity of

the demand for clothing with respect to the price of food?

c.) In 2014, the price of clothing is PC0 = $45 and the price of food is PF0 = $6. Compute

the Laspeyres index for Sarah in 2014.

d.) The Laspeyres index represents an overestimate of the true cost-of-living index.

Explain why as clearly and concisely as possible. Use a a graph or equiations to illustrate

you discussion. (Less than 100 words, 1 graph only)

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Microeconomic Theory Econ 230 D1 001 Version 1

NM- Question 3 Uncertainty

Consider Ann and Bob and assume that Ann has a felicity function with respect to
√
consumption given by UA (c) = c. Bob has a felicity function given by UB (c) = c. Assume

that Ann receives $100,000 with certainty. Bob has uncertain prospects. With probability

p=0.5 he will earn $40,000 and with probability p=0.5 he will earn $90,000.

a.) What is the expected utility of both of these agents?

b.) Assume that Ann could oer an insurance contract to Bob. Bob will accept this

contract as long as it makes him at least as well o as if he faces the risk. Describe the

contract that Ann would oer Bob and how much her expected utility would be given this

contract.

c.) Now assume that there are many other people like Ann out there who will compete

with each other (i.e.: there is a perfectly competitive market for insurance). Bob will take

the contract that is best for him. What contract would be oered to Bob in equilibrium?

What would be his expected utility.

d.) Are the allocations in b and c Pareto ecient? Explain in less than 50 words.

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Microeconomic Theory Econ 230 D1 001 Version 1

NM- Question 4 Choice over time

Assume an individual lives for two time-periods t=0 (today) and t=1. She has preferences
1
given by ln(c0 ) + 1+δ
ln (c1 ). Now, assume further that she has income of $20,000 today and
$30,000 tomorrow.

a.) Assume that she can borrow and lend at an interest rate of r. Please draw her Budget

constraint with t=1 on the vertical axis and t=0 on the horizontal axis. Label the intercepts.

b.) How much does she save or borrow today? Please show this as a function of r and δ.
If the government pays the consumer a stipend of
c.) Consider the following statement:

$1,000 today and taxes her tomorrow, then consumption will be unchanged. This is
1
1+r
1, 000
an example of the Permanent Income Hypothesis. True or False - Explain your answer (less
than 200 words). No credit will be given without an explanation.

d.) The economic advisor to the Prime Minister observes that the government can actually

borrow at half the interest rate than young people in the economy can. Thus, he suggests

that the government should provide stipends to students in the economy and tax their income

after they leave university to nance these stipends. What do you think of this proposal?

(less than 200 words).

e.) Going back to the situation the consumer faces. Assume that the consumer has to

pay a higher interest for borrowing rather than lending money. Please draw the consumers

budget constraint.

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