ECON 002 - Principles of Microeconomics Drake University, Fall 2015 William M. Boal Course page: faculty.cbpa.drake.edu/econ/boal/002 Blackboard: drake.blackboard.com william.boal@drake.edu

### Version A

I. Multiple choice

(1)b. (2)c. (3)b. (4)b. (5)b.

II. Problems

(1) [Budget line: 14 pts]

1. exactly affordable.
2. not affordable.
3. affordable with money left over.
4. 3/4 sandwich.
5. 3/4 (because MRS = slope of budget line at consumer's best choice).
6. \$3.
7. \$4.

(2) [Consumer choice and demand: 16 pts]

1. 4 smoothies and 4 units of other goods.
2. 5 smoothies and 5 units of other goods.
3. Budget line A has intercepts at 10 units of other goods and 15 smoothies.
4. 6 smoothies.
5. Budget line B has intercepts at 10 units of other goods and 6 smoothies.
6. 3 smoothies.
7. (P,Q) = (\$2,6), (\$5,3).

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ miles = \$0.6 million, \$0.8 million, \$1.0 million, \$1.2 million.
2. MB = Δ TB / Δ miles = \$4.0 million, \$0.6 million, \$0.6 million, \$0.4 million.
3. 0.5 miles, where MB = MC.

(4) [Basic definitions, cost and revenue: 3 pts]

1. marginal cost.
2. total cost.
3. marginal revenue.

(5) [Discounting: 4 pts]

1. \$1583.
2. \$1000 million.

(6) [Short-run cost curves and supply: 20 pts]

1. \$18 thousand (= 2000 × SATC).
2. \$12 thousand (= 2000 × SAVC).
3. \$6 thousand (= STC - SVC).
4. \$2 (= SMC).
5. \$8 (= minimum SATC).
6. \$4 (= minimum SAVC).
7. zero components, because price is less than shutdown price.
8. loss, equal to short-run fixed cost.
9. 1800 components, using the rule P=MC.
10. profit, because price is greater than breakeven price.

(7) [Long-run competitive equilibrium: 24 pts]

1. \$9.
2. 14 million pounds.
3. \$9, because price = AC in long-run equilibrium.
4. \$1.
5. 10 million pounds.
6. losses, because below long-run supply curve.
7. exit.
8. \$7.
9. 7 million pounds.
10. \$7, because price = AC in long-run equilibrium.
11. decreased, because of exit of firms making losses.
12. increasing-cost industry, because long-run supply curve slopes up.

III. Critical thinking [4 pts]

(1) Bundles A, B, and C must first be plotted and labeled.

1. One of Caitlin's indifference curves must connect bundles A and B because they are equally preferred, but lie entirely above bundle C because it is less preferred. Another of Caitlin's indifference curves must pass through bundle C but lie below the first indifference curve.
2. The shape of Caitlin's indifference curves is peculiar because they curve the "wrong way." They are bowed out away from the origin instead of bowed in toward the origin (see problem 1 for more typically-shaped indifference curves). Formally, Caitlin's indifference curves slope down, as is typical, but they do not show a diminishing marginal rate of substitution.

(2) Profit equals revenue minus cost. Since price is less than marginal cost here, you should downsize (paint fewer houses). Price is given as P=\$1000 and marginal cost is given as MC=\$1200. So if you painted one more house, your cost would rise by MC=\$1200 but your revenue would rise by only P=\$1000, so you profit would decrease by \$200. On the other hand, if you painted one less house, you would save MC=\$1200 in cost and sacrifice only P=\$1000 in revenue, so your profit would increase by \$200.

[Note that average cost is irrelevant for computing the change in cost from a change in the quantity of houses painted.]

### Version B

I. Multiple choice

(1)c. (2)f. (3)c. (4)c. (5)c.

II. Problems

(1) [Budget line: 14 pts]

1. affordable with money left over.
2. not affordable.
3. exactly affordable.
4. 1/2 sandwich.
5. 1/2 (because MRS = slope of budget line at consumer's best choice).
6. \$3.
7. \$6.

(2) [Consumer choice and demand: 16 pts]

1. 3 smoothies and 4 units of other goods.
2. 9 smoothies and 7 units of other goods.
3. Budget line A has intercepts at 15 units of other goods and 6 smoothies.
4. 4 smoothies.
5. Budget line B has intercepts at 15 units of other goods and 10 smoothies.
6. 6 smoothies.
7. (P,Q) = (\$10,4), (\$6,6).

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ miles = \$0.6 million, \$0.8 million, \$1.0 million, \$1.2 million.
2. MB = Δ TB / Δ miles = \$4.0 million, \$1.0 million, \$0.4 million, \$0.2 million.
3. 1.0 miles, where MB = MC.

(4) [Basic definitions, cost and revenue: 3 pts]

1. marginal revenue.
2. average cost.
3. total revenue.

(5) [Discounting: 4 pts]

1. \$1485.
2. \$800 million.

(6) [Short-run cost curves and supply: 20 pts]

1. \$26 thousand (= 2000 × SATC).
2. \$16 thousand (= 2000 × SAVC).
3. \$10 thousand (= STC - SVC).
4. \$2 (= SMC).
5. \$11 (= minimum SATC).
6. \$3 (= minimum SAVC).
7. 1100 components, using the rule P=MC.
8. loss, because price is less than breakeven price.
9. 1500 components, using the rule P=MC.
10. profit, because price is greater than breakeven price.

(7) [Long-run competitive equilibrium: 24 pts]

1. \$8.
2. 12 million pounds.
3. \$8, because price = AC in long-run equilibrium.
4. \$2.
5. 9 million pounds.
6. losses, because below long-run supply curve.
7. exit.
8. \$8.
9. 6 million pounds.
10. \$8, because price = AC in long-run equilibrium.
11. decreased, because of exit of firms making losses.
12. constant-cost industry, because long-run supply curve is perfectly elastic.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

(1)d. (2)b. (3)d. (4)a. (5)d.

II. Problems

(1) [Budget line: 14 pts]

1. not affordable.
2. affordable with money left over.
3. exactly affordable.
4. 4/5 sandwich.
5. 4/5 (because MRS = slope of budget line at consumer's best choice).
6. \$4.
7. \$5.

(2) [Consumer choice and demand: 16 pts]

1. 4 smoothies and 5 units of other goods.
2. 7 smoothies and 5 units of other goods.
3. Budget line A has intercepts at 12 units of other goods and 16 smoothies.
4. 8 smoothies.
5. Budget line B has intercepts at 12 units of other goods and 12 smoothies.
6. 7 smoothies.
7. (P,Q) = (\$3,8), (\$4,7).

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ miles = \$0.8 million, \$0.6 million, \$1.0 million, \$1.2 million.
2. MB = Δ TB / Δ miles = \$4.0 million, \$1.2 million, \$1.4 million, \$0.4 million.
3. 1.5 miles, where MB = MC.

(4) [Basic definitions, cost and revenue: 3 pts]

1. marginal revenue.
2. marginal cost.
3. marginal cost.

(5) [Discounting: 4 pts]

1. \$1207.
2. \$500 million.

(6) [Short-run cost curves and supply: 20 pts]

1. \$6 thousand (= 500 × SATC).
2. \$1 thousand (= 500 × SAVC).
3. \$5 thousand (= STC - SVC).
4. \$4 (= SMC).
5. \$8 (= minimum SATC).
6. \$2 (= minimum SAVC).
7. zero components, because price is less than shutdown price.
8. loss, equal to short-run fixed cost.
9. 1200 components, using the rule P=MC.
10. profit, because price is greater than breakeven price.

(7) [Long-run competitive equilibrium: 24 pts]

1. \$4.
2. 8 million pounds.
3. \$4, because price = AC in long-run equilibrium.
4. \$10.
5. 11 million pounds.
6. profits, because above long-run supply curve.
7. enter.
8. \$4.
9. 14 million pounds.
10. \$4, because price = AC in long-run equilibrium.
11. increased, because of entry of firms seeking profits.
12. constant-cost industry, because long-run supply curve is perfectly elastic.

III. Critical thinking

Same as Version A.