ECON 002 - Principles of Microeconomics Drake University, Spring 2015 William M. Boal Course page: www.cbpa.drake.edu/econ/boal/002 Blackboard: bb.drake.edu william.boal@drake.edu

### Version A

I. Multiple choice

(1)b. (2)d. (3)a. (4)c. (5)a. (6)b. (7)b. (8)b. (9)a. (10)c. (11)a. (12)c.

II. Problems

(1) [Extreme preferences: 10 pts]

1. 6 bottles of Coke and 0 bottles of Pepsi, because this bundle is on the higher indifference curve.
2. perfect substitutes.
3. Budget line is a straight line with intercept on "Pepsi" axis = 10/2 = 5, and intercept on "Coke" axis = 10/1.25 = 8.
4. 0 bottles of Pepsi.
5. 8 bottles of Coke.

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

1. 8 units of food and 6 units of other goods, because this bundle is on the higher indifference curve.
2. 4 units of food and 5 units of other goods, because this bundle is on the higher indifference curve.
3. Budget line A has intercepts at 12 units of other goods and 6 units of food.
4. 3 units of food.
5. Budget line B has intercepts at 12 units of other goods and 12 units of food.
6. 5 units of food.
7. (P,Q) = (\$10,3), (\$5,5).

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ q = \$20 thousand, \$16 thousand, \$24 thousand, \$32 thousand.
2. MB = Δ TB / Δ q = \$60 thousand, \$20 thousand, \$10 thousand, \$10 thousand.
3. 10 miles, where MB = MC.

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

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

(5) [Discounting: 4 pts]

1. \$697.
2. \$450 million.

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

1. \$7 thousand (= 500 × SATC, rounded).
2. \$4 thousand (= 500 × SAVC, rounded).
3. \$3 thousand (= STC - SVC).
4. \$7 (= SMC).
5. \$7 (= minimum SATC).
6. \$5 (= minimum SAVC).
7. 1700 parts, using the rule P=MC.
8. profit, because price is greater than breakeven price.
9. zero parts, because price is less than shutdown price.
10. loss, equal to short-run fixed cost.

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

1. \$6.
2. 4 thousand.
3. \$6, because price = AC in long-run equilibrium.
4. \$10.
5. 8 thousand.
6. profits, because above long-run supply curve.
7. enter.
8. \$6.
9. 10 thousand.
10. \$6, because price = AC in long-run equilibrium.
11. increased.
12. constant-cost industry, because long-run supply curve is horizontal.

III. Critical thinking [3 pts]

(1) By definition, indifference curves connect bundles of goods that are equally desirable. If one good is undesirable, such as pollution, then more of this good makes a bundle less desirable, all else equal. If bundle A contains more pollution than bundle B, the only way the two bundles can be equally desirable is for bundle A also to contain more housing (the desirable good) than bundle B. So in this case, if bundle A and bundle B are equally desirable, the indifference curve connecting them must slope up.

(2) One should disagree with this statement. The profit-maximizing level of output always depends on the product price.

To maximize profit, produce output up to the point where marginal cost equals price, provided price is greater than or equal to average cost. If price is less than average cost, shut down. (Full credit requires a graph showing the firm's average cost and marginal cost curves, and dotted lines demonstrating how to choose output using the rule "price = marginal cost.")

[The above answer assumes a long-run time horizon for the firm. You could instead answer the question using a short-run time horizon, as follows.]

To maximize profit in the short run, produce output up to the point where short-run marginal cost equals price, provided price is greater than or equal to short-run average variable cost (SAVC). If price is less than SAVC, shut down. (Full credit requires a graph showing the firm's SAVC, SATC, and SMC curves, and dotted lines demonstrating how to choose output using the rule "price = SMC.")

### Version B

I. Multiple choice

(1)a. (2)e. (3)c. (4)a. (5)b. (6)a. (7)c. (8)b. (9)b. (10)d. (11)b. (12)a.

II. Problems

(1) [Extreme preferences: 10 pts]

1. 4 bags of chips and 4 jars of salsa, because this bundle is on the higher indifference curve.
2. perfect complements.
3. Budget line is a straight line with intercept on "chips" axis = 45/5 = 9, and intercept on "salsa" axis = 45/2.50 = 18.
4. 6 bags of chips.
5. 6 jars of salsa.

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

1. 7 units of food and 9 units of other goods, because this bundle is on the higher indifference curve.
2. 6 units of food and 6 units of other goods, because this bundle is on the higher indifference curve.
3. Budget line A has intercepts at 10 units of other goods and 15 units of food.
4. 6 units of food.
5. Budget line B has intercepts at 10 units of other goods and 5 units of food.
6. 3 units of food.
7. (P,Q) = (\$6,3), (\$2,6).

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ q = \$20 thousand, \$16 thousand, \$34 thousand, \$38 thousand.
2. MB = Δ TB / Δ q = \$60 thousand, \$10 thousand, \$6 thousand, \$4 thousand.
3. 5 miles, where MB = MC.

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

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

(5) [Discounting: 4 pts]

1. \$626.
2. \$360 million.

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

1. \$18 thousand (= 1500 × SATC, rounded).
2. \$12 thousand (= 1500 × SAVC, rounded).
3. \$6 thousand (= STC - SVC).
4. \$5 (= SMC).
5. \$10 (= minimum SATC).
6. \$4 (= minimum SAVC).
7. 1000 parts, using the rule P=MC.
8. loss, because price is less than breakeven price.
9. 1200 parts, using the rule P=MC.
10. profit, because price is greater than breakeven price.

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

1. \$5.
2. 4 thousand.
3. \$5, because price = AC in long-run equilibrium.
4. \$11.
5. 10 thousand.
6. profits, because above long-run supply curve.
7. enter.
8. \$7.
9. 12 thousand.
10. \$7, because price = AC in long-run equilibrium.
11. increased.
12. increasing-cost industry, because long-run supply curve slopes up.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

(1)d. (2)d. (3)b. (4)b. (5)c. (6)c. (7)d. (8)e. (9)b. (10)a. (11)c. (12)c.

II. Problems

(1) [Extreme preferences: 10 pts]

1. 4 bottles of Coke and 4 bottles of Pepsi, because this bundle is on the higher indifference curve.
2. perfect substitutes.
3. Budget line is a straight line with intercept on "Pepsi" axis = 10/1 = 10, and intercept on "Coke" axis = 10/2 = 5.
4. 10 bottles of Pepsi.
5. 0 bottles of Coke.

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

1. 7 units of food and 7 units of other goods, because this bundle is on the higher indifference curve.
2. 3 units of food and 11 units of other goods, because this bundle is on the higher indifference curve.
3. Budget line A has intercepts at 15 units of other goods and 3 units of food.
4. 2 units of food.
5. Budget line B has intercepts at 15 units of other goods and 10 units of food.
6. 6 units of food.
7. (P,Q) = (\$10,2), (\$3,6).

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ q = \$20 thousand, \$16 thousand, \$8 thousand, \$16 thousand.
2. MB = Δ TB / Δ q = \$60 thousand, \$20 thousand, \$10 thousand, \$10 thousand.
3. 15 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. \$557.
2. \$300 million.

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

1. \$7 thousand (= 500 × SATC, rounded).
2. \$3 thousand (= 500 × SAVC, rounded).
3. \$4 thousand (= STC - SVC).
4. \$5 (= SMC).
5. \$7 (= minimum SATC).
6. \$4 (= minimum SAVC).
7. zero parts, because price is less than shutdown price.
8. loss, equal to short-run fixed cost.
9. 1300 parts, using the rule P=MC.
10. loss, because price is less than breakeven price.

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

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

III. Critical thinking

Same as Version A.