ECON 002 - Principles of Microeconomics
Drake University, Fall 2016
William M. Boal

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

(1) [Extreme preferences, consumer choice: 10 pts] Consumers pick the best bundle of goods that is affordable.

  1. 4 jars of peanut butter and 3 jars of jelly.
  2. perfect complements.
  3. Budget line is a straight line with intercepts at 4 jars of peanut butter and at 12 jars of jelly.
  4. 3 jars of peanut butter.
  5. 3 jars of jelly.

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

  1. 11 sandwiches and 6 cupcakes.
  2. 6 sandwiches and 4 cupcakes.
  3. Budget line A is a straight line with intercepts at 12 cupcakes and at 12 sandwiches.
  4. 8 sandwiches.
  5. Budget line B is a straight line with intercepts at 12 cupcakes and at 5 sandwiches.
  6. 5 sandwiches.
  7. (P,Q) = ($5,8), ($10,5).

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ miles = $4 million, $3 million, $2 million, $2 million.
  2. MB = Δ TB / Δ miles = $10 million, $5 million, $3 million, $1 million.
  3. 6 miles, where MB = MC.

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

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

(5) [Discounting: 4 pts]

  1. $299.
  2. $40 million.

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

  1. $28 thousand (= 2000 × SATC).
  2. $24 thousand (= 2000 × SAVC).
  3. $4 thousand (= STC - SVC).
  4. $5 (= SMC).
  5. $7 (= minimum SATC).
  6. $3 (= minimum SAVC).
  7. 1000 flashlights, using the rule P=MC.
  8. loss, because P is less than breakeven price.
  9. 1300 flashlights, using the rule P=MC.
  10. profit, because price is greater than breakeven price.

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

  1. $4.
  2. 5 million.
  3. $4, because price = AC in long-run equilibrium.
  4. $10.
  5. 8 million.
  6. profits, because above long-run supply curve.
  7. new firms enter, seeking profits.
  8. $4.
  9. 11 million.
  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 horizontal (perfectly elastic).

III. Critical thinking [4 pts]

(1) The $100 nonrefundable deposit is a sunk cost that cannot be recovered no matter what choice you make. So it should not affect your decision. Instead, you should compare the remaining $300 cost at Store A with the $350 total cost at Store B. Therefore you will buy your computer from Store A, although you may choose to mutter unpleasant things under your breath while you are so doing.

(2) If indifference curves cross, they violate the "More is Better" assumption. That assumption implies that if bundle A is above and to the right of bundle B, then any consumer will prefer bundle A to bundle B. Now if indifference curves cross, then all bundles on either curve should be equally preferred to all other bundles on either curve. This would mean that some bundles on one curve are equally preferred to bundles on the other curve that are above and to the right of them--which cannot be true given the "More is Better" assumption. (Full credit requires a graph similar to the one in the slide "What's wrong with these indifference curves?" in the slideshow on "Indifference curves.")

Version B

I. Multiple choice

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

II. Problems

(1) [Extreme preferences, consumer choice: 10 pts] Consumers pick the best bundle of goods that is affordable.

  1. 6 bottles of Gatorade and 0 bottles of Powerade.
  2. perfect substitutes.
  3. Budget line is a straight line with intercepts at 4 bottles of Gatorade and at 6 bottles of Powerade.
  4. 6 bottles of Powerade.
  5. 0 bottles of Gatorade.

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

  1. 3 sandwiches and 4 mini-pizzas.
  2. 5 sandwiches and 8 mini-pizzas.
  3. Budget line A is a straight line with intercepts at 12 mini-pizzas and at 15 sandwiches.
  4. 8 mini-pizzas.
  5. Budget line B is a straight line with intercepts at 6 mini-pizzas and at 15 sandwiches.
  6. 4 mini-pizzas.
  7. (P,Q) = ($5,8), ($10,4).

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ miles = $3 million, $4 million, $4 million, $3 million.
  2. MB = Δ TB / Δ miles = $10 million, $5 million, $3 million, $1 million.
  3. 4 miles, where MB = MC.

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

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

(5) [Discounting: 4 pts]

  1. negative $314.
  2. $20 million.

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

  1. $26 thousand (= 2000 × SATC).
  2. $20 thousand (= 2000 × SAVC).
  3. $6 thousand (= STC - SVC).
  4. $6 (= SMC).
  5. $10 (= minimum SATC).
  6. $5 (= minimum SAVC).
  7. zero flashlights, because P is less than shutdown price.
  8. loss, equal to SFC.
  9. 1500 flashlights, 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.
  3. $8, because price = AC in long-run equilibrium.
  4. $3.
  5. 10 million.
  6. losses, because below long-run supply curve.
  7. existing firms will exit, to avoid losses.
  8. $7.
  9. 8 million.
  10. $7, because price = AC in long-run equilibrium.
  11. decreased, because of exit of firms avoiding losses.
  12. increasing-cost industry, because long-run supply curve slopes up.

III. Critical thinking [4 pts]

(Same as version A.)

[end of answer key]