ECON 002 - Principles of Microeconomics Drake University, Fall 2017 William M. Boal

### Version A

I. Multiple choice

(1)a. (2)e. (3)a. (4)c. (5)c. (6)b. (7)c. (8)b. (9)b. (10)c. (11)a. (12)b. (13)d.

II. Problems

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

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

(2) [Rational choice: 10 pts]

1. MC = Δ TC / Δ lanes = \$10 million, \$6 million, \$4 million, \$4 million.
2. MB = Δ TB / Δ lanes = \$20 million, \$10 million, \$6 million, \$2 million.
3. 6 lanes, where MB = MC.

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

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

(4) [Discounting: 4 pts]

1. \$621.
2. \$75 million.

(5) [Short-run cost: 26 pts] Note that SVC = cost of labor, energy and materials.

1. SAVC = SVC / output = \$8, \$6, \$8, \$12.
2. SAFC = 120 / output = \$24, \$12, \$8, \$6.
3. SATC = SAVC + SAFC = \$32, \$18, \$16, \$18.
4. SMC = Δ SVC / Δ output = \$8, \$4, \$12, \$24.
5. Shutdown price = min SAVC = \$6.
6. Breakeven price = min SATC = \$16.
7. Produce 15 units, where \$18 = SMC.
8. Enjoys profit because price > breakeven price.
9. Profit = TR - SFC - SVC = (\$18 × 15) - 120 - 120 = \$30.

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

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

III. Critical thinking [4 pts]

(1) Marginal revenue is given as \$1000 and marginal cost is given as \$1200. Since marginal revenue is less than marginal cost, you should downsize (paint fewer houses). By painting one less house, your profit will increase by \$1200-\$1000=\$200.

(2) The \$500 expense for the non-refundable airline ticket is a sunk cost because it cannot be avoided. Therefore it should not enter the decision. Instead, you should compare the remaining \$300 costs with the \$400 benefit. Since the benefit exceeds the remaining costs, you should take this vacation. You should not cancel it.

### Version B

I. Multiple choice

(1)b. (2)a. (3)b. (4)b. (5)c. (6)d. (7)a. (8)c. (9)c. (10)d. (11)b. (12)c. (13)b.

II. Problems

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

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

(2) [Rational choice: 10 pts]

1. MC = Δ TC / Δ lanes = \$8 million, \$7 million, \$6 million, \$6 million.
2. MB = Δ TB / Δ lanes = \$20 million, \$10 million, \$5 million, \$4 million.
3. 4 lanes, where MB = MC.

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

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

(4) [Discounting: 4 pts]

1. \$447.
2. \$50 million.

(5) [Short-run cost: 26 pts] Note that SVC = cost of labor, energy and materials.

1. SAVC = SVC / output = \$10, \$15, \$20, \$30.
2. SAFC = 48 / output = \$24, \$12, \$8, \$6.
3. SATC = SAVC + SAFC = \$34, \$27, \$28, \$36.
4. SMC = Δ SVC / Δ output = \$10, \$20, \$30, \$60.
5. Shutdown price = min SAVC = \$10.
6. Breakeven price = min SATC = \$27.
7. Produce 4 units, where \$25 = SMC.
8. Suffers loss because price < breakeven price.
9. Profit = TR - SFC - SVC = (\$25 × 4) - 48 - 60 = -\$8 (that is, a loss of \$8).

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

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

III. Critical thinking [4 pts]

(Same as version A.)