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

EXAM 3 ANSWER KEY

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 / $Delta; 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.
  4. 3 cookies.
  5. Budget line B is a straight line with intercepts at 6 cookies and at 10 hamburgers.
  6. 4 cookies.
  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 / $Delta; 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.)

[end of answer key]