ECON 002 - Principles of Microeconomics
Drake University, Fall 2019
William M. Boal

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

(1)a. (2)b. (3)c. (4)a. (5)c. (6)c. (7)b. (8)c. (9)c. (10)b. (11)f. (12)c. (13)a. (14)b. (15)a. (16)b. (17)d.

II. Problems

(1) [Special indifference curves: 4 pts] "Alex likes to eat one donut with each cup of coffee he drinks. Extra donuts are worthless to him, and a cup of coffee without a donut is also worthless." So for Alex, donuts and coffee are perfect complements. Combinations A, C, and D lie on the same L-shaped indifference curve. Combination B lies at the vertex of a higher L-shaped indifference curve.

(2) [Consumer choice and demand: 14 pts]

  1. 7 bagels and 10 smoothies.
  2. 6 bagels and 9 smoothies.
  3. Budget line A is a straight line with intercepts at 12 bagels and at 8 smoothies.
  4. 6 smoothies.
  5. Budget line B is a straight line with intercepts at 12 bagels and at 4 smoothies.
  6. 3 smoothies.
  7. (P,Q) = ($6,3), ($3,6).

(3) [Rational choice: 10 pts]

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

(4) [Business revenue and cost--definitions: 3 pts]

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

(5) [Discounting: 4 pts]

  1. $533.
  2. $20 million.

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

  1. $8 thousand (= 800 × SATC).
  2. $4 thousand (= 800 × SAVC).
  3. $4 thousand (= STC - SVC).
  4. $3 (= SMC).
  5. $6 (= minimum SATC).
  6. $4 (= minimum SAVC).
  7. 1600 parts, using the rule P=MC.
  8. profit, because P is greater than breakeven price.
  9. zero parts, because P is less than the shutdown price.
  10. loss, because price is less than breakeven price. (The loss is equal to the short-run fixed cost, which must be paid even when the firm is shut down.)

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

  1. $9.
  2. 12 million.
  3. $9, because price = AC in long-run equilibrium.
  4. $3.
  5. 6 million.
  6. losses, because below long-run supply curve.
  7. existing firms exit, avoiding losses.
  8. $7.
  9. 4 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]

(1) What is wrong with the diagram is that the indifference curves curves cross. This violates the assumption that more is better for consumers, for the following reason. According to the diagram, combination A is equally preferred to both combination B and combination C, so therefore combinations B and C are equally preferred. But combination B includes more pizzas and more movie admissions than combination C, so it should be strictly more preferred.

(2) Firm A is more likely to take the price of its product as given. Dozens of other companies make the same product as Firm A, so it must match its competitors' price or lose customers. Firm B is the only seller of its product, so it need not match other firms' prices. Firm B therefore has "market power" or "pricing power."

Version B

I. Multiple choice

(1)b. (2)d. (3)b. (4)b. (5)b. (6)c. (7)d. (8)a. (9)d. (10)c. (11)f. (12)a. (13)c. (14)c. (15)b. (16)c. (17)b.

II. Problems

(1) [Special indifference curves: 4 pts] "Brianna likes apple juice and orange juice equally. For her, a bottle of apple juice is just as good as a bottle of orange juice, regardless of how many she already has of each." So for Brianna, apple juice and orange juice are perfect substitutes. Combinations A, B, and D lie on the same straight-line indifference curve. Combination C lies on a lower straight-line indifference curve.

(2) [Consumer choice and demand: 14 pts]

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

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ stations = $5 million, $4 million, $3 million, $2 million.
  2. MB = Δ TB / Δ stations = $7 million, $5 million, $2 million, $0.5 million.
  3. 4 stations, where MB = MC.

(4) [Business revenue and cost--definitions: 3 pts]

  1. marginal cost.
  2. total reveue.
  3. marginal cost.

(5) [Discounting: 4 pts]

  1. $621.
  2. $25 million.

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

  1. $22 thousand (= 2000 × SATC).
  2. $16 thousand (= 2000 × SAVC).
  3. $6 thousand (= STC - SVC).
  4. $6 (= SMC).
  5. $8 (= minimum SATC).
  6. $3 (= minimum SAVC).
  7. 1100 parts, using the rule P=MC.
  8. loss, because P is less than breakeven price.
  9. zero parts, because P is less than the shutdown price.
  10. loss, because price is less than breakeven price. (The loss is equal to the short-run fixed cost, which must be paid even when the firm is shut down.)

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

  1. $3.
  2. 4 million.
  3. $3, because price = AC in long-run equilibrium.
  4. $7.
  5. 12 million.
  6. profits, because above long-run supply curve.
  7. firms exit, seeking profits.
  8. $3.
  9. 14 million.
  10. $3, 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.

III. Critical thinking [4 pts]

(Same as version A.)

[end of answer key]