ECON 002 - Principles of Microeconomics Drake University, Fall 2021 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

(1) [Budget line: 10 pts]

1. Adam's budget line should have intercepts at \$600/\$12=50 units of clothing and at \$600/\$6=100 units of food.
2. Exactly affordable. The bundle costs \$600.
3. Not affordable. The bundle costs \$660.
4. Affordable with money left over. The bundle costs \$540.
5. Opportunity cost of a unit of food = \$6/\$12=1/2 units of clothing.

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

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

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ signals = \$3 thousand, \$2 thousand, \$1 thousand, \$1 thousand.
2. MB = Δ TB / Δ signals = \$4 thousand, \$3 thousand, \$0.6 thousand, \$0.4 thousand.
3. 10 signals, where MB = MC.

(4) [Discounting: 4 pts]

1. \$44 = -600 + (200/1.05) + (500/1.052).
2. \$40 million = \$2 million / 0.05.

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

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

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

1. \$3.
2. 4 million.
3. \$3, because price = AC in long-run equilibrium.
4. \$9.
5. 10 million.
6. profits, because above long-run supply curve.
7. new firms enter the industry seeking profits.
8. \$5.
9. 12 million.
10. \$5, 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) The \$200 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 doing so.

(2) We know that your lawn-mowing business is making a profit, because average cost (\$10) is less than price (\$20). Nevertheless, you should downsize, because marginal cost (\$30) is greater than price. If you mow one fewer lawn, you save \$30 in cost while you sacrifice only \$20 in revenue. Thus if you mow one fewer lawn, your profit will increase by \$30-\$20=\$10.

### Version B

I. Multiple choice

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

II. Problems

(1) [Budget line: 10 pts]

1. Adam's budget line should have intercepts at \$600/\$15=40 units of clothing and at \$600/\$5=120 units of food.
2. Not affordable. The bundle costs \$700.
3. Exactly affordable. The bundle costs \$600.
4. Affordable with money left over. The bundle costs \$500.
5. Opportunity cost of a unit of food = \$5/\$15=1/3 units of clothing.

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

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

(3) [Rational choice: 10 pts]

1. MC = Δ TC / Δ signals = \$3 thousand, \$2 thousand, \$1 thousand, \$1 thousand.
2. MB = Δ TB / Δ signals = \$4 thousand, \$4 thousand, \$2 thousand, \$0.4 thousand.
3. 15 signals, where MB = MC.

(4) [Discounting: 4 pts]

1. \$-5 = -600 + (200/1.10) + (500/1.102). (negative!)
2. \$20 million = \$2 million / 0.10 .

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

1. \$8 thousand (= 1000 × SATC).
2. \$3 thousand (= 1000 × SAVC).
3. \$5 thousand (= STC - SVC).
4. \$2 (= SMC).
5. \$8 (= minimum SATC).
6. \$2 (= minimum SAVC).
7. 800 parts, using the rule P=MC.
8. loss, because P is less than breakeven price.
9. 1200 parts, using the rule P=SMC.
10. profit, because P is greater than breakeven price.

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

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

III. Critical thinking [4 pts]

(Same as version A.)