ECON 002 - Principles of Microeconomics
Drake University, Fall 2023
William M. Boal

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

(1) [Consumer's budget constraint: 10 pts]

  1. Budget line is a straight line with intercepts at 5 pizza slices and 10 arcade games.
  2. Not affordable (because outside budget line).
  3. Affordable with money left over (because inside budget line).
  4. Exactly affordable (because on budget line).
  5. 1/2 pizza slice (because along budget line, to move to the right for one more arcade game, must move down 1/2 unit, giving up 1/2 pizza slice).

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

  1. 2 hamburgers and 6 gallons of gasoline.
  2. 5 hamburgers and 6 gallons of gasoline.
  3. Budget line A is a straight line with intercepts at 10 hamburgers and at 15 gallons of gasoline.
  4. 9 gallons of gasoline (at the tangency point).
  5. Budget line B is a straight line with intercepts at 10 hamburgers and at 5 gallons of gasoline.
  6. 4 gallons of gasoline (at the tangency point).
  7. (P,Q) = ($2,9), ($6,4).

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ miles = $6 million, $4 million, $8 million, $10 million.
  2. MB = Δ TB / Δ miles = $10 million, $10 million, $4 million, $2 million.
  3. 10 miles, where MC begins to exceed MB.

(4) [Discounting: 4 pts]

  1. -$25 = -500 + (250/1.10) + (300/1.102).
  2. $50 million = $5 million / 0.10.

(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. $10 (= SMC).
  5. $7 (= minimum SATC).
  6. $4 (= minimum SAVC).
  7. 1300 parts, using the rule P=MC.
  8. loss (because price is less than breakeven price).
  9. zero parts (because price is less than shutdown price).
  10. loss (profit = -SFC, because firm has shut down).

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

  1. $7.
  2. 12 million.
  3. $7, because price = AC in long-run equilibrium.
  4. $1, at intersection of new demand and short-run supply.
  5. 6 million.
  6. losses, because below long-run supply curve.
  7. firms exit the market to escape losses.
  8. $5, at intersection of new demand and long-run supply.
  9. 4 million.
  10. $5, because price = AC in long-run equilibrium.
  11. decreased, because of exit of firms escaping losses.
  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 must 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 say nasty things about them on Yelp).

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

II. Problems

(1) [Consumer's budget constraint: 10 pts]

  1. Budget line is a straight line with intercepts at 5 pizza slices and 15 arcade games.
  2. Exactly affordable (because on budget line).
  3. Affordable with money left over (because inside budget line).
  4. Affordable with money left over (because inside budget line).
  5. 3 pizza slices (because along budget line, to move up for one more pizza slice, must move left 3 units giving up 3 arcade games).

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

  1. 4 hamburgers and 9 gallons of gasoline.
  2. 5 hamburgers and 10 gallons of gasoline.
  3. Budget line A is a straight line with intercepts at 10 hamburgers and at 10 gallons of gasoline.
  4. 4 hamburgers, the tangency point.
  5. Budget line B is a straight line with intercepts at 5 hamburgers and at 10 gallons of gasoline.
  6. 3 hamburgers, the tangency point.
  7. (P,Q) = ($4,4), ($8,3).

(2) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ miles = $6 million, $4 million, $6 million, $8 million.
  2. MB = Δ TB / Δ miles = $16 million, $12 million, $8 million, $4 million.
  3. 15 miles, where MC begins to exceed MB.

(3) [Discounting: 4 pts]

  1. $18 = -500 + (250/1.04) + (300/1.042).
  2. $125 million = $5 million / 0.04.

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

  1. $22 thousand (= 2000 × SATC).
  2. $16 thousand (= 2000 × SAVC).
  3. $6 thousand (= STC - SVC).
  4. $2 (= SMC).
  5. $8 (= minimum SATC).
  6. $3 (= minimum SAVC).
  7. 0 parts, because price is less than the shutdown price.
  8. loss, because price is less than breakeven price (profit = -SFC).
  9. 1400 parts, using the rule P=MC.
  10. profit, because P is greater than breakeven price.

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

  1. $5.
  2. 3 million.
  3. $5, because price = AC in long-run equilibrium.
  4. $9, at intersection of new demand and short-run supply.
  5. 7 million.
  6. profits, because above long-run supply curve.
  7. new firms will enter the market seeking profits.
  8. $5, at intersection of new demand and long-run supply.
  9. 9 million.
  10. $5, because price = AC in long-run equilibrium.
  11. increased, because of entry of new 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]