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

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

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

  1. Budget line should be perfectly straight and have intercepts at 30/6 = 5 sandwiches and 30/3 = 10 gallons of gasoline.
  2. Exactly affordable because on the budget line.
  3. Affordable with money left over because inside the budget line.
  4. Not affordable because outside the budget line.
  5. Opportunity cost of a gallon gas equals 1/2 sandwich, because a gallon of gas costs as much to Aaron as half a sandwich.

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

  1. 5 pizzas and 3 ice cream cones because on a higher indifference curve.
  2. 7 pizzas and 3 ice cream cones because on a higher indifference curve.
  3. Budget line A is a straight line with intercepts at 10 ice cream cones and at 15 pizzas.
  4. 9 pizzas, the tangency point.
  5. Budget line B is a straight line with intercepts at 10 ice cream cones and 10 pizzas.
  6. 7 pizzas, the tangency point.
  7. (P,Q) = ($4,9), ($6,7).

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ miles = $20 thousand, $16 thousand, $24 thousand, $32 thousand.
  2. MB = Δ TB / Δ miles = $60 thousand, $20 thousand, $10 thousand, $10 thousand.
  3. 10 miles, where MC begins to exceed MB.

(4) [Discounting: 4 pts]

  1. $43 = -800 + (300/1.04) + (600/1.042).
  2. $50 million = $2 million / 0.04.

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

  1. $6 thousand (= 500 × SATC).
  2. $2 thousand (= 500 × SAVC).
  3. $4 thousand (= STC - SVC).
  4. $3 (= SMC).
  5. $7 (= minimum SATC).
  6. $3 (= minimum SAVC).
  7. 0 parts, because price < shutdown price.
  8. loss, because no revenue but still must pay fixed cost.
  9. 1100 parts, using the rule P=MC.
  10. loss, because price < breakeven price.

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

  1. $3.
  2. 5 million.
  3. $3, because price = average cost in long-run equilibrium.
  4. $9, at intersection of new demand and short-run supply.
  5. 11 million.
  6. profits, because above long-run supply curve.
  7. new firms enter the industry seeking profits.
  8. $3, at intersection of new demand and long-run supply.
  9. 14 million.
  10. $3, because price = average cost in long-run equilibrium.
  11. increased, because of entry of firms seeking profits.
  12. cost-cost industry, because long-run supply is perfectly elastic (horizontal).

III. Critical thinking [4 pts]

(1) Marginal revenue is given as $2000 and marginal cost is given as $2500. Since marginal revenue is less than marginal cost, you should downsize (paint fewer houses). By painting one less house, your revenue will decrease by $2000, but your cost will decrease by $2500, so your profit will increase by $2500-$2000=$500.

(2) You should not switch to Vendor B's system. You should stay with Vendor A's system. The $100,000 you paid to install Vendor A's system is a sunk cost because the money cannot be recovered. It must be paid whether or not you switch. So you should compare the other costs. Excluding sunk costs, Vendor A's system will cost only $50,000, which is less than the $75,000 total you must pay for Vendor B's system. Therefore you should stay with Vendor A's system.

Version B

I. Multiple choice

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

II. Problems

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

  1. Budget line should be perfectly straight and have intercepts at 60/12 = 5 sandwiches and 60/4 = 15 gallons of gasoline.
  2. Not affordable because outside the budget line.
  3. Exactly affordable because on the budget line.
  4. Affordable with money left over because inside the budget line.
  5. Opportunity cost of a sandwich equals 3 gallons of gas, because a sandwich costs as much to Aaron as 3 gallons of gas.

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

  1. 4 burritos and 5 nachos because on a higher indifference curve.
  2. 7 burritos and 7 nachos because on a higher indifference curve.
  3. Budget line A is a straight line with intercepts at 10 burritos and at 15 nachos.
  4. 6 burritos, the tangency point.
  5. Budget line B is a straight line with intercepts at 6 burritos and 15 nachos.
  6. 4 pizzas, the tangency point.
  7. (P,Q) = ($10,4), ($6,6).

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ miles = $20 thousand, $16 thousand, $34 thousand, $38 thousand.
  2. MB = Δ TB / Δ miles = $60 thousand, $10 thousand, $6 thousand, $4 thousand.
  3. 5 miles, where MC begins to exceed MB.

(4) [Discounting: 4 pts]

  1. -$50 = -1000 + (500/1.10) + (600/1.102).
  2. $20 million = $2 million / 0.10.

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

  1. $6 thousand (= 500 × SATC).
  2. $3 thousand (= 500 × SAVC).
  3. $3 thousand (= STC - SVC).
  4. $6 (= SMC).
  5. $8 (= minimum SATC).
  6. $5 (= minimum SAVC).
  7. 1300 parts, using the rule P=MC.
  8. profit, because price > breakeven price.
  9. 0 parts, because price < shutdown price.
  10. loss, because no revenue but still must pay fixed cost.

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

  1. $8.
  2. 12 million.
  3. $8, because price = average cost in long-run equilibrium.
  4. $2, at intersection of new demand and short-run supply.
  5. 6 million.
  6. losses, because below long-run supply curve.
  7. existing firms exit the industry to avoid losses.
  8. $6, at intersection of new demand and long-run supply.
  9. 4 million.
  10. $6, because price = average cost in long-run equilibrium.
  11. decreased, because of exit of firms avoiding losses.
  12. increasing-cost industry, because long-run supply is slopes upward.

III. Critical thinking [4 pts]

Same as Version A.

[end of answer key]