ECON 002 - Principles of Microeconomics
Drake University, Spring 2024
William M. Boal

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

(1)a. (2)d. (3)b. (4)c. (5)b. (6)c. (7)c. (8)e. (9)f. (10)d.
(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 lattes and 20 donuts.
  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. 1/4 latte (because along budget line, to move to the right for one donut, must move down 1/4 unit, giving up 1/4 latte).

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

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

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ hours = $25, $20, $15, $10.
  2. MB = Δ TB / Δ hours = $50, $50, $20, $5.
  3. 12 hours, where MC begins to exceed MB.

(4) [Discounting: 4 pts]

  1. $39 = -1000 + (600/1.04) + (500/1.042).
  2. $250 million = $10 million / 0.04.

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

  1. $5 thousand (= 500 × SATC).
  2. $3 thousand (= 500 × SAVC).
  3. $2 thousand (= STC - SVC).
  4. $13 (= SMC).
  5. $7 (= minimum SATC).
  6. $5 (= minimum SAVC).
  7. zero parts (because price is less than shutdown price).
  8. loss (profit = -SFC, because firm has shut down).
  9. 1400 parts, using the rule P=MC.
  10. profit (because price is greater than breakeven price).

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

  1. $3.
  2. 5 million.
  3. $3, because price = AC 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. firms enter the market seeking profits.
  8. $5, at intersection of new demand and long-run supply.
  9. 13 million.
  10. $5, because price = AC in long-run equilibrium.
  11. increased, because of entry of new firms seeking profits.
  12. increasing-cost industry, because long-run supply curve slopes up.

III. Critical thinking [4 pts]

(1) Sam's budget constraint has vertical intercept at 5 cans of sodapop. It then passes through the following points: 4 cans of sodapop and 1 candy bar, 3 cans of sodapop and 2 candy bars, 2 cans of sodapop and 3 candy bars, 1 can of sodapop and 5 candy bars, zero cans of sodapop and 7 candy bars. Sam's budget constraint is straight except for a kink point at 2 cans of sodapop and 3 candybars, where the price of candy bars changes abruptly from $1 to $0.50. At that point, the opportunity cost of a candy bar drops from 1 can of sodapop to half a can of sodapop.

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

II. Problems

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

  1. Budget line is a straight line with intercepts at 5 lattes and 15 donuts.
  2. Exactly affordable (because on budget line).
  3. Not affordable (because outside budget line).
  4. Affordable with money left over (because inside budget line).
  5. 1/3 latte (because along budget line, to move to the right for one donut, must move down 1/3 unit, giving up 1/3 latte).

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

  1. 8 sub sandwiches and 7 gallons of gasoline.
  2. 6 sub sandwiches and 6 gallons of gasoline.
  3. Budget line A is a straight line with intercepts at 10 sub sandwiches and at 15 gallons of gasoline.
  4. 6 sub sandwiches (at the tangency point).
  5. Budget line B is a straight line with intercepts at 5 sub sandwiches and at 15 gallons of gasoline.
  6. 4 sub sandwiches (at the tangency point).
  7. (P,Q) = ($6,6), ($12,4).

(3) [Rational choice: 10 pts]

  1. MC = Δ TC / Δ hours = $25, $20, $25, $30.
  2. MB = Δ TB / Δ hours = $50, $50, $15, $10.
  3. 8 hours, where MC begins to exceed MB.

(3) [Discounting: 4 pts]

  1. $-41 = -1000 + (600/1.10) + (500/1.102).
  2. $100 million = $10 million / 0.10.

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

  1. $6 thousand (= 2000 × SATC).
  2. $2 thousand (= 2000 × SAVC).
  3. $4 thousand (= STC - SVC).
  4. $3 (= SMC).
  5. $5 (= minimum SATC).
  6. $2 (= minimum SAVC).
  7. 1300 parts, using the rule P=MC.
  8. loss, because price is less than breakeven price.
  9. 1600 parts, using the rule P=MC.
  10. profit, because P is greater than breakeven price.

(5) [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 will exit the market to avoid losses.
  8. $7, at intersection of new demand and long-run supply.
  9. 3 million.
  10. $7, 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]