ECON 002 - Principles of Microeconomics
Drake University, Fall 2025
William M. Boal

EXAM 3 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

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

  1. Budget line is a straight line with intercepts at 5 ice cream cones and 10 bagels.
  2. Affordable with money left over, because inside budget line.
  3. Exactly affordable, because on budget line.
  4. Not affordable, because outside budget line.
  5. 1/2 ice cream cone, because along budget line, to get one more bagel (by moving to the right one unit) one must sacrifice half of an ice cream cone (by moving down half a unit).

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

  1. 6 pizza slices and 6 milkshakes.
  2. 4 pizza slices and 4 milkshakes.
  3. Budget line A is a straight line with intercepts at 10 pizza slices and at 15 milkshakes.
  4. 6 pizza slices (at the tangency point).
  5. Budget line B is a straight line with intercepts at 6 pizza slices and at 15 milkshakes.
  6. 4 pizza slices (at the tangency point).
  7. (P,Q) = ($6,6), ($10,4).

(3) [Rational choice: 10 pts]

  1. MC = Δ Total cost / Δ traffic signals = $3 thousand, $2 thousand, $1 thousand, $1 thousand.
  2. MB = Δ Total benefit / Δ traffic signals = $4 thousand, $1 thousand, $0.6 thousand, $0.4 thousand.
  3. 10 signals, 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. $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 < breakeven price).
  9. zero parts (because price < shutdown price).
  10. loss (profit = -SFC, because firm has shut down).

(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) Marginal revenue is given as $50 and marginal cost is given as $80. Since marginal revenue is less than marginal cost, you should downsize. By serving one less customer, your revenue will decrease by $50, but your cost will decrease even more, by $80, so your profit will increase by $80-$50=$30. It does not make sense to shut down entirely, however, because price is greater than average cost ($30).

(2) You should not switch to Lights-On Company. The $10,000 nonrefundable deposit to Sun Company 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, Sun Company's system will cost only $20,000, which is less than the $25,000 total you would pay to Lights-On Company. Therefore you should stay with Sun Company.

Version B

I. Multiple choice

(1)b. (2)b. (3)a. (4)d. (5)d. (6)c. (7)d. (8)e. (9)a. (10)c.
(11)a. (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 ice cream cones and 15 bagels.
  2. Not affordable, because outside budget line.
  3. Exactly affordable, because on budget line.
  4. Affordable with money left over, because inside budget line.
  5. 1/3 ice cream cone, because along budget line, to get one more bagel (by moving to the right one unit) one must sacrifice one-third of an ice cream cone (by moving down one-third unit).

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

  1. 7 pizza slices and 5 milkshakes.
  2. 6 pizza slices and 6 milkshakes.
  3. Budget line A is a straight line with intercepts at 10 pizza slices and at 15 milkshakes.
  4. 6 milkshakes (at the tangency point).
  5. Budget line B is a straight line with intercepts at 10 pizza slices and at 6 milkshakes.
  6. 3 milkshakes (at the tangency point).
  7. (P,Q) = ($4,6), ($10,3).

(3) [Rational choice: 10 pts]

  1. MC = Δ Total cost / Δ traffic signals = $3 thousand, $2 thousand, $1 thousand, $1 thousand.
  2. MB = Δ Total benefit / Δ traffic signals = $4 thousand, $4 thousand, $2 thousand, $0.4 thousand.
  3. 10 signals, where MC begins to exceed MB.

(3) [Discounting: 4 pts]

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

(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. zero parts because price < shutdown price.
  8. loss (profit = -SFC, because firm has shut down).
  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. $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]