Quiz 3 Ec21 W2013 Solutions.pdf

Quiz 3 Ec21 W2013 Solutions.pdf - Economics 21 Winter 2013...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Page 1 of 5 Economics 21 Winter 2013 Quiz 3 SOLUTIONS 1. Short Answer Questions (21 points) a. Define “sunk cost” and explain its relevance for economic decisions. A sunk cost is a cost of production that has already been paid for (incurred) and has no alternative use. I.e., it has an opportunity cost of zero, and should not be counted among the firm’s economic costs when making decisions like whether or not to shut down. b. Define the “Law of Diminishing Marginal Returns”. As you increase one input, at some point the marginal product of that input decreases as output increases, holding other inputs constant. E.g. Suppose that there are two inputs, capital (K) and labor (L). Under the law of diminishing marginal returns, when you hold L constant, you will find that the marginal product from capital will begin to decrease at some point as you keep increasing output. If you are adding more and more sewing machines to the same number of seamstresses, there are not enough seamstresses to operate each machine, and the marginal product of the machine (i.e. the extra output added because of the last machine) starts to fall. c. What is a “price support”? A price support is when a minimum price is supported by the government’s commitment to buy up the excess supply (i.e. via market intervention), as opposed to simply legislating a certain price floor. d. What are the five conditions for “perfect competition”? (1) Free entry and exit (2) Identical products (i.e., homogeneous products) (3) Negligible transaction costs (4) Large number of firms and buyers (5) Perfect information Note that price taking follows from conditions (4) and (2). Note also that perfect competition does not require firms to have identical technologies (i.e. identical cost or production functions).
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Page 2 of 5 e. For each of the functions below circle whether it could be correct or is always wrong, and for the ones marked wrong, explain why. All notation is standard, so: K: units of capital; L: units of labor: Q: output; p: price of output; w: wage rate; r: rental rate of capital; C: total cost. The function Max(a, b) is equal to a if a b, and is equal to b if b a. The ln function denotes the natural log. (1) [ Correct / Wrong ] Unconditional factor demand for capital: K(w, r, L) = (w/r) 0.5 L (2) [ Correct / Wrong ] Conditional factor demand for labor: L(w, r, Q) = Q 1.5 (3) [ Correct / Wrong ] Supply function: S(p, w, r) = Max(0.85 ln(p) – 0.50 ln(w) – 0.35 ln(r), 0) (4) [ Correct / Wrong ] Cost function: C(Q, w, r) = 12.904 Q -2/7 w 5/7 r 4/7 One-line explanation for each function you circled as wrong: (1) Unconditional factor demand should be a function of wages, rent and prices; K(w, r, p) because it takes p, r, and w as given. Note that a factor demand function can never depend on the quantity of the other factor of production (L in this case), because that is an unknown that we have to solve for.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern