Quiz 3 Ec21 S2013 Solutions.pdf

Quiz 3 Ec21 S2013 Solutions.pdf - Economics 21 Spring 2013...

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Page 1 of 4 Economics 21 Spring 2013 Quiz 3 SOLUTIONS 1. Short Answer Questions (20 points) a. (3 points) Define “opportunity cost” and explain how it is related to “economic cost”. The opportunity cost of a resource is the value of that resource in its best alternative use. Opportunity cost is the same as economic cost. b. (3 points) Define “isoquant”. An isoquant consists of all combinations of factor inputs (typically: K and L) that yield the same level of output. c. (3 points) What are the arguments of a Social Welfare Function, and what is a Social Welfare function used for? The arguments of a social welfare function are the levels of utility of the individuals in society, so SWF=V(u 1 , u 2 , u 3 ,…) where u 1 is the utility of individual 1, u 2 is the utility of individual 2, etc. A SWF is used to rank alternative allocations and thus reflects “society’s” preferences. d. (4 points) 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). e. (3 points) Suppose a producer of iPad covers has a contract to deliver 1,000,000 such covers per month to Apple. Currently, the company employs 150 workers and rents 50 machines to produce these covers. With the current number of workers and machines, the marginal product of a worker is 2000 covers/month and the marginal product of a machine is 6000 covers/month. The wage rate for a worker is 1000 Yuan per month and the rental rate for a machine is 4000 Yuan per month. Is the firm using the optimal combination of workers and machines? If so, explain why. If not, explain how the firm should adjust the number of workers and the number of machines. At the optimum the relative factor prices, w/r = 1000/4000 = 1/4, should be equal to the ratio of marginal products, MP L / MP K =2000/6000 = 1/3. This is not the case (and the firm is not a corner solution because it uses non-zero quantities of each input), so the firm is not using the optimal input mix.
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