Unformatted text preview: University of North Carolina Chapel Hill KenanFlagler Business School BA281 Microeconomics Final Exam Prof. Robert A. Connolly October 10, 2005 Instructions: Answer all questions following directions carefully as to the format of the answer. The questions have roughly equal value. OK for this exam: Using your laptops to access the course website on the intranet. Consulting your notes, book, and other course material at your seat. Using a calculator or Excel to make computations. Not OK for this exam: Using email or surfing the web for additional material or insight into questions. Consulting with anyone other than me about any aspect of the exam. I am available in the event you need to clarify the meaning of a question, but I cannot provide an early indication if your answer is heading in the right direction (getting warmer...). There is no penalty for getting legitimate questions answered. When you are finished with your exam, please try to avoid congregation inside the main doors on the second floor. The (high and rising) noise level is usually a problem in the nearby classrooms. Thanks and good luck. I understand and accept the UNC Academic Honor Code: _______________________________ (signature) Print Name Here: SUGGESTED ANSWERS 2
1. Farm land in the upper Midwest is some of the most productive land in the world: rich soil, moderate temperatures, good drainage, and enough rainfall (except in drought years). Farmers produce a harvest whose value reflects (in part) their own productivity (along with the quality of their land), and the price of particular crops (i.e. corn, soybeans, sugar beets). Costs include fuel, seed, fertilizer (whose price is positively related to oil prices), insecticide, and borrowed money. The value of their land reflects the profits they earn from their land and labor, and the discount rate on future profits. Farmers can change the crops they grow in the long run, but some of the equipment is very specific to particular crops and additional, specialized machinery is generally required whenever the farmer changes from one crop to another (i.e., corn vs. sugar beets). For purposes of this problem, assume farmers experience normal temperatures and normal rainfall (i.e., not too hot/wet, not too cool/dry). Treat each case separately (i.e., nothing cumulates). a) What do you expect to happen to the price of farm land if the spike in oil/gas prices persists for the indefinite future? (Circle one of the alternatives below) Price of farm land: Rises Falls Doesn't change Can't tell for sure One bullet point explanation for answer (put it in the box): Higher oil/gas prices raise the cost of farming which reduces the income stream from the farm and leads to lower land prices. b) What do you expect to happen to the price of farm land if the ethanol program expands for the indefinite future? (ethanol is made by combining gasoline with an additive made from corn) (Circle one of the alternatives below) Price of farm land: Rises Falls Doesn't change Can't tell for sure One bullet point explanation for answer (put it in the box): An increased demand for corn to make ethanol will raise the income stream from corn farms and lead some farmers to switch to corn farming in the long run. The first effect should lead to higher land prices, while the second should moderate the increase in the long run. c) The federal government negotiates a liberalized food trade environment so that foreign markets are more open to U.S. exports than before, but U.S. food markets are also more open to imports, too. This deal will persist for the indefinite future. (Circle one of the alternatives below) Price of farm land: Rises Falls Doesn't change Can't tell for sure One bullet point explanation for answer (put it in the box): Increased exports lead to higher incomes for U.S. farmers raising crops that are competitive in world markets. Increased imports will reduce incomes for inefficient U.S. farmers. The first effect should lead to higher land prices, while the second should lead to lower farm prices. 2pts 2pts 2pts 2pts 2pts 2pts 3 For the following four questions (i.e., 2 5), circle all that apply: (Hint: don't get crazy here......the basis of the question isn't to get you to find bizarre, crazy, low probability results......If something seems really unlikely, that isn't the point of the question.) 2 pts. for each right/wrong answer Circle all that apply: 2. The value (to shareholders) of substantial capacity investments by an individual firm depends on (a) the firm's ability to differentiate the product generated by this new capacity (b) the expected rate of income growth for consumers of the product (c) limits on entry into the market by other firms (d) the probability of substantial changes in technology in the next few years 3. In a commodity industry characterized by low transportation costs, (a) fixed cost reductions raise profits in the short run (b) fixed cost reductions reduce the firm's ability to compete in the long run (c) variable cost reductions may be due to productivity improvements at input suppliers (d) variable cost reductions through higher productivity are more important in the long run 4. For a firm in an industry with decreasing returns to scale, (a) finding cheaper inputs is crucial to longrun profitability (b) it is particularly important concentrate on selling to high willingnesstopay customers (c) home currency depreciation reduces profits if the supply chain extends to other countries (d) increasing demand can actually lead to a smaller profit margin. 5. For a firm interested in exploiting increasing returns to scale, (a) marketing investments directed at "new and improved" are likely to be very important (b) it is particularly important concentrate on selling to high willingnesstopay customers (c) price cutting is obviously less important if consumer income is rising very rapidly (d) a low crossprice elasticity of demand makes it easier to ignore other firms. 4
6. Consider the following data for a product produced in two plants (in different countries): Cost Component Plant 1 Plant 2 Direct Labor Local Parts 8 hrs. at $25/hr. MP4320 $120 20% 10 hrs. at 25.20/hr. PLN1251 101 20% Imported Parts Overhead Allocation Exchange Rates: MP10.8/$1 PLN3.91/1 Mexican Peso/US$ new Polish Zloty/Euro US$1.25/1 US$/Euro a) Calculate MC for the product produced in each market in US$ and in : US$ 576 Plant 1 MC $720 2 pts. for each of 4 answers $841.13 ($841.25) 672.9 (673) Plant 2 MC b) If shipping for Plant 1 is 8% of MC (measured in US$), which plant has the lowest cost of serving the European market? (circle one below) Plant 1 Plant 2 Same MC for both 2 pts. ($777.6) ($841.25) c) What does the /US$ rate have to be for each firm to have the same MC measured in terms? 2 pts. /US$ = .924/US$1 (vs. .80/US$1 now) d) How does zloty depreciation affect the MC of production in plant 2? (circle one below) 2 pts. MC falls MC rises MC doesn't change can't tell for sure e) How would zloty depreciation affect the allocation of output from plant 1 and plant 2 to the European market under the conditions described in part b)? (circle one on each line below) 2 pts. More output from plant 1 Less output from Plant 1 No change for Plant 1 2 pts. More output from plant 2 Less output from Plant 2 No change for Plant 2 5
7. Consider a firm whose monthly costs are well represented by the following diagram: $ ATC for Product $80 3rd shift $55 $40 2nd shift 1st shift Quantity 8,000 15,000 21,500 a) MC for the 4,000th unit of this product is $40 $55 2 pts. for each of 3 answers MC for the 12,000th unit of this product is $80 MC for the 20,000th unit of this product is b) Is any difference in MC in the diagram an obvious example of diminishing marginal product? (Circle either Yes or No, and then put a bullet point in the appropriate box addressing the most important reason for your answer.) Yes, because (Put one bullet point in the box next to your choice of Yes and No; don't fill in both boxes!) No, because This may reflect different pay rates across the different shifts. There can be productivity effects, but the rising MC isn't an obvious example of diminishing marginal product. 2 pts. 1 pt. 6
c) The firm's market research group estimates that monthly demand facing the firm is given by P = 20 - .0046Q + .0143Inc + .0003 ADV where Inc is income (it averages $4200/month) and ADV is the firm's advertising spending (currently it is $220,000/month). Find optimal price and quantity for this firm and report them below: Quantity = 9897.8 (rounded to 9897) Price = $100.53 2 pts. for each of 2 answers P= 146.06 .0046Q so MR = 146.06 .0092Q MC = $55 (the other MC choices lead to optimal output outside the output range) $55 = 146.06 .0092Q so Q = 9897.8 P = 164.06 .0046 (9897.8) so P = $100.53 d) What is the price elasticity of demand at the optimal price and quantity? Solving for Q form: .0046Q = 146.06 P Elasticity = 2.21 so Q = 31752 217.39P Ed = 217.39 (100.53/9897.8) = 2.21 e) What do you expect will happen to the optimal price and quantity and to the profit margin under the following circumstances? 1 pt. for each of 3 answers Income rises: Price (circle one): Higher Lower No change Can't tell Quantity (circle one): Higher Lower No change Can't tell Profit margin (circle one): Higher Lower No change Can't tell The profit margin story depends on whether the new quantity puts the firm into the next production shift. If it doesn't, the margin should increase. 1 pt. for each of 3 answers Productivity rises on the 3rd shift: Price (circle one): Higher Lower No change Can't tell Quantity (circle one): Higher Lower No change Can't tell Profit margin (circle one): Higher Lower No change Can't tell A productivity change on 3rd shift won't matter unless demand is large enough to justify running a third shift. Higher productivity will raise the profitability of 3rd shift production. 3 pts. 7
8. Market segmentation is commonly used to transfer consumer surplus from consumers to sellers of differentiated products. There are many schemes used to implement market segmentation, but the interesting issue is the value to be realized by the firm from implementing these schemes. With this in mind, evaluate the validity of the following claims about market segmentation: (Hint: Again, don't get crazy here......the basis of this question isn't to get you to find bizarre, crazy, lowprobability results......) a) Investing in market segmentation methods is particularly important if income is expected to increase at a relatively high rate among high willingnesstopay groups. Circle one: True Never true True under limited circumstances b) Segmentation is particularly important if the firm is facing serious price competition for customers in the low willingnesstopay segment. Circle one: True Never true True under limited circumstances c) The ability to segment customers is the most important profitmaking strategy at the end of the product lifecycle. Circle one: True Never true True under limited circumstances d) Investments in segmenting a foreign market are of limited value in terms of home currency profits if the home currency appreciates. Circle one: True Never true True under limited circumstances d) If done properly, segmentation yields high prices to consumers with inelastic demand and low prices to consumers with elastic demand. Circle one: True Never true True under limited circumstances 2 pts. 2 pts. 2 pts. 2 pts. 2 pts. ...
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