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# Answers July 07 - Answers to July 3 2007 Midterm Economics...

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Answers to July 3 2007 Midterm: Economics 333 1. Note that a similar question was on the December 2006 midterm (Question 2), with question and answers posted as handouts on www.ccnet.utoronto.ca/20069/ eco333y1y . (a) This part is a short essay worth seven marks. It is based on discussion in the text beginning on page 104 and on pages 1-2 of the Chapter 7 notes (posted as a handout on the above-cited web site). The cost factor that varies with location is the cost of employee travel (to meetings with other firms). Office firms need information to produce their output, and this information is obtained at face- to-face meetings with employees of other firms. To any given firm, there is an opportunity cost of employees’ time when they are travelling to meetings. The more accessible a firm’s location is to other firms, the lower its travel cost will be. The points in the preceding paragraph are worth two marks. Another two marks for identifying the median location as the location that minimizes travel cost, with one additional mark if a travel distance by location example (like the example on page 105) is included. The two remaining marks are for discussion of whether travel cost at x = 0 is zero or just lower than at other locations. The relevant points are in the Chapter 7 notes. Essentially, travel cost can be defined as zero at x = 0 because travel cost will be higher at all other locations. With this definition, travel cost at x = 0 is included in “other non-land cost” – an exogenous cost variable that is the same for firms at all locations. In that case the defined travel cost at any given location becomes the difference between travel cost at that location and travel cost at x = 0. (b) This part, which is worth 10 marks, is based on the Chapter 6 notes, particularly the analysis accompanying Table 1 in those notes. A similar question (Question 2) was on the December 2006 midterm, with questions and answers posted as handouts on the above-cited web site. One key difference between the December 2006 and July 2007 questions is that in December travel costs were given and land rents had to be derived. In July, the land rents were given and the travel costs had to be “reverse engineered” – that is, calculated by working backwards from the rents. Another key difference is that the December question started with unrestricted factor substitution in production of office space, and then used zoning to eliminate factor substitution. The July question starts with no factor substitution due to zoning and then eliminates the zoning to allow factor substitution. At all three locations given in the present exam the zero economic profit condition must be met:

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That is Total Revenue (TR) = Total Cost = Other Non-land cost (ONLC) + Travel Cost (TC) + Capital Cost (C) + Land Cost (R x L, where L is fixed at 0.25). Note that zero economic profit still leaves the firm with just enough profit to stay in business (included in ONLC). At x = 2, TR (\$1500) = Total Cost = ONLC (\$500) + TC + C (\$200) + R (\$2400) x
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