practice final - Faculty of Arts ECN 154-250D1:Introduction...

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Unformatted text preview: Faculty of Arts ECN 154-250D1:Introduction to Economic Theory Final Exam (4 Pages, including the cover page) Examiner: Daniel Parent; Associate Examiner: Jim Engle-Warnick December 12, 2006; 2PM; . Instructions: Closed book exam; answer in exam booklet; students are allowed to use calculators; no documentation is allowed; students can keep the exam; translation dictionaries are allowed; regular de nition dictionaries are not allowed. ECN154-250D1: FINAL EXAM; December 12 2006 Part One (30%): All Questions Must Be Answered (zero points are awarded for simply answering true , false , or uncertain without any explanation) 1. (10%) Mr. Deming rides yet again. He visits another company which produces a single output y from two inputs x 1 and x 2 with an increasing returns to scale production function f ( x 1 ,x 2 ) . He discovers that when the input prices are ( w 1 ,w 2 ) = (2 , 5) , the rm uses the input combination ( x 1 ,x 2 ) = (6 , 2) and produces 100 units of output. When the input prices are ( w 1 ,w 2 ) = (3 , 6) , the rm uses the input combination ( x 1 ,x 2 ) = (9 , 10) to produce 300 units of output. Upon learning of these facts, Mr. Deming makes the following remark to management: "I cannot reject the assumption that you are a cost minimizing rm". Why does he say that? Why can he not be more de nitive? Answer: We have w 1 x 1 + w 2 x 2 = 2 × 6 + 5 × 2 = 22 with y = 100 and w 1 x 1 + w 2 x 2 = 3 × 9 + 6 × 10 = 87 with y = 300 . If we use the new prices w with 3 times the original quantities we have w 1 3 x 1 + w 2 3 x 2 = 3 × 18 + 6 × 6 = 90 With increasing returns to scale, the rm should be able to produce more than 300 units of y when using three times the initial quantities of the factors. Alternatively, the rm should be able to produce 300 units of y with the x and w at less than three times w x when prices are equal to w , which it is doing. Also, 1/3 of x at the old prices would give C = 22 . 67 , which is greater than 22. Hence there is nothing that can allow us to reject the assumption that the rm is minimizing its cost. However, we do not know for sure whether it is actually minimizing its cost simply because there could be another combination x 00 such that, at w the rm achieves an even lower total cost than 87. 2. (5%) A commodity bundle lying above an individual's budget line must be superior to all bundles lying on the line. True, False, Uncertain, Explain. Answer: It depends on whether the consumer is endowed with the goods or not. If he is, he's actually strictly better o since he can trade o his initial endowment position. If he is not endowed with the goods, then the answer is false in general: it's not because a bundle is above one's budget constraint that it is necessarily preferred to all the bundles in the budget set....
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