Midterm revision 1

# Midterm revision 1 - ECON 1001 Midterm#1 Revision Q1 After...

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ECON 1001 Midterm #1 Revision

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Q1) After paying the movie distributor and meeting all other non-interest expenses, the owner expects to net \$2.00 per ticket sold. Construction costs are \$1,000,000 per screen. How many screens should be built if the real interest rate is 7% ? A) 1 B) 2 C) 3 D) 4 E) 5 Ans: B N u m b e r o f T o t a l n u m b e r S c r e e n s o f p a t r o n s 1 5 0 , 0 0 0 2 9 0 , 0 0 0 3 1 2 0 , 0 0 0 4 1 4 0 , 0 0 0 5 1 5 0 , 0 0 0
Installing the ↑ in patrons ↑ in revenue (MB) 1st 50000 \$100000 2nd 40000 \$80000 3rd 30000 \$60000 4th 20000 \$40000 5th 10000 \$20000 We should use a ‘cost-benefit’ analysis In particular, ‘Marginal Benefit vs Marginal Cost’ of installing ONE MORE screen. MB of installing ONE MORE screen =(increase in patrons)∙\$2

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Installing the n-th screen Interest income forgone (MC) 1 \$70000 2 \$70000 3 \$70000 4 \$70000 5 \$70000 How about the MC of installing ONE MORE screen? Cost of constructing ONE screen = \$1,000,000 If you save the money in a bank instead of investing it in the cinema, how much do you get? (r=7% per annum) So MC of installing ONE MORE screen = \$1m∙0.07
Should you install the first screen? YES! Because MB>MC How about the second one? The third one? How many screens would you install in total? Installing the ↑ in revenue (MB) Interest income forgone (MC) 1st \$100000 \$70000 2nd \$80000 \$70000 3rd \$60000 \$70000 4th \$40000 \$70000 5th \$20000 \$70000

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Q2)Mike gives a non-refundable \$100 to ACE adventure to reserve a raft for a group rafting trip in the New River. The raft has room for 5 people. He can only sell 3 tickets at \$25 each for a total of \$75. Should Mike cancel the trip? A) Yes, because he will lost \$100. B) No, because he is making \$75. C) Yes if Mike values going on the trip at less than \$25. D) No, because losing \$25 is better than losing \$100. E) Yes, because he will lost \$25 on the venture. Ans: D
This is a question about opportunity cost . If Mike cancels the trip, he loses \$100 and gets nothing. Hence, the net loss is \$100. If the trip goes as planned, Mike loses \$100, and gets \$75 back. The net loss is \$25. In other words, if he cancels, he loses \$100; if he goes, he loses \$25 only.

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As a rational economic agent, what would Mike choose? NOT to cancel the trip! Because losing \$25 is better than losing \$100 (D). The key word in the question is ‘non-refundable’. That means the \$100 is already sunk. Mike would endeavour to recover as much money as possible from the venture.
Q3) How many hours should IBM employ Pam to maximise its benefit from her employment? A) 1 hour. B) 2 hours. C) 3 hours. D) 4 hours. E) 5 hours. Ans:D

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This is a slightly tricky question. However, all we have to do is to apply the usual π-max principle: MR=MC. To summarise the information provided:
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Midterm revision 1 - ECON 1001 Midterm#1 Revision Q1 After...

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