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1 ECMC02H Intermediate Microeconomics - Topics in Price Theory Term Test – October 19, 2009 Time: 80 minutes Professor Gordon Cleveland ANSWERS TO THE TEST QUESTIONS ARE SHOWN BELOW EACH QUESTION. DIFFERENT VERSIONS OF THE TEST HAD THE SAME QUESTIONS BUT IN A DIFFERENT ORDER ______________________________________ ____________________ PART I - 15 Multiple Choice Questions - 75 marks 1-5. A firm in a perfectly competitive constant cost industry has total costs in the short run given by: TC = 2.5q 2 + 5q + 40 where q is output per day and TC is the total cost per day in dollars. The firm has fixed costs of \$30 (already included in the TC equation above). The TC equation generates minimum average costs of \$25 (per unit) at q = 4. You are also told that this size firm generates minimum long run average costs (that is, minimum LRAC occurs at q = 4, with min LRAC = \$25). In the short run, there are 200 firms in this industry. Questions 1 through 5 concern this firm and this industry. 1. In the short run there are 200 firms in the industry, all with the same cost curves described above. Suppose that the demand curve facing the industry is given by the equation P = 125 - .075Q where P is the price per unit and Q is the number of units demanded per day. The equilibrium price in the short run is: A) \$25 B) \$30 C) \$35 D) \$40 E) \$45 F) \$50 G) \$55 H) \$60 I) \$65 J) none of the above MC = dTC/dq = 5 + 5q. Since the PC firm sets MC = P, we have P = 5 + 5q, which is the equation of the firm’s supply curve (above min AVC). 200q = Q, so q = .005Q. Substituting, we can find the industry supply curve for this group of 200 firms. P = 5 + 5(.005Q) = 5 + .025Q. Since demand is P = 125 - .075Q, we have 125 - .075Q = 5 + .025Q or Q 0 *= 1200 and P 0 * = \$35. The correct answer is (C). 2. Continuing the situation described in question 1 (the short run, with 200 firms and demand given by P = 125 - .075Q ), the profit earned by an individual firm per day in the short run is: A) \$0 B) -\$50 C) -\$30 D) -\$20 E) \$20 F) \$30 G) \$50 H) \$70 I) \$90 J) none of the above Profit = 35 x 6 – (2.5[6 x 6] + 30 +40) = 210 – 160 = \$50. The correct answer is (G).

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2 3. How much is sum of consumer surplus and producer surplus in this industry in the short run? A) \$0 B) -\$5000 C) -\$3000 D) -\$2000 E) \$2000 F) \$4,500 G) \$13,500 H) \$18,000 I) \$21,000 J) \$24,000 K) \$30,000 L) \$36,000 M) \$44,000 N) \$54,000 O) \$60,000 P) \$66,000 Q) \$70,000 R) \$72,000 S) \$76,000 T) \$80,000 U) \$88,000 V) \$96,000 W) \$100,000 X) \$102,000 Y) \$108,000 Z) none of the above The sum of consumer surplus and producer surplus is the whole area between the demand and supply curves up to the equilibrium quantity. This is:([125 – 5] x 1200)/2 = \$72,000. The correct answer is (R). 4. Imagine that, somehow or other, the amount of output traded in this industry is not at its equilibrium level, but is artificially held down to 600 units of output, so that 600 units are consumed and 600 units are produced in this industry. What now would be the sum of consumer surplus and producer surplus in this industry? A) \$0 B) -\$5000 C) -\$3000 D) -\$2000 E) \$2000 F) \$4,500 G) \$13,500 H) \$18,000 I) \$21,000 J) \$24,000 K) \$30,000 L) \$36,000 M) \$44,000 N) \$54,000 O) \$60,000 P) \$66,000 Q) \$70,000 R) \$72,000 S) \$76,000 T) \$80,000 U) \$88,000 V) \$96,000 W) \$100,000 X) \$102,000 Y) \$108,000 Z) none of the above If output is 600, then the demand price is \$80 and the supply price is \$20. The sum of CS and PS is [(125 – 80) x 600]/2 + [60 x 600] + [(20-5) x 600]/2 = \$54,000. The correct answer is (N).
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