Key for Sample Exam(2)

Key for Sample - multiple choice 2 points A production technology is characterized by all convex isoquants Consider any two factor combinations

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Unformatted text preview: multiple choice, 2 points) A production technology is characterized by all convex isoquants. Consider any two factor combinations that generate the same total product. Then a third factor combination which is the average of the other two factor combinations will generate a. b. c. d. the same total product once more. a greater output. a smaller output. Any of the above are possible situations. (multiple choice, 2 points) Any reduction in the total cost of producing two goods in the same plant, as opposed to producing them separately, is said to reflect a. b. c. d. economies of scale. economies of scope. constant returns to scale. increasing returns to scale. (short answer, 6 points) The graph is showing isoquants for a firm for three different production techniques, A, B, and C, all of them for the same given output of 250. In the long run, the firm is free to vary all inputs, and to choose the production technique. The firm is also able to use two production techniques simultaneously, if desired. a. If the relative price of factor 1 is very high, which technique is the firm most likely to be using in the long run? In the graph identify, and briefly explain, the firm's overall 250, that isoquant for the same level output, optimizes over choice of technique. Factor 2 A B C b. q=250 a. q=250 q=250 Factor 1 The isocost lines showing a very high relative price of factor 1 are very steep. Seeking to minimize the cost of producing the given level of output, the firm will most likely select technique A. [And if the firm does not, for the given relative price of factor 1, then there is an even higher relative price of factor 1 that would induce the firm to choose technique A.] Optimization over choice of technique entails finding the lower envelope durve of the three isoquants shown. That curve is the overall isoquant. [The only question here would be whether the firm is able to mix techniques, e.g. to use A half the time and B the remaining time. If it cannot, then the overall isoquant traces out the three isoquants shown. If it can mix techniques, then the overall isoquant contains two straight segments, which are portions of two straight lines. The first of these straight lines is tangent to both isoquant A and B, and the portion of the line is which lies between the two points of tangency, and similarly for the second straight line segment.] b. (multiple choice, 2 points) A firm is using a production function for which labor and capital are perfect complements. Then the shortrun total product curve with labor on the horizontal axis and for a fixed amount of capital a. b. c. d. e. slopes up as a straight line up to some point, then turns horizontal. is concave and shows a zero output when no labor is used at all. has a positive intercept. is a straight, upwardsloping line at every level of labor input. None of the above. (multiple choice, 2 points) In a market at longrun equilibrium, a. b. c. d. e. each firm's marginal profit is equal to zero. each firm's total profit is equal to zero. price is equal to longrun marginal cost. price is equal to longrun average cost. All of the above. (short answer, 6 points) This graph shows a firm's isoquants for various levels of output, as well as one isocost line. a. b. What is the significance of point A in this graph? With given factor prices, what is ths firm's output expansion path? Briefly explain. Capital A Labor a. b. [The point identified by the small circle should have been labeled `A'.] At point A, the firm is minimizing the cost of producing the output represented by the isoquant that runs through point A. Alternatively, at point A the firm is maximizing the output that can be produced at the total expense that is represented by the isocost line through point A. See graph. The line traces out all those points on the various isoquants where these isoquants have the same slope as at point A. (multiple choice, 2 points) A firm is using capital and labor in fixed proportions, i.e. capital and labor are perfect complements. Then an increase in the price of capital will a. b. c. d. e. cause the costs of producing any given level of output to rise. make the firm substitute capital for labor. make the firm substitute labor for capital. make the firm shut down. None of the above. (multiple choice, 2 points) In class it was argued that the term "fixed cost" is actually a misnomer, the reason being that. a. b. c. d. fixed costs are never really fixed, even in the short run. there are no fixed costs in the long run (other than possibly a licensing fee). this "cost" is not an opportunity cost, since there is nothing the firm can do in the short run to avoid these expenses. the magnitude of this cost depends on how much capital the firm is using. (short answer, 6 points) A firm's shortrun marginal cost and average total cost curves are shown on the right. a. b. Find this firm's average variable cost curve (AVC). This is a pricetaking, profitmaximizing firm. What is this firm's shortrun supply curve? (Consider the full range of prices, including prices close to zero.) $/q ATC MC AVC output q a. See graph. This AVC curve has the same vertical intercept as the marginal cost curve (MC), it slopes up, it lies everywhere below MC, and it also lies everywhere below ATC. Because MC is linear, AVC is linear as well and has half the slope of the MC curve. See graph. The firm's supply curve is the same as its marginal cost curve, except at low prices where it follows along the price axis and the quantity supplied is simply equal to zero. This meets the usual conditions, which are that the firms sells that amount of output where MC is equal to price whenever price is above AVC; otherwise it produces a quantity of zero. b. (multiple choice, 2 points) Compare the impact on consumer surplus of a price increase for two different market demands. The initial price and quantity demanded are the same. The change in consumer surplus will be greater for the demand curve that is a. b. c. d. more inelastic at all prices. more elastic at all prices. more elastic at prices above the initial price, but less elastic at lower prices. A comparison of this sort cannot be made. (multiple choice, 2 points) When we add consumer surplus and producer surplus to determine the total surplus for the market, s a. b. c. d. we value all buyers' and all sellers' dollars the same. some allowance is made for the fact that an extra dollar's worth of consumption is more valuable than an extra dollar's worth of profit. some allowance is made for the fact that an extra dollar's worth of consumption is more valuable for lowincome consumers. None of the above. (short answer, 6 points) This graph is showing a firm's longrun average cost curve (LRAC). a. The graph shows a second curve. What kind of a curve is this? Briefly explain. The point of tangency of the two curves and the associated output are of particular interest. What is the economic significance of the point of tangency? Find the firm's longrun marginals cost curve (LRMC) based on the LRAC of this graph. $/q ATC LRAC b. LRMC c. output q a. b. c. That curve is a shortrun average total cost curve (ATC, or SRATC). It is a restricted cost curve that is why it lies almost everywhere above LRAC. At the point of tangency, the firm is using the longrun optimal amount of capital for the output identified by that point. That is why the height of the ATC at that output is the same as that of LRAC. See graph. LRMC has to have the same vertical intercept, lies below LRAC whenever LRAC slopes down, lies above LRAC whenever LRAC slopes up, and therefore passes through the minimum of LRAC from below. [The geometry of LRMC relative to LRAC is the same as that of MC compared with AVC. (multiple choice, 2 points) A firm uses a production function that displays constant returns to scale at every level of output, and all of its isoquants have the regular, convex shape. (I.e. the factors of production are not perfect substitutes or perfect complements.) Then a. b. c. d. the marginal product of each input diminishes with increased use of that input. the marginal product of each input has to be constant. the firm is also experiencing economies of scope. the firm is also experiencing diseconomies of scale. (multiple choice, 2 points) Consider a firm that minimizes the cost of producing a given output. Then a. b. c. d. e. the marginal cost of increasing output by using more of one factor at a time will be the same for all factors. the marginal product per dollar spent on each factor must be the same. the slope of the isoquant equals the slope of the isocost line at the factor combination chosen by the firm. All of the above. None of the above. (short answer, 6 points) The graph on the right shows the longrun market supply curve for razor blades. a. What type of market is this? Is this a constantcosts, increasingcosts, or decreasingcosts market? How do you know? Suppose there is a technological breakthrough and that with the new technology each firm is able to produce 20% more output than before [from any given quantity of resources]. Suppose also that all factor prices remain the same. Show and briefly explain the chasnges in market equilibrium resulting from this change in technology. Suppose instead that with all factors having become more productive, all factor prices rise by 20%. In this alternative situation, what will be the changes in market equilibrium? Price D b. LRS P1 P2 new LRS c. Q1 Q2 Quantity Q a. b. c. This is a constantcost (constantcosts) market, as is seen from the fact that LRS is horizontal, meaning that the longrun average cost of production of each firm is invariant to the market output. The ability to produce 20% more output from given resources, i.e. at given total cost, means that the total cost of producing any given output will be 20% less than before. Then the average cost, too, will be 20% less. That gives the new longrun supply curve shown in the graph. As a result, the longrun market equilibrium position moves from P1 and Q1 to P2 and Q2. The new equilibrium price is 20% less than before. The increase in factor prices shifts the LRS upwards in a parallel fashion and neutralizes the impact of the increase in productivity on the LRS curve. One should expect that the market equilibrium will remain the same. [Note that this is not entirely accurate because 0.8 (the fraction of unit cost remaining the 20% reduction) times 1.2 (the factor of increase in unit cost due to the increase in factor prices by 20%) is not equal to 1.0. It is equal to 0.96. In other words, it is more accurate to say that the final LRS curve is positioned 4% below the initial LRS curve, that the new longrun equilibrium price is 4% below the initial price, and that the new equilibrium output exceeds the initial output. That said, both answers (no change in LRS, drop in LRS by 4%) are acceptable to me.] (multiple choice, 2 points) A firm that experiences increasing returns to scale over some range of output will also a. b. c. d. e. experience economies of scale over the same range of output. find that its longrun average costs are constant. find that its longrun average costs are increasing as well. All of the above are possible. None of the above. (multiple choice, 2 points) A pricetaking firm operating in the short run finds that the price of the product is below its lowest average total cost but also above its lowest average variable cost. Then the best the firm can do is a. b. c. d. to exit the market. to produce an output of zero but remain in the market. to produce the output at which average variable cost bottoms out, which is positive. to product the output where price is equal to marginal cost, which is positive. (short answer, 6 points) Suppose the market for compact fluorescent light bulbs (CFL bulbs) is a decreasingcost market. The diagram is showing the market demand for CFL bulbs. a. Show, and briefly explain, the longrun market supply curve. Identify the longrun market equilibrium price and quantity. Trace the effects on the longrun equilibrium in this market of an increase in demand. What will be the effect on the longrun equilibrium price and on the longrun equilibrium quantity? Price D D2 b. P1 P2 Q1 Q2 Quantity Q a. b. Because this is a decreasingcost market, the longrun market supply curve (LRS) slopes down. The longrun market equilibrium occurs at the point of intersection with the demand curve, at P1 and Q1. [The graph shows an LRS curve that intersects the demand curve once. But the LRS curve might have two (or more) intersections with the demand curve in different places, meaning that there would be multiple longrun equilibria.] Demand rises to D2, the new market equilibrium occurs at price P2 and quantity Q2. Because LRS slopes down, the new longrun equilibrium price is less than before and the increase in the market equilibrium quantity excees the increase in demand. (multiple choice, 2 points) When a pricetaking, profit maximizing firm with rising marginal costs sees a price increase in the market, then in general the increase in the firm's producer surplus will a. b. c. d. e. be equal to the change in price times quantity supplied. be equal to the change in price times the change in quantity supplied. be equal to price times quantity. exceed the increase in price times the initial quantity supplied. None of the above. (multiple choice, 2 points) For a demand curve with a constant price elasticity of 1 at every price, a. b. c. d. consumer spending falls whenever price increases. consumer spending falls whenever there is a price decrease. consumer surplus, measured as the area below the demand curve and above the price line, is infinite. None of the above. (short answer, 6 points) Suppose the U.S. can import any quantity of rechargeable batteries at the world price without influencing the world price. There is a domestic supply of such batteries, shown in the graph as the curve labeled S. The graph also shows the demand of U.S. buyers of such batteries. There is an import tariff, which raises the price in the U.S. market above the world price by the unit tariff; see graph. Consider the alternative trade policy of an import quota. More specifically, suppose the tariff is replaced with a quota that allows that amount to be imported, but no more, that is imported with the given tariff. If the tariff were to be replaced with a quota, how would this change in trade policy affect price and quantity for U.S. buyers and U.S. sellers? Price S world price + tariff world price D Qs For U.S. buyers and sellers, price and quantity would be the same as under the quota policy. Qd Quantity Q Note that it is not strictly required to use the graph to answer this question. But it is convenient. In reference to the graph, under the quota policy one must search for one price applying equally to U.S. buyers and U.S. sellers at which the difference between the U.S. quantity demanded and the U.S. quantity supplied is precisely equal to the import quota. Because the quota was determined as the equilibrium import quantity under the tariff, that price will be the same as that which results from the tariff. And then the quantities demanded and supplied in the U.S. market will be the same as well. [There is an important difference between the two policies, but which this problem does not ask about. The tariff delivers revenues to the U.S. government, whereas the quota policy does not, unless the quota licenses are auctioned off and the auction delivers the maximum market value of the licenses, reflecting the quota rents. Otherwise the Treasury comes out worse. That leaves the question of who secures those surpluses/rents. If the quota licenses are simply given away, say by lottery, but only to U.S. companies, the market value of the licenses will be captured by someone in the United States, though not by the Treasury. But the quota licenses might also go to foreign companies, in which case the overall sum of U.S. surpluses will be less. But the overall U.S. surplus would also be less if U.S. companies are awarded licenses in response to lobbying efforts on their part, not by lottery, giving them an incentive to lobby then these companies will be spending resources in trying to secure of those licenses, resources that are then no longer available for directly productive uses. The "winners" among the lobbying firms capture the quota rents, but the total amount of resources spent before the licenses are even awarded may be as large as those rents, so that in the aggregate the net social value of those rents may be reduced to zero.] ...
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This note was uploaded on 04/08/2008 for the course ECON 605 taught by Professor Schmidt during the Spring '08 term at New Hampshire.

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