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ECON 2X03/2G03 Fall 2005

Answers to the Final Exam


1. (A) The opportunity cost of something is the value of the resources used to obtain that
something in their best alternative use. Here the resources are Milan's time used for
labour. Its best alternative use is through employment with Ishmael, and the value of that
employment is $25 per hour. So that's the opportunity cost of his labour in his kitchen.

1 2
1 2 1 2 1
TP z12 z23 − − −
2. (C) AP = = = z1 2 z23 = z1 2 ( 64 ) 3 = 16 z1 2
z1 z1
∂AP
3. (C) It is certain that MP < AP ⇔ <0.
∂z
4. (C) STC = 3 y 2 + 2 y + 50
VC = 3 y 2 + 2 y (The part that depends upon output.)
VC
AVC = = 3y + 2
y
∂AVC w
5. (D) AVC < SMC ⇔ > 0 so we know AVC is increasing. Since AP = ,
∂y AVC
AP must be decreasing.
6. (A)
1 4

MP1 3 ( 23 ) z1 3 z23 z 3 3
MRTS = = = 2 = =
MP2 2 1
2 z1 2 ( 5 ) 10
3 ( 34 ) z13 z23
7. (B)
i)
Case 1: 3 z1 < 2 z2
y = 3 z1
F ( az1 , az2 ) = 3 ( az1 ) = a ( 3z1 ) = aF ( z1 , z2 )
∴ constant returns to scale if 3z1 < 2 z2
Case 2: 3z1 ≥ 2 z2
y = 2 z2
F ( az1 , az2 ) = 2 ( az2 ) = a ( 2 z2 ) = aF ( z1 , z2 )
∴ constant returns to scale if 3z1 ≥ 2 z2
∴ constant returns to scale in all z1 , z2
ii)
1 1 5 1 1 1 1
F ( az1 , az2 ) = ( az1 ) 3 ( az2 ) 2 = a 6 z13 z22 < az13 z22 = aF ( z1 , z2 )
so decreasing returns to scale
iii)
3 3 3
⎛ 3 3
⎞ ⎛ 3 3

F ( az1 , az2 ) = ( az1 ) 4 + ( az2 ) 4 = a 4 ⎜ z14 + z24 ⎟ < a ⎜ z14 + z24 ⎟ = aF ( z1 , z2 )
⎝ ⎠ ⎝ ⎠
so decreasing returns to scale

8. (C)
It's a Cobb-Douglas production function, so it must have diminishing MRTS. In this
particular case:
MP1 az1a −1 z2a z2
MRTS = = =
MP2 az1a z2a −1 z1
1
y = ( z1 z2 ) ⇒ z2 = y a z1−1
a

1
z y a z1−1 1
MRTS = 2 = = y a z1−2
z1 z1
∂MRTS 1
a −3
= −2 y z1 < 0 ∴ diminishing MRTS
∂z1

9. (D)
Note that a conditional input demand gives us the cost-minimizing amount of that input
as a function of output and input costs (not as a function of other inputs) so this rules out
(A) and (B).
It's perfect substitutes so the cost-minimizing bundles will (if unique) be at one of the
points (the less costly one) where the isoquants cross an axis.
The cost of the bundle where z1 = 0 and z2 = y is w2 y .
The cost of the bundle where z1 = 12 y and z2 = 0 is 12 w1 y .
So (0, y ) is less costly than ( 12 y, 0 ) ⇔ w2 y < 12 w1 y ⇔ 2w2 < w1
This gives us z1 = 0 if 2 w2 < w1 and z1 = 12 y if 2 w2 > w1 .
(If 2w2 = w1 then every point on the isoquant is equally costly and thus every point on the
isoquant is cost-minimizing and the cost-minimizing amount of input one is not unique.)

10. (C) This question is asking us whether a particular input bundle is cost-minimizing,
and if not, what sort of change would be necessary to make it so. The information about
the levels of the inputs is irrelevant. The marginal products and the input costs are what
matter. In this case we have:
MPK 14 7 20 wK
= = >2= =
MPL 6 3 10 wL
MPK
To cost minimize, a bundle where MPL
is smaller must be chosen. Since there is
MPK
diminishing MRTS, more capital and less labour will make MPL
smaller.

11. (D) The output expansion path gives us the cost-minimizing bundles for different
levels of output but constant input costs. If it's upward-sloping, both inputs increase as
output increases and so both inputs are normal. If it's downward-sloping, one is
increasing and the other is decreasing as output increases, so one is normal and the other
is inferior.

( z1 − 5)
1 − 12 1
MP1 z22 z2 w w w
12. (A) = 2
= = 1 ⇒ z2 = 1 z1 − 5 1
2 ( z1 − 5 )
− 12
z1 − 5 w2
1
MP2 1
z 2
2
w2 w2
That's our output expansion path and it doesn't pass through the origin so the production
function isn't homothetic.

13. (D) (Long-run) total cost (TC) will be the smallest of the possible short-run total
costs (STC). In this case, the smallest STC for 100 units of output is 1000. LAC = TC/y
= 1000/100 = 10.

14. (B) There are decreasing returns to scale everywhere that LAC is increasing in
output. There are increasing returns to scale everywhere that LAC is decreasing in
output. In this case:
LAC = TCy = y 2 − 20 y + 150
∂LAC
∂y = 2 y − 20
Decreasing returns to scale ⇔ ∂LAC
∂y > 0 ⇔ y > 10
Increasing returns to scale ⇔ ∂LAC
∂y < 0 ⇔ y < 10

15. (D)
a) The different values placed on slithy-toves by different people merely results in a
downward-sloping demand curve. Product homogeneity merely requires that the value
not arise from intrinsic differences between specific slithy-toves.
b) Product homogeneity isn't violated when the individual units of output are practically
the same; it's satisfied.
c) The independence assumption is not addressing the independence of the producers but
rather the independence of preferences from the consumption levels of other people and
the independence of costs from the production levels of other firms.
d) Perfect mobility of resources requires that shifting resources into or out of production
for the product (out of or into production of some other product) be costless. Needing
more than 10 years of training to be a proper slithy-tove maker implies the shifting of
resources into the market is not costless. It's violated.
e) Perfect information requires (among other things) firms to all have the same
production technology. It doesn't require consumers to also have it.
16. (C) It's able to cover its variable costs since price is greater than the minimum value
of AVC so it will produce in the short run. That leaves us with (B) and (C) as possible
answers. A firm might not leave in the long run (even if the price doesn't come down) if
it is able to change the level of its fixed input in the long run and reduce costs enough to
not earn negative profits. i.e. It could be this situation came about because demand fell,
the price fell, and now the firm finds itself with, say, too much of the fixed input (relative
to what it wants in the long run) and so temporarily (until it can change that fixed input) it
is operating at a loss.

17. (D)
1 1 1 1 1
y = z12 z22 = z12 ( 25 ) 2 = 5 z12 ⇒ z1* = 1
25 y2
VC = w1 z1* = 50
25 y2 = 2 y2
SMC = ∂VC
∂y = 4y
P = SMC ⇒ P = 4 y ⇒ y = 14 P

18. (A)
P = SMC ⇒ P = 5 + 10 y ⇒ y = 101 P − 12 if P ≥ 5, y = 0 if P < 5
100 100
If P ≥ 5, Y = ∑ yi = ∑ 101 P − 12 = 100 ( 101 P − 12 ) = 10 P − 50
i =1 i =1
100 100
If P < 5, Y = ∑ yi = ∑ 0 = 0
i =1 i =1

19. (C) It's definitional.

20. (C) It's definitional.

21. (A)
QD = QS
50 − 2 P = 3P ⇒ P = 10
QD = 50 − 2 P = 50 − 2 (10 ) = 30
QS = 3P = 3 (10 ) = 30
22. (A)
π i = Pqi − qi − 10
π i = (100 − Q−i − qi ) qi − qi − 10
π i = ( 99 − Q− i − qi ) qi − 10
∂π i
∂qi = 99 − Q− i − 2qi = 0
99 − Q − qi = 0
99 − nqi − qi = 0 (Since q i = q j ∀i, j )
qi = 1
n +1 99
Q = nqi = n
n +1 99
P = 100 − Q = 100 − nn+1 99
π i = Pqi − qi − 10 = (100 − nn+1 99 ) n1+1 99 − n1+1 99 − 10 = (100 − nn+1 99 − 1) n1+1 99 − 10
π i = ( 99 − nn+1 99 ) n1+1 99 − 10 = ( n1+1 99 ) n1+1 99 − 10 = 992
− 10
( +1)2
n

πi = 0 ⇒ 992
= 10 ⇒ 99
n +1 = 10 ⇒ n = 99
− 1 ⇒ 30 < n < 31
( n +1)2 10

< 0 ⇒ ( if n = 30, π i > 0; if n = 31, π i < 0 )


∂π i
∂n
So the equilibrium number of firms is 30.

23. (E) The long-run equilibrium involves a market price equal to the minimum value of
LAC and firms producing at the corresponding level of output (since the price will cross
LMC there). The only answer consistent with this is (E). We know there will be more
firms since market output has gone up (demand increased but the price is the same) and
output per firm didn't change.

24. (A)
LAC = TCy = y 2 − 6 y + 19
∂LAC
∂y = 2y − 6 = 0 ⇒ y = 3
At y = 3, LAC = ( 3) − 6 ( 3) + 19 = 10
2

So P = 10.
At P = 10, QD = 1000 − 40 (10 ) = 600
n= QD
y = 600
3 = 200

25. (A)
The part where increased market output results in decreased input costs is the definition
of a decreasing-cost competitive market. The downward sloping supply results from the
lower minimum value of LAC where profits are zero and LR equilibrium is established.
26. (B)
The lower costs result in a lower SMC for each firm for any given level of output. The
horizontal sum of these SMCs involve a higher quantity supplied for any given price,
hence supply has increased. Demand isn't affected by costs of production, so the new
equilibrium involves a higher quantity (both quantity demanded and quantity supplied
since they are equal at the equilibrium).

27. (D)
The price will be that which results in a quantity demanded equal to the quota.

28. (D)
*** needs diagram

29. (B)
Without a tax:
QD = QS ⇒ 500 − 8P = 2 P ⇒ P = 50
With a tax of t per unit:
QD = 500 − 8 PD
QS = 2 PS
PD = PS + t
QD = 500 − 8 ( PS + t )
QD = QS ⇒ 500 − 8 ( PS + t ) = 2 PS ⇒ PS = 50 − 54 t
PD = PS + t = 50 − 54 t + t = 50 + 15 t
PD − PNo Tax = 50 + 15 t − 50 = 15 t < 54 t = 50 − ( 50 − 54 t ) = PNo Tax − PS
PD − PNo Tax < PNo Tax − PS , so the consumers' tax burden is smaller.

30.
a) Since the resource is being depleted over time, supply is falling, so the higher prices
won't necessarily result in a higher quantity supplied. (The implicit thrust of the
statement is that supply falls quickly enough that even the higher prices result in a lower
quantity supplied.)
b) Demand doesn't fall because price increases--quantity demanded does.
c) If supply is dwindling and demand growing, then price is increasing and the quantity
is indeterminate. But since the initial statement is arguing that the quantity supplied will
be insufficient, we can't use the theoretically indeterminate effect on quantity to amend
this part of the statement.
d) By process of elimination this looks like the answer. The part about "ever-higher"
prices follows from the increasing demand and the decreasing supply. The "probable"
lower quantities reflects the concern about the nature of the market for a non-renewable
resource. No problems with the application of micro theory here.
e) It needs amendment on the grounds that there is no explanation provided for the rising
price that should equate supply and demand.
31. (B)

32. (D)
MR = P 1 −( 1
ε )⇒ ε = P
P − MR = 1212−10 = 6 ⇒ ε = −6

33. (C)
Since profit maximizing involves MR=MC and MR=10, we can conclude MC=10.

34. (E)
QD = 48 − P ⇒ P = 48 − y
TR = Py = 48 y − y 2
MR = ∂TR
∂y = 48 − 2 y
MC = ∂TC
∂y = 2y
MR = MC ⇒ 48 − 2 y = 2 y ⇒ y = 12
P = 48 − y = 48 − 12 = 36

35. (
*** needs diagram

36. (D) It's definitional.

37. (E)
That little story of what happens when a second firm enters means that the Sylos
postulate applies.
The existing monopolist's behaviour:
MCm = ∂∂TCy = c
MRm = a − 2 ym
MRm = MCm ⇒ ym = a −c
2

Pm = a − y = a − a 2−c = a +2 c
The residual demand: P = PM − y = a+c
2 −y
The potential entrant's behaviour:
MCe = ∂TC
∂y =c
MRe = a+c
2 − 2 ye
MRe = MCe
a +c
2 − 2 ye = c
ye = a −c
4

Pe = a+c
2 − ye = a +c
2 − a 4−c = a + 3c
4 = c + a 4−c
π e = Pe ye − cye − F = ( Pe − c ) ye − F = ( c + a 4−c − c ) a 4−c − F = (
a −c )
2

16 −F
( a − c )2
Natural monopoly ⇔ π e < 0 ⇔ F > 16

38. (C)
π i = ( P − c ) yi − F = ( a − c − yi − y j ) yi − F
∂π i
∂yi = a − c − y j − 2 yi = 0 ⇒ yi = a −c
3

P = a − yi − y j = c + a 3−c

π i = ( P − c ) yi − F = ( c + a 3−c − c ) a 3−c − F = (
a −c )
2

9 −F
( a −c ) 2

Natural monopoly ⇔ π i < 0 ⇔ F > 9

39. (B)
Note that even though it isn't put in those terms, this is a Cournot model.
Q = y1 + y2 ⇒ P = 9 − y1 − y2
MC1 = 1 & FC1 = 0 ⇒ TC1 = y1
MC2 = 2 & FC2 = 0 ⇒ TC2 = 2 y2
π 1 = Py1 − y1 = ( 9 − y1 − y2 ) y1 − y1 = ( 8 − y2 ) y1 − y12
π 2 = Py2 − 2 y2 = ( 9 − y1 − y2 ) y2 − 2 y2 = ( 7 − y1 ) y2 − y22
∂π1
∂y1 = 8 − y2 − 2 y1 = 0 ⇒ y1 = 4 − 12 y2
∂π 2
∂y2 = 7 − y1 − 2 y2 = 0
7 − ( 4 − 12 y2 ) − 2 y2 = 0 ⇒ y2 = 2
y1 = 4 − 12 y2 = 4 − 12 ( 2 ) = 3
P = 9 − y1 − y2 = 9 − 3 − 2 = 4

40. (D)
Note that even though it isn't put in those terms, this is a Bertrand model. So in the
equilibrium, both firms set P=MC. Since MC=10, P=10, resulting in a quantity
demanded of 30 and each firm producing half of it (15).