By Russell Richardson,2014-06-28 21:51
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    SPRING 2007

    PART I: MULTIPLE CHOICE (3 pts each; 36 points in total)

1. Which of the following will lead to a shift in the supply of Florida oranges? Assume that orange is normal good.

    I. A severe frost in California, the other major orange-supplier state

    II. An increase in households’ income

    III. Decrease in the price of oranges

    a) I and III

    b) III only

    c) II and III

    d) II only

    e) None of the above

2. An inferior good

    a) is a giffen good

    b) has a demand curve that shifts rightward when income rises

    c) has a demand curve that shifts leftward when income rises

    d) has a demand curve that shifts rightward when income rises and is perfectly inelastic.

3. When a consumer's marginal rate of substitution of good X for good Y exceeds the ratio of the price of X to the price of Y,

    a) the marginal utility per dollar expenditure on good X exceeds the marginal utility per dollar expenditure on good Y.

    b) the consumer is maximizing total utility.

    c) the consumption bundle chosen by the consumer lies along the price consumption curve.

    d) the total utility obtained from the consumption of good X exceeds the total utility obtained from the consumption

    of good Y.


    4. As an economist you are asked to observe the market for Sudafed tablets. You know that 10,000 tablets sell for $3.00 each. Suppose that consumers realize that Sudafed is far tastier after they cook it, causing an increase in demand. The market now sells 12,000 tablets for $5.00 each. The arc elasticity of demand is

    a) 4/11

    b) 11/4

    c) 1/1000

    d) 1000

    e) Cannot be determined

    5. Jane maximizes her utility by consuming 1 glass of wine and 5 bottles of beer. If beer sells for $1 and wine for $3, Jane’s marginal utility for consuming one more bottle of beer is

    a) 1/3 of the marginal utility from consuming an extra glass of wine

    b) 1/5 of the marginal utility from consuming an extra glass of wine

    c) the same as that from consuming an extra glass of wine

    d) 5 times as high as the marginal utility from consuming an extra glass of wine.

    6. A perfectly competitive firm operating in the short-run faces a market price for its product of $20 and is able to hire its workers at $10 per hour. The firm will hire labor until the marginal product of labor is

    a) 200.

    b) 2.

    c) 1/2.

    d) 5.

    e) None of the above.

    7. Suppose a lubricant plant is producing a new form of highly slick lubricant. If the marginal private cost is equal to the marginal social cost (the sum of the marginal cost to the firm and society), then the marginal external cost

    a) equals the MSC

    b) equals the MC of the firm

    c) is zero

    d) depends on the amount of lubricant that society enjoys.

8. The budget line shows

    a) the combination of goods which can be purchased by an individual who has a particular income regardless of


    b) all combinations of goods which satisfies the individual equally well.

    c) all combinations which satisfy the individual equally well at given prices and income level.


    d) which combinations of goods can be purchased by an individual with a particular income with prices of the goods


9. Which of the following corresponds to the economic concept of rent?

    a) The monthly payment made by a renter for his apartment.

    b) The payment to a factor of production over and above its opportunity cost.

    c) The difference between the marginal revenue product of a factor and what it is paid.

    d) The excess paid to a factor of production over and above his marginal revenue product.

10. The key characteristics of oligopoly is interdependence, that is

     a) each oligopolist formulates its pricing policies with the effect on its rival in mind.

     b) there are important external diseconomies in an oligopolistic market.

     c) there is inevitable collusion among producers.

     d) within each product group, each oligopolist's product is identical.

11. A physical examination is a good screening device for life insurance companies if

    a) doctors can easily be bribed to write a good report.

     b) one’s current state of health is a good predictor of life expectancy.

    c) medical history is a good predictor of life expectancy.

     d) life-threatening diseases are usually undetected.

PART II: TRUE/FALSE (16 points in total)

For each question in this part, please clearly state your reasoning. Only “true” or “false” will

    not receive any credits, even though your answer is correct.


12. (4 pts) A consumer is determining whether to buy a bottle of wine from a new vineyard in the Napa Valley. The bottle of

    wine costs $100. If the vineyard becomes world-famous, the bottle will rise in value to $800. If the vineyard turns out to be

    full of bad grapes, the bottle falls in value to $50. A risk-loving individual will buy the bottle.


13. (4 pts) Adverse selection occurs when a transaction encourages undesirable behavior.

14. (8 pts) A plant is causing $200 of pollution damages to households and it can eliminate the damages by

    installing a filter at a cost of $100, while it would cost households $150 to protect themselves. Then, according to

    the Coase Theorem, it will always be more efficient for the polluter to be held liable for pollution damages.


PART III: PROBLEMS (148 points in total)

15. (5 points) Suppose the demand curve for Urinetown, the Rice University musical, is P=20-2Q and the supply is P=5+Q. DS

a) (2 points) Determine the equilibrium price per ticket __________ and the quantity of tickets sold____________.

b) (3 points) Suppose the University finds out that most of the students can not afford the ticket price (students are sneaking

    in through the side doors) and places a per unit subsidy of $3 on the tickets. Calculate the consumer surplus___________,

    producer surplus____________, and the total amount of the subsidy____________.


16. (6 points) The auto industry in Toontown consists of 6 firms each having the following annual sales:

    Firms Annual Sales

    (million $)

    Batmobile 200

    Scubido 125

    Honk-Honk 100

    Mach 5 40

    Speed Buggy 25

    Residual Inc. 10

    Total Industry Sales 500

     a) (3 pts) This industry is best classified as a (Circle the best alternative.)

     (i) Competitive industry.

     (ii) Monopolistically competitive industry.

     (iii) A pure monopoly

     (iv) An oligopoly.

     (v) A monopsony.

     b) (3 pts) What is the three firm concentration ratio?


    17. (13 points) The diagram below shows the demand curve facing a firm in a monopolistically competitive industry and its

    average total cost curve.





     a) (2 pts) How much output will the firm produce? (Draw in any other curves that you need.) Label this quantity Q 0

    on the graph.

     b) (3 pts) Is the firm in long-run equilibrium? Why or why not?

     c) (3 pts) By what process will the firm (and industry) achieve long run equilibrium?

     d) (2 pts) What are the long-run equilibrium price (p) and output (q) for this firm? Denote them in the diagram. LL

     e) (3 pts) Compare your answer for (d) to the characteristics of the equilibrium in perfectly competitive market.


18. (8 pts) Middleville, Arkansas has only 2 movie theaters, Toones and Peegee. Each theater considers whether or not to

    advertise in the town newspaper. If neither theater advertises, each earns $30 per day in profits. If both advertise, they earn

    $25 each per day. If only one advertises, that theater earns $40 and the other gets $15. The profits resulting from the two

    theaters' strategies (A, NA) are as follows:


    NA A

    NA30, 30 15, 40


    40, 15 25, 25A

    a) (4 pts) Find the Nash equilibrium of this game.

    b) (4 pts) Explain why this is the outcome.


19. (13 pts) Levin has $120,000 in wealth and has just inherited a farm from a distant relative. He knows that there is a 25%

    risk of drought, in which case the farm would cause him a loss of $20,000. If there is no drought, the farm will bring $80,000.

    The figure below shows Levin’s utility from different levels of wealth.

    a) (2 pts) What is the expected value of the farm?

    b) (2 pts) What is Levin’s expected utility from keeping the farm?

    c) (2 pts) Anna lives close to this farm and is thinking about running it. If she offers Levin $30,000 for the right to

    run the farm, would Levin accept her offer?


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