Econ 301: Practice Problems for the Final Exam

This set of problems contains two sets of multiple choices problems and three
longer analytical problems.
You should also carefully study the Problems assigned in the Problem sets and
other problems in the textbook, particularly in chapters 6-10 covered after the
midterm, and some from chapter 12.

MULTIPLE CHOICE Set 1. Choose the one alternative that best completes the statement or answers the
question.
1) Which of the following events will cause a leftward shift in the supply curve of gasoline?
A) An improvement in oil refining
technology
B) A decrease in the price of gasoline C)
Decrease in the price of crude oil
D) An increase in the wage rate of refinery workers
E) all of the above

2) Which of the following statements about the diagram below is true? 2)

A) Demand becomes more inelastic as price declines.

B) Demand is completely inelastic.
C) Demand is infinitely elastic.
D) Demand becomes more elastic as price declines.
3)
3) The cross price elasticity of demand for peanut butter with respect to the price of jelly is 0.3. If we
expect the price of jelly to decline by 15%, what is the expected change in the quantity demanded for
peanut butter?
A) 4.5% B) 45% C) 4.5% D) 15%

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 4) Other things equal, expected income can be used as a direct measure of wellbeing
A) always. 4)
B) if and only if individuals are not risk loving.
C) if and only if individuals are risk neutral.
D) no matter what a person's preference to risk.
E) if and only if individuals are risk averse.

5) An examination of the production isoquants in the diagram below reveals that: 5)

A) capital and labor must be used in fixed proportions.

B) except at the corners of the isoquants the MRTS is constant.
C) capital and labor are perfectly substitutable.
D) Both B and C are correct.
E) none of the above
6)
6) The total cost of producing a given level of output is
A) minimized when the ratio of marginal product to input price is equal for all inputs.
B) maximized when a corner solution exists.
C) minimized when marginal product multiplied by input price is equal for all inputs.
D) minimized when the marginal products of all inputs are equal.

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 7) The short run supply curve for a competitive firm is
7)
A) its MC curve above the minimum point of the ATC curve.
B) its MR curve.
C) its entire MC curve.
D) upwardsloping portion of its MC curve above the minimum point of the AVC curve.
E) the upwardsloping portion of its MC curve.

8) Producer surplus in a perfectly competitive industry is: 8)

A) the difference between revenue and variable cost.
B) the difference between revenue and fixed cost.
C) the same thing as revenue.
D) the difference between revenue and total cost.
E) the difference between profit at the profit maximizing output and profit at the profit minimizing
output.
9) Consider the following three market baskets:

Food Clothing

A 15 18
B 13 19
C 14 17
If baskets B and C are on the same indifference curve, and if preferences satisfy
all four of the basic assumptions, then:
A) A is preferred to B. B) A is preferred to C.
C) Both A and B answer choices are correct. D) none of the above
10) To determine whether an increase in the price of gasoline results in a consumer
spending a larger share of their expenditure on gasoline we need to know
A) only the change in the price of gasoline
B) only how much money the consumer spends on gasoline before
the price change
C) only the change in the price of gasoline as a percentage of the original
price
D) only the own price elasticity of demand for gasoline
E) none of the above
11) Suppose the major soft drink companies develop vending machines for
canned and bottled drinks that can determine your maximum willingness to
pay for a drink, and the machine charges you that price when you purchase
a drink. If this were possible, the consumer surplus in the vended soft drink
market would be:
A) positive because the market demand curve is perfectly inelastic in this
case.
B) positive because consumer surplus equals consumer expenditures in this
case.
C) negative because people are not actually willing to pay their maximum
value for the product.
D) zero because all surplus value is captured by the seller.

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12) Steve knows average variable cost for every level of output. Which of the
following costs can she not determine given this information?
A) variable cost B) marginal cost C) the additional cost of increasing output
from 10 to 20 units D) fixed cost

13) Suppose the government raises the price of cheese above the market
equilibrium level (P0) by imposing a high minimum price and purchasing all of
the excess supply from the market, and these quantities are destroyed. Based
on the areas in the figure below, what is the change in consumer surplus after
this policy is adopted?

Price

A B D
E
P0 C

G F

D
Cheese

A) Consumers lose area A but gain area B. B) Consumers lose areas A and B.
C) Consumers gain areas A and B. D) Consumers lose area B.

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14) Is there a first mover advantage in the Cournot duopoly model with homogenous products?
A) Yes, first movers hold the advantage over other firms in this model.
B) No, the second mover would be able to set a slightly lower price and capture more market share.
C) No, first movers cannot choose a profit maximizing quantity because the second mover can always
produce a bit less and earn higher profits.
D) Yes, first movers always have an advantage, in every situation.

15) Consider the following payoff matrix for a game in which two firms may attempt to collude:
Firm B competesFirm B colludes

Firm A competes 6,6 24,0

Firm A colludes
0,24 12,12

Here, the possible options are to retain the collusive structure (collude) or to increase try increase
market share (compete). The payoffs are stated in terms of millions of dollars of profits earned per
year. What is the Nash equilibrium for this game?

A) B competes and A colludes. B) Both firms compete

C) Both firms collude. D) A competes and B colludes.

16) Jack's utility of income function is U= log(I), where I represents income. From this information you can
say that
A) Jack is risk loving.
B) Jack is risk averse.
C) Jack is risk neutral.
D) We need more information before we can determine Jack's preference for risk.

17) Suppose your firm has a U-shaped average variable cost curve and operates in a perfectly
competitive market. If you produce where the product price equals average variable cost (on the
upward sloping portion of the AVC curve), then your output will: A) exceed the profit maximizing
level of output.
B) generate zero economic profits.
C) equal the profit maximizing level of output.
D) be smaller than the profit maximizing level of output.

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 Figure 9.1

18) Refer to Figure 9.1. Suppose the market is currently in equilibrium. If the government establishes a price
ceiling of $20, producer surplus will
A) rise by $300.
B) fall by $300.
C) rise by $200.
D) fall by $200.
E) remain the same.

Figure 9.3

19) Refer to Figure 9.3. If the government establishes a price ceiling of $1.00, the transfer of surplus from producers
to consumers will be:
A) $400. B) -$150. C) $250. D) $300. E) $200.

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20) . A monopolist faces the following demand curve and total cost for its product:
Q =200- 2P, TC = 5Q. What level of output maximizes total revenue?
A) 90
B) 0
C) 100
D) 95
E) none of the above

(21)The production function for earthquake detectors (Q) is given as follows:

Q= 4K1/2 L1/2 where K is the amount of capital employed and L is the amount of labor employed. The price of capital, PK, is
$18 and the price of labor, PL, is $2. Suppose that you receive an order for 60 earthquake detectors. How much labor will
you use to minimize the cost of 60 earthquake detectors?

A) 45
B) 10
C) 5
D) 1
E) none of the above

Scenario 8.2:
Yachts are produced by a perfectly competitive industry in Dystopia. Industry output (Q) is currently 30,000 yachts per year.
The government, in an attempt to raise revenue, places a $20,000 tax on each yacht. Demand is highly, but not perfectly,
elastic.

(22) Refer to Scenario 8.2. The result of the tax in the long run will be that
(A) Q falls from 30,000; P rises by less than $20,000.
(B) Q stays at 30,000; P rises by less than $20,000.

(C) Q stays at 30,000; P rises by $20,000.

(D) Q falls from 30,000; P rises by $20,000.

(E) Q falls from 30,000; P does not change.

24)Refer to Scenario 8.2. The more elastic is demand for yachts,

(A) the less Q will fall and the less P will rise.
(B) the closer is the new equilibrium point to the old.
C) the more Q will fall and the less P will rise.
D) the less Q will fall and the more P will rise.
E) the more Q will fall and the more P will rise.

(23). For national security reasons a government decides that all of its base metal industry should not be
located in the same geographical region, as it presently is. The government decides to allocate
production quotas to firms in different parts of the country, but does not restrict in any way the
transactions between consumers and base metal producers. This scheme is
a. efficient as consumers still buy from whoever they like
b. efficient as those consumers who value base metals the most value them
c. likely to be inefficient as some of the industry's output is not produced by the firms with the lowest
cost
d. likely to be inefficient as the scheme will require subsidies to work
e. efficient as learning by doing effects will be strongest in the firms set up in new geographical
regions

Monopoly Problems

M1). Why for a monopoly, marginal revenue is less than price?

M2). If the inverse demand function for a monopoly's product is p = 100 - 6Q, what is the firm's marginal
revenue function ?

M3). If the inverse demand curve a monopoly faces is p = 30 - 2Q, and MC is constant at 2, then what
quantity is profit maximizing for the monopoly?

M4). A monopoly incurs a marginal cost of $1 for each unit produced. If the price elasticity of demand at the
monopoly optimum equals –1.5, what price should monopoly charge to maximize its profits?

M5). A monopoly sets a price of $25 per unit for an item that has a marginal cost of $10. Assuming profit
maximization, what is the demand elasticity?

M6). If the inverse demand curve a monopoly faces is p = 30 - 2Q, and MC is constant at 2, then what is the
deadweight loss from monopoly?

M7). Why does this cost function suggests a natural monopoly? TC = 500 + 5Q

M8) What is the justification for patents giving an inventor a monopoly for a product?

(M9) John Gardner is the city planner in a medium sized city. The city is considering a proposal to award an exclusive
contract to Clear Vision, Inc., a cable television carrier. Mr. Gardner has discovered that an the demand in the city and C,,
and total cost of Clear Vision are equal to: P= 28- 0.0008Q and TC= 120,000 + 0.0006Q 2

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where Q the number of cable subscribers and P the price of basic monthly cable service. Mr. Gardner knows relatively little
economics and has hired you to answer the questions listed below.

a. What price and quantity would be expected if the firm is allowed to operate completely unregulated?
b. Mr. Gardner has asked you to recommend a price and quantity that would be socially efficient. Recommend
a price and quantity to Mr. Gardner using economic theory to justify your answer.
Compare the economic efficiency implications of (a) and (b) above. Your answer need not include numerical calculations, but
should include relevant diagrams to demonstrate deadweight loss.

Answer Key to Multiple Choice Questions.

1) D
2) A
3)C
4)C
5) D
6) A
7) D
8) A
9) C
10) D
11) D
12) D
13) B
14) A
15) B
16) B
17) A
18) B
19) E
20) C
(22) A
(23) A
(24) C
(25) C

Answers to Monopoly Problem:

(M1) because the marginal revenue of a monopoly, P(Q)+P’(Q)Q has a term negative term P’(Q)Q<0 which measures the
decrease in revenue from a reduction in price due to an increase in ouput.
(M2) 100-12Q
(M3) 7 units
(M4) 3
(M5) -1.67
(M6) 49
(M7) the average cost is decreasing.
(M8) if there is not patent protection, firms would not invest in R&D and the product would not be invented
(M9)
(a) Without regulation we would expect the firm to behave as a monopolist, equating MR and MC.
28- 0.0016Q= 0.0012Q
Q = 10,000
P = 28 - 0.0008(10,000)
P = $20

(b) Microeconomics suggests that price should be equal

to MC to achieve allocative efficiency.
P=28- 0.0008Q
MC= 0.0012Q
28 - 0.0008Q = 0.0012Q
28 = 0.002Q
Q = 14,000
P =28 - 0.0008(14,000)
P = 28 - 11.20= 16.80
(c ) In (a), the price is higher ($20 as opposed to $16.80), and quantity lower (10,000 as opposed to 14,000).
The monopolist's higher price and smaller quantity result in a deadweight loss as shown below.

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Analytical Problems. Three shorter problems where you need to carefully derive
answers and explain them are provided below.

Problem I Estimated demand in the world oil market is given by QD = 25.2 - 0.225P, where P is measured in
$/bl and Q in bb/yr (billions of barrels per year). Supply in the oil market has two components. The first is
"competitive" supply which has been estimated to follow the equation QS = 5.4 + 0.15P. The second is the
OPEC cartel.

A. Suppose the OPEC cartel is inactive (producing zero). Find the market equilibrium values of P and Q.

B. Now suppose the supply behavior of the OPEC cartel is as follows: the various members of the cartel
decide on a total quantity, Q0, to be produced by OPEC and supplies this quantity to the market on a
completely inelastic basis.
How does such OPEC behavior affect P, QS and total quantity in the market equilibrium compared to part A?.
C. Suppose Q0 = 12 bb/yr. Find the market equilibrium P, QS and total equilibrium quantity.
D. Answer the question in part C) when OPEC cuts Q0 back to 6 bb/yr.
E. Describe the impact of the OPEC behavior in (C) and (D) on buyers and "competitive" suppliers.

Problem II

All sugar cane growers in Hawaii have the following cost function both in the long-run and short-run
(regardless of how many of them there are): C(x)=18+(1/2)x2 . (Notice that 18 is the fixed cost.) The demand
function is D(p)=180-10p.

a) Find each firm’s short run supply function. Suppose that there are eight firms. Find the short-run
equilibrium price and quantity.

b) Find the long-run competitive equilibrium price in the market, per firm output, industry output, and
number of firms.

c) Consider the long-run equilibrium you found in b). Suppose that the demand increases to: D(p)=210-
10p. First, find the new short-run equilibrium price and quantity. Also find the long-run equilibrium
price, per firm output, industry output, and number of firms.

Problem III.

Firm ``Trio’’’ produces widgets using capital and labor according to the following production
function q=K 1/4 L ½ . Trio also has a fixed cost FC=1000. The rental rate for capital is r= 40
The wage rate is w=10. Derive Trio’s total cost function.
Solution to Problem I.

A. With Q0 = 0, market equilibrium is given by P and Q satisfying QD = QS. First, we solve for P:

25.2 - .225P = QD = QS = 5.4 + .15P

19.8 = .375P
=> P = 19.8/.375 = 52.8 $/bl
and, plugging this P into the QD equation (or QS)
Q = 25.2 - .225 (52.8)
= 13.32 bb/yr

B. Because OPEC supplies affixed quantity Q0 at any price, the total market supply is given by
Q0+QS(P). So QS(P) simply shift horizontally by Q0 to the right.

Thus, OPEC behavior moves the market equilibrium from point A to point B. This means that:

(i) P declines. The greater Q0 is, the greater the decline in P.

(ii) QS declines (see point C). OPEC sells Q0, and, at the lower resulting market price, QS is smaller. The
greater Q0 is, the greater is the decline in QS.

(iii) total quantity (QS + Q0) rises. The greater Q0 is, the greater the rise in total quantity.

C. Total supply is now QS + Q0. Thus, to find market equilibrium price, we solve for P:
QD = QS + Q0
25.2 - .225P = 5.4 + .15P + 12
7.8 = .375P
P = 20.8 $/bl,
Competitive quantity supplied is:
QS = 5.4 + .15(20.8) = 8.52 bb/yr,
Total quantity supplied is
QS + Q0 = 20.52 bb/yr.

D. For Q0 = 6, we repeat the steps in C to find

P = 13.8/.375 = 36.8 $/bl
QS = 10.92 bb/yr
QS + Q0 = 16.92 bb/yr

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E. For buyers, we see that as OPEC cuts back on Q0, from 12 bb/yr in C) to 6 bb/yr in D), the market
price rises and the total quantity purchased by buyers declines. Thus, restrictive OPEC supply impacts
negatively on buyers.

For "competitive" suppliers, OPEC cutbacks push up P, and QS rises. Thus, restrictive OPEC supply allows
"competitive" suppliers to sell a greater quantity at a higher price.

Solution to Problem II
1
C( X )=18+ X 2
2
The $18 is a fixed cost. Therefore, if the firm decides to shut down in the long-run the fixed costs are in fact
zero.

D( P)=180−10 P

VC ( X ) X
AVC ( X )= =
a) X 2
∂ C( X )
MC ( X )= =X
∂X
Clearly, the minimum of AVC ( X ) obtains at X=0.

The short-run supply function of an individual firm is then given by:

S i ( P )=P When P>0
To obtain the industry supply we have to add up the 8 individual firms’ supply:
S ( P)=8 P
¿ ¿
S ( P )=D( P )
¿ ¿
8 P =180−10 P
¿ ¿
P =10 ( P >6 )
¿
X =80
Each firm produces 10 units.

b) First, let us compute the long-run supply curve for each firm.
∂ ATC ( X )
∂X ( )
18 1
= − 2 + =0
X 2
, the solution to which is X =6
Notice that when X =6 , MC ( X )=ATC ( X )=6 . The long run supply function of an individual firm is then
given by:

{
SLR i ( P)= 0 if P<6
P if P≥6
Note, when P=6 , both X =0 and X =6 will yield a profit of zero. To obtain the industry supply we have
to add up the 8 individual firms’ supply:

SLR (P )= {0 if P<6
8 P if P≥6

In the long run, firm’s profit is always zero.

¿
Since firm’s profit becomes zero at P=6, PLR =6 . It is clear from a).
¿
PLR =6
¿ ¿
X LR =D( P LR )=180−10⋅6=120
Each firm i produces

.
Therefore, there exists the following number of firms at long run equilibrium.
¿
¿
X LR 120
N LR = = =20
Xi 6
¿

LR
c)
-Short run equilibrium-
There are 20 firms, so the short-run supply function is given by

S ( P)= {200P if
if
P<6
P≥6
^
S( P)=D( P^ )
^
20 { P=210−10 ^  P=7
{ P¿¿ ^
X^ =210−10⋅7=140  X^ =7

-Long run equilibrium-

The new long-run equilibrium is characterized as follows:
The same argument can be applied again. In the long run, firm’s profit is always zero.
¿
Since firm’s profit becomes zero at P=6, PLR =6 .
¿
PLR =6
X i =6¿

LR
Since the demand increases, there are more demand even under the same long-run equilibrium price.
¿ ¿
X LR=D( P LR )=210−10⋅6=150
¿
¿
X LR 150
N LR = = =25
Xi ¿ 6
LR
Five firms will enter this industry.

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 Solution to Problem III

For each q, Trio must find the combination of inputs K*(q) and L*(q) which solve the following problem:

min w L + rK
such that q=K 1/4 L ½

Then Trio’s cost function is C(q)= rK*(q) + wL*(q)+ FC

With w=10 and r=40 and FC=100, this problem becomes:

min 10 L +20K
such that q=K 1/4 L ½
We know that the optimality condition for the choice of inputs K* and L* is
MPL/MPK=w/r which becomes MPL/MPK=10/40=0.5 when w=10 and r=40,
where MPL is the marginal product of labor and MPK is the marginal product of capital.
We compute MPL by differentiating the production function K 1/4 L ½ with respect to L to obtain:
MPL =0.5 K 1/4 L -1/2
MPK,the marginal product of capital, is computed by differentiating the production function K 1/4
L ½
with
respect to K to obtain: MPK =0.25 K -3/4 L ½
Now, we can simplify: MPL/ MPK=(0.5 K 1/4 L -1/2)/( 0.25 K -3/4 L ½)=2K/L

Next, we equate the ratio of marginal products to w/r=10/40=1/4 to get: 2K/L =1/4 or L=8K. This is the
optimal capital/labor ratio which we can now use to complete the derivation of the cost function as follows:
Instead of L, put 8K into the production function to get: q=K 1/4 (8K) ½
This can be simplified to give us: q=81/2 K 3/4
Now we can solve this to get K in terms of q obtaining the optimal K*(q):
K*(q)=q4/3/((81/2 )4/3)=q4/3/82/3= q4/3/4
Now, we can use the L=8K, to get L*(q)=2 q4/3
With K*(q) and L*(q) computed, we now obtain our cost function:
C(q)=10L*(q)+40K*(q)+FC= 10*2 q4/3+ 40*q4/3/4+1000=30 q4/3+1000.