Microeconomic FRQ’s
2008
1. Callahan’s Orchard grows apples and operates in a constant-cost, perfectly competitive industry. Callahan’s Orchard is
currently in long-run equilibrium.
a. Draw correctly labeled side-by-side graphs for the apple market and Callahan’s Orchard, and show each of the
following.
i. Market output and price, labeled as “Qm” and “Pm”, respectively.
ii..Callahan’s output and price, labeled as “Qf” and “Pf”, respectively.
b. Now assume that the government provides farm support to apple growers by granting an annual lump-sum subsidy to
all apple growers. Indicate the effect the subsidy would have on each of the following in the short run.
i. Callahan’s quantity of output. Explain.
ii. Callahan’s profit
iii. The number of firms in the industry
c. Indicate how each of the following will change in the long run as a result of the lump-sum subsidy.
i. the number of firms in the industry
ii. Price
iii. Industry output
Scoring guidelines and answers
a.
P
S
P
ATC
MC
Pm
Pf
D=MR
D
Qm
Quantity
Qf
Quantity
a. 4 pts. – 1 for correctly labeled graph; 1 for showing that Pm=Pf; 1 for showing that ATC is tangent to Pf and MR; 1 for Qf where MR
= MC
b. 4 pts. – 1 for concluding that subsidy will have no effect on output; 1 for saying that subsidy won’t affect MR or MC; 1 for saying that
profit will increase; 1 for saying that the number of firms won’t change
c. 4 pts. – 1 for saying the # of firms will increase; 1 for saying that the short-run profits will attract new firms; 1 for saying price will
fall; 1 for saying output will increase
2. Utility and price elasticity of demand are important concepts in explaining consumer behavior.
a. Define marginal utility
b. The table below shows the quantities, prices, and marginal utilities of 2 goods, fudge and coffee, which Mandy
purchases.
Fudge
Coffee
Quantity of purchase
10 pounds
7 pounds
Price per pound
$2
$4
Marginal utility of last pound
12
20
Mandy spends all her money and buys only these 2 goods. In order to maximize her utility, should Mandy purchase
more fudge and less coffee, purchase more coffee and less fudge, or maintain her current consumption? Explain.
c. Assume that consumers always buy 20 units of good R each month regardless of its price.
i. What is the numerical value of the price elasticity of demand for good R?
ii. If the government implements a per-unit tax of $2 on good R, how much of the tax will the seller pay?
Scoring guidelines and answers
a. 1 pt – defining marginal utility as the additional satisfaction received from consuming an additional unit of a good or service.
b. 2 pts. – 1 for saying Mandy should purchase more fudge and less coffee; 1 for saying that the per dollar marginal utility for fudge is
greater than the per dollar MU for coffee
c. 2 pts. – 1 for saying price elasticity of demand for good R is zero; 1 for saying that none of the tax would be paid by the seller or that
all would be paid by the buyer
3. Social efficiency is affected by government policy and the structure of markets.
a. For a competitive market for which there is a binding (effective) price ceiling, draw a correctly labeled graph and
label the price ceiling “Pc”, the quantity sold “Qa”, and the socially efficient output “Qb”.
b. The graph below shows a natural monopoly.
P
P6
A
P5
P4
P3
P2
P1
B
Marginal cost
C
D
E
F
Q1
Q2 Q3
Average Total Cost
Demand
Q4
Quantity
i. Using the labeling in the graph, identify each of the following.
1. The profit-maximizing output
2. The socially efficient ouput
ii. At the socially efficient output, is the monopoly making a profit or incurring a loss? Using the labeling on
the graph, identify the area of profit or loss.
Scoring guidelines and answers
P
S
P
Pc
Qa Qb
Quantity
a. 3 pts. – 1 for correctly labeled supply and demand graph w/ a price ceiling located below market equilibrium; 1 for labeling Qa and 1
for labeling Qb
b. 4 pts – i. 1 for identifying Q1 as the profit-maximizing output; 1 for identifying Q3 as the socially efficient output
ii. 1 for recognizing that at Q3, the monopolist incurs a lost; 1 for identifying the area of loss – P1P3DF
2007
1.
A patent gives inventors the exclusive right to produce and market a product for a period of time. GCR Company is a profitmaximizing firm. It has a patent for a unique antispyware computer program called Aspy.
a. Assume that GCR is making economic profit. Draw a correctly labeled graph and show the profit-maximizing price and
quantity.
b. Assume that the government imposes a lump-sum tax on GCR.
i. What will happen to output and market price? Explain
ii. What will happen to GCR’s profits?
c. Assume instead that the government grants a per-unit subsidy to GCR for Aspy.
i. What will happen to output and market price? Explain.
ii. What will happen to GCR’s profits?
d. Now assume that GCR’s patent on Aspy expires. What will happen to GCR’s economic profits in the long run?
Explain.
Scoring guidelines and answers
P
MC
ATC
P*
MR
a.
b.
c.
d.
D
Q*
Q
4 pts. – 1 for correct graph; 2 for profit-maximizing Q and P where MR = MC; 1 for showing that P>ATC at Q*
3 pts. – 2 – profit-maximizing P and Q will not change b/c a lump-sum tax doesn’t affect MC. It would only affect ATC, shifting
it upward. 1 pt. for saying that profits will decrease
3 pts. – 2 – Q increases and P decreases b/c MC curve shifts down (to right) – subsidy makes it cheaper to produce b/c it gives
producers $$$ for each one they produce; 1 pt. for saying profits will increase
2 pts –profits will fall in the long-run b/c new firms will enter the market
2.
# of unskilled workers
Quantity of radios
hired
produced (per day)
0
0
1
20
2
45
3
60
4
70
5
75
6
79
7
80
Assume that HZRad Company produces clock radios as shown in the short-run production function in the table above. HZRad can sell all
the clock radios it produces at a market price of $20 each and can hire all the unskilled labor it needs at a wage of $90 per day per worker.
Assume also that labor is the only variable input.
a. Using the specific information above, draw a correctly labeled graph of HZRad’s current supply curve for unskilled labor.
b. What is HZRad’s profit-maximizing output level? Explain.
c. Suppose that HZRad is the 1st company to use a new technology that increases the productivity of its unskilled workers.
i. How will the new technology affect the quantity of labor HZRad hires? Explain.
ii. How will the new technology affect the wage paid to HZRad’s unskilled workers?
Scoring guidelines and answers
Wage
rate
90
SL
Q of workers
a. 1 pt for graph – horizontal supply curve at $90 wage rate & correctly labeled axes
b. 2 pts – 1 for identifying profit-maximizing output as 75 (or between 75 and 79) – profits are maximized where MR=MC; the MC of
the 5th worker is $90; the MR from the 5th worker is 5 units x $20 = $100; the MC of the 6 th worker is $90 but the MR = 4 units x $20 =
$80. So 5 workers should be hired, producing 75 units. The marginal revenue product for the 5 th worker is greater than $90 but the MRP
for the 6th worker is less than $90.
c. 3 pts – 2 – Quantity of workers hired will increase b/c marginal product of labor increases at each input level OR D curve for labor
shifts to right; 1 pt – wages remain constant
3. Two bus companies, Roadway and Rankin Wheels, operate a route from Greensboro to Spring City, transporting a mix of passengers
and freight. They must file their schedules with the local transportation board each year and cannot alter them during that year. Those
schedules are revealed only after both companies have filed. Each company must choose between an early and a late departure. The
relevant payoff matrix appears below, with the first entry in each cell indicating Roadway’s daily profit and the second entry in each cell
indicating Rankin Wheels’ daily profit.
Rankin Wheels
Early
Late
Roadway --Early
$1000; $900
$950; $850
Roadway – Late
$750; $650
$700; $800
a. In which market structure do these firms operate? Explain.
b. If Roadway chooses an early departure, which departure time is better for Rankin Wheels?
c. Identify the dominant strategy for Roadway.
d. Is choosing an early departure a dominant strategy for Rankin Wheels? Explain.
e. If both firms know all of the information in the payoff matrix but do not cooperate, what will be Rankin Wheels’ daily
profit?
Scoring guidelines and answers
a. 1 pt – market is an oligopoly b/c there are only 2 firms and their actions are mutually interdependent
b. 1 pt. – early departure
c. 1 pt – Roadway’s dominant strategy is early departure since, regardless of Rankin’s departure time, Roadway makes more $$ w/
an early departure
d. 2 pts. – early departure is NOT a dominant strategy for Rankin b/c, if Roadway chooses a late departure, Rankin is better off
choosing a late departure.
e. 1 pt. -- $900 – both firms have an incentive to adopt an early departure strategy; it is Roadway’s dominant strategy as they’re
better off w/ early no matter what; therefore, since it is in Roadway’s interest to depart early, Rankin knows they will make more
profit by also departing early b/c they’ll make $900 rather than $850
2006
P
P6
P5
P4
P3
P2
P1
Marginal Cost
Average Total Cost
Key – P6, Q1 – ATC = MR
P5, Q2 – MR = MC
P4, Q3 – MC = D
P3, Q4 – ATC = MR
P2, Q5 – ATC = D
P1, Q6 – MC = MR
Demand
0
Q1Q2 Q3Q4Q5 Q6
Q7
Attendance
Marginal Revenue
1. There is one art museum on the island of Watsonia. The museum’s demand and cost curves are shown in the graph above. The
museum currently relies on an admission charge for some of its funding. Its directors are debating about how to set the admission charge.
a. Using the labeling of the graph above, identify the price and quantity associated with the following objectives.
i. The museum maximizes its profit
ii. The museum maximizes its total revenue
iii. The museum maximizes the sum of consumer and producer surplus
iv. The museum maximizes its attendance, as long as it breaks even.
b. When the attendance is Q1, is the demand price elastic, inelastic, or unit elastic? Explain.
c. Assume that the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s
accounting profits would be positive, negative, or zero. Explain why.
d. Assume that the government decides the museum should charge no admission and agrees to subsidize the museum for any
losses.
i.
Using the labeling in the graph, identify the museum’s attendance under that circumstance.
ii.
Would the outcome be allocatively efficient? Explain.
Scoring guidelines and answers
1. a. 4 pts.
i.
P5, Q2
ii.
P3, Q4
iii.
P4, Q3
iv.
P2, Q5
b. 2 pts. – demand is elastic at Q1 b/c MR > 0 OR Q1 is to the left of the midpoint OR Q1 is in the upper half of the demand
curve
c.
d.
2.
2 pts. – accounting profits are positive b/c economic profits are 0, opportunity costs are present and economic profits =
accounting profits – opportunity costs
3 pts – Q7, the outcome is not allocatively efficient b/c MC > B or MSC > MSB
Short-run total cost function
Quantity produced
Total Cost in dollars
0
20
1
27
2
38
3
53
4
72
5
95
6
122
The table above gives the short-run total cost function for a typical firm in a perfectly competitive industry.
a. What is the dollar value of the firm’s total fixed cost?
b. Calculate the marginal cost of producing the first unit of output.
c. If the price the firm receives for its product is $20, indicate the firm’s profit-maximizing quantity of output and explain
how you determined your answer.
d. Given your results in part (c), explain what will happen to the number of firms in the industry in the long run.
e. Assume that this firm operates in a constant-cost industry and has reached long-run equilibrium. If the government
imposes a per-unit tax of $2, indicate what will happen to the firm’s profit-maximizing output in the long run.
Scoring guidelines and answers
2. a. TFC = $20
b. MC for the first unit = $7
c. 2 pts. – profit maximizing output = 4 units (or between 4 and 5 units) b/c MR > MC for all units until Q = 5
d. 2 pts. – number of firms will increase b/c profits will cause new firms to enter the industry
e. there is no change in the profit-maximizing output
P
Supply
Pe
Demand
0
Qe
3.
Quantity of Land for residential development (acres)
The supply and demand for land for residential development is shown in the diagram above. The land supplied for such
development comes from privately held open-space land or privately held farmland.
a. Redraw the graph above and show how an increase in income will affect the equilibrium price and quantity of land
converted into residential development, assuming that land for residential development is a normal good.
b. Redraw the graph above and show how a decrease in government per-unit subsidies to farmers will affect the
equilibrium price and quantity of land converted into residential development.
c. Assume that the conversion of open-space land and farmland imposes costs on the general population, which can no
longer enjoy the scenic vistas.
i. Indicate whether the marginal social cost of converting land is greater than, less than, or equal to the marginal
private cost of converting land.
ii. Explain whether the private market quantity of land converted into residential development is socially optimal.
Scoring guidelines and answers
3. 2 pts. – a. 1 for rightward shift of the demand curve, equilibrium price and quantity increases
b. 2 pts. – rightward shift of supply curve, equilibrium price decreases and quantity increases
c. 2 pts. – MSC > MPC, the conversion of land to residential development is not socially optimum b/c MSC > MSB
2005
1. Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry that is in long-run
equilibrium.
a. Draw correctly-labeled side by side graphs for the dairy market and for Bestmilk showing the following: price and output for the
industry and price and output for Bestmilk.
b. Assume that milk is a normal good and consumer income falls. Assume that Bestmilk continues to produce. On your graph in part a,
show the effect of the decrease in income on each of the following in the short-run: price and output in the industry, price and output for
Bestmilk, area of loss or profit for Bestmilk.
c. Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short-run?
d. Assume that the industry adjusts to a new long-run equilibrium. Compare the following between the initial and the new long-run
equilibrium: price in the industry, output of a typical firm, the number of firms in the dairy industry.
Scoring guidelines and answers
MC
P
S
ATC
P
P1
P2
P1
MR1
P2
MR2
ATC intersects MR1
at ATC’s minimum;
line from q2 intersects
ATC; shaded area
represents loss
following D decrease
D1
D2
Q2 Q1
Q
q2
q1
Q
INDUSTRY
BESTMILK
a. 4 pts. – 1 for graph of industry, 1 for industry P & Q, 1 for horizontal D for Bestmilk, 1 for equilibrium Q where P=MC=ATC.
b. 4 pts. – 1 for decrease in D, 1 for decrease in market (industry) P and Q, 1 for change to new lower profit-maximizing P and Q for
Bestmilk, 1 for shading the area of loss for Bestmilk
c. 1 for stating that P>AVC, or TR>TVC, or stating that losses are less than total fixed costs
d. 3 pts. – 1 for stating that price returns to original long-run equilibrium price, 1 for stating that output of a typical firm returns to
original profit-maximizing quantity, 1 for stating that there is a decrease in the # of firms.
Supply + tax
P
13
12
A
B
Supply
C
F
G
D
Demand
11
E
10
80
100
Q
2. The graph above shows the market for a good that is subject to a per-unit tax. The letters in the graph represent the enclosed areas.
a. Using the labeling on the graph, identify each of the following: equilibrium price and quantity before the tax, area representing
consumer surplus before the tax, area representing producer surplus before the tax.
b. Assume that the tax is now imposed. Based on the graph, does the price paid by the buyers rise by the full amount of the tax? Explain.
c. Using the labeling on the graph, identify each of the following after the imposition of the tax: net price received by the sellers, amount
of tax revenue, area representing consumer surplus, area representing deadweight loss.
Scoring guidelines and answers
a. 3 pts. – 1 pt. for P = $12 and Q = 100 units; 1 pt. for identifying consumer surplus before the tax (CS = A+B+C+F); 1 pt. for
identifying producer surplus before the tax (PS = D+E+G = $100)
b. 2 pts. – 1 pt. for stating that the price paid by the buyers does not increase by the full amount of the tax; 1 pt. for correct explanation: P
increases by $1 and the tax is $2 per unit.
c. 4 pts. – 1 pt. for identifying the net price received by the sellers, $11; 1 pt. for identifying the tax revenue, B+C+D or $160; 1 pt. for
identifying consumer surplus, A; 1 pt. for identifying deadweight loss, F+G or $20.
3. P&L is a profit-maximizing shirt manufacturing firm. The firm can sell all the shirts it can produce to retailers at a price of $20 each.
P&L can hire all the workers it wants at a market wage of $120 per day per worker. The table below shows the firm’s short-run
production function.
a.
b.
c.
d.
# of workers
# of shirts per day
0
0
1
10
2
25
3
45
4
60
5
72
6
80
7
85
8
82
In what kind of market structure does this firm sell its output? How can you tell?
In what kind of market structure does this firm hire its workers? How can you tell?
Calculate the marginal revenue product of the 3 rd worker. Show your work.
How many workers should the firm hire to maximize profit? Explain.
Scoring guidelines and answers
a.
b.
c.
d.
2 pts. – 1 pt. for identifying perfect competition; 1 pt. for correct explanation, price is constant or the firm is a price taker
2 pts. – 1 pt. for identifying perfect competition; 1 pt. for correct explanation, price is constant or the firm is a price taker in the
labor market
2 pts. – 1 pt. for stating the MRP is $400; 1 pt. for showing the calculation: MRP = P x MP so MRP = $20 x 20 = $400
2 pts. – 1 pt. for indicating 6 workers, or in between 6 and 7 workers; 1 pt. for correct explanation: MRP > Wage for 6 th worker
but MRP < Wage for 7th worker (7th worker adds 5 shirts so 5 x $20 (P of shirt) = $100; wage for 7 th worker is $120)
2004
1.
The production of good X creates an externality. The following questions are based on the graph above, which show s the
marginal revenue, marginal social benefit, marginal private cost, and marginal social cost associated with the production of good
X.
a. Is the externality positive or negative? Explain.
b. Using labeling from the graph above, identify the socially optimum output. Explain how you determined your answer.
c. Suppose that good X is produced by a profit-maximizing monopoly. Answer each of the following.
i. Using labeling from the graph above, identify the unregulated firm’s output. Explain how you determined
your answer.
ii. To produce the socially optimum output, indicate whether the government should tax or subsidize the firm.
iii. Calculate the dollar value of the needed per-unit tax or subsidy.
d.
Suppose that good X is produced in a perfectly competitive industry. Answer each of the following.
i. Identify equilibrium output in the absence of regulation. Explain how you determined your answer.
ii. To produce the socially optimum output, indicate whether the government should tax or subsidize the firms in
the industry.
iii. Calculate the dollar value of the needed per-unit tax or subsidy.
2.
The graph above shows the demand for oil by US residents, the supply of oil by US producers, and the world price of oil. Use
the labeling of the graph to answer the following questions.
a. Identify the following before international trade occurs.
i. Price of oil in the US market
ii. Quantity of oil produced in the US market
b. Now assume that the US begins to import oil at the world market price of Pw. Identify the quantity imported by the US.
c. Identify the consumer surplus in the US market for each of the following cases.
i. Before international trade
ii. After international trade
d. Identify the producer surplus in the US market for each of the following cases.
i. Before international trade
ii. After international trade
3.
Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium.
a. Draw a correctly labeled graph that shows the profit-maximizing firm’s price and output.
b. Assume that the city in which this industry operates eliminates the business license fee (a fixed cost) for all firms in this
industry. How does the elimination of the license fee affect each of the following for the individual firm in the short
run? Explain your answers.
i. Output
ii. Economic profits
Scoring guidelines and answers
1. 12 total pts.
a. As shown on the graph, MSC>MPC indicates the existence of a negative externality. 2 pts.: 1 for identifying the
negative externality; 1 – MSC > MPC
b. Socially optimal quantity = Q2 b/c MSB = MSC at this output level; 2 pts: 1 – identifying Q2; 1 – MSB = MSC
c. Profit-maximizing quantity is Q1 b/c MR = MPC at this output level. To produce the socially optimum quantity, the
government should grant the monopolist a per-unit subsidy of $3; 4 pts.: 1 – identifying Q1; 1 – at Q1, MPC = MR (or
MC = MR); 1 – subsidize firm; 1 --- $3 per unit
d. Equilibrium quantity for perfectly competitive industry is Q3 b/c MPC = D(MSB) at this output level. To produce the
socially optimal quantity, the government should levy a per-unit tax of $5 on firms in this industry; 4 pts.: 1 –
identifying Q3; 1 – MSB = MPC; 1 – tax the industry; 1 -- $5 per unit
1.
a. The externality is negative, because the social cost for each additional unity is higher than the private cost for that unit.
b. The socially optimal output is at Q2, because that is where marginal social cost = marginal social benefit.
c. i.) An unregulated monopoly would produce at Q1, because that is where the marginal production cost (marginal private cost) =
marginal revenue
ii.) To move output from Q1 to Q2, a government subsidy is required.
iii.) The subsidy should be #3 per unit. This would push marginal private costs down to $4, which would then intersect the marginal
revenue curve at Q2, the desired output.
d. i.) A perfectly competitive firm would produce at an equilibrium output of Q3, because that is where their marginal private cost =
demand.
ii.) To move output from Q3 to Q2, the government should tax the industry.
iii.) A $5 tax is needed, which would move the marginal private cost curve up to $12. This makes the marginal private cost intersect the
demand curve at the desired output of Q2.
2.
8 total pts.
a. As shown on the graph, P2 and Q2 were the price and quantity of oil before trade in the US market; 2 pts.: 1 each –
identifying P2 and Q2
b. The amount of oil imported into the US market after trade would be equal to Q3 – Q1. US production drops to Q1 but
quantity demanded rises to Q3; 1 pt – identifying (q3 – Q1) or H-J
c. The triangle P2KG represents consumer surplus before trade, while triangle PwKH represents consumer surplus after
trade (1 pt. each)
d. The triangle P1P2G represents producer surplus before trade, while triangle P1PwJ represents producer surplus after
trade (1 pt. each)
e. The triangle JGH shows the net gain in total surplus from trade (1 pt)
3.
8 pts.
a.
b.
a.
The correct graph for a monopolistically competitive firm will show a downward-sloping D curve with a downwardsloping MR curve below it. The firm’s price and output would be found at the equality of MR and MC. In the longrun, the ATC curve is tangent to the demand curve and equal to price directly above the output level at which MR =
MC. (see graph below); 4 pts.: 1 – graph w/ downward-sloping D curve w/ correctly labeled axes; 1 – downwardsloping MR curve below the D curve; 1 – Q from MR = MC and P from D directly above Q; 1 – long-run equilibrium
AC (or ATC) tangent to D at Q
When the fixed cost decreases, MC is not affected so that the output and price remain constant. Economic profit
increases since ATC falls; 4 pts.: 1 – individual firm’s output does not change; 1 – license fee is a fixed cost, thus it
does not affect the firm’s marginal cost; 1 – economic profits increase; 1 – explanation
(graph)
b.
i.) output would not change; Output is determined by the point where marginal revenue equals marginal cost. If fixed costs
change, the average total cost decreases but marginal cost does not change.
ii.)
Profits increase. The firm moves from earning normal or zero economic profit to earning an economic profit. The average
total cost curve decreases below the demand curve. Demand remains the same and since output doesn’t change, price stays
the same. The cost though is now below price and the firm is making an economic profit.
2004 – Form B
1.
Due to a new technology, Brunelle, Inc. enjoys monopoly power. Brunelle does not engage in price discrimination.
a. Explain why the demand curve lies above the marginal revenue curve.
b. Assume that Brunelle is earning short-run economic profits. Using a correctly labeled graph, show the following for
Brunelle.
i. Profit-maximizing level of output, labeled as Q*
ii. Profit-maximizing price, labeled as P*
iii. Economic profits as a shaded area
c.
If Brunelle wants to maximize its total revenues instead of profits, using the graph from part b show the following.
i. Revenue-maximizing level of output labeled as Qr
ii. Revenue-maximizing price, labeled as Pr
d.
e.
Given your answer in part b, indicate whether Brunelle is producing the allocatively efficient level of output. Explain.
Explain what wil happen to Brunelle’s demand curve as other firms adopt the same technology.
2.
In each part below, assume that the government imposes a per-unit sales tax and that the supply curve is upward-sloping.
a. In industry X, consumers buy the same quantity no matter what the price is.
i. Using a correctly labeled graph, show what happens to the quantity sold when the tax is imposed.
ii. How will the burden of the tax be distributed between buyers and sellers?
b. In industry Y, the market demand curve is perfectly elastic.
i. Using a correctly labeled graph, show what happens to the price of the good that he consumers pay when the
tax is imposed.
ii. How will the burden of the tax be distributed between buyers and sellers?
c. In industry Z, the market demand curve is downward-sloping. Using a correctly labeled graph, shad the area that
represents total tax revenues.
3.
The diagram above shows the domestic supply and demand for good X in the country of Placonia.
a. If the current world price of good X is Pw, does Placonia export or import good X? Explain.
b. Given your answer in part a, indicate the quantity of good X that Placonia exports or imports.
c. Assume that the government of Placonia imposes a tariff on good X, increasing the price from Pw to Pt. Using labels in
the graph, indicate the change in each of the following in Placonia.
i. Consumer surplus
ii. Producer surplus
d. Indicate how employment in the domestic industry that produces good X is affected by the tariff.
Scoring guidelines and answers
1. 9 pts.
a. 1 pt. – Brunelle must lower its price on all units to sell additional units. Thus, the additional revenue from the last unit
sold is the price minus the loss on units that would otherwise sell at a higher price.
b. 4 pts:
1 – correctly labeled graph w/ downward-sloping D and MR below demand; 1 – for Q* at MC=MR; 1 – for P* at the height
of the demand curve above MC=MR; 1 – for shading the correct area of profit (P* - ATC)Q*
c. 2 pts: 1 – for identifying Qr at MR=0; 1 – for identifying Pr at the height of the demand curve above Qr
d. 1 pt. – Brunelle is not producing the allocatively efficient level of output b/c P>MC (MSB > MSC)
e. 1 pt. – Brunelle’s demand curve will shift inward to the left
1.
a.) As Brunelle, Inc enjoys monopoly power, its demand curve is the demand curve for the industry and is therefore
downsloping. Brunelle needs to lower the price of its product in order to sell more output, but this lower price also applies to all
previous units of output produced, resulting in a marginal revenue curve that is lower than its demand curve.
b.) (see graph)
c.) As shown above, total revenue is maximized at the level of output which MR = 0 and the Pr is the price level of this quantity
along the demand curve.
d.) No it is not. At Q*, Brunelle is producing at a price that is above the marginal cost the firm faces (P>MC). In this scenario,
there is an underallocation of resources, as society is willing to pay more for the good than it is for other uses of the money.
e.) Shift inward to the left
2.
6 pts.
a.
2 pts: 1 – perfectly inelastic demand curve showing that Q does not change; 1 – since producers can raise the price by
the full amount of the tax, the tax falls entirely on buyers
b.
2 pts.: 1 – horizontal demand curve showing that price does not change; 1 – the tax falls entirely on sellers since they
can’t charge more and thus must absorb the entire amount of the tax
c.
2 pts.: 1 – for shifting either the supply or the demand curve inward to the left; 1 – for shading the correct profits area
2. a.: i.) the tax makes the supply curve shift to the left. But since the demand is perfectly inelastic, the quantity sold does not
change.
ii.) As seen in the graph, the burden falls entirely on consumers.
b. i.) As the supply curve shifts to the left, the quantity sold decreases from Q1 to Q2 in the graph.
ii.) As seen in the graph, the burden of tax falls entirely on suppliers of the good.
c. The tax revenue is shown in the graph above. Goods are sold at P2 and Q2. The tax paid is (P2 – P0) for each unit sold. The quantity
sold is Q2. So the total tax revenue is (P2 – P0) x Q2
3.
6 pts:
a.
b.
c.
d.
2 pts: 1 – Placonia imports the good; 1 – the domestic opportunity cost of producing good X is higher than the world
price (Pw) for unit JN. Or they can get it cheaper at the world price
1 pt. – They import 300 (350 – 50) units or JN units
2 pts: 1 – consumer surplus decreases from PwNH to PtMH, or a decrease of MNPwPt; producer surplus increases by
JKPtPw
1 pt: Employment would increase b/c domestic production of good X increases in Placonia
a.) Placonia imports good X because its domestic equilibrium price is higher than the world price, therefore it would be inclined to
buy good X cheaper from abroad.
b.) Placonia imports 300 units of good x (quantity demanded at point N (350) minus quantity supplied at point J (50))
c.) i. consumer surplus would change from area NHPw to area MHPt ( a net change of PtMNPw); ii – producer surplus would
change by area PtKJPw
d.) Because of the tariff, more of good X will be produced domestically, therefore employment in the industry will increase.
2003
1.
J & P Company operates in a perfectly competitive market for smoke alarms. J & P is currently earning short-run positive economic
profits.
a. Using correctly labeled side-by-side graphs for the smoke alarm market and J &P Company, indicate each of the
following for both the market and the J & P Company.
i.
Price
ii.
Output
b. In the graph in part for J & P, indicate the area of economic profits that J & P Company is earning in the short run.
c. Using a new set of correctly labeled side-by-side graphs for the smoke alarm market and J & P Company, show what
will happen in the long run to each of the following.
i.
Long-run equilibrium price and quantity in the market
ii.
Long-run equilibrium price and quantity for J & P Company
d.
Assume that purchases of smoke alarms create positive externalities. Draw a correctly labeled graph of the smoke
alarm market.
i.
Label the market equilibrium quantity as Qm
ii.
Label the socially optimum equilibrium quantity as Qs
e. identify one government policy that could be implemented to encourage the industry to produce the socially optimum
level of smoke alarms.
2.
a. Draw a correctly labeled graph showing a typical monopoly that is maximizing profit and indicate each of the following.
i. Price
ii. Quantity of output
iii. Profit
b.
c.
3.
describe and explain the relationship between the monopolist’s demand curve and marginal revenue curve.
Label each of the following on your graph in part a
i. Consumer surplus
ii. Deadweight loss
Assume that Company XYZ is a profit-maximizing firm that hires its labor in a perfectly competitive labor market and sells its
product in a perfectly competitive output market.
a. Define the marginal revenue product of labor (MRPl).
b. Using correctly labeled side-by-side graphs, show each of the following.
i. The equilibrium wage in the labor market
ii. The labor supply curve the firm faces
iii. The number of workers the firm will hire
c. Company XYZ develops a new technology that increases its labor productivity. Currently this technology is not
available to any other firm. For Company XYZ, explain how the increased productivity will affect each of the
following.
i. Wage rates
ii. Number of workers hired
Scoring guidelines and answers
1.
12 pts:
a. 4 pts.: 1 – market graph w/ downward-sloping D curve and an upward-sloping S curve; 1 – correctly labeling
equilibrium P and Q for market; 1 – for the firm graph (horizontal D or P curve); 1 – applying MR = MC to find
equilibrium quantity (MR must be logically consistent with demand curve)
The market graph should have a downward-sloping demand curve and an upward-sloping supply curve with an equilibrium
price and quantity clearly labeled. The firm graph should have a perfectly elastic (horizontal) demand curve at the
equilibrium market price. The firm’s profit-maximizing quantity is found at the intersection of this demand or marginal
revenue curve with the firm’s marginal cost curve.
b.
c.
1 pt.: showing the area of economic profit (above) for the firm (must use P, ATC, and q); The firm’s profits are
represented by the rectangle that has a height or (vertical distance) of P – ATC multiplied by the firm’s profitmaximizing output or q.
4 pts.:
i.
2 pts.: 1 – showing an increase in supply on market graph (resulting from entry of new firms); 1 –
showing both a lower P and a higher Q due to an increase in supply
ii.
2 pts.: 1 – downward shift in the firm’s demand curve (P or MR or D); 1 – for q (for firm) where P = min
ATC for firm
With profits being earned, new firms will enter the smoke alarm market. The market supply will increase
(shift to the right) and the equilibrium price will fall and quantity will increase. As the market price falls, the
firm has a downward shift in its horizontal demand curve. The process continues until price of output has
fallen to the minimum of the average total cost of the firm.
d.
2 pts: 1 – showing that Qs > Qm; 1 – having 2 marginal benefit curves: one with and one without the positive
externality
With a positive consumption externality in the market for smoke alarms, the demand curve with marginal social benefits
should lie above the demand curve with only marginal private benefits. Thus, the socially optimal output level will exceed
the output level produced by an unregulated private market.
e.
1 pt. for any of the following: subsidize sellers or buyers, mandatory smoke alarm system, or tax relief; To increase the
market output to the socially optimal output, the government could subsidize the consumption or production of smoke
alarms.
2.
7 pts.
a.
4 pts.: 1 – correctly labeled graph w/ downward-sloping D curve and marginal revenue curve below demand; 1 –
indicating Q at MR = MC; 1 – finding the appropriate P on the demand curve directly above MR = MC output; 1 --area of profit (must use P, ATC, and Q)
For the monopolist, a correctly labeled graph should show a downward-sloping demand curve with a marginal revenue
curve that lies below the demand curve. The monopolist’s profit-maximizing output is found at the intersection of marginal
revenue and marginal cost. The price is found on the demand curve, above the quantity produced. The firm’s profits are
represented by the rectangle that has a height (or vertical distance) of P – ATC multiplied by the profit-maximizing output or
Q.
b.
c.
3.
7 pts.
a.
b.
1 pt. – the monopolist must lower its price on all units to sell additional quantities so MR < P; Marginal revenue is less
than price since to sell additional units of output, the monopolist must lower price on all units of output sold.
2 pts.: 1 – indicating correct area for consumer surplus; 1 – correct area for deadweight loss; Consumer surplus is the
area bounded vertically by the difference between the demand curve (willingness to pay) and monopolist’s price over
the number of units sold by the monopolist. The deadweight loss from monopoly is the combination of consumer and
producer surplus that is lost when comparing the monopoly output to the output that would be produced under
competitive conditions (where P – MC).
1 pt. – definition: the additional revenue from hiring an additional worker or MRP = MP x MR or MRP = MP x P; The
marginal revenue product of labor is the change in total revenue associated with the change in output following a unit
change in the employment of labor; MRP of labor = MR (or P of output) x MPP of labor
4 pts.: 1 – correctly labeled labor market graph showing equilibrium wage; 1 – firm graph indicating downward-sloping
demand (MRPl) curve; 1 – horizontal labor supply curve for the firm; 1 – showing quantity of labor for the firm at the
intersection of labor supply and labor demand
The perfectly competitive labor market will have a downward-sloping labor demand curve and an upward-sloping labor
supply curve. There will be an equilibrium wage and quantity of labor. The firm will be a wage taker and have a perfectly
elastic labor supply at the market wage rate. The firm’s labor demand curve is its marginal revenue product of labor curve.
Thus, the profit-maximizing firm will hire the amount of labor associated with the intersection of its marginal revenue
product of labor curve and its horizontal labor supply curve. The firm will pay each unit of labor the market wage.
c.
2 pts.: 1 – wage rate for the firm remains constant at the original wage.; 1 – the number of workers hired by XYZ
increases b/c XYZ’s MRP increases or labor demand curve shifts to the right.; With an increase in labor productivity
that affects only Company XYZ there will be no perceptible change in labor market. The equilibrium wage stays the
same. Company XYZ will have an outward shift in its marginal revenue product of labor (or labor demand) curve,
leading to more employment at the unchanged market wage.
2002
3.The table below shows total utility in utils that a utility-maximizing consumer receives from consuming two goods: apples and
oranges.
Apples
Total utility
0
20
35
45
50
52
Quantity
0
1
2
3
4
5
Oranges
Total Utility
Quantity
0
1
2
3
4
5
0
30
50
65
75
80
Assume that apples cost $1 each, oranges cost $2 each, and the consumer spends the entire income of $7 on apples and oranges.
a. Using the concept of marginal utility per dollar spent, identify the combination of apples and oranges the consumer will
purchase. Explain your reasoning.
b. With the prices of apples and oranges remaining constant, assume that the consumer’s income increases to $12.
Identify each of the following.
i.
The combination of apples and oranges the consumer will now purchase.
ii.
The total utility the consumer will receive from consuming the combination in (i)
c. with income remaining at $12, assume the price of oranges increases to $4 each. Identify each of the following.
i.
The combination of apples and oranges the consumer will now purchase.
ii.
The total utility the consumer will receive from consuming the combination in (i)
Scoring and answer
3 6 pts.
a.
b.
c.
2 pts.: 1 – 3 apples and 2 oranges; 1 --marginal analysis: equalization of MU/$ or 10/1 (apples) = 20/2
(oranges); student may not simply use the maximizing of total utility for the explanation.; The utilitymaximizing consumer will exhaust her income, purchasing quantities of each good such that for each
commodity the marginal utility of the last unit purchased divided by the price of the commodity is equal. This
consumer will purchase 3 apples and 2 oranges. The marginal utility per dollar of each commodity is equal:
10/$1 for apples and 20/$2 for oranges. (Marginal utility of 2nd orange = 20 divided by price of $2; marginal
utility of 3rd apple is 10 divided by price of $1)
2 pts.: 1 – 4 apples and 4 oranges; 1 – 50 + 75 = 125 utils; With the increase in income, the consumer will now
purchase 4 apples and oranges and have 125 utils (50 from apples and 75 from oranges)
2 pts.: 1 – 4 apples and 2 oranges; 1 – 50 + 50 = 100 utils: With the increase in the price of oranges, the
consumer will now purchase 4 apples and 2 oranges and have 100 utils (50 from apples and 50 from oranges)
2002 Form B
1.
Assume that two firms are operating with identical cost schedules, but one firm is in a perfectly competitive industry,
and the other is in a monopolistically competitive industry.
a. Using two correctly labeled graphs, show the long-run equilibrium price and output levels for each of these
two firms.
b. Compare the long-run equilibrium price and output levels for these two firms.
c. What level of economic profit will each firm earn in the long run? Why do these results occur?
d. For each of the two firms at the equilibrium quantity, indicate whether the firm’s demand curve is perfectly
elastic, elastic, unit elastic, inelastic, or perfectly inelastic. How can you tell?
Scoring and answers
15 points
a.
b.
c.
d.
2001
1.
6 pts.: 1 each – two graphs with appropriate cost curves; 1 each – Q indicated for each firm where MR = MC;
1 each – P for each firm read off the correct D curve at correct Q; see graphs above. The long-run equilibrium
price and quantity are labeled Pm and Qm, for the monopolistically competitive firm and Pc and Qc for the
perfectly competitive firm.
2 pts.: 1 – P in perfect competition is lower than P in monopolistic competition; 1 – Q in perfect competition is
smaller than Q in monopolistic competition; The perfectly competitive firm has a lower price and a larger
quantity of output than the monopolistically competitive firm.
3 pts.: 1 – firm in perfect competition earns zero economic profit; 1 – firm in monopolistic competition earns
zero economic profit; 1 – entry of new firms increases industry output, individual firm’s output decreases,
prices will fall to level of ATC; Each of these firms will earn zero economic profits in the long run. With no
barriers to entry, the existence of positive economic profits or economic losses motivates the entry or exit of
firms in and out of the industry, forcing prices to the level of average costs.
4 pts.: 1 – for perfectly competitive firm, D is perfectly elastic; 1 – b/c P is constant, the % change in P is 0; 1
– for the monopolistically competitive firm, demand is elastic; MR is positive in the elastic portion of the D
curve; Demand is perfectly elastic for the perfectly competitive firm because price is constant, making the
percentage change in price zero for any change in quantity. For the monopolistically competitive firm, demand
is elastic because MR is positive at Qm.
a. Assume that a profit-maximizing firm in a perfectly competitive industry is earning economic profits. For a given market
price, draw a correctly labeled graph and show each of the following for a typical firm in this perfectly competitive industry.
i.
Marginal revenue
ii.
Output
iii.
Economic profits
b.
using the information given in (a), draw correctly labeled side-by-side graphs for the industry and a typical firm.
i.
Given the existence of economic profits of the typical firm, show on the graphs how the industry adjusts in the
long run and explain the process that leads to the long-run equilibrium.
ii.
Show on the graphs each of the following for the industry and for the typical firm in long-run equilibrium:
price, output
c.
Now assume that the government sets a price that is less than the equilibrium price but greater than average variable cost.
Indicate how each of the following will change for the typical firm and explain why the change occurs.
i.
Marginal revenue
ii.
Level of output
iii.
Short-run total cost
iv.
Short-run total revenue
3. Sparkle Car Wash is a profit-maximizing firm with the following production information.
Number of workers
Number of Cars Washed Per Day
0
0
1
15
2
35
3
60
4
75
5
85
6
80
a.
b.
c.
d.
With which worker is marginal product maximized?
Identify and define the economic principle that explains why marginal product eventually decreases.
Explain why Sparkle would never hire the sixth worker.
If Sparkle charges $6 for washing a car, what is the maximum daily wage that Sparkle would be willing to pay the
fourth worker?
Scoring and answers
1. The firm has a perfectly elastic (horizontal) marginal revenue curve that is equal to the market price. The firm produces the
output level where marginal revenue equals marginal cost. The economic profit of the firm is the area bounded by the quantity
produced multiplied by the difference between price and average total cost ( P – ATC) at that output level.
With economic profits, new firms will enter the industry. The market supply will shift outward with the entry of firms, and
market price will fall. The process continues until a long-run equilibrium is established. At this equilibrium, the market price is
equal to the minimum of the long-run average cost of the typical firm. Each firm produces where P=MR=MC, which is the level
of output that corresponds to the minimum of the long-run average cost. The firm makes zero economic profits.
A price control below the long-run equilibrium price but above the firm’s average variable cost will result in short-run
production. Since the price has fallen, the firm’s marginal revenue falls. The firm’s output level, where MR = MC, will also
decrease. Since the firm is producing less output, total cost falls. Since both the firm’s price and quantity have fallen, total
revenue falls.
a.
3 pts: 1 – a horizontal MR curve; 1 – show and indicate that output should be where MR = MC; 1 – show the area
of profit as the rectangle whose width is the distance between 0 and the equilibrium quantity and whose height is
the distance between the P(AR) and ATC at that quantity.
b.
5 pts. total:
i.
3 pts.: 1 – showing correctly side-by-side graphs of the firm and the market, both correctly labeled; 1 –
showing a market supply curve shifting out and a market price decreasing with this price being used in the
firm graph; 1 – explaining that w/ economic profits, more firms enter the market
ii.
2 pts.: 1 – showing the industry equilibrium price and quantity. Students can either use a vertical line
from the x axis to the equilibrium pt. and one from the equilibrium pt. to the y axis (labeling each) or else
they can mark the equilibrium pt. w/ a letter and somehow indicate that that pt. represents the equilibrium;
1 – showing the long-run equilibrium price and quantity for the firm at the minimum ATC, indicating it
via either of the methods discussed above
c.
4 pts.:
i.
ii.
iii.
iv.
1 – indicating that MR has fallen b/c P has been lowered
1 – indicate that output has fallen b/c MR = MC is at a lower q
1 – indicating that total costs fell b/c output fell
1 – indicating that price AND quantity fell
2.
3.
Worker #3 has the highest marginal product (60 – 35 = 25 cars washed). With additional workers the marginal product falls.
This is consistent with the Law of Diminishing Returns. That law states that as more units of a variable input (labor) are
employed with a fixed input, output will eventually increase at a decreasing rate. The sixth worker would never be hired since
the marginal product of that worker is negative (80 – 85 = -5 cars). A firm would never hire a unit of an input that reduces total
output. The firm would be willing to pay the fourth worker as much as its marginal revenue product or $90 per day found by
multiplying the price of a car wash by the number of cars washed by the fourth worker ($6 x 15 cars = $90 per day). 5 points
total
a. 1 – 3rd worker
b. 1 – diminishing marginal returns; 1 – definition of diminishing marginal returns that includes both variable and
fixed inputs
c. 1 – negative marginal product for 6th worker
d. 1 -- $90