Department of Economics
College of Saint Benedict | Saint John's University
Fall Semester 2015
Louis Johnston
Economics 111
Exam #2
Model answers
Part I. True, False, Uncertain Questions. (8 total points; 10 minutes)
For each of the following statements, state whether it is true, false, or uncertain. If it is true, prove why it is true. If
it is false, explain why it is false and provide a correct analysis. If it is uncertain, show how the statement can be
true in some instances and false in others.
1.
(4 points) Suppose that a firm is earning a negative economic profit (i.e. the firm is making a loss in
economic terms.) This implies that the firm’s accounting profit must also be negative.
Accounting profit = revenue – explicit costs
Economic profit = revenue – explicit costs – implicit
costs
Thus,
Economic profit = Accounting profit – implicit costs
If implicit costs > accounting profit
 Economic profit is negative
False
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2.
(4 points) Suppose that sellers of bottled water find that the quantity demanded by consumers changes very
little when the price falls or rises. This implies that the price elasticity of demand for bottled water is very
inelastic.
True. The price elasticity of demand is the percentage
change in quantity demanded that results from a 1 percent
change in price. If the quantity demanded changes very
little then this elasticity will be close to 0, which implies
that the demand for bottled water is very inelastic.
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Part II. Short answer questions (32 total points; 45 minutes)
1. (8 total points) The figure below shows the demand curve (D) for general admission concert tickets to see
Anthony Benedetto, a singer who covers all of Tony Bennett’s greatest hits. The marginal cost (MC) of an
additional ticket sold is $10.
a. (4 points) Suppose that the concert promoter can charge any price they choose but according to city law
they cannot price discriminate. What price will she charge if she wants to maximize her profit?
Explain your reasoning.
Since the promoter can choose any price, they will
find the number of tickets where marginal revenue
(MR) equals marginal cost (MC) and then charge the
price associated with this quantity. In this case, MR =
MC at 20 tickets, and consumers are willing to pay
$30 for 20 tickets.
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P
Q
50
45
40
35
30
25
20
15
10
0
5
10
15
20
25
30
35
40
Total
Total
Revenue Cost
Profit
0
0
0
225
50
175
400
100
300
525
150
375
600
200
400
625
250
375
600
300
300
525
350
175
400
400
0
b. (4 points) Suppose that the city in which the concert is held relaxes its law and allows rush tickets, i.e.
tickets available one hour prior to the concert on a first-come, first-served basis. At what price should
the promoter offer these tickets? Explain your reasoning.
The promoter’s marginal cost is $10, so if they charge
a price slightly above that they will maximize their
profit on the rush tickets. For example, if they can
only charge prices in $5 increments, the best choice is
to charge $15; they will sell 15 more tickets and earn
$225 of revenue and incur costs of $150 for a profit of
$75.
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2. (12 total points) Suppose that the market for distilled water is perfectly competitive. The market demand
and supply curves are given in the table below:
Price
($ per liter)
Quantity demanded
(thousands of liters)
Quantity supplied
(thousands of liters)
6
5
4
3
2
1
0
0
3
6
9
12
15
18
18
15
12
9
6
3
0
a. (4 points) Find the equilibrium price and equilibrium quantity in this market. Explain your reasoning.
The equilibrium price is $3 because that is where the
quantity supplied and the quantity demanded are equal
to each other, at 9000 liters.
b. (4 points) Suppose that a price floor is imposed on this market at a price of $5 per liter. How, if at all,
will the quantity demanded and quantity supplied of distilled water be affected? If the market is
affected, calculate the amount of the excess demand or excess supply. If not, explain why the market is
unaffected by the price floor.
At $5 the quantity demanded is 3000 liters but quantity
supplied is 15,000, so there is an excess supply of
distilled water equal to 12,000 liters
c.
(4 points) Is total economic surplus in this market affected by the price floor? If so, please calculate the
amount of total economic surplus that is lost due to the price floor, showing your work and explaining
your reasoning. If total economic surplus is not affected by the price floor, please explain why it not
affected.
Total economic surplus is affected. Instead of 5000
liters bought only 3000 are purchased; the lost surplus
is
½ (9000-3000)*(5 – 1) = $12,000
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3. (12 points) Suppose that a laundry has the following costs for washing men’s dress shirts:
Output
per day
(shirts)
0
40
80
120
160
200
Total cost
(dollars)
Marginal
cost
100
110
140
190
250
330
0.25
0.75
1.25
1.50
2.00
a. (4 points) Briefly explain the meaning of the term marginal cost and calculate the firm’s marginal cost
for each level of output. Please write your results in the table above.
Marginal cost is the additional cost incurred when a
firm produces an additional unit of output.
b. (4 points) Suppose that the market price for washing men's shirts is $1.50 per shirt. What is the firm's
profit-maximizing level of output? Explain your reasoning.
At an output of 160 shirts the P = MC. Thus, 160 shirts
is the profit-maximizing level of output.
c. (4 points) Suppose that the market price for washing men's shirts fell to $0.50 per shirt. Should the firm
stay in business in the short run? Explain your reasoning.
At a price of $0.50 per shirt, the firm would clean 40
shirts. Their total revenue is $20 and their total cost is
$110, so their loss is $90. If they close they will lose
$100, so yes they should stay in business in the short
run.
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