Economics 301 – Intermediate Microeconomics
Final Exam
Exam C
John Moran
Fall 2005
INSTRUCTIONS – PLEASE READ BEFORE BEGINNING THE EXAM.
Please write your name on your examination book.
The exam consists of 3 pages. Please make sure that you have all of the pages.
There are 4 questions worth a total of 100 points. The point values associated with
each question are listed on the exam.
With the exception of the True-False questions, you must show your work
(explanations, diagrams, calculations, etc.) to receive full credit. Simply having stated
the correct conclusion is not sufficient, and will not earn you many points.
Please write neatly (particularly in constructing and labeling any diagrams). If I can’t
read it, it’s wrong!
Partial credit is available, so you should attempt to answer all of the questions, even if
you think that you do not know the answer.
Cheating is forbidden. If caught, you will be penalized severely.
You have the entire class period to complete the exam. Good luck!
1.
Some True-False Questions (25 points)
Please indicate whether each statement is “true” or “false.” You do not need to
explain your answer. Be sure to write out the words “true” and “false.”
a) (5 points) True or False? “When a perfectly competitive firm is maximizing
profits in the short-run, the profit-maximizing quantity occurs at the minimum
of average total cost.”
False. This occurs in the long run, but not (generally) in the short run.
Draw a standard diagram with price above the minimum of average cost
to see this.
b) (5 points) True or False? “In a perfectly competitive market, it is possible to
calculate the long-run market equilibrium without information on the market
demand curve.”
True. See your class notes for a discussion. In a nutshell, because firms
produce at the minimum of their long-run AC curves in any long-run
competitive equilibrium, each firm’s optimal quantity, the total quantity
produced by all firms, and the equilibrium price in the market can all be
determined from the long-run average and marginal cost curves.
c) (5 points) True or False? “The average fixed cost curve is downward sloping.”
True. AFC declines with output because output “Q” is in the
denominator and the numerator is a constant (TFC).
d) (5 points) True or False? “In a short-run competitive equilibrium, all units of
output for which the marginal benefit to society exceeds the marginal cost are
produced.”
True. See your class notes for a discussion.
e) (5 points) True or False? “In a long-run competitive equilibrium, all units of
output for which the marginal benefit to society exceeds the marginal cost are
produced.”
True. See your class notes for a discussion.
2.
Short-Run Profit Maximization (25 points)
Alpha Industries manufactures toothpicks that consumers perceive as identical to
those produced by numerous other manufacturers. Recently, Alpha hired an
economist to estimate its cost function for producing boxes of toothpicks. The
estimated total cost function is:
TC  100  2Q  4Q 2
with marginal cost function
MC  2  8Q
Suppose the current market price for a box of toothpicks is $18.
a) (20 points) What is the optimal level of output to maximize profits in the short
run? Explain how you arrived at your answer.
There are two steps required to compute the profit-maximizing level of
output. Many of your neglected the first step.
Step 1: Is P > AVC for some Q > 0, i.e. should the firm remain open and
produce a positive level of output? Plugging P = 18 and the equation for AVC
into this inequality leads to the expression: 4 > Q. Clearly there are many
positive values of Q that satisfy this inequality. Thus, the firm should remain
open (i.e. produce Q > 0).
Note: AVC = 2 + 4Q and is obtained by dividing TVC by Q.
Step 2: Set P = MC in the region where MC is increasing. Here, MC is
increasing for all Q > 0, so simply set P = MC and solve for Q. Doing so yields
Q = 2.
b) (5 points) How much profit will be earned?
Plug P = 18 and Q = 2 into the following expression and solve for profit:
Profit = PQ – 100 – 2Q – 4Q2
Doing so yields profit = - $84.
3.
Outsourcing of Jobs (25 points)
You are starting up a company that will produce genetically-altered viruses for
use in vaccines and you must decide whether to locate your main production
facility in Thailand or the United States. In Thailand, you can hire workers for
$2.00 per hour whose marginal product is 6 viral specimens per hour. In the
United States, the available workers must be paid $10 per hour and can produce
25 viral specimens per hour. If your only objective is to minimize production
costs, where should you locate your factory? Explain your reasoning in detail
using the specific numbers provided in the question.
Calculate MC in both countries using the expression:
MC = w / MP
Plugging in the numbers from the problem yields a MC of approximately
$0.33 in Thailand and a MC of $0.40 in the U.S. Thus, to minimize production
costs, you should build the factory in Thailand.
Note: A similar conclusion can be reached by calculating the marginal
product per dollar spent in each country and observing that this ratio is
higher in Thailand (3) than in the U.S. (2.5).
4.
Optimal Choice of a Variable Input (25 points)
Consider a firm in the short run whose marginal product of labor function is
given by
1
MPL 
L
a) (20 points) If the firm can sell its output for $20 per unit, how much labor
should the firm hire if the wage rate (the unit price of labor) is $2? Be sure to
show all of your calculations.
Despite all of the moaning about this problem, the majority of you solved
it correctly. The variable input should be hired up to the point where
VMP = w, in the region where MP is declining. Here, MP is declining for
all positive values of L, so simply set VMP = w and solve for L.
Remembering that VMP = P*MP, we obtain L* = 100.
b) (5 points) What is the firm’s total variable cost at the optimal quantity of
labor?
TVC = w*L* = $2*100 = $200.