I. Which of the following is correct? a) The pivot of the budget line shows the substitution effect while a slope gives the income effect. b) The pivot of the budget line shows the substitution effect while a shift gives the income effect. c) The pivot of the budget line shows the income effect while a shift gives the substitution effect. :1) None of the above. 2. If the income effect is in the same direction as the substitution effect then the good is a) normal b) inferior but not Giffen c) Giffen d) There is not enough information to answer. 3. If a good is normal and its price increases a) the income effect will be positive and the substitution effect will be positive. b) the income effect will be negative and the substitution effect will be negative. e) the income effect will be positive and the substitution effect will be negative. :1) the income effect will be negative and the substitution effect will be positive. 4. Which of the following statements is correct? a) The Hicks substitution effect keeps utility constant while the Slutsky effect keeps purchasing power constant. b) The Slutsky substitution effect keeps utility constant while the Hicks effect keeps purchasing power constant. c) Both Slutsky and Hicks keep utility constant while the purchasing power changes. :1) Both Slutsky and Hicks keep purchasing power constant while the utility changes. 5. The utility that Rachel receives by consuming food F and clothing C is given by U(F, C) = FC. Rachel's has $800 to spend on the two goods the prices of food and clothing are $1 and $1 respectively. The price of food suddenly increases to $2. a) Before the price change how many food and clothing does Rachel buy? in} How many food and clothing does she buy at the new price? c) How large would Rachel's income, m', be if after the increase in pr exactly could afford her old consumption bundle? d} How many food and clothing would she buy if she was faced with pf', pc and m'? c; Draw three budget lines on a graph. One illustrating a) normal by inferior but not Gif'f'en c) Giffen :1) There is not enough information to answer. 3. If a good is normal and its price increases a) the income effect will be positive and the substitution effect will be positive. b) the income effect will be negative and the substitution effect will be negative. c] the income effect will be positive and the substitution effect will be negative. dithe income effect will be negative and the substitution effect will be positive. 4. Which of the following statements is correct? a) The Hicks substitution effect keeps utility constant while the Slutsky effect keeps purchasing power constant. b) The Slutsky substitution effect keeps utility constant while the Hicks effect keeps purchasing power constant. c} Both Slutsky and Hicks keep utility constant while the purchasing power changes. in Both Slutsky and Hicks keep purchasing power constant while the utility changes. 5. The utility that Rachel receives by consuming food F and clothing C is given by U(F, Q = FC. Rachel's has $800 to spend on the two goods the prices of food and clothing are $1 and $1 respectively. The price of food suddenly increases to $2. a] Before the price change how many food and clothing does Rachel buy? in) How many food and clothing does she buy at the new price? c) How large would Rachel's income, m', be if after the increase in pf exactly could afford her old consumption bundle? at How many food and clothing would she buy if she was faced with pf', pc and m"? c] Draw three budget lines on a graph. One illustrating the budget line before the price decrease, one after the price decrease, and nally the budget line he would face if he had income In\" and the new prices. Denote his original consumption bundle by A, the final bundle by C, and the bundle she would buy at (pf', pc, m') by B. o How large a decrease in the total demand for x is due to the income effect? and how large a decrease in the demand for x is due to the substitution effect? 1) For each ofthe following changes, show the effect on the demand curve, and state what will happen to market equilibrium price and quantity in the short run. a. Consumers expect that the price ofthe good will be higher in the future. b. The price ofa substitute good rises. c. Consumer incomes fall, and the good is normal. d. Consumer incomes fall, and the good is inferior. e. A medical report is published showing that this product is hazardous to your health. f. The price of the product rises. 2) For each of the following changes, show the effect on the supply curve, and state what will happen to market equilibrium price and quantity in the short run. a. The government requires pollution control lters that raise production costs. b. Wages of workers in this industry fall. c. There is an improvement in technology. (1. The price of the product falls. e. Producers expect that the price of the product will fall in the future. 4) For each of the following sets of supply and demand curves, calculate equilibrium price and quantity. a. QD = 2000 - 2P; QS = 2P b. QDZSOO-P;QS:50+P c. QD : 5000 -10P;QS : -1000 + 5P 5) Annual demand and supply for the Entronics company is given by: QD = 5,000 + 051+ 0.2 A - l00P, and Q3 = -5000 +100P where Q is the quantity per year, P is price, I is income per household, and A is advertising expenditure. a. IfA = $10,000 and I = $25,000, what is the demand curve? b. Given the demand curve in part a., what is equilibrium price and quantity? c. If consumer incomes increase to $30,000, what will be the impact on equilibrium price and quantity? 6) The market for milk is in equilibrium. Recent health reports indicate that calcium is absorbed better in natural forms such as milk, and at the same time, the cost of milking equipment rises. Carefully analyze the probable effects on the market. 7. List the majorWand. 5) Annual demand and supply for the Entronics company is given by: QD = 5,000 + 051+ 02 A - 100P, and Q8 = -5000 +100P where Q is the quantity per year, P is price, I is income per household, and A is advertising expenditure. a. IfA = $10,000 and I = $25,000, what is the demand curve? b. Given the demand curve in part a., what is equilibrium price and quantity? c. If consumer incomes increase to $30,000, what will be the impact on equilibrium price and quantity? 6) The market for milk is in equilibrium. Recent health reports indicate that calcium is absorbed better in natural forms such as milk, and at the same time, the cost of milking equipment rises. Carefully analyze the probable effects on the market. 7. List the major nonprice determinants of demand. 8) List the major nonprice determinants of supply. ELASTICITY I. Explain the concept of elasticity of demand. 2. Given the demand function Q = 700-2P + 0.02}: where P = 25 and Y = 5000 a) Determine the price elasticity of demand interpret its value. b} Determine the income elasticity of demand interpret the value. 3. Suppose in Manchester market place the demand for the good Apples is given by QdA=500-15PA+2PB+0.7DI where PA is the price of good Apples, PB is the price of the good Banana, and I is income. Assume that P, is currently $10, P,35 is currently $5, and I is currently $100. 3) Calculate the cross-price elasticity of the demand for good A with respect to the price of good B at the current situation and interpret your result. b} Calculate the income elasticity of the demand for good A and interpret your result. 4. On Wednesday, the price of envelopes was $3 a box, and Jill was willing to buy 10 boxes. On Thursday, the price has gone up to $3.75 a box, and Jill is now willing to buy 8 boxes. Determine Jill's elasticity of demand for envelopes and interpret your result. 5. If Nick's elasticity of demand for hot dogs is constantly 0.9, and he buys 4 hot dogs when the 3. Suppose in Manchester market place the demand for the good Apples is given by dA=500-15PA+2PB+0.7DI where PA is the price of good Apples, PB is the price of the good Banana, and I is income. Assume that PA is currently $10, PP5 is currently $5, and I is currently $100. 3) Calculate the cross-price elasticity of the demand for good A with respect to the price of good B at the current situation and interpret your result. b} Calculate the income elasticity of the demand for good A and interpret your result. 4. On Wednesday, the price of envelopes was $3 a box, and Jill was willing to buy 10 boxes. On Thursday, the price has gone up to $3.75 a box, and Jill is now willing to buy 8 boxes. Dctcrminc Jill's elasticity of demand for cnvclopcs and interpret your result. 5. If Nick's elasticity of demand for hot dogs is constantly 0.9, and he buys 4 hot dogs when the price is $1.50 per hot dog, how many will he buy when the price is $1.00 per hot dog? (Remit a}, is ve.) s. Derive and explain the relationship between a} elasticity and total revenue b) elasticity and marginal revenue 7. Given the special case of the inverse demand curve p(q) = a 7 hr}, show that the marginal revenue curve has the same vertical intercept as the demand curve and but has twice the slope. 8. Assume the demand function is Q = 240 2P. Determine the inverse demand function and explain what the inverse demand function measure. 9. Consider the following demand function for a given consumer Q9 = 40 2P, where QB is the quantity demanded ofa given good and P is the price of that good. a) Determine the inverse demand function and plot it in a graph. bl Suppose that the price the consumer is going to pay to buy the good is P = 10. [n the same graph i. Show the consumer surplus. it. Find the value ofthe consumer surplus. iii. Explain what the consumer surplus represents. ID. Explain what the consumer surplus should be in the following special cases: i. The demand is perfectly inelastic, meaning that the demand is vertical at a given quantity level; i.. The demand is perfectly elastic, meaning that the demand is horizontal at a given price level; Multiple Choice\" ii. The and is perfectly elastic, I leaning that the demand is horizontal at a given price level; Multiple Choice Questions 1. The sensitivity of the change in quantity demanded to a change in price is called A) income elasticity. B) cross-elasticity. C) price elasticity of demand. D) coefficient of elasticity. 2. The sensitivity of the change in quantity consumed of one product to a change in the price of a related product is called: A) cross-elasticity. B) substitute elasticity. C) complementary elasticity. D) price elasticity of demand. 3. A product that is similar to another, and can be consumed in place of it, is called A) a normal good. B) an inferior good. C) a complementary good. D) a substitute good. 4. The government unit that wants to achieve "revenue enhancement" will find it considerably more favorable to enact an excise tax on products whose demand is A) highly elastic. B) relatively elastic. C) highly inelastic. D) unitary elastic. 5 . When total revenue increases from $18,000 to $26,000 when quantity increases from eight to ten, marginal revenue is equal to A) $3,000. B) $4,000. C) $8,000. D) $2,600. 6. The owner of a produce store found that when the price of a head of lettuce was raised from 50 cents to $1, the quantity sold per hour fell from 18 to 8. The arc elasticity of demand for lettuce is A) -0.56. B) -1.15. C) -0.8. D) -1.57. 7. When the consumption of chicken (whose price has not changed) increases following an increase in the price of beef, the two products can be considered to be A) complements. B) substitutes. C) unrelated. D) correlated. 8. If there is an increase in consumer income and the demand for a product declines, then the product is A) a luxury good. B) a necessity good. C) a normal good. D) an inferior good.correlated. 8. If there is an increase in consumer income and the demand for a product declines, then the product is A) a luxury good. B) a necessity good. C) a normal good. D) an inferior good. 9. If the price of a product is decreased and total revenue received from the sale of this product does not change, then the price elasticity of demand for the product is A) elastic. B) inelastic. C) unitary. D) None of the above. 10. Which of the following is not a determinant of price elasticity of demand? A) product durability B) technology C) ease of substitution D) proportion of total expenditures The initial price of a cup of coffee is $1, and at that price, 400 cups are demanded. If the price falls to $0.90, the quantity demanded will increase to 500. a. Calculate the (arc) price elasticity of demand for coffee. b. Based on your answer, is the demand for coffee elastic or inelastic? c. Based on your answer to a., if the price of coffee is increased by 10%, what will happen to the revenues from coffee? Carefully explain how you know. 2) The demand curve is: QD = 500 - 1/2 P. a. Calculate the (point) price elasticity of demand when price is $100. Is demand elastic or inelastic? b. Calculate the (point) price elasticity of demand when price is $700. Is demand elastic or inelastic? c. Find the point at which point elasticity is equal to -1. 3) Suppose that the price elasticity of demand for wheat is known to be -0.75. Will a good wheat crop (which increases the supply of wheat) be likely to increase or decrease the revenues of farmers? Carefully explain. 5) The demand for salt is relatively price inelastic, while the demand for pretzels is relatively price elastic. How can you best explain why?nThe difference between the short-run and the long-run production function is A) three months or one business quarter. B) the time it takes for rms to change all production inputs. C) the time it takes for firms to change only their variable inputs. D) More information is required to answer this question. 2) A rm using two inputs, X and Y, is using them in the most efficient manner when A) MPX = MPY. B) PX = PY and MPX = MPY. C) MPXJ'PY = MPYEPX. D) MPXEMPY = PXI'PY. 3) Which of the following is not true about the law of diminishing returns? A) It is a short-run phenomenon. B) It refers to diminishing marginal product. C) It will have an impact on the rm's marginal cost. D) It divides Stage I and II of the production process. B) All of the above are true. 4) Which of the following indicates when Stage II ends and Stage III begins in the short-run production function? A) when AP = 0 B) when MP = 0 C) when MP = AP D) when MP starts to diminish 5) Which of the following statements about the short-run production function is true? A) MP always equals AP at the maximum point of MP. B) MP always equals zero when TP is at its maximum point. C) TP starts to decline at the point of diminishing returns. D) When MP diminishes, AP is at its minimum point. B) None of the above is true. 6) Decreasing returns to scale A) indicates that an increase in all inputs by some proportion will result in a decrease in output. B) must always occur at some point in the production process. C) is directly related to the law of diminishing returns. D) All ofthe above are true. E) None of the above is true. 7) A rm that operates in Stage III of the short run production function A) has too much xed capacity relative to its variable inputs. B) has too little xed capacity relative to its variable inputs. C) has greatly overestimated the demand for its output. D) should trWiable input used. will result in a decrease in output. B) must always occur at some point in the production process. C) is directly related to the law of diminishing returns. D) All of the above are true. E) None of the above is true. 7) A firm that operates in Stage III of the short run production function A) has too much fixed capacity relative to its variable inputs. B) has too little fixed capacity relative to its variable inputs. C) has greatly overestimated the demand for its output. D) should try to increase the amount of variable input used. 8) In the short run, finding the optimal amount of variable input involves which relationship? A) MP = MC B) AP = MP C) MP=0 D) MRP = MFC 9) The perfect substitution of two inputs implies that A) two inputs can be substituted at a ratio of 1 to 1. B) one input can be substituted for another up to some point. C) two inputs can be substituted at some constant ratio. D) one input can be substituted for another. 10) If a firm finds itself operating in Stage I, it implies that A) variable inputs are extremely expensive. B) it overinvested in fixed capacity. C) it underinvested in fixed capacity. D) fixed inputs are extremely expensive. 11) If MRP > MLC, it means that a firm should A) use less labor. B) use more labor. C) increase its fixed capacity. D) decrease its fixed capacity. 12) In the long run, a firm is said to be experiencing decreasing returns to scale if a 10 percent increase in inputs results in A) an increase in output from 100 to 110. B) a decrease in output from 100 to 90. C) an increase in output from 100 to 105. D) a decrease in output from 100 to 85. 13) An isoquant indicates A) different combinations of two inputs that can be purchased for the same amount of money. B) different combinations of two inputs that can produce the same amount of output. C) different combinations of output that can be produced with the same amount of input. D) different combinations of output that cost the same amount to produce. 14) If a firm that was to the leftex! 1'\" uunvv' l4) Ifa rm used a combination of inputs that was to the left of its isocost line, it would indicate that A) it is exceeding its budget. B) it is not spending all of its budget. C) it is operating at its optimal point because it is saving money. D) None of the above. 15) functions are very useful in an analyzing production functions, which exhibit both increasing and decreasing marginal products. A) Cobb-Douglas B) Straight-line C) Quadratic D) Cubic 16) The following Cobb-Douglas production function, Q = 1.8L0'7'4K0'3", exhibits A) increasing returns. B) constant returns. C) decreasing returns. D) Both A and B. 17) A Production Function represents A) the method used to convert inputs into outputs. B) the amounts of output that can be created by various amounts of inputs. C) the optimum mix ofinputs to maximize output. D) All of the above. 18) Stage III of the short-run Production Function is A) the most efficient mix of inputs. B) the least costly level of output. C) where additional units of inputs will lead to less output. D) where additional units of inputs will lead to more output. 19) The "Law of Diminishing Returns" states that A) additional inputs will reduce output. B) additional inputs will decrease average productivity. C) the supply of inputs is becoming scarce. D) additional inputs will lead to less additional output. 20) Increasing Returns to Scale results when A) in the long-run, an increase in inputs will lead to an increase in the average products of inputs. B) in the long nth an ingrgasg in inpts will lead to an ennivalent increase in nutnut. 20) Increasing Returns to Scale results when A) in the long-run, an increase in inputs will lead to an increase in the average products of inputs. B) in the long run, an increase in inputs will lead to an equivalent increase in output. C) labor becomes more skilled. D) All of the above. 21) Output (Total Product) is maximized when A) input average productivity is at its maximum. B) the l'law of diminishing returns" sets in. C) input marginal productivity is zero. D) input marginal productivity is at its maximum. 22) Isocost curves represent A) least cost combinations of inputs. B) combinations of inputs that can be purchased given their prices and the funds available. C) a producers cost function. D) None of the above. 23) Which of the following indicate when Stage I ends and Stage II begins in the short-run production? A) when AP = 0 B) when MP = 0 C) when MP : AP D) when MP starts to diminish 24) Which of the following statements about the short-run production function is true? A) MP always equals AP at the maximum point of MP. B) MP always equals zero when TP is at its maximum point. C) TP starts to decline at the point of diminishing returns. D) When MP diminishes, AP is at its minimum point. B) None of the above is true. 2.5) Assume a rm employs 10 workers and pays each $15 per hour. Further assume that the MP of the 10th worker is 5 units of output and that the price of the output is $4. According to economic theory, in the short run, A) the rm should hire additional workers. B) the rm should reduce the number of workers employed. C) the rm should continue to employ 10 workers. D) More information is required to answer this question. C) the firm should continue to employ 10 workers. D) More information is required to answer this question. Number Of Output Workers 0 0 1 50 2 110 3 300 4 450 5 590 6 665 700 8 725 9 710 10 705 26) The table above shows the weekly relationship between output and number of workers for a factory with a fixed size of plant. a. Calculate the marginal product of labor. b. At what point does diminishing returns set in? c. Calculate the average product of labor. d. Find the three stages of production. 27) Given Q = K1/2L1/2 ; w = $2, and r = $2 The firm would like to know the minimum cost of producing 2000 units of output. Find the combination of inputs that minimizes the cost of producing 2000 units, the total cost, and identify the expansion path. 28) Discuss the assumptions of well-behaved technologies. 29) For each of the following functions calculate the marginal products, the MRTS and state the type of scale these functions exhibit (i.e. increasing constant or decreasing) A) 9= 34+2K B) 9 = 3LK C) q= D'KZ 30) Suppose the production function for a firm is f (x, , x2 ) [ - 1/2 x 3/2 a) What is the marginal product of the first input? i. Is it increasing in the first input? Is it increasing in the second input? b) What is the marginal product of the second input? i. Is it increasing in the first input? Is it increasing in the second input? c) Derive the technical rate of substitution. d) What kind of returns-to-scale does the technology demonstrate? 31) Illustrate examples of well behaved isoquants and explain what these shapes tell you about the nature of the production function.d) What kind of returns-to-scale does the technology demonstrate? 31) Illustrate examples of well behaved isoquants and explain what these shapes tell you about the nature of the production function. 32) Brown's Tailoring specializes in making male corporate wear clothing and has a production function F (K, L) = KL2. The wage rate for labour is $40 per unit and the rental rate for capital is $20. a) Determine the firm's fixed costs if capital stock is fixed at 9 units. b) Write down how much labour will the firm use to produce q units of output (hint: L must be a function of q) c) Derive the total variable cost function for this firm. d) Write down the firm's short-run total cost function. 33) Ms. Annie operates a fast food restaurant in Gordon Town where she currently pays $5 per hour for servers and $100 per hour for rental machinery. a) Determine whether the restaurant is minimizing its cost of production when the ratio of marginal productivityes (MP, /MP ) is 0.10. b) Assume that Ms. Annie's production can be represented as Q=4L K." and wage=$10 and rental rate=$50 with a TC (budget) of $10,000. Determine the production equilibrium and show ALL these points on a well labelled isocost. If the TC budget increases to $15,000 show the new isocost line indicating the production equilibrium. Sketch out the firm's long run and short run expansion path. 34) If a production function is given by the equation: Q = 12X + 10X2 - X', where Q = Output and X = Input, then calculate the equations for a. average product b. marginal product c. point of diminishing average returns d. point of diminishing marginal returns 35) Given the Production Function: Q = 72X + 15X2 - X3, where Q = Output and X = Input a. What is the Marginal Product (MP) when X = 8? b. What is the Average Product (AP) when X = 6? c. At what value of X will Q be at its maximum? d. At what value of X will Diminishing Returns set in? Part II THEORY OF THE FIRM - Unit 6B - Cost minimizationPart II THEORY OF THE FIRM - Unit 6B - Cost minimization 36) Which of the following relationships is correct? A) When marginal product starts to decrease, marginal cost starts to decrease. B) When marginal cost starts to increase, average cost starts to increase. C) When marginal cost starts to increase, average variable cost starts to increase. D) When marginal product starts to decrease, marginal cost starts to increase. 37) The law of diminishing returns begins first to affect a firm's short-run cost structure when A) average variable cost begins to increase. B) marginal cost begins to increase. C) average cost begins to increase. D) average fixed cost begins to decrease. 36) The relationship between MC and AC can best be described as follows: A) when AC increases, MC starts to increase. B) when MC increases, AC starts to increase. C) when MC decreases, AC decreases. D) when MC exceeds AC, AC starts to increase. 37) Average fixed cost is A) AC minus AVC. B) TC divided by Q. C) AVC minus MC. D) TC minus TVC. 38) Which of the following cost relationships is not true? A) AFC = AC - MC B) TVC = TC - TFC C) The change in TVC/the change in Q = MC. D) The change in TC/ the change in Q = MC. 39) Which of the following is a reason for economies of scale? A) Fixed costs are spread out as volume increases. B) The law of diminishing returns does not take effect. C) Input productivity increases as a result of greater specialization. D) There is greater savings in transportation costs. 40) Diseconomies of scale can be caused by A) the law of diminishing returns.specialization. D) There is greater savings in transportation costs. 40) Diseconomies of scale can be caused by A) the law of diminishing returns. B) bureaucratic inefciencies. C) increasing advertising and promotional costs. D) All ofthe above. 41) Economies of scale is indicated by A) declining long-run AVC. B) declining long-run AFC. C) declining long-run AC. D) declining long-run TC. 42) Which ofthe following distinctions helps to explain the difference between relevant and irrelevant cost? A) accounting cost vs. direct cost B) historical cost vs. replacement cost C) sunk cost vs. xed cost D) variable cost vs. incremental cost 43) MC increases because A) MC naturally increases as rm nears capacity. B) labor is paid overtime wages when volume increases. C) in the short run, MC always increases. D) the law of diminishing returns takes effect. 44) How would each of the following affect the rm's marginal, average, and average variable cost curves? a. An increase in wages b. A decrease in material costs c. The government imposes a xed amount of tax. d. The rent that the rm pays on the building that it leases decreases. 45) Suppose Angie's production function for cell phones is given by F(K, L) = KLZ, the price of capital is $10, and the price of labour $15. What combination of labour and capital minimizes the cost of producing any given output? 46) The production function for Economics textbooks is given by Q = 100KL. If the price of capital is $120 per day and the price of labour $30 per day, determine the minimum cost of producing 1000 units of output. 47) For each of the following cost functions, find MC, AC, and AVC. a. To = 20,000 + 10 Q b. TC = 18,000 + Q + 0.2 Q2 48) Given the Production Function: Q = 21X + 9X2 - X3, marginal, average, and average variable cost curves? a. An increase in wages b. A decrease in material costs c. The government imposes a xed amount of tax. d. The rent that the firm pays on the building that it leases decreases. 45) Suppose Angie's production function for cell phones is given by F(K, L) = KLZ, the price of capital is $10, and the price of labour $15. What combination of labour and capital minimizes the cost of producing any given output? 46) The production function for Economics textbooks is given by Q = lOOKL. If the price of capital is $120 per day and the price of labour $30 per day, determine the minimum cost of producing 1000 units of output. 47) For each of the following cost functions, find MC, AC, and AVC. a. To = 20,000 + 10 Q b. TC = 18,000 + Q + 0.2 Q2 48) Given the Production Function: Q = 21X + 9X2 - X3, where Q = Output, and X = Input a. At what value of X docs Stage II of the production function begin? b. At what value ofX does Stage III of the production function begin? c. At what value ofX does diminishing returns set in? Duality in Production and Cost Theory 49) The production function for a local carpet cleaning company is the function 50) q-IUK'\" -r_"' 9 where q is the number of carpets cleaned in a day. K is the number of the working hours of carpet cleaning machines, and L is labour. The cost ofa unit of labour is $20 and the cost ofa unit of capital is 880. Show that if the firm is maximizing its prots it must also be minimizing costs The production function for a local cement company is the function W = '\"K 1 , where q is the number ofcement produced in a day. K is the number ofthe working hours of machines, and L is labour. The cost of a unit of labour is $20 and the cost of a unit ofcapital is $80