Econ 2610 - Youngstown State University



Practice Problem Answers.

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1. Consider the graphs above where “1” represents the first budget line and “2” represents how the budget line would change as a result of a change in price or income.

a.) Which graph represents what would happen if the price of X were to increase? B

b.) Which graph represents what would happen if income were to decrease? D

c.) Which graph represents what would happen if the price of X were to decrease? A

d.) Which graph represents what would happen if the price of Y were to decrease? E

e.) Which graph represents what would happen if income were to increase? C

2. Assume at the current level of consumption Joe’s Marginal Utility of X is 50 utils and his marginal utility of Y is 20 utils. The price of X is $10 and the price of Y is $5. In order to maximize utility, what will Joe purchase next?

The Marginal Utility/dollar of X is 5 (50/$10) and the Marginal Utility/dollar of Y is 4 (20/$5) so he will purchase X.

Quantity Total Utility

0 0

1 30

2 44

3 49

4 48

3. Refer to the table above. Marginal utility begins to decline when this individual consumes the

2nd quantity.

4. A utility maximizing consumer purchases 8 units of good A and 2 units of good B each week. What do we know must be true of the 8th unit of good A compared to the 3rd unit of good B?

We know that the marginal utility per dollar received from the 8th unit of good A must be greater than the marginal utility per dollar that s/he would receive from the 3rd unit of good B.

5. Total utility is maximized generally when a consumer’s marginal utility per dollar (MU/Price) is equalized for the last unit of each good he or she buys.

6. Harry spends all his income ice cream and snicker bars. The price of ice cream is $5/quart and the price of a snickers bar is $1. Harry has $20 to spend on the two goods. Note, we’re starting at the 9th snickers bar, which means he has already purchased the first 8 snickers bars.

Harry's preferences for ice cream and snickers bars are as stated in the table below.

|Q ice cream |Utility ice |MU ice cream |MU/$ |Q snickers bars |MU snickers bars |MU/$ |

| |cream | | | | | |

|1 |60 | 60 | 12  |9 |14 |14 |

|2 |110 | 50 | 10 |10 |10 |10 |

|3 |150 | 40 |  8 |11 |8 |8 |

|4 |180 | 30 |  6 |12 |6 |6 |

|5 |200 | 20 |  4 |13 |4 |4 |

6a. Fill in the blanks in the table above

6b. In order to maximize utility given the prices and income above, Harry will buy 2 quarts of ice cream and 10 snicker bars.

7. How is productivity measured and what does it mean to become more productive?

It is measured as output per unit of input (so labor productivity is given by Q / L). To become more productive means to produce more per unit of input (so for labor productivity Q increases or L decreases, other things constant).

8. What is the distinction between short-run and long-run production decisions?

In the short run at least one input is fixed. In the long run all inputs are variable.

9. Use the following production table to answer questions.

Labor Output(Q)

0 0

1 10

2 22

3 30

4 38

5 40

6 41

9a. What is the marginal productivity of the second worker? 12

9b. Marginal productivity begins to decline when the firm hires the 3rd worker.

9c. Marginal costs begin to rise with the firm hires the 3rd worker.

10. Explain the law of diminishing marginal returns and how it relates to marginal costs.

Additional output received from additional inputs will eventually decline in the short run as more of an input is employed. As marginal productivity declines, marginal costs rise (and vice versa).

11. Suppose at the current level of production average total costs=$300 and average variable costs=$250. If marginal costs associated with the next units are $275, what will happen to average total costs and average variable costs if they expand production?

Average total costs will fall (because marginal costs are below average total costs), and average variable costs will rise (because marginal costs are above average variable costs).

12. Use the following production/cost table to answer the following questions.

Labor Output(Q) Fixed Costs Variable Costs Total Costs Marginal Costs

0 0 400 0 400

1 10 400 50 450 50/10=$5

2 22 400 100 500 50/12=$4.17

3 30 400 150 550 50/8=$6.25

4 38 400 200 600 50/8=$6.25

5 40 400 250 650 50/2=$25

6 41 400 300 700 50/1=$50

15a. Fill in the blanks in the table above.

15b. If this firm sells all its output at a constant price of $25, what is the profit maximizing Q? P=MC at Q=40.

15c. What do their profits equal?

TR=P*Q – TC = $25*40 - $650 = $1,000 - $650 = $350

13a. It costs a firm $50 to produce an additional unit of their product. If they can sell the product for $50, what would happen to their profits if they produce it?

If their MR=$50 and MC=$50, their profit would not change if they produce an additional unit.

13b. What will happen to their profit if they can sell it for $40 and their costs equal $50?

If their MR=$40 and their MC=$50 their profit would decrease by $10 if they produce an additional unit (so they will not produce the additional unit).

13b. What will happen to their profit if they can sell it for $50 and their costs equal $30?

If their MR=$50 and their MC=$30 their profit would increase by $20 if they produce an additional unit (so they will produce the additional unit).

14. Suppose a firm announces that they are investing $10 million in their facility in order to expand production. What do we know must be true in order for this firm to be willing to make this investment?

We know the firm will only do it they expect it to be profitable. It will only be profitable if they receive at least an additional $10 million in revenue as a result.

15. A firm knows it can make an additional $800 in revenue if it produces one more unit. Their current average total costs equal $700. What happens to their profits if they produce the additional unit.

We don’t know (it’s indeterminate). You need information on marginal costs, not average costs to figure out what will happen to profit.

16. Suppose a Firm A has half of the fixed costs as firm B, but the same total revenue and variable costs for all quantities. What does this mean as far as the profit maximizing quantity of the 2 firms (will Firm A’s be greater than, less than, or equal to Firm B’s?). What does this mean as far as the profit of the two firms?

Fixed costs don’t matter in how much a firm produces, so Firm A and Firm B will produce the same quantity. However, fixed costs do matter in how profitable a company is (because they are part of total costs), so Firm A, which has a lower total cost, will have a higher profit than Firm B.

17. What are the three characteristics of perfectly competitive markets?

There are very many firms (so many no single firm can influence the market price).

All firms produce the same thing (a standardized product).

There are low barriers to entry and exit.

18. The demand curve in a perfectly competitive market is downward sloping. The demand curve of a perfectly competitive firm is horizontal (equal to the market price).

19. Use the following diagram representing to answer the following questions

a. What is the profit maximizing quantity? 600

b. What does profit equal at the profit maximizing Q? ($20 - $15)*600=3,000

c. What is the shutdown price? $6 (minimum of AVC)

d. At what price would profits equal zero? $14 (minimum of ATC)

e. If price changes from $20 to $14, what happens to this firm’s output? Output would decrease from 600 to 450.

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20. Refer to the graph above. If the market price increases from $50 per unit to $60 per unit, how will a profit-maximizing perfectly competitive firm change their output?

They will increase production from 65 to 75.

21. Refer to the graph above. If the market price equals $60, what will this firm’s revenue equal? What will their profits equal?

Their revenue will equal $60*75=$4500. We can’t calculate their profits however because we’re not told or shown their average total cost.

22. Suppose a firm is earning negative profit, but is continuing to operate. What do we know must be true of TC compared to TR, and VC compared to TR? What do we know must be true of ATC compared to P, and AVC compared to P?

Because profit is negative, we know that TRVC.

Similarly, we know that AVC ................
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