SECTIONS I-TV ANSWERS TO REVIEW QUESTIONS

1 (d). Review the definitiou in Section 1 if unsure. 2 (e). No commodities are sacrificed in such a move, although there may be some opportunity cost in terms of foregone leisure. 3 (d). 4 (d). Ratio of marginal uulities equals price ratios. 5 (c). This will cause a reducdon in the quantity demanded, not a reduction in demand. 6 (e). This will shift the endre gasoline demand curve. Other options shift the supply curve. 7 (b). Bus travel is inferior, so both effects increase demand. 8 (c). In this case, total revenue can be increased without the addidonal cost of extra trains. 9 (c). Total expenditure remains constant at $18,000. Exacdy 600 dckets would be sold at a price of $30. 10 (c). At $15, 1200 tickets would be demanded so excess demand is 600 tickets. 1 1 (a). The price of beef will rise, increasing the demand for a substitute good like fish. 12 (e). Improved technology will increase supply. 13 (b). If good is inferior, a rise in incomes will reduce demand and hence lend to reduce prices. 14 (b). We may expect prices to rise, which will raise revenues if demand is inelasdc. 15 (d). Assuming a linear demand curve, the loss in consumer surplus equals $0.25 X 20 million plus 1/2 x $0.25 x 8 million, totalling $6 million. 16 (d). Use arc formula. 17 (d). First of all the invariant quantity (1,000 tons) should be esdmated. 18 (b). See answer to 17. 19 (b). Government revenue is 1,000 X $10. 20 (c). No consumer would pay more than $15. 21 (e). At a price of $15, domestic producers would recei\e $5 and hence supply 500 tons, yielding tax revenues of $5000. 22 (a). Expenditure is constant at $200,000 and so at a price of $1.80 per liter, consumpdon would be 111,111. 23 (d). It is not only constant but equal to one. 24(c). Using the arc elasticinformula, we get [(80+60)x25,000] - [(100,000+125.600)x20] = 7/9. 25 (e). In purchasing 5 loaves, 8 botdes of beer, and one movie ticket, Fred spends all his income and satisfies the equilibrium condition that the marginal udlity per dollar spent on each good be equal. 26 (b). A negative cross elasdcity implies complementarity, while a positive income elasticity indicates a normal good. 27 (e). We have opposing effects on demand. 28 (c). Only (c) states the hypothesis correctly. 29 (b). At $2 the consumer surplus is $14 - $8; at SO the consumer surplus is $15. The gain is therefore $9. 30 (c). Refer to the text if unsure. 31 (e). Opportunity cost ratios are the same for both Crusoe and Friday. 32 (d). Will result in a movement along the demand curve, not an increase in demand. 33 (a). See text. 34 (a). Use the

total revenue lest to find total revenue falling as price falls. 35 (c). At a price of zero, use any of the computation formulas to see that elasticity must also be zero. 36 (c). Elasdc demand. 37 (c). If supply is infinitely elastic, a lax will raise the price by the full amount of the tax, 10?. Refer lo a supply/demand diagram. .38 (b). Demand is unit elasdc, so total expenditure is constant at $60,000. Hence, at a price of 60c, 100,000 will be sold. 39 (d). The 20% price increase would bring about a 10% reducdon in quantity demanded to about 110,000. 40 (e). Each barrel of oil sacrificed yields one-half a bale of wool, so one million sacrificed would yield 500,000 bales of wool. 41 (e). Since demand is inelasdc, a price cut would reduce revenues, but the decline in incomes during recessions will increase ridership if the good is inferior. 42 (b). A=3, B=5 exhausts income and satisfies the utility max-imizadon condition. 43 (e). If youve missed this one, weve failed. 44 (b). At $3. exacdy 2.000 shares will be demanded. 45 (d). At $1, 6,500 would be demanded. 46 (e). All the other options zie consistent with complementarity. 47 (b). Because supply is perfecdy elasdc, price will rise by the full amount of the tax to $5. At this price, since demand is unit elasdc, 800,000 botdes will be purchased, and the government obtains $1 on each of these. 48 (a). Represents more favorable alternatives for the farmer.-andsahtgher opportunity costs. 49 (e). This would imply an income elasticity of demand everywhere equal to one. 50 (d). Check with text if unsure. 51 (c). This is an economists convention. 52 (d). See text. 53 (e). See Table in text or better yet, reason through with the definidon. 54 (b). Increase in supply plus reduction in demand; only the price decrease can be predicted. 55 (e). For margarine, we have an increase in supply (lower price, greater quantity sold). For butter, a substitute, we have a decrease in demand (lower price, lower quandty). 56 (a). Excess demand clearly exists at the current rent; otherwise, there wouldnt be so many applicants reladve to spaces. 57 (b). Lower wage was equilibrium wage. 58 (d). Will increase tape demand, a complement. 59 (b). Elastic demand implies P and TR move inversely. 60 (e). See text; they are all correct. 61 (b). Easts trade-off is 2 voodoo dolls for one magic potion. West s trade-off is 5 voodoo dolls for one magic potion. Any ratio between these will do. 62 (b). Supplv and demand analysis. 63 (c). Demand oi.\ shifts in. 64 (c). No prediction can be made about price. 65 (e). Price cant change. 66 (d). Suppressing price competition always rebounds with increased non-price compedtion. 67 (c). See text. 68(d). If P increases and TR

decreases, demand is elasdc. 69 (c). Would shift the demand curve for cars rightward. 70 (a). New price of water is greater than zero. 71 (c). Movement along the supply curve. 72 (b). A is a complement to B. 73 (b). See text. 74 (e). At this cover charge hell attend four times per week, paying $32. Adding the marginal benefits, we see he would be willing lo pay $56, so the consumer surplus is $24. 75 (c). The opportunity cost of a MU quesdon is the number of CA quesdons that must be foregone to write the MU quesdon. For Kevin, 1 MU quesdon costs 6/15ths (2/5) CA questions. For John the number is 12/lOths (6/5) CA questions. Therefore Kevin has a comparative advantage in wridng MU quesdons. You should be able to recover the opportunity cost of a CA question from this answer without any additional calculadon. 76 (a). Without specializadon their combined output will be 10 CA and 15 MU quesdons. By specializing, they can produce 12 CA and 20 MU quesdons, so the gain is 2 and 5 respecdvely. 77 (c). Start by drawing and labeling the graph. The area you want to measure is a trapezoid. The triangular part has a height of $15 and a base of 30 units, so its area is $225. The rectangular part has a height of $15 and a base of 70 units, so its area is $1050. Summing gives the answer 78 (c). The percentage change in quandty of 35% exceeds the percentage change in price of 20%-, so demand is elastic. Decreasing the price raises total revenue under such condidons. 79 (d). See text. 80 (b). People wanted to subsdtute out of oil headng and into natural gas. Hence the demand (not quantity demanded) for natural gas increased. 81 (e). The high income person will buy as much or more of every good. Therefore, on the last unit of every good purchased, the marginal udlity and the marginal utilit) per dollar spent will be the same or lower 82 (b). If A has a positive cross elasticity reladve to B, the goods are substitutes. As such,

a complementary (negative) cross elasticity is ruled out. 83 (b). If demand is perfectly elastic, the price cannot rise. Therefore, the consumers burden is zco 84 (a). Sec text. 85 (b). By defmition. 86 (e). The rauo of the marginal utilities equals the ratio of the prices. 87 (c). The opportunit) cost is given by the slope of the production possibility curve. 88 (e). Australia gives up 2 tons of jujubees for every 8 gallons of vegimite, so the opportunity cost of 1 gallon of vegimite is 1/4 ton (2/8) of jujubees. 89 (d). Belgium will be better off if it can get anything more than 3 gallons of vegimite for 1 ton of jujubees since this is its own trade-off 90 (a). See text. 91 (b). The marginal udlity per dohar spent on a martini is 4 udls per dollar, so thai of a gin and tonic must also be 4 udls per dollar. 92 (c). The unit elasdc demand curve is not shaped at all like a straight line, 93 (a). An increase in demand is a shift of the endre curve; a decrease in a products price is a movement along a stadonary curve. No shift. 94 (c). In equilibrium, the quantity supplied equals that demzmded. In this case, equilibrium occurs at a price of $2. Nineteen units are supplied, and firms A and combined sell ten of these. 95 (e). Both effects work together to raise the quandty. but the price effects work in opposite direcdons. 96 (c). This absurdly easy question actually showed up in the spring 84 midterm. Even stranger, some people actually missed it! 97 (e). There would be an increase in the demand for coal-fired plants, and hence an increase in the quantity supplied. Nothing shifts the supply curve of coal, so there is no increase in supply. 98 (a). We have an increase in demand and a decrease in supply. The two effects work together to raise price, but their effects on quantity oppose each other, so we can make no prediction. 99 (e). Horizontal deinand and supply curves have infinite elasticities. 100 (d). Elastic demand.

SECTION V: THE COMPETITIVE FIRM

Up to this point we have manipulated supply curves, but have yet lo derive them. To do so, we now take on the intellectually demanding task of developv-ing the theory of the compeddve firm. In addidon, we begin to evaluate the efficiency of competidon, continuing the evaluation in the next section dealing with monopoly. Since the dieory of the firm and a great deal else which follows relies upon average/marginal relations, we start with them.

MARGINAL/AVERAGE RELATIONSHIPS

Marginal and average relationships are often a source of student grief Yet, the relationships are basically simple if a few fundamental organizing principles are kept in mind. An example best illustrates the point. Suppose so far youve received a 10 and a 20 in the quizzes. Then your average score, points divided by the number of exams, P/N = 30/2 = 15. The next quiz is your marginal or incremental quiz. In other words, it is the change in total points divided by the change in the number of quizzes, namely I in this case. If your marginal score is 20, your average will rise to 16 2/3 If your marginal score is 5, your average will fall to 11 2/3 If your marginal score is 15, your average will remain 15. In summary, your marginal score will raise your average if its above your average, will lower your average if its below, and wont affect \our average if

theyre the same. Say you got a 5, and now you take the 4th quiz and get a lOi-Note here that your marginal score is now rising firom 5 lio 10, but your average score is still falling from 11 2/3 down to 11 1/4 Your marginal is still below your average and so continues to pull your average dovm. This simple example illustrates four fundamental relations between marginal and average functions, including those used in economics:

(1) If the marginal is above the average, the average is rising.

(2) If the marginal is below the average, the average is falling.

(3) If the marginal equals the average, the average is constant.

(4) The above rules hold whether the marginal is itself increasing or decreasing.

We will use these four rules throughout the remainder of this book.

THE SHORT RUN AND THE LONG RUN

Two definitions are needed to begin the theory of the firm, that cf the short rim and that of the long run. The short run is defmed as a time span such that the firm must incur a certain total fixed cost (TFC) regardless of its level of output. Rent on a building, loan payments, and property taxes, are all examples of fixed costs which must be paid even if production is