Problem Set #2

(Due Date: June 8 , Submit your answers before the class starts)
th

1. The fundamental objective of a firm is

A) making a quality product.
B) increasing market share.
C) achieving employee satisfaction.
D) maximizing profits.
2. Heidi quit her job as a chef making $40,000 per year to start her own restaurant. The first year,
Heidi's restaurant earned $100,000 in revenue. Heidi pays $50,000 per year in wages to the
waitresses and waiters, $20,000 per year to buy food, etc. What is Heidi's profit as measured by an
accountant for the year? And what is her economic profit for the year?
A) $30,000, $50,000
B) $50,000, $80,000
C) $30,000, -$10,000
D) -$10,000, $30,000
3. The short run is a period of time in which
A) the quantities of some resources the firm uses are fixed.
B) the amount of output is fixed.
C) prices and wages are fixed.
D) nothing the firm does can be altered.
4. Which of the following statements regarding the marginal product curve is FALSE?
A) Increasing marginal returns occur only when the total product increases as the number of workers
increases.
B) Increasing marginal returns is due to greater efficiency from specialization in the production
process.
C) The law of diminishing returns applies in the short run.
D) Along the marginal product curve, increasing marginal returns occur first and then diminishing
marginal returns.
5. If a firm's marginal product of labor is less than its average product of labor, then an increase in
the quantity of labor it employs definitely will
A) decrease its total product.
B) decrease its average product of labor.
C) increase its marginal product of labor.
D) not change its average product of labor.
6. Angel Rodriguez pulls up in his 24-foot panel truck in front of Sezz Medi Brick Oven Pizza in
Upper Manhattan. Even though it's the middle of the summer, he's delivering -- firewood. He says
even though fuel costs have doubled in the past year, its still worth the premium he gets delivering
ash and cherry to the captive and growing market in NYC. Which of the following statements is true
about short run costs for Angel?
A) His truck is a fixed cost and gasoline is a variable cost.
B) His truck is a variable cost and gasoline is a fixed cost.
C) Both his truck and gasoline is a variable cost.
D) Neither his truck nor gasoline is a variable cost.
7. Which of the following shifts the AVC curve upward at Barney's Bagel Bakery?
A) an increase in the hourly wage that Barney pays his workers
B) an increase in Barney's daily output from hiring more workers
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C) an increase in the fixed amount of local property tax that Barney pays on the building he owns
and uses
D) all of the above
8. A technological change that increases productivity ________ marginal product and ________
marginal cost.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases
9. Silvio's Pizza is a small pizzeria. The firm's production function is shown in the table in the lecture
note 9 and 10. Suppose that Silvio's costs include only the cost of renting ovens, which is $100 per
oven per week, the labor cost, $280 per worker per week, and the opportunity cost of Silvio's
entrepreneurship, $1,000 per week. Suppose Silvio's uses Plant 2. What is the marginal cost of
producing the 200th pizza?
A) $5.09
B) $7.00
C) $10.55
D) $4.40
10. A firm experiences ________ when its ________ downward at larger outputs.
A) diseconomies of scale; average total cost curve slopes
B) economies of scale; long-run average cost curve slopes
C) diminishing marginal returns; long-run average cost curve slopes
D) diminishing marginal returns; average total cost curve shifts

11. Which of the following is a distinguishing characteristic of oligopoly?

A) A small number of firms compete.
B) No one firms actions directly affect the actions of the other firms.
C) Firms are free to enter and exit the industry.
D) Natural barriers cannot prevent the entry of new firms.
12. In a prisoner's dilemma, the Nash equilibrium occurs where
A) neither person ends up with their best outcome
B) both end up with their best outcome
C) only one ends up with his best outcome
D) the one who goes first ends up with his best outcome
13. When two firms collude to maximize profit the total quantity produced by both firms taken
together is determined at the quantity where ________.
A) excess capacity is minimized
B) industry marginal cost equals industry marginal revenue
C) the price equals the industry's marginal cost
D) excess capacity is as large as possible zero
14. If the production of a good creates pollution, then the
A) marginal social benefit curve lies above the marginal private benefit curve.
B) marginal social cost curve lies above the marginal private cost curve.
C) marginal social benefit curve lies below the marginal private benefit curve.
D) marginal social cost curve lies below the marginal private cost curve.
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15. A country has several factories that emit sulfur dioxide. The main methods that the government
can use to overcome the accompanying environment externalities include all of the following
EXCEPT ________.
A) marketable permits
B) emission charges
C) subsidies
D) taxes

16. There are two industries that emit sulfur dioxide. The government decides to issue marketable
permits. If Harry's industry has a higher marginal cost of reducing sulfur dioxide than does Joe's
industry, ________.
A) marketable permits will not make the amount of pollution efficient
B) Joe's industry will sell marketable permits to Harry's industry
C) Harry's industry will sell marketable permits to Joe's industry
D) Harry's industry and Joe's industry will emit the same quantity of sulfur dioxide
17. Goods that are nonrival and nonexcludable are called
A) external goods.
B) public goods.
C) private goods.
D) free goods.
18. Because of the free-rider problem, ________.
A) there is an efficient allocation of resources for common resources
B) private provision leads to the production of more than the efficient quantity of a public good
C) private provision leads to the production of less than the efficient quantity of a public good
D) the public uses too little of a common resource
19. The granite boulders in Rocky Mountain National Park are a favored place among talented
climbers who specialize in the art of bouldering, or climbing harder (but shorter) routes without tying
into a rope. Climbers have taken to (illegally) stashing foam crash pads underneath the boulders but
marmots and other rodents chew up the pads and the litter is spread by the wind. Why would the
park be overused in this manner?
A) Because the marginal benefit of using the park is greater than the marginal social benefit of using
the park
B) Because the marginal social benefit of using the park is greater than the marginal benefit of using
the park
C) Because there are no external costs to using the park
D) Because the marginal cost of using the park is equal to the marginal benefit of using the park
20. Which of the following is true regarding a perfectly competitive firm?
A) The firm can charge a lower price than its competitors and thereby sell more output and increase
its profits.
B) The firm always earns a normal profit.
C) The firm's marginal revenue continually decreases.
D) The firm's minimum efficient scale is small relative to the market demand.
21. Sarah's Garage Cleaning is a perfectly competitive firm that currently cleans 40 garages a week.
Sarah's marginal cost is less than the price she charges. Sarah can increase her profit if she
A) charges a higher price.
B) charges a lower price.
C) cleans fewer than 40 garages a week.
D) cleans more than 40 garages a week.
22. For a perfectly competitive firm, the shutdown point is the
A) amount of output at which price equals minimum average variable cost.
B) amount of output at which price equals minimum average total cost.
C) price at which economic profit is zero.
D) price at which total opportunity cost is zero.
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23. If firms in a competitive industry are making ________ then there is ________ for firms to
________ the industry.
A) economic losses; an incentive; exit
B) economic losses; no incentive; exit
C) economic profits; no incentive; enter
D) normal profits; an incentive; exit
24. Which of the following is a barrier to entry for a monopoly?
A) a patent
B) severe diseconomies of scale
C) close substitutes for the good or service exist
D) All of the above answers are correct.
25. It is easier for a monopolist to price discriminate between groups for a service than for a product
because
A) it is easier to calculate average willingness to pay for services.
B) it is easier to distinguish between groups of customers for services than customers for products.
C) it is easier for consumers to resell products than services.
D) customers for products usually do not differ with respect to their average willingness to pay.
26. Before summer 2008, if you wanted a cell phone in Bhutan, you only had one choice. B-Mobile,
owned and operated by the government. Then, this past spring, a privately owned competitor, Tashi,
was let in. What do you predict will happen to equilibrium price and quantity in the cell phone
market?
A) Price will decrease and quantity will increase
B) Price will increase and quantity will decrease
C) Both price and quantity will increase
D) Both price and quantity will decrease
27. Monopolistic competition is a market in which ________ firms produce ________ goods and
services.
A) many; identical
B) many; differentiated
C) few; differentiated
D) few; identical
28. In the short run, a firm in a monopolistic competition will produce the amount of output where its
A) marginal revenue equals marginal cost and will set its price according to the demand for that
output level.
B) marginal revenue equals marginal cost and takes the market price as given.
C) average revenue equals average cost and will set its price according to the demand for that output
level.
D) average revenue equals its average cost and takes the market price as given.
29. In the long run, monopolistically competitive firms are ________ to perfectly competitive firms
because ________.
A) similar; both firms produce at the minimum ATC
B) similar; both firms earn zero economic profit
C) not similar; monopolistically competitive firms set P = MC to maximize profits
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D) not similar; monopolistically competitive firms can earn an economic profit and perfectly
competitive firms cannot

30. Professor Rush decides to quit teaching economics and opens a shoe store out at the mall. He
gave up an annual income of $50,000 to open the store. A year after opening the shoe store, the total
revenue for the year was $200,000. Rush's expenses were $30,000 for labor, rent was $18,000, and
utilities were $1,200. He also had to purchase new shoes from manufacturers, at a cost of $60,000,
which was financed by cashing in his savings of $60,000 that had been in a bank earning 8 percent
per year.
a. Calculate Professor Rushs explicit cost.

b. Calculate Professor Rushs opportunity cost.

c. According to his accountant, what profit did Professor Rush make?
d. Determine Professor Rushs economic profit.

31. Suppose the local newspaper hires students to fold and bag newspapers for delivery and pays
them $20 per shift. Five students can fold and bag 300 newspapers per shift. The fourth student
added 50 newspapers to total output. The capital cost is fixed at $50 per shift.
a. Is the newspaper operating in the long run or short run? Why?

b. What is the average product of 5 students?

c. Calculate the total fixed, total variable, and total costs of folding and bagging 300 newspapers.

d. What is the marginal cost of one of the 50 newspapers folded and bagged by the fourth student?

32. The table shows the production function of Bonnies Balloon Rides. Bonnies pays $500 a day
for each balloon it rents and $25 a day for each balloon operator it hires.
Table 1
Labor
(workers per day)
10
20
30
40
50

Output (rides per day)

Plant 2
Plant 3
10
13
15
18
18
22
20
24
21
25

Plant 1
4
10
13
15
16
7

Plant 4
15
20
24
26
27

Balloons (number)

a. Graph the ATC curves for Plant 1 and Plant 2.

b. On your graph in a, plot the ATC curves for Plant 3 and Plant 4.
c. On your graph in a, plot Bonnies LRAC curve.
d. On Bonnies LRAC curve, what is the average cost of producing 18 rides and 15 rides a day?
e. Explain how Bonnies uses its long-run average cost curve to decide how many balloons to rent.

33. Pats Pizza Kitchen is a price taker. Its costs are illustrated in Table 2.
Table 2
Output (pizzas per hour)
0
1
2
3
4
5

Total cost (dollars per hour)

10
21
30
41
54
69

a. Calculate Pats profit-maximizing output and economic profit if the market price is
i) $14 a pizza
ii) $12 a pizza
iii) $10 a pizza

b. What is Pats shutdown point and what is Pats economic profit?

c. At what price will firms with costs identical to Pats exit the pizza market in the long run?

d. At what price will firms with costs identical to Pats enter the pizza market in the long run?

34. Bills Bakery has a fire and Bill loses some of his cost data. The part of paper that he recovers
after the fire provides the information in the table (all the cost numbers are dollars). Bill asks you to
examine missing data and find the right values for it in the following table.
Total Product (Q)
10
20
30
40
50

AFC
120
(1)
40
30
24

AVC
100
(2)
90
(3)
108

ATC
220
150
130
(4)
132

a. Find the value for (1). Hint: use the definition of AFC.

b. Find the value for (2). Hint: use the relationship among AFC, AVC, and ATC.

c. Find the value for (3). Hint: use the relationship between VC and MC.

d. Find the value for (4). Hint: use the relationship among AFC, AVC, and ATC.

e. Find the value for (5). Hint: use the relationship between VC and MC.

10

MC
100
80
90
130
(5)

35. Read the following article and answer the questions.

... Pfizers antidepressant Zoloft, with $3.3 billion in 2005 sales, loses patent protection
on June 30. When a brand name drug loses its patent, both the price of the drug and
the dollar value of its sales each tend to drop about 80 percent over the next year, as
competition opens to a host of generic drugmakers. ... Some of those lost revenue will
go to generic drugmakers. But the real winners are the patients and the insurers, who
pay much lower prices. The Food and Drug Administration insists that generics work
identically to brand-names.
CNN, June 15, 2006
a. On the graph below, identify consumer surplus, producer surplus and deadweight loss. Assume
that Zoloft is the only antidepressant on the market and that price discrimination is not an option.
The graph below illustrates the market price and quantity of Zoloft sold. Explain the consumer
surplus, producer surplus, and deadweight loss of the antidepressant market.

Price
(dollars per does)
10
8

6
4

2
0
10 20 30 40 50

Quantity (millions of does per day)

b. How might you justify protecting Pfizer from competition with a legal barrier to entry?

c. Explain how the market for an antidepressant drug changes when a patent expires.

d. On the graph below, illustrate how the expiration of the Zoloft patent will change the price and
quantity in the market for antidepressants. Explain how consumer surplus, producer surplus, and
deadweight loss change with the expiration of the Zoloft patent.
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Price
(dollars per does)
10
8

6
4

2
0
10 20 30 40 50

Quantity (millions of does per day)

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