Econ 201 - Study Guide - Test 2

Price Controls
What is a binding/non-binding price ceiling? Price floor? Show graphically and give some examples.
What forms of non-price competition may tend to appear under ceilings or floors?
How do price ceilings/floors affect CS, PS, and DWL? Show graphically.

Ex. The table gives the demand and supply curves for hot dogs

Price 0 1 2 3 4 5 6 7 8
Quantity demanded 240 210 180 150 120 90 60 30 0
Quantity supplied 0 30 60 90 120 150 180 210 240

Assume there is a price floor at $6. What is the level of producer surplus?
a) $60
b) $120
c) $240
d) $300
e) $400

Ex. Suppose a price ceiling is set on milk, preventing its price from reaching its normal equilibrium level. At this
price what would happen to the size of producer surplus? How about consumer surplus?

a) Producer surplus will increase. Consumer surplus will decrease

b) Producer surplus will decrease. Consumer surplus will increase
c) Producer surplus will increase. Consumer surplus could increase or decrease
d) Producer surplus will decrease. Consumer surplus could increase or decrease
e) Producer surplus will decrease. Consumer surplus will decrease

Essay: Assume a price ceiling on television is set below the market equilibrium price. What forms of non-price
competition might you expect to find in this market? Why would they occur?

Burden of a Tax
Be able to find the change in CS, PS, deadweight loss and tax revenue (including consumer and
producer tax burdens) graphically when a tax is implemented on a good and explain each area
Compare the elastic and inelastic cases when a good is taxed. For what economic reasons might a
government prefer to tax an inelastic good rather than an elastic one?
When will the tax burden fall mostly on consumers? On producers? Show graphically and explain

Ex. Suppose a per-unit tax is implemented on a good with an elastic demand curve. All else equal, which one of the
following is false?
a) The percentage decrease in quantity will be larger than the percentage increase in price.
b) There will be a relatively large amount of deadweight loss.
c) It will be difficult to predict the amount of tax revenue that will be received.
d) The drop in total consumer surplus will be larger than the drop in producer surplus.
e) The bulk of the tax will be paid by producers.

Essay: Assume a tax is placed on the producer of an inelastic good. Graphically show the new CS, PS, DWL and
tax revenue. Why might the government prefer to tax an inelastic good rather than an elastic good?
Consumer Choice and Utility Maximization
Define utility
State and explain the law of diminishing marginal utility
Be able to find a persons utility-maximizing bundle of goods when given prices and a budget
Explain how an individuals demand curve follows from utility maximizing behavior
Be able to find the market demand curve from individual consumer demand curves
Know the difference between the substitution and income effect

Ex. The following table describes Jimis utility for televisions and VCRs.

Q of Televisions Total Utility Q of VCRs Total Utility

0 0
1 400
2 600
3 650
4 675
5 690
6 700
0 0
1 300
2 400
3 420
4 435
5 440
6 442

If the price of each television is $200 and the price of each VCR is $100, what is the maximum amount of
utility Jimi could receive given he has $1000 to spend on these two goods?

Economic Profit
What is the difference between explicit and implicit costs? Be able to give examples.
What is the difference between economic and accounting profit? Be able to solve for alternative choices.

Ex. What are the economic profits for the following firm? Assume all pertinent information is given (based yearly).
- The firm sells 100,000 units at $60 each
- Utility expenses are $400,000
- Employee wages equal $2M
- Costs to replace worn-out equipment are $1M
- The building currently being used could instead be rented out for $500,000
- Tax payments are equal to $500,000
- Advertising costs amount to $200,000
- The owner turned down a $200,000 job to start the business
- There is $10M in machinery and equipment.
- The market interest rate is 15%

SR Cost Curves
What is the difference between the short-run and long-run?
Define fixed and variable costs. Be able to give examples.
Graph the TFC and AFC curves. Explain their shape.
Define increasing and decreasing marginal returns. Explain how they relate to the cost curves
Graph the TVC curve. Explain its shape.
Graph the MC and AVC curves. Explain their shape.
Be able to calculate any type of firm costs (TVC,TFC,TC,AVC,AFC,ATC, or MC) if given enough information
Ex. The costs of production for a firm are given below.

Quantity 0 1 2 3 4 5 6
Total Cost 1000 1400 1700 1900 2100 2500 3000

What is the average variable cost of the 3rd unit?

Essay: Given the following information, find the firms TFC, TVC, MC, AFC, AVC, and ATC curves. Sketch them.

Output 0 1 2 3 4 5 6 7 8
Total Cost 100 150 180 200 240 300 380 480 600

Ex. Suppose a firm has the following costs:

Quantity 0 1 2 3 4 5 6
AVC undef. 500 450 400 ? ? ?
AFC undef. ? ? ? 250 ? ?

What is the total cost of producing 3 units?

Ex. If the total cost of producing 6 units is $310 for the following firm, what is their total fixed cost?

Quantity 0 1 2 3 4 5 6 7
MC - 50 40 30 40 50 60 70

Ex. For the following firm, what is the marginal cost of the 5th unit?

Quantity 0 1 2 3 4 5 6
AVC - 80 70 60 62.5 70 83.3
 Answers
Ex. The table gives the demand and supply curves for hot dogs

Price 0 1 2 3 4 5 6 7 8
Quantity demanded 240 210 180 150 120 90 60 30 0
Quantity supplied 0 30 60 90 120 150 180 210 240

Assume there is a price floor at $6. What is the level of producer surplus?

- The area of PS extends from below the price of 6, above the Supply curve, and stops at a quantity of 60. It
can be looked at as a rectangle and a triangle together. Rectangle area is 4*60 = 240, triangle area is *
2 * 60 = 60. Total PS is therefore 300.

Ex. Suppose a price ceiling is set on milk, preventing its price from reaching its normal equilibrium level. At this
price what would happen to the size of producer surplus? How about consumer surplus?

a) Producer surplus will increase. Consumer surplus will decrease

b) Producer surplus will decrease. Consumer surplus will increase
c) Producer surplus will increase. Consumer surplus could increase or decrease
d) Producer surplus will decrease. Consumer surplus could increase or decrease
e) Producer surplus will decrease. Consumer surplus will decrease

- The Answer is D. A binding price ceiling must go below an otherwise occurring equilibrium price. This
will cause producers to receive less money per unit and sell less units as the quantity supplied decreases.
Consumer surplus could increase or decrease. On the one hand, consumers may receive the good at a
lower price (assuming forms of non-price competition dont negate this) but on the other they will be less
able to purchase units. This CS lost to deadweight loss could potentially be larger than any gains received.

Essay: Assume a price ceiling on television is set below the market equilibrium price. What forms of non-price
competition might you expect to find in this market?

- With a price ceiling there is excess demand in the market. We listed out several things consumers may need
to do to get the good in the face of these shortages.

Ex. Suppose a per unit tax is implemented on a good with an elastic demand curve. All else equal, which one of the
following is false?
a) The percentage decrease in quantity will be larger than the percentage increase in price.
b) There will be a relatively large amount of deadweight loss.
c) It will be difficult to predict the amount of tax revenue that will be received.
d) The drop in total consumer surplus will be larger than the drop in producer surplus.
e) The bulk of the tax will be paid by producers.

- Answer is D. The Consumer Tax Burden should be smaller than the producer Tax Burden. The equilibrium
price will not increase much, as producers will have a hard time passing the tax onto consumers.

Essay: Assume a tax is placed on the producer of an inelastic good. Graphically show the new CS, PS, DWL and
tax revenue. Why might the government prefer to tax an inelastic good rather than an elastic good?

- We discussed three reasons to tax an inelastic good. The three very briefly are smaller deadweight loss,
easier prediction of tax revenue, and a smaller distribution of the burden falling on each person.
Ex. The following table describes Jimis utility for televisions and VCRs.

Q of Televisions Total Utility Q of VCRs Total Utility

0 0
1 400
2 600
3 650
4 675
5 690
6 700
0 0
1 300
2 400
3 420
4 435
5 440
6 442

If the price of each television is $200 and the price of each VCR is $100, what is the maximum amount of
utility Jimi could receive given he has $1000 to spend on these two goods?

- The prices must be used to calculate marginal utility per dollar. The table should then look like the
following:

Quantity 1 2 3 4 5 6
TV MU per dollar 2 1 0.25 0.125 0.075 0.05
VCR MU per dollar 3 1 0.2 0.15 .05 .02

The answer will be 3 TVs and 4 VCRs.

Ex. What are the economic profits for the following firm? Assume all pertinent information is given (based yearly).
- The firm sells 100,000 units at $60 each
- Utility expenses are $400,000
- Employee wages equal $2M
- Costs to replace worn-out equipment are $1M
- The building currently being used could instead be rented out for $500,000
- Tax payments are equal to $500,000
- Advertising costs amount to $200,000
- The owner turned down a $200,000 job to start the business
- There is $10M in machinery and equipment.
- The market interest rate is 15%

- Revenue is $6M. Explicit costs are 400k+2M+1M+500k+200k= $4.1M. Implicit costs are
500k+200k+1.5M= $2.2M. Therefore economic profit is -300,000.

Ex. The costs of production for a firm are given below.

Quantity 0 1 2 3 4 5 6
Total Cost 1000 1400 1700 1900 2100 2500 3000

What is the average variable cost of the 3rd unit?

- The fixed costs in this problem will be 1000, since any cost existing at a Q=0 must be fixed. That means
the total variable cost of producing 3 units is 900, or an AVC = 300.
Essay: Given the following information, find the firms TFC, TVC, MC, AFC, AVC, and ATC curves. Sketch them.

Output 0 1 2 3 4 5 6 7 8
Total Cost 100 150 180 200 240 300 380 480 600

- TFC 100 100 100 100 100 100 100 100 100
TVC 0 50 80 100 140 200 280 380 500
MC 50 30 20 40 60 80 100 120
AFC undef 100 50 33 25 20 16.7 14.3 12.5
AVC undef 50 40 33 35 40 46.7 54.3 62.5
ATC undef 150 90 66.7 60 60 63.3 68.6 75

Ex. Suppose a firm has the following costs:

Quantity 0 1 2 3 4 5 6
AVC undef. 500 450 400 ? ? ?
AFC undef. ? ? ? 250 ? ?

What is the total cost of producing 3 units?

- The total fixed cost is 250*4 = 1000. The total variable cost of 3 units is 400*3=1200. Together they are
2200.

Ex. If the total cost of producing 6 units is $310 for the following firm, what is their total fixed cost?

Quantity 0 1 2 3 4 5 6 7
MC - 50 40 30 40 50 60 70

- The TVC can be calculated from the marginal costs. The TVC of producing 6 units is
50+40+30+40+50+60 = 270. Since TC = TVC + TFC it follows 310 = 270 + TFC, and the TFC=40.

Ex. For the following firm, what is the marginal cost of the 5th unit?

Quantity 0 1 2 3 4 5 6
AVC - 80 70 60 62.5 70 83.3

- The TVC can be calculated with AVC*Q. TVC of 4 units is 250, and TVC of 5 units is 350, therefore the
MC would be the difference of 100.