Microeconomics First Semester Final Exam

Name:__________________________ Per:____

Microeconomics First Semester Final Exam Free Response Solutions

Directions: You have 50 minutes to answer all three of the following questions. It is suggested that you spend approximately half your time on the first question and divide the remaining time equally between the next two questions. In answering the questions, you should emphasize the line of reasoning that generated your results; it is not enough to list the results of your analysis. Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. Use a pen with black or dark blue ink.

1. [12 pts] Bestmilk, a typical profit-maximizing dairy firm, is operating in a constant-cost, perfectly competitive industry that is in long-run equilibrium. (a) [4 pts]Draw correctly labeled side-by-side graphs for the dairy market and for Bestmilk and show each of the following: (i) Price and output for the industry (ii) Price and output for Bestmilk

One point is earned for a correctly labeled market graph of the dairy industry. One point is earned for correctly labeled equilibrium industry price and quantity. One point is earned for drawing a horizontal demand curve for Bestmilk at the market price. One point is earned for showing the equilibrium quantity for Bestmilk where price equals marginal cost and the minimum of average total cost (P = MC = ATC)
(b) [4 pts] Assume that milk is a normal good and that consumer income falls. Assume that Bestmilk continues to produce. On your graphs in part (a), show the effect of the decrease in income on each of the following in the short run. (i) Price and output for the industry (ii) Price and output for Bestmilk (iii) Area of loss or profit for Bestmilk

One point is earned for showing a decrease in market demand. One point is earned for showing a decrease in equilibrium market price and quantity. One point is earned for showing the change to a new lower profit-maximizing price and quantity for Bestmilk. One point is earned for shading the area of loss for Bestmilk.
(c) [1 pt] Following the decrease in consumer income, what must be true for Bestmilk to continue to produce in the short run?

One point is earned for stating that P AVC, or TR TVC, or P AVC, or TR > TVC, or losses are less than total fixed costs.
(d) [3 pts] Assume that the industry adjusts to a new long-run equilibrium. Compare the following between the initial and the new long-run equilibrium. (i) Price in the industry (ii) Output of a typical firm (iii) The number of firms in the dairy industry

One point is earned for stating that industry price returns to the original long-run equilibrium price. One point is earned for stating that the output of a typical firm returns to the original profit=maximizing quantity. One point is earned for stating that there is a decrease in the number of firms.

2. [8 pts] The graph above shows the market for a good that is subject to a per-unit tax. The letters in the graph represent the enclosed areas. (a) [3 pts] Using the labeling on the graph, identify each of the following. (i) [1 pt] The equilibrium price and quantity before the tax (ii) [1 pt] The area representing the consumer surplus before the tax (iii) [1 pt] The area representing the producer surplus before the tax

P = $12; Q = 100 units A+ B+C+F D + E + G or $100

(b) [2 pts] Assume that the tax is now imposed. Based on the graph, does the price paid by the buyers rise by the full amount of the tax? Explain.

One point is earned for stating that the price paid by the buyers does not rise by the full amount of the tax. One point is earned for a correct explanation: P increases by $1 and the tax is #2 per unit; or a correct elasticity explanation, such as S is not perfectly elastic, or D is not perfectly inelastic, or D and S have the same elasticities.
(c) [3 pts] Using the labeling on the graph, identify each of the following after the imposition of the tax. (i) (ii) [1 pt] The net price received by the sellers [1 pt] The amount of tax revenue

$11 B + C + D or $160 A F + G or $20

(iii) [1 pt] The area representing the consumer surplus (iv) [1 pt EC] The area representing the deadweight loss

3. [8 pts] Assume that a profit-maximizing firm in a monopolistically competitive industry is in long-run equilibrium. (a) [4 pts] Draw a correctly labeled graph that shows the profit-maximizing firms price and output.

Correct Answer: The correct graph for a monopolistically competitive firm will show a downward-sloping D curve with a downward sloping MR curve below it. The firms price and output would be found at the equality of MR and MC. In the long run, the ATC curve is tangent to the demand curve and equal to price directly above the output level at which MR MC.

One point earned for a graph with downward-sloping demand curve with correctly labeled axes. One point earned for downward-sloping marginal revenue curve below the demand curve. One point earned for Q from MR = MC and P from Demand directly above Q. One point earned for long-run equilibrium, AC (or ATC) tangent to Demand at Q
(b) [4 pts] Assume that the city in which this industry operates eliminates the business license fee (a fixed cost) for all firms in this industry. How does the elimination of the license fee affect each of the following for the individual firm in the short run? Explain your answers. (i) Output (ii) Economic profit

Correct Answer: When the fixed cost decreases, MC is not affected so that the output and price remain constant. Economic profit increases since the ATC falls. One point earned for showing that individual firms output level does not change One point for explaining that the license fee is a fixed cost, thus it does not affect the firms marginal cost. One point for explaining that the economic profits increase Explanation in general.