Sample Midterm Exam

Question 1 (12 points)

The painted necktie industry is perfectly competitive. Each firm has an identical cost structure and the minimum efficient scale of the​​ typical firm is qMES​​ = 20. The minimum average cost is $10. The market demand is Qd = 1,500 – 50P.

• Find the long run equilibrium price, the long run equilibrium quantity and the long run equilibrium number of firms.​​ The short run total cost of the typical firm is TCSR(q) = 0.5q2​​ -10q +​​ 200.

• What is the​​ shutdown​​ price of the typical firm? What is the short run supply curve of the typical​​ firm?

• Find the short run market supply​​ curve.

Painted necktie become more fashionable and the market demand function shifts upward to Q = 2,000-50P.

• Find the new short run equilibrium price and​​ quantity.

• In a diagram, illustrate the demand and supply curves and highlight the industry producer surplus when the market is in short run equilibrium.

• In a separate diagram, illustrate the typical firm’s MC, AVC and ATC curves and the short run profit or​​ loss.

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Question 2 (3 points)

Suppose a firm is maximizing profits in the short run with variable factor x1​​ and fixed factor x2. If the price of x2 goes down, what happens to the firm’s use of x1? What happens to the firms’ level of profit?

Question 3 (5 points)

Suppose​​ a​​ consumer​​ earns​​ an​​ income​​ of​​ $45,000​​ in​​ period​​ 1​​ and​​ an​​ income​​ of​​ $50,000​​ in​​ period​​ 2.​​ In​​ period​​ 1,​​ the​​ consumer​​ can borrow​​ funds​​ from​​ a​​ local​​ loan-shark​​ at​​ an​​ interest​​ if​​ 25%​​ and​​ he​​ can​​ save​​ money​​ by​​ hiding​​ it​​ in​​ a​​ cupboard.

• In a diagram, illustrate this consumer’s inter-temporal budget constraint.​​ The consumer’s utility function is U =​​ C1C2.

• In period 1, will this consumer borrow funds? Will he save money? Clearly justify your​​ answer.

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• In your diagram, add an indifference curve to illustrate the consumer’s optimal inter-temporal allocation of​​ income.

Question 3 (11 points)

Dave is looking for a job. He has a time endowment of 80 hours per week. He has some experience waiting on tables and he could do ​​ work for The Hobbit, a new restaurant. At The Hobbit, the hourly pay (including tips) is $20 and he could tailor the number of hours worked according to his needs. Alternatively, he was offered an internship at a design company. The internship would pay $30 an hour, however​​ he​​ could​​ work​​ only​​ up​​ to​​ 15​​ hours​​ each​​ week.​​ Dave​​ has​​ no​​ income​​ from​​ other​​ sources​​ and​​ does​​ not​​ want​​ to​​ hold​​ two​​ jobs.

• In a Leisure time/Consumption diagram, illustrates Dave’ budget constraint if he chooses to intern at the design company. Dave’s​​ utility function for consumption​​ (C) and leisure (N) is​​ U​​ (C,​​ N​​ )​​ =.

Suppose Dave chose to work at The Hobbit;

• How many hours would he work per week? What would his weekly earnings be? Show your work. Suppose Dave chose to work at the design​​ company;

• How many hours would he work there and what would his level of consumption​​ be?

• What does Dave choose to do?​​ Why?

• Dave’s grandmother decides to help him out financially and starts sending him $400 each week. Will Dave keep working? If so, for which company?​​ Discuss.

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Question 4 (12 points)

In California, a firm uses skilled labor (SL) and unskilled labor (UL) to produce videogames according to the production function ​​ q = LS0.5​​ x​​ LU.

• Does the production function exhibit increasing, constant or decreasing returns to scale? Justify your answer. Skilled workers are paid $64 an hour while unskilled workers are paid $16 an​​ hour.

Currently, the firm employs 9 skilled workers under a two-year contract. The workers signed a non- agreement.

• What is the short run conditional demand for unskilled labor? Show your​​ work.

• What is the short run total cost function? Show your​​ work.

• What is the long run conditional demand for unskilled​​ labor?

• What is the long run total cost​​ function?

Suppose skill biased technological change altered the firm’s production function.

• If the cost of skilled and unskilled labor remained unchanged, in the long run would the firm increase or decrease the number of unskilled workers it employed? Briefly​​ explain.

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Question 5 (7 points)

An​​ economic​​ agent​​ owns​​ a​​ house​​ worth​​ $120,000.​​ There​​ is​​ one​​ chance​​ in​​ 20​​ that​​ the​​ house​​ will​​ burn​​ down.​​ The​​ agent​​ has​​ utility​​ from wealth represented by the utility function U(W) =​​ lnW.

• Is this economic agent risk averse? Justify your​​ answer.

To selected customers, Coverall, an insurance company, sells a policy that for a premium of $3,500 covers a potential loss of $80,000.

• Would the agent apply to buy this policy?​​ Why?

The agent is refused coverage by Coverall. However,​​ Safety-first, a competitor offers him a contract with a premium of $6 for each $100 of coverage.

• Would this policy be a fair gamble for the economic agent? Justify your​​ answer.

• Under this policy, what is the agent’s optimal amount of​​ coverage?

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