1. Are you really willing to pay BIG bucks for a DAT?  If consultants have estimated that a 10 percent fall in the price of DATs will increase demand for DATs by 15 percent, then

1. demand is unit-elastic.
2. demand is elastic.
3. demand is inelastic.
4. elasticity of demand cannot be calculated.

Price elasticity is the percentage change in demand divided by the percentage change in price. In this problem we get 15/-10 = -1.5. Since the absolute value is greater than 1, demand is elastic.

2. Which of the following is correct?

1. AC = AFC/Q
2. AC = AFC - AVC
3. FC + MC = AVC
4. TC = FC + VC
5. MC = AC - TFC

The only option here that makes sense is the fourth one. Answers d and c should be suspect since you are mixing average, marginal, and total concepts which does not work. The total cost of production equals the fixed cost plus the variable cost. 

3. I overheard some students talking about how they had been studying so long that they felt that the extra grades they gained from the extra studying time was beginning to fall.  This would be an example of:

1. diminishing marginal product
2. diminishing marginal cost
3. increasing returns to scale
4. increasing marginal product
5. economies of scale

This is an example of diminishing marginal product.  As you study more (input) the additions to output (grades) that you earn begin to decline as it gets harder to improve your grade.   

4.  When confronted with the following options, the majority of you chose option B.  This would be an example of 

• A: A sure loss of $750
• B: A 75% chance of losing $1,000 and a 25% chance of losing $0.

1. asymmetric value function
2. asymmetric information
3. adverse selection
4. expected utility
5. sunk costs

The expected value of the two is identical, but you were not indifferent to the two choices.  This is an example of asymmetric value function - people value losses more highly than gains.   

5. How much are people willing to pay for those Palm Pilots?  If the elasticity of demand for Palm Pilots is estimated at -1.5, then an increase in the price of a Pilot from $200.00 to $220.00 would reduce quantities demanded by about

1. 20 percent.
2. 15 percent..
3. 10 percent
4. 5 percent.

The first step here is calculating the percentage change in the price of vodka = (220-200)/200 = 10%. The formula for elasticity is: elasticity = %D Q/% DP. In this problem the unknown is the change in output. Using a little algebra we get % DQ = % DP * elasticity = 10*(-1.5) = -15

Below you will find the production relationship that exists in Tommy's Tutoring, an on-campus tutoring business.  You are to use the following information to answer the following questions.   

6.  What is the marginal product of the third hour of tutoring?

1. 12
2. 11
3. 10
4. 9
5. 8.5

The key to answering this question is MP.  With four hours your grade is 48 and the MP of the fifth hour is 6 which means that your grade will increase by 6 points so that your grade will be 54.  

8. Biggy's Burgers is currently producing 100 units of output (burgers) that it sells for $6 per unit and the consultants that it has hired have convinced Biggy that an expansion of output to 150 will lower the sales price of all units to to $5.  What is the MR of expanding output above 100 units?

1. 2
2. 3
3. 4
4. 5
5. 6

At an output level of 100, revenue = 100*$6 = $600, while at an output level of 150, revenue = 150*$5 = 750.  Plugging into the formula for MR = D(revenue)/D(output) = (750-600)/(150-100) = (150/50) = 3

9. Which curve is the MC curve

1. G
2. H
3. K
4. L
5. not shown

The MC curve intersects the AC curve at the bottom of the AC curve and thus H is the MC curve

Let's return to Tina's and add in some revenue data based on the market analysis conduced by Tina's consultants.  The consultant is fairly confident that Tina is operating in a very competitive environment, one that could be approximated by the perfect competition model.  It is their opinion that Tina can sell the grades at $20 a point.   Use this information to answer the following questions

10. What is the profit maximizing level of grades produced?

1. 17
2. 30
3. 40
4. 48
5. 54

Profit is maximized when MR = MC.   In this example MR = $20 since the business is in a perfectly competitive industry.  The firm will operate where MR = MC which happens at an output of 40 points. 

11. Biggy's Burgers is currently producing 100 units of output (burgers) that it sells for $6 per unit and the consultants that it has hired have convinced Biggy that an expansion of output to 150 will not affect the sales price.  What type of market is Biggy's operating in??

1. perfect competition
2. monopoly
3. monopolistic competition
4. oligopoly

The key here is the fact that the price did not change as output changed - the basic premise of the perfect competition model.  In this model you find that no producer is large enough to influence price so the price remains the same regardless of the firm's level of output. 

12. A local music store has begun a PR campaign where they offer a volume discount. If you buy five CDs you pay $16 a CD, but if you buy more than five CDs, the price per CD is lowered to $14 for each CD. What is the marginal revenue of the 6^th CD?

1. $16
2. $14
3. $8
4. $6
5. $4

If you buy five CDs the cost (revenue) is $80 [$5*16].  The total cost (revenue) of six CDs would be $84 [$6*14].   The marginal revenue of the 6^th gallon would be D(revenue)/D(output) = ($84-$80)/(6-5) = $4

13. If at an output level of 4,000 cones, Jim & Benny’s Ice Cream Company is making an economic profit and MC = $.08 and MR = $07, the firm should:

1. increase output
2. decrease output
3. leave output level at 4,000 cones
4. Not enough information to make a decision.

As long as marginal profit is greater than zero [MR > MC], the firm will increase profit if it expands output.  In this case where MR < MC, the firm will benefit by lowering the level of output.

14. What is the optimal level of output for the firm with the cost and revenue curves in the above diagram?

1. 1
2. 2
3. 3
4. 4
5. 5

The optimal level of output happens when MR = MC.  This happens when the two curves intersect - at an output level of 5.  

15.  You are offered a "Deal" -  a 25% chance of winning $10,000 and a 75% chance of losing $1,000.  What is the expected value of the deal?

1. $2,500
2. -$750
3. $1,750
4. $0

The expected value = .25*10,000 - .75*1000 = 2,500 - 750 = 1,750

16. The demand for all gasoline is ________ the demand for Shell gasoline.

1. exactly as elastic as and of the same slope from
2. more elastic than
3. less elastic than
4. exactly as elastic and of different slope from

The issue here is availability of substitutes. There are more substitutes for Shell so you would expect that demand for Shell would be more elastic.

17. Suppose that a perfectly competitive industry is in long-run competitive equilibrium. Then the government launches a massive ad campaign identifying the negative effects of the product.  The short-run impact will be a _______ shift in the MR curve and a _____ in the firm's optimal level of output.

1. increase   /  decrease
2. increase   /  increase
3. decrease   /  decrease
4. decrease   /  increase

The advertising campaign, if we assume it is effective, will shift demand for the product downward.  The result will be a lower market price so that the MR line will shift downward as P falls.  The intersection of MR and MC will now be to the left of the initial equilibrium level. 

18. The rule for optimal use of any input says that:

1. when MRP is less than price, it pays to expand resource use
2. when MRP is greater than price, it pays to expand resource use
3. when MRP equals price, resource use should be cut back
4. resources should be used only if MRP exceeds price

The rule is that you will continue to use inputs as long as the MR from using them is greater than the MC of hiring them. IF MRP > price of input, then you should expand your use of the input.

19. If the marginal physical product of labor at Toni's Toys for Tykes is 8, and its toys sell for $20, what is the MRP of labor at Toni's?

1. $8
2. $20
3. $80
4. $160

Marginal revenue product is simply marginal revenue * marginal product. In this example MP = 8 and MR = $20 so the MRP equals $20*8 = $160.

20. If the marginal cost of producing education exceeds the marginal utility of using legal services, then for economic efficiency,

1. the price of legal services should fall.
2. society should produce less legal services.
3. the price of goods made with legal services should fall.
4. society should direct resources toward legal services production and away from the production of other goods.

The key to this is recognizing that the marginal utility declines with greater output while marginal cost increases with output. In the ‘optimal’ situation MC = MU so we would need to reduce the supply of legal services which would raise MU and lower MC.  {Note: this question was dropped - education should have been legal services}. 

1. free entry and exit
2. heterogeneous products
3. numerous firms
4. perfect information

Now that you have mastered the production aspects of Tommy's Tutoring, it is time to move over to the cost side of the ledger.  Below you will find some cost data that you should use to answer the following questions.

24.  What is the level of fixed costs?

1. 50
2. 100
3. 150
4. 200
5. 300

The key to answering this question is recognizing that TC = FC + VC and that VC at a zero output level = $0 so that TC must equal FC = $100.  

25.  What is the marginal cost of improving my grade when I want to move from 40 to 48 points?

1. 22
2. 25
3. 27
4. 29
5. 31

The key to answering this question is recognizing that we are talking about MC - what happens to cost when output increases. The formula for MC is D(cost)/D(output) = D(cost)/D(grades) = (900-700)/(48-40) = 200/8 = 100/4 = 25

26. Assume that you run a Tuna's T's, a Newport T-shirt shop where the price received for each T shirt is $5 and the marginal product of your worker is 12.  What would be the most you would pay for an hour of work based on the traditional labor market analysis that assumes that you are maximizing? 

1. $2.5
2. $5
3. $12
4. $60

The key to answering this question is recognizing that the most you would pay would be MRP = Price of the output * MP of the input.  In this case the marginal product of the fourth hour is 8 - by adding the extra hour the grade increases by 8.  If each one of these points is priced at $5, then the revenue generated is $5*8 = $40.  

27. Which of the following is one of the characteristics of the perfect competition model?

1. the AC curve is horizontal
2. the MC curve is horizontal
3. the TR curve is horizontal
4. the MR curve is horizontal
5. the TC curve is horizontal

The "special" feature of the perfect competition model is that the firm's output level does not influence price.  This means that TR = P*Q where P is a constant. In this situation, the change in revenue from selling one more unit of output (MR) equals price.  

28. Reebok and Nike are fierce competitors in the sneaker market.  If we wanted information on the impact that a price change for Nike sneakers would have on demand for Reeboks, then we would want to know the_____ 

1. own-price elasticity of demand
2. income elasticity of demand
3. cross-price elasticity of demand
4. price elasticity of supply

The relationship between demand for a product and the price of other products is captured in the cross-price elasticity of demand.   

29. What can you forecast for a competitive firm if you find that at the present time a profit maximizing firm would be in a situation where P >AC?

1. output for the firm and industry would contract
2. new firms would enter the industry
3. firms would leave the industry
4. costs in the industry would shift down

If the firms are maximizing profit and P > AC then the price received for each unit of output is greater than the cost of the unit of output.  In this situation the firm is making a profit so new firms will enter the industry

30. The baby boomers are not a force to be ignored.  You will do so at your own risk.  The baby boomer generation refers to people who are now approximately how old?

1. 25-35
2. 35-45
3. 45-55
4. 55-65
5. 65-75

The boomers are those people born after WWII and before the mid 1960s.  The leading edge of the baby boomer generation recently turned 50, but the majority of the boomers are between 40 and 50. 

Use the diagram to answer the next xx questions

31. Based on the analysis of choice, the equilibrium point will be:

1. A
2. B
3. C
4. U4

The consumer is striving to maximize utility - move to the highest indifference curve.  The point B is not as desirable as A and C so it is out.  Point C is the preferred choice, but it is not attainable with the current budget - which leaves us with A.  

32. Based on the analysis of choice, an increase in the price of X will show up as a:

1. steeper set of indifference curves
2. steeper budget constraint
3. flatter set of indifference curves
4. flatter budget constraint

The two pieces in the traditional model of choice are the constraints and the preferences.  The constraint is shown in the graph by the budget constraint and it is influenced by both prices and income.  If you have more income the curve will shift outward letting you reach higher levels of utility.  If the price of either X or Y changes then the slope of the curve will shift.  An increase in the price of X will give us a smaller X intercept which will result in a steeper budget constraint.   

33. There are a large number of poor countries in the world and one of the factors cited as a cause of their poverty is the country's industrial structure.  One of the problems facing these countries is their reliance on agricultural exports as a source of money.  The problem is that as the world economy grows the demand for agricultural products does not increase substantially - people will spend the additional income on "stuff" other than food.  What feature of demand does this discussion refer to? 

1. own-price elasticity of demand
2. income elasticity of demand
3. cross-price elasticity of demand
4. price elasticity of supply

The relationship between demand for a product and the strength of the economy is captured in the income elasticity of demand.   As the world economy grows, the additional income does not translate into substantially higher demand for agricultural "stuff."

34.  When you were offered a lifetime guarantee on a watch from Rolex and Timmy's Time pieces, a vendor selling watches out of a cart on a street corner in SoHo, NYC you overwhelmingly chose Rolex.  This is an example of the importance

1. signaling
2. adverse selection
3. asymmetric value function
4. expected utility
5. sunk costs