Temple University
Department of Economics
Econ 52, 2nd Hour Exam, Spring 2006

Name__________KEY____________________________

Directions: You have 50 minutes for this exam.  You must complete all questions. Your answers must be your own work; you may neither give nor receive help.  This is a closed book exam.

Multiple Choice (30 points) Answers at the end of the exam.

Use the following to answer question 1:
Figure 7.3

	1.	After the price ceiling is imposed, consumer surplus  _________ and is represented by the points _______. 
	A)	decreases; JAE 
	B)	does not change; BAC 
	C)	increases; BAEH 
	D)	increases; GAEF 
	E)	decreases; BJEH 

2. 	Except in the extreme cases of perfectly inelastic or elastic demand and/or supply curves, the burden of a per unit tax imposed on sellers falls 
	A)	partially on consumers and partially on producers. 
	B)	entirely on consumers. 
	C)	equally on consumers and producers. 
	D)	mostly on producers. 
	E)	entirely on producers. 

Use the following to answer question 3:

	3.	When the firm uses 9 employee-hours, it will experience _______ in labor costs. 
	A)	$84 
	B)	$210 
	C)	$126 
	D)	$56 
	E)	$30 
	
	4.	In regulated markets, the invisible hand 
	A)	may or may not influence the market outcome. 
	B)	serves to allocate resources on the basis of price as in unregulated markets. 
	C)	is irrelevant. 
	D)	becomes truly invisible. 
	E)	will guide resources on some basis other than the price that is regulated. 

	5.	When some factors of production are fixed, equal sized increases in production will eventually require 
	A)	smaller increases in the variable factor. 
	B)	higher profits. 
	C)	larger increases in the fixed factors. 
	D)	larger increases in the variable factor. 
	E)	equal sized increases in the variable factor. 

	6.	Assume the consumer is correctly applying the rational spending rule for goods X and Z.  If the consumer's income increases, purchases of X and Z rises because 
	A)	the marginal utility of X decreases. 
	B)	the price of X increases. 
	C)	combinations of X and Z that could not be considered before now become available. 
	D)	the marginal utility of Z decreases. 
	E)	the price of Z falls. 

	7.	A price setter finds that it has 
	A)	the ability to set the price wherever it wants. 
	B)	to accept the price the market sets. 
	C)	some control over the price it charges. 
	D)	few competitors. 
		E)  the ability to always earn an economic profit.

Use the following to answer question 8:

Suppose the city of Austin, TX chooses to regulate the number of street vendors operating on "the Drag," near the University of Texas.  Prior to regulation, the costs (including implicit costs) of operating was $85,000 and revenues were $150,000.  The city ordinance allows the permits to be bought and sold without restriction and permits were issued to all current vendors.  The interest rate is 10 percent. 

	8.	Suppose the interest rate falls from 10% to 9%.  The price of a permit is now 
	A)	$6.5 million. 
	B)	$58,500. 
	C)	$722,222. 
	D)	$65,000. 
	E)	$650,000. 

Use the following to answer question 9:
Figure 7.8

	9.	The cost to producers of producing the 12th unit through the 20th unit is 
	A)	$48. 
	B)	$8. 
	C)	$56. 
	D)	$18.64. 
	E)	$10.64. 

	10.	According to the textbook, the homes of the wealthy in Seattle average in excess of 10,000 square feet while the homes of the wealthy in New York City average less than 5,000 square feet.  The difference is primarily due to 
	A)	a ban on construction of new homes in excess of 5,000 square feet in NYC. 
	B)	property tax abatements granted to new homes with at least 10,000 square feet in Seattle. 
	C)	greater "tastes" for crowding in NYC. 
	D)	a significantly higher price for land and construction in NYC. 
	E)	greater "tastes" for space in Seattle. 

	11.	In order to sell another unit, an imperfectly competitive firm must 
	A)	increase its advertising. 
	B)	increase the value of its product. 
	C)	raise its price. 
	D)	lower its quality. 
	E)	lower its price. 

	12.	Which of the following statements is false? 
	A)	A price taker must charge the market price. 
	B)	If a price setter raises price, they will sell less. 
	C)	To sell more, a price setter must lower price. 
	D)	Price setters can sell any quantity at any price. 
	E)	A price taker's revenues will rise if they sell more. 

	13.	The allocative function of price means price 
	A)	allocates Porches to the wealthy. 
	B)	guides resource across different sectors of the economy. 
	C)	allocates low quality goods and services to the poor. 
	D)	guides resources to the same market. 
	E)	ensures that sometimes those who value the good the most are able to acquire it. 

	14.	Which one of the following goods or services should have the lowest price elasticity of demand coefficient based on the share of income devoted to the good or service? 
	A)	Hamburger meat. 
	B)	Renting an apartment. 
	C)	Toothpicks. 
	D)	A new car. 
	E)	Owning a home. 

	15.	Of the following characteristics, which one applies exclusively to a perfectly competitive firm? 
	A)	It has a narrow range of prices it can charge for its output. 
	B)	It seeks only to minimize costs. 
	C)	It will never earn a profit. 
	D)	It always earns a profit. 
	E)	It can sell all it wants to at the market price. 

Problem (50 points)

The catnip industry is a constant cost perfectly competitive industry.  That is, as firms enter and leave the industry the price of inputs does not change with the scale of the industry.  Each firm in the industry has a U-shaped long run average cost curve that reaches a minimum at a value of $90 per ton at an output of q=80.  The consequence of the foregoing is that while a given firm has an increasing marginal cost curve, the long run supply curve for the industry is horizontal.
As you go through the numerical results you would do well to look at the graph at the end.
a.	The industry long run supply curve for catnip is a horizontal line at what price? __90_____

b.	 What will be the long run equilibrium price of a ton of catnip? _90________

c.	The market demand curve for catnip is Q = 5800 – 20 P.  What will be the equilibrium quantity in the catnip market?

Q = 5800 – 20(90) = 5800 – 1800 = 4000
 
d.	 If each firm is in long run equilibrium, how much catnip will each firm produce?

q = 80, as given in the question.

e.	 Given your earlier answers, how many firms will there be in the industry in the long run equilibrium?

Industry output is 4000 and each firm is producing 80, so the industry will have 50 firms.

f.	What profit is each firm earning?  _____0, as a consequence of perfect competition____

g.	 As a consequence of a report by the USDA that catnip spread in the garden will improve plant health, the demand for catnip immediately increases and the new market demand curve is now Q = 10,600 – 20 P.   In the short run catnip firms are stuck with a given size plant and so the industry’s short run supply curve is given by Q = 100 P – 5000.  What are the new short run market equilibrium price and quantity, before any new firms can enter the industry?

10,600 – 20P = 100 P – 5000
120 P = 15600
P = 15,600/120 = 130

Q = 100 (130) -5000 = 8000

h.	How much catnip is being produced by each of the incumbent firms in the short run?

In the short run there are still only 50 firms supplying 8000 units, so each produces 160.

i.	 As a consequence of the increase in demand and the concomitant increase in price, incumbent firms will be earning a profit and new firms will be attracted to the industry until those profits disappear.  What will be market price and quantity in the final long run equilibrium?

P = 90

Q = 10,600 – 20 (90) = 10,600 -1800 = 8800

j.	 How much catnip will be produced by each firm in the new long run equilibrium and how many firms will there be?

Q = 80 from the given information.  Since total output must be 8800 there will be 8800/80 = 110 firms.

Essay (20 points) As usual, you will be graded on spelling, grammar and syntax as well as content.

Why do we prefer a competitive market structure to a monopoly market structure?

We know from our analysis of markets using supply and demand that in equilibrium the benefit to consumers of the last unit consumed is equal to the additional cost resulting from the production of that unit.  This is the MB = MC principle. When markets are working then economic surplus, the sum of consumer and producer surplus, is maximized.

When competitive markets are in long run equilibrium P = MC.  That is, the marginal benefit to the consumer is equal to the firm’s marginal cost, the condition we observed in our supply-demand analysis.  Since P = MR for the competitive firm it is also true that marginal benefit and marginal cost are equal for the firm.  Furthermore, the competitive firm will choose output corresponding to the point where average cost attains a minimum; there is no cheaper way to produce the same output.  Lastly, economic profits are zero in long run equilibrium; the allocative function of the price system has attracted just enough resources to the industry.

Under monopoly none of the three features observable in perfect competition are present.  To begin with P > MC.  This means that society values the last unit more highly than the resources used to produce it.  Secondly, there is no incentive for the monopoly to produce at the minimum of average cost.  Thirdly, profits for the monopolist are >= 0.  Although there may be a signal to attract resources to the industry, nothing will happen.

We can measure the loss attributable to existence of monopoly as deadweight loss.  

Answer Key

	1.	D	
	2.	A
	3.	C		
	4.	E	
	5.	D	
	6.	C	
	7.	C	
	8.	C	
	9.	C	
	10.	D	
	11.	E	
	12.	D	
	13.	B	
	14.	C	
	15.	E