Homework answers / question archive / Michigan State University - EC 201 Econ 201 Final Exam Review--Practice Quiz— Sample Quiz #1 Scarcity means there is poverty; there is income inequality; people want more than is freely available; opportunity costs exceed sunk costs; sunk costs should be ignored

Michigan State University - EC 201 Econ 201 Final Exam Review--Practice Quiz— Sample Quiz #1 Scarcity means there is poverty; there is income inequality; people want more than is freely available; opportunity costs exceed sunk costs; sunk costs should be ignored

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Michigan State University - EC 201

Econ 201 Final Exam Review--Practice Quiz—

Sample Quiz #1

Scarcity means

there is poverty;
there is income inequality;
people want more than is freely available;
opportunity costs exceed sunk costs;
sunk costs should be ignored.

Suppose that a company has signed a lease for $20,000 for office space. If it decides to move to another location, it can sublet the space for $15,000. What is the opportunity cost of staying in the leased space?

$20,000;
$15,000;
$5,000;
1.33;
0.67.

For questions 3 and 4 use the following information.

The Dean has $600,000 to spend. Faculty can be hired for $100,000 each. Assistant deans can be hired for $150,000 each. Draw her budget constraint with faculty hired on the horizontal axis.

If the Dean’s budget increases to $800,000, the budget constraint

rotates clockwise around the horizontal intercept;
rotates counter-clockwise around the horizontal intercept;
rotates clockwise about the vertical intercept.
shifts parallel to the right;
shifts parallel to the left.

4. If the cost of hiring faculty rises to $200,000, the budget constraint

rotates clockwise around the horizontal intercept;
rotates counter-clockwise around the horizontal intercept;
rotates clockwise about the vertical intercept.
shifts parallel to the right;
shifts parallel to the left.

5. The principle of diminishing returns implies that

every activity eventually fails;
as the level of activity pursued increases the (marginal) opportunity cost rises;
as the level of activity pursued increases the (marginal) opportunity cost falls;
as the level of activity pursued increases the (average) opportunity cost rises;
as the level of activity pursued increases the (average) opportunity cost falls.

6. The lost surplus that results when an incorrect decision is made is referred to as the

a. deadweight burden;

b. trade-off;

c. opportunity cost;

d. sunk cost;

e. little triangle.

The dean has received a donation of $90,000 for technology acquisition. He will spend the money on either desktop computers for the faculty at a price of $3,000 each or technology training seminars for the faculty at a price of $9,000 each.

Draw his budget constraint. Be sure to label both axes and intercepts.

What is the opportunity cost of a training seminar?
What is the opportunity cost of a desktop computer?

2. Marginal benefits and costs. Researchers believe that we can reduce the incidence of emphysema by reducing particulate matter in the atmosphere. A program to reduce pollution by hiring more inspectors has been proposed and evaluated. The costs of benefits of the program are given below.

Inspectors Total Benefits Marginal benefits Total costs Marginal costs

0 0

1 10

2 18

5 36

6 40

7 43

8 45

Find marginal benefits and costs and enter in the table.
What is the optimal number of inspectors to hire?
What are the net benefits (benefits minus costs)?

Sample Quiz #2

When two countries trade,

each individual and firm in each country benefits;
any individual benefits from the trades that she engages in;
particular groups in each country may be hurt by trade in some goods;
b. and c. are correct;
none of the above.

Which of the following describes the relationship between comparative and absolute advantage?

If a country has comparative advantage in the production of a good, then it also has absolute advantage.
If a country has absolute advantage in the production of a good, then it also has comparative advantage.
A country cannot have absolute advantage and comparative advantage in the production of the same goods.
All of the above.
None of the above.

If the price of silk ties is $40 and the price of silk handkerchiefs is $20, then the relative price of a silk tie is

2 handkerchiefs;
½ handkerchief;
$40;
$20;
none of the above.

4 If the United States has a absolute advantage in the production of a good, then

fewer resources are required to produce the good in the U.S.;
the U.S. also has comparative advantage in the production of the good;
the relative cost of producing the good is lower in the U.S.;
the U.S. will import the good:

e. the U.S. will export the good;

5. A country with comparative advantage in the production of apricots?

a. will have a trade surplus;

b. will have a trade deficit;

c. will export apricots;

d. will import apricots;

e. will also have absolute advantage in apricots.

6. A country with a highly educated, skilled workforce will

a. have comparative advantage in goods requiring skilled workers;

b. have comparative advantage in goods requiring low wage workers;

c. have comparative advantage in goods requiring abundant, fertile cropland;

d. have comparative advantage in goods requiring physical capital, such as plant and equipment;

e. all of the above.

Problems

1. Comparative advantage. The following table gives the annual productivities of typical workers in Bulgaria and Poland for wine and wheat. World prices for wine and wheat are $20 per case and $5 per bushel.

Bulgaria Poland

wine (cases) 6 6

wheat (000s bu) 18 30

a. Plot the production possibilities frontiers.

What is the opportunity cost of wine in Poland?
What is the opportunity cost of wine in Bulgaria?
In which good does Bulgaria have comparative advantage?

e. Suppose that the relative price is 4 wheat per wine. Which good will Bulgaria export?

f. At the relative price of 4 wheat per wine, show how both countries can gain from trade. Show the change on your diagrams on part a

Sample Quiz #3

An increase in the number of suppliers

shifts supply to the right reducing price and quantity;
shifts supply to the left increasing price and reducing quantity;
shifts supply to the right reducing price and increasing quantity;
shifts supply to the left increasing price and quantity;
rotates the supply curve, giving it a flatter slope.

How is the college textbook market affected by an increase in tuition rates?

Demand shifts to the right increasing price and quantity.
Demand shifts to the left decreasing price and quantity.
Supply shifts to the right increasing quantity and decreasing price.
Supply shifts to the left decreasing quantity and increasing price.
It creates a shortage of textbooks.

When the market price lies above the market clearing price, there will be a

shortage and then price will rise;
surplus and then price will rise;
shortage and then price will fall;
surplus and then price will fall;

e. no change in price.

At the equilibrium price in a competitive market

any buyer can find a willing seller;
any seller can find a willing buyer;
there is only one price;
the quantity demanded equals the quantity supplied;
all of the above.

The Law of Demand states that

when the price rises a larger quantity is demanded;
when the price falls a larger quantity is demanded;
when the opportunity set does not change, the quantity demanded does not change;
when the quantity demanded increases, the marginal benefit declines;
when the quantity demanded increases, the marginal cost increases.

The reservation price of demanders equals

the marginal cost of production;
the marginal benefit of the good;
the average benefit of the good;
the consumer surplus;
the slope of the demand curve.

The U.S. government is going to buy 18 million does of flu vaccine. There are two suppliers, and there supplies (marginal costs) are given below

Price Ouch Vaccines Don’t Poke Vaccines Market supply

(millions of doses) (millions of doses)

$5 1 2

$10 2 4

$15 3 6

$20 4 8

$25 5 10

$30 6 12

$35 7 14

$40 8 16

Find the market supply and enter in the table.
What is the equilibrium price?

c. How many doses will Ouch supply at the equilibrium price?

Sample Quiz #4

1. The deadweight burden of a tax refers to

the revenue lost by the private economy and gained by the government;
the lost gains from trades not made at the lower level of economic activity;
the higher prices paid by consumers;
the lower net revenue received by producers;
c and d.

2. A subsidy paid to users (buyers) of recycled plastics

shifts the demand for recycled plastics to the right;
shifts the supply of recycled plastics to the right;
shifts the demand for recycled plastics to the left;
shifts the supply of recycled plastics to the left;
leads to an excess demand.

3. If the price rises by 10% and the quantity falls by 20% the price elasticity of demand equals (change in quantity divided by change in price) (.2 divided by.1)

one;
two;
one-half;
zero;
infinity.

4. A price floor set below the market clearing price for sugar leads to

an inelastic demand for sugar;
a surplus of sugar;
a shortage of sugar;
no change in the sugar market;
a shift to the left in demand.

5. If the demand is perfectly elastic, then a 50 cent per case tax on soft drinks will

Be paid entirely by suppliers;
Be paid entirely by demanders;
Be paid partly by demanders and partly by suppliers;
Not change the quantity of soft drinks;
Shift supply down (to the right) by 50 cents.

6. The incidence of a tax falls most heavily on

households;
business firms;
the side of the market that must send the money to the government;
the relatively elastic side of the market;
the relatively inelastic side of the market.

demand supply

price quantity price quantity price + tax

(bushels) (bushels)

$5.00 1,000 $5.00 15,000 8

$4.50 1,200 $4.50 12,000 7.50

$4.00 1,400 $4.00 9,000 7

$3.50 1,600 $3.50 6,000 6.5

$3.00 1,800 $3.00 3,000 6

$2.50 2,000 $2.50 2,000 5.5

$2.00 2,300 $2.00 1,000 5

$1.50 2,700 $1.50 500 4.5

$1.00 3,000 $1.00 200 4

a. (1 pts) Find the market clearing price and quantity.

(1 pt) Suppose a price floor (minimum price) is set at $1.50. Will there be a surplus or shortage of oranges? How much? _no surplus or shortage_

c. (1 pt) Now suppose that the price floor is $3.50. Will there be a surplus or shortage? How much?

d. (1 pt) Now suppose that a tax of $3 per bushel is place on oranges. The tax is paid by suppliers. What will be the price that consumer pay?

e. (1 pt) How much is the consumer’s burden of this tax?

f. (1 pt) How much is the supplier’s burden of this tax?

2. Use supply and demand analysis to answer each off the following. Show using diagrams and explain.

What is the effect of a decrease in income on the market for ramen noodles, which is an inferior good?
What is the effect of an increase in nurses’ wages on the market for emergency room visits?
What is the effect of lower jet fuel prices on the market for overnight package delivery?

Sample Quiz #5

Ec 201 Fall, 2010

Michigan State University L. Martin

Multiple Choice

1. The ease with which an asset can be converted into money is called its

diversity;
liquidity;
risk;
efficiency;

portfolio.

2. Which of the following is not a tenet of efficient market theory?

No arbitrage possibilities remain for the investor.
Current prices reflect all available information.
Prices fluctuate randomly about an upward trend.
All of the above.
None of the above.

3. Inflation represents an important risk for holders of

bonds;
stocks;
housing;
money market accounts;
none of the above.

4. If two assets have the same risk, liquidity and expected returns, the tax-favored asset will

a. sell for a higher price;

b. sell for a lower price;

c. sell for the same price;

d. sell for a higher price if it is a stock and a lower price if it is a bond;

e. sell for a lower price if it is a stock and a higher price if it is a bond;

5. Of the following assets, which is the most liquid?

housing;
artwork;
certificates of deposit;
stocks;
money market funds.

6. Suppose that the jobs of lab assistant in disease research and in forensic testing require equivalent training, but that the former is riskier. In particular disease research result in occasional illness and some deaths. Compared to those doing forensic testing, the wage of lab assistant doing disease research will

be lower due to the required compensating differential for the risk;
be higher due to the required compensating differential for the risk;
be the same due to the law of one price;
be lower if the demand is elastic and the same otherwise;
be higher if the demand is elastic and the same otherwis

7. Suppose that an investment is expected to earn $39,000 one year from now. If the opportunity cost of funds is 30%, the present value of the investment is

$30,000;
$33,400;
$36,130;
$11,700;
$40,000.

8. An asset may sell for $80,000 with a probability of 0.2, or it may sell for $100,000 with a probability of 0.8. Its expected value is

$80,000;
$96,000;
$20,000;
$16,000;
$84,000.

9. Suppose that condos on the first floor sell for $150,000 and those on the 10^th floor sell for $200,000. Which of the following explains this data?

a. People are willing to pay up to $50,000 to avoid riding elevators;

b. Every purchaser is willing to pay $50,000 to live on a higher floor;

c. The market value of 10 floors of elevation is $50,000;

d. Only the rich can afford to live at high elevation;

e. No explanation is needed because the markets are unrelated.

Problems

1. With only one more year before graduation, Sam is considering the purchase of an investment property. The current cost will be $95,000. He plans to sell next year at this time but is uncertain of the future price. He has made his list of the possible outcomes and probabilities and these are given in the table below.

Probability earnings

0.3 $100,000

1. $120,000

0.2 $45,000

a. Compute the expected value of the investment one year from now.

b. Sam’s opportunity cost of funds is 10%. Find the present expected value of the future earnings.

c. Should he go forward with the investment? Explain.

(Worked problem) Almost everyone prefers to work the day shift. Night workers usually require a compensating differential to induce them to work the late shift. Suppose that the compensating differential for one shift is $20. The demands for late shift work and day shift work are given below. The supply is 21 workers.

Wage Night shift workers Wage Day shift workers

$100 120 4 $100 10

$90 110 5 $90 12

$80 100 6 $80 14

$70 90 7 $70 16

$60 80 8 $60 18

$50 70 9 $50 20

Find the equilibrium wage and allocation in each market.

Sample Quiz #6

Ec 201 Fall, 2010

Michigan State University L. Martin

1. Which of the following is not true of pure public goods?

The marginal cost of another user equals zero.
The marginal cost of production equals zero.
No one can be excluded from consumption.
The goods are consumed jointly.
All of the above are true.

2. Which of the following is an external cost?

noise caused by airplanes landing and taking off at airports;
airplane fuel
wages and salaries of airport personnel;
property taxes on buildings owned by airlines;
costs of security.

3. When there are external costs, the market-clearing quantity

exceeds the efficient quantity;
equals the efficient quantity;
is less than the efficient quantity;
exceeds the efficient quantity for normal goods but is less for inferior goods;
exceeds the efficient quantity for inferior goods but is less for normal goods;

4. When there is an external benefit, the market equilibrium quantity

is less than the efficient quantity;
equals the efficient quantity;
is greater than the efficient quantity;
is less than the efficient quantity when demand is elastic, but greater when demand is inelastic;
is greater than the efficient quantity when demand is elastic, but less when demand is inelastic.

5. In the market for pollution the demand is the

a. marginal damage of the pollution;

b. marginal benefit of the goods produced when pollution is emitted;

c. marginal cost of producing the goods that cause the pollution;

d. marginal cost of abating (reducing) the pollution;

e. marginal utility of the pollution.

II. Problems

In the market for Carbon monoxide pollution the marginal abatement cost and the marginal damage are given below.

Quantity of Carbon monoxide Marginal abatement cost Marginal damage

(tons)

100 $100 $20

200 $90 $30

300 $80 $40

400 $70 $50

500 $60 $60

600 $50 $70

700 $40 $80

800 $30 $90

900 $20 $100

1000 $10 $110

1100 $0 $120

a. If there is no government intervention, how much carbon monoxide will be emitted?

b. What is the efficient level of carbon monoxide emissions?

c. If the government issues the efficient level of tradable permits to emit carbon monoxide, what will be the price of these permits?

2. The private flying lessons at Daredevil airport cause noise that disturbs local residents. the residents are also uneasy about the periodic crashes. One estimate of the magnitude of the negative externalities is $15 per flight. The market supply and demand curves for flight lessons are given below.

Demand Supply

Price Quantity Price Quantity Social Marginal Cost

$75 10 $75 100

$70 20 $70 80

$65 30 $65 60

$60 40 $60 40

$55 50 $55 20

$50 60 $50 0

a. Find the market equilibrium price and quantity.

b. Calculate the social marginal cost and enter in the table above.

c. Find the efficient quantity.

d. What tax on flights is necessary to bring about the efficient quantity?

Sample Quiz #7

Ec 201 Fall, 2010

Michigan State University L. Martin

1. The average product of labor is the

a. firm’s output divided by the number of workers;

b. extra output produced by the last worker

c. cost of producing the next unit of output;

d. revenue from the sale of the next unit of output;

e. cost of hiring the next worker.

2. The marginal product of labor is the

a. firm’s output divided by the number of workers;

b. extra output produced by the last worker;

c. cost of producing the next unit of output;

d. revenue from the sale of the next unit of output;

e. cost of hiring the next worker.

3. When resources are commonly owned and there is open access, users impose an external cost equal to

a. average product divided by marginal product;

b. average product minus marginal product;

c. average product plus marginal product;

d. average product multiplied by marginal product;

e. none of the above.

4. Marginal cost equals the slope of the

a. total cost curve;

b. total variable cost curve;

c. total fixed cost curve;

d. a. and b.

e. all of the above.

5. When marginal cost lies above average cost,

a. average cost is increasing;

b. average cost is decreasing;

c. marginal cost is decreasing;

d. average cost is constant;

e. marginal cost is constant.

Problems

1. (open access resources) As the water table recedes deeper into the ground, desperate farmers are able to draw less and less water from their wells. The relationship between the number of active wells and the water yield (measured in hectares) is given below.

# of wells average yield total yield marginal yield

8 8 -
8 16 8
8 24 8
7 28
6 30 2
5 30 0
4 28 -2
3 24 -4
2 18 -6
1 -8
0 0 -10

The wells were drilled decades ago, and there is no cost to operate them.

a. Calculate the marginal yield and enter in the table.

b. What is the equilibrium number of active wells?

c. What is the efficient number of wells?

(congestion) A raft trip down the Whee river takes 2 hours when uncongested. As it gets congested the time grows according to the table below. An hour is worth $10 to each rafter. The marginal benefit of a raft trip is $80.

# rafts average time average cost total cost marginal cost

1 2 20 20 --

0 40 0
2 20 60 20
2 20 80 20
2 20 100 20
3 30 180 80
4 40 210 30
5 50 400 190
6 60 560 160
7 70 700 140
8 80 880 180
9 90 1080 200

Compute the marginal cost and enter in the table.

b. What is the equilibrium number of trips?

c. What is the efficient number of trips?

d. What congestion toll would bring about the efficient allocation?

Sample Quiz #8

Ec 201 Fall, 2010

Michigan State University L. Martin

The extra output produced by the last worker is called the

marginal cost;
marginal product;
value of the marginal product;
average variable cost;
marginal revenue.

The competitive firm’s demand for labor is the

marginal product of labor;
marginal cost;
marginal cost above the shut-down point;
value of the marginal product;
marginal revenue.

The competitive firm finds the profit maximizing quantity to supply be setting

wage equal to the marginal product;
wage equal to the value of the marginal product;
price equal to marginal revenue;
marginal cost equal to average cost;
price equal to marginal cost.

In the short run the competitive firms shuts down when price falls below the minimum of

average total cost;
average variable cost;
average total cost excluding all sunk costs;
average fixed cost;
average revenue.

In the long run in the competitive model, price is driven down to the minimum of

average total cost;
average variable cost;
average total cost excluding all sunk costs;
average fixed cost;
average revenue.

If the normal rate of return on invested capital is 15% and the firm is making 10%, then its economic profits are

greater than its accounting profits;
positive;
negative;
zero;
greater than its sunk costs.

Problems.

1. Profit maximization. Bug-BE-Gone offers to clean up virus infections at web sites. It hires free-lance programmers and its production function is given in the table below. Programmers are paid $200 per day, and customers are charged $100 for the service.

Programmers Output (sites Marginal product Value of the

cleaned) marginal product

1 10 --

2 18 8

3 24 6

4 28 4

5 30 2

6 31 1

Complete the table above (value of marg product =margin prod times price)

Find the profit maximizing number of technicians to hire.

2. The Molekillers, a company that assassinates small grass-eating rodents has fixed costs equal to $95. Its costs are given in the table below. The market price for its services is $50.

Output TotalCost Marginal cost Average cost Average recoverable cost

0 $95

1 $100

2 $110

3 $130

4 $160

5 $200

6 $250

7 $310

Average cost=total cost divided by output

Average recoverable cost= subtract sunk cost from total cost and divide it by output

Complete the table

b. Find the profit maximizing level of output.

c. Find the entry price.

d. Assume that all but $40 of its fixed costs are sunk. (That is, $55 is sunk and $40 is recoverable.) Find the exit price.

Sample Quiz #9

Ec 201 Fall, 2010

Michigan State University L. Martin

I. Multiple choice

1. Marginal revenue is less than price for a monopolist who cannot price discriminate because

of diminishing returns;
the firm is a price taker;
in order to sell more the monopolist must lower price on all units;
of the prisoner’s dilemma;
of asymmetric information.

2. When firms produce differentiated products and there is free entry, the market structure is called

oligopoly;
monopoly;
monopsony;

d. monopolistic competition;

e. natural monopoly.

3. In long run equilibrium in monopolistically competitive industries price equals

the minimum of average cost;
average cost, but not at its minimum;
the minimum of marginal cost;
marginal cost, but not at its minimum;
marginal revenu

4. In the long run equilibrium of monopolistically competitive industries,

price exceeds marginal cost;
price equals average cost;
marginal revenue equals marginal cost;
the firm earns zero economic profits;
all of the above.

5. Price discrimination refers to

the practice of charging higher prices to minorities;
the practice of charging different prices to different customers;
the fact that prices decline as the market expands;
the fact that prices for foreign goods must be adjusted for the exchange rate;
none of the above.

6. Suppose that a monopoly can employ perfect price discrimination. Then

the lowest price equals marginal cost;
the lowest price equals marginal revenue;
The average price equals average cost;
marginal revenue equals marginal cost;
none of the above.

7. Consider a pharmaceutical company that does research and development and patents its discoveries. An increase in its research costs will

increase the price of its patented drugs;
have no effect on the price of its patented drugs;
decrease the price of its patented drugs;
reduce the demand for its patented drugs;
increase the demand for its patented drugs.

Problems

As we the plague of viruses and spam spreads among users, there is a great demand for solutions to this problem. A young programmer has discovered a simple cure. For a marginal cost of $6000 she can hire and direct programmers to solve any similar problem. The demand is given below.

Price Quantity Revenues Marginal (change in revenue divided by

Revenue change in price)

$10,000 1,000 10000000 --

$9,000 2,000 18000000

$8,000 3,000 24000000

$7,000 4,000 28000000

$6,000 5,000 30000000

$5,000 6,000 30000000

Compute here marginal revenue and enter in the table.

b. Find the profit maximizing price and quantity.

c. Draw a diagram illustrating the market for her service.

The NPBA (National Pogostick Basketball Association) is the only employer of devotees of the new sport, pogo stick basketball, where players must bound around the court on pogosticks. (The games appear on ESPN 5, “The Pentad.” ) The supply curve of pogoballers (as the players are called) is given below. The league is willing to pay $1600 per pogoballer.

# pogoballers Wage Total input cost Marginal input cost

1,000 00 --

1,100 400 2100

1,200 72000 1400

1,300 104000 1600

1,400 140000 1800

1,500 180000 2000

140 1,600 224000 2200

a. How many pogoballers will be hired?

b. What will be the wage for pogoballers?

Sample Quiz #10

Ec 201 Fall, 2010

Michigan State University L. Martin

I. Multiple choice

A group of firms seeking to coordinate their price and output decisions to maximize group profits is called an

oligopoly;
monopoly;
cartel;
monopsony;
monopolistically competitive industry.

Natural monopolies are characterized by

high marginal cost and low fixed cost;
high fixed cost and low marginal cost;
high average cost and low marginal cost;
low average cost and high marginal cost;
constant cost.

3. Suppose that firms in an oligopoly promise to charge the monopoly price and share the market. Furthermore, they promise to continue monopoly pricing as long as all firms do similarly. If lower prices are observed, the firms promise to revert to aggressive price competition. This implicit agreement is called a

a. prisoner’s dilemma game;

b. battle of the sexes game;

c. trigger strategy;

d. natural monopoly;

e. barrier to entry.

4. Public utilities, such as electric power and water are examples of

monopolistic competition;
oligopolies;
cartels;
perfect competition;
natural monopolies.

5. When firms offer to match the lowest price available,

consumers gain because prices are lower;
average price is higher because firms have less incentive to lower price;
firms make losses and must exit the market;
barriers to entry are created;
firms make normal returns on invested capital.

Problems

In Little Rapids storms often fell large trees. One of the city’s residents has a large chipper, which could dispose of the felled trees for a marginal cost of $5 each. The fixed cost (allowing for a normal rate of return on capital) associated with this chipper is $2,000 and the demand is given below.

Price Quantity Revenues Marginal Total Cost Average cost

Revenue

$25 100 250 --

$20 200 4000 37.5

$15 300 4500 5

$10 400 4000 5

$5 500 2500 15

$0 600 0 25

a. Find the profit maximizing price and quantity.

b. Find the efficient price and quantity.

c. Compute total and average cost and enter in the table.

d. Find the price and quantity that would just allow the chipper firm to make a normal return. (price =average cost)

e. Draw a diagram, labeling all prices and quantities answered in this question.

2. (2 points) Three dentists Dr. Payne, Dr. Love and Dr. A. Gony want to collude to fix prices for treatments. They are the only dentists in Blackwater. The following data applies.

Monopoly profits per firm = $100,000

Cheating profits = $250,000

Profits with aggressive price competition = $0

Discount factor = 0.8

a. Can this oligopoly sustain a collusive agreement to charge the monopoly price? Show the calculation and explain.

Sample Quiz #11

Ec 201 Fall, 2010

Michigan State University L. Martin

1. The model in which consumers do not know quality while producers do know quality is called the

principal-agent model;
reputation model;
trigger strategy model;
prisoner’s dilemma model;
lemons model.

2. According to the reputation model, price

a. equals the minimum of the long run average cost;

b. equals average cost, but not at the minimum;

c. exceeds average cost because customers reward firms for their history of high quality service;

d. is less than average cost because customers do not believe the firms promise to deliver high quality service;

e. exceeds average cost and customers promise to return with future business if the firm gives high quality service.

3. A firm hires a consultant to evaluate its marketing strategy.

a. the firm is the principal and the consultant is the agent;

b. the consultant is the agent and the firm is the principal;

c. both the consultant and the firm are principals;

d. both the consultant and the firm are agents;

e. none of the above.

4. In the principal agent model

a. the principal cannot observe the agent’s effort;

b. the principal cannot observe the agent’s ability;

c. the agent cannot observe the principal’s effort;

d. a. and b;

e. all of the above.

5. In the principal agent model the information rent is the

a. net earnings of the principal;

b. amount paid to the high cost agent;

c. amount paid to the low cost agent;

d. difference between the cost for the high cost agent and the cost for the low cost agent, when they are doing the job assigned to the low cost agent.

e. difference between the cost for the high cost agent and the cost for the low cost agent, when they are doing the job assigned to the high cost agent.

Dave has a house-painting business called Master of Arts. (Dave has a Masters degree in history; hence the name.) The point of the name is to indicate that Dave provides the highest quality painting. Unfortunately, the quality of Dave’s work only becomes clear as time progresses; it cannot be observed at the time he is paid. Specifically, the value of a room painted by Dave is $1500. The value of a low quality paint job is $200. The cost of a high quality job is $1000, and the cost of a low quality job is $400. The discount factor is 0.8.

Write down the payoffs in a box (the normal form), showing the players and their strategies.

b. What is the best response of Dave to the customer’s choice of “Buy”?

What is the equilibrium.

What is the minimum price that will eliminate the market failure when the customers use a trigger strategy?

2. Firms often hire headhunters to find qualified candidates for management positions. The firm is the principal and the headhunter is the agent. The benefits of this service for a typical firm are given below.

# candidates total benefits marginal benefits

1 $10,000 --

2 $18,000 8,000

3 $24,000 6,000

4 $28,000 4,000

5 $30,000 2000

6 $31,000 1000

There are two types of headhunters. Low cost headhunters can find a good candidate for $2000, and high cost headhunters can find a good candidate for $6000. This is a principal agent problem; so there is asymmetric information about the cost and effort of the agents. .

a. What is the efficient allocation for each type of agent?

b. With perfect information how much would the firm have to pay each type of agent to produce the efficient number of reports?

Find the information rent for the low cost agent.

d. How much would the firm have to pay the low cost agent to produce the efficient number of reports?

Sample Quiz #12

Ec 201 Fall, 2010

Michigan State University L. Martin

1. When the price of a good falls, the substitution effect

encourages the individual to consume more of the good;
encourages the individual to consume less of the good;
leads to more consumption if the good is an inferior good, but less if it is a normal good;
leads to less consumption if the good is an inferior good, but more if it is a normal good;
a. and c.

2. When the price of a good falls, the income effect

encourages the individual to consume more of the good;
encourages the individual to consume less of the good;
leads to more consumption if the good is an inferior good, but less if it is a normal good;
leads to less consumption if the good is an inferior good, but more if it is a normal good;
a. and c.

3. The idea that the chosen alternative is at least as good as the other alternatives in the opportunity set is called

diminishing returns;
the substitution effect;
income elasticity;
inferiority;
revealed preference.

4. Lakeesha can work as much as 50 weeks per year at a take-home wage of $1,000 per week. She also has non-wage income equal to $5,000 per year. The (absolute value of the) slope of her leisure-consumption budget constraint is

$1,000/50;
$4,000/year;
$5,000/year;
$5,000 + $1,000 x 50;
$1,000/year.

5. Use the data from question 4. An increase in her non-wage income will cause Lakeesha to

work more due to the income effect;
work more due to the substitution effect;
work less due to the income effect;
work less due to the substitution effect;
no change his work effort.

6. Han currently takes home $90,000 per year after taxes. He expects to receive $10,000 after taxes when he retires in 10 years. Over this period he could earn 100% on any money he invested in the company pension plan. The slope of his two-period budget constraint equals

2;
1.3;
1.2;
1.1;
101.

7. Use the data from question 6. A decrease in his rate of return will cause Han to

save more due to the income effect;
save less due to the income effect;
save more due to the substitution effect;
save less due to the substitution effect;
a. and d.

Problems.

1. Recently divorced, Billy-Bob gets $30,000 per year in alimony from his ex-wife the noted country singer, Bella-Belle. He can earn $1000 per week as a party planner. He has 50 weeks available for work. (He must spend the other two weeks huntin’.)

Draw his budget constraint.

Suppose that he chooses to work 31 weeks.

2. Larry Martin has current income of $100,000 after tax. He expects $20,000 income when he retires in 20 years. (That’s right, another 40 semesters of that dumb Martin Lawrence joke!) He invests his money in broadly diversified mutual funds that are expected to earn 100 % over the next 20 years.

Draw his budget constraint.

He saves $20,000 per year. Show this choice on the above diagram.

He gains access to a private equity investment fund that promises to return 200%. Show the effect on his budget constraint.

Now show the substitution effect of this change.

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Michigan State University - EC 201 Econ 201 Final Exam Review--Practice Quiz— Sample Quiz #1 Scarcity means there is poverty; there is income inequality; people want more than is freely available; opportunity costs exceed sunk costs; sunk costs should be ignored

Business

Ec 201 Fall, 2010