Team of Teaching Assistant of Microeconomics 1

  

MICROECONOMICS 1 MODULE

TEACHING ASSISTANTS OF MICROECONOMICS

AND MACROECONOMICS

ECONOMICS AND DEVELOPMENT STUDIES

FACULTY OF ECONOMICS AND BUSINESS

PADJADJARAN UNIVERSITY

  

2016

  

ACKNOWLEDGEMENT

In the name of Allah, The Most Gracious, The Most Merciful

  Alhamdulillah, all praises to Allah SWT, The Almighty, for giving belief, health,

confidence and blessing for the writers to accomplish this Module of Microeconomics I.

Shalawat and Salam be upon our Prophet Muhammad SAW, who has brought us from the

darkness into the brightness and guided us into the right way of life.

  In this opportunity, we also like to express our deep thanks to Head Department of Economics, Coordinator of Undergraduate Program of Department of Economics, lecturers,

and those who contributed and helped in the process of making this module. All of your

kindness and help means a lot to us. Thank you very much

  We realise that the contents in this module is not that perfect. Therefore, we are

willing to receive and consider feedback, suggestions and constructive criticisms, and eager

to implement improvements.

  Hopefully this module can be the short guide for the students in order to deepen the understanding and the analysis of Microeconomics I theory. Thank you.

  List of the Module Writers:

  1. Arjuni Rahmi Barasa 120210130104

  2. Hygea Marwany 120210130091

  3. Amatul Ghina 120210120130

  4. Safira Kirami 120210120016

  5. Citra Kumala 120210110155

  6. Rahma 120210110124

  7. Ridho Al-Izzati 120210110095 Acknowledge and Agree, Coordinator of Undergraduate Program of Department of Economics Dr. Adiatma Yudistira Manogar Siregar, S.E., ME. conSt.

  NIP. 19801205 200812 1 001

  

CHAPTER 6

PRODUCTION FUNCTION

• The firm’s production function for a particular good (q) shows the maximum amount of the good that can be produced using alternative combinations of capital (k) and labor (l) q = f(k,l)
• In general, we assume diminishing marginal productivity

  2

  2  MP  f  MP  f _{k l}   f  f    f  f  _{kk ll}

  11

  22

  2

  2  k  k  l  l _{l l l} is at its maximum, AP and MP are equal

• When AP
• An isoquant shows those combinations of k and l that can produce a given level of output (q ) f(k,l) = q
• Each isoquant represents a different level of output
• output rises as we move northeast
• The marginal rate of technical substitution (MRTS) shows the rate at which labor can be substituted for capital while holding output constant along an isoquant

   dk RTS ( l for k )  d l _{q  q}

• Take the total differential of the production function:
• Along an isoquant dq = 0, so

   f  f

  dq d l dk MP d l MP dk

          _{l k}

  l k

   

  Effect on Output Returns to Scale _{f f} (tk,tl) = tf(k,l) Constant _f (tk,tl) < tf(k,l) Decreasing (tk,tl) > tf(k,l) Increasing

MULTIPLE CHOICES

1. This graphic below shows an isoquant map for….

  a. Constant return of scale

  b. increasing return of scale

  c. decreasing return of scale

  d. normal return of scale

  2. In a bakery, 60 workers can produce 5000 pieces of bread each day, with 30 ovens available. This bakery increase its workers until 70 workers, and increase the production up to 5700 piece of breads. The marginal physical product of labor is….

  a. 700 roti

  b. 70 roti

  c. 350 roti

  d. 100 roti 3. The slope of an isoquant is termed as ….

  a. the marginal product of substitution

  b. the marginal rate of technical substitution

  c. cross-productivity effects

  d. the elasticity of substitution 4. A production function measures the relation between ….

  a. Input prices and output prices

  b. Input prices and the quantity of output

  c. The quantity of inputs and the quantity of output

  d. The quantity of inputs and input prices

  5. A firm can maximize profit (net benefit) by choosing to produce that level of a. the additional revenue from the last unit sold is maximized

  b. the additional revenue from the last unit sold equals the additional cost of that unit.

  c. total revenue equals total cost

  d. the difference between the additional revenue from the last unit sold and the additional cost of that unit is maximized.

  6. Which of the following statements describes increasing returns to scale? a. Doubling the inputs used leads to double the output.

  b. Increasing the inputs by 50% leads to a 25% increase in output.

  c. Increasing inputs by 1/4 leads to an increase in output of 1/3.

  d. None of the above.

  7. A firm faces the following long run cost function

  3

2 TC = q - 40q +450q Average Cost, AC, will be at its minimum when ….

  a. q = 10, AC = 20

  b. q = 40, AC = 60

  c. q = 40, AC = 10

  d. q = 20, AC = 50 8. Production function where its elasticity of substitution is infinite is ….

  a. Fixed proportions

  b. Cob-douglas

  c. CES

  d. Linear

  9. What is the marginal rate of technical substitution for the following production function?

  0.5

0.5 Q = 10K L

  a. 0.5 K / L

  b. 0.5 L / K

  c. K / L

  d. L / K

  10. Which of the following represents decreasing return to scale?

  a. Q = 0.5KL

  b. Q = 2K + 3L

  0.5

  0.5

  c. Q = 10K L

  0.7

  0.2

  d. Q = K L

  ESSAY 1.

  Suppose a chair manufacturer is producing in the short run when equipment is fixed. The manufacturer knows that as the number of laborers used in the production process increases from 1 to 7, the number of chairs produced changes as follows: 10, 17, 22, 25, 26, 25, 23.

  a. Calculate the marginal and average product of labor for this production function.

  b. Does this production function exhibit diminishing returns to labor? Explain.

  c. Explain intuitively what might cause the marginal product of labor to become negative.

  2. The marginal product of labor in the production of computer chips is 50 chips per hour. The marginal rate of technical substitution of hours of labor for hours of machine-capital is 1/4. What is the marginal product of capital?

  3. The production function for the personal computers of DISK, Inc., is given by Q

  0.5

  0.5

  = 10K L where Q is the number of computers produced per day, K is hours of machine time, and L is hours of labor input. DISK’s competitor, FLOPPY,

  0.6

  0.4 Inc., is using the production function Q = 10K L .

  a. If both companies use the same amounts of capital and labor, which will generate more output? b. Assume that capital is limited to 9 machine hours but labor is unlimited in supply. In which company is the marginal product of labor greater? Explain.

  4. Explain the term “marginal rate of technical substitution”? What does a MRTS=4 mean?

  1/2 1/2 5. Find the MRTS for the production function: F (z , z ) = z + z .

  1

  2

  1

  2

  6. Suppose the production function of Z is:

  2

  2

  3

  3 Q = f(k,l) = 900 k l - k l

  And k= 10. Please calculate :

  a. Marginal product of labor

  b. Average product of labor

  c. Optimum labor unit

  7. Suppose the production function for widgets is given by where q represents the annual quantity of widgets produced, k represents annual capital input, and l represents annual labor input.

  a. Assuming that k =10, at what level of labor input does MPl = 0? How many widgets are produced at that point? b. Suppose capital inputs were increased to k = 20. How would your answers to c. Does the widget production function exhibit constant, increasing, or decreasing returns to scale?

  1/4 1/4

  8. Suppose that a firm has the production function F(K,L) = K L where K represent capital and L is labor. Let r =2 and w=2. Assume that both K and L are variable.

  c. Find the greatest output that the firm can produce at a total cost of C

  d. What are the total, marginal, and average costs as a function of output Q

  9. The marginal product of labor in the production of computer chips is 50 chips per hour. The marginal rate of technical substitution of hours of labor for hours of machine-capital is 1/4. What is the marginal product of capital?

  10. Explain why the marginal rate of technical substitution is likely to diminish as more and more labor is substituted for capital!

  

CHAPTER 7

COST MINIMIZATION

   We must differentiate between:

• Accounting cost

  : the accountant’s view of cost stresses out-of-pocket expenses, historical costs, depreciation, and other bookkeeping entries.

• Economic cost: is that the cost of any input is given by the size of the payment necessary to keep the resources in its present employment.

   Two simplification about the inputs firm uses; First, assuming that there are only two inputs; homogenous labor and homogenous capital. Second, assuming that labor is hired under perfectly competitive market.

  (Cobb-  The Lagrangian expression for cost minimization of producing q

  Douglas) is

  a b L = vk + wl + - k l )

  (q (CES) is

   The Lagrangian expression for cost minimization of producing q

  γ ⁄

  L

• ( – ( )
• =

   A firm that wishes to minimize the economic costs of producing a particular level of output should choose that input combination for which the rate of technical substitution (RTS ) is equal to the ratio of the inputs’ rental prices.

  ⁄

  = = RTS (l for k)

  ⁄

   derived directly from the total-cost function

  The firm’s average cost (AC = C/q) and marginal cost (MC = C/q) can be

• if the total cost curve has a general cubic shape, the AC and MC curves will be u-shaped
• if the use of an input falls as output expands, that input is an inferior input

• it can then alter its level of production only by changing the employment of its variable inputs
• it may have to use nonoptimal, higher-cost input combinations than it would choose if it were possible to vary all inputs

   Envelope theorem applied to either input is

  ℒ( , , , )

  =

  ( , , )

  = k ^c (v,w,q),

  ℒ( , , , )

  =

  ( , , )

  ln / ln /

   The firm’s expansion path is the locus of cost-minimizing tangencies. Assuming fixed input prices, the curve shows how inputs increase as output increases.

  =

  / /

  .

  ( ) ⁄ ( ) ⁄

  =

  s

   Firm will substitute input uses by putting it in proportional terms as:

   In the short run, the firm may not be able to vary some inputs

  = l ^c (v,w,q)  The long run average cost is the envelope of the firm’s short run average cost curves, and it reflects the presence or absence of returns to scale.

MULTIPLE CHOICE

  1. Suppose that PT. TAMIMA produces 150,000 units a year and sells them all for $15 each. The explicit costs of production are $2,500,000 and the implicit costs of production are $150,000. The firm has an accounting loss of: a. $250,000 and an economic loss of $400,000.

  b. $300,000 and an economic loss of $300,000.

  c. $350,000 and an economic loss of $450,000.

  d. $400,000 and an economic loss of $350,000.

  2. Which of the following statements is true?

  a. AVC curve will eventually fall with output, while AFC curve always rises with output. These two effects produces a U-shaped AC curve.

  b. AVC curve will eventually rise with output, while AFC curve always falls with output. These two effects produces a positive sloped AC curve.

  c. AVC curve will eventually rise with output, while AFC curve always falls with output. These two effects produces a U-shaped AC curve.

  d. AVC curve will eventually rise with output, while AFC curve always falls with output. These two effects produces a negative sloped AC curve.

  3. If all resources used in the production of a product are increased by 20 percent and output increases by 20 percent, then there must be: a. Economies of scale.

  b. Constant returns to scale.

  c. Diseconomies of scale.

  d. Increasing return to scale.

  4. To minimize the cost of producing a given level of output, a firm should choose that point on the q isoquant at which…

  a. k can be traded for l in production to the rate at which they are demanded in the marketplace b. RTS is equal to the ration v/w

  c. Isoquant and RTS do not tangent d. The rate of technical substitution of l for k is equal to the ratio w/v.

  5. Suppose you operate a sandwich shop and currently have two employees. If you hire a third employee, your output of sandwiches per day rises from 75 to 90. If you hire a fourth employee, output rises to 110 per day. A fifth and sixth employee would cause output to rise to 120 and 125 per day, respectively. Choose the correct statement: a. Diminishing returns set have not yet set in because output is still increases.

  b. Diminishing returns set in with the hiring of the fourth worker.

  c. Diminishing returns set in with the hiring of the fifth worker.

  d. Diminishing returns set in with the hiring of the sixth worker.

  6. In a constrained maximization problem: G= ln(Q) - λ(wL+rK-C), λ represents the term of… a. Lagrangian multiplier

  b. Lagrangian

  c. Rate of technical substitution

  d. Return to scale

  7. A long- run total cost curve… a. always has a constant slope.

  b. is always upward sloping.

  c. never has a constant slope.

  d. is always downward sloping.

  8. These are not a simplified assumption about the inputs firm used, except ….

  a. Homogenous labor & homogenous capital

  b. Inputs are hired in imperfectly competitive markets c.

  Firms can affect the input’s price

  d. Heterogenous labor and capital

  9. Suppose that derived CES function = . If σ > 1, means

  a. Changes in the ratio of wages to rental rates cause a greater than proportional increase in the cost-minimizing capital-labor ratio.

  b. Changes in the ratio of wages to rental rates cause a less than proportional increase in the cost-minimizing capital-labor ratio.

  c. Changes in the ratio of rental to wage rates cause a less than proportional decrease in the cost-minimizing capital-labor ratio.

  d. Changes in the ratio of rental to wage rates cause a greater than proportional increase in the cost-minimizing capital-labor ratio.

  10. If the sum of parameters α and β in Cobb-Douglas function exceed 1, it means…

  a. Constant return to scale production

  b. Decreasing return to scale production

  c. Increasing return to scale production

  d. None of above

  ESSAY

  1. There are some properties of total costs functions, explain 3 of them!

  2. Suppose that TC = 40 K+ 10 L with Cobb-Douglas production function Q = 10

  0.5

0.5 K L

  (Q=80). Calculate the values of K, L, λ, and value of TC (firm’s long run marginal cost) that minimizes TC.

  3. Professor Smith and Professor Jones are going to produce a new introductory textbook. As true scientists, they have laid out the production function for the book as

  1

  1

  2

  2

  q = J where q = the number of pages in the finished book, S = the number of working hours spent by Smith, and J = the number of hours spent working by Jones. Smith values his labor as $3 per working hour. He has spent 900 hours preparing the first draft. Jones, whose labor is valued at $12 per working hour, will revise Smith’s draft to complete the book.

  a. How many hours will Jones have to spend to produce a finished book of 150 pages? Of 300 pages? Of 450 pages? b. What is the marginal cost of the 150th page of the finished book? Of the

  300th page? Of the 450th page? 4. Suppose that a firm’s fixed proportion production function is given by

  Q = min(5k, 10l) Suppose that k is fixed at 10 in the short run. Calculate the firm’s short-run total, average, and marginal cost functions (v=1 and w=3).

  5. If we had the production function TC (q) = kl , we might draw the isoquant for TC (q) = 120 If the prices of capital and labor were v=12 and w=40, b. draw the set of all input combination (isocost, isoquant curve)

  6. You manage a plant that mass produces engines by teams of workers using assembly machines. The technology is summarized by the production function.

  

q =

   10 KL

  where q is the number of engines per week, K is the number of assembly machines, and L is the number of labor teams. Each assembly machine rents for = $20,000 per week and each team costs w = $10,000 per week. Engine costs

  r

  are given by the cost of labor teams and machines, plus $4,000 per engine for raw materials. Your plant has a fixed installation of 10 assembly machines as part of its design.

  a. What is the cost function for your plant — namely, how much would it cost to produce q engines? What are average and marginal costs for producing q engines? How do average costs vary with output?

  b. How many teams are required to produce 500 engines? What is the average cost per engine? c. You are asked to make recommendations for the design of a new production facility. What capital/labor (K/L) ratio should the new plant accommodate if it wants to minimize the total cost of producing any level of output q?

  7. Calculate the number of labor (L & L ), capital (K & K ), and cost that solve

  1

  

2

  1

  2

  the minimization problem below :

  1

  1

  (i) Minimize wL +rK subject to Q = min }, and

  1

  1

  { ,

  1/3 2/3

  (ii) Minimize wL +rK subject to Q = min {4K , 5L }

  2

  2

  2

  2 Where w = 25 is the wage rate, and r = 10 is the rental rate of capital. The target

  level of output is Q= 100. Show the both of function with the relevant graph!

  8. A firm has production function Q = 4 √ + 2√ , where Q is the level of output produced, K is the level of capital used, L is the number of labor used. The target level of output is Q= 120 with the wage rate is w= $5 and the rent rate is r = $4.

  a. What kind of production function above? b. Calculate number of Labor and Capital if the firm want to minimize cost.

c. Calculate the fir m’s minimum cost.

  9. Calculate the number of labor (L) and capital (K) that solve the minimization problem below :

  2

  3

• minimize wL + rK subject to Q =

  5

  5

  where w = 25 is the wage rate and r = 10 is the rent rate. The target output is Q =

  10. Suppose the total-cost function for a firm is given by C = qw

  2/3

  v

  1/3 a.

  Use Shephard’s lemma to compute the constant output demand functions for inputs l and k.

  b. Use your results from part (a) to calculate the underlying production function for q.

  

CHAPTER 8

PROFIT MAXIMIZATION

   A profit-maximizing firm chooses both its inputs and its outputs with the sole goal of achieving maximum economic profits. That is, the firm seeks to make the difference between its total revenues and its total economic costs as large as possible.

   Total revenues (R) are given by R(q) = p(q) . q  In the production of q, certain economic costs are denoted by C(q).

  The difference between revenues and costs is called economic profits (π).  Π(q) = R(q) - C(q) = p(q) . q - C(q)

   To maximize economic profits, the firm should choose that output for which marginal revenue is equal to marginal cost.

  = = = . For sufficiency, it is also required that “marginal” profit must be decreasing at the optimal level of q.  Profit maximization : MR = MC. The concept of marginal revenue is directly related to the elasticity of the demand curve facing the firm shown in the equation

  1 q,p : .

  = ( 1 + ) and =

  q,p 1+ q,p

   In the short run, a price-taking firm will produce the level of output for which SMC=P and the SMC curve is above SAVC. For prices below SAVC, however, the firm will choose to produce no output.

   Economic profits are also defined as a function of inputs: Π = Pq – C = Pf (k,l) – vk –wl. The firm’s profit function shows its maximal profits as a function of the prices

   that the firm faces: Π (P,v,w) max Π(k,l) = max Pf (k,l) – vk –wl.  The application of the envelope theorem see how profits respond to changes in output and input prices.

  ( , , ) ( , , ) , ( , , )

  = ( , , ) = − ( , , ) , = − ( , , ).

  2

  2 = ( 2, . . ) − ( 1, . . ).

   Welfare gain = ∫ ( ) = ∫

  1

  1

  1 .

   Producer surplus = ( 1, . . ) − ( 0, . . ) = ∫ ( )

  = Pf and MRP = Pf .  In price-taking case, MRP l l k k /f = w/v.

   The profit-maximizing also imply cost minimization because RTS=f l k  Because the profit function depends on two variables, k and l, the second order conditions for a profit maximum are somewhat more complex than in the single variable case, to ensure a true maximum, the profit function must be concave.

   In principle, the first-order conditions for hiring inputs in a profit-maximizing way can be manipulated to yield input demand functions that show how hiring depends on the prices that the firm faces. We will denote these demand functions by capital demand = k(P,v,w) and labor demand l(P,v,w).

   In single- input case, one reason for expecting ∂l=∂w to be negative is based on the presumption that the marginal physical product of labor declines as the quantity of labor employed increases. At least in the single-input case, a ceteris paribus increase in the wage will cause less labor to be hired.

   For the case of two (or more) inputs, If w falls, there will not only be a change in but also a change in k as a new cost-minimizing combination of inputs is chosen.

  l

  When k changes, the entire f l function changes (labor now has a different amount of capital to work with).  Substitution and output effects in input demand. When the price of an input falls, two effects cause the quantity demanded of that input to rise:

  a. the substitution effect causes any given output level to be produced using more of the input; and b. the fall in costs causes more of the good to be sold, thereby creating an additional output effect that increases demand for the input. For a rise in input price, both substitution and output effects cause the quantity of an input demanded to decline.

   Differentiation of this expression with respect to the wage (and holding the other prices constant) yields ( , , ) ^ ( , , ) ^ ( , , ) + = .

MULTIPLE CHOICE

  1. To maximize economic profits, the firm should choose the output for which … a.

  = ≥ = b. = > = c. = = = d. = < =

  2. Suppose that the demand curve for a cheesecake is q = 100

• – 10p. Marginal revenue will be given by…

  a. MR = dR/dq = -q/5 + 10

  b. MR = dR/dq = q/5 - 10

  c. MR = dR/dq = -2q/5 + 10

  d. MR = dR/dq = 2q/5 - 10

  3. Profit maximization requires that the firm hire each input up to the point at which its… a. Marginal revenue product is equal to its market price

  b. Marginal revenue product is less than its market price

  c. Marginal revenue product is more than its market price

  d. Marginal cost is less than its market price

  4. If MR = 20

• – q/10 and MC = 1 + q, then q that will be maximized profit equal to…

  a. 5

  b. 10

  c. 15

  d. 20 5.

  Based on the graph above, the profit would be… a.

  > 0 b. < 0 c. = 0 d. ≠ 0

  6. The supply curve for a price taking, profit maximizing firm is given by the positively sloped portion of its… a. Marginal cost curve below the point of minimum average variable cost

  (AVC)

  b. Marginal cost curve above the point of minimum average variable cost (AVC)

  c. Marginal cost curve above the point of minimum average total cost (ATC)

  d. Marginal cost curve above the point of minimum average fixed cost (AFC)

  7. At a price of P , the firm earns short-

  1 run producer surplus given by area…

  a. P Bq

  1

  b. P Bq

  1

  1

  c. P BP

  1

  d. P BAP

  1

  2 8.

  A firm’s … can also be expressed as a function of inputs where (k,l) = pq –C(q) = pf(k,l)

• – (vk + wl)

  a. Gross profit

  b. Operating profit

  c. Normal profit

  d. Economic profit 9. One reason for expecting ∂l=∂w to be negative in single-input case of input demand functions is based on the presumption that the marginal physical product of labor … as the quantity of labor employed…

  a. constant, constant

  b. increases,increases

  c. declines, declines

  d. declines, increases

  10. At a price of P1, the firm earns short-run producer surplus given by area

  a. P Bq

  1

  b. P Bq

  1

  1

  c. P BP

  1

  d. P BAP

  1

2 ESSAY

  1. Laundrette Dry Cleaning & Laundry Service is a small business that acts as a price taker. The prevailing market price of lawn mowing is $20 per acre.

  Laundrette’s costs are given by ₂ TC = 0.1q + 10q + 100 where q is the number of acres Laundrette chooses to cut a day.

  a. How many acres should Laundrette choose to cut in order to maximize profit? b.

  Calculate Laundrette’s maximum daily profit c. Graph these results and label Laundrette’s supply curve 2.

  Explain briefly the meaning of “marginal profit must be decreasing at the optimal level of quantity”!

  3. Would a lump-sum tax affect the profit-maximizing quantity of output? How about a proportional tax on profits? How about a tax assessed on each unit of output?

  4. A firm faces a demand curve given by q = 100

• – 2p Marginal and average costs for the firm are constant at $10 per unit.

  a. What output level should the firm produce to maximize profits? What are profits at that output level? b. What output level should the firm produce to maximize revenues? What are profits at that output level? c. Suppose the firm wishes to maximize revenues subject to the constraint that it earns $12 in profits for each of the 64 machines it employs. What level of output should it produce?

  5. Universal Widget produces high-quality widgets at its plant in Gulch, Nevada, for sale throughout the world. The cost function for total widget production (q) is

  2

  given by TC = 0.25q . Widgets are demanded only in Australia (where demand is q = 100

• – 2p), and Lapland (where demand is q = 100 – 4p). If Universal Widget can control q in each market, how many should it sell in each location in order to maximize profits? What price will be charged in each location?

  6. Explain short-run supply by a price-taking firm using the graph!

  7. Explain Envelope Theorem briefly! 8.

  Consider the “Primal” problem faced by a producer. Namely, a producer (or firm) can be thought to maximize profits, subject to producing their goods based on a particular kind of technology, or production function. Suppose that production of good y requires two inputs: K (capital) and L (Labor), which have input prices r and w respecti vely. Furthermore, assume that the firm’s price is normalized to 1, and that the production function is given by a constant elasticity of substitution (CES) production function:

  1 ρ

• = ( , ) = (K )

  a. Calculate the partial derivatives of y with respect to K and with respect to L

  b. Consider that the total derivative of the production function above would be calculated as:

• = The technical rate of substitution measures how one of the inputs must adjust in order to keep output constant (i.e. when dy

   0) when the other changes, and can be calculated from the total derivative above

  /

  as: Using your answer to part (a), calculate the = = −

  /

  technical rate of substitution for the CES production function above

  c. Using your answer from part (b), re ‐write the equation so that you have (K/L) as a function of the TRS. [Hint: take the absolute values of the TRS and then re ‐arrange for (K/L)]].

  d. Take logs of both sides and differentiate to show that the elasticity of substitution is a constant

  9. Consider the following convex, decreasing returns to scale technology: y = min[K, √ L] a. What is the profit function?

  b. Determine optimal production plans for two cases

  c. What happens to the capital-labor ratio?

  10. Explain The Substitution and Output Effects of a Decrease in the Price of a Factor

  

CHAPTER 9

THE PARTIAL EQUILIBRIUM COMPETITIVE MODEL

   The Market demand curve is the horizontal sum of each individual demand curve at a price the quantity demanded in the market is the sum of the amount each individual demand.

   Price elasticity of market demand: the demand for Q depends on many factors other than its own price, such as the prices of other goods and the income of all potential demanders.

   In the very short-run, or the market period, there is no supply response. The goods already “in” the marketplace and must be sold for whatever the market will bear. In this situation, price acts only as a device to ration demand.

   Short-run price determination: the number of industries is fixed. The relationship between price and quantity supplied is called a short run market supply curve.  Long-run analysis: a firm may adapt all inputs to fit the market condition, a profit maximizing firm that is priced taker will produce the output level for which price is equal to long-run marginal cost, the entry of the entirely new firm in the industry or the exit of existing firms from the industry.

   An industry supply curve exhibits one of the three shapes:

  a. Constant cost: entry does not affect input costs, the long-run supply curve is horizontal at the long-run equilibrium price.

  b. Increasing cost: entry increases input costs, the long-run supply curve is positively sloped.

  c. Decreasing cost: entry reduces input costs, the long-run supply curve is negatively sloped

MULTIPLE CHOICES

  1. In Perfectly Competitive Industry short-run pricing has several assumptions, except… a. Each firm attempts to maximize profit.

  b. Transactions are costly.

  c. Information is perfect: Prices are assumed to be known by all market participants.

  d. A large number of small firms exist in the industry.

  2. Assume a partial equilibrium model of a perfectly competitive market for bikes, where demand for and supply of bikes jointly determine the price of bikes and the quantity of bikes traded. If the price of bikes rises, then, other things equal, demand for bikes falls and supply of bikes rises. Neither the demand curve nor the supply curve runs vertical or horizontal. Demand for bikes depends also on consumer income. Supply of bikes depends also on labor costs. Scooters are a substitute for bikes. Both the bikes sector and the scooters sector are small sectors of the economy. In a graph of a market, the quantities demanded and supplied are displayed on the horizontal axis, whereas the price of the product concerned is displayed on the vertical axis. If the price of scooters rises owing to a tax measure that only pertains to the scooters sector, and, at the same time, consumer income rises, then in the market for bikes the following must result: a. The demand curve shall move right and, as a result, the price of bikes shall rise.

  b. The demand curve shall move left and, as a result, the quantity of bikes traded shall fall.

  c. The supply curve shall move right and, as a result, the quantity of bikes traded shall rise.

  d. None of the above.

  0.4

  0.8

  3. The production function Y = 0.5 K L implies: a. Constant Returns to Scale.

  b. Increasing Returns to Scale c. Decreasing Returns to Scale.

  d. More information is needed to answer this question.

  4. General equilibrium analysis focuses on the effects of links between markets.

  Which of the following provide examples of general equilibrium issues?

  a. The impact of gasoline price increases on the demand for fuel efficient cars is one example of demand side links.

  b. The impact of increased ethanol production on the price of food products (due to the impact on the price of corn) is an example of supply side links.

  c. None of the above.

  d. Both A and B. a. Partial equilibrium analysis always provides an accurate computation of the impact of a specific tax.

  b. Partial equilibrium analysis does not provide an accurate computation of the impact of a specific tax on one good if that good is a substitute or complement for other goods.

  c. General equilibrium analysis provides an accurate computation of the impact of a specific tax on one good.

  d. Both B and C.

  6. The First Welfare Theorem states that, in a general equilibrium with perfect competition, the allocation of resources is… a. Fair.

  b. Pareto Efficient.

  c. Biased toward the rich.

  d. Unduly influenced by power relationships.

  7. Input efficiency occurs when…

  a. Every pair of firms shares the same marginal rate of technical substitution between every pair of inputs.

  b. It is not possible to reallocate inputs to increase production of one good without reducing production of another good.

  c. Both A and B.

  d. None of the above.

  8. The mathematician of market demand function is: = ∑ ( , … . , )

  =1 ,

  1

  means that the market demand curve for X is constructed from the demand

  i

  function by varying P , while holding all other determinants of X

  i i… a. Change.

  b. Decrease.

  c. Constant.

  d. More information is needed to answer this question.

  9. The equation below shows that the marginal revenue will be more than 0. If …

  1 = + )

  = (1 + . ) = (1 +

  , a. If the elasticity is less than 1.

  b. If the elasticity is more than 1.

  c. If the elasticity is equal to 0.

  d. None of the above.

  10.

  ( ) = ( ). − ( ) = ( ) − ( ). This is called … a. Marginal Revenue.

  b. Marginal Cost.

  c. Profit.

  ESSAY

  1. How is the effect of a shift in the short-run supply curve depends on the shape of the demand curve. Graph and explain it!

  2. Describe the effect of a shift in the demand curve depends on the shape of the supply curve. Graph and explain it!

  3. When a perfectly competitive industry is in long run equilibrium?

  4. Use a partial-equilibrium model to answer the following questions about the effects of a tariff in a small country: Show that an ad valorem tariff will cause output to increase in the import competing industry if that industry is perfectly competitive.

  5. Suppose a perfectly discriminating monopolist faces market demand P = 100 —

  10Q and has constant marginal cost MC = 20 (with no fixed costs). How much does the monopolist sell? How much profit does the monopolist earn? What is the maximum per-period license fee the government could charge the firm and have the firm still stay in business?

  6. Graph and explain the long-run equilibrium for a perfectly competitive industry in a decreasing case!

  7. If there are 1000 firms in a competitive market, and each firm in the very short- run has a fixed supply of 100 units. The market demand function is Q = 150.000

• – 10.000P.

  a. How is the equilibrium price and quantity?

  b. Calculate the demand schedule facing any one firm in the industry!

  8. Suppose the demand for Sour Sally is: Q = 100

• – 2P, and the supply is: Q = 20 +

  6P. What is the equilibrium price and quantities for Sour Sally?

  9. The market supply is given by Q = 50.000 and the market demand are given by Q = 100.000 = 120.000 = 80.000

  1

  2

  3 – 4000P, Q – 4.000P, and Q – 4.000P.

  Calculate each equilibrium of the rice!

  10. Graph and explain what is Ricardian rent!