STUDY GUIDE for 2Nd MIDTERM

Econ 2610*

STUDY GUIDE FOR 2nd MIDTERM

* The study guide is not necessarily exhaustive. It is intended to give you direction as to what you should focus on understanding given your limited study time. It is also necessary to review questions on quizzes, your assignment, practice problem, your notes, read the book, etc.

-Consumer Choice

-The budget line

-Law of diminishing marginal utility

-New York Times article “Don’t Do the Things You Love”

-Utility maximization

-Marginal utility per dollar

-The rational spending rule

-Study by Kahneman and Deaton, “Does Money Buy Happiness?”

-Profit Maximization, Production and Costs

-Why firm’s maximize profit, and why it’s generally ok

-Adam Smith Quote

-How productivity is measured and why it’s important

-How productivity has changed over time

-Difference between long-run and short-run production

-Marginal productivity of labor

-Law of diminishing marginal returns

-Relationship between marginal productivity and marginal costs

-Relationship between marginal costs and average costs

-General shape of various cost curves

-Perfect competition

-How firms maximize profit

-The profit maximizing rule (MR and MC)

-Determine profit maximizing quantity using a production table or graph

- Perfect Competition

-Characteristics that determine perfect competition

-Measure firms profits with P, ATC, and Q

-The shutdown rule (TR and VC, P and AVC).

-Label firms’ profit or loss area on a graph, the shutdown price.

-Long run condition for perfectly competitive firms

-Economic and accounting profit

-Implicit costs and normal profit

-Long-run adjustments to profits and losses

-The allocative function of price (the invisible hand)

-Limitations of markets and roles for the government

-Barriers to entry

Practice Problems:

1. Consider the graphs above where “1” represents the first budget line and “2” represents how the budget line would change as a result of a change in price or income.

a.) Which graph represents what would happen if the price of X were to increase?

b.) Which graph represents what would happen if income were to decrease?

c.) Which graph represents what would happen if the price of X were to decrease?

d.) Which graph represents what would happen if the price of Y were to decrease?

e.) Which graph represents what would happen if income were to increase?

2. Assume at the current level of consumption Joe’s Marginal Utility of X is 50 utils and his marginal utility of Y is 20 utils. The price of X is $10 and the price of Y is $5. In order to maximize utility, what will Joe purchase next?

Quantity Total Utility

0 0

1 30

2 44

3 49

4 48

3. Refer to the table above. Marginal utility begins to decline when this individual consumes the

___ quantity.

4 A utility maximizing consumer purchases 8 units of good A and 2 units of good B each week. What do we know must be true of the 8th unit of good A compared to the 3rd unit of good B?

5. Total utility is maximized generally when a consumer’s ______is equalized for the last unit of each good he or she buys.

6. Harry spends all his income ice cream and snicker bars. The price of ice cream is $5/quart and the price of a snickers bar is $1. Harry has $20 to spend on the two goods. Note, we’re starting at the 9th snickers bar, which means he has already purchased the first 8 snickers bars.

Harry's preferences for ice cream and snickers bars are as stated in the table below.

6a. Fill in the blanks in the table above

6b. In order to maximize utility given the prices and income above, Harry will buy ___ quarts of ice cream and ___ snicker bars.

7. How is productivity measured and what does it mean to become more productive?

8. What is the distinction between short-run and long-run production decisions?

9. Use the following production table to answer questions.

Labor Output(Q)

0 0

1 10

2 22

3 30

4 38

5 40

6 41

9a. What is the marginal productivity of the second worker?

9b. Marginal productivity begins to decline when the firm hires the ___ worker.

9c. Marginal costs begin to rise with the firm hires the ___ worker.

10. Explain the law of diminishing marginal returns and how it relates to marginal costs.

11. Suppose at the current level of production average total costs=$300 and average variable costs=$250. If marginal costs associated with the next units are $275, what will happen to average total costs and average variable costs if they expand production?

12. Use the following production/cost table to answer the following questions.

Labor Output(Q) Fixed Costs Variable Costs Total Costs Marginal Costs

0 0 ____ 0 400

1 10 ______450 ____

2 22 ____ 100 ______

3 30 ____ 150 ______

4 38 ____ 200 ______

5 40 ____ 250 ______

6 41 ____ 300 ______

12a. Fill in the blanks in the table above.

12b. If this firm sells all its output at a constant price of $25, what is the profit maximizing Q?

12c. What do their profits equal?

13a. It costs a firm $50 to produce an additional unit of their product. If they can sell the product for $50, what would happen to their profits if they produce it?

13b. What will happen to their profit if they can sell it for $40 and their costs equal $50?

13b. What will happen to their profit if they can sell it for $50 and their costs equal $30?

14. Suppose a firm announces that they are investing $10 million in their facility in order to expand production. What do we know must be true in order for this firm to be willing to make this investment?

15. A firm knows it can make an additional $800 in revenue if it produces one more unit. Their current average total costs equal $700. What happens to their profits if they produce the additional unit.

16. Suppose a Firm A has half of the fixed costs as firm B, but the same total revenue and variable costs for all quantities. What does this mean as far as the profit maximizing quantity of the 2 firms (will Firm A’s be greater than, less than, or equal to Firm B’s?). What does this mean as far as the profit of the two firms?

17. What are the three characteristics of perfectly competitive markets?

18. The demand curve in a perfectly competitive market is ______. The demand curve of a perfectly competitive firm is ______.

19. Use the following diagram representing to answer the following questions

a. What is the profit maximizing quantity?

b. What does profit equal at the profit maximizing Q?

c. What is the shutdown price?

d. At what price would profits equal zero?

e. If price changes from $20 to $14, what happens to this firm’s output?

20. Refer to the graph above. If the market price increases from $50 per unit to $60 per unit, how will a profit-maximizing perfectly competitive firm change their output?

21. Refer to the graph above. If the market price equals $60, what will this firm’s revenue equal? What will their profits equal?

22. Suppose a firm is earning negative profit, but is continuing to operate. What do we know must be true of TC compared to TR, and VC compared to TR? What do we know must be true of ATC compared to P, and AVC compared to P?

23. Suppose a barber shop has fixed cost equal to $1,000/month and total costs equal to $5000/month. This shop will continue to operate in the short run as long its total revenue is greater than ____?

24. What was Adam Smith talking about when he used the analogy of an “invisible hand” leading us and allocating resources in society?

25. Give the formulas for economic and accounting profit. Why can economic profits never be below accounting profit?

26. If total revenue=$3,000, explicit costs=$2,000, and implicit costs=$1,200, what is this firms economic and accounting profit?

27. What does it mean when economic profits are negative for a firm (mathematically and intuitively)?

28. A firm’s accounting profit is $20,000, economic profit is $5,000, and total revenue equals $100,000. What do their explicit costs and what implicit costs equal?

29. Draw the MR, MC, ATC curves for a perfectly competitive firm that is earning zero profit.

30. Explain the sequence of events that will occur when firms are earning economic profits in a perfectly competitive industry by filling in the blanks below:

1. Firms ______the industry; 2. Market ______shifts ______. ;

3. Equilibrium price ______. ; 4. Firms’ marginal ______;.

5. Firms’ profits ______to zero.

31. Suppose farmers suddenly can earn considerably more per acre from growing wheat than from growing potatoes. What can we expect will happen in the long run as far as number of farmers in each industry and the prices of each good?

32. List three limitations of markets (or roles for the government in market systems).

33. List four barriers to entry.