ECON 4333: Economics of Organizations Name:__KEY________
Exam 1
Fall 2007 Dr.
Cary Deck
This exam consists of two sections.
The first section is a series of 15 multiple choice/short answer questions
worth 3 points each. The second section has 3 written problems/essay
questions worth 20 points each. Grades are out of 100 so there
are 5 bonus point built into the exam. To receive partial credit
on written problems, you must show your work in the space provided including
the back of the page if necessary. No electronic devices may be
used except for approved calculators.
In the long run the firm
is able to change all inputs. If the firm has increasing (decreasing)
returns then doubling inputs which will double costs will more (less)
than double output. Therefore, the ATC=TC/Q will decrease (increase).
In the short run, some
factors are fixed. As the marginal product of the variable input
diminishes, the firm will have to hire incrementally greater amounts
of the input to generate an additional unit of output. This makes
the average variable and average total cost increase as output grows.
ATC may initially fall since it also includes AFC which will start high
and then decline.
For each of the following, determine if it is 1st, 2nd, or 3rd degree price discrimination. Old Navy offering one shirt at $12 or two shirts at $7.50 each. _2____ AT&T charging lower prices on Night and Weekend minutes. _3____ Village Inn offering discounts for senior citizens. _3___
Explain what is meant by a public good. In the experiment we conducted in class, how did we overcome the free rider problem?
A public good is non-rival
(one person00 consumption does not diminish another person00 usage)
and non-excludable (there is no way to stop someone from consuming the
good). The free rider problem was resolved by assigning property
rights so that each family kept what it produced.
Suppose that demand is given by P=120-Q2-3Q and TC=Q+25. If a monopolist operates engages in first degree price discrimination then Consumer Surplus = _0__.
A first degree price
discriminating monopolist extracts
all of the surplus.
How much more profit could the seller earn using block pricing, assuming that TC=5Q?
2 The profits increase from 5 to 7. 3 4 7The slope of the budget constraint is 00x/Py 00Ux/MUy I/Px I/MUx
If you estimated the following regression y=a+b (ln x) you could interpret b as the change in y for a change in x. the percentage change in y for a percentage change in x. the change in y for a percentage change in x. the percentage change in y for a change in x.
Tom has to choose between two investment plans. Plan A will pay $100 with probability 0.5 and $0 with probability 0.5, while plan B will pay $225 with probability .25 and $0 with probability .75. If Tom00 preference are given by u(w)=w1/2, which plan should Tom select? A has a higher expected utility B
Which of the following is not an example of a contracting cost? information gathering menu costs monitoring costs search costs
If the cross price elasticity of two goods is positive then the goods are said to be Inferior Normal Complements Substitutes
In class we discussed how incentive plans such as tipping can lead workers to exert more effort than a fixed wage for any effort above some threshold needed to keep a job. Demonstrate how such incentive plans can lead to more effort even for the same income level. (Hint: Consider a worker that values two good - income and leisure, which is the opposite of effort.)
You are managing a firm that operates in a monopolistically competitive industry. Your analyst hands you some computer output that forecasts sales as a function of your price and the prices of several of your rivals based upon data from the last several quarters. Explain what is meant by multicolinearity and why it is a potential concern in this case.
Multicolinearity occurs
when the independent variables are highly correlated, and this leads
to errors in the estimated standard errors. It is a problem here
as the price of the rivals are likely to move together and thus be highly
correlated.
Written Problem 1
You operate a firm that competes
in a competitive market. The current price of output in this market
is $10. Your production is given by f(L,K)=L1/2K1/3
and you have a contract specifying that you will hire 8 units of capital
at a cost of $5 each. Each unit of labor you hire costs $2.
Determine the equation for
your total cost curve and identify fixed cost and variable cost.
TC=wL+vK. K=8, w=2 and v=5 are given. q= L1/2K1/3 = 2L1/2 so L=q2/4.
Hence TC=2 *q2/4
+5*8= q2/2 + 40. FC=40 and VC= q2/2
Verify that MC intersects ATC
at the minimum ATC. Keep in mind that the slope of ATC will be
0 at the minimum.
ATC=TC/Q = (q2/2
+ 40)/q = q/2+40/q. The slope of ATC is 1/2 - 40/q2.
Setting this equal to 0 to find the minimum ATC gives q2=80.
MC=dTC/dq= q.
Setting MC=ATC gives q= q/2+40/q or q2=80.
Q.E.D.
What is the optimal quantity
for your firm to produce and what profit will you earn?
A firm sets MR=MC to maximize
profits. For a competitive firm, MR=P so we have 10=q. Revenue
will be 10*10=100 and TC= 102/2+40=90 so the
profits are 10.
What would you expect to see
occur in this market and what would the effect on price be?
Since firms are earning
a profit, other firms will enter thus pushing out supply and lowering
prices. Also, in the long run costs must be no greater than in
the short run, which will also push price lower.
Written Problem 2
Amy drives a moped and Betty
does not. Otherwise the two women are the same and each has $10,000
in savings. Both have utility given by u(w)=w1/2.
There is a 2% chance that Betty will need medical care and a 10% chance
that Amy will. Medical care will cost $7,500.
How much would each person be willing to pay for insurance to completely cover the expense?
Expected utility for Amy w/o Ins. = .9 (10000)1/2
+ .1 (2500) 1/2
= 95.
Expected utility for Amy w/ Ins. = (10000-c)1/2.
Amy will buy insurance if
(10000-c)1/2 > 95 or c < 975.
Expected utility for Betty w/o Ins. = .98 (10000)1/2 + .02 (2500) 1/2 = 99.
Expected utility for Betty w/ Ins. = (10000-c)1/2.
Betty will buy insurance
if (10000-c)1/2 > 99 or c <
199.
In expectation, how much would
it cost the insurance company to insure each person?
Cost to insure Amy is .1 (7500) +.9 (0) = 750.
Cost to insure Betty is
.02 (7500) + .9(0) = 150.
If the insurance company cannot
tell which person is which, what will happen in this market? Explain.
If the insurance company
sets a price at or below 199 then both women will buy insurance.
The expected profit would be 2 * price -750 -150 which is less than
0 so the company would lose money. At any price between 975 and
199 only Amy would buy insurance. The profit would be price 00
750 which is maximized when the insurance company charges 975.
In this case it would earn a profit of 225. If it charged more
than 975 nobody would buy insurance and the company would make 0
profit. Therefore, the best choice is to sell insurance at a price
of 975.
Written Problem 3
BMS holds a patent for a drug
that can cure both the flu and the hiccups. Demand from people
with the flu is P=1000-Qf and demand from people with the hiccups is
P=25-Qh/10. The drug is easy to produce and has a cost of 10Q
where Q is the total quantity produced for both uses (Q=Qf+Qh).
Currently, the drug is only
available by prescription and buyers cannot sell it to each other.
Given this, what price should BMS charge in each market and how much
profit will it earn?
Flu Market: MR= 1000-2Qf
and MC=10 so Qf=495 and Pf=505. Profit = 505*495-10*495=$245025.
Hiccups Market: MR=25-Qh/5
and MC= 10 so Qh=75 and Ph=17.5. Profit = 17.5*75-10*75=$52.5
Total Profit = 245025+52.5
=$ 245077.5
Suppose that the government
no longer required medicine to be bought with a prescription.
What would happen in this market now that BMS could only charge one
price?
The firms profit would equal
(1000-Qf)Qf-10Qf+(25-Qh/10)*Qh-10Qh.
But since there is a single price it must be that 1000-Qf = 25-Qh/10
or Qh= 10Qf-9750. You can plug this into profit and then solve
the optimization problem. What you will find is that the firm
wants to sell a negative quantitiy in hiccups market. This indicates
that the firm would rather ignore the hiccups market and focus on the
flu market. Therefore the price will be 505 and no one will buy
the medicine for the hiccups.
What is the efficient quantity
of this drug?
The efficient quantity is
where P=MC. MC=10 so we have 10=1000-Qf or
Qf=990 and 10=25-Qh/10 or Qh=150. Therefore the efficient quantity
is 990+150=1140.
Why would the government intentionally
create a situation that would generate a dead weight loss by creating
a barrier to entry such as a patent?
This is to encourage R&D. CS under a monopoly will be positive, which is greater than the 0 consumers would receive if the market did not exist.
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