ECN2101 Exam 2 Answers November 6, 2009

1. • (a) amount that utility increases when you obtain one more unit of a good
   • (b) situation where it is not possible to produce more of one good without producing less of another. On the graph, this means you are on the production possibility frontier..
2. Click here for marginal cost / average cost / average variable cost diagram (keep clicking on diagram to advance)
3. Click here for monopoly diagram
4. • (a) follow the rule: price = marginal cost
   • (b) follow the rule: marginal revenue = marginal cost
5. see the video question sheet
6. • (a) a situation where all mutually advantageous trades have already been made, so that it is not possible for people to make a trade that makes one person better off without making someone else worse off.
   • (b) If two people meet and talk it over, they can reach an agreement so that one person trades one good in exchange for another good so that they both end up better off.
   • (c) If there are many people in the economy it is not feasible for them all to meet with each other to reach agreements on mutually advantageous trades. However, the market prices will act as signals that will lead to mutually advantageous trades. For example, the low price of oranges in Florida and the high price in Washington will make it profitable to buy oranges in Florida and sell them in Washington (the reverse will be true for apples). As a result people in both Florida and Washington become better off.
7. • (a)Economic profit is revenue minus total opportunity costs (implicit plus explicit costs). Accounting profit is revenue minus explicit costs. (See Mankiw, page 270).
   • (b) If economic profit is zero, then accounting profit will be equal to implicit cost. This means that the money the firm is earning is equal to what it could be earning at its next best alternative.
   • (c)If firms in a competitive industry is making positive economic profits, then then more firms will be attracted to that industry. As those firms enter, the market price falls. In long run equilibrium, the economic profit will be zero.
8. • (a) openness (in Russian)
   • (b) Mikhail Gorbachev
   • (c) In the Russia ruled by Stalin, Krushchev, and Brezhnev, information was very tightly controlled. Once personal computers started to become available, Russia could either continue to control information by denying its people access to computers (resulting in the country falling further and further behind technologically) or else allow its people to have access to information (the policy of glasnost).
9. If the market price is below the minimum of average cost, the firm will be making negative profits (losses). However, in the short run, it is better staying in business as long as price is above the minimum of average variable cost, since in this case it would lose more by shutting down and paying the fixed cost than it would by staying in business. However, in the long run the firm would not want to stay in business if the market price was always below average cost.
10. Deng's attitute toward Mao was a bit contradictory. One the one hand he says that Mao's thought must still be the guide for the country. On the other hand, he said that Mao made some mistakes, and in practice Deng began the process of slowly moving the Chinese economy away from the socialist economy that it had been under Mao. He criticizes the "Gang of Four" and their "phoney Marxism." He calls for China to begin the four modernizations, in agriculture, science and technology, national defense, and industry.
11. (a)
    

    
          Q        TC     MC         AC            AVC
          0       100                 x              x
                          60
          1       160           160.000         60.000
                         100
          2       260           130.000         80.000
                         120
          3       380           126.667         93.333
                         140
          4       520           130.000        105.000
                         160
          5       680           136.000        116.000
                         180
          6       860           143.333        126.667
                         200
          7     1,060           151.429        137.143
                         220
          8     1,280           160.000        147.500
    
    

    
    
    • (b) 6 or 7
    • (c) 126.67 (minimum of average cost)
    • (d) a perfectly competitive firm is a price taker, so it cannot choose the price to charge. It has to charge the price determined by the supply and demand in the market.
    • (e) if market price is greater than marginal cost, then increase production. The profit-maximizing optimum occurs where price equals marginal cost.
    • (f) the part of marginal cost curve that is above the shutdown price (where it intersects average variable cost)
    • (g) Because of the law of diminishing returns: in the short run, at least one input is fixed, so marginal cost will eventually start to rise if you keep trying to expand production.