Name: Recitation teacher’s name:

Day and time of recitation:

Microeconomics
Spring 2018
Midterm Examination

There are two sections to the exam. Part A contains 10 short-answer questions worth 4 points
each (40 points total) and Part B contains two problem-questions worth 60 points in total.

Instructions:
- Please fill in the information above and wait for the signal to begin.
- You may use only a basic calculator (no storage capacity).
- The use of class notes, textbooks is not permitted.
- Read the questions carefully. Please write legibly, and provide concise but justified
answers.
- Show your work. Include labels on axes/curves in all diagrams you draw.
- You have 1 hour and 15 minutes.

Good luck!
Part A: 10 short-answer questions (4 points each; 40 points total)
1. Suppose a firm has a cost function C = 20 + Q3. What are this firm’s fixed costs, variable
costs, and marginal costs when Q = 10?

FC =20

VC = Q3. At Q=10, VC = (103)= 1000

MC = dTC/dQ = dVC/dQ = 3Q2=3*(102) = 300

2. Suppose that a firm has the following production function: Q = 3L2/3. What is this firm’s
marginal product of labor? Does this firm’s production exhibit diminishing marginal returns
to labor? Explain.

MPL=dQ/dL = 3*(2/3)*L-(1/3)=2/(L1/3)

As L increases, MPL decreases. This firm’s production function does exhibit diminishing
marginal returns to labor.

Example:

L=8, MPL=2/(8(1/3))=1

L=64, MPL=2/(64(1/3))=1/2

3. Supposed that Maria likes smoothies, but only when they have 1 banana and 3 kiwis per
smoothie. Draw a set of Maria’s indifference curves. What is Maria’s utility function for
bananas and kiwis?

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 U = min{1B,(1/3)K} or multiples of this expression. From this form, we can see if B=1,
K=3, then Usmoothies=min{1,(1/3)*3}=1. If B=2, K=6, Usmoothies=min{2,(1/3)*6}=2.

4. Suppose NYC bans Airbnb and other home-sharing services, which compete with hotels. At
the same time, a new technology lowers the costs of cleaning hotel rooms between guest
visits. The price of a hotel room in NYC will: Increase/Decrease/Uncertain.

Circle one of the three options. Justify your answer with a graph.

Answer: uncertain. The new equilibrium price of hotel rooms depends on the relative size of
the demand shift from D to D’ and S to S’. With a large shift in supply and a small shift in
demand, we can expect prices to fall. With a large shift in demand and small shift in supply,
the price may increase. As drawn, the price nearly remains the same. The quantity of hotel
rooms increases.

5. Suppose the demand curve for stuffed toys is Q = 15 – 3P. The market price is $3. What is
the consumer surplus for the units sold at this price? Show your work.

Q=15-3p is the same as P=5-(1/3)Q. Here, if Q=0, P=5. If P=0, Q=15. If P=3, Q=6.
Then CS = (1/2)(6-0)(5-3) = (1/2)*6*2 = 6. See graph.

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6. A Giffen good is necessarily an inferior good. True or False? Explain.

True. To be a Giffen good, we need the income effect from a price change to outweigh the
substitution effect. In this way, the total effect will break the law of demand. That is, as the
price of the good falls, the income effect pushes toward less consumption of the good
sufficiently such that quantity demanded of the good falls. Only inferior goods would have
this change in quantity demanded in response to the increase in income that stems from the
decrease in price.

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7. Latika’s company has the following short-run cost function: q3 - 16q2 + 30q. What is the
firm’s marginal cost and average cost? What positive level of output will minimize the
average cost?

MC = 3q2-32q+30
AC = (q3 - 16q2 + 30q)/q = q2 - 16q + 30.

We can find the minimum of average cost as the positive quantity at which MC = AC. Setting
MC=AC, we find 2q2-16q = 0. Thus, 2q*(q-8)=0, or q=8.

8. Suppose that the market demand for Honey Wheats is Q = 80 − 30P. Write down the formula
of the elasticity of demand. What is the price elasticity of the demand for Honey Wheats
when a box costs P=$2.00? Is demand elastic or inelastic? Explain.

Ed=(dQ/dP)*(P/Q).
Here, dQ/dP = -30. At P=2, Q = 80-30(2) = 20.
So Ed=(-30)*(2/20) = -3. Demand is elastic, since the elasticity (in absolute value) is greater
than 1.
9. Josue likes fish sandwiches. It makes no difference to Josue whether he makes his fish
sandwiches with trout or salmon. Draw Josue’s indifference curves for trout and salmon
sandwiches. If a salmon sandwich costs $2 and a trout sandwich costs $3, and Josue has $6 to
spend, how many of each type of sandwich will he consume?

Let T = trout sandwiches and S = salmon sandwiches. Here, I = PsS+PTT, or with the
numbers, 6 = 2S + 3T. Rearranging, T = 2- (2/3)S.
From the plot below, we can see that Josue consumes 3 salmon and 0 trout to use up all of
his income and achieve the largest utility (consume a bundle on the highest possible
indifference curve given his income).

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10. Consider the indifference curves over goods x and y, pictured below. Do these curves
violate our preference axioms? Explain.

Yes, these indifference curves violate out axioms. Drawing in points A, B, and C in the
graph, we can see which axioms are violated. Point A, as drawn, lies on both curves at the point

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at which they intersect. By the definition of an indifference curve, the utility at all points on both
indifference curves must equal. So A~B~C.
But we know C>B by strict monotonicity. If C>B but A~B, and A~C, we cannot have this
result by transitivity. That is, A~C and C>B, then A>B by transitivity. But if A,B are on the
same indifference curve, A~B. This violates transitivity.

______________________________________________________________________________

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Part B: 2 long-answer questions (60 points total)
1. The firm BK Industries has the following production function:

Q = 2 L1/4 K1/2

a. [5pts] Does this production function exhibit increasing, decreasing or constant returns to
scale? Explain.

Decreasing returns to scale.

Explanation: Either use Cobb-Douglas trick that ¼+1/2 <1 or,

F(2L,2K)=2 (2L)1/4 (2K)1/2 = 23/4 (2 L1/4 K1/2) = 23/4 F(K,L) < 2 F(K,L)

b. [5pts] What is the marginal product of labor and the marginal product of capital for BK
Industries?

MPL= ½ L-3/4K1/2

MPK=L1/4K-1/2

c. [5pts] The wage is $10 per worker and the price of capital is $20. Draw an isocost curve
for C=$1000. Be sure to label the axes.

Use C=wL+rK. This give 1000=10L+20K. Solving we have K = 50 - 1/2 L.

50

100 L

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d. [5 pts] What is optimal ratio of K/L that BK Industries uses in production given the
firm’s production function and the input prices in part c (wage of $10, price of capital of
$20).

Use MRTS = MPL / MPK = w/r. From part b., MPL / MPK = K/2L. So K/2L = 10/20.
Solving we have K/L=1.

e. [5pts] Derive the firm’s cost function in terms of quantity Q.

To derive the cost function we use (1) K=L from part d above, (2) Q=2L1/4K1/2 and (3)
C=wL+rK. We start by using (1) and (2) to solve for L in terms of K. Substituting for K in
(2) we have: Q=2L1/4L1/2=2 L3/4. So L=(1/2 Q)4/3.

Next, start with C=10L+20K and substitute out K using K=L to get C=30L. Finally,
plugging in for L we have,

C=30 (1/2 Q)4/3 = 30 (1/2)4/3 Q4/3

f. [5pts] Does this firm exhibit economies or diseconomies of scale? Explain and show your
reasoning.

Diseconomies of scale.

Could solve using MC= 30 (1/2)4/3 (4/3) Q1/3 and AC=[30 (1/2)4/3 Q4/3]/Q = 30 (1/2)4/3
Q1/3. Then the ratio of MC/AC=4/3 > 1 tells us diseconomies.

Alternatively, could use C(2Q)=30 (1/2)4/3 (2Q)4/3 = 24/3 [30 (1/2)4/3 Q4/3] = 24/3 C(Q) > 2
C(Q).

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2. Tomasz consumes only pizza and pasta. His utility function is

U(x,y) = 2x + 3y

where x denotes pizza and y denotes pasta.

a. [5pts] What is the marginal utility of x and the marginal utility of y?

Taking derivatives of the production function gives:

MUX = 2

MUY = 3

b. [5pts] The price of pizza (x) is $4 and the price of pasta (y) is $12. Tomasz has an income
of $24. How much pizza and how much pasta does he consume? Explain.

We can see that this will have a corner solution by graphing the budget lines and
indifference curves or by showing MUx/MUy = 2/3 while Px/Py=1/3 so these cannot be
equal. Once we know that this is going to be a corner solution case, one way to find the
answer is to graph the problem.

The budget line graph comes from I=Px X + Py Y. Plugging in and solving for Y, we
have Y=2 – 1/3 X. This appears as the heavy line in the graph below. To graph the
indifference curves we use U=2X+3Y and solve for Y to get Y=U/3 - 2/3 X. Now we can
graph an indifference curve for each value of U. In the graph below we can see that given
the budget constraint the highest utility level is achieved when Tomasz consumes only
Pizza. At this point X=6 and Y=0.

Pasta

3 6 Pizza

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c. [5pts] Is pizza an inferior good? Explain.

Pizza is not an inferior good. If Tomasz’s income increases his consumption of pizza
increases. Thus, pizza is a normal good.

d. [5pts] Suppose that the price of pizza increases to $6. Show graphically how this affects
Tomasz’s budget constraint. What are his optimal consumption choices under the new
price of pizza?

The budget constraint rotates inwards to the new (dotted) line. Tomasz’s new
consumption choice is X=4 and Y=0.

Pasta

3 6 Pizza
4

e. [5pts] What is the size of the total effect on the quantity of pizza resulting from the
increase in the price of pizza from $4 to $6? What is the size of the income effect on the
quantity of pizza resulting from this price increase?

Total effect: Quantity of pizza decreases from 6 to 4 (so -2)

Income effect: Quantity of pizza decreases from 6 to 4 (so -2)

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f. [5pts] Draw Tomasz’s individual demand curve for pizza given that the price of pasta is
fixed at $12.

Here, we have Income =24, PY=12. We want to see what happens to quantity demanded
of X as the price is X varies.

We know that at PX=4, quantity of X = 6. At PX =6, quantity of X = 4. We can find a

range of points by recognizing that until the budget constraint becomes parallel to the
indifference curves, the consumer will spend all of her of income on X. Thus, X = 24/PX.
So, if PX =3, X=24/3 = 8. If PX = 4, X=6. If PX = 5, X=24/5 = 4.8. We can repeat this
calculation as we increase price, until PX =8. At PX =8, the slope of the budget constraint
is 8/12 = -2/3. At this price, the consumer would get the same utility from using her
budget to consume X=3 or Y=2. At any price of X above PX =8, the consumer will
achieve higher utility by consuming all Y.
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