Solutions to

Sample Final Examination

Part A: Multiple Choice Questions

1. E

2. C - There is insufficient information to determine which choice she should make, but an optimal choice should include the opportunity cost of the $75,000 salary offer if the management position is the best alternative to her current position.

3. A - We must give up something in order to get more of another. Note that increasing opportunity costs tells us the shape of the curve, not why we have a negative slope.

4. A

5. C

6. B - Set 6 = 10 –2×Q, solve for Q = 2. Thus =(1/-2)×(6/2) = |-1.5|.

7. A - Set 5 = 20 –5×Q, solve for Q = 3. Thus, TR = P×Q = 5×3 = 15.

8. C - Since a perfectly competitive firm has no control over the market price, the only decision to make is how much to produce.

9. C

10. E

11. C; that is, inelastic demand.

12. A

13. C

14. C

15. B

16. A

17. E

18. E

19. C

20. C

21. D

22. E

23. D

24. B

25. C

26. C

27. D

28. C

29. D

30. B

Part B: Short-Answer Questions

B1. Rational Spending Rule

David has two leisure activities – riding his new Triumph “Bonneville” motorcycle and growing award-winning orchids. David estimates that an hour’s worth of riding his motorcycle costs him $15 while an hour’s worth of orchid growing costs him $5.

(a) Assume David spends $100.00 per month on these two activities, “consuming” them in full hours only. How many hours/month will he ride his motorcycle? How many hours/month will he grow orchids? Explain your answer.

The Rational Spending Rule stipulates that spending is allocated across goods so that the marginal utility per dollar is the same for each good. Namely,

Where, MUM = the marginal utility of motorcycle riding; MUO = the marginal utility of orchid growing; PM = price of motorcycle riding / hour; and PO = price of orchid growing / hour. In this case, we need to divide all the marginal utilities by the respective dollar prices AND find the appropriate ratio, given our restriction on spending.

Hours Per Month

MU of Motorcycle Riding

MU of

Orchid Growing

1

2,250

150

500

100

2

1,950

130

475

95

3

1,650

110

450

90

4

1,500

100

425

85

5

1,200

80

400

80

6

1,050

70

375

75

7

900

60

350

70

8

750

50

325

65

9

600

40

300

60

10

450

30

275

55

There are four combinations of motorcycling riding and orchid growing where the Rational Spending Rule occurs:

# of hours motorcycle riding

# of hours orchid growing

Total Cost

100

4

1

$65

80

5

5

$100

70

6

7

$125

60

7

9

$150

The only combination that adds up to David’s income constraint is 5 hours of motorcycle riding and 5 hours of orchid growing.

(b) Suppose now that the price of motorcycle riding doubles to $30 per hour. How many hours/month will he ride his motorcycle? How many hours/month will he grow orchids? Explain your answer.

Following the same approach as above, we can construct a new table:

Hours Per Month

MU of Motorcycle Riding

MU of

Orchid Growing

1

2,250

75

500

100

2

1,950

65

475

95

3

1,650

55

450

90

4

1,500

50

425

85

5

1,200

40

400

80

6

1,050

35

375

75

7

900

30

350

70

8

750

25

325

65

9

600

20

300

60

10

450

15

275

55

Giving us the following three combinations of motorcycling riding and orchid growing where the Rational Spending Rule occurs:

# of hours motorcycle riding

# of hours orchid growing

Total Cost

75

1

6

$60

65

2

8

$100

55

3

10

$140

The only combination that adds up to David’s income constraint is 2 hours of motorcycle riding and 8 hours of orchid growing.

(c) Sketch a demand curve showing David’s demand for riding his motorcycle based on your answers to (a) and (b). You can assume that the demand curve is linear. Be certain to clearly label your graph.

From our results, we see that when:

PM = $15, = 5 hours of motorcycle riding and PM = $30, = 2 hours of motorcycle riding.

Therefore the demand curve is:

B2. Relationship between Productivity and Costs

Foothills Refrigerators assembles refrigerators for retail sales and