Student Name_______________________ Student Number___________________

Department of Economics
University of Ottawa
ECO2144
Microeconomic Theory I
Final

P Brochu Fall 2007

Instructions:

1. Print your name and student number at the top of this exam.

2. Each multiple choice is worth 1 mark.

3. The maximum grade possible is 52 marks.

4. This exam consists of 6 pages (including equation sheet and title page).

5. Programmable calculators are NOT allowed.

Part A
Multiple Choice: Circle the ONE alternative that best completes the statement or
answers the question.

1. Which of the following will not be true of a perfectly competitive market?

a) Buyers and sellers will have an imperceptible effect on the market.
b) Firms can freely enter and exit the market.
c) Different consumers may pay different prices.
d) Buyers and sellers and price takers in the market.

2. Suppose at the current level of output, P  MC . The firm

a) Is currently maximizing profit since it is charging a price higher than marginal cost.
b) Could increase profit by lowering the level of output.
c) Could increase profit by increasing the level of output.
d) Cannot increase profit without raising price.

Suppose market demand is given by Q  100  P and market supply is Q s  3P , producer

d
3.
surplus at the long-run perfectly competitive equilibrium is
a) 25
b) 75
c) 937.50
d) 1,875

4. Assume that capital is measured along the vertical axis, and labor is measured along the horizontal
axis. The firm has an initial isocost line called TC1 . Now suppose that the price of capital falls.
Which statement accurately describes the movement of the isocost line from TC1 to TC2 ?
a) The slope of the isocost line becomes flatter.
b) The slope of the isocost line becomes steeper.
c) The slope of the isocost line is unchanged.
d) We cannot determine whether the slope becomes flatter or steeper.

5. If long-run average cost exceeds long-run marginal cost for a specific level of output, then long-
run average cost is
a) Rising.
b) Falling.
c) Constant.
d) Zero.

6. Suppose the average cost of producing output falls over time as the firm produces more units.
This can best be explained by
a) Economies of scale.
b) Economies of scope.
c) Increasing returns to scale.
d) Economies of experience.
7. The long-run is
a) A time period in which all input levels are fixed.
b) A time period in which at least one input level is fixed.
c) One year.
d) A time period in which no input levels are fixed.

8. Suppose capital and labor are perfect complements for a particular production process. If the price
of labor increases, holding the price of capital and the level of output constant, the firm should
a) Use more capital and less labor.
b) Use more labor and less capital.
c) Use the same amounts of capital and labor.
d) Any of the above may be true.

9. The slope of the isoquant can be expressed as

a) The ratio of the input prices.
b) The ratio of the inputs.
c) The ratio of the marginal productivities of the inputs.
d) The sum of the marginal productivities of the inputs.

10. The production function Q  KL exhibits

a) Increasing returns to scale.
b) Constant returns to scale.
c) Decreasing returns to scale.
d) Undefined returns to scale.

11. Identify the statement that is true. Assume that the price of good x increases.
a) The substitution effect shows that, if x is an inferior good, the consumption of x rises.
b) The substitution effect shows that, if x is a normal good, the consumption of x rises.
c) The income effect shows that, if x is a normal good, the consumption of x falls.
d) The income effect shows that, if x is an inferior good, the consumption of x falls.

12. The income effect associated with a change in price describes

a) The change in the level of consumption as a result of the consumer’s change in utility,
holding price constant.
b) The change in the level of consumption, holding utility constant.
c) The change in relative purchasing power.
d) Both a) and c) are correct.

13. Identify the statement that is false.

a) An increase in the amount of income changes the intercepts of the budget constraint but
not the slope.
b) An increase in the price of good x changes both the x -intercept and the slope of the
budget constraint.
c) An increase in the price of good x and an equal percentage increase in the price of good
y changes the x -intercept, the y -intercept, and the slope of the budget constraint.
d) An increase in the price of good x and an increase in the price of good y may or may
not change the slope of the budget constraint.
14. Suppose that the MU x  y and the MU y  x . Further suppose that the consumer’s budget
constraint can be expressed as 10 x  40 y  400 . For this consumer, the optimal amount of
good x to buy would be
a) 5.
b) 10.
c) 20.
d) 40.

15. Indifference curves have a negative slope when

a) The consumer likes good X but dislikes good Y .
b) The consumer likes good Y but dislikes good X .
c) The consumer likes both good X and good Y .
d) The consumer dislikes both goods.

16. Which of the following utility functions is an example of preferences for perfect substitutes?
a) U ( x, y)  xy .
b) U ( x, y)  min 2 x, y .
c) U ( x, y)  3x  5 y .
d) U ( x, y)  2 x2  4 y .

17. Law of demand

a) Holding all other factors that influence demand fixed.
b) Demand for a good that comes from the desired buyer.
c) Demand for a good that is derived from production and sale.
d) An increase in supply and demand.

18. Which of the following statements is false?

a) Demand can be both inelastic at market level and highly elastic at the brand level.
b) Demand can be both highly elastic at the market level and inelastic at the brand level.
c) The distinction between market-level and brand-level elasticity reflects the impact of the
availability of substitutes.
d) Brand-level elasticity of demand is more negative than industry-level price elasticity of
demand.

Part B:
In answering the following questions, be sure to show all your work. Diagram (if
necessary) should be clearly labeled and explained.

1. Briefly explain the purpose of an economic model, and the role of its underlying assumptions. (4
marks)

2. Suppose a perfectly competitive firm has the following cost function

TC(Q) = 10 + 20Q+Q2
and can sell its output at price $100 per unit.
a) Calculate the profit maximizing output, and profit level (4 marks)
 b) The government decides to impose a lump-sum tax of $k on each firm. Set up the profit
maximization problem of the firm, and explain in words how this would affect the output
level of the firm? (4marks)

3. The government is considering the merits of subsidizing the purchase of capital equipment by
firms. As the government analyst, you know that the elasticity of substitution is close to zero, and
that the demand for the good (produced by the firm) is price elastic. Should the government be
concerned about potential disemployment effects? Briefly explain. (5 marks)

4. Given the following production function: F(L,K) = L + KL

a) Are there economies of scale present? Justify your answer (4 marks)

b) Assume a short-run problem where capital is fixed at 50, the price of labour is $10 (per
unit), and the price of capital is $20 (per unit). Finally assume that the firm wishes to
produce 200 units of output. What will be the optimal level of labour hired by the firm?
(4 marks)

Part C: Answer ONLY one of the following two questions (8 marks)

1. Luc has $100 to spend on goods A and B, and the price of each good is $1. Luc’s preferences over
the two goods can be summarized by the following utility function.

U(x1, x2) = logA + 2logB

a) How much of each good will he consume? (4 marks)
b) How would the introduction of the General Sales Tax (GST), affect the set up of the
utility maximization problem. For ease of exposition, assume that the GST is 10% (4
marks)

2. Alice has $30 to spend on x1 and x2, and the prices are $2 and $1, respectively. Alice’s preferences
over the two goods can be summarized by the following utility function.

U(x1, x2) = min(2x1, x2)

Hint: The indifference curve for U=10, for example, will take the following shape

a) How much of each good will she consume? (4 marks)

b) In a graph, show the income and substitution effect for a drop in price of good A. (4
marks)