Addis Ababa University

School of Economics
Worksheet I on Microeconomics I

Workout Questions: Attempt all questions. Clear and neat answers deserve credit.

1. The production function of a competitive firm is described by the equation Q = 6L 0.5K0.5. The factor prices w
= 1 and r = 4 (where w = wage and r = rent). The firm can hire as much of either factor it wants at these
prices. Derive the firm's total cost and marginal cost functions. (Ans. TC=2Q/3 and MC = 0.667)

2. Consider the following production function: Q = 6L0.6K0.4 where Q = Output, L = Labor , and K = Capital.
If the rental price of capital and wage rate for labor is 3 birr and 9 birr respectively, then determine the
following questions given that the firm decides to produce total output of 900 units.
A) Calculate optimal unit of labor and capital that would minimize total cost.
B) Calculate the minimum cost
C) Formulate the isocost curve equation.
D) Show the equilibrium condition graphically.
E) Check the above production function for returns to scale

3. Consider the following total cost function: TC = 2/3Q3 – 10Q2 + 200Q + 50

A) Identify the FC and VC function?
B) Calculate AVC, AFC, ATC, and MC functions
C) Determine the level of output at which AVC reaches minimum point and the minimum AVC at that
level of output?

4. Consider the following Total Revenue (TR) and Total Cost (TC) functions for a firm operating in a perfect
competition market:
TR = 6Q and TC = Q3 – 2Q2 + 50Q + 25
A) Determine the profit maximizing or loss minimizing equilibrium level of output.
B) Compute the level of profit or loss at the above equilibrium quantity and comment on the decision of
the firm.
C) Mathematically and graphically derive the supply function of the firm.

5. Suppose a particular consumer has Birr 8 to be spent on two goods, A and B. The unit price of good A is Birr
2 and the unit price of B is Birr 1.The marginal utility (MU) she gets from consumption of the goods is given
below.

Quantity MU A MU B
1 36 30
2 24 22
3 20 16
4 18 12
5 16 10
6 10 4
A) Based on the cardinal analysis, what is the combination of the two goods that gives maximum utility to
the consumer?
B) What is the total utility at the utility maximization level?

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6. Consider the demand curve Q =100 - 50P. Draw the demand curve and indicate which portion of the curve is
elastic, which portion is inelastic, and which portion is unitary elastic.
7. A person has $100 to spend on two goods X and Y whose respective prices are $3 and $5.
A) Find the equation of the budget line and sketch its graph.
B) What will be the equation of the new budget line if the original budget falls by 25%? Sketch its graph.
C) What will be the equation of the new budget line if only the price of X doubles? Sketch its graph.
8. A household consumes only apples (A) and bananas (B). The preference of the household is given by the
utility function U(A, B) = A0.8B0.2. If the income of the household is $20 and the price of apple (A) and
banana (B) is $4 and $2, respectively, then
A) Find the optimal consumption of A and B
B) Show the equilibrium condition graphically
9. Suppose that the demand for ABAY CAR (QA) is estimated to be
QA = 150 – 9PA – 5PG + 10M + 0.5PT
Where QA is demand for Abay Car, PA is price of Abay car, PG is price of gasoline, M is consumer
income and PT is Price of Toyota Car. If PA = 10, PG = 10, M = 50 and PT = 180, then determine
A) Own Price elasticity of demand, and interpret the result.
B) Income elasticity of demand, and interpret the result.
C) Cross price elasticity of demand between quantity demand for Abay Car and price of Gasoline, and
interpret the result.
10. Suppose preferences are characterized by the utility function U(X 1; X2) = X1X22. As usual, the budget
constraint is P1X1 + P2X2 = M. Suppose also that P1 = P2 = 10 and M = $90
A. Now suppose the government places a 50% tax on X 1. Write the new budget constraint, given this tax.
Identify the utility maximizing bundle of X 1 and X2 for the consumer, the amount of tax revenue
collected by the government, and calculate the consumer’s utility. Ignore second-order conditions.
B. Now suppose instead the government places a 20% tax on X 2. Once again, write the new budget
constraint, given this tax. Identify the utility maximizing bundle of X 1 and X2 for the consumer, the
amount of tax revenue collected by the government, and calculate the consumer’s utility. Ignore second-
order conditions.
11. Jane has utility function over her net income
A) What are Jane’s preferences towards risk? Is she risk averse, risk neutral or risk loving?[Explain briefly
your answer]
B) Jane drives to work every day and she spends a lot of money in parking meters. Many days the thought
of cheating and not paying for parking crosses her mind. However she knows that there is a ¼
probability of being caught in a given day if she cheats, and that the cost of the ticket is $36. Her daily
income is $100. What is the maximum amount of she will be willing to pay for one day parking? [Hint:
by paying that amount she avoids the risk of getting a ticket!].
C) Paul also faces the same dilemma every single day. But he has a utility function U(I)=I. His daily
income is also $100. What are Paul’s preferences towards risk? Is he risk averse, risk neutral or risk
loving?
D) If the price of one day parking is 9.25, will Paul cheat or pay the parking meter? Will Jane cheat or pay
the parking meter under this price?
12. The marginal cost curve of a firm is MC=8Q. Calculate total variable costs to produce 7 units of output.
13. A firm has the short run total cost function TC = 9Q 2 + 441. At what quantity of output is short run average
cost minimized? Calculate the minimum average cost. How much is the breakeven price?
14. Eric receives utility from days spent traveling on vacation domestically (D) and days spent traveling in a
foreign country(F) as given by the utility U(D, F) = DF. The price of a day spent traveling domestically is
$160 and in a foreign country $200. Eric’s annual budget for traveling is $8,000.

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 A) Find Eric’s utility maximizing choice of days traveling domestically and in a foreign country. Find also
his utility level from consuming that bundle.
B) Suppose that the price of domestic traveling increases to $250 per day. Calling his budget for traveling
x, (suppose by now that it is unknown) find the demand for D and F under the new prices as a function
of x.
C) Find the income necessary to make Eric reach the same utility level as before the price change.
D) Compute the quantities demanded with the new prices and the income you found in section c.
E) Compute the quantities demanded with the new prices and the original income.
F) Using your previous answers tell us what is the total change in quantity of D due to the price increase in
PD that the consumer experiences and what part of that change is due to income or substitution effects.
Give definitions of what income and substitution effects mean.
G) Draw a graph showing the income effect and substitution effect you found above.

15. Suppose KALDIS COFFEE has a production function for coffee, which is given by
Q = 20LK, where Q is cups of coffee, L is labour and K is coffee machine. Furthermore, the company
allocated only Birr 20,000 for the production of cups of coffee. It employs workers (L) at a wage rate (w) of
Birr 100 and coffee machine (K) at a rental price (r) of Birr 2000.
A. Write the Isocost function
B. How many workers (L) and coffee machine (K) must be acquired by the company to produce the
maximum possible number of cups of coffee.
C. How many cups of coffee will be produced at the equilibrium of the company?
D. Identify the types of return to scale that Kaldis‘s production function exhibits?

16. A production function is given by: Q= 4L1/2 K1/2 where L and K are the number of units of labor and capital
used respectively and Q is output. If the cost of labor is birr 40 per unit while that of capital is birr 20 per
unit,
A. Determine the amount of labor and capital that must be used to minimize the cost of producing 40
units of output.
B. Calculate the minimum cost of producing the 40 units.

17. A firm operates in a perfectly competitive market. The market price of its product is 4 birr and the total cost
1 3
Q −5 Q2 +20 Q+50
3
function is given by TC= , where TC is the total cost and Q is the level of output.
A. Calculate the equilibrium level of output the firm should produce.
B. Determine the level of profit or loss at equilibrium.
C. What is the shut-down price of this firm?

18. A cloth producing firm in a perfectly competitive market has the following short-run total cost function: TC
= 6000 + 400Q – 20Q2 + Q3. If the prevailing market price is birr 250 per unit of cloth,
A. Should the firm produce at this price in the short-run?
B. If the market price is birr 300 per unit, what will be the profit (loss) of the firm at equilibrium?
Should the firm continue to produce or not?
C. Calculate the shut-down price of this firm?
19. Suppose the following utility maximization problem of a consumer. Answer the following questions by
applying the Lagrange Method.
Maximize: U(X, Y) = 5X2Y
Subject to: 10X + 10Y=1000

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 A) Calculate MRSX,Y and interpret the result.
B) Calculate MRSY,X and interpret the result.
C) Calculate optimal choice of the consumer.
D) Calculate the maximum utility.
E) Calculate the budget share of each commodity at optimum.

20. The marketing department of Moha Soft Drink Company has confirmed that the price elasticity of demand
for Pepsi is estimated to be 1/4 . Should the company increase or decrease the price of this soft drink in
order to increase its sales revenue? Explain!
21. Consider a small coffee shop owning firm that mobilizes small funds of Birr 6000 to produce coffee drinks.
The firm is ready to employ workers with a wage rate of w= 100 Birr and purchase coffee machines with a
price of K = 200 Birr. Suppose this firm faces a production function given by Q = 20LK, where Q is cups of
Coffee produced, L is labour and K is Coffee machine. Then reply to the following questions,
A. Determine the marginal product function of labor (MPL) and machine/capital (MPK).

B. Find and .
C. How many workers (L) and machines (K) must be acquired for this small coffee shop to produce the
maximum possible number of cups of coffee?
D. How many cups of coffee will be produced at optimum?

22. Assume a wheat producing farmer engaged in selling its product under perfect competition market faces
cost functions as TC= Q3-3Q2+8Q + 2 and Average Revenue of the farmer is given as Birr 8. Having this
information,
A) Determine the profit maximizing levels of output and price in the short run.
B) Calculate the profit (loss) the farmer will obtain (incur) at equilibrium (1point).
C) Suppose the price level is fixed at p = birr 6 per unit. How much will be the profit or loss of the
firm? Should the farmer continue or stop production? Why?

23. Assume a wheat producing farmer engaging in selling its product under perfect competition market
faces cost functions as TC= Q 3-2Q2+8Q and Average revenue of the farmer is given as Birr 8 . Having
this information,
A. Determine the optimal level of output and price in the short run.
B. Calculate the economic profit (loss) the farmer will obtain (incur)
C. What will be the minimum price level the farmer gets to continue in wheat production?

24. Suppose that the price of commodity X and Y is given as Birr 1 and 2 per unit respectively and the
consumer’s income is Birr 200.
A. Write the budget line equation
B. What is the slope of the budget line.
C. If the government decides to impose an ad-valorem tax on good X of 1% and a quantity subsidy on
good Y of 50 cents, then write the formula for the new budget line.

25. Suppose that Ms. Bethlehem consumes only two commodities, say X and Y, and has the following Cob-
Douglas utility function
U = 9X1/3Y2/3
The market price of good X and Y are $6 and $24 respectively. The income Ms. Bethlehem is 900 $. Based
on the above information answers the following questions
a. Write down the budget equation
b. Calculate MRSxy

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 c. Find the optimal consumption of X and Y
d. Compute the maximum utility
e. Show the equilibrium condition graphically
f. Compute the income share of X and Y good
26. When the price of a DVD version of a new film is £12 per unit, 180,000 DVDs are demanded each
week. The manufacturer estimates that the price elasticity of demand is 1.4. If the price of the DVD were cut
by £3, how many DVDs would be demanded at the new price?
27. Sheri's demand function for apple is: Q=10-2P, where Q is the pounds of apples per week, and P is the
price per pound of apples.
A. If the price of apples is $3 per pound, what is Sheri's consumer surplus?
B. If the price goes down to $2 per pound, what is the change in consumer surplus?
C. Compute the price elasticity of demand at the price 3 and interpret your result?
E. Determine the total expenditure of the consumer both at price 2 and at price 3?

28. A household consumes only apples and bananas. We denote a consumption bundle consisting X bags of
apple and Y bags of bananas is denoted by (X, Y). The preference of the household is given by the utility
function U(X, Y) = X0.8Y0.2. If the income of the household is 20 $ and the price of apple (X) and banana
(Y) is 4 $ and 2, respectively, then
A) Write down the budget line equation
B) Calculate MRS
C) Find the optimal consumption of X and Y
D) Compute the maximum utility
E) Show the equilibrium condition graphically
F) Compute the income share of x and y good

29. The price of a SAMSUNG Galaxy decreased from from 15000 to 10,000. As a result, the quantity
demanded for iPhone declined from 30,000 units to 20,000 units.
A. Calculate the cross price elasticity of demand between the two goos (2pts)
B. Are they substitutes, complementary or unrelated goods? ( 1pt)

30. Suppose that Mr. John has the following Cobb-Douglas utility function: U = 9X 1/3y2/3. The market price of
X and Y commodity are $1 and $2, respectively. If Mr. John's total income is $90, then answer the
following questions:
A) Find the utility maximizing equilibrium quantity of X and Y commodities.
B) Show the equilibrium condition graphically.
λ
C) Calculate (Lagrange multiplier) and interpret.

31. Suppose demand for inkjet printers is estimated to be Q X = 1000 – 5PX + 10PY – 2PZ + 0.1M If own price
(PX) = 80, related prices, PY = 50, PZ = 150, and income, M = 20,000; answer the following:
A) Compute the price elasticity of demand for good X and give also economic interpretation
B) Compute the cross price elasticity X with respect to commodity and give also economic
interpretation
C) Compute income elasticity and give also economic interpretation

32. In a market there are 20 buyers of a leather bag each having identical demand function Qd = 10 - 2P
and 40 producers each with identical supply curve given by P= 4+Qs where Qd and Qs are quantity
demanded and supplied respectively.
A) Calculate the market equilibrium price and quantity
B) Calculate the price elasticity of supply at the market equilibrium
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 C) Calculate the price elasticity of demand at the market equilibrium
D) Compute the consumer and producer surplus at the equilibrium
E) What happens in the market if the price is 2 in the market?
F) Is there surplus or shortage at price 15 in the market?

33. Assume a production process in the short run that uses labor as variable input and a capital as fixed input.
Given the price of capital, rent = $ 500, and the price of labor, w=$10, fill in the following table.

Averag
Total e
Variable Product Product AV AT
Input (TP) (AP) MP FC VC TC AFC C C MC
0.00 0.00 XX XX XX XX XX XX
1.00 2.00 2.00 2.00
2.00 8.00 4.00 6.00
3.00 18.00 6.00 10.00
4.00 32.00 8.00 14.00
5.00 45.00 9.00 13.00
6.00 56.00 9.33 11.00
7.00 63.00 9.00 7.00
8.00 66.00 8.25 3.00
9.00 67.00 7.44 1.00

34. Assume Mr. X has $10 to spend on pizza, ice cream sundaes, or some combination of the two. Assume the
price of a slice of pizza (PP) is $2, and the price of ice cream sundae (PI) is $3. The total utility from
consuming various quantities of pizza and ice cream sundaes are given in the table below. Knowing that Mr.
X is a utility maximizer, fill out the table and use it to predict the quantities of slices of pizza and ice cream
sundaes Mr. X would purchase with $10.

Pizza Ice
Cream
0 0 XX XX 0 0 XX XX
1 16 1 21
2 28 2 39
3 36 3 48
4 40 4 54
5 42 5 57

35. A firm uses a single variable input x to produce outputs according to the production function f(x) = 300x -
5x2. This firm has fixed costs of $300. This firm's short run marginal cost curve lies below its short run
average variable cost curve for all positive values of x. True/False?
36. Explain the difference between Economies of Scale and Diseconomies of Scale.
37. A firm has the production function Q=L 0.5K. In the short run it must use exactly 20 units of capital. The
price of labor is $60 per unit and the price of capital is $2 per unit. Determine the firm's short run marginal
cost function.

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 P $ MC
ATC

$40 AVC
$35
S

$25 $25 P e  D f  MR  AR
$23
D
Q Q
100 175 250

38. Given the information in the above diagram, will the firm STAY OPEN or SHUT DOWN? Why?
39. Calculate Total Revenue, Total Cost and Profit at the breakeven point.

Use the diagram above to answer the next two questions.

40. In order to maximize profits, the firm will produce ______ units.
41. Calculate the firm’s profit (or loss) at equilibrium point; be sure to show your work and label your answer as
profit, loss, or break even.
42. Calculate the Total Revenue, Total Cost and Profit at the Breakeven point.
43. How much is the shut-down price?
44. Calculate TR, TC and Profit at the Shutdown point.
45. Drive the Supply curve graphically.

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