Question

T or F

______ 1. An inferior good can be demand inelastic but not demand elastic.

______ 2. Demand is elastic if price changes by a smaller percent than quantity demanded

______ 3. Total utility always decreases as marginal utility decreases.

______ 4. The law of diminishing marginal utility cannot be used to make interpersonal utility comparisons.

______ 5. If the demand for a product is highly elastic, a price drop may reduce incomes of the producers.

Short answer problems

1. Using the data below,

a. Calculate the elasticity of demand, and indicate whether demand is elastic, inelastic or unitary elastic at each price.

b. Verify the answer in (a.) by using the total revenue test.

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Price($)                        1.00   0.9   0.8    0.7   0.6   0.5 0.4

Quantity Demanded        300   400   500 600   700   800 900

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2. A consumer is choosing between two goods, X and Y, and his total utility from each is as shown below. The price of X is $2, and the price of Y is $1.

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Units of X              1       2     3    4      5    6

TUx                      16    28   36    42   47   51

MUx/Px                ___ ___ ___ ___ ___ ____

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Units of Y           1     2     3       4       5      6

TUy                    8    15    21     26     30     33

MUy/Py            ___ ____ ____ ____ ____ ____

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a. Complete the marginal utility per dollar column in the above table. If this consumer's income is

$7, What quantities of X and Y will he purchase to maximize his utility?

____________________________________________________________________________

How much total utility will he realize? ___________________________________________

b. Assume other things remaining unchanged, the price of X falls to $1, what quantities of X and

Y will he now purchase to stay in equilibrium?

______________________________________________________________________

c. Using the two prices and quantities for X, derive a demand schedule for X.

3. Assume the firm finds that its profit will be at maximum when it produces $40 worth of product A. Suppose also that each of the three techniques shown in the following table will produce the desired output.

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Resources       Price per unit of resources       Resource units required

                                                     Technique 1   Technique 2   Technique 3

Labor                        $2                                 5               2               3

Land                           4                                 2               4               2

Capital                        2                                 2               4               5

Entrepreneurial            2                                 4               2               4

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a. Which technique will the firm choose?__________ Why?_________

b. Will the production entail profits or losses?__________ Will the industry expand or

contract? When is a new equilibrium output achieved?

c. Suppose now that a shortage in labor supply causes the price of labor to rise

to $4, the other resources price being unchanged. which technique will the

producer now choose? Explain.

4. A firm's fixed cost is $100. The firm's total variable cost is indicated in the table. Complete the table.

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Output                      1        2        3           4          5       6

Total Variable Cost    200    360     500       700     1000    1800

Total Cost             ______ _____ _______ _____ ______ ______

Average total cost ______ _____ _______ _____ ______ ______

Marginal cost        ______ _____ _______ _____ ______ ______

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Is this firm in long run or short run? __________________

At which unit of output will this firm experiences diminishing returns ______________________

Answer 1

True/False

1. False

Inf3erior goods are those whose demand falls when income rises. They have a negative income effect. This shows that demand is elastic as it changes with the change in the customer’s income. Thus the answer is false.

2. True

Demand is elastic when a change in prices causes a big or small change in quantity.

3. False

When Marginal Utility gets negative, then total utility starts declining.

4. True

5. False

Elastic demand means that when price changes, then the quantity demanded also changes. The price drop will increase the quantity demanded and thus income of the producers will increase.