S. Klepper, Economics 73-100, Fall 2007

Exam II

There are a total of three major questions, each weighted according to the points listed to the left of the question. These are the points apportioned to each question. They sum to 100

Each of the major questions has a series of subsidiary questions. Each of these subsidiary questions is a true-false question. To answer the question, indicate in your exam booklet whether the answer is true or false and provide a brief explanation for your answer. Correct answers with insufficient explanations will get no points. When you finish, hand in only your exam booklet.

The exam is open-book and open-notes. If you have any questions at all, then ask the proctor to help you. Do not introduce any assumptions (beyond those introduced in class) without consulting the proctor.

[35] 1. Consider the fourth experiment conducted in class concerning production. Suppose that an innovation were developed that reduced the total amount of labor required to produce each level of output by the same percentage. Assume that the price of labor remained at $1 per unit in rounds 1-3 and $10 per unit in rounds 4-6 and that it continued to cost $20 to play each round of the experiment regardless of the level of output produced in the round.

Which of the following correctly describe the effects of the innovation on the costs and profit-maximizing choices of producers, where all comparisons pertain to the situation after the innovation versus before the innovation? Mark true for correct statements and false for incorrect ones.

_____1. In each round, the innovation caused the marginal cost of production at every level of output to fall by the same percentage as the decrease in labor required to produce each level of output.

_____2. In each round, the innovation caused the average total cost of production at every level of output to fall by the same percentage as the decrease in labor required to produce each level of output.

_____3. If the price of output was unchanged in each round and the innovation reduced the amount of labor required to produce each level of output by at least 20%, producers would not have shut down in any round after the innovation.

_____4. If the price of output was unchanged in each round and the innovation reduced the amount of labor required to produce each level of output by at least 20%, in some rounds producers would have produced a larger level of output than before the innovation.

_____5. If the price of output was unchanged in each round, then in rounds in which producers produced a positive level of output before the innovation, they would earn greater profits after the innovation.

_____6. If the price of output declined in each round by the same percentage as the decrease in labor required to produce each level of output, then producers would have supplied the same level of output in each round as before the innovation.

_____7. If the price of output declined in each round by the same percentage as the decrease in labor required to produce each level of output, then producers would have earned the same profits in each round as before the innovation.

[27] 2. Consider the way movies are distributed. Theaters commit to accept all the movies produced by a particular company before they know how popular the movies will be. They must pay a fixed distribution fee for each movie that they receive from the  production company, and then must decide whether to show the movie. If they decide to show a movie, they incur the costs of projecting it. This is their only cost, and it is independent of the number of people that view the movie. Theaters set their own ticket price for each movie based on demand for the movie. 

Assuming theaters set a price for each movie that maximizes their profits, which of the following statements correctly describe this situation?

_____8. The theater should set a ticket price for each movie that just sells out the theater—i.e., at the chosen price the quantity demanded should equal the capacity of the theater.

_____9. If the maximum revenues the theater could get from showing a movie were less than the distribution fee they pay for the movie, then the theater would be better off not showing the movie.

_____10. If the price of tickets for a movie were such that the quantity demanded exceeded the capacity of the theater, the theater could not be maximizing its profits.

_____11. If the price of tickets for a movie were such that the theater did not sell out and the price elasticity of demand was greater than one, then the theater could not be maximizing its profits.

_____12. If the price of tickets for a movie were such that the income elasticity of demand was greater than one then the theater could increase its profits by lowering the ticket price for movies.

_____13. If the price of tickets for a movie were such that the price elasticity of demand were less than one, then the theater could not be maximizing its profits.

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[38] 3. Congress is considering two alternative plans to help U.S. steel producers compete with steel producers in other countries. In one plan, it would provide a subsidy to U.S. steel firms based on their average output over the prior five years. Each firm would receive an annual payment, where the magnitude of the payment would be based on the firm’s average steel production over the past five years. All firms would receive the payment, even if they were temporarily shut down (but still owned a steel plant and incurred the fixed costs of production). In the other plan, each firm would receive an annual payment equal to some percentage of its labor payroll in the next year. Under this plan, the greater a firm’s expenditure on labor during the next year then the greater the payment it would receive, and if it did not hire any labor then it would receive no subsidy.

Assume that in the next year the only input that steel firms could vary is labor and that the price of steel is the same as in prior years. Which of the following correctly describe the effect of the two subsidy plans in the next year? Mark true for correct statements and false for incorrect ones.

_____14. If the subsidies were large enough in both plans, under both plans some steel producers that were shut down last year would start producing again next year.

_____15. Both subsidy plans would cause the average total cost of production at every level of output to be lower next year than last year.

_____16. Both plans would cause the short-run market supply curve of steel to shift to the right next year relative to last year.

_____17. For steel producers that produced a positive level of output last year, both plans would cause steel producers to produce a greater level of output next year.

_____18. Both subsidy plans would enable steel producers that had temporarily shut down last year to increase their profits next year.

_____19. Both subsidy plans would enable steel producers that produced a positive output last year to increase their profits next year.

_____20. For steel producers that produced a positive level of output last year, under both subsidy plans the marginal cost of the marginal unit of output would be the same next year as last year.