Review #2

Suggested Solutions

Section I: Multiple Choice

Indicate the best answer in the space provided to the right of each question.

1. After some level of output, marginal cost begins to rise because B (a) total costs always increase.

(b) marginal product eventually decreases.

(c) poorer quality inputs are hired as output expands.

(d) average variable costs eventually increase.

2. If an isoquant is given by Q = 5L + 4K, it implies thatA (a) the two inputs are perfect substitutes for each other.

(b) the MRTS is decreasing constant.

(c) that the inputs must be used in fixed proportions.

No, that’s Leontief production functions.

(d) none of the above

3. Suppose a firm’s production technology is Leontief. If the ratio of the price of C labor to the price of capital decreases by 10%, how does the ratio of the cost-minimizing amount of capital and labor change?

(a) The ratio will increase, due to higher capital.

(b) The ratio will increase, due to lower labor.

(c) The ratio will not change.

(d) The ratio will decrease.

4. Mr. Larson’s production function is 0.1J½L¾ , where J is number of old jokes D used and L is the number of hours of cartoonists’ labor. Suppose Gary can vary both jokes and cartoonists labor. If old jokes cost $2 each and cartoonists’ labor costs $18 per hour, then the cheapest way to produce comic books requires using old jokes and labor in the ratio J/L = ? (a) 12

(b) 3

(c) 2/3

(d) 6

Use MRTS = w/r which is MPL/MPK = w/r

5. Increasing returns to scale imply average costs are B (a) constant.

(b) falling.

(c) increasing.

(d) negative.

6. The equilibrium for a consumer involves a tangency between the indifference C curve and a budget line, and the equilibrium for a firm involves a tangency between an isoquant and an isocost line. The two equilibria differ in that (a) indifference curves are convex and isoquants are concave. also convex (b) the slope of the budget line is a ratio of prices while the slope of the isocost line is determined by the ratio of marginal products. also a ratio of prices: price of labor/price of capital (c) the consumer is constrained by a budget line while the firm is not constrained to a specific isocost line. (d) the consumer is not constrained by an indifference curve while the firm can produce on any isoquant.

7. The production function Q = 0.2L0.4K0.5, exhibits C (a) decreasing returns to scale and has diminishing marginal returns to one input only. (b) increasing returns to scale and has diminishing marginal returns to one input only. (c) decreasing returns to scale and has diminishing marginal returns to both inputs. (d) increasing returns to scale and has diminishing marginal returns to both inputs. If the sum of exponents in a Cobb-Douglas production function is > 1, that implies increasing returns to scale, = 1 implies constant returns to scale, and < 1 implies decreasing returns to scale. The exponent on each input indicates diminishing marginal returns to that input if the exponent is < 1.

8. Which of the following is incorrect? C

(a) Homogeneity of degree 1 in a Cobb-Douglas production function implies constant returns to scale. (b) Homothetic production functions imply linear output expansion paths. (c) Fixed-proportion (Leontief) production functions exhibit increasing constant returns to scale. (d) All of the above are correct.

9. An individual who unfortunately only lives for two periods has decided to borrow A $1000 in period 1, given his endowment and the interest rate. If the interest rate increases, then he will

(a) borrow less than $1,000.

(b) still borrow $1,000.

(c) borrow more than $1,000.

(d) borrow more or less depending upon whether or not the substitution effect is greater than the income effect.

C2

B

C1

U1

N

A

A’

B’

If the individual borrows money in year 1, then their optimal...