# Mid Term Key

15 Problems*30 points each = 450 points

Score based on 400 points

Midterm

10/25/2012

Name:___________________________

1.

Zelda Manufacturing has a rather unique product that sells for $15 per unit, and the marginal cost is $7.50. Determine the Lerner index for Zelda Manufacturing. Does this index indicate market power? Using the SCP paradigm, what might the conduct of Zelda indicate about the structure of the industry?

The Lerner index is (P - MC)/P = (15 - 7.5)/15 = .50. Since the Lerner index is positive, there is evidence of market power. The ability to exercise Market power suggests that Zelda is participating in a market that is much closer to a monopoly than a perfectly competitive market.

2.

A manager derives satisfaction from income and leisure on the job (shirking).

a. If the manager is paid a fixed salary of $100,000, how much leisure will he or she consume on the job during an eight-hour day? Explain.

b. When the manager is given a salary of $100,000 plus 10 percent of the firm's profits, she or he chooses to spend six hours managing and two hours consuming leisure. Salary and bonus total $120,000. Does the manager necessarily prefer this situation to the situation in part a? a. He will consume the whole eight (8) hours as leisure because working (putting forth effort) causes dissatisfaction to the manager. Hence he will shirk if there is no punishment for doing so. b. The manager does prefer this situation to the situation in (a). There are two consumption bundles now: (1) $100,000 salary plus eight (8) hours of leisure a day, and (2) $120,000 salary plus two (2) hours of leisure a day. Since the original choice of 8 hours shirking and $100,000 is still available, the fact that she chose to work 2 hours reveals that she prefers the second pay scheme.

EconS452

Midterm

10/25/2012

3.

The total costs for Morris Industries are summarized in the following table. Based on this information, fill in the missing entries in the table for fixed cost, variable cost, average fixed cost, average variable cost, average total cost, and marginal cost.

4.

The demand function for VCRs has been estimated to be:

Qv = 134-1.07Pt +46Pm -2.1Pv -5M,

where Qv is the quantity of VCRs, Pt is the price of a videocassette, Pm is the price of a movie, Pv is the price of a VCR, and M is income. Based on this information, answer the following questions.

a. Are VCRs normal or inferior goods?

b. Are movies substitutes or complements for VCRs?

c. What additional information is needed to calculate the price elasticity of demand for VCRs?

a. Since the coefficient associated with income is negative, an increase in income leads to a reduction in demand for VCRs. Hence, VCRs are inferior goods. b. Movies are substitutes for VCRs, since the coefficient associated with the price of a movie is positive.

c. The actual values of prices and income are needed to calculate the price elasticity of demand for VCRs.

EconS452

Midterm

10/25/2012

5.

While at a discount shoe store, a customer asked a clerk, "I see that your shoes are ‘buy one, get one free - limit one free pair per customer.' Will you sell me one pair for half-price?" The clerk answered, "I can't do that." When the customer started to leave the store, the clerk hastily offered, "However, I am authorized to give you a 40 percent discount on any pair in the store." Assuming the consumer has $200 to spend on shoes (X) or all other goods (Y), and that shoes cost $100 per pair, answer the following questions:

a. Illustrate the consumer's opportunity set with the "buy one, get one free" deal and with a 40 percent discount.

b. Why was the 40 percent discount offered only after the consumer rejected the "buy one, get one free" deal and started to leave the store?

c. Why was the clerk willing to offer a "buy one, get one free" deal, but unwilling to sell a pair of shoes for half-price?

a. The straight line connecting points A and...

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