Managerial Economics - Midterm Study Guild

University of Lethbridge Econ 3030Y – Managerial Economics PRACTICE MIDTERM EXAMINATION

Fall 2012 Marks: 80 Time: 2 hours

The examination is out of 80 marks. You have 2 hours to complete it – please note the value of each section and plan your work accordingly. This is your opportunity to demonstrate your knowledge and understanding of the material. A premium will be placed on the clarity of the exposition.

Question 1 (10 marks) Copy the following table in your examination booklet, complete it, and answer the accompanying questions: (1 mark) Output (Q) 106 107 108 109 110 Total Revenue 2250 2390 2520 2640 2750 Marginal Revenue 150 Marginal Cost 100 110 120 130 140

a) At what level of output are the firm’s profits maximized? Please explain your answer (the explanation should include the definition of “marginal revenue” and “marginal cost”). (6 marks) b) When the firm produces 106 units of output, its total cost is $1,400. What is the firm’s profit for the level of output determined in part (a)? (3 marks)

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Econ 3030Y – Practice Midterm Examination – Fall 2012

Question 2 (10 marks) Rare-earth elements are used in iPods, Blackberries, high-fidelity speakers, MRI machines, night-vision goggles etc. The demand for these innovative products is expected to increase. China, the dominant supplier, is raising export taxes and lowering export quotas (the maximum amounts Chinese producers are allowed to export) to conserve rare-earth output for domestic requirements. Given this information and holding everything else constant, explain and graphically illustrate the impact of these factors on the North-American equilibrium price and quantity of rare-earth elements. You must clearly identify the initial equilibrium, the new equilibrium, and properly label both axes and all lines in your graph.

Question 3 (10 marks)

The Vancouver 2010 torchbearer red mittens sold by the Hudson’s Bay Company for $10 per pair are the must-have mementos of this year’s Olympics. Assume that the demand function for red mittens is:
D Qred mittens  1,100  10Pred mittens

a) Calculate and interpret the own-price elasticity of the demand for red mittens. (4 marks) b) Given the value calculated above, should the Hudson’s Bay Company have chosen a higher or a lower price for these mittens to maximize their revenues? (2 marks) c) What factors, other than their own price, could influence the own-price elasticity of the demand for red mittens? Please explain your answer. (4 marks)

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Econ 3030Y – Practice Midterm Examination – Fall 2012

Question 4 (10 marks) Jason purchases only Mountain Equipment Co-op (MEC) backpacks (B) and another good, Y. The price of a backpack is PB and the price of good Y is PY. The figure below shows his initial choice, (B1, Y1), on the indifference curve IC1. Now assume that he lost his membership card, without which he cannot purchase backpacks at his favourite store, so his optimal consumption bundle moves to point C, which is associated with a lower utility level (indifference curve IC 0). What is the maximum amount the store can charge him for a replacement card without losing him as a customer? Please explain your answer.

Question 5 (10 marks) a) Explain the difference between fixed costs, sunk costs, and variable costs. Provide a realistic example for each. (6 marks) b) Explain the concepts of “economies of scale” and “economies of scope”. (4 marks)

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Econ 3030Y – Practice Midterm Examination – Fall 2012

Question 6 (30 marks) A consumer must spend all his income, M, on two goods, X and Y (you might want to choose more realistic names for these goods, such as “plane tickets” and “food”). His utility function is U ( X , Y )  XY 3 . Marginal utilities: MU X  Y 3 and MUY  3 XY 2 . Note:

Y3 Y  . 2 3 XY 3X

The price of good X is p X and the price of good Y is pY . a) If X=1 and Y=12, calculate the marginal utility of good X. What does this number show? How many units of Y is this consumer willing to give up for an additional unit of X while holding his utility constant? (4 marks) b) This consumer chooses the amount of X and Y which maximizes his utility. What are the two conditions that must be satisfied for utility maximization? (4 marks) c) Prove that the demand function for good X is

M and the demand function for good Y is 4 pX

3M . What percentage of this consumer’s income is spent on good Y? (4 marks) 4 pY
d) Assume that M = $80, p X =$4, and pY =$4. What is the student’s optimal consumption bundle? Draw a diagram showing his available choices, his preferences over these choices, and his optimal consumption bundle. (4 marks) e) Use the numbers from part (d) and change the price of X to pX '  $2 . Determine the new optimal bundle and the new budget constraint and add them to your diagram. Show the income and substitution effects that this change in price has on the consumption of good X. What does the income effect show? (8 marks) f) Now assume that initially M = $80, p X =$4, and pY =$4. The consumer receives a $40 gift card which can only be used to purchase good X. Draw the diagram from part (d) again and add the new budget constraint. How many units of X and Y will the consumer choose to purchase? Would he have been better off with cash than with the gift card? Why? (6 marks)

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