MIDTERM EXAMINATION III

        Intermediate Microeconomics
        (ECON 520)

November 13, 1998       Professor D. Weisman

Instructions: There are two parts to this examination weighted 50 points each. Please 
write legibly and think carefully about your answers. You may find that graphical 
and/or mathematical analysis will assist you in answering some of these questions. 
Good Luck!

Part I.  Multiple Choice (50 points). Please indicate your answers on the 
standardized answer sheet provided.

1.      The function that indicates the maximum output per unit of time that a firm can 
produce for every combination of inputs is called 
a.      an indifference curve.
b.      a production possibility curve.
c.      a production function.
d.      an iso-cost function.

2.      Suppose a firm=s production function is given by Q = 2KL, where K is capital 
and L is labor. What is the marginal product of capital when 4 units of labor 
are employed. 
a.      2.
b.      4.
c.      6.
d.      8.
e.      None of the above.

3.      The law of diminishing returns assumes that
a.      there is at least one fixed input.
b.      all inputs are changed by the same percentage.
c.      additional inputs are added in smaller and smaller increments.
d.      all inputs are held constant.

4.      A production function in which the inputs are perfectly substitutable would 
have isoquants that are
a.      L-shaped.  
b.      convex to the origin.
c.      linear.
d.      characterized by a diminishing MRTS.
e.      (b) and (d). 

5.      A firm=s marginal product of labor is 10 and its marginal product of capital is 
5. If the firm adds one unit of capital, but does not want its output quantity to 
change, the firm should
a.      reduce its use of labor by 2 unit.
b.      reduce its use of labor by 5 units.
c.      maintain the same level of labor utilization.
d.      also increase capital by 1.5 units.

6.      Decreasing returns to scale in production means
a.      more than twice as much of all inputs is required to double output.
b.      less than twice as much of all inputs is required to double output.
c.      more than twice as much of only one input is required to double output.
d.      isoquants must be linear.

7.      A firm is operating in a range of production where the Law of Diminishing 
Returns has set in. The firm=s total product when 6 units of labor is employed 
is 20. The marginal product of the 7th unit of labor is 4. The firm=s total 
product when 5 units of labor is employed is
a.      less than 16.
b.      16.
c.      greater than 16. 
d.      24.
e.      b. or c. 

8.      The marginal product of labor in the production of computer chips is 50 chips 
per hour. The marginal rate of technical substitution of hours of labor for hours 
of machine capital is 1/4. What is the marginal product of capital?
a.      200.
b.      12.5.
c.      100.
d.      50.
e.      None of the above. 

9.      Which of the following statements is true regarding sunk costs?
a.      Sunk costs are avoidable costs. 
b.      Sunk costs cannot be recouped once they are incurred.
c.      Sunk costs are irrelevant for making forward-looking decisions. 
d.      All of the above.
e.      b. and c. 

10.     The joint operation of a lumber yard and a termite farm is likely to be 
characterized by
a.      economies of scale.
b.      diseconomies of scale. 
c.      economies of scope.
d.      diseconomies of scope.

11.     Assume that a firm=s production process is subject to decreasing returns to 
scale over a broad range of outputs. Long run average costs over this range of 
output will tend to 
a.      increase.
b.      decrease.
c.      remain constant.
d.      fall to a minimum and then rise. 

12.     A firm that produces using a typical production function finds that at current 
levels of input utilization it is producing the desired level of output and MPK/r 
> MPL/w. To minimize the cost of producing this level of output, the firm 
should
a.      increase capital utilization and decrease labor utilization.
b.      maintain current levels of capital and labor utilization.
c.      increase labor utilization and decrease capital utilization.
d.      increase both capital and labor utilization.
e.      none of the above.  

13.     The firm=s average fixed cost of production is 20 when 5 units of output are 
produced and its average variable cost of production is a constant and equal to 
6. The firm=s total cost of producing 10 units of output is 
a.      106.
b.      100.
c.      110.
d.      160.
e.      None of the above. 

14.     A firm=s production function is given by Q = 2K + L. Suppose the firm is in 
equilibrium and is observed to produce its output with positive quantities of 
both K and L. What set of input prices are possible?
a.      r = 2, w = 2.
b.      r = 4, w = 1.
c.      r = 2, L = 1.
d.      r = 2, w = 4.
e.      None of the above.      

15.     In the long run, which of the following is considered a variable cost?
a.      Expenditures for wages.
b.      Expenditures for research and development.
c.      Expenditures for raw materials.
d.      Expenditures for capital machinery and equipment.
e.      All of the above. 


Part II. Problems (50 points). Answer both questions. Each question is worth 25 
points. Show all of your work to receive partial credit. Please write legibly, be precise 
with your answers, and remember that economy of presentation is a desirable quality. 

1.      Let the firm=s production function be given by Q = 2KL, with MPk = 2L and 
MPL = 2K. Suppose that r = 2  and w = 8.

a) (8)  How much K and L is employed in the efficient production of 50 units of 
output?

b) (5)  What is the minimum cost of producing 50 units of output? 

c) (4)  Illustrate your results graphically with a representative isoquant map and iso-
cost curve.

d) (4)  Determine whether this production function reflects increasing, decreasing, or 
constant returns to scale. Are there diminishing, constant, or increasing returns 
to labor with this production function? Provide the economic analysis to 
support your conclusions. 

e) (4)  Using your answer in part d), provide a representative graph that illustrates the 
long-run average cost curve for this production function.

2.      A profit-maximizing firm must make a choice in time period 1 as to the type 
of technology it will use in time period 2 to produce its output. The firm can 
make an up-front (sunk) investment of I1 in time period 1 to operate with the 
following production function in time period 2: Q = 2K + L. Alternatively, the 
firm can make an up-front (sunk) investment of I2 in time period 1 to operate 
with the following production function in time period 2:  Q =    2 min {2K, L}. 
[Assume there are only 2 periods in this model.]

a) (8)          Suppose that r = $12 and w = $2. Derive the cost functions that prevail in 
time period 2 for each of the two production functions. 

b) (4)          What is the average and marginal cost associated with each cost function 
in part a)?

c) (7)          The firm forecasts in time period 1 that it will produce 100 units of output 
in time period 2. If the firm decides to make the investment I2 and produce 
using the production function  Q = 2 min {2K, L}, what must be the 
relationship between I1 and I2? Provide a precise economic rationale for 
your answer. 

d) (6)          Suppose that the conditions of part c) continue to hold and that I2 = 80. In 
time period 2 the bottom falls out of the market for the firm=s output. As a 
result, the market price for the firm=s output falls to $4.20 per unit. [Assume 
that the firm still anticipates a demand for its product of 100.] What 
recommendation would you make to the board of directors as to whether 
the firm can continue to operate profitably or should shut down its 
operations to minimize its losses? Provide a precise economic rationale for 
your answer.   

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