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Part I: Multiple Choice.

1. Which of the following is most likely to be a variable cost in the short run?
a) a fee paid to obtain a license.
b) the cost of owning machinery.
c) the energy costs of running a factory.
d) rent payments for office space.

2. If the average cost curve is downward sloping, then:
a) marginal cost is smaller than average cost.
b) the marginal cost curve is also downward sloping.
c) there are increasing marginal returns to labor.
d) wages and other input prices are falling.

3. The marginal rate of technical substitution of labor for capital measures:
a) the amount of capital that can replace a unit of labor without affecting the firm's output.
b) the additional output attributable to a 1% increase in labor and capital usage.
c) the rate at which the firm can exchange labor for capital in the input markets.
d) the slope of the firm's expansion path.

4. A firm is currently producing 200 units of output using 60 hours of labor and 80 hours of capital. The marginal product of labor is 12 units of output per hour, and the marginal product of capital is 15 units of output per hour. If the wage rate is $6 per hour and the rental rate of capital is $3 per hour, then:
a) the firm's use of labor and capital is cost-efficient.
b) the firm should use more labor and less capital.
c) the firm should use more capital and less labor.
d) we cannot determine if the firm's use of inputs is efficient without more information.

5. If the local government increases the cost of the annual liquor license required for a restaurant to serve alcohol, which of the restaurant's short-run cost curves will shift upward?
a) the average total cost curve
b) the average variable cost curve
c) the marginal cost curve
d) the average total cost and marginal cost curves will both shift upward
e) none of the above will shift upward.

6. The government authorized $12 million to build a new missile system. After $8 million were spent, serious flaws in the system were discovered. At that point, experts testified that the government must authorize another $10 million in funding to make the system operational, bringing the project's total cost to $22 million. The government should authorize the additional funding as long as the benefits from the completed missile system exceed:
a) $10 million
b) $12 million
c) $18 million
d) $20 million
e) $22 million

7. The demand curve faced by a competitive firm is:
a) perfectly elastic at the established market price.
b) downward sloping, with the same elasticity as the industry demand curve.
c) more inelastic than the demand curve faced by its competitors.
d) nonexistant.

8. In a perfectly competitive industry, the market price of the product is $12. Firm A is currently producing 300 units. The firm's marginal cost is $12, its fixed costs amount to $1000 and its average total cost equals $14. If this firm is to maximize its profits in the short run, it should:
a) maintain its current output.
b) reduce output.
c) expand output.
d) raise its price.
e) temporarily shut down.

9. Suppose all firms in an industry are identical. In the long run, entry and exit guarantee that all firms will have zero:
a) marginal cost.
b) average cost.
c) economic profit.
d) accounting profit.

10. The factor-price effect occurs when increases in the industry's output:
a) attract new firms to the industry.
b) raise the cost of a variable input.
c) cause new subindustries to be developed.
d) result in lower prices for consumers.

11. Assume dental care is provided by a competitive industry. A new government regulation requires each dentist to have a newly-developed ultrasound machine for sterilizing dental instruments. What happens to the price of dental care?
a) The price of dental care rises in the short run and rises further in the long run.
b) The regulation will cause higher prices in the short run, but it will have no long run impact.
c) There is no change in the short run, but dentists will exit and prices will rise in the long run.
d) The machine is a sunk cost, so the price of dental care does not change in either the short run or the long run.

12. Assume that at the current output level, a monopolist is earning positive economic profit, has a marginal revenue of $56, and a marginal cost of $64. Which of the following is an accurate conclusion with regard to the monopolist's profit?
a) the firm is producing the profit maximizing output.
b) the firm could increase its profit by decreasing its price.
c) the firm could increase its profit by increasing its output.
d) the firm could increase its profit by decreasing its output.
e) none of the above is correct.

13. When first-degree price discrimination is perfectly implemented:
a) social gain is maximized, with all gains going to the monopoly.
b) consumers' surplus and producer's surplus are both larger than in the case of simple monopoly.
c) the resulting deadweight loss is larger than if the monopoly did not price discriminate.
d) the consumers' and producer's gains from trade are identical to those in a competitive market.

14. Suppose a monopoly soft drink producer has constant average and marginal costs and faces a straight-line demand curve. An increase in the price of sugar causes a 10 cent per can increase in the monopoly's marginal cost. The price of the monpoly's soft drinks will:
a) remain unchanged.
b) rise, but by less than 10 cents per can.
c) rise by more than 10 cents per can.
d) rise by precisely 10 cents per can.

15. What price does a monopoly charge when it perfectly implements a two-part tariff?
a) the simple monopoly price.
b) the competitive price.
c) a price higher than that charged by a simple monopoly.
d) a price between the monopoly and competitive price.

Part II: Essay. You must answer all three.

16. Define diminishing marginal returns to labor. Define decreasing returns to scale. What do each of them imply about the firm's cost curves? How are they different?

17. Define price discrimination. What conditions must hold for a firm to be able to practice price discrimination? How are consumers affected by price discrimination?

18. According to the situation in question #2 above, what impact will the increase in the liquor license have on the firm's profit-maximizing price and output?

Part III: Analytical. You must answer both questions.

19. Consider the following demand and cost information.

P = 6000 - 25Q (Market Demand)

ATC = MC = $1000

a) Assuming this is a constant cost, competitive industry, calculate the long run equilibrium price and quantity. Illustrate the market situation with a graph.
b) Calculate the consumer surplus, producer surplus, and social gain. Show all work.
c) Assume that the industry becomes monopolized. What is the equation for MR? What is the profit-maximizing output and price? Illustrate this outcome on the above graph.
d) Calculate the consumer surplus, producer surplus, social gain, and deadweight loss. Show all work.

20. Assume that the domestic beer industry is an increasing cost industry currently in a long run equilibrium.
a) What is meant by a long run equilibrium?
b) Suppose society's demand for beer increases. Explain precisely what happens to the price and output of beer for a typical firm and for the industry as a whole in both the short run and long run. Illustrate your argument with the appropriate graphs.