Dr. Barry Haworth
University of Louisville
Department of Economics
Economics 301
Summer 2000

Exam #2

Your answers will be assessed in terms of both accuracy and completeness, but also upon your ability to clearly demonstrate that you understand the relevant concepts involved in each question. When math is needed to answer a question, you must show all relevant work to get full credit.

Section 1: Answer parts a-e of question #1 below
1. Gas stations operate in a perfectly competitive industry. The costs facing each station are given by (note: q = gallons of gasoline sold in one day)

Total Variable Costs = 0.001q2 - q
Sunk Costs = 5000
Recoverable Fixed Costs = 4000
Marginal Cost = 0.002q - 1

a. Describe how prices and output are determined in the perfectly competitive industry/firm model.

b. If the gas prices are $2, then what are the highest profits earned by each gas station?

c. Given your results in part b, this industry will change in the long run. Compare the changes that would occur if there are increasing returns to scale within the industry to those that would occur if there were decreasing returns to scale within the industry.

d. How do the characteristics of this industry lead to each firm charging the same long run market price and making zero profits?

Assume that crude oil is supplied within a perfectly competitive market.
e. Briefly discuss how US suppliers and consumers (refineries) in the crude oil market are affected by our country's being open to international trade.

Section 2: Answer any two of the following three questions
1. Assume that a small firm produces with both skilled and unskilled labor. Address the following situations (separately) using isoquant/isocost analysis.

a. Modest increases in the minimum wage are accompanied by tax breaks for small firms which lower the total cost of these firms. The tax breaks are designed to offset the increased cost of hiring unskilled labor.

b. The firm decides to provide training for its employees, and the training raises the productivity of both types of worker.

2. Assume that the market for rental housing is perfectly competitive with the following demand and supply information (math required on this problem, but a solid discussion here makes partial credit a possibility also):

Market Demand: QD = 1400 - 2P
Market Supply (SR): QSRS = 200 + P
Market Supply (LR): QLRS = -200 + 2P

(QD = quantity demanded in the market, QSRS = quantity supplied in the short run, QLRS = quantity supplied in the long run, P = price of rental housing)

a. How would a $200 price ceiling directly affect this market in the short run?

b. How would a $200 price ceiling affect consumer and producer surplus in this market (in the short run)?

c. How would this market react in the long run to the $200 price ceiling?

3. Firm A is perfectly competitive with the following (monthly) short run cost curves:

TC = (1/3)q3 - q2 + 10q + 100
MC = q2 - 2q + 10

(math is required on part a, but partial credit is possible for a good discussion)
a. If all of this firm's fixed costs are sunk, then how much output does the firm produce each month at their "shut down point"?

b. If this firm is required (by the government) to pay a $100 license fee each month, then discuss how consumer and producer surplus, and the firm's profit maximizing choice of output are affected.

c. Suppose the government decides to charge a $5 fee on every unit of output each month. Discuss how consumer and producer surplus, and the firm's profit maximizing choice of output are affected.