Write all answers in your blue book and show all work there. Return your exam in
your blue book.
1) a) Use a well-labeled indifference curve diagram to derive a compensated demand
b) If the good is highly inferior, will that affect your demand curve in part a?
c) Can you tell from your indifference curve diagram if your good is inferior or
d) Show the substitution effect in your diagram.
Suppose that the total product curve looks like this.
Draw a well-labeled diagram of the MPL curve and the SRMC curve and the SRTC curve.
2) a) Suppose that Able paid $100,000 for the machinery used in his business. But
now demand is down and profit based on the $100,000 cost is unsatisfactory. Should
Able necessarily sell the assets and quit the business? Explain.
b) Suppose that Baker was renting his machinery for $100,000 a year, but now the
rent has been increased to $200,000 a year. Will the price of Baker's product increase
to cover this additional cost in the short run? Explain. Will the price of Baker's
product increase to cover this additional cost in the long run? Explain.
3) Suppose the isoquant map looks like this.
Draw a well-labeled diagram of the LRAC curve and the LRMC curve. What kind of returns to scale do we have here? Why?
5) Suppose that demand increases in a perfectly competitive increasing cost industry.
Use a well-labeled two-frame diagram to show the effect on
a) price in the short run.
b) price in the long run.
c) average cost of the typical firm.
I have neither given nor received unfair aid on this test.