AF1605 Introduction to EconomicsMake-up quiz (Last) 2017 Spring

Name: Student ID: Instructor: KC / Hong / Tina

Total marks: 75 Time allowed: 45 minutes

There are FIVE questions in this quiz and you have to answer ALL of them.

Q1.
Given that beef and pork are substitutes in consumption and beef and leather are
complements in production, what will happen to the equilibrium prices and quantities of beef
and leather if the price of pork increases? Briefly explain your answer with appropriate
diagrams. (15 marks)

Answer of Q1.

When the price of pork increases, the demand for beef increases. Therefore, both the
equilibrium price and quantity of beef will increase.
When the equilibrium quantity of beef increases, the supply for leather increases. Therefore, the
equilibrium price of leather drops and the equilibrium quantity of leather increases.
Correct diagrams.

Q2.
Peter has a problem of mice. There are 100 mice living in Peters bran per week and they
are eating the rice that Peter has stored in his bran. Even if Peter catches all the mice this
week, there will be another 100 mice next week. It is estimated that each mouse will
cause Peter a damage of $10 per week. The marginal cost of catching mouse per week
can be described by the following equation:
MC=0.125q, where q is the total number of mice caught per week.
Should Peter catch all the mice every week? If not, how many mice should Peter catch
per week? Briefly explain your answer. (15
marks)

Answer of Q2.
The marginal benefit (MB) of catching mouse is $10 per week.
The marginal cost (MC) of catching mouse is 0.125q.
To maximize benefit, Peter should catch mouse up to the quantity at which MC=MB.

$10=0.125q implies that q=80.

Therefore, Peter should not catch all the mice and he should only catch 80 mice per week.

Q3.
Peter grows apples in his small farm and he would like to maximize the profit of his
business. The marginal cost of producing apple per year can be described by the
following equation:
MC=0.005q, where q is the total number of apples produced per year.
 The apple market is a competitive market. Currently the market equilibrium price is $5
per apple and all the apple farms earn normal profits.

a. How many apples should Peter produce per year? Briefly explain your answer.
(5
marks)

b. Suppose that the Government imposes a license fee of $100 per year on the apple
farms. In order to grow apples, each farm needs to pay this license fee regardless of the
amount of apples produced. How will this new policy affect the amount of apples
produced by Peters farm in the short run? How will this new policy affect the market
equilibrium price and quantity of apples in the long run?
(10 marks)

Answer of Q3.
a.
The marginal revenue (MR) of producing apple is $5 per year.
The marginal cost (MC) of producing apple is 0.005q.
To maximize benefit, Peter should produce apple up to the quantity at which MC=MR=Price.
$5=0.005q implies that q=1000.

b.
The license fee is a fixed cost. Therefore, the MC is not affected by this new policy.
To maximize profit, Peter will continue to produce 1000 apples per year.

This new policy makes each apple farm to have loss.

Some farms will quit in the long run and hence the market supply will decrease.
The long run market equilibrium price will be higher and the equilibrium quantity will be
smaller.

Q4 (Page limit: HALF a page)

Suppose that the Hong Kong Government imposes a subsidy of $1 per bulb on energy-
saving bulbs and the Government pays the subsidies directly to the consumers. How will
this policy affect the equilibrium market price and quantity of energy-saving bulbs?
Briefly explain your answer with a demand-supply diagram. (15
marks)
Answer of Q4:
The cost of buying energy-saving bulb will decrease by $1 at each quantity.
The demand will increase.
Both the equilibrium price and quantity will increase.
Correct Diagram.

Q5.
The following items show the annual accounting cash flows of a firm.
Revenue from sale of goods: $5,000,000
Cost of raw materials: $2,000,000
Salaries: $1,000,000
Depreciation: $500,000

Suppose that the profit tax rate is 50% and the opportunity cost of owners time and capital is
$1,500,000. Over the year, the market value of the assets of this firm decreases by $1,000,000.
The owner does not receive any salary from his/her firm.

a. What is the accounting profit before taxes? Please show your calculation but explanation
is not required. (5 marks)
b. What is the economic profit after taxes? Please show your calculation but explanation is
not required. (10 marks)

Answer of Q5:
a. Accounting profit before taxes=$5,000,000-$2,000,000-$1,000,000-$500,000
=$1,500,000.
b. Economic profit=Sales cost of raw materials - salaries profit tax- the opportunity cost
of owners time and capital Economic depreciation.
= $5,000,000-$2,000,000 - $1,000,000 -$1,500,000*0.5-$1,500,000-$1,000,000
=-$1,250,000.