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These questions cover aspects of the "new" material that is relevant for the final exam. There's probably not much need to again explain how this page work. Remember that the sample questions for Exams #1-4 are still available. [The final, of course, is comprehensive.]
The firm's output can be sold for $4 a unit; it costs the firm $110 a day to hire a worker. This firm would maximize its profits by hiring _____ workers. [answer and explanation]
Question 1 answer is: c. MRP = marginal product (measured as units of output produced for each additional unit of input used) × price (of output). Explanation: The marginal revenue product measures the additional revenue brought into a firm as a result of using one more unit of a input. A input produces revenue through a two-stage process. First, the new unit of the input allows the firm to increase its production of output. Second, the firm can sell that output, and collect revenue as a result. The marginal revenue product that results from using a certain unit of a input is thus the product of two terms. The first term (which is called the "marginal product") is the increase in the number of physical units of output that arises from using that one unit of the input. The second term is the price at which the output can be sold. Multiplying these two terms produces a number which tells us how much additional revenue was brought in as a result of using that particular unit of the input. An example of how MRP is calculated follows. Suppose that using the 3rd unit of a input (hiring the third worker, for example, or buying a third machine) allows a firm to increase its production of output from 25 units to 35 units, an increase of 10 units. Suppose that each of those units of output can be sold for $5. In this case, using the 3rd unit of the input produced a revenue increase of $50 for the firm (10 new units of output that can be sold for $5 apiece means that revenue rises by 10 × $5 = $50). Note that the per-unit price of the input itself is not used when computing marginal revenue product. This is because MRP measures only the firm's benefit as a result of using a input -- and the benefit is the rise in the firm's revenue. The price of the input is irrelevant to this calculation. The place where the price of the input becomes important is when the firm decides how much of the input it is profitable to use. For this decision, the firm must compare the revenue that it will collect if it uses a particular unit of the input (the input's MRP) with the cost of obtaining that input (the input's price). If the MRP of the input exceeds its price, then using that input will raise the firm's profit. The question of whether or not the firm wishes to buy the input is, however, a different issue than simply computing the input's marginal revenue product; the input's Price is not used to compute its MRP.
Question 2 answer is: d. 4 Explanation: One way (probably the best way) to answer this question is to convert the information you are given into "marginal revenue" and "marginal cost" terms. In this particular question, you are given Total Output, and you want to convert that into Marginal Revenue Product (the gain in revenue that results from using another unit of the input). As described in the answer to the previous question, Marginal Revenue Product is found using a two-step procedure. First, find Marginal Product (the change in total output that results from using one more unit of the input). For example, when the firm hires a second worker, its output rises from 60 to 110. The Marginal Product of the second worker (the second unit of the input) thus equals 50. Then, multiply the Marginal Product by the price at which the output can be sold, in order to find the gain in revenue that results from using that unit of the input. For example, hiring a 2nd worker increases output by 50 units, which can be sold for $4 apiece, so hiring the second worker allows the firm to collect an additional $200 (= 50 × $4) in revenue. Conducting the same calculations for the other workers allows one to add two columns to the table.
One can now compare the change in revenue from using more of the input (this is what MRP measures) to the change in cost (which is $110). Hiring each of the first four workers increases the firm's revenue by more than so doing increases its cost. We therefore know that hiring the first worker increases the firm's profit, as does hiring the second, and the third, and the fourth. [Note that the rise in profit from hiring the fourth worker is smaller than the rise in profit from hiring the third worker (or the second or the first worker), but it is still a rise in profit since marginal revenue (MRP) exceeds marginal cost (input price).] However, if the firm hired a fifth worker, the firm would bring in only an additional $80 in revenue, and it would cost the firm $110 to hire the worker. Thus, hiring the 5th worker would reduce the firm's profit. The firm therefore maximizes its profit by hiring 4 workers.
Question 3 answer is: d. Knowing only that Margaret has increased her work hours isn't enough to tell us whether her hourly wage rose or fell. Explanation: Remember that when a worker's hourly wage rises, she experiences two (opposing) influences on her behavior. First, the higher hourly wage increases her reward for working an hour, and thus gives her a reason to increase the number of hours she works. [Put another way, choosing not to work an hour costs her more money (has a higher opportunity cost), so she feels an incentive to reduce the number of hours that she spends not working.] Second, the higher wage makes Margaret feel better off -- it raises her income. As a result, she has a reason to decrease the number of hours she works (her higher income means that she can now afford to increase the number of hours she devotes to doing other (more enjoyable) things rather than working). If Margaret's hourly wage rises, therefore, she might decide to work more hours, or to work fewer hours, or to keep her number of hours of work unchanged. We can't predict which of these three she'll choose. In a similar way, if Margaret's hourly wage were to fall, she might decide to work fewer hours (an hour of work is less rewarding), or to work more hours (she can't afford to take as much time off from her job), or to keep her number of hours of work unchanged. If we observe Margaret working more hours, it could be because she is a person who responds to a rise in her wage by increasing her labor supply. On the other hand, we could also observe Margaret working more hours because she is a person who responds to a fall in her wage by increasing her labor supply. Without more information about Margaret or her situation, we can't be sure which of these two possibilities is correct.
Question 4 answer is: a. adverse selection ; moral hazard Explanation: Both "adverse selection" and "moral hazard" are terms that refer to behaviors that are (among other things) associated with buying insurance. The difference between them is that adverse selection refers to questions about who chooses to participate in a certain transaction (for example, people deciding whether or not to buy insurance), while moral hazard refers to questions about how a person behaves (for example, what actions does a person take after buying insurance). The people who voluntarily choose to buy insurance may very well be those who believe that they are particularly likely to collect on the insurance. Relative to an average member of the population, therefore, those who buy insurance are those to whom the insurance company would be more likely to have to pay out money. From the company's point of view, therefore, this makes those who choose to buy an "adverse" (or bad) sample (as opposed to a random sample) of the total population. In this question, Andy believes that he's likely to live quite a long time; Bobbi believes that she's likely to die rather young. Buying insurance that pays you as long as you live (by the way, this type of "insurance" is insurance against living "too long" and therefore running out of money) thus looks like a good deal to Andy, but looks rather pointless to Bobbi. Since Andy (who's particularly likely to receive a lot of payments) wants to buy the insurance, while Bobbi doesn't, the insurance company's customers will be an adverse selection of the overall population. In contrast, the concept of "moral hazard" relates not to who buys insurance but rather to how a buyer behaves after the purchase. A person who is insured will bear less cost when something "bad" happens to him or her. As a result, the person is likely to take fewer precautions to prevent that "bad" thing from occurring. This change in behavior is an example of moral hazard. In this question, if Sam were uninsured and if the jewels were stolen, Sam would know that he or she would lose their full value. In order to reduce the likelihood of this major loss, Sam would most likely lock the jewels in the safe. When the jewels are insured, however, a jewel theft would cost Sam much less money (since the insurance company would pay Sam part (at least) of their value). Since the cost of a robbery is reduced, Sam takes fewer precautions to prevent it. This is an example of moral hazard. To repeat: adverse selection relates to who buys insurance, while moral hazard relates to how a person behaves after buying it.
Question 5 answer is: b. signaling ; less Explanation: When a person who possesses information wants to credibly communicate that information to another person, the informed party is said to wish to "signal" what he or she knows. When a person who does not possesses information wants to determine what another person knows, the uninformed party may wish to make the informed party choose among a number of different options -- knowing that the person's choice will depend on what he or she knows. The uninformed party can then figure out what the informed party knows by looking at his or choice. Such a method of determining information is called a "screening" system. In this case, it is the informed party (Person A) who wants to communicate that information to Person C; this is thus a situation in which "signaling" is relevant. The complication in situations like the one described here is that Person C would have little reason to believe a simple statement -- such as "I possess characteristic X" -- if it were made by Person A. Person C would have a good reason to be skeptical -- Person B is also capable of making such a statement (even though Person B doesn't really possess the characteristic). What Person A needs to find is some action ("actions speak louder than words") that only people who truly possess characteristic X would be willing to undertake. Because people are different, a given action may well be more "costly" for one person to undertake than it is for the other to do so. Person A needs some action that (even though it's costly to him) he's willing to take, but that a pretender like Person B wouldn't undertake. In this case, Person C can then believe that anybody who takes the action truly has the desirable characteristic. The action must be somewhat costly -- if it was very easy to undertake the action, Person B as well as Person A would do it, and Person C would learn nothing from observing. The action, however, should be less costly for somebody who truly possess characteristic X than it is for somebody who is just pretending to possess it. In fact, it should be so costly for "pretender" B that he chooses not to do it, but sufficiently less costly for Person A that he (while unhappy about having to bear the cost) is willing to do it (in order to credibly communicate with Person C). In class, the example of a costly action was to devote a year (or two) to studying for an MBA degree -- those truly committed to a career in business will be more likely to incur this cost than are those less committed. Other examples would include actions taken by a person to impress a potential "date" -- the point being that only somebody who is legitimately interested in a potential long-term relationship would be willing to incur certain costs.
Question 6 answer is: c. both candidates to support spending $80,000 Explanation: Given the assumptions spelled out in this question, this is a situation in which the Median-Voter Model applies. [A bit more explanation -- the Median-Voter Model applies because (i) based on their opinions, voters can be placed along a "one-dimensional spectrum," (ii) each voter prefers that the outcome be as close as possible to his or her own most-desired spending level, (iii) each voter will vote for the candidate whose platform puts the candidate closest to the voter's own most-desired level, and (iv) the goal of each candidate is to win the election.] In such a situation, a candidate always chooses his or her platform in order to attract the largest possible number of votes. Put another way, any candidate who can increase his or her vote total by changing his or her platform will do so. As will be explained below, the implication of this model is that each candidate will adopt the viewpoint of the median voter. The "median voter" is the voter whose views are such that half of the other voters are to his or her "left," and half of the other voters are to his or her "right." The quick way to answer this question, therefore, is to find the location of the median voter, and conclude that both candidates will adopt his or her viewpoint. When the 5000 voters in this town are put in order of desired spending level, the median voter will be the 2500th (or 2501st) in line. In this problem, voter #2500 supports spending $80,000. If both candidates are concerned only with winning the election, they will both also support spending $80,000. The explanation of the above conclusion hinges on the economic concept of an equilibrium. If only one candidate is proposing spending $80,000, the candidate who is proposing a different amount could increase his or her vote total by changing to a $80,000 platform. For example, if Candidate A's platform called for spending $80,000, while Candidate B's called for spending $100,000, Candidate A would get 2,750 votes (everybody who wanted to spend $80,000 or less), while Candidate B would get only 2,250 votes (everybody who wanted to spend $100,000 or more). If Candidate B instead proposed spending $80,000, A and B would split the votes, each getting 2500. Similar reasoning applies in any case where neither candidate is proposing $80,000 -- whichever candidate would lose the election can guarantee a win by switching to his or her platform to "spend $80,000." An equilibrium -- in which neither candidate has an incentive to alter his or her position -- can exist only if each candidate proposes spending $80,000. Incorrect answers (a) and (b) point out that what is important to the above story is the "location" of the median voter, not the median viewpoint, or the average viewpoint. In this example, there are 9 different desired levels of spending, and $100,000 is the one in the middle. However, the distribution of voters is such that voter #2500 (when voters are arranged by desired spending level) sopports spending $80,000. A candidate who supports spending $100,000, therefore, would lose to a candidate who supports spending $80,000. Since the candidates are interested in the number of votes they receive, it is the location of the median voter (not of the median viewpoint) that is important in the above story. The figure in answer (b) -- $94,000 -- is the "average" desired spending level (since $94,000 = (250 × $20,000) + (500 × $40,000) + ...), but again this number isn't important to the story told above. If the 200 people who favor spending $200,000 change their opinions and instead favor spending $400,000, the average desired spending level would change, but there is no reason to think that any votes would change. We therefore conclude that the average desired spending level doesn't affect the equilibrium political outcome (at least under the assumptions that we are using in this problem). |