Key for midterm2 spring 2001.pdf
Economics 101 - Key for Midterm #2
April 18, 2001
Parts a, b, c and d are worth 6, 12, 7 and 8, respectively for a total of 33 points.
1a. The U.S. has a comparative advantage in the production of automobiles since it can produce
automobiles at a lower opportunity (foregoes 1/2 shirt for 1 automobile) cost than Indonesia
(foregoes 6 shirts for 1 automobile). Indonesia has a comparative advantage in the production of
shirts since it can produce shirts at a lower opportunity (foregoes 1/6 automobile for 1 shirt) cost
than the U.S. (foregoes 2 automobiles for 1 shirt).
1c. With automobile production being very capital-intensive and shirt production being very labor-
intensive, each automobile worker in the U.S. has more capital than each textile worker in
Indonesia. As a result, the marginal product of labor (productivity rates) for U.S. automobile
workers is higher than for Indonesian textile workers. The higher marginal product of labor in the
U.S. increases the demand for U.S. labor and drives wages up relative to Indonesia. (The reason
though that there are fewer U.S. automobile workers than Indonesian textile workers is not because
of less labor demand in the U.S. but because there is less labor supply).
1d. According to the Hecksher-Ohlin model, the demand for the labor-intensive good (shirts) will rise in
the heavily-populated country (Indonesia), while the demand for the capital-intensive good
(automobiles) will rise in the high capital country (the U.S.) after trade takes place. This increases
the demand for textile workers in Indonesia, but decreases the demand for textile workers in the
U.S. As a result, employment and wages in the Indonesian textile industry would increase, but
employment and wages in the U.S. textile industry would decrease.
Parts a, b, c and d are worth 8, 6, 11 and 8, respectively for a total of 33 points.
2a. At the market price is $2.00 per gallon, Starvin’ Marvin would produce 5 units of output to
maximize economic profits. Remember that a price-taking firm produces so long as
. At an output level of 5 units, then total revenue = price*quantity =
($2.00 per cup)*(5 units) = $10.00 and total cost = $11.00. Therefore, Starvin’ Marvin suffers an
2b. In the short-run
, the price-taking Starvin’ Marvin would produce 5 units of output since the total
revenue of $10.00 covers the variable cost of $6.00 (alternatively, the price of $2.00 per gallon is
greater than average variable cost of $1.20)
The Gasoline Market
Price ($ per gallon)
Gasoline (millions of gallons)
ATC, AVC, MC, price ($ per gallon)
gasoline (millions of gallons)
2d. In a long-run equilibrium
, the economic profit of the price-taking Starvin’ Marvin would be zero
due to exiting of incumbent firms. Moreover, Starvin’ Marvin would be producing at the bottom-
most point of the average total cost (ATC
) curve which means that per unit costs are minimized and
Parts a, b, c and d are worth 6, 9, 9 and 9, respectively for a total of 33 points.
3a. Here is the marginal revenue and marginal cost for the price-making Pfizer.
3b. The price-making Pfizer would produce 3 million units to maximize economic profits. Remember
that a price-making firm produces so long as MR
. At an output level of 3 million units, the
total revenue (TR
) = 7500 million, the total cost (TC
) = 6900 million and thus Pfizer earns an
3c. If the price- making Pfizer were to lose its patent on Zoloft®, then more firms would enter the
antidepressant market which would decrease the demand for Zoloft® (produced by Pfizer). This
would show up as a leftward shift of the downward sloping demand curve faced by the price-
making Pfizer. As a result, the total revenue, total cost and economic profit would all fall. The lose
of the patent by Pfizer would be good for consumers because the resulting competition lowers the
price and thus increases the consumer surplus.
3d. The fixed cost of producing Zoloft® is 5000 million. The granting of a patent encourages drug
companies to discover new drugs because it provides the possibility of a firm to cover its high fixed
costs. By granting a patent, the government shields the drug company from competition for a
certain time period and thus makes an economic profit more likely for the drug company. This
system benefits society in that more drugs which extend the quality and quantity of life are
discovered that, but the downside is that the new drugs are priced by monopolists. Remember that
all firms ranging from the gentle organic farmer to the “evil” drug company maximize profits, some
are simply more successful at doing it than others.
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