Instructions: Answer all of the questions below. You may have a writing utensil(s) and a calculator, but all other items should be stored away and off of your table. If you have a question, raise your hand or come to the front. Once the exam has begun there are no bathroom breaks.
1. a. Give an example of an external cost. Explain why the cost is external to the market.
b. Draw a graph of a market illustrating an external cost. Mark the market output and price Qm and Pm. Mark the socially efficient output and price Qs and Ps.
c. Give an example of how this external cost could be eliminated so that the market output and price corresponded to the socially efficient output and price.
d. Explain why the market output and price is inefficient.
2. a. Draw a graph for the competitive market (Pe, MR, MC, ATC) that is earning a negative economic profit. Mark the profit-maximizing output Q*.
b. Explain how the market should adjust in the long run. Use a market supply and demand graph in your explanation.
c. If the equilibrium price = $40, ATC = $45 and AVC = $30 will the perfectly competitive firm shutdown in the short run? Explain why or why not.
d. Explain why profits are maximized at Q*.
3. a. Draw a graph of a monopoly (demand, MR, MC, ATC). Mark the profit-maximizing output Qm and the profit-maximizing price Pm. Shade the area representing profit.
b. Explain thoroughly why the monopoly output and price is inefficient.
c. Give an example of a barrier to entry that allows a monopoly to exist. Explain how this barrier limits competition.
4. a. Draw a graph of the marginal product of labor curve and the wage rate. Mark the profit-maximizing quantity of labor L*.
b. Explain why adding labor up to L* adds to profits, and why adding labor beyond L* reduces profit.
c. Explain why Marginal Product of labor declines as more labor is hired.
d. Explain two reasons for why wages are different between countries or industries.
5. What is the Optimal Consumption Rule? Explain why this rule must be satisfied for utility to be maximized.
6. Explain either the theory of Rational Ignorance or the Median Voter Theorem.