Midterm 2 Review Questions
Q1. The production function for Marty’s Frozen Yogurt is described in this table. Marty pays each of his
workers $80 per day. The cost of his other variable inputs is $0.50 per cup of yogurt. His fixed cost is $100 per
Quantity of labor (workers) Quantity of frozen yogurt (cups)
a. What is Marty’s variable cost and total cost when he produces 110 cups of yogurt?
b. For each of the given levels of output, calculate the average fixed cost (AFC), average variable cost (AVC),
and average total cost (ATC) per cup of frozen yogurt.
c. What principle explains why the AFC declines as output increases? What principle explains why the AVC
increases as output increases? Explain your answers.
d. How many cups of frozen yogurt are produced when average total cost is minimized?
e. What is the marginal cost of the 3rd cup?
f. What is the marginal product of the 1st worker? The second worker? The third worker? Why does marginal
product decline as the number of workers increases?
Q2. Kory has an income of $50, which she can spend on two goods: CDs and cups of hot chocolate. Both are
normal goods for her; each CD costs $10, and each cup of hot chocolate costs $2.
a. Draw her budget line (put CDs on the x-axis).
b. Kory is thinking about buying 4 CDs and 5 cups of hot chocolate. At that bundle, her marginal rate of
substitution of CDs in place of hot chocolate is 1; that is, she would be just willing to exchange 1 fewer cup of
hot chocolate for 1 more CD. Is this Kory’s optimal consumption bundle? If not, what should Kory do to achieve
her optimal consumption bundle?
c. Kory is thinking about buying 2 CDs and 15 cups of hot chocolate. Kory’s marginal utility of the second CD
is 25, and her marginal utility of the fifteenth cup of hot chocolate is 5. Is this Kory’s optimal consumption
bundle? If not, what should Kory do to achieve her optimal consumption bundle?
Q3. The above graph describes the market for corn. Suppose the government imposes a $4 unit tax.
a. Without the tax, what is the equilibrium quantity and price? Where is consumer and producer surplus?
b. With the tax, what is the equilibrium quantity? What is the price producers get? What is the price
c. Label the areas on the graph that correspond to consumer surplus, producer surplus, government
revenue and deadweight loss.
d. If instead the government imposes a price floor of $5, what is the quantity produced? What is the
a. At 110 cups, VC=80*1+0.5*110=135. Total cost=variable cost + fixed cost, or 135+100.
Q (labor) Q (output) VC FC TC AVC AFC ATC MC MP
0 0 - 100 100 - - - - -
1 110 135 100 235 135/110 100/110 235/110 135/110 110
2 200 260 100 360 260/200 100/200 360/200 125/90 90
3 270 375 100 475 375/270 100/270 475/270 115/70 70
4 300 470 100 570 470/300 100/300 570/300 95/30 30
c. AFC is decreasing because there are more units of output to spread the fixed cost over. AVC increases with
output because of diminishing returns to the variable input (ie, the last unit you produce requires more of the
d, 3 cups of yogurt
e. MC=change in total cost/change in output, or (475-360)/(270-200)
f. Marginal product decreases because of diminishing returns (the last worker you hire is less productive).
b. This is not optimal. The MRS of CDs for hot chocolate is 1, so her marginal utility from a CD is 1 and her
MU from hot chocolate is 1. The price of each CD is 10, so the marginal utility per dollar (MU/P) for the 4th
CD is 1/10. The marginal utility per dollar for the 5th hot chocolate is ½, so she can increase her total utility by
buying more hot chocolate (and fewer CDs).
c. This is the optimal bundle. The relative price of CDs to hot chocolate is 5, and the ratio of marginal utilities is
a. Q*=1000, P*=3
b. With tax, Q=800, consumers pay $5 but producers get $1.
d. If there is a price floor, 1200 units are supplied, but only 800 are demanded. This creates a surplus of 400.