BMME5103/MAY2009-F/FA

PART A
INSTRUCTIONS: 1. THERE ARE FOUR (4) QUESTIONS IN THIS PART.
2. ANSWER ALL QUESTIONS.

Question 1

a. A firm has two plants, one in the United States and one in Mexico, and it cannot change
the size of the plants or the amount of capital equipment. The wage in Mexico is $5. The
wage in the U.S. is $20. Given current employment, the marginal product of the last
worker in Mexico is 100, and the marginal product of the last worker in the U.S. is 500.

i) Is the firm maximising output relative to its labour cost? Show proof.
[2 marks]

ii) If not, what should the firm do?

[2 marks]

b. A firm is making a long-run planning decision. It wants to decide on the optimal size of
plant and labour force. It is considering building a medium-sized plant and hiring 100
workers. Engineering estimates suggest that at those levels, the marginal product of
capital will be 100 and the marginal product of labour will be 75. If the wage rate is $5
and the rental rate on capital is $10, is the firm making the right decision? Support your
answer.
[3 marks]

[TOTAL: 7 MARKS]

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Question 2

a. When one automaker begins offering low cost financing or rebates, others tend to do the
same. Name TWO (2) oligopoly models that might offer an explanation to this
behaviour?
[2.5 marks]

b. Fast food restaurants tend to cluster together. That is, on one corner, there may be four
similar fast-food restaurants. Explain this phenomenon using a location game theory
model?
[2.5 marks]

[TOTAL: 5 MARKS]

Question 3

Pic Industries produces plastic toothpicks that it sells to distributors in the Southwest. During the
early 1990s, the price of the plastic it uses to produce toothpicks fell by 46 percent, due to a
local glut of recycled plastic containers. Assuming that the market for plastic toothpicks most
closely resembles that of perfect competition and that other firms in the industry do not
experience similar cost savings in the short run, what impact would this have on the profit-
maximising output, price, and profits of Pic Industries?

[TOTAL: 3 MARKS]

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Question 4

You are the general manager of TU modems Inc., and your accounting department has
provided you with the following information about the total cost of producing three potential
quantities of a commercial-grade modem:

100,000 Units 150,000 Units 200,000 Units

Materials RM 250,000 RM 375,000 RM 500,000
Depreciation 900,000 900,000 900,000
Labour 10,000 15,000 20,000
Total costs RM1,160,000 RM1,290,000 RM1,420,000

The market is saturated with modems, and your sales department has been able to identify only
one potential buyer of your modems. This customer has numerous alternative options and as a
result is only willing to pay RM300 per modem for an order of 100,000 modems. You must
decide whether to sign a contract under these terms or simply shut down your operations. What
is your optimal decision?
[TOTAL: 5 MARKS]

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 BMME5103/MAY2009-F/FA

PART B
INSTRUCTIONS: 1. THERE ARE FOUR (4) QUESTIONS IN THIS PART.
2. ANSWER THREE (3) QUESTIONS ONLY.

Question 1

Demand and supply in the wheat market are given by:

QD = 2000 - 1000 P and QS = -500 + 1000 P

Where Q is quantity in million bushels and P is price per bushel.

a. Find the equilibrium price and quantity.

[3 marks]

b. Suppose that the government wishes to support farm income and thus sets a price floor
of RM1.50/bushel, find the size of the farm surplus.
[4 marks]
c. What is the cost of this program to the government?
[3 marks]

[TOTAL: 10 MARKS]

Question 2

A monopolist’s Demand function is P = 1624 - 4Q and its Total Cost function is TC = 22,000 +
24Q -4Q2 + ⅓Q3, where Q is output produced and sold.

a. At what level of output and sales (Q) and price (P) will Total Profits be maximised?
[4 marks]

b. At what level of output and sales (Q) and price (P) will Total Revenue be maximised?
[3 marks]
c. At what price (P) should the monopolist shut down?
[3 marks]

[TOTAL: 10 MARKS]

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Question 3

According to a study of U.S. cigarette sales between 1955 and 1985, when the price of
cigarettes was 1% higher, consumption would be 0.4% lower in the short run and 0.75% lower
in the long run (Becker et al., 1994).

a. Calculate the short-and long-run price elasticities of the demand for cigarettes.
[4 marks]

b. Is demand more or less elastic in the long run than in the short run? Explain your
answer.
[3 marks]

c. If the government were to impose a tax that raised the price of cigarettes by 5 percent,
would total consumer expenditure on cigarettes rise or fall in the short run? What about
in the long run?
[3 marks]

[TOTAL: 10 MARKS]

Question 4

a. The Burrito Barn is considering a price reduction on the Firegut Burrito, which currently
sells at the price of RM5.00. Giuseppe, the proprietor of Burrito Barn, knows the price
elasticity for the Firegut is roughly equal to -2.3 over the range being considered for the
price change. The Firegut has been selling at the brisk pace of 500 burritos per week.
To increase market share, Giuseppe would like to increase sales to 750 per week. What
price should Giuseppe set?
[6 marks]

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b. Toyota reported that between 2002 and early 2004, the rise in U.S. steel prices raised
the price to produce its vehicles in North America by $100. Among the causes for the
increased price of steel was the growth of the Chinese economy. (“Steel-Price Rise
Crimps Profits, Adds Uncertainty,” Wall Street Journal, February 24, 2004, p. A1).

How can the Chinese economy affect the cost of production of Toyota vehicles in North
America? Use demand and supply to explain. How would the stockpiling of steel by steel
buyers affect the market?
[4 marks]

[TOTAL: 10 MARKS]

QUESTION PAPER ENDS HERE