Practice problem set 3

Managerial Economics
PGP – 1: Term 1, Section A, 2019-2020

Scenario 5.4:
Suppose an individual is considering an investment in which there are exactly three possible
outcomes, whose probabilities and pay-offs are given below:

Outcome Probability Pay-offs

A .3 $100
B ? 50
C .2 ?

The expected value of the investment is $25. Although all the information is correct,
information is missing.

1) Refer to Scenario 5.4. What is the probability of outcome B?

A) 0
B) -0.5
C) 0.5
D) 0.4
E) 0.2

2) Refer to Scenario 5.4. What is the pay-off of outcome C?

A) -150
B) 0
C) 25
D) 100
E) 150

3) Other things equal, expected income can be used as a direct measure of well-being
A) always.
B) no matter what a person's preference to risk.
C) if and only if individuals are not risk-loving.
D) if and only if individuals are risk averse.
E) if and only if individuals are risk neutral.

4) An individual with a constant marginal utility of income will be

A) risk averse.
B) risk neutral.
C) risk loving.
D) insufficient information for a decision

5) A farmer uses L units of labor and K units of capital to produce Q units of corn using a
production function F(K,L). A production plan that uses K' = L' = 10 to produce Q' units of
corn where
Q' < F(10, 10) is said to be
A) technically feasible and efficient.

1
B) technically unfeasible and efficient.
C) technically feasible and inefficient.
D) technically unfeasible and inefficient.
E) none of the above

6) Which of the following equations based on capital (K) and labor (L) inputs does not
represent a plausible production function?
A) F(K,L) = 3KL
B) F(K,L) = 3K
C) F(K,L) = K + L - 1
D) F(K,L) = 10(KL)0.5

Figure 6.1

7) Refer to Figure 6.1. At point A, the marginal product of labor is

A) rising.
B) at its minimum.
C) at its maximum.
D) diminishing.

8) Refer to Figure 6.1. At which point on the total product curve is the average product of
labor the highest?
A) point A.
B) point B.
C) point C.
D) point D.
E) none of the above

9) Refer to Figure 6.1. Which of the following statements is false?

A) At point E the marginal product of labor is decreasing.
B) At point E the marginal product of labor is negative.
C) At point E the average product of labor is decreasing.
D) At point E the average product of labor is negative.
E) At point E the marginal product of labor is less than the average product of labor.

10) Refer to Figure 6.1. At point C

A) the marginal product of labor is greater than the average product of labor.
B) the average product of labor is greater than the marginal product of labor.

2
C) the marginal product of labor and the average product of labor are equal.
D) the marginal product of labor and the average product of labor are both increasing.
E) Both B and D are correct.

11) A firm uses two factors of production. Irrespective of how much of each factor is used,
both factors always have positive marginal products which imply that
A) isoquants are relevant only in the long run
B) isoquants have negative slope
C) isoquants are convex
D) isoquants can become vertical or horizontal
E) none of the above

12) An upward sloping isoquant

A) can be derived from a production function with one input
B) can be derived from a production function that uses more than one input where reductions
in the use of any input always reduces output
C) cannot be derived from a production function when a firm is assumed to maximize profits
D) can be derived whenever one input to production is available at zero cost to the firm
E) none of the above

Figure 6.2

13) Refer to Figure 6.2. The situation pictured is one of

A) constant returns to scale, because the line through the origin is linear.
B) decreasing returns to scale, because the isoquants are convex.
C) decreasing returns to scale, because doubling inputs results in less than double the amount
of output.
D) increasing returns to scale, because the isoquants are convex.
E) increasing returns to scale, because doubling inputs results in more than double the
amount of output.

14) The situation pictured in Figure 6.2

A) is one of increasing marginal returns to labor.
B) is one of increasing marginal returns to capital.

3
C) is consistent with diminishing marginal product.
D) contradicts the law of diminishing marginal product.
E) shows decreasing returns to scale.

15) A farmer uses M units of machinery and L hours of labor to produce C tons of corn, with
the following production function C = L0.5M0.75. This production function exhibits
A) decreasing returns to scale for all output levels
B) constant returns to scale for all output levels
C) increasing returns to scale for all output levels
D) no clear pattern of returns to scale

Short answer questions:

16) Leann's Telecommunication firm production function is given by y(K, L) = 200 ,

where K is the number of internet servers and L is the number of labor hours she uses. Does
this production function exhibit increasing, constant or decreasing returns to scale? Holding
the number of internet servers constant at 8, is the marginal product of labor increasing,
constant or decreasing as more labor is used?

17) Describe Larry, Judy and Carol's risk preferences. Their utility as a function of income is
given as follows

Larry: UL(I) = 10 .
Judy: UJ (I) = 3I2.
Carol: UC (I) = 20I.

18) Sam's utility of wealth function is U(w) = 15 . Sam owns and operates a farm. He is
concerned that a flood may wipe out his crops. If there is no flood, Sam's wealth is $360,000.
The probability of a flood is 1/15. If a flood does occur, Sam's wealth will fall to $160,000.
Calculate the premium Sam is willing to pay for flood insurance.

19) Ronald's Outboard Motor Manufacturing plant production function is y(K, L) = 25 .

Ronald is investigating a new outboard motor manufacturing technique. Ronald believes that
if he adopts the new technique, his production function for outboard motors will become:
y(K, L) = 36 . Given that Ronald uses 4 units of machine hours, sketch his production
function with the old technique and the new technique as he increases labor hours. With the
new technique, do labor hours contribute more to production?

20) Sarah's Pretzel Plant produces pretzels according to the function y(K, L) = 100 . K
is the number of ovens, and L is the number of labor hours Sarah uses to produce her pretzels.
At the moment, Sarah uses 9 ovens. Also, she plans to hire 64 labor hours. Sarah can sell
each unit of pretzels produced for $3.50. Fill in the table below. If Sarah increased her use
of labor hours to 65, would the value of the marginal product of labor exceed the wage rate of
$8.50?

4
 y(9, L) L MPL = $3.50 ∗ MPL

64
65