1. Opportunity cost is the cost of forgone opportunities, while sunk cost is a past expenditure that cannot be recovered. Based on this conceptual distinction, fill the blank with “True” or “False”. (4 points)
a) If a firm buys a forklift for $10,000 and can resell it for the same price, it is not a sunk expenditure and the opportunity cost of the forklift is $10,000.
b) If instead the firm buys a specialized forklift for $10,000 and cannot resell it, then the original expenditure is a sunk cost.
c) If the specialized forklift that originally cost $10,000 can be resold for $4,000, then only $6,000 of the original expenditure is a sunk cost, and the opportunity cost is $4,000.
d) A sunk cost is not relevant to a firm’s decision on how much to produce.
2. Fill the blank with “True” or “False” (2 Points)
a. It is impossible to have diminishing marginal return to a single factor (e.g. labor) and constant returns to scale at the same time.
b. External cost leads to an efficiency loss to society, but external benefit does not.
3. Suppose a firm employs labor as its only variable input. All workers are paid $40 per day. Output per day and total variable cost are shown in the table below. Complete the table, showing the number of labor, average variable cost, and marginal cost for the first eight units of output. (6 points)
4. In 2005, the U.S. government passed a law mandating increased use of ethanol as a vehicle fuel. As most ethanol is made from corn, this mandate made corn farming more attractive. This question asks you to consider how the increased demand for corn affects corn farmers in the Midwestern United States. There are many farmers in this region, so that the market is perfectly competitive. (9 points)
a) Suppose that, before policies supporting corn-based ethanol were enacted, the corn market was in long-run equilibrium. Using two diagrams, one to represent the market for corn, and a second to represent the costs of a typical farm, illustrate the price, quantity, and profits of a typical farm in long-run equilibrium. Briefly explain why you have drawn the curves as you did.
b) Redraw your graph from part (a). Show how the corn market responds in the short-run after the new law increasing the use of ethanol passes. How does the market equilibrium and profits of a typical corn farmer change in the short run? Explain briefly.
c) Suppose that there is plenty of land available for farming in the Midwest. How will the market respond in the long run? Once again using separate diagrams for both the industry and a typical farm, illustrate the new long run equilibrium for the corn market. What happens to the market equilibrium price and quantity of corn in the long-run?
5. Briefly explain why a lot of countries subsidize education from an externality perspective. (3 points)
6. What is Coase theorem? (2 Points) And explain how the Coase theorem would apply to a meat packing plant and a spring water producer located downstream. (4 points)
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a. True. This is because sunk costs are those that cannot be recovered. In this case, the same amount can be regained if the forklift is sold and therefore, it has opportunity cost associated with it.
b. True. This is because the forklift has no resale value and the investment cannot be recovered through any means. Therefore, it is a sunk cost....
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