Essay-- show all work.

1. Assuming Peter enjoys guitars (G) and cigarettes (C).

a) Suppose his utility was given by U=20GC.Draw some indifference curves for Peter. (Place cigarettes on the horizontal axis for this and the following parts of the question)

(5 points)

b) Peter has $80,000 to spend on guitars and cigarettes. The price of guitars $4000 and the price of a crate of cigarettes is $200. Plot a budget line for Peter.

(5 points)

c) Using the conditions of optimality discussed in class (MRS = price ratio, and all income is spent), calculate the number of cigarettes and the number of guitars that Peter will consume.

(5 points) [Hint Marginal Utility of Cigarettes is 20G, and MU of Guitars is 20C]

2. Consider the following data on the production of records taken from Josy's Noisy Record Shop while she was operating in the short run. Josy knows that if she increased her labor force from 1 to 7 in increments of one, the numbers of records produced each day would be 8, 8, 17, 30, 40, 45, and 47 respectively. (5 points for each part)

a) If records sell for $20 each, how much money does the third worker add to Josy's revenues each day?

b) If workers will work for any wage above $190/day, would Josy be willing to hire the third worker? Would she be willing to hire the fourth?

c) Provide your best estimate in dollars of the cost to Josy of a worker calling in sick for a day and explain.

3. Suppose the demand for drinking water in a remote village near the Sahara is such that if the amount of water doubled, the market price of water would fall to one quarter the original price.Evaluate the following statement: high rainfall that doubles the annual amount of water would halve the total value of water, indicating a loss to consumers in the village (10 points).

4.

5 points each part

Suppose a firm must pay an annual franchise fee, which is a fixed sum, independent of

whether it produces any output. How does this tax affect the firm's fixed, marginal, and average costs?

Now suppose the firm is charged a tax that is proportional to the number of items it produces. Again, how does this tax affect the firm's fixed, marginal, and average costs?

5 points each part

6.

A computer company's cost function, which related its average cost of production (AC) to it cumulative output in thousands of computers (CQ) and its plant size in terms of thousands of computers produced per year (Q) is given by the following: AC = 10-.1(CQ) + .3(Q).

Is there a learning curve effect?

During its existence, the firm has produces a total of 50,000 computers and is producing 10,000 computers this year. Next year it plans to increase its production to 12,000 computers. Will its average cost of production increase or decrease? Explain.