Correct Answer and Standards for 1997 Micro Free Response

1.   Grading Rubric for Microeconomics Question 1: 9 Points

Part (a): 4 Points

    Part (a) P = $5 Part (b) P = $6
Workers Output Revenue MRPL Revenue MRPL
3 60 300   360  
4 80 400 100 480 120
5 105 525 125 630 150
6 125 625 100 750 120
7 140 700 75 840 90
8 150 750 50 900 60

graph 1

OR

graph 2

Jones determines the number of workers by equating marginal revenue product to marginal factor cost. Jones will hire 7 workers.

1 point - supply curve horizontal at $75 (see either graph above).
1 point - for labor demand curve as in either graph above. The demand curve must have two correct wage/labor combinations. Simply having a downward sloping demand curve is not sufficient.
1 point - MRP = MFC.
1 point - 6 or 7 workers.

If the answer uses the total revenue-total variable cost approach to find the optimal number of workers, the answer must recognize that this difference is not economic profit. Costs in this problem do not include any fixed costs.

Part (b): 3 Points

The increase in the product price from $5 to $6 increases the marginal revenue product of labor thus shifting the demand curve for workers to the right. Given the increase in the wage to $120 per day, Jones will only hire 6 (or 5) workers with the new MRP curve. Jones will produce 125 (or 105) T-shirts.

1 point - for increase in the demand for labor.
1 point - for tying the increase in the demand for labor to the product price increase.
½ point - for correct number of workers.
½ point - for correct quantity of T-shirts produced.

Part (c): 2 Points

Jones operates under perfect competition. The problem says that he can sell as many T-shirts as he wants at the going price => MR = D = AR = P.

1 point - for perfect competition (simply saying competitive or competition without an explanation that indicates perfect competition is insufficient to receive credit).
1 point - for explanation. The assertion that Jones is a price taker (without further explanation) is not sufficient. If the answer goes on to explain that Jones does not control the product price or that Jones can sell any number of T-shirts at the market price, full credit is given.

2.   Grading Rubric for #2:  5 Points

Part (a): 3 Points

1 point - Correct natural monopoly graph.
½ point - Correct relationship between Demand and MR.
½ point - Correct price.
½ point - Correct quantity.
½ point - Correct economic profits.

NOTE: A correct natural monopoly graph has the following characteristics:

  1. ATC is falling in the relevant range of demand.
  2. MC is below the ATC in the relevant range.
  3. Answer must have the correct relationship between MC and ATC.

[If D=ATC occurs when ATC is rising, then no credit is given for the graph. An unexpected exception to this rule would be for an answer that explicitly states that there is insufficient demand for more than one firm to produce at minimum average cost]

Part (b): 1 Point

To achieve a price at which the firm will earn normal profits only, the government would attempt to set the price at the point where the market demand curve intersects the average total cost curve. If the government's objective were to have allocative efficiency, then price would be set at the point where the MC curve intersects the demand curve.

½ point for D = ATC = P.
½ point for D = MC = P.

Part (c): 1 Point

Since P < ATC, the firm will experience losses (negative profits) at the point where D = MC = P. So the firm will not continue in the long run without some form of adequate subsidization by the government.

Three ways to earn the 1 point

  1. Proper use of the natural monopoly case where P<ATC at P=MC;
  2. Student who has not previously used the natural monopoly explicitly states that a natural monopoly results in P<ATC when P=MC; or
  3. Produce in short run-- Student has used the classic monopoly case and has P>ATC where P=MC.

3.  Grading Rubric for #3:  5 Points

Part (a): 2 Points

We equate MR = MC= P to determine how much a firm will supply; the supply curve is the MC curve above the point where MC = AVC.

1 point - Equate MR=MC or P=MC.
1 point - MC curve above AVC curve (or shut-down price).

Part (b): 1 Point

The least cost combination of factors to produce a given level of output occurs where the ratio of marginal productivity to price is equal across factor inputs.

MPL/PL = MPK/PK ==> 1 point - Winner take all.

The statement that MRPL/PL = MRPK/PK does not receive credit.

[Although this statement defines a least-cost combination of labor and capital, it implies that knowledge of the output price is necessary to determine this combination of L and K.]

Part (c): 2 Points

An industry which produces a product that generates negative externalities operates at the point where marginal social costs are greater than marginal private costs. Regulators of the industry attempt to equate marginal social costs (MSC) to marginal private costs (MPC) by raising the marginal private costs (usually by taxation of the firms in the industry).

For 2 points:

  1. Observe that with a negative externality MSC>MPC. Thus, there is a need to regulate (e.g., per unit tax) to make marginal private cost equal marginal social cost so as to achieve the equality of MSB and MSC. or,
  2. Equate the MB of reducing pollution to the MC of reducing pollution.

[An answer that simply defines an externality as a situation where MSC>MPC earns 1 point. An answer that simply states the government should regulate until MSC=MSB earns 1 point.]