ECON 002 - Principles of Microeconomics Drake University, Spring 2013 William M. Boal Course page: www.cbpa.drake.edu/econ/boal/002 Blackboard: bb.drake.edu william.boal@drake.edu

FINAL EXAM ANSWER KEY

### Version A

I. Multiple choice

(1)c. (2)b. (3)a. (4)b. (5)e. (6)d. (7)d. (8)b. (9)a. (10)a.
(11)b. (12)a. (13)a. (14)b. (15)b. (16)a. (17)a. (18)b. (19)a. (20)a.
(21)b. (22)e. (23)b. (24)b. (25)a. (26)b. (27)c. (28)c.

II. Problems

(1) [Comparative addvantage, gains from trade: 17 pts]

1. 1 bushel of tomatoes.
2. 1/2 bushel of tomatoes.
3. 1 bushel of zucchini.
4. 2 bushels of zucchini.
5. Ken.
6. Jennifer.
7. Both people can consume combinations of zucchini and tomatoes outside their individual production possibility curves if Ken gives three bushels of zucchini to Jennifer, who gives 2 bushels of tomatoes in return.
8. Plot should show each person's production before trade, and consumption after trade.

(2) [Market equilibrium: 12 pts]

1. excess supply.
2. \$5.
3. 4 units.
4. \$20.
5. \$26.
6. buyers.

(3) [Calculating elastities: 2 pts] -2/3.

(4) [Using price elasticity of demand: 10 pts]

1. inelastic.
2. increase.
3. 25 percent.
4. increase.
5. 10 percent.

(5) [Arbitrage: 12 pts] Arbitrageurs will buy in the low-priced city, shifting its demand curve to the right. Then they will sell in the high-priced city, shifting its supply curve to the right by exactly the same amount. If there are no costs of arbitrage, curves will continue to shift until the final prices are identical in the two cities.

1. unchanged.
2. right.
3. right.
4. unchanged.
5. \$7.
6. \$7.

(6) [Welfare analysis of price controls or quotas: 18 pts]

1. \$5.
2. \$9.
3. increase.
4. \$120 thousand.
5. decrease.
6. \$240 thousand.
7. \$120 thousand.
8. \$6.
9. \$240 thousand.

(7) [Consumer choice and demand: 16 pts]

1. 6 units of food and 6 units of other goods.
2. 7 units of food and 7 units of other goods.
3. Budget line A has an intercept on the "other goods" axis at 10, and an intercept on the "food" axis at 15.
4. 6 units of food.
5. Budget line B has an intercept on the "other goods" axis at 10, and an intercept on the "food" axis at 5.
6. 3 units of food.
7. (Q,P) = (6,\$2), (3,\$6).

(8) [Basic definition: 18 pts]

1. Total cost.
2. Marginal revenue.
3. Marginal revenue.
4. Average cost.
5. Marginal cost.
6. Marginal cost.

(9) [Discounting: 4 pts]

1. \$336.
2. \$240 million.

(10) [Economy-wide efficiency: 20 pts]

1. 1/4 units of clothing.
2. 4 units of food.
3. \$12, because in competitive equilibrium, price equals marginal cost.
4. \$3, because in competitive equilibrium, prices reflect the slope of the production possibility curve for the economy as a whole: if the opportunity cost of a unit of clothing is 4 units of food, then a unit of clothing must be 4 times as expensive as a unit of food.
5. \$3, because in competitive equilibrium, price equals marginal cost.
6. Brian's budget line should have intercept at 20 on food axis, and intercept at 5 on clothing axis.
7. -4.
8. 4 units of food.
9. 1/4 units of clothing.
10. 4, because Brian's preferred bundle is at a tangency between his budget line and the highest indifference curve he can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(11) [Competition versus collusion: 16 pts]

1. 14 thousand.
2. \$6.
3. \$6, because height of supply curve = marginal cost.
4. MR curve should have intercept at \$13 on price axis, and slope = -1/1 thousand.
5. 8 thousand, where MR=MC.
6. \$5, from joint marginal cost curve.
7. \$9, on demand curve.
8. \$12 thousand.

(12) [Externalities: 12 pts]

1. \$5, at intersection of demand and supply.
2. 6 million, at intersection of demand and supply.
3. 9 million, at intersection of marginal social benefit and supply.
4. \$12 million, the area of the triangle between marginal social benefit, supply and a vertical line at 6 million vaccinations.
5. Subsidy, to increase the quantity to the social optimum.
6. \$5 per vaccination, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(13) [Nonrival goods: 4 pts]

1. MSB = 1000 (40 - 4 Q) = 40,000 - 4000 Q.
2. 5 miles (found by setting MSB = MC and solving for Q).

(14) [Regulating pollution: 20 pts]

1. Factories A and B.
2. \$7 thousand.
3. Factories C, D, E, F, G.
4. \$6 thousand.
5. \$7 thousand.
6. Factories C, D, E, F, G.
7. \$6 thousand.
8. \$7 thousand.
9. \$6 thousand.
10. \$7 thousand.

III. Critical thinking

(1) One should disagree with this statement. If producers set prices cooperatively, as in a cartel, then producers benefit. However, consumers lose more than producers gain. The cartel would set prices above the competitive level (that is, above marginal cost) to a level similar to the monopoly price. Some consumers willing to pay the marginal cost will not be served and deadweight loss would therefore result. Society would be worse off, not better off, if producers set prices cooperatively. (Full credit requires a supply-and demand graph showing the welfare loss from price rising above the competitive level.)

(2) You should not switch to Vendor B's system. You should stay with Vendor A's system. The \$100,000 you paid to install Vendor A's system is a sunk cost because the money cannot be recovered. It must be paid whether or not you switch. So you should compare the other costs. Excluding sunk costs, Vendor A's system will cost only \$50,000, which is less than the \$75,000 total you must pay for Vendor B's system. Therefore you should stay with Vendor A's system.

### Version B

I. Multiple choice

(1)b. (2)a. (3)b. (4)a. (5)b. (6)c. (7)c. (8)d. (9)b. (10)a.
(11)a. (12)b. (13)c. (14)c. (15)a. (16)c. (17)c. (18)d. (19)d. (20)b.
(21)d. (22)b. (23)d. (24)c. (25)b. (26)a. (27)a. (28)d.

II. Problems

(1) [Comparative addvantage, gains from trade: 17 pts]

1. 2 bushels of tomatoes.
2. 1 bushel of tomatoes.
3. 1/2 bushel of zucchini.
4. 1 bushel of zucchini.
5. Ken.
6. Jennifer.
7. Both people can consume combinations of zucchini and tomatoes outside their individual production possibility curves if Ken gives two bushels of zucchini to Jennifer, who gives 3 bushels of tomatoes in return.
8. Plot should show each person's production before trade, and consumption after trade.

(2) [Market equilibrium: 12 pts]

1. excess supply.
2. \$4.
3. 6 units.
4. \$24.
5. \$57.
6. buyers.

(3) [Calculating elastities: 2 pts] -3/4.

(4) [Using price elasticity of demand: 10 pts]

1. inelastic.
2. increase.
3. 15 percent.
4. increase.
5. 9 percent.

(5) [Arbitrage: 12 pts] Arbitrageurs will buy in the low-priced city, shifting its demand curve to the right. Then they will sell in the high-priced city, shifting its supply curve to the right by exactly the same amount. If there are no costs of arbitrage, curves will continue to shift until the final prices are identical in the two cities.

1. right.
2. unchanged.
3. unchanged.
4. right.
5. \$6.
6. \$6.

(6) [Welfare analysis of price controls or quotas: 18 pts]

1. \$5.
2. 60 thousand pounds.
3. excess supply.
4. 60 thousand pounds.
5. increase.
6. \$110 thousand.
7. decrease.
8. \$140 thousand.
9. \$30 thousand.

(7) [Consumer choice and demand: 16 pts]

1. 7 units of food and 5 units of other goods.
2. 6 units of food and 6 units of other goods.
3. Budget line A has an intercept on the "other goods" axis at 15, and an intercept on the "food" axis at 6.
4. 4 units of food.
5. Budget line B has an intercept on the "other goods" axis at 15, and an intercept on the "food" axis at 10.
6. 6 units of food.
7. (Q,P) = (4,\$5), (6,\$3).

(8) [Basic definition: 18 pts]

1. Marginal cost.
2. Marginal cost.
3. Total cost.
4. Marginal revenue.
5. Marginal revenue.
6. Average cost.

(9) [Discounting: 4 pts]

1. \$305.
2. \$200 million.

(10) [Economy-wide efficiency: 20 pts]

1. 1/3 units of clothing.
2. 3 units of food.
3. \$12, because in competitive equilibrium, price equals marginal cost.
4. \$4, because in competitive equilibrium, prices reflect the slope of the production possibility curve for the economy as a whole: if the opportunity cost of a unit of clothing is 4 units of food, then a unit of clothing must be 4 times as expensive as a unit of food.
5. \$4, because in competitive equilibrium, price equals marginal cost.
6. Brian's budget line should have intercept at 15 on food axis, and intercept at 5 on clothing axis.
7. -3.
8. 3 units of food.
9. 1/3 units of clothing.
10. 3, because Brian's preferred bundle is at a tangency between his budget line and the highest indifference curve he can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(11) [Competition versus collusion: 16 pts]

1. 10 thousand.
2. \$6.
3. \$6, because height of supply curve = marginal cost.
4. MR curve should have intercept at \$16 on price axis, and slope = -2/1 thousand.
5. 6 thousand, where MR=MC.
6. \$5, from joint marginal cost curve.
7. \$10, on demand curve.
8. \$12 thousand.

(12) [Externalities: 12 pts]

1. \$5, at intersection of demand and supply.
2. 12 million, at intersection of demand and supply.
3. 9 million, at intersection of demand and marginal social cost.
4. \$7.5 million, the area of the triangle between demand, marginal social cost and a vertical line at 12 million liters.
5. Tax, to decrease the quantity to the social optimum.
6. \$4 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(13) [Nonrival goods: 4 pts]

1. MSB = 1000 (60 - 4 Q) = 60,000 - 4000 Q.
2. 10 miles (found by setting MSB = MC and solving for Q).

(14) [Regulating pollution: 20 pts]

1. Factories A, B, and C.
2. \$14 thousand.
3. Factories D, E, F, G.
4. \$8 thousand.
5. \$14 thousand.
6. Factories D, E, F, G.
7. \$8 thousand.
8. \$14 thousand.
9. \$8 thousand.
10. \$14 thousand.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

(1)d. (2)a. (3)c. (4)b. (5)d. (6)c. (7)a. (8)b. (9)b. (10)b.
(11)a. (12)b. (13)f. (14)c. (15)c. (16)d. (17)b. (18)a. (19)b. (20)c.
(21)e. (22)d. (23)b. (24)d. (25)b. (26)b. (27)b. (28)d.

II. Problems

(1) [Comparative addvantage, gains from trade: 17 pts]

1. 2 bushels of tomatoes.
2. 3 bushel of tomatoes.
3. 1/2 bushel of zucchini.
4. 1/3 bushel of zucchini.
5. Jennifer.
6. Ken.
7. Both people can consume combinations of zucchini and tomatoes outside their individual production possibility curves if Jennifer gives two bushels of zucchini to Ken, who gives 5 bushels of tomatoes in return.
8. Plot should show each person's production before trade, and consumption after trade.

(2) [Market equilibrium: 12 pts]

1. excess demand.
2. \$10.
3. 5 units.
4. \$50.
5. \$56.
6. sellers.

(3) [Calculating elastities: 2 pts] -1/2.

(4) [Using price elasticity of demand: 10 pts]

1. elastic.
2. increase.
3. 5 percent.
4. decrease.
5. 1 percent.

(5) [Arbitrage: 12 pts] Arbitrageurs will buy in the low-priced city, shifting its demand curve to the right. Then they will sell in the high-priced city, shifting its supply curve to the right by exactly the same amount. If there are no costs of arbitrage, curves will continue to shift until the final prices are identical in the two cities.

1. right.
2. unchanged.
3. unchanged.
4. right.
5. \$5.
6. \$5.

(6) [Welfare analysis of price controls or quotas: 18 pts]

1. \$7.
2. 80 thousand pounds.
3. excess demand.
4. 60 thousand pounds.
5. decrease.
6. \$200 thousand.
7. increase.
8. \$80 thousand.
9. \$120 thousand.

(7) [Consumer choice and demand: 16 pts]

1. 8 units of food and 6 units of other goods.
2. 4 units of food and 5 units of other goods.
3. Budget line A has an intercept on the "other goods" axis at 12, and an intercept on the "food" axis at 6.
4. 3 units of food.
5. Budget line B has an intercept on the "other goods" axis at 12, and an intercept on the "food" axis at 12.
6. 5 units of food.
7. (Q,P) = (3,\$10), (5,\$5).

(8) [Basic definition: 18 pts]

1. Marginal revenue.
2. Average cost.
3. Marginal cost.
4. Marginal cost.
5. Total cost.
6. Marginal revenue.

(9) [Discounting: 4 pts]

1. \$367.
2. \$300 million.

(10) [Economy-wide efficiency: 20 pts]

1. 2 units of clothing.
2. 1/2 units of food.
3. \$6, because in competitive equilibrium, price equals marginal cost.
4. \$12, because in competitive equilibrium, prices reflect the slope of the production possibility curve for the economy as a whole: if the opportunity cost of a unit of clothing is 4 units of food, then a unit of clothing must be 4 times as expensive as a unit of food.
5. \$12, because in competitive equilibrium, price equals marginal cost.
6. Brian's budget line should have intercept at 15 on food axis, and intercept at 5 on clothing axis.
7. -1/2.
8. 1/2 units of food.
9. 2 units of clothing.
10. 1/2, because Brian's preferred bundle is at a tangency between his budget line and the highest indifference curve he can reach, and at a tangency the slope of the indifference curve must equal the slope of the budget line.

(11) [Competition versus collusion: 16 pts]

1. 9 thousand.
2. \$7.
3. \$7, because height of supply curve = marginal cost.
4. MR curve should have intercept at \$16 on price axis, and slope = -2/1 thousand.
5. 5 thousand, where MR=MC.
6. \$6, from joint marginal cost curve.
7. \$11, on demand curve.
8. \$10 thousand.

(12) [Externalities: 12 pts]

1. \$6, at intersection of demand and supply.
2. 10 million, at intersection of demand and supply.
3. 8 million, at intersection of demand and marginal social cost.
4. \$6 million, the area of the triangle between demand, marginal social cost and a vertical line at 10 million liters.
5. Tax, to decrease the quantity to the social optimum.
6. \$5 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(13) [Nonrival goods: 4 pts]

1. MSB = 200 (90 - Q/2) = 1800 - 100 Q.
2. 8 movies (found by setting MSB = MC and solving for Q).

(14) [Regulating pollution: 20 pts]

1. Factories A, B, C, D.
2. \$23 thousand.
3. Factories E, F, G.
4. \$10 thousand.
5. \$23 thousand.
6. Factories E, F, G.
7. \$10 thousand.
8. \$23 thousand.
9. \$10 thousand.
10. \$23 thousand.

III. Critical thinking

Same as Version A.

[end of answer key]