ECON 002 - Principles of Microeconomics Drake University, Spring 2014 William M. Boal Course page: www.cbpa.drake.edu/econ/boal/002 Blackboard: bb.drake.edu william.boal@drake.edu

EXAM 2 ANSWER KEY

### Version A

I. Multiple choice

(1)d. (2)a. (3)b. (4)a. (5)a. (6)b. (7)b. (8)b. (9)a. (10)b. (11)a. (12)b. (13)c.

II. Problems

(1) [Calculating elasticities: 2 pts] Using arc-elasticity formula: (ΔQ/Qavg) / (ΔP/Pavg) = -1/3.

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

1. inelastic.
2. increase.
3. 20 percent.
4. increase.
5. 14 percent.

(3) [Using income elasticities: 10 pts]

1. necessary good.
2. increase.
3. 3 percent.
4. decrease.
5. 7 percent.

(4) [Welfare effects of international trade: 18 pts]

1. \$8.
2. import.
3. 4 million.
4. increase.
5. \$11 million.
6. decrease.
7. \$9 million.
8. increase.
9. \$2 million.

(5) [Arbitrage: 22 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 prices are identical in the two cities.

1. Denver.
2. Houston.
3. 2 thousand.
4. \$6.
5. \$6.

(6) [Welfare effects of market controls: 18 pts] Price floor of \$8.

1. \$6.
2. 80 million pounds.
3. excess supply.
4. 60 million pounds.
5. increase.
6. \$150 million.
7. decrease.
8. \$180 million.
9. \$30 thousand.

(7) [Welfare effects of tax or subsidy: 18 pts] Tax of \$6: in equilibrium, the demand curve must be higher than the supply curve by \$6.

1. 6 thousand.
2. \$4 per teeshirt.
3. \$10 per teeshirt.
4. decrease.
5. \$16 thousand.
6. decrease.
7. \$32 thousand.
8. \$36 thousand.
9. \$12 thousand.

III. Critical thinking [3 pts]

(1) The study indicates that marijuana and tobacco cigarettes are complements for young people because the price of tobacco cigarettes is negatively related to the quantity of marijuana. The cross-price elasticity is defined as percent change in quantity of one good divided by the percent change in the price of the other good. Therefore the cross-price elasticity is -1.2 for young people, according to this study. Complements always have a negative cross-price elasticity.

(2) A price ceiling would not ensure tha more babies had access to infant formula. A price ceiling, or maximum price, pushes price below the equilibrium price. The quantity demanded increases and the quantity supplied decreases, causing excess demand (a shortage). Because the quantity supplied decreases, the quantity actually sold decreases. (Full credit requires a graph showing demand, supply, and a horizontal line at the price ceiling, below the equilibrium price. The quantity sold before and after the price ceiling should be marked.)

### Version B

I. Multiple choice

(1)a. (2)b. (3)a. (4)b. (5)b. (6)c. (7)c. (8)c. (9)c. (10)c. (11)b. (12)a. (13)d.

II. Problems

(1) [Calculating elasticities: 2 pts] Using arc-elasticity formula: (ΔQ/Qavg) / (ΔP/Pavg) = -1/2.

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

1. inelastic.
2. increase.
3. 16 percent.
4. increase.
5. 4 percent.

(3) [Using income elasticities: 10 pts]

1. luxury (or superior) good.
2. increase.
3. 7 percent.
4. increase.
5. 2 percent.

(4) [Welfare effects of international trade: 18 pts]

1. \$8.
2. export.
3. 8 million.
4. decrease.
5. \$16 million.
6. increase.
7. \$24 million.
8. increase.
9. \$8 million.

(5) [Arbitrage: 22 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 prices are identical in the two cities.

1. Houston.
2. Denver.
3. 4 thousand.
4. \$5.
5. \$5.

(6) [Welfare effects of market controls: 18 pts] Price ceiling of \$4.

1. \$6.
2. 60 million pounds.
3. excess demand.
4. 60 million pounds.
5. decrease.
6. \$160 million.
7. increase.
8. \$40 million.
9. \$120 thousand.

(7) [Welfare effects of tax or subsidy: 18 pts] Subsidy of \$4: in equilibrium, the demand curve must be lower than the supply curve by \$4.

1. 10 thousand.
2. \$6 per teeshirt.
3. \$2 per teeshirt.
4. increase.
5. \$9 thousand.
6. increase.
7. \$27 thousand.
8. \$40 thousand.
9. \$4 thousand.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

(1)c. (2)a. (3)a. (4)a. (5)c. (6)d. (7)d. (8)d. (9)a. (10)a. (11)a. (12)b. (13)e.

II. Problems

(1) [Calculating elasticities: 2 pts] Using arc-elasticity formula: (ΔQ/Qavg) / (ΔP/Pavg) = -2/3.

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

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

(3) [Using income elasticities: 10 pts]

1. necessary good.
2. increase.
3. 4 percent.
4. decrease.
5. 1 percent.

(4) [Welfare effects of international trade: 18 pts]

1. \$8.
2. import.
3. 8 million.
4. increase.
5. \$24 million.
6. decrease.
7. \$16 million.
8. increase.
9. \$8 million.

(5) [Arbitrage: 22 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 prices are identical in the two cities.

1. Houston.
2. Denver.
3. 3 thousand.
4. \$4.
5. \$4.

(6) [Welfare effects of market controls: 18 pts] Quota on sellers of 40 million pounds.

1. increase, because a quota on sellers bends the supply curve up vertically at the quota quantity.
2. \$12.
3. increase.
4. \$150 million.
5. decrease.
6. \$420 million.
7. \$9.
8. \$270 million.

(7) [Welfare effects of tax or subsidy: 18 pts] Tax of \$3: in equilibrium, the demand curve must be higher than the supply curve by \$6.

1. 8 thousand.
2. \$5 per teeshirt.
3. \$8 per teeshirt.
4. decrease.
5. \$9 thousand.
6. decrease.
7. \$18 thousand.
8. \$24 thousand.
9. \$3 thousand.

III. Critical thinking

Same as Version A.

[end of answer key]