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

### Version A

I. Multiple choice

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

II. Problems

1. 1 computer.
2. 2 computers.
3. 1 bicycle.
4. 1/2 bicycles.
5. Country A.
6. Country B.
7. Both countries can consume combinations of bicycles and computers outside their individual production possibility curves if Country A exports two million bicycles to Country B, which exports 3 million computers in return.
8. Plot should show each country's production before trade, and consumption after trade.

(2) [Shifts in demand and supply: 15 pts] Full credit requires accurate graphs.

1. unchanged, left, increase, decrease.
2. right, unchanged, increase, increase.
3. right, left, increase, cannot be determined.

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

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

(4) [Using income elasticities: 10 pts]

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

(5) [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.

(6) [Consumer choice and demand: 14 pts]

1. 8 units of food and 12 units of other goods, because this bundle is on the higher indifference curve.
2. 4 units of food and 6 units of other goods, because this bundle is on the higher indifference curve.
3. Budget line A has intercepts at 10 units of food and 16 units of other goods.
4. 5 units of food.
5. Budget line B has intercepts at 4 units of food and 16 units of other goods.
6. 3 units of food.
7. (P,Q) = (\$8,5), (\$20,3).

(7) [Rational choice: 10 pts]

1. MC = Δ TC / Δ q = \$10 million, \$6 million, \$4 million, \$4 million.
2. MB = Δ TB / Δ q = \$20 million, \$10 million, \$6 million, \$2 million.
3. 6 lanes, where MB = MC.

(8) [Basic definitions, cost and revenue: 3 pts]

1. marginal cost.
2. marginal revenue.
3. average cost.

(9) [Monopoly, price discrimination: 22 pts]

1. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$12 on price axis, and slope = -1/2 thousand.
2. 12 thousand, where MR=MC.
3. \$9, on demand curve.
4. \$72 thousand = Rev - TC = price × quantity - AC × quantity.
5. \$18 thousand.
6. \$6 thousand.
7. 16 thousand, because anyone willing to pay at least the marginal cost will be served.
8. \$160 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$96 thousand = Rev - TC = Rev - AC × quantity.
10. \$0, because consumer surplus is defined as willingness-to-pay minus price, but with perfect price discrimination willingness-to-pay equals price for every customer.
11. \$0, because with perfect price discrimination, everyone willing to pay the marginal cost is served.

(10) [Monopolistic competition: 12 pts]

1. Al's demand equation is
PA = PB + 1 - (Q/1000) = 2.00 + 1 - (QA/1000) = 3 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 3 - 2(QA/1000).
2. Set MR = MC = \$2 and solve to get 500 gallons.
3. Insert 500 gallons into demand equation to get \$2.50.
4. Now Al's demand equation is
PA = PB + 1 - (Q/1000) = 3.50 + 1 - (QA/1000) = 4.50 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 4.50 - 2(QA/1000).
5. Set MR = MC = \$2 and solve to get 1250 gallons.
6. Insert 1250 gallons into demand equation to get \$3.25.

(11) [Externalities: 12 pts]

1. \$6, at intersection of demand and supply.
2. 10 million, at intersection of demand and supply.
3. 6 million, at intersection of demand and marginal social cost.
4. \$12 million, the area of the triangle between marginal social cost, demand, and a vertical line at 10 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.

(12) [Regulating pollution: 20 pts]

1. Factories A and B.
2. \$13 thousand.
3. Factories C, D, E, F, G.
4. \$9 thousand.
5. \$13 thousand.
6. Factories C, D, E, F, G.
7. \$9 thousand.
8. \$13 thousand.
9. \$9 thousand.
10. \$13 thousand.

(13) [Nonrival goods: 4 pts]

1. MSB = 500 (6-Q) = 3000 - 500 Q.
2. 4 concerts (found by setting MSB = MC and solving for Q).

(14) [Common property resources: 6 pts]

1. 1000 cars, because cars will continue to enter the freeway as long as they (the entering cars) save time.
2. 500 cars, because additional cars do not save total time of all drivers.
3. \$2, because once 500 cars have entered the freeway, additional cars will find that the value of time saved is less than the toll.

III. Critical thinking [3 pts]

(1) Free markets are indeed efficient if no firms have market power and there are no externalities. In that situation, government intervention makes society worse off. Price controls, quotas, taxes, or subsidies all create winners and losers, but the gains to the winners are less than the losses to the losers, so society as a whole is worse off because of government intervention. (Full credit requires a graph illustrating at least one of these examples.)

On the other hand, free markets are not efficient if one or more firms have market power. Government intervention to break up cartels makes markets more efficient and makes society better off. Similarly, if a market generates external costs such as pollution, then government intervention with a pollution tax makes society better off. If a market generates external benefits as for example the market for vaccinations, then government intervention with a vaccination subsidy makes society better off. (Full credit requires a graph illustrating at least one of these examples.)

### Version B

I. Multiple choice

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

II. Problems

1. 1/3 computer.
2. 1/2 computer.
3. 3 bicycles.
4. 2 bicycles.
5. Country A.
6. Country B.
7. Both countries can consume combinations of bicycles and computers outside their individual production possibility curves if Country A exports five million bicycles to Country B, which exports 2 million computers in return.
8. Plot should show each country's production before trade, and consumption after trade.

(2) [Shifts in demand and supply: 15 pts] Full credit requires accurate graphs.

1. left, unchanged, decrease, decrease.
2. unchanged, right, decrease, increase.
3. left, left, cannot be determined, decrease.

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

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

(4) [Using income elasticities: 10 pts]

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

(5) [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.

(6) [Consumer choice and demand: 14 pts]

1. 10 units of food and 6 units of other goods, because this bundle is on the higher indifference curve.
2. 7 units of food and 4 units of other goods, because this bundle is on the higher indifference curve.
3. Budget line A has intercepts at 20 units of food and 12 units of other goods.
4. 5 units of food.
5. Budget line B has intercepts at 10 units of food and 12 units of other goods.
6. 3 units of food.
7. (P,Q) = (\$3,10), (\$6,6).

(7) [Rational choice: 10 pts]

1. MC = Δ TC / Δ q = \$10 million, \$9 million, \$9 million, \$8 million.
2. MB = Δ TB / Δ q = \$20 million, \$7 million, \$5 million, \$3 million.
3. 2 lanes, where MB = MC.

(8) [Basic definitions, cost and revenue: 3 pts]

1. marginal revenue.
2. total cost.
3. marginal cost.

(9) [Monopoly, price discrimination: 22 pts]

1. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$13 on price axis, and slope = -1/1 thousand.
2. 6 thousand, where MR=MC.
3. \$10, on demand curve.
4. \$36 thousand = Rev - TC = price × quantity - AC × quantity.
5. \$9 thousand.
6. \$3 thousand.
7. 8 thousand, because anyone willing to pay at least the marginal cost will be served.
8. \$88 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$48 thousand = Rev - TC = Rev - AC × quantity.
10. \$0, because consumer surplus is defined as willingness-to-pay minus price, but with perfect price discrimination willingness-to-pay equals price for every customer.
11. \$0, because with perfect price discrimination, everyone willing to pay the marginal cost is served.

(10) [Monopolistic competition: 12 pts]

1. Al's demand equation is
PA = PB + 1 - (Q/1000) = 2.50 + 1 - (QA/1000) = 3.50 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 3.50 - 2(QA/1000).
2. Set MR = MC = \$2 and solve to get 750 gallons.
3. Insert 750 gallons into demand equation to get \$2.75.
4. Now Al's demand equation is
PA = PB + 1 - (Q/1000) = 4 + 1 - (QA/1000) = 5 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 5 - 2(QA/1000).
5. Set MR = MC = \$2 and solve to get 1500 gallons.
6. Insert 1500 gallons into demand equation to get \$3.50.

(11) [Externalities: 12 pts]

1. \$4, at intersection of demand and supply.
2. 6 million, at intersection of demand and supply.
3. 8 million, at intersection of supply and marginal social benefit.
4. \$5 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. \$3 per vaccination, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(12) [Regulating pollution: 20 pts]

1. Factories A, B, and C.
2. \$23 thousand.
3. Factories D, E, F, G.
4. \$11 thousand.
5. \$23 thousand.
6. Factories D, E, F, G.
7. \$11 thousand.
8. \$23 thousand.
9. \$11 thousand.
10. \$23 thousand.

(13) [Nonrival goods: 4 pts]

1. MSB = 1000 (10-2Q) = 10,000 - 2,000 Q.
2. 3 concerts (found by setting MSB = MC and solving for Q).

(14) [Common property resources: 6 pts]

1. 600 cars, because cars will continue to enter the freeway as long as they (the entering cars) save time.
2. 300 cars, because additional cars do not save total time of all drivers.
3. \$3, because once 500 cars have entered the freeway, additional cars will find that the value of time saved is less than the toll.

III. Critical thinking

Same as Version A.

### Version C

I. Multiple choice

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

II. Problems

1. 1 computer.
2. 1/2 computers.
3. 1 bicycle.
4. 2 bicycles.
5. Country B.
6. Country A.
7. Both countries can consume combinations of bicycles and computers outside their individual production possibility curves if Country B exports fourmillion bicycles to Country A, which exports 3 million computers in return.
8. Plot should show each country's production before trade, and consumption after trade.

(2) [Shifts in demand and supply: 15 pts] Full credit requires accurate graphs.

1. right, unchanged, increase, increase.
2. unchanged, left, increase, decrease.
3. right, right, cannot be determined, increase.

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

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

(4) [Using income elasticities: 10 pts]

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

(5) [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.

(6) [Consumer choice and demand: 14 pts]

1. 9 units of food and 5 units of other goods, because this bundle is on the higher indifference curve.
2. 10 units of food and 6 units of other goods, because this bundle is on the higher indifference curve.
3. Budget line A has intercepts at 15 units of food and 12 units of other goods.
4. 8 units of food.
5. Budget line B has intercepts at 6 units of food and 12 units of other goods.
6. 4 units of food.
7. (P,Q) = (\$4,8), (\$10,4).

(7) [Rational choice: 10 pts]

1. MC = Δ TC / Δ q = \$10 million, \$7 million, \$8 million, \$9 million.
2. MB = Δ TB / Δ q = \$20 million, \$9 million, \$3 million, \$3 million.
3. 4 lanes, where MB = MC.

(8) [Basic definitions, cost and revenue: 3 pts]

1. average cost.
2. marginal revenue.
3. marginal cost.

(9) [Monopoly, price discrimination: 22 pts]

1. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$14 on price axis, and slope = -2 thousand.
2. 3 thousand, where MR=MC.
3. \$11, on demand curve.
4. \$18 thousand = Rev - TC = price × quantity - AC × quantity.
5. \$4.5 thousand.
6. \$1.5 thousand.
7. 4 thousand, because anyone willing to pay at least the marginal cost will be served.
8. \$48 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve down to horizontal axis.
9. \$24 thousand = Rev - TC = Rev - AC × quantity.
10. \$0, because consumer surplus is defined as willingness-to-pay minus price, but with perfect price discrimination willingness-to-pay equals price for every customer.
11. \$0, because with perfect price discrimination, everyone willing to pay the marginal cost is served.

(10) [Monopolistic competition: 12 pts]

1. Al's demand equation is
PA = PB + 1 - (Q/1000) = 3.00 + 1 - (QA/1000) = 4 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 4 - 2(QA/1000).
2. Set MR = MC = \$2 and solve to get 1000 gallons.
3. Insert 1000 gallons into demand equation to get \$3.00.
4. Now Al's demand equation is
PA = PB + 1 - (Q/1000) = 4.50 + 1 - (QA/1000) = 5.50 - (QA/1000).
Al's marginal revenue curve must have same intercept and twice slope:
MR = 5.50 - 2(QA/1000).
5. Set MR = MC = \$2 and solve to get 1750 gallons.
6. Insert 1250 gallons into demand equation to get \$3.75.

(11) [Externalities: 12 pts]

1. \$5, at intersection of demand and supply.
2. 12 million, at intersection of demand and supply.
3. 8 million, at intersection of demand and marginal social cost.
4. \$8 million, the area of the triangle between marginal social cost, demand and a vertical line at 8 million liters.
5. Tax, to decrease the quantity to the social optimum.
6. \$3 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(12) [Regulating pollution: 20 pts]

1. Factories A, B, C, D.
2. \$35 thousand.
3. Factories E, F, G.
4. \$13 thousand.
5. \$35 thousand.
6. Factories E, F, G.
7. \$13 thousand.
8. \$35 thousand.
9. \$13 thousand.
10. \$35 thousand.

(13) [Nonrival goods: 4 pts]

1. MSB = 1000 (8-Q) = 8000 - 1000 Q.
2. 5 concerts (found by setting MSB = MC and solving for Q).

(14) [Common property resources: 6 pts]

1. 1000 cars, because cars will continue to enter the freeway as long as they (the entering cars) save time.
2. 500 cars, because additional cars do not save total time of all drivers.
3. \$1, because once 500 cars have entered the freeway, additional cars will find that the value of time saved is less than the toll.

III. Critical thinking

Same as Version A.