ECON 002 - Principles of Microeconomics Drake University, Fall 2016 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

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

1. inelastic.
2. decrease.
3. 6 percent.
4. increase.
5. 9 percent.

(2) [Production functions: 8 pts] Recall that average product = total output / total input. Marginal product = Δ output / Δ input .

• 2 chairs per worker
• 3 chairs per worker
• 6 chairs per worker
• 4 chairs per worker

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

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

1. 3 refrigerators.
2. 1 refrigerator.
3. 1/3 car.
4. 1 car.
5. Country Y, because it has lower opportunity cost of producing cars.
6. Country X, because it has lower opportunity cost of producing refrigerators.
7. Both countries can consume combinations of products outside their individual production possibility curves if Country X exports three refrigerators to Country Y, which exports 2 cars in return.
8. Plot should show each country's production before trade, and consumption after trade.

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

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

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

1. \$4.
2. export.
3. 12 million.
4. decrease.
5. \$16 million.
6. increase.
7. \$40 million.
8. increase.
9. \$24 million.

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

1. 11 sandwiches and 6 cupcakes.
2. 6 sandwiches and 4 cupcakes.
3. Budget line A is a straight line with intercepts at 12 cupcakes and at 12 sandwiches.
4. 8 sandwiches.
5. Budget line B is a straight line with intercepts at 12 cupcakes and at 5 sandwiches.
6. 5 sandwiches.
7. (P,Q) = (\$5,8), (\$10,5).

(8) [Short-run cost curves and supply: 20 pts]

1. \$28 thousand (= 2000 × SATC).
2. \$24 thousand (= 2000 × SAVC).
3. \$4 thousand (= STC - SVC).
4. \$5 (= SMC).
5. \$7 (= minimum SATC).
6. \$3 (= minimum SAVC).
7. 1000 flashlights, using the rule P=MC.
8. loss, because P is less than breakeven price.
9. 1300 flashlights, using the rule P=MC.
10. profit, because price is greater than breakeven price.

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

1. 3 units of other goods.
2. 1/3 gallons of gasoline.
3. \$6, 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 gallon of gasoline is 3 units of other goods, then the price of a gallon of gasoline must be 3 times the price of other goods.
4. \$2, because in competitive equilibrium, price equals marginal cost.
5. \$6, because in competitive equilibrium, price equals marginal cost.
6. Amy's budget line should have intercepts at 30 units of other goods and 10 gallons of gasoline.
7. -3, same as slope of country's production possibility curve.
8. 3 units of other goods.
9. 1/3 gallongs of gasoline.
10. 3, because Amy's preferred bundle is at a tangency between her budget line and the highest indifference curve she can reach, and at a tangency the slope of her indifference curve must equal the slope of her budget line.

(10) [Competition versus collusion: 16 pts]

1. 12 million.
2. \$5 (= marginal cost).
3. \$5.
4. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$8 on price axis, and slope = -1/1 million.
5. 8 million, where MR = MC.
6. \$4 (= marginal cost).
7. \$6, on demand curve.
8. \$4 million.

(11) [Regulating pollution: 20 pts]

1. Factories A, B, E.
2. \$700.
3. Each factory's willingness-to-pay for a permit equals its annual cost of cleanup. Graph should show five downward-sloping stairsteps.
4. Factories C, D.
5. \$500.
6. \$700.
7. \$500.
8. \$700.

(12) [Externalities: 12 pts]

1. \$5, at intersection of demand and supply.
2. 9 million, at intersection of demand and supply.
3. 12 million, at intersection of marginal social benefit and supply.
4. \$6 million, the area of the triangle between marginal social benefit, supply, and a vertical line at 9 million. Deadweight loss is the gap between the benefit to society and the cost of production of all those vaccinations that should have been produced but were not.
5. Subsidy, to increase the quantity to the social optimum.
6. \$2 per vaccination, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(13) [Nonrival goods: 4 pts]

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

(14) [Common property resources: 6 pts]

1. 800 cars, where time saved by next car equals zero.
2. 400 cars, where change in total time saved by all cars equals zero.
3. \$4, the dollar equivalent of time saved by next car, at the socially optimal number of cars.

III. Critical thinking [4 pts]

1. Example of government intervention that makes a market less efficient might be
• price ceiling or price floor.
• quota on buyers or sellers.
• tax or subsidy.
Answer should explain in words how the intervention increases or decreases quantity from the competitive equilibrium, and how the gains to the winners are less than the losses to the losers. Supply-and -demand graph should show deadweight-loss triangle (or loss of potential gains from international trade) caused by the intervention. All axes and curves must be labeled.
2. Example of government intervention that makes a market more efficient might be
• antitrust laws breaking up cartels.
• taxes on products that create external costs (e.g., coal).
• subsidies for products that create external benefits (e.g., vaccinations).
Answer should explain in words how the intervention ensures true marginal cost pricing (breaking up cartels) or ensures that marginal social cost equals marginal social benefit. Supply-and -demand graph should show how deadweight-loss triangle is eliminated by the intervention. All axes and curves must be labeled.

### Version B

I. Multiple choice

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

II. Problems

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

1. elastic.
2. decrease.
3. 7 percent.
4. decrease.
5. 2 percent.

(2) [Production functions: 8 pts] Recall that average product = total output / total input. Marginal product = Δ output / Δ input .

• 4 chairs per worker
• 5 chairs per worker
• 4 chairs per worker
• 6 chairs per worker

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

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

1. 1/2 refrigerators.
2. 1 refrigerator.
3. 2 cars.
4. 1 car.
5. Country X, because it has lower opportunity cost of producing cars.
6. Country Y, because it has lower opportunity cost of producing refrigerators.
7. Both countries can consume combinations of products outside their individual production possibility curves if Country Y exports two refrigerators to Country X, which exports 3 cars in return.
8. Plot should show each country's production before trade, and consumption after trade.

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

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

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

1. \$5.
2. import.
3. 6 million.
4. increase.
5. \$18 million.
6. decrease.
7. \$12 million.
8. increase.
9. \$6 million.

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

1. 3 sandwiches and 4 mini-pizzas.
2. 5 sandwiches and 8 mini-pizzas.
3. Budget line A is a straight line with intercepts at 12 mini-pizzas and at 15 sandwiches.
4. 8 mini-pizzas.
5. Budget line B is a straight line with intercepts at 6 mini-pizzas and at 15 sandwiches.
6. 4 mini-pizzas.
7. (P,Q) = (\$5,8), (\$10,4).

(8) [Short-run cost curves and supply: 20 pts]

1. \$26 thousand (= 2000 × SATC).
2. \$20 thousand (= 2000 × SAVC).
3. \$6 thousand (= STC - SVC).
4. \$6 (= SMC).
5. \$10 (= minimum SATC).
6. \$5 (= minimum SAVC).
7. zero flashlights, because P is less than shutdown price.
8. loss, equal to short-run fixed cost.
9. 1500 flashlights, using the rule P=MC.
10. profit, because price is greater than breakeven price.

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

1. 3/2 units of other goods.
2. 2/3 gallons of gasoline.
3. \$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 gallon of gasoline is 3/2 units of other goods, then the price of a gallon of gasoline must be 3/2 times the price of other goods.
4. \$2, because in competitive equilibrium, price equals marginal cost.
5. \$3, because in competitive equilibrium, price equals marginal cost.
6. Amy's budget line should have intercepts at 30 units of other goods and 20 gallons of gasoline.
7. -3/2, same as slope of country's production possibility curve.
8. 3/2 units of other goods.
9. 2/3 gallons of gasoline.
10. 3/2, because Amy's preferred bundle is at a tangency between her budget line and the highest indifference curve she can reach, and at a tangency the slope of her indifference curve must equal the slope of her budget line.

(10) [Competition versus collusion: 16 pts]

1. 6 million.
2. \$7 (= marginal cost).
3. \$7.
4. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$10 on price axis, and slope = -1/1 million.
5. 4 million, where MR = MC.
6. \$6 (= marginal cost).
7. \$8, on demand curve.
8. \$2 million.

(11) [Regulating pollution: 20 pts]

1. Factories A, E.
2. \$700.
3. Each factory's willingness-to-pay for a permit equals its annual cost of cleanup. Graph should show five downward-sloping stairsteps.
4. Factories B, C, D.
5. \$300.
6. \$300.
7. \$300.
8. \$300.

(12) [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 marginal social cost and demand.
4. \$8 million, the area of the triangle between marginal social cost, demand, and a vertical line at 12 million. Deadweight loss is the gap between the benefit to consumers and the cost to society of all those units that should not have been produced.
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.

(13) [Nonrival goods: 4 pts]

1. MSB = 1000 (32-4Q) = 32,000 - 4000 Q.
2. 3 miles (found by setting MSB = MC and solving for Q).

(14) [Common property resources: 6 pts]

1. 1200 cars, where time saved by next car equals zero.
2. 600 cars, where change in total time saved by all cars equals zero.
3. \$3, the dollar equivalent of time saved by next car, at the socially optimal number of cars.

III. Critical thinking

Same as Version A.