ECON 002 - Principles of Microeconomics Drake University, Fall 2017 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

(1) [Price elasticity of demand: 10 pts]

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

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

(3) [Market equilibrium: 12 pts] First use the graph to draw demand and supply curves. The curves should have stairsteps, similar to those for the trading activity we did in class.

1. excess demand.
2. \$10.
3. 6 units.
4. \$60 (= price × quantity).
5. \$51.
6. sellers.

(4) [Welfare effects of international trade: 18 pts] International price = \$8.

1. \$6.
2. export.
3. 6 million.
4. decrease.
5. \$18 million.
6. increase.
7. \$24 million.
8. increase.
9. \$6 million.

(5) [Welfare effects of tax or subsidy: 18 pts] Tax = \$3. Since PD = PS + 3, in equilibrium, the demand curve must be higher than the supply curve by \$3. Both consumers and producers lose from the tax, but government gains tax revenue.

1. 10 million tee-shirts.
2. \$6 per tee-shirt.
3. \$9 per tee-shirt.
4. decrease.
5. \$11 million.
6. decrease.
7. \$22 million.
8. \$30 million.
9. \$3 million.

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

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

(7) [Short-run cost: 26 pts] Note that SVC = cost of labor, energy and materials.

1. SAVC = SVC / output = \$10, \$15, \$20, \$30.
2. SAFC = 48 / output = \$24, \$12, \$8, \$6.
3. SATC = SAVC + SAFC = \$34, \$27, \$28, \$36.
4. SMC = Δ SVC / \$Delta; output = \$10, \$20, \$30, \$60.
5. Shutdown price = min SAVC = \$10.
6. Breakeven price = min SATC = \$27.
7. Produce 4 units, where \$25 = SMC.
8. Suffers loss because price < breakeven price.
9. Profit = TR - SFC - SVC = (\$25 × 4) - 48 - 60 = -\$8 (that is, a loss of \$8).

(8) [Economy-wide efficiency: 14 pts]

1. 1/2 units of clothing.
2. 2 units of food.
3. \$12, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of clothing is 2 units of food, then the price of a unit of clothing must be 2 times the price of a unit of food.
4. Amy's budget line should have intercepts at 60/6=10 units of food and 60/12=5 units of clothing.
5. 1/2 units of clothing, same as PP curve.
6. 2 units of food, same as PP curve.
7. -1/2, 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.

(9) [Competition versus collusion: 16 pts]

1. 6 million.
2. \$6 (= marginal cost).
3. \$6.
4. 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 = -2/1 million.
5. 4 million, where MR = MC.
6. \$4 (= marginal cost).
7. \$8, on demand curve.
8. \$4 million.

(10) [Externalities: 12 pts]

1. \$8, at intersection of demand and supply.
2. 10 million, at intersection of demand and supply.
3. 6 million, at intersection of marginal social cost and demand.
4. \$12 million, the area of the triangle between marginal social cost, demand, and a vertical line at 10 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. \$4 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(11) [Regulating pollution: 20 pts]

1. Factories A, C.
2. \$40.
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, D, E.
5. \$30.
6. \$40.
7. \$30.
8. \$40.

(12) [Nonrival goods: 4 pts]

1. MSB = 500 (8-Q) = 4000 - 500 Q.
2. 6 concerts (found by setting MSB = MC and solving for Q).

(13) [Common property resources: 6 pts]

1. 100 boats, where fish caught by the next boat equals zero.
2. 50 boats, where change total fish caught equals zero.
3. \$500, the dollar equivalent of fish caught by the next boat, at the socially optimal number of boats.

III. Critical thinking [4 pts]

1. This question asks for an example of a nonrival good. There are many possible examples, including radio and TV programs, landscaping, outdoor art, downloaded apps, species preservation, and national defense. Websites, bridges, roads, parks, and museums are also nonrival goods if they are uncongested. Items shared with roommates or housemates, such as refrigerators or televisions, could even be considered nonrival goods on a small scale. The reason that they are nonrival goods is that each unit of the good can be consumed by many people simultaneously. Each person's consumption of a nonrival good does not leave less for other people, in contrast to rival goods like food, clothing, shelter, etc.
2. Marginal cost pricing of a good leads to economic efficiency because everyone willing to pay the marginal cost will consume the good, but no one else will. The demand curve shows how much people are willing to pay for each unit of the good, ranged from highest to lowest. For example, the demand for teeshirts shows how much people are willing to pay for a teeshirt, ranged from highest to lowest. If the price of teeshirts is, say, \$10, then everyone for whom a teeshirt is worth \$10 will buy the good, but no one for whom a teeshirt is worth less than \$10 will buy a teeshirt. Now if \$10 is actually the marginal cost making a teeshirt, as under perfect competition, then we have economic efficiency, because everyone willing to pay the marginal cost of making a teeshirt will buy a teeshirt, but no one who is unwilling to pay the marginal cost will buy one.

### Version B

I. Multiple choice

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

II. Problems

(1) [Price elasticity of demand: 10 pts]

1. elastic.
2. decrease.
3. 6 percent.
4. decrease.
5. 1 percent.

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

(3) [Market equilibrium: 12 pts] First use the graph to draw demand and supply curves. The curves should have stairsteps, similar to those for the trading activity we did in class.

1. excess supply.
2. \$4.
3. 4 units.
4. \$16 (= price × quantity).
5. \$43.

(4) [Welfare effects of international trade: 18 pts] International price = \$5.

1. \$6.
2. import.
3. 3 million.
4. increase.
5. \$10.5 million.
6. decrease.
7. \$9 million.
8. increase.
9. \$1.5 million.

(5) [Welfare effects of tax or subsidy: 18 pts] Subsidy = \$3. Since PS = PD + 3, in equilibrium, the supply curve must be higher than the demand curve by \$3. Both consumers and producers gain from the subsidy, but government loses.

1. 14 million tee-shirts.
2. \$8 per tee-shirt.
3. \$5 per tee-shirt.
4. increase.
5. \$13 million.
6. increase.
7. \$26 million.
8. \$42 million.
9. \$3 million.

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

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

(7) [Short-run cost: 26 pts] Note that SVC = cost of labor, energy and materials.

1. SAVC = SVC / output = \$8, \$6, \$8, \$12.
2. SAFC = 120 / output = \$24, \$12, \$8, \$6.
3. SATC = SAVC + SAFC = \$32, \$18, \$16, \$18.
4. SMC = Δ SVC / \$Delta; output = \$8, \$4, \$12, \$24.
5. Shutdown price = min SAVC = \$6.
6. Breakeven price = min SATC = \$16.
7. Produce 15 units, where \$18 = SMC.
8. Enjoys profit because price > breakeven price.
9. Profit = TR - SFC - SVC = (\$18 × 15) - 120 - 120 = \$30.

(8) [Economy-wide efficiency: 14 pts]

1. 1/3 units of clothing.
2. 3 units of food.
3. \$2, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 1/3 units of clothing, then the price of a unit of food must be 1/3 times the price of a unit of clothing.
4. Amy's budget line should have intercepts at 30/2=15 units of food and 30/6=5 units of clothing.
5. 1/3 units of clothing, same as PP curve.
6. 3 units of food, same as PP curve.
7. -1/3, 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.

(9) [Competition versus collusion: 16 pts]

1. 12 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 \$13 on price axis, and slope = -1/1 million.
5. 8 million, where MR = MC.
6. \$5 (= marginal cost).
7. \$9, on demand curve.
8. \$8 million.

(10) [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 marginal social benefit and supply.
4. \$5 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. \$3 per vaccination, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(11) [Regulating pollution: 20 pts]

1. Factories A, B, C.
2. \$75.
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 D, E.
5. \$40.
6. \$75.
7. \$40.
8. \$75.

(12) [Nonrival goods: 4 pts]

1. MSB = 1000 (8-Q) = 8000 - 1000 Q.
2. 7 concerts (found by setting MSB = MC and solving for Q).

(13) [Common property resources: 6 pts]

1. 60 boats, where fish caught by the next boat equals zero.
2. 30 boats, where change total fish caught equals zero.
3. \$300, the dollar equivalent of fish caught by the next boat, at the socially optimal number of boats.

III. Critical thinking

Same as Version A.