ECON 002 - Principles of Microeconomics Drake University, Fall 2018 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

1. 1 bicycle.
2. 2 bicycles.
3. 1 television.
4. 1/2 televisions.
5. Country A, because it has lower opportunity cost of producing televisions.
6. Country B, because it has lower opportunity cost of producing bicycles.
7. Both countries can consume combinations of products outside their individual production possibility curves if Country B exports three bicycles to Country A, which exports 2 televisions 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. left, left, cannot be determined, decrease.

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

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

(4) [Business revenue and cost--definitions: 3 pts]

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

(5) [Welfare effects of international trade: 18 pts] International price = \$3.

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

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

1. 5 pizzas and 3 ice cream cones.
2. 7 pizzas and 3 ice cream cones.
3. Budget line A is a straight line with intercepts at 10 ice cream cones and at 15 pizzas.
4. 9 pizzas.
5. Budget line B is a straight line with intercepts at 10 ice cream cones and 10 pizzas.
6. 7 pizzas.
7. (P,Q) = (\$6,7), (\$4,9).

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

1. \$16 thousand (= 2000 × SATC).
2. \$12 thousand (= 2000 × SAVC).
3. \$4 thousand (= STC - SVC).
4. \$2 (= SMC).
5. \$6 (= minimum SATC).
6. \$3 (= minimum SAVC).
7. 1600 parts, using the rule P=MC.
8. profit, because P is greater than breakeven price.
9. 1300 parts, using the rule P=MC.
10. loss, because price is less than breakeven price.

(8) [Efficiency of competition: 12 pts]

1. \$14, because the height of the demand curve = marginal willingness-to-pay.
2. \$10, because the height of the supply curve = marginal cost.
3. \$4, because the increase in total surplus = willingness-to-pay minus marginal cost.
4. \$12, because the height of the demand curve = marginal willingness-to-pay.
5. \$12, because the height of the supply curve = marginal cost.
6. \$0, roughly, because the increase in total surplus = willingness-to-pay minus 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 = TR - TC = (price × quantity) - (AC × quantity).
5. \$9 thousand.
6. \$3 thousand.
7. 8 thousand, where the demand curve intersects the marginal cost curve, 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 from zero to 8 thousand.
9. \$48 thousand = TR - TC = \$88 thousand - (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) [Externalities: 12 pts]

1. \$6, at intersection of demand and supply.
2. 8 million, at intersection of demand and supply.
3. 4 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 8 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, E.
2. \$250.
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. \$200.
6. \$250.
7. \$200.
8. \$250.

(12) [Nonrival goods: 4 pts]

1. MSB = 1000 (30-2Q) = 30,000 - 2,000 Q.
2. 5 miles (found by setting MSB = MC and solving for Q).

(13) [Common property resources: 6 pts]

1. 1000 cars, where marginal private benefit equals zero.
2. 500 cars, where marginal social benefit equals zero.
3. \$5, the dollar equivalent of marginal private benefit, at the socially optimal number of cars.

III. Critical thinking [4 pts]

(1) The country of Fredonia is at point B. Too little energy is produced because it is overpriced. The energy monopoly raises its price above marginal cost.

(2) The country of Fredonia is at point A. Too much energy is produced because it is underpriced. The price of energy includes only marginal private cost, but not marginal external cost.

[Fredonia is the imaginary country in the Marx Brothers' movie "Duck Soup." Groucho Marx becomes Prime Minister of Fredonia and things go downhill from there.]

### Version B

I. Multiple choice

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

II. Problems

1. 1 bicycle.
2. 1/2 bicycles.
3. 1 television.
4. 2 televisions.
5. Country B, because it has lower opportunity cost of producing televisions.
6. Country A, because it has lower opportunity cost of producing bicycles.
7. Both countries can consume combinations of products outside their individual production possibility curves if Country A exports two bicycles to Country B, which exports 3 televisions 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) [Price elasticity of demand: 10 pts]

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

(4) [Business revenue and cost--definitions: 3 pts]

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

(5) [Welfare effects of international trade: 18 pts] International price = \$7.

1. \$5.
2. export.
3. 6 million.
4. decrease.
5. \$14 million.
6. increase.
7. \$20 million.
8. increase.
9. \$6 million.

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

1. 4 burritos and 5 nachos.
2. 7 burritos and 7 nachos.
3. Budget line A is a straight line with intercepts at 10 burritos and at 15 nachos.
4. 6 burritos.
5. Budget line B is a straight line with intercepts at 6 burritos and at 15 nachos.
6. 4 burritos.
7. (P,Q) = (\$6,6), (\$10,4).

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

1. \$9 thousand (= 1500 × SATC).
2. \$6 thousand (= 1500 × SAVC).
3. \$3 thousand (= STC - SVC).
4. \$2 (= SMC).
5. \$6 (= minimum SATC).
6. \$4 (= minimum SAVC).
7. 1800 parts, using the rule P=MC.
8. profit, because P is greater than breakeven price.
9. zero parts, because P is greater than shutdown price.
10. loss, because price is less than breakeven price. Note that since the firm is shut down, it has no revenue and no variable cost. It does pay a fixed cost (see part (c)), equal to its loss.

(8) [Efficiency of competition: 12 pts]

1. \$20, because the height of the demand curve = marginal willingness-to-pay.
2. \$8, because the height of the supply curve = marginal cost.
3. \$12, because the increase in total surplus = willingness-to-pay minus marginal cost.
4. \$14, because the height of the demand curve = marginal willingness-to-pay.
5. \$14, because the height of the supply curve = marginal cost.
6. \$0, roughly, because the increase in total surplus = willingness-to-pay minus 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. 8 thousand, where MR=MC.
3. \$9, on demand curve.
4. \$48 thousand = TR - TC = (price × quantity) - (AC × quantity).
5. \$16 thousand.
6. \$8 thousand.
7. 12 thousand, where the demand curve intersects the marginal cost curve, because anyone willing to pay at least the marginal cost will be served.
8. \$120 thousand, because with every customer paying a different price, revenue = area of the trapezoid under demand curve from zero to 12 thousand.
9. \$72 thousand = TR - TC = \$88 thousand - (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) [Externalities: 12 pts]

1. \$4, at intersection of demand and supply.
2. 8 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 8 million. Deadweight loss is the gap between the benefit to society and the cost to sellers of all those units that should have been produced.
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.

(11) [Regulating pollution: 20 pts]

1. Factories A, B, E.
2. \$500.
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. \$300.
6. \$500.
7. \$300.
8. \$500.

(12) [Nonrival goods: 4 pts]

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

(13) [Common property resources: 6 pts]

1. 800 cars, where marginal private benefit equals zero.
2. 400 cars, where marginal social benefit equals zero.
3. \$4, the dollar equivalent of marginal private benefit, at the socially optimal number of cars.

III. Critical thinking

Same as Version A.