Version A

I. Multiple choice

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

II. Problems

(1) [Computing price elasticity of demand: 6 pts]

• -0.5 (using arc-elasticity formula: (ΔQ/Q_avg) / (ΔP/P_avg) ).

(2) [Cross-price elasticity of demand: 8 pts]

1. complements, -1/5 = -0.2.
2. substitutes, 1/10 = 0.1.

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

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

(4) [Using income elasticities: 10 pts]

1. luxury (or superior) good.
2. increase.
3. 6 percent.
4. increase.
5. 2 percent.

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

1. $4.
2. import.
3. 3 million.
4. increase.
5. $6.5 million.
6. decrease.
7. $5 million.
8. increase.
9. $1.5 million.

(6) [Welfare effects of market controls: 18 pts] Price floor = $7.

1. $5.
2. 6 thousand.
3. excess supply.
4. 6 thousand.
5. increase.
6. $11 thousand.
7. decrease.
8. $14 thousand.
9. $3 thousand.

(7) [Welfare effects of tax or subsidy: 18 pts] Subsidy = $3. Under this subsidy, P_D + 3 = P_S, so in equilibrium, the supply curve must be higher than the demand curve by $3. Both consumers and producers gain from a subsidy, but government must pay.

1. 12 thousand.
2. $7 per shovel.
3. $4 per shovel.
4. increase.
5. $11 thousand.
6. increase.
7. $22 thousand.
8. $36 thousand.
9. $3 thousand.

III. Critical thinking [4 pts]

(1) The country's overall welfare decreases by $6 million from the tax on calculators. Graph should show demand and supply intersecting at a quantity of 20 million. Demand is higher than supply by $3, the tax rate, at 16 million. The area of the deadweight loss triangle is therefore $6 million. (Full credit requires a supply-and-demand graph, with all axes and curves labeled. Note that from the information given, it is not possible to compute separately the loss of consumer surplus or the loss of producer surplus.)

(2) Speculators disagree with the blogger. Speculators buy now, expecting to sell in the future at a profit. In equilibrium, the price today equals the expected price in the future (less any costs of speculation). If speculators really expected the price of petroleum to rise quickly from $50 to $200, they would buy petroleum now at its low price of $50, store it, and resell it in three months for $200. By doing so, they would drive up the price today to almost $200 (that is, $200 less the cost of speculation such as storage costs). Since the price today remains at $50, speculators must not expect the price to rise to $200 in the near future.

Version B

I. Multiple choice

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

II. Problems

(1) [Computing price elasticity of demand: 6 pts]

• -1.5 (using arc-elasticity formula: (ΔQ/Q_avg) / (ΔP/P_avg) ).

(2) [Cross-price elasticity of demand: 8 pts]

1. substitutes, 1/5 = 0.2.
2. complements, -1/4 = -0.25.

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

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

(4) [Using income elasticities: 10 pts]

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

(5) [Welfare effects of international trade: 18 pts] International price = $6.

1. $4.
2. export.
3. 6 million.
4. decrease.
5. $10 million.
6. increase.
7. $16 million.
8. increase.
9. $6 million.

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

1. $5.
2. 6 thousand.
3. excess demand.
4. 3 thousand.
5. decrease.
6. $7 thousand.
7. increase.
8. $4 thousand.
9. $3 thousand.

(7) [Welfare effects of tax or subsidy: 18 pts] Tax = $6. Under this tax, P_D = P_S + 6, so in equilibrium, the demand curve must be higher than the supply curve by $6. Both consumers and producers lose from a tax, but government gains tax revenue.

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

III. Critical thinking

Same as Version A.

[end of answer key]