ECON 002 - Principles of Microeconomics Drake University, Fall 2021 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

(1) [Calculating elasticities: 2 pts]

• -0.75, using arc-elasticity formula (ΔQ/Qavg) / (ΔP/Pavg) .

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

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

(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. luxury (or superior) good.
2. increase.
3. 10 percent.
4. increase.
5. 6 percent.

(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) [Welfare effects of market controls: 18 pts] Price floor = \$5.

1. \$3.
2. 4 million.
3. excess supply.
4. 6 million.
5. increase.
6. 7 million.
7. decrease.
8. \$10 million.
9. \$3 million.

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

1. 6 thousand.
2. \$6 per rake.
3. \$9 per rake.
4. decrease.
5. \$7 thousand.
6. decrease.
7. \$14 thousand.
8. \$18 thousand.
9. \$3 thousand.

III. Critical thinking [4 pts]

(1) a. The study indicates that marijuana and tobacco cigarettes are complements for young people because the quantity of marijuana consumed is negatively related to the price of tobacco cigarettes.
b. The cross-price elasticity is defined as the percent change in quantity of one good divided by the percent change in the price of the other good. Therefore the cross-price elasticity is -12/10 = -1.2 for young people, according to this study. Complements always have a negative cross-price elasticity.

(2) A maximum price on smoke alarms would decrease the number of homes that have smoke alarms. A maximum price, or price ceiling, pushes price below the equilibrium price. The quantity demanded increases and the quantity supplied decreases, causing excess demand (a shortage). Because sellers are not willing to supply as many smoke alarms at the lower controlled price, the quantity actually sold to homeowners decreases. (Full credit requires a graph showing demand, supply, and a horizontal line at the price ceiling, below the equilibrium price. The quantity sold before and after the price ceiling should be marked.)

### Version B

I. Multiple choice

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

II. Problems

(1) [Calculating elasticities: 2 pts]

• -3, using arc-elasticity formula (ΔQ/Qavg) / (ΔP/Pavg) ).

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

1. substitutes, 1/10 = 0.1.
2. complements, -2/5 = -0.4.

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

1. elastic.
2. decrease.
3. 10 percent.
4. decrease.
5. 6 percent.

(4) [Using income elasticities: 10 pts]

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

(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) [Welfare effects of market controls: 18 pts] Price ceiling = \$2.

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

(7) [Welfare effects of tax or subsidy: 18 pts] Subsidy = \$3. Under this subsidy, PD + 3 = PS, 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. 10 thousand.
2. \$8 per shovel.
3. \$5 per shovel.
4. increase.
5. \$9 thousand.
6. increase.
7. \$18 thousand.
8. \$30 thousand.
9. \$3 thousand.

III. Critical thinking

Same as Version A.