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

### Version A

I. Multiple choice

(1)e. (2)d. (3)d. (4)b. (5)a. (6)c. (7)b. (8)c. (9)b. (10)e. (11)b. (12)a. (13)b. (14)a. (15)c. (16)b. (17)c.

II. Problems

1. 3 bicycles.
2. 1 bicycle.
3. 1/3 phones.
4. 1 phone.
5. Country Y, because it has lower opportunity cost of producing phones.
6. Country X, 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 X exports three bicycles to Country Y, which exports 2 phones 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, left, increase, cannot be determined.

(3) [Calculating elasticities: 2 pts]

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

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

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

(5) [Discounting: 4 pts]

1. \$44 = -600 + (200/1.05) + (500/1.052).
2. \$40 million = \$2 million / 0.05.

(6) [Monopoly price discrimination: 4 pts]

1. \$20 = MC / (1 + (1/ε)), where ε = elasticity for children.
2. \$27, using same formula, where ε = elasticity for adults.

(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.

(8) [Consumer choice and demand: 14 pts]

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

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

1. \$8 thousand (= 1000 × SATC).
2. \$3 thousand (= 1000 × SAVC).
3. \$5 thousand (= STC - SVC).
4. \$2 (= SMC).
5. \$8 (= minimum SATC).
6. \$2 (= minimum SAVC).
7. 800 parts, using the rule P=MC.
8. loss, because P is less than breakeven price.
9. 1200 parts, using the rule P=SMC.
10. profit, because P is greater than breakeven price.

(10) [Efficiency of competition: 16 pts]

1. \$8, the height of the demand curve.
2. \$5, the height of the supply curve.
3. increase.
4. by \$3 = \$8 - \$5.
5. \$2, the height of the demand curve.
6. \$8, the height of the supply curve.
7. increase.
8. by \$6 = \$8 - \$2.

(11) [Competition versus collusion: 16 pts]

1. 7 million.
2. \$5 = marginal cost = height of supply curve.
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 \$12 on price axis, and slope = -2/1 million.
5. 4 million, where MR = MC.
6. \$4 = marginal cost = height of supply curve.
7. \$8, on demand curve.
8. \$6 million, the area of a triangle

(12) [Nonrival goods: 4 pts]

1. Zero miles, because MC > MB for all positive values of Q.
2. MSB = 1000 (40-4Q) = 40,000 - 4000 Q.
3. 5 miles (found by setting MSB = MC and solving for Q).

(13) [Common property resources: 6 pts]

1. 1200 cars, where marginal private benefit equals zero.
2. 600 cars, where marginal social benefit equals zero.
3. \$3, the dollar equivalent of marginal private benefit, at the socially optimal number of cars.

(14) [Externalities: 12 pts]

1. \$3, 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, the unregulated quantity. 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. \$5 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(15) [Regulating pollution: 20 pts]

1. Factories A and 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, and E.
5. \$30.
6. \$40.
7. \$30.
8. \$40.

III. Critical thinking [4 pts]

(1) People prefer to use money because it is more convenient. Barter requires a "double coincidence of wants." In other words, the each person must want what the other person has and must have what the other person wants. This rarely holds. For example, the grocer may have the tomatoes I want, but probably does not want what I have to offer (economics lectures). By contrast, everyone accepts money as payment because they can use it to buy anything else.

(2) YES, both countries can enjoy combination of goods outside their individual PP curves through specialization and trade. Here is an example. Country A produces 10 units of electronics and no cars. Country B produces 10 units of cars and no electronics. Country A then exports 5 units of electronics to Country B. In return, Country B exports 5 units of cars to Country A. Both countries then can consume 5 units of electronics and 5 units of cars, a combination that is clearly outside their individual PP curves. (Full credit requires that this trade be plotted on the graphs.)

### Version B

I. Multiple choice

(1)c. (2)d. (3)b. (4)a. (5)b. (6)e. (7)a. (8)f. (9)f. (10)d. (11)a. (12)b. (13)a. (14)c. (15)b. (16)a. (17)a.

II. Problems

1. 1/2 bicycle.
2. 2 bicycles.
3. 2 phones.
4. 1/2 phone
5. Country X, because it has lower opportunity cost of producing phones.
6. Country Y, 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 Y exports two bicycles to Country X, which exports 2 phones in return (3 phones would also work).
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) [Calculating elasticities: 2 pts]

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

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

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

(5) [Discounting: 4 pts]

1. \$-5 = -600 + (200/1.10) + (500/1.102). (negative!)
2. \$20 million = \$2 million / 0.10 .

(6) [Monopoly price discrimination: 4 pts]

1. \$18 = MC / (1 + (1/ε)), where ε = elasticity for children.
2. \$30, using same formula, where ε = elasticity for adults.

(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.

(8) [Consumer choice and demand: 14 pts]

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

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

1. \$7 thousand (= 500 × SATC).
2. \$3 thousand (= 500 × SAVC).
3. \$4 thousand (= STC - SVC).
4. \$5 (= SMC).
5. \$7 (= minimum SATC).
6. \$4 (= minimum SAVC).
7. zero parts, because P is less than the shutdown price.
8. loss, because price is less than breakeven price. (The loss is equal to the short-run fixed cost, which must be paid even when the firm is shut down.)
9. 1300 parts, using the rule P=MC.
10. loss, because P is less than breakeven price.

(10) [Efficiency of competition: 16 pts] *** Needs checking. ***

1. \$10, the height of the demand curve.
2. \$4, the height of the supply curve.
3. increase.
4. by \$6 = \$10 - \$4.
5. \$4, the height of the demand curve.
6. \$7, the height of the supply curve.
7. increase.
8. by \$3 = \$7 - \$4.

(11) [Competition versus collusion: 16 pts]

1. 12 million.
2. \$6 = marginal cost = height of supply curve.
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 = -1/1 million.
5. 8 million, where MR = MC.
6. \$4 = marginal cost = height of supply curve.
7. \$8, on demand curve.
8. \$8 million, the area of a triangle

(12) [Nonrival goods: 4 pts]

1. Zero miles, because MC > MB for all positive values of Q.
2. MSB = 500 (100-6Q) = 50,000 - 3000 Q.
3. 10 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. \$2, the dollar equivalent of marginal private benefit, at the socially optimal number of cars.

(14) [Externalities: 12 pts]

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

(15) [Regulating pollution: 20 pts]

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

III. Critical thinking

Same as Version A.