ECON 002 - Principles of Microeconomics
Drake University, Spring 2023
William M. Boal

EXAM 2 ANSWER KEY

Version A

I. Multiple choice

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

II. Problems

(1) [Calculating elasticities: 2 pts]

(2) [Cross-price elasticity of demand: 4 pts]

  1. complements.
  2. -4 percent / 20 percent = -1/5 = -0.2.

(3) [Income elasticity of demand: 4 pts]

  1. necessary good, because income elasticity < one.
  2. 3 percent / 10 percent = 3/10 = 0.3.

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

  1. inelastic, because price elasticity is less than one in absolute value.
  2. decrease.
  3. 6 percent, using definition: elasticity = percent change quantity divided by percent change price.
  4. increase.
  5. 2 percent, using approximation formula: percent change in revenue = percent change in price + percent change in quantity.

(5) [Welfare analysis of international trade: 18 pts] International price = $8.

  1. $6.
  2. export, because quantity supplied is now greater than quantity demanded.
  3. 8 million = quantity supplied minus quantity demanded.
  4. decrease, because price rose.
  5. $16 million = area of trapezoid bounded by new and old prices and demand curve.
  6. increase, because price rose.
  7. $24 million = area of trapezoid bounded by new and old prices and supply curve.
  8. increase, because producers gain more than consumers lose.
  9. $8 million = increase in producer surplus minus decrease in consumer surplus.

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

  1. $5.
  2. 5 million. That is the most that sellers are willing to sell at this price.
  3. excess demand, because quantity demanded is greater than quantity supplied at this price.
  4. 3 million = quantity demanded minus quantity supplied.
  5. decrease, because producers face a lower price.
  6. $6 million = area of trapezoid bounded by new and old prices and supply curve.
  7. increase.
  8. $3 million. Consumers enjoy an increase of $5 million in CS due to the lower price (the lower rectangle) but a decrease of $2 million in CS due to fewer units sold (the upper-right triangle).
  9. $3 million = decrease in producer surplus minus increase in consumer surplus = area of triangle. Note that producer's loss is greater than consumers' gain, so this price ceiling does not pass the compensation test.

(7) [Welfare analysis of tax or subsidy: 18 pts] Tax = $3. Under this tax, PD = PS + $3, so at the new equilibrium quantity, 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. 8 thousand.
  2. $5 per shovel, on the supply curve.
  3. $8 per shovel, on the demand curve.
  4. decrease, because the sellers' price fell.
  5. $9 thousand = area of trapezoid bounded by new and old prices for sellers and supply curve.
  6. decrease, because the buyers' price rose.
  7. $18 thousand = area of trapezoid bounded by new and old prices for buyers and demand curve.
  8. $24 thousand = new quantity times tax rate ($3).
  9. $3 thousand = area of deadweight-loss triangle.

III. Critical thinking

(1) One should disagree with this statement. Limiting the number of barbers will shift the supply curve to the left, increasing the equilibrium price of a haircut. So limiting the number of barbers would hurt consumers, although it would help barbers who are already in the market. (Full credit requires a supply-and-demand graph showing the effects of shifting supply to the left.) [One could also analyze this question as a quota on sellers, bending the supply curve up vertically. A quota on sellers would similarly increase the price and hurt consumers.]

(2) Consultant A is right because demand is inelastic according to the company statistician. Since the elasticity of demand is less than one in absolute value, the percent change in quantity demanded must be smaller in absolute value than the percent change in price along the demand curve. Now percent change in revenue = percent change in price + percent change in quantity. So if price is raised, the percent increase in price will be greater than the percent decrease in quantity, and revenue will increase. Conversely, if price is lowered as Consultant B recommends, the percent decrease in price will be greater than the percent increase in quantity, and revenue will decrease.


Version B

I. Multiple choice

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

II. Problems

(1) [Calculating elasticities: 2 pts]

(2) [Cross-price elasticity of demand: 4 pts]

  1. substitutes.
  2. 5 percent / 10 percent = 1/2 = 0.5.

(3) [Income elasticity of demand: 4 pts]

  1. luxury good or superior good, because income elasticity > one.
  2. 6 percent / 5 percent = 6/5 = 1.2.

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

  1. elastic, because price elasticity is greater than one in absolute value.
  2. decrease.
  3. 9 percent, using definition: elasticity = percent change quantity divided by percent change price.
  4. decrease.
  5. 3 percent, using approximation formula: percent change in revenue = percent change in price + percent change in quantity.

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

  1. $6.
  2. import, because quantity demanded is now greater than quantity supplied.
  3. 4 million = quantity demanded minus quantity supplied.
  4. increase, because price fell.
  5. $11 million = area of trapezoid bounded by new and old prices and demand curve.
  6. decrease, because price fell.
  7. $9 million = area of trapezoid bounded by new and old prices and supply curve.
  8. increase, because consumers gain more than producers lose.
  9. $2 million = increase in consumer surplus minus decrease in producer surplus.

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

  1. $5.
  2. 5 million. That is the most that consumers are willing to buy at this price.
  3. excess supply, because quantity supplied is greater than quantity demanded at this price.
  4. 6 million = quantity supplied minus quantity demanded.
  5. increase.
  6. $9 million. Producers enjoy an increase of $10 million in PS due to the higher price (the upper rectangle) but a decrease of $1 million (the lower-right triangle).
  7. decrease, because consumers face a higher price.
  8. $12 million = area of trapezoid bounded by new and old prices and demand curve.
  9. decrease, because consumers lose more than producers gain.
  10. $3 million = decrease in consumer surplus minus increase in producer surplus = area of triangle. Note that producer's gain is less than consumers' loss, so this price floor does not pass the compensation test.

(7) [Welfare analysis of tax or subsidy: 18 pts] Subsidy = $3. Under this subsidy, PD + 3 = PS, so at the new equilibrium quantity, the supply curve must be higher than the demand curve by $3. Both consumers and producers gain from a subsidy, but government pays.

  1. 12 thousand.
  2. $7 per shovel, on supply curve.
  3. $4 per shovel, on demand curve.
  4. increase, because sellers' price rose.
  5. $11 thousand = area of trapezoid bounded by new and old prices for sellers and supply curve.
  6. increase, because buyer's price fell.
  7. $22 thousand = area of trapezoid bounded by new and old prices for buyers and demand curve.
  8. $36 thousand = new quantity times subsidy rate ($3).
  9. $3 thousand = area of triangle.

[end of answer key]