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

### Version A

I. Multiple choice

(1)c. (2)c. (3)b. (4)a. (5)a. (6)a. (7)b. (8)d. (9)a. (10)e.
(11)e. (12)b. (13)c. (14)a. (15)a. (16)a. (17)b. (18)b. (19)d. (20)a.
(21)f. (22)b. (23)e. (24)d. (25)c. (26)b. (27)b. (28)b. (29)d. (30)b.
(31)b. (32)a. (33)c. (34)b. (35)a. (36)d.

II. Problems

(1) [Market equilibrium: 12 pts] First use the graph to draw demand and supply curves. The curves should have stairsteps, similar to those for the trading activity we did in class.

1. excess supply, because quantity demanded is 2-3 and quantity supplied is 5.
2. \$5.
3. 4 units.
4. \$20 (= price × quantity).
5. \$40.

(2) [Shifts in demand and supply: 15 pts] Full credit requires accurate graphs.

1. right, unchanged, increase, increase.
2. unchanged, left, increase, decrease.
3. left, left, cannot be determined, decrease.

(3) [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, because the increase in price is less than the decrease in quantity.
5. 3 percent, using approximation formula: percent change in revenue = percent change in price + percent change in quantity.

(4) [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.

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

1. 4 burritos and 5 nachos because on a higher indifference curve.
2. 7 burritos and 7 nachos because on a higher indifference curve.
3. Budget line A is a straight line with intercepts at 10 burritos and at 15 nachos.
4. 6 burritos, the tangency point.
5. Budget line B is a straight line with intercepts at 6 burritos and 15 nachos.
6. 4 pizzas, the tangency point.
7. (P,Q) = (\$10,4), (\$6,6).

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

1. \$6 thousand (= 500 × SATC).
2. \$2 thousand (= 500 × SAVC).
3. \$4 thousand (= STC - SVC).
4. \$3 (= SMC).
5. \$7 (= minimum SATC).
6. \$3 (= minimum SAVC).
7. 0 parts, because price < shutdown price.
8. loss, because no revenue but still must pay fixed cost.
9. 1100 parts, using the rule P=MC.
10. loss, because price < breakeven price.

(7) [Economy-wide efficiency: 16 pts]

1. 3 units of clothing.
2. 1/3 units of food.
3. \$9, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 3 units of clothing, then the price of a unit of food must be 3 times the price of a unit of clothing.
4. Anna's budget line should have intercepts at 60/6=10 units of food and 60/12=5 units of clothing.
5. 3 units of clothing, same as PP curve.
6. 1/3 units of food, same as PP curve.
7. 2 units of food, at tangency between budget line and highest indifference curve that Anna can reach.
8. 3, because at a tangency the slope of her indifference curve (MRS) must equal the slope of her budget line.

(8) [Competition versus collusion: 16 pts]

1. 10 million.
2. \$5 = marginal cost = height of supply curve.
3. \$5. Note that perfect competition yields marginal-cost pricing.
4. Since demand curve is linear, MR curve must have same intercept and twice the slope. So MR curve should have intercept at \$10 on price axis, and slope = -1/1 million.
5. 6 million, where MR = MC.
6. \$4 = marginal cost = height of supply curve.
7. \$7, on demand curve.
8. \$6 million, the area of a triangle between demand curve, joint MC curve, and vertical line at cartel quantity (6 million).

(9) [Nonrival goods: 6 pts]

1. Zero miles because MC > MB for all positive values of Q.
2. MSB = 1000 (50-5Q) = 50,000 - 5000 Q.
3. 6 miles (found by setting MSB = MC and solving for Q).

(10) [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 (15 minutes), at the socially optimal number of cars.

(11) [Externalities: 12 pts] Trees evidently provide an external benefit.

1. \$40, at intersection of demand and supply.
2. 60, at intersection of demand and supply.
3. 100, at intersection of marginal social benefit and supply.
4. \$800, the area of the triangle between marginal social benefit, supply, and a vertical line at 60, the unregulated quantity. Deadweight loss is the gap between the benefit to society and the cost of all those units that should have been produced.
5. subsidy, to increase the quantity to the socially-optimal quantity.
6. \$30, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(12) [Regulating pollution: 20 pts]

1. Factories F and G, the factories with the lowest clean-up costs.
2. \$20.
3. Each factory's willingness-to-pay for a permit equals its annual cost of cleanup. Graph should show six downward stairsteps. The stairstep at \$40 is twice as wide because two factories have this same cost of cleanup.
4. Factories A, B, C, D, and E, which have the highest clean-up cost and are therefore willing to pay the most for a permit.
5. \$20, between the price that Factory E is willing to pay and the next-highest willingness to pay.
6. \$20.
7. \$20. Every factory except F and G would rather clean up than pay the fee.
8. \$20.

III. Critical thinking [4 pts]

(1) A nonrival good is a good whose consumption by one person does not necessarily preclude consumption by another. Examples might include roads, biketrails, parks, websites, television shows, etc.

(2) In country X, the energy industry causes substantial external costs, so that too much energy is produced. This corresponds to point A on the graph. If less energy and more food were produced, the country could reach a higher indifference curve.

### Version B

I. Multiple choice

(1)e. (2)c. (3)a. (4)b. (5)a. (6)b. (7)b. (8)d. (9)b. (10)c.
(11)a. (12)e. (13)b. (14)b. (15)b. (16)b. (17)a. (18)a. (19)c. (20)f.
(21)e. (22)a. (23)e. (24)b. (25)a. (26)d. (27)b. (28)c. (29)b. (30)c.
(31)b. (32)a. (33)c. (34)b. (35)a. (36)d.

II. Problems

(1) [Market equilibrium: 12 pts] First use the graph to draw demand and supply curves. The curves should have stairsteps, similar to those for the trading activity we did in class.

1. excess demand, because quantity demanded is 5 and quantity supplied is 1-2.
2. \$10.
3. 5 units.
4. \$50 (= price × quantity).
5. \$43.
6. sellers.

(2) [Shifts in demand and supply: 15 pts] Full credit requires accurate graphs.

1. unchanged, right, decrease, increase.
2. right, unchanged, increase, increase.
3. right, left, increase, cannot be determined.

(3) [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, because the increase in price is greater than the decrease in quantity.
5. 2 percent, using approximation formula: percent change in revenue = percent change in price + percent change in quantity.

(4) [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.

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

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

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

1. \$6 thousand (= 500 × SATC).
2. \$3 thousand (= 500 × SAVC).
3. \$3 thousand (= STC - SVC).
4. \$6 (= SMC).
5. \$8 (= minimum SATC).
6. \$5 (= minimum SAVC).
7. 1300 parts, using the rule P=MC.
8. profit, because price > breakeven price.
9. 0 parts, because price < shutdown price.
10. loss, because no revenue but still must pay fixed cost.

(7) [Economy-wide efficiency: 16 pts]

1. 1/2 units of clothing.
2. 2 units of food.
3. \$6, because in competitive equilibrium, prices reflect opportunity costs for the economy as a whole: if the opportunity cost of a unit of food is 1/2 units of clothing, then the price of a unit of food must be 1/2 times the price of a unit of clothing.
4. Anna's budget line should have intercepts at 60/6=10 units of food and 60/12=5 units of clothing.
5. 1/2 units of clothing, same as PP curve.
6. 2 units of food, same as PP curve.
7. 3 units of clothing, at tangency between budget line and highest indifference curve that Anna can reach.
8. 1/2, because at a tangency the slope of her indifference curve (MRS) must equal the slope of her budget line.

(8) [Competition versus collusion: 16 pts]

1. 9 million.
2. \$3 = marginal cost = height of supply curve.
3. \$3. Note that perfect competition yields marginal-cost pricing.
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. 5 million, where MR = MC.
6. \$2 = marginal cost = height of supply curve.
7. \$7, on demand curve.
8. \$10 million, the area of a triangle between demand curve, joint MC curve, and vertical line at cartel quantity (5 million).

(9) [Nonrival goods: 6 pts]

1. Zero miles because MC > MB for all positive values of Q.
2. MSB = 2000 (50-5Q) = 100,000 - 10000 Q.
3. 8 miles (found by setting MSB = MC and solving for Q).

(10) [Common property resources: 6 pts]

1. 1000 cars, where marginal private benefit equals zero.
2. 500 cars, where marginal social benefit equals zero.
3. \$2, the dollar equivalent of marginal private benefit (10 minutes), at the socially optimal number of cars.

(11) [Externalities: 12 pts] The chemical evidently creates an external cost.

• \$3, at intersection of demand and supply.
• 10 million liters, at intersection of demand and supply.
• 6 million liters, at intersection of marginal social cost and demand.
• \$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.
• tax, to decrease the quantity to the social optimum.
• \$5 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(12) [Regulating pollution: 20 pts]

1. Factories E, F and G, the factories with the lowest clean-up costs.
2. \$45.
3. Each factory's willingness-to-pay for a permit equals its annual cost of cleanup. Graph should show six downward stairsteps. The stairstep at \$40 is twice as wide because two factories have this same cost of cleanup.
4. Factories A, B, C, and D, which have the highest clean-up cost and are therefore willing to pay the most for a permit.
5. \$30, between the price that Factory D is willing to pay and the next-highest willingness to pay.
6. \$45.
7. \$30. Every factory except E, F, and G would rather clean up than pay the fee.
8. \$45.

III. Critical thinking

Same as Version A.