ECON 002 - Principles of Microeconomics Drake University, Spring 2024 William M. Boal

### Version A

I. Multiple choice

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

II. Problems

1. 1/2 car.
2. 1 car.
3. 2 motorcycles.
4. 1 motorcycle.
5. Country X, because it has lower opportunity cost of producing motorcycles
6. Country Y, because it has lower opportunity cost of producing cars.
7. Both countries can consume combinations of products outside their individual production possibility curves if Country Y exports three cars to Country X, which exports 4 (or 5) motorcyles 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. left, unchanged, decrease, decrease.
2. unchanged, right, decrease, increase.
3. right, right, cannot be determined, increase.

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

1. inferior good, because an increase in income causes a decrease in the quantity demanded.
2. -1/5=-0.2, using formula: percent change quantity / percent change income.

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

1. inelastic, because price elasticity is less than one in absolute value.
2. decrease.
3. 3 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.

(5) [Welfare analysis of international trade: 18 pts] International price = \$4.

1. \$7.
2. import, because quantity supplied is now less than quantity demanded.
3. 4 million = quantity demanded minus quantity supplied.
4. increase, because price fell.
5. \$14 million = area of trapezoid bounded by new and old prices and demand curve.
6. decrease, because price fell.
7. \$10 million = area of trapezoid bounded by new and old prices and supply curve.
8. increase, because consumers gain more than producers lose.
9. \$4 million = increase in consumer surplus minus decrease in producer surplus. Note that consumer's gain is greater than producers' loss, so international trade passes the compensation test.

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

1. 8 sub sandwiches and 7 gallons of gasoline.
2. 6 sub sandwiches and 6 gallons of gasoline.
3. Budget line A is a straight line with intercepts at 10 sub sandwiches and at 15 gallons of gasoline.
4. 6 sub sandwiches (at the tangency point).
5. Budget line B is a straight line with intercepts at 5 sub sandwiches and at 15 gallons of gasoline.
6. 4 sub sandwiches (at the tangency point).
7. (P,Q) = (\$6,6), (\$12,4).

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

1. \$5 thousand (= 500 × SATC).
2. \$3 thousand (= 500 × SAVC).
3. \$2 thousand (= STC - SVC).
4. \$13 (= SMC).
5. \$7 (= minimum SATC).
6. \$5 (= minimum SAVC).
7. zero parts (because price is less than shutdown price).
8. loss (profit = -SFC, because firm has shut down).
9. 1400 parts, using the rule P=MC.
10. profit (because price is greater than breakeven price).

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

1. 3 units of clothing.
2. 1/3 units of food.
3. \$5, 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. Carmen's budget line should have intercepts at 45/5=9 units of clothing and 45/5=9 units of food.
5. 3 units of clothing, same as country's PP curve.
6. 1/3 units of food, same as country's PP curve.
7. 2 units of clothing, at tangency between budget line and highest indifference curve that Carmen can reach.
8. 3, because at the tangency, the |slope| of her indifference curve (MRS) must equal the slope of her budget line.

(9) [Monopoly: 12 pts]

1. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$12 on price axis, and slope = -2/1 thousand.
2. 4 thousand, where MR=MC.
3. \$8, on demand curve.
4. \$24 thousand = TR - TC = (price × quantity) - (AC × quantity).
5. \$8 thousand = area of triangle between monopoly price (\$8), demand curve, and vertical axis.
6. \$4 thousand = area of triangle between demand curve, MC curve, and vertical line at monopoly quantity (4 thousand).

(10) [Nonrival goods: 6 pts]

1. Zero concerts because MC > MB for all positive values of Q.
2. MSB = 1000 (10-2Q) = 10,000 - 2,000 Q.
3. 3 concerts (found by setting MSB = MC and solving for Q).

(11) [Common property resources: 6 pts]

1. 800 cars, where marginal private benefit equals zero.
2. 400 cars, where marginal social benefit equals zero.
3. \$4, the dollar equivalent of marginal private benefit (20 minutes), at the socially optimal number of traps.

(12) [Externalities: 12 pts] The vaccine evidently provides an external benefit.

1. \$4, at intersection of demand and supply.
2. 6 million, at intersection of demand and supply.
3. 12 million, at intersection of marginal social benefit and supply.
4. \$12, 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 of all those units that should have been produced.
5. subsidy, to increase the quantity to the socially-optimal quantity.
6. \$3, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(13) [Regulating pollution: 20 pts]

1. Factories A, B, C, and E, the factories with the lowest clean-up costs.
2. \$80.
3. Each factory's willingness-to-pay for a permit equals its annual cost of cleanup. Graph should show five downward stairsteps.
4. Factory D, which has the highest clean-up cost and is therefore willing to pay the most for a permit.
5. \$40, between the price that Factory D is willing to pay and the next-highest willingness to pay (Factory B).
6. \$80.
7. \$40. Only Factory D would rather pay this fee than clean up.
8. \$80.

III. Critical thinking [4 pts]

(1) In Fredonia, the governmlent has imposed a price floor on energy, so that too little energy is produced and consumed because the price is artificially raised above marginal cost. This corresponds to point B on the graph. (Evidently, if more energy and less food were produced, Fredonia could reach a higher indifference curve.)

(2) In Fredonia, the energy industry causes substantial external costs, so that too much energy is produced and consumed because the price is below marginal social cost. This corresponds to point A on the graph. (Evidently, if less energy and more food were produced, Fredonia could reach a higher indifference curve.)

### Version B

I. Multiple choice

(1)d. (2)d. (3)b. (4)b. (5)d. (6)a. (7)b. (8)d. (9)a. (10)b.
(11)b. (12)c. (13)a. (14)c. (15)b. (16)b. (17)d. (18)a. (19)b. (20)d.
(21)c. (22)a. (23)b. (24)d. (25)a. (26)b. (27)d.

II. Problems

1. 1 unit of wheat.
2. 1/2 unit of wheat.
3. 1 unit of corn.
4. 2 units of corn.
5. Farmer B, because has lower opportunity cost of producing corn.
6. Farmer A, because has lower opportunity cost of producing wheat.
7. Both farmers can consume combinations of products outside their individual production possibility curves if Farmer A sends two units of wheat to Farmer B, who sends 3 units of corn in return.
8. Plot should show each farmer'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) [Income elasticity of demand: 4 pts]

1. luxury (or superior) good, because the percent change in quantity is greater than the percent change in income.
2. 2/3 = 1.5, using formula: percent change quantity / percent change income.

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

1. elastic, because price elasticity is greater than one in absolute value.
2. decrease.
3. 6 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. 1 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 = \$10.

1. \$8.
2. export, because quantity supplied is now greater than quantity demanded.
3. 4 million = quantity supplied minus quantity demanded.
4. decrease, because price rose.
5. \$12 million = area of trapezoid bounded by new and old prices and demand curve.
6. increase, because price rose.
7. \$16 million = area of trapezoid bounded by new and old prices and supply curve.
8. increase, because producers gain more than consumers lose.
9. \$4 million = increase in producer surplus minus decrease in consumer surplus. Note that producer's gain is greater than consumers' loss, so international trade passes the compensation test.

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

1. 3 sub sandwiches and 5 gallons of gasoline.
2. 5 sub sandwiches and 6 gallons of gasoline.
3. Budget line A is a straight line with intercepts at 10 sub sandwiches and at 15 gallons of gasoline.
4. 9 gallons of gasoline (at the tangency point).
5. Budget line B is a straight line with intercepts at 10 sub sandwiches and at 10 gallons of gasoline.
6. 7 gallons of gasoline (at the tangency point).
7. (P,Q) = (\$4,9), (\$6,7).

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

1. \$6 thousand (= 2000 × SATC).
2. \$2 thousand (= 2000 × SAVC).
3. \$4 thousand (= STC - SVC).
4. \$3 (= SMC).
5. \$5 (= minimum SATC).
6. \$2 (= minimum SAVC).
7. 1300 parts, using the rule P=MC.
8. loss, because price is less than breakeven price.
9. 1600 parts, using the rule P=MC.
10. profit, because P is greater than breakeven price.

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

1. 1/2 units of clothing.
2. 2 units of food.
3. \$8, 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. Carmen's budget line should have intercepts at 40/8=5 units of clothing and 40/4=10 units of food.
5. 1/2 units of clothing, same as country's PP curve.
6. 2 units of food, same as country's PP curve.
7. 3 units of clothing, at tangency between budget line and highest indifference curve that Carmen can reach.
8. 1/2, because at the tangency, the |slope| of her indifference curve (MRS) must equal the slope of her budget line.

(9) [Monopoly: 12 pts]

1. Since demand curve is linear, MR curve must also be linear and have same intercept and twice the slope as demand. So MR curve should have intercept = \$14 on price axis, and slope = -1/1 thousand.
2. 8 thousand, where MR=MC.
3. \$10, on demand curve.
4. \$48 thousand = TR - TC = (price × quantity) - (AC × quantity).
5. \$16 thousand = area of triangle between monopoly price (\$10), demand curve, and vertical axis.
6. \$8 thousand = area of triangle between demand curve, MC curve, and vertical line at monopoly quantity (8 thousand).

(10) [Nonrival goods: 6 pts]

1. Zero concerts because MC > MB for all positive values of Q.
2. MSB = 1000 (20-2Q) = 20,000 - 2,000 Q.
3. 8 concerts (found by setting MSB = MC and solving for Q).

(11) [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 traps.

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

1. \$4, at intersection of demand and supply.
2. 7 million liters, at intersection of demand and supply.
3. 5 million liters, at intersection of marginal social cost and demand.
4. \$4 million, the area of the triangle between marginal social cost, demand, and a vertical line at 7 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. \$3 per liter, which equals the vertical gap between demand and supply and the socially-optimal quantity.

(13) [Regulating pollution: 20 pts]

1. Factories A, C, and E, 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 five downward stairsteps.
4. Factories B 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 B is willing to pay and the next-highest willingness to pay (Factory C).
6. \$45.
7. \$30. Only Factory D would rather pay this fee than clean up.
8. \$45.

III. Critical thinking

Same as Version A.