Guide to the Answers to Midterm 1, Fall 2010 (Form A)(This was put together quickly and may have typos. You should really think of it as an unofficial guide that might be of some use.) 1. First, it’s important to know what market we are looking at. The question states that it’s the market for sugar. So for #1, if scientists invent a new cost effective way to make ethanol out of sugar, then it means that the demand of sugar will go up (since you can now use sugar to make ethanol). Thus, if you draw the supply and demand diagram, this causes price and quantity to both go up. So the answer is A. 2. Right off the bet, you see that lowering cost of production process will shift the supply curve. More specifically, it shifts it to the right, which makes sense because the price drops. We also observe that the quantity moves up when there is a rightward shift of the supply curve. So the answer is C. 3. We are given that sugar and corn syrup are both used as sweeteners. This means that they are substitutes. Then if the price of a substitute falls, then we see that people will start buying corn syrup instead, so the demand for sugar will decrease. This causes a leftward shif t of the demand, and thus quantity and price both goes down. The answer is D. 4. If sugar is a necessity good, it means that it is also a normal good. A necessity good just means that the rise in the demand of that good is less than the increase in income. Keep in mind that this means the change is positive but not just as great. For example, if income goes up by 10%, a necessity good will be one that goes up by 2% or 5% (anything more than 0% and less than 10%). Thus, if income decreases, this means that being a normal good, the demand will fall. Thus, the answer is D. 5. We’ve already seen what happened in #2 and #3. This question is just putting the two together. If #2, we see that Q goes up and P goes down. In #3 we see that Q goes down and P goes down. Thus, we see that P goes down no matter what, but the change in Q is not clear since one causes it to go up and one causes it to go down. Thus, the answer is D. 6. First, rank the buyers from order of highest to lowe st (we want to put the one willing to pay the most first) and the sellers from lowest to highest (we want to put the one willing to sell for the lowest first). Then, we can see clearly that at $7, we have the price that clears the market since the buyer wants to buy at $7 and the seller wants to sell at $7. The answer is C. 7. Just counting down, we see that Brian, Dale, and Chuck will buy and Beth, Dolly, and Alice will sell. Thus, since each person is buying or selling only one thing, the quantity that clears the market is 3. The answer is D. 8. So we are given that price of widgets go up and quantity of widgets remain unchanged. First of all, we see that this is the case when the supply curve is completely vertical, which means it’s completely inelastic. Right away, since part of the question asks you what the elasticity of the supply curve is, you should try to draw it completely vertical or completely horizontal (we see that there’s an option for unit elastic as well, but we know that if it was unit elastic then quantity will have to change). But if the supply curve was horizontal, then we see that quantity does move with a shift in the demand curve but price stays the same. This is not what we want. So we see that if the supply curve is completely inelastic, then a shift in the demand curve can cause the result we are looking for. But which way does the demand curve shift? Well, since price goes up, we see that it shifts to the right. This means that the invention of smidgets increased demand for widgets, which means they must be complementary goods. So the answer is B. 9. By the First Welfare Theorem, we see that only 2 and 3 have to hold. The theorem and Pareto Optimal allocations say nothing about whether or not the good is normal, and a Pareto Optimal allocation also does not mean everyone gets the same amount. Remember that in a marke t where there are ten pies, giving 10 to person A and none to person B is a Pareto Optimal allocation, since you can’t make someone better off without making someone worse off. The answer then is B. 10. It must be true that the lowest cost producers produce. The other answers don’t make any sense or don’t have anything to do with an efficient allocation. The answer is D. 11. In a binding price floor, we see that producer surplus cannot be determined right away because it depends on the elasticity of the curves. (i.e. We are trying to compare the area that the producers lose from inefficiencies of the market to the rectangular area that they gain from the price floor). We also see that there is no way consumer surplus can increase with a price floor. Thus, the answer is A. 12. First notice right away that the allocati on is not efficient because it’s not at equilibrium. Thus, we can guess that it’s not Pareto efficient because of something to do with D4, D5, or S4, S5 – since there are actually allocations where everyone will gain if they were selling. We see that D makes this connection between S4 and D4, and if S4 sold his widget to D4 for $4.50, both S4 and D4 will be better off and as a result it’s an example to why the allocation where S1, S2, S3 produces and D1, D2, D3 each consume a widget is not a Pareto efficient allocation. The answer is D. 13. If there was a price ceiling at $4, this me ans that now anyone who wanted to buy at $4 can buy. This includes D1, D2, D3, D4, D5, and D6. Thus we know (1) is not true, and that (2) is true – since in the price ceiling, there will only be 4 units for sale on market and there are 6 people who would want to buy. (i.e. It could be D1, D2, D3, D4 buying or D1, D3, D4, D5 buying… who knows?) 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