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U of M ECON 1101 - Midterm1_2012_Guide

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This is the midterm 1 solution guide for Fall 2012 Form A. 1) The answer to this question is A, corresponding to Form A. 2) Since widgets are an inferior good (like ramen noodles) and income increases, the demand curve will shift to the left. The suppl y curve does not shift. The quantity and price will both decrease. The answer is D. 3) If the price of smidgets increases, where smidgets and widgets are complements, the demand curve for widgets will shift to the left. The supply curve does not shift. The quantity and price will both decrease. The answer is D. 4) The price of wood increases. Wood is an input in the production of widgets. This causes the supply curve to shift to the left. The demand curve does not shift. The quantity decreases and the price increases. The answer is B. 5) Two things happen: (i) the price of smidgets increases; (ii) the price of wood increases. Smidgets and widgets are complements, so the demand curve for widgets will shift to the left. Wood is an input in the production of widgets, so the supply curve to shift to the left. The quantity decreases (since both the supply shift and the demand shift put downward pressure on quantity) and we can’t tell what happens to price (because the demand curve shift puts downward pressure on price, and the supply curve shift puts upward pressure on price). The answer is B. 6) The price of an input for production went up; this is a shifter for our supply curve. Demand is unchanged. If demand was perfectly inelastic, then quantity would be unchanged and the equilibrium price would rise. On the opposite end, if demand is perfectly elastic, then the price is unchanged and the equilibrium quantity falls, which is exactly the situation described in the question. The answer is C. 7) We know that the less elastic part of the market bears the burden of taxation. Also we know that when demand is perfectly inelastic, the demand curve is a vertical line, which is equivalent to say that the demanded quantity is constant for any price. So here demand is less elastic (it’s perfectly inelastic!) so buyers pay the tax and since demand is perfectly inelastic, the equilibrium quantity is unchanged. The answer is B. 8)D1 and S1, who are respectively the consumer that value the widget the most and the most efficient producer, are out, so this violates 2 of our efficiency principles. (a) and (b) can’t be right, since D7 values the widget less than $5 (so he’s not better off if he consumes and pays $5) and also S7 has a cost of production of $7, so he won’t be better off if he sells the widget for $5. (c) is wrong because it’s not feasible: we have only 5 widgets in the original situation, and if nobody gives up anything in exchange for something else (trading), D1 and S1 are just out. (d) works: S6 has a cost of $6 to produce, so he can just pay $3 to S1, that will spend only $1 to produce the wi dget and will then make a profit: both are better off, nobody is worse off and the allocation is feasible. The answer is D. 9)Price ceiling means that nobody can sell for more than $3. At that price there is excess demand: only 3 producers are willing to sell the widget but 7 consumers will be willing to buy. Not only the quantity is too low, but we don’t even know who’s going to consume. We know that the most efficient producers will sell: so (c) and (d) are wrong. (a) is wrong because D9 values the widget less than $3, so he/she will never buy for $3. (b) works: D6 values the widget $4 and he/she might end up buying the widget while D1, who values the widget more, might not. The answer is B. Variable Free Market $4 Tax Change Q 6 2 ‐4PD 2 6 4PS 2 2 0CS 18 2 ‐16PS 0 0 0G 0 8 8TS 18 10 ‐8 Note that the producer surplus(PS) is the area above the supply curve(S) and below the suppl ier price(PS). Since in this market S= PS, PS=0. 10) Without externalities, the efficient output level is the free market equilibrium quantity, 6. The answer is C. 11) As you can see in the graph, the $4 tax brings the equilibrium quantity to 2, and PD becomes 6. The answer is C. 12) The consumer surplus (CS) is the area below the demand curve(D) and above the consumer price (PS), which is the area colo red in pink in the graph above. So CS = 2 x 2 x 0.5 = 2. The answer is B. 13) TS = CS + PS + G. With tax, G = 4 x 2 =8 ($4 tax per unit, for 2 units), and corresponds to the rectangle in green. So with $4 Tax TS = 2 + 0 + 8 = 10. TS in the free market was 18, so with tax TS has changed by ‐8. The answer is D. 14) When the government limits quantity to 4 units in the market, this means that the market price of the good is $4, since at $4, exactly 4 people (D1, D2, D3, D4) are willing to buy the item. Remember now that the market price of a quota must be such that the cost of the last seller selling plus the price of the quota is equal to the market price of the good. In other words, the marginal seller must break even. Thus, we are trying to find the price of the quota such that when we add the quota price onto the last producer’s cost, we will get exactly $4. Since the cost is always $2 for suppliers, the price of the quota must be $2 in order for there to be exactly 4 sellers in the market. We see that this is the equilibrium price of a quota because at $2, there are 4 units of quotas being sold and 4 units of quota being demanded. The answer is C. 15) We can simply calculate the market value at each quota to see which one maximizes the market value of quota. Starting with a quota of 2, we see that the market price of quota will be $4. Since there are two units of quotas, the total market value is 2 times $4, or $8. At a quota of 3, the market value of quota is $3. Thus, the total market value is $9. At a quota of 4, as we found in the previous question, the market value of a quota is $2. Thus, the total market value is $8. At a quota of 5, the market value of a quota is $1, so the total market value of quotas is $5. Lastly, when there is a quota of 6 units, the quota has no value, since the free marke t quantity is at 6, and a quota does not limit the market at all. We see then that the quota market …


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U of M ECON 1101 - Midterm1_2012_Guide

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