These are solutions to Fall 2013’s Econ 1101 Midterm 1. No guarantees are made that this guide is error free, so please consult your TA or instructor if anything looks wrong. 1) If the price of sweeteners, a complementary good to coffee, decreases. This causes a shift in the demand curve (since the price of a related good changes). Demand will shift up and to the right, w hile the supply curve is unchanged. This results in an increase in the equilibrium price and quantity of coffee. The answer is A. 2) Incomes decrease. Income is a determinate of demand, so this causes the demand curve to shift. We are told to assume that coffee is an inferior good, so this means that a decrease in income will cause the demand curve to shift up and to the right (the supply curve is again unchanged). This results in an increase in the equilibrium price and quantity of coffee. The answer is A. 3) Two things happen, (i) technology improves the ef ficiency of harvesting coffee and (ii) tem perature falls and more people buy coffee. The first event (technological improvement) causes the supply curve to shift. Improved technology means that it is cheaper to prod uce coffee which will result in the supply curve shifting out to the right. The second event (temperature falls and more people buy coffee) is a seasonal change in consumer tastes that causes the demand curve to shif t up and to the left. Both the first and second events result in the equilibrium quantity of coffee increasing. However, the supply shift will put downward pressure on price and the demand shift will result in upward pressure on price. Therefore the net effect on price is ambiguous. The answer is C. 4) Income increases by 31% and the quantity demanded of spam increases by 32%. This tells us nothing about the price elasticity of spam, so we can rule out answers a‐c. For a normal good, if income increases quantity demand ed increases, which is what we are observing here with spam. Therefore spam is a normal good. The answer is D. 5) Since quantity demanded of widgets stayed the same, one of the curves will be perfectly inelastic. It cannot be the demand curve that is perfectly inelastic, however, since income increases and will cause the demand curve to shift to the right. This means that the supply is perfectly inelastic. The demand, therefore, just needs to be something that is not perfectly inelastic, and so the demand being unit elastic is a possible case. The answer is A. 6) Consumer surplus is the red area in the following graph. It is 0.5*5*5=12.5. The answer is C. 7) Producer surplus is the red area in the following graph. It is 0.5*3*5=7.5. The answer is A. 8) For an $8 tax, we can draw a tax wedge like in the graph above. Here quantity will be zero. No one produces and no one consumes. Therefore consumer surplus is zero. The answer is A. 9) Since no one produces, nothing can be taxed on. Government receives zero tax revenue. The answer is A. 10) An $8 tax gives zero CS and zero PS, so TS=0. Compare to the free market allocation, the DWL is the entire triangle on the left. Area of this triangle is (1/2)*(9‐1)*5=20. Or you could add up your answers in Question 6 and 7 to get the TS in free market. The answer is D. 11) When there is a price floor that is above the equilibrium price (such as in this case), we see that we will have a binding price floor. A binding price floor will cause the quantity supplied to be higher than the quantity demanded in this market. In other words, there are more suppliers (10 of them) that want to sell than there are buyers (2 of them) who want to buy. We know that the quantity in the market will be 2, since at a price of $7, only 2 people would want to buy. Those two people will be the two that values a widget at the highest – and they will be D1 and D2. Because of this, we know that the consumer surplus will be based on the consumer surplus of these two consumers. The area of their consumer surplus is the red triangle in the diagram above. The area of this triangle is 2 (base is 2, height is 2, so ½ x base x height = 2). The answer is B. 12) As mentioned above, there are 10 producers who want to sell but only 2 consumers who want to buy. Because of this, only 2 out of the 10 producers will get to sell the widget. Because no rule for rationing is given, we don’t know which two of the ten suppliers will be selling widgets in this market. Because of that, we do not have enough information to know what producer surplus is. The answer is E. 13) From the $8 tax, we saw that the quantity was brought to zero, and so deadweight loss was equal to the entire area of the free market total surplus (since, the market with a tax has a total surplus of 0). We see that while the price floor is inefficient, it is not so inefficient such that the total surplus will be zero. At the very least, we will have some area for consumer surplus and some minimal area for producer surplus. Therefore, this price floor is more efficient (since it has higher total surplus) than a tax of $8. The answer is A 14) The First Welfare Theorem states that under competitive markets without externalities, market allocation is Pareto efficient; that is, market allocation maximizes the total surplus (the social pie). Remember that the Pareto efficient concept is not related with equity of an allocation. The answer is E. 15) A good is defined luxury good if it is income elastic; that is, if the percentage increase in the quantity demanded is higher than the percentage increase in income. This implies that the share of income you spend on cheesecake increases. The answer is E. 16) To calculate the price elasticity of demand we need a change in the price of the corn while all the other forces affecting supply and/or demand remains constant. So, it is necessary to have a change in the price of corn. The answer is C. 17) A price ceiling is a maximum price allowed for sale in a market. Remember that a price ceiling is only binding, that is it actually affects the equilibrium of the market, when the free market equilibrium price is higher than the price ceiling. In the market for flowers, the equilibrium price is $12. The price ceiling of $6 would be binding here because the ceiling prevents the market from reaching the price it wants of $12. At the equilibrium price of $12, it would have been that su pply = demand. At any lower price than $12, it should be that