This is the solution guide compiled by your instructors of Econ 1101 This is a guide for exam 2 form A If you had form B you can still figure from this guide what the answers to your questions are If you have any questions please contact your TAs or instructors 1 This is form A so the answer is A 2 From Buckeye s indifference curves 8 pizzas 16 sodas is on the second highest indifference curve IC from the above graph and the only bundle from choices on the same indifference curve is 32 pizzas 4 sodas which I also show in red point in the graph The answer is D 3 I show the budget constraint BC in blue line and the opportunity cost of one more pizza is just the slope of BC 32 8 4 sodas The answer is E 4 The tangent point on both BC and IC where marginal rate of substitution equals price ratio is just the optimal consumption bundle shown as black point on the graph 4 pizza 16 sodas 5 The new BC is shown in green and the new optimal consumption bundle is 8 pizza 16 sodas so consumption of pizza increased by 4 units The answer is B 6 To identify the income effect we draw a yellow line parallel to the new budget constraint and tangent to the original indifference curve and the tangent point is 6 pizza 11 sodas so the income effect on demand of pizza is the increment on pizza from this point to the new optimal consumption bundle 8 6 2 pizzas The answer is C 32 30 28 26 24 22 s20 o18 d16 a14 12 10 8 6 4 2 0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 pizza 7 As income decreases the budget constraint shifts inward in a parallel fashion because neither the price of pizza nor the price of soda changed The new budget constraint now intersects the pizza axis at Q 8 because income price 8 1 8 and the soda axis at Q 16 because income price 8 0 5 16 Buckeye s new optimal consumption bundle is pizza 4 soda 8 Now consider the three statements a TRUE When Buckeye s income was 16 he used to spend 50 of his income on pizza 1 8 8 Now Buckeye s income is 8 he is still spending 50 of his income on pizza 1 4 4 b FALSE Consumption of both pizza and soda decreases as income decreases This meets the definition of a normal good If either item were an inferior good instead e g ramen spam its consumption would increase instead of decrease when income decreases c FALSE Income elasticity Q Income Since both the numerator and the denominator are negative in this case the overall fraction is positive Income elasticity is positive Thus the correct answer is A 45 45 40 40 35 35 30 30 O r 25 a n 20 g e 15 s O r 25 a 20 n g 15 e s 10 U3 10 U2 5 U3 U2 5 U1 U1 0 0 0 5 10 15 20 25 30 Apples Robinson 35 40 45 0 5 10 15 20 25 30 35 Apples 40 45 Friday 8 A person has an absolute advantage in producing apples if he requires the least amount of resources per unit produced Robinson requires 1 hr apple while Friday requires 0 125hr apple 8 apples hr Thus Friday has an absolute advantage in producing apples A person has a comparative advantage in producing apples if he requires the least opportunity cost expressed in terms of number of oranges forgone per apple Opportunity cost of producing an apple is given by the slope of the person s budget constraint Robinson s budget constraint has slope 4 i e he has to sacrifice 4 oranges per apple produced i e his opportunity cost of producing each apple is 4 oranges Friday s budget constraint has slope 0 25 i e he has to sacrifice 0 25 oranges per apple produced i e his opportunity cost of producing each apple is 0 25 oranges Friday has a comparative advantage in producing apples Thus the answer is A 9 Optimal consumption bundles are defined as the point where the highest indifference curve is tangent to the budget constraint They are illustrated in the above diagrams Robinson s optimal consumption bundle is 5 apples 20 oranges The answer is E 10 When trade is possible each person will specialize in the good in which he has comparative advantage in Robinson has comparative advantage in oranges while Friday has comparative advantage in apples Thus Robinson produces 0 apples 40 oranges while Friday produces 40 apples 0 oranges Their common budget constraint under trade is 40 apples 40 oranges which is illustrated above in blue Both will consume the bundle 20 apples 20 oranges which is the point where the highest indifference curve is tangent to the new budget constraint under trade The answer is C 11 Let s consider each statement individually i FALSE MC is not required to be less than ATC at all quantities At any quantity where MC ATC quantity produced for each firm will simply be zero in the firm s LR supply curve In an industry LR equilibrium each firm can choose to produce at its profit maximizing quantity which is where ATC is at minimum This is also where ATC intersects MC ii FALSE The shape of the demand curve has no effect on the shape of the supply curve iii TRUE This is to ensure that all firms have the same cost curves I e a firm is more costly when it has worse technology This is necessary because all firms will then have the same profit maximizing price the minimum ATC which gives the price of the LR supply curve iv TRUE There cannot be barriers to entry because in the LR the industry s supply adjusts to changing demand by changing the number of firms not changing the amount of production within each firm v TRUE This is similar to iii This ensures that cost curves of firms do not change as the number of firms in the industry increases Thus the answer is C The following chart is for questions 12 18 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 26 25 MC ATC AVC q 0 1 2 3 4 5 6 7 8 9 10 11 12 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 D2 D1 0 300 600 900 1200 1500 1800 2100 Q 2400 12 Fixed cost equals 36 The correct answer is e To find the fixed cost note that AFC ATC AVC and FC Q AFC For example at a quantity of 6 ATC is 12 and AVC is 6 so AFC is 6 …