Midterm I.Econ 101Professor GuseMonday October 16, 2006.Instructions. You have 55 minutes to complete the exam. There are 55 points available. Pleasewrite your responses on the exam itself in the space provided. If you require additional space, writeon the back of the page. You may refer only to your own handwritten, two-sided, “cheat sheet”.Calculators and all other references materials are not allowed. If a question asks for a numericquantity you may leave your answer in expression form for full credit. (e.g. “40−305” would beperfectly acceptable in place of “2”.) Be sure to label any diagrams you draw, to show your workand to explain your reasoning. Please turn in your cheat sheet with your exam. Thank you andgood luck!Name:Pledge:11. SHORT ANSWER (10 Points).(a) (4 points) In a classical short-run total product curve, if output is increasing at anincreasing rate theni. marginal product is increasing.ii. average product is increasing.iii. marginal cost is decreasing.iv. average variable cost is decreasing.GRADING: 4 Points for selecting all the right directions. 0 otherwise. (Note any othercombination has good chance of being selected randomly.)(b) (2 points) Johanna is willing to acce pt a loss of not more than 5 Republican seats inthe House of Representatives for a gain of 2 Republican seats in the Senate. Johanna’sof House seats for Senate seats is52.ANSWER: Marginal Rate of SubstitutionGRADING: 1 Point awarded for closely related notion of “marginal willingness topay”. Though this is not exactly correct, since what is being given up here is anothergood, not money.(c) (4 points) It takes Elisa 1 hour to bake a loaf of bread and 3 hours to catch a fish. Janetakes 2 hours to make a loaf of bread. Jane has comparative advantage over Elisa inbread making. What can you say about Jane’s fishing?ANSWER: Since Jane has a comparative advantage in bread making, it means thatfewer caught fish are given up when she bakes a loaf of bread. Note that Elisa must giveup13of a fish to bake a loaf. Jane therefore gives up less than13of a fish to bake a loaf.Since it takes Jane 2 hours to bake a loaf, this translates to at least 6 hours for Jane tocatch of fish.GRADING: 2 Points awarded for reasonable and correct discussion of comparativeadvantage without specifically mentioning the fact that we know it takes Jane at least6 hours to catch a fish.22. (20 points) Scrooge has wealth equal to $2000 which he can spend on two goods, currentconsumption and savings. The of price of current consumption is $1. The price of savings is$1.(a) (5 Points) In a diagram with current consumption on the horizontal axis and savings onthe vertical axis, draw Scrooge’s budget line. Label it “(a)”.(b) (10 Points) The government decides to tax current consumption over $1000 at a rate of$1 per $1. That is, Scrooge will not owe any tax if he spends $1000 or less in currentconsumption. However, if, for example, Scrooge spends $1060 in current consumption,he would have to pay a tax of $60. Draw his new budget line. Label it “(b)”.(c) (5 Points) Difficult. It turns out that under the new tax, Scrooge lowers his currentconsumption to exactly $1000. Moreover, the tax rate imposed was the lowest tax ratethat induces Scrooge to do this. Carefully draw Scrooge’s indifference curve runningthrough the point (1000, 1000). What is Scrooge’s MRS of savings for consumption atthat point? ANSWER. MRS = 2 dollars in savings per dollar in current consumptionat (1000, 1000).2000(b)(a)A Budget Line for a LowerTax Rate1000 1500 20001000Current Consumption ($)Saving ($)1200600Figure 2. The Purple Line is the budget line from (b). The Blue Line is thebudget line that would result if the tax rate were lower than 100%. Since theMRS at (1000, 1000), we see that setting the tax any lower than 100% (suchas the blue line) would induce Scrooge to consume more current consumption(and less savings). If the tax were higher than 100% (not s hown), Scroogewould still choose (1000, 1000). The bundle (1200, 600) on budget line (b) isfor illustration purposes only to verify the how the line was constructed; IfScrooge spends $1200 in current consumption under the tax, his tax bill wouldbe $200, leaving only $2000 - $1200 - $200 = $600 for savings.33. (25 Points) Virginia receives $350 each month to spend on pizza and beer. Her preferencesfrom month to month never change. Her budget lines and choices for July and August areshown below in Figure 1.Pizza (Pies)JulyAug5070Beer (Pints)B024.318 35Figure 1. Virginia’s budgets and choices for pizza and beer in July and August.(a) (3 points) What were the prices of beer in July and August?ANSWER: According to the picture, the most beer Virginia could buy in July andAugust with her $350 was 70 and 50 respectively. Therefore prices in July and Augustmust have been such that70 =350pJulyB50 =350pAugustBsolving for each pBwe getpJulyB=35070= 5pAugustB=35050= 74(b) (2 points) What were the prices of pizza in J uly and August?ANSWER: Since income did not change, it is clear from the picture that the price ofpizza did not change from July to August. Using the same method as in the prev iousquestion, in both months it was $35035or $10 per pizza.(c) (5 points) B0was Virginia’s level of beer consumption in July. What is B0equal to?ANSWER The consumption bundle (18, B0) is on Virginia’s July budget line. There-fore it must be true thatm = pZ24 + pJulyBB0350 =3503518 +35070B0Solving for B0we getB0=70(350 −3503518)350= 24GRADING: Any equivalent expression acceptable.5(d) (5 points) Going solely on the one change in price we know about, what is the cross-priceelasticity of pizza with respect to the price of beer. Explain.ANSWER: Since the Vriginia’s demand for pizza did not change when the price of beerchanged, our best guess is that the cross-price elasticity is exactly zero.(e) (10 points) Sketch a demand curve for beer from the data in Figure 1. Be sure that yourdiagram is well-labeled.Price of BeerBeer (Pints)7 =350505 =35070B0(34)24.3($ / pint)Figure 3. From the choice diagram we know that Virginia’s demand for beeris 24.3 when the brice of beer is $7 / pint and the demand for beer is 34 whenthe price of beer is $5 per pint holding constant m = 250 and pz=