Eco 201 Name______________________________ Test 2 25 June 2008 Please write answers in ink. You may use a pencil to draw graphs. Questions 1-4 are 17 points each, 5-6 are 16 points each. Allocate your time efficiently. Good Luck. 1. Suppose the weekly demand and supply curves for used DVDs in Lincoln, Nebraska, are as shown in the diagram. Calculate a. The weekly consumer surplus. Consumer surplus is the triangular area between the demand curve and the price line. Its area is equal to 0.5bh, where b is the base of the triangle and h is the height. The base is 6 units and the height is 1.5 units, measured in dollars. Therefore, consumer surplus is 0.5($1.50/unit)(6 units/wk), or $4.50 per week. b. The weekly producer surplus. Producer surplus is the triangular area between the supply curve and the price line. Using the base-height formula, it is (0.5)($4.50/unit)(6 units/wk), or $13.50 per week. c. The maximum weekly amount that producers and consumers in Lincoln would be willing to pay to be able to buy and sell used DVDs in any given week. The maximum weekly amount that consumers and producers together would be willing to pay to trade in used DVDs is the sum of gains from trading in used DVDs—namely, the total economic surplus generated per week, which is $18 per week. 2. The Kubak crystal caves are renowned for their stalactites and stalagmites. The warden of the caves offers a tour each afternoon at 2 p.m. sharp. The caves can be shown to only four people per day without disturbing their fragile ecology. Occasionally, however, more than four people want to see the caves on the same day. The following table lists the people who wanted to see the caves on September 24, 2003, together with their respective times of arrival and reservation prices for taking the tour that day.Arrival time Reservation price ($) Herman 1:48 20 Jon 1:50 14 Kate 1:53 30 Jack 1:56 15 Penny 1:57 40 Fran 1:59 12 Faith 2:00 17 a. If the tour is "free" and the warden operates it on a first-come, first-served basis, what will the total consumer surplus be for the four people who get to go on the tour on that day? When there is no charge for the tour, the surplus enjoyed by someone who takes it equals his or her reservation price for the tour. If the warden operates the tour on a first-come-first served basis, Faith, Penny, and Fran will be turned away. The combined consumer surplus when the four who arrive first take the tour is $20 + $14 + $30 + $15 = $79. b. Suppose the warden solicits volunteers to postpone their tour by offering increasing amounts of cash compensation until only four people still wish to see the caves that day. If he gives each volunteer the same compensation payment, how much money will he have to offer to generate the required number of volunteers? What is the total economic surplus under this policy? An offer of $15 compensation generates 3 volunteers to return another day: Fran, Jack, and Jon. The four who go on the tour receive a total consumer surplus of $40 + $30 + $20 + $17=$107. The warden pays $45 in compensation payments to the three volunteers, which causes him a loss in economic surplus of $45 that is exactly offset by the gain in economic surplus to the three volunteers. Total economic surplus from the tour operation is now $107, or $28 higher than before. c. Why is the compensation policy more efficient than the first-come, first-served policy? The compensation policy is more efficient than the first-come-first-served policy because it establishes a market for a scarce resource that would otherwise be allocated by non-market means. People who choose not to miss the tour that day are paying an opportunity cost of $15 not to miss it. Therefore, only those people to whom the tour is worth more than $15 will actually take it. 3. In Charlotte, North Carolina, citizens can get their electric power from two sources: a hydroelectric generator and a coal-fired steam generator. The hydroelectric generator can supply up to 100 units of power per day at a constant marginal cost of 1 cent per unit. The steam generator can supply any additional power that is needed at a constant marginal cost of 10 cents per unit. When electricity costs 10 cents per unit, residents of Charlotte demand 200 units per day. a. Draw the marginal cost curve of electric power production in Charlotte.100101Units of power per dayPrice (cents/unit)Marginal cost of power b. How much should the city charge for electric power? Explain. Should it charge the same price for a family whose power comes from the hydroelectric generator as it does for a family whose power comes from the steam generator? The city should charge 10 cents per unit since that is the marginal cost when residents use at least 100 units/day, which they will if the city charges 10 cents or less. It should charge 10 cents per unit to all users, even those who are receiving their power from the hydroelectric facility, since if those users were to cut their consumption, they would free up hydroelectric capacity, which could then be used to serve others who are currently receiving their power from the more costly steam generator. 4. A price-taking firm makes air conditioners. The market price of one of their new air conditioners is $120. Its total cost information is given in the table below: Air conditioners per day Total cost ($ per day) 1 100 2 150 3 220 4 310 5 405 6 510 7 650 8 800 How many air conditioners should the firm produce per day if its goal is to maximize its profit? What is the firm’s profit? The marginal cost of each of the first 6 air conditioners produced each day is less than $120, but the marginal cost of the 7th air conditioner is $140. So the company should produce 6 air conditioners per day. Profit = TR − TC. Profit = $720 – $510 = $210. 5. Ann lives in Princeton and commutes by train each day to her job in New York City (20 round trips per month). When the price of a round trip goes up from $10 to $20, she responds by consuming exactly the same number of trips as before, while spending $200 per month less on restaurant meals.a. Does the fact that her quantity of train travel is completely unresponsive to the price increase imply that Ann is not a rational consumer? Even at twice the original price, the marginal utility per dollar of the 20th train trip may be higher than the corresponding ratio for any