Economics Midterm 1 2020

Multiple Choice Questions (best 7 out of 8: 35 points) 1. (5 points) Adrian paid $1000 for campus parking which is 50% refundable upon cancelation. Feeling the need to exercise a bit more, Adrian is now considering canceling his campus parking and biking to school. Buying a new bike would cost him an additional $200. He values biking to work at $500. What is his opportunity cost of driving to work? √ $300 $800 $1,000 $0 Not enough information to calculate 2. (5 points) The market for kiwis has downward sloping demand and upward sloping supply. Which of the following could independently explain a decrease in the equilibrium quantity of kiwis? I. The wages of kiwi pickers increases. II. Consumer incomes fall, and kiwis are a normal good for all consumers. III. Excessive rainfall causes an unexpected increase in the supply of kiwis. I. only II. only √ III. only I. and II. I. and III. II. and III. I., II., and III. 3. (5 points) Peter gets the same additional satisfaction from 3 cookies as he does from 1 chocolate bar at any level of consumption. Which of the statements is NOT true? √ If the price of a chocolate bar is twice the price of a cookie, he will only buy cookies. His marginal rate of substitution is constant. His indifference curves are linear. Cookies and chocolates are perfect substitutes. 4. (5 points) Adam consumes two goods, apples and bananas. Apples, for Adam, are an inferior good. If the price of apples decreases, what can we say about his consumption of bananas? Adam will consume more bananas than before √ Adam will consume fewer bananas than before His change in banana consumption is indeterminate Adam will consume more at first and then less. 5. (5 points) Tom’s demand for organic apple juice is inelastic and downward sloping. At a price of $2 per bottle Tom demands 10 bottles. Suppose now the price increases to $4 per bottle. Which of the following statements are consistent with this information? I. Tom’s expenditure on organic apple juice decreases. II. The absolute value of Tom’s price-elasticity is at least 1. III. At the new price, Tom demands 4 bottles. IV. At the new price, Tom demands 6 bottles. I only II only √ III only IV only I and II I and IV III and IV 6. (5 points) A bakery has total costs T C(q) = 10 + 2q + q 2 . Which of the following are possible short-run profits at which the bakery should continue to operate in the short run? 2 0 -5 √ -9 All of the above 7. (5 points) A local market for bananas has demand QD = 10−P and supply QS = P . An unexpected fire reduces the quantity supplied at every price by 2 units. Which of the following is the producer surplus after the fire? √ 12.5 8 16 10 8. (5 points) Consider the perfectly competitive market for potted cacti, which was in long-run equilibrium. Then, an “event” occurred. Now, the market has returned to long-run equilibrium, with a price higher than it was at the start. Which of the following could have been the “event” that could explain this spike in the long-run equilibrium price? √ The invention of the Cacti-gloveTM , which reduced labor costs associated with handling cacti The exceptionally dry winter caused cacti (fixed) storage costs to increase The CDC issued a statement that cacti are excellent at purifying the air in your home All of the above Short Answer Questions (65 points total) To get any point you must show your work 9. Ava has budgeted $240 per month for her hobbies which include watching plays or taking archery lessons. She likes both activities, and consumes positive quantities of each. The price of a ticket to a play is $40 and the price of an archery lesson is $20. (a) Draw her Budget constraint in the graph below. Archery lessons 12 10 8 6 A 4 2 2 4 6 8 10 12 Plays (Fill-in the blanks). The y-intercept of her budget constraint is x-intercept of her budget constraint is 6 plays. 12 Archery lessons, and the (b) Suppose her optimal consumption is (3 plays, 6 archery lessons). Mark her optimal consumption point A and draw a typical indifference curve through A (assuming regular preferences for the two goods). Solution: See graph from part (a) (c) Suppose that if Ava’s income increases to $260, she purchases (2 plays, 9 archery lessons), while if her income decreases to $220, she purchases (4 plays, 3 archery lessons). According to this information, in this range of income, what type of goods are plays and archery lessons for Ava? • Ava views plays as a(n) • Ava views archery lessons as a(n) inferior good normal good (d) Based on your answer to part (c), describe the substitution effect and the income effect of an increase in the price of archery lessons: (Fill in the blanks with “increase” or “decrease”). If the price of archery lessons increases: • The substitution effect will: – decrease her consumption of archery lessons – increase her consumption of plays. • The income effect will: – – decrease increase her consumption of archery lessons her consumption of plays. (e) Suppose that prices and Ava’s income are the same as initially (income is $240, the price of a play is $40 and the price of an archery lesson is $20). However, her preferences have changed: now she always gets the same additional satisfaction from one archery lesson as she does from one play. Given her new preferences, her optimal consumption is lessons. 0 plays and 12 archery (f) Suppose Ava still has the same preferences as in part (e), but prices change, such that her new optimal consumption is now (3 plays, 5 archery lessons). Given this information, the price of an archery lesson is now $30 . $30 and the price of a play is now (g) Suppose Ava’s demand for archery lessons is given by : P = 50 − 5QD . What is her consumer surplus if the price of an archery lesson is back to $20? Show your work in the box below your answer. Her consumer surplus is $90 Solution: The demand ”choke price” is $50. At a price of $20, she buys 6 lessons. Her consumer surplus is the triangle below her demand curve and above the price of $20: CS = (50 − 20) × 6 × 0.5 = $90 10. Suppose that the market for all-terrain vehicles (ATVs) is perfectly competitive, with the inverse demand function: P = 510 − QD Each firm in the industry faces Cost and Marginal Cost functions: T C(q) = q 2 + 150q + 400, M C(q) = 2q + 150 (a) Write out equations for the Fixed Cost (FC), Average Variable Cost (AVC(q)), and Average Total Cost (ATC(q)). 400 Fixed cost: F C = Average variable cost: AV C(q) = Average total cost: AT C(q) = q + 150 q + 150 + 400 q (b) Suppose the industry is currently in long-run equilibrium. Find the individual quantity produced by each firm, q, and the market price, p. Show your work in the box below your answer. The individual quantity is q = 20 and the market price is p = $190 Solution: The market is in LR equilibrium, thus we have the zero-profit condition of AT C(q) = M C(q) = p. Setting AT C(q) = M C(q), we obtain q + 150 + 400 = 2q + 150 =⇒ q = 20 q Plugging in q = 20 into M C or AT C gives us p = $190 (c) How many firms, N , are currently in the industry? Show your work in the box below your answer. There are N = 16 firms. Solution: Taking the market price p = $190 and plugging into Inverse Demand, we obtain market demand Q. 190 = 510 − Q =⇒ Q = 320. Taking market quantity and dividing by q = 20, we obtain N= 320 = 16 firms. 20 (d) Should any firms enter or exit the market? Explain in the box below. Solution: No, each firm in the market is currently making an economic profit of 0, thus no firm has an incentive to enter or exit. (e) Suppose the government decides to impose strict safety standards on ATV producers, who now have to pay a yearly fee for safety certification of their vehicles. i. In the graphs below, show how this change will affect the market (left hand side) and the individual firm (right hand side). More specifically, show the initial long-run equilibrium (with price PLR , market quantity QLR and individual quantity qLR ), and the change to the new long-run equilibrium (with price 0 0 PLR , market quantity Q0LR and individual quantity qLR ). P P M C AT C 0 AT C S0 S 0 PLR 0 PLR PLR PLR D0 0 Q Q0LR QLR Figure 1: Market 0 0 qLR qLR q Figure 2: Individual Firm ii. Explain (in words) how the new long run equilibrium compares with the initial long run equilibrium: In the new long run equilibrium: • the number of firms is • the price is lower higher • the market quantity is • each firm’s profit is lower the same