prelim2-corrected-20081115 - Two Buyer ‐ Two Seller...

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Unformatted text preview: Two Buyer ‐ Two Seller Double Oral Auction Economics 1110 Introductory Microeconomics Prelim 2 READ THIS FIRST. NAME: fill in your name LAST NAME FIRST. IDENTIFICATION NUMBER spaces A to G: fill in your 7‐digit CU identity number. This is the ID number on your student ID card. Please do not use any other ID number. Your exam may not be properly graded if you do. USE THE ANSWER SHEET PROVIDED. NO BOOKS, NOTES, PROGRAMMABLE CALCULATORS, PERSONAL DIGITAL ASSISTANTS, CELL PHONES, MUSIC PLAYERS, COMPUTERS, NOR OTHER ELECTRONIC DEVICES ARE ALLOWED. ALL VIOLATIONS OF THIS RULE WILL RESULT IN IMMEDIATE CONFISCATION OF THE EXAM AND INITIATION OF A HEARING UNDER THE CORNELL CODE OF ACADEMIC INTEGRITY. ONLY A $5.00 CALCULATOR THAT ADDS, SUBTRACTS, MULTIPLIES AND DIVIDES, AND A STRAIGHTEDGE (RULER) ARE PERMITTED. USE A NUMBER 2 PENCIL. THERE ARE 25 QUESTIONS. ALL QUESTIONS HAVE THE SAME WEIGHT (4 POINTS). NEITHER THE INSTRUCTOR NOR THE PROCTORS WILL ANSWER ANY QUESTIONS DURING THE EXAM. CHOOSE THE BEST POSSIBLE ANSWER FOR EACH QUESTION. THERE IS A 90 MINUTE TIME LIMIT. Glossary of abbreviations: AFC: average fixed cost AVC: average variable cost ATC: average total cost ERS: economic rate of substitution MC: marginal cost MR: marginal revenue MRS: marginal rate of substitution MB: marginal benefit MU: marginal utility TC: total cost TR: total revenue P: price Q: quantity S: supply D: demand Quantity 1 2 3 Marginal Benefit Buyer 1 Buyer 2 20 24 17 16 13 7 Marginal Cost Seller 1 Seller 2 18 4 20 8 23 13 1. Consider the two‐buyer, two‐seller double auction shown above. The rules of this auction are the same as the ones on Aplia except that each buyer/seller can sell up to three units. The table shows the buyers’ values (MB) and the sellers’ costs (MC) for each unit and each person (buyer or seller). In the competitive equilibrium how many units are sold by Seller 2 if there is a tax on buyers of $5 per unit purchased? A. 0 B. 1 C. 2 D. 3 E. Cannot be determined from the information given. 2. Using the same auction data as in the question above, suppose that instead of a $5 tax on the buyer per unit purchased, we imposed a $5 tax per unit sold by the sellers. In the competitive equilibrium, what are the (total surplus + tax revenue) and the deadweight loss in the market when subject to this tax? A. Total surplus + tax revenue = 36; deadweight loss = 10 B. Total surplus+ tax revenue = 32; deadweight loss = 10 C. Total surplus+ tax revenue = 36; deadweight loss = 4 D. Total surplus+ tax revenue = 32; deadweight loss = 4 E. The answer cannot be determined from the information given. 3. A production function A. measures the maximum quantity that sellers are willing to sell at any given price. B. shows the amount of profit that will be realized at each level of output. C. shows the amount of profit that will be realized for a given level of inputs. D. shows the minimum input requirements for each level of output. E. none of the above. Oranges Total (tons) Cost 0 20,000 100 42,200 200 80,000 210 84,000 220 88,000 230 94,000 240 106,000 Bicycles 0 1,000 2,000 3,000 4,000 5,000 Fixed Cost 30,000 30,000 30,000 30,000 30,000 30,000 Variable Cost 0 60,000 90,000 120,000 190,000 300,000 4. The table above shows the total cost function for an orange grower who produces the indicated number of tons of oranges per season. If the market price of oranges is $500/ton, what is the optimal (profit maximizing) output? A. 200 B. 210 C. 220 D. 230 E. 240 5. Using the same information as in the question above, what is the orange grower’s producer surplus at the optimal output? A. 20,000 B. 22,000 C. 40,000 D. 42,000 E. None of the above. 6. The table above represents the cost structure for BikesAreUs. If the market price of bicycles is $30, what is the profit maximizing quantity of bicycles to produce? A. 0. Bikes Are Us should not produce. B. 1,000 C. 2,000 D. 3,000 E. 4,000 7. Using the same table of cost information as in the previous question (but not necessarily the same market price), what is the minimum efficient scale assuming that BikesAreUs is using the best available production technology? A. 2,500 B. 3,000 C. 3,500 D. 4,000 E. None of the above. 8. Using the same table of cost information as in the previous question (but not necessarily the same market price), if the long run demand for bicycles is QD = 1,000,000 – 5,000P, what is the long run number of bicycle businesses in the industry. Assume that BikesAreUs operates in a constant cost competitive industry. A. 250 B. 333 C. 500 D. 4,000 E. None of the above. 9 . Again, using the same information as in the previous question, if the long run demand for bicycles increases to QD = 1,450,000 – 5,000P, which of the following statements must be false? A. The price of bicycles in the short run (no entry) will rise to $90. B. Every firm in the industry will make short run profits of $210,000. C. There will be long run entry until there are 150 new firms in the industry. D. Existing firms will produce at a short‐run output of 4,000 bicycles. E. The long run supply curve is horizontal at P = $50. 10. If output increases by exactly 10% when all inputs are increased by exactly 8%, then this technology displays A. increasing returns to scale. B. decreasing returns to scale. C. constant returns to scale. D. external economies of scale. E. external diseconomies of scale. 11. When the price of a good increases, producers would like to produce more of the good, but may not be able to hire new workers or purchase new capital equipment in the short run. In the long run, however, firms can do both in order to increase production. Therefore, the long‐run price elasticity of supply A. is less than the short‐run price elasticity of supply. B. is greater than the short‐run price elasticity of supply. C. is equal to the short‐run price elasticity of supply. D. is less than the short‐run price elasticity of supply when the price increases, but greater than the short‐run price elasticity of supply when the price decreases. E. Answer cannot be determined from the information given. ABC Company Cost Curves 150,000 125,000 100,000 Dollars/unit 75,000 ATC AVC 50,000 AFC 25,000 0 0 1 2 3 Quantity 4 5 6 12. The graph above shows the annual average cost curves of ABC company, an airplane and jet manufacturer. At what quantity is marginal cost equal to average total cost? A. 1 B. 3. C. 5. D. 6. E. Cannot be determined from the information given. 13.Using the same information as in the question above, if ABC Company can sell each jet at a price of $120,000, what is the economic profit made by ABC Company if they produce 4 jets per year ? A. $40,000 B. $160,000 C. $320,000 D. $480,000 E. None ofthe above. 14. Suppose that an entrepreneur were to start a business. Inputs into the business include commercial real estate property (land and structures), hired labor, and the owner’s managerial time. If accounting profits are positive A. then economic profits must be positive. B. then economic profits must be negative. C. then economic profits must be zero. D. then long run accounting profits must be zero in a competitive market. E. None of the above. Comparison of Technologies 120 100 80 Average Total Cost 60 Alpha Beta Gamma 40 20 0 0 1 2 3 4 5 Quantity 6 7 8 9 10 15. The figure above shows the ATC curves for three different technologies that can be used to produce the same good. Market demand for this good is at least 100 at prices between 20 and 50. The minimum efficient scale is A. 3 B. 5 C. 7 D. Both B and C. E. None of the above. 16. Using the same figure as in the question above and assuming a constant cost industry, which of the following statements is false? A. The long run supply curve is perfectly elastic. B. If the quantity demanded in the industry were 350, then the market demand could be met with 70 firms of type Alpha or 50 firms of type Beta. C. Technology Gamma will never be optimal at any quantity of production. D. If the quantity demanded is 140 units, then the demand will be met optimally will 20 firms of type Beta. Food Tax and Subsidy 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 C B I6 I5 I4 17. When an industry exhibits external diseconomies of scale, which of the following statements are true? I. When firms enter the industry, the average total cost of each firm in the industry decreases (shifts down). II. When an individual firm increases all of its inputs, the firm’s long run average total cost increases (shifts up). III. The market long run supply curve is upward sloping. A. I and II. B. I and III. C. II and III. D. III only. E. None of the above. 18. The budget constraint A. is the total amount of money an individual can spend on goods and services. B. is the total amount of utility an individual can receive from goods and services. C. is the combined price of all goods and services an individual can consume. D. is the maximum amount of money an individual can gain without earning it. E. applies only to society as a whole, not to individuals. 19. Suppose that Brian’s MRS between coffee (numerator) and tea (denominator) is 3 when he is consuming his optimal consumption bundle. If the price of coffee is $6.00, then the price of tea is A. $0.33 B. $2.00 C. $6.00 D. $18.00 E. None of the above. A I3 I2 I1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Shelter 20. Refer to the tax and transfer system described in the graph above. Suppose that the consumer’s initial income is $16 before the tax or subsidy is imposed. Suppose that the prices of food and shelter are $1 before any tax is imposed on either good. The tax on food is 100% of the pre‐tax price. There is no tax on shelter. The revenue from the food tax is redistributed as a subsidy (transfer payment) of $8. Which of the following statements is true? A. Before imposing the tax on food, the consumer’s optimal choice is A. B. After imposing the tax on food, but before accounting for the effects of the subsidy (transfer payment), the consumer’s optimal choice is C. C. The movement from B to C is the substitution effect associated with the increase in the price of food caused by the tax. D. The effect of the subsidy (transfer payment) is to increase the consumer income by $4. E. The movement from B to A is the income effect associated with the increase in the price of food caused by the tax (before accounting for the subsidy). 21. Antonio would like to spend all of his income on wine and cheese. Suppose that the price of cheese is $5.00, price of wine is $10.00. One allocation that uses all of Antonio’s income sets the marginal utility that Antonio gained from the last sip of wine he consumed at 9 and the marginal utility gained from the last bite of cheese he consumed at 3. In order to maximize his utility, Antonio should A. consume more wine and less cheese. B. consume more cheese and less wine. C. consume less cheese and less wine. D. consume more cheese and more wine. E. change nothing; his utility is maximized. 22. Suppose that Anita would like to spend all of her income on milk and eggs. If the price ratio of milk to eggs is ½, according to the axioms of choice used to build demand theory, which of the following consumption bundles is most preferred compared to the other choices listed? A. 10 glasses of milk and 20 eggs. B. 20 glasses of milk and 10 eggs. C. 5 glasses of milk and 15 eggs. D. 20 glasses of milk and 20 eggs. E. Cannot be determined from the information given. 10 9 8 7 6 Movies 5 4 3 2 1 0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 Video games 23. Suppose that Tao spends all his income on movies and video games. The graph above shows his indifference curves. The price of movies is $12 each and Tao’s weekly income is $120/week. When the price of video games is $3, $6 and $12/game, respectively, the quantity of video games demanded (to the nearest whole number) is A. 16, 10, 7 B. 6, 5, 3 C. 20, 18, 16 D. 3, 5, 7 E. 7, 10, 16 MRS between Goods Y and Z 9 8 7 6 8 25. Suppose that the demand curve is perfectly inelastic and the supply curve is upward sloping but not perfectly inelastic. If tax is levied on sellers, then A. there is no deadweight loss and the sellers pay all of the tax (sellers’ after‐tax price is lowered by the full amount of the tax). B. there is no deadweight loss and the buyers pay all of the tax (buyers’ after‐tax price is increased by the full amount of the tax). C. .there is a deadweight loss and the sellers and buyers each pay part of the tax, but the sellers pay a larger part of the tax (sellers’ after‐tax price falls by more than the buyers’ after tax price rises). D. there is a deadweight loss and the sellers and buyers each pay part of the tax, but the buyers pay a larger part of the tax (buyers’ after‐tax price rises by more than sellers’ after‐tax price falls). E. The answer cannot be determined from the information given. MRS 5 4 3 2 1 0 2 1 0.5 0.25 4 1 2 3 4 5 6 7 Good Y 0 Good Z 7 6 5 4 3 2 1 0 24. Refer to the figure above. The figure plots the MRS of goods Y and Z for the quantities specified along the X‐axis. For example, when the quantity of good Y is 1 and the quantity of good Z is 6, the MRS is 8 (good Y is the numerator good). If the price of good Y is $50 and the price of good Z is $200,which consumption bundle is optimal, given the budget constraint. A. 1 unit of good Y and 6 units of good Z. B. 2 units of good Y and 5 units of good Z. C. 5 units of good Y and 2 units of good Z. D. 6 units of good Y and 1 unit of good Z. E. Cannot be determined from the information given. Thompson's Tulip Price Option and Spot Indices (1636‐1637) 250 200 February 3, 1637 Index (November 25, 1636 = 100) 150 100 November 25, 1636 50 0 0 20 40 60 80 100 120 140 160 May 1, 1637 180 Days Since November 1, 1636 Option Exercise Price Spot or Futures Price 26. (Bonus Question) The figure above shows Earl Thompson’s analysis of the 1636‐1637 Tulip Price bubble in the Netherlands. Which of the following statements about the tulip bubble is false? A. The peak price (dashed line) shown on February 3, 1637 is an option exercise price which means that the owner of the option could have purchased tulips at an index value of 200 but did not have to purchase them at that price. B. The peak price (solid line) shown on November 25, 1636 was a spot or futures price, which means that tulips were actually bought and sold at that price. C. The difference between the solid price line (spot or futures price) and the dashed price line (option exercise price) implies that the bubble was substantially less severe than the magnitude indicated for February 3, 1637. D. All of the actual transaction prices were at or below an index value of approximately 110. E. Because the solid line (spot or futures price) and the dashed line (option exercise price) are equal around May 1, 1637, the bubble ended on this date (when the spring crop of tulip bulbs was delivered). WORK AREA WORK AREA WORK AREA Economics 1110 Introductory Microeconomics Prelim 2 Answers November 6, 2008 1 C is correct. The tax‐distorted demand and supply curves are shown in the table below. Only seller 2 makes any sales, and two units are sold. Note on the demand curve in the table the MB is shown net of the tax, so the prices are comparable to the sellers’ costs. The first two units sold have MC of 4 and 8, respectively, and are therefore sold by seller 2. Answers A and B are wrong because there is unexploited total surplus if zero or one unit is transacted. Answer D is wrong because it is the undistorted equilibrium, but the question has a tax. Answer E is wrong because answer C is correct. answer are conceptually linked and I did not want to reward partial solutions. Buyer Tax Demand Supply Curv e Curve 19 4 15 8 12 13 11 18 8 20 2 23 Total Surplus Tax Revenue 2 Surplus 15 7 No Tax Demand Supply Curv e Curve 24 4 20 8 17 13 16 18 13 20 7 23 Total Surplus Tax Revenue Seller Tax Demand Supply Curv e Curve 24 9 20 13 17 18 16 23 13 25 7 28 Total Surplus Tax Revenue 3 Surplus 20 12 4 36 0 Surplus 15 7 22 10 22 10 D is correct. The production function shows how much output will be produced when inputs are set at different levels, or, equivalently, the minimum input requirements for each level of output. Answer A is the definition of a supply function. Answer B is the definition of a profit function. Answer C is the result solving for the optimum output then stating the input demands that correspond to this output. Answer E is wrong because answer D is correct. C is correct. The table below shows the marginal cost function for the orange grower. If P = $500, then profits are maximized at P = MC = 500, which occurs at an output of 220 tons/season. Economic profits are positive, so the orange grower does not need to consider the shutdown rule because P is obviously greater than minimum AVC. Answers A and B are too low (MC < P). Answer D is too high (P < MC). Answer E is wrong because the profits at Q = 240 are $14,000, which is less than the 4 D is correct. In the undistorted market three units are transacted and the total surplus is 36 (see No Tax table below). There is no tax revenue in this case. There is also no deadweight loss in the undistorted market. When the tax is imposed on the seller the outcome is identical to the answer to when the tax is imposed on the buyer, two units are transacted. Total surplus is 22, tax revenue is 10; hence, total surplus + tax revenue = 32. Deadweight loss must be 36 – 22‐ 10 = 4 (see Seller Tax table below). Answer A is wrong because 36 is the undistorted total surplus, not the total surplus after taxes, and 10 is the tax revenue not the deadweight loss. Answer B is wrong because 10 is the tax revenue, not the deadweight loss. Answer C is wrong because 36 is the undistorted total surplus. Answer E is wrong because answer D is correct. No partial credit was given because the two parts of the correct profits at Q = 220. Oranges Total (tons) Cost 0 20,000 100 42,200 200 80,000 210 84,000 220 88,000 230 94,000 240 106,000 5 Marginal Cost 300.00 380.00 400.00 500.00 900.00 Total Revenue 0 50,000 100,000 105,000 110,000 115,000 120,000 Economic Profit Fixed Cost ‐20,000 20,000 7,800 20,000 20,000 20,000 21,000 20,000 22,000 20,000 21,000 20,000 14,000 20,000 Dollars/Bicycle BikesAreUs Cost Functions 100 90 80 70 60 50 40 30 20 10 0 0 1,000 2,000 3,000 Bicycles 4,000 5,000 6,000 MC AVC ATC D is correct. The table from the question above still applies. Fixed costs are the costs associated with output of zero. So, fixed costs are $20,000, even though they are not stated explicitly, you can deduce them from the cost function. Producer surplus at the optimum is economic profits plus fixed costs, which equals $42,000. Answer A is fixed costs. Answer B is economic profit at the optimum. Answer C is producer surplus at Q = 200 or Q = 230. Answer E is wrong because answer D is correct. A is correct. The table and figure below show all of the relevant cost function information. At P = $30, P = MC at Q = 2,000, but that is not the correct answer because $30 is less than minimum AVC, which is $40. So BikesAreUs should produce no output. The market price is below the shutdown price. Answers B, D, and E are wrong. Answer C would be correct if P > minimum AVC, but since it is not, answer C is incorrect. The best that BikesAreUs can do in this market is to produce nothing and suffer a loss of $30,000. Any other action results in a greater loss when P = $30. Variable Bicycles Fixed Cost Cost MC Total Costs AVC ATC 0 30,000 0 30,000 1,000 30,000 60,000 45.00 90,000 60.00 90.00 2,000 30,000 90,000 30.00 120,000 45.00 60.00 3,000 30,000 120,000 50.00 150,000 40.00 50.00 4,000 30,000 190,000 90.00 220,000 47.50 55.00 5,000 30,000 300,000 330,000 60.00 66.00 6 7 B is correct. At a production level of 3,000 bicycles, average total costs are $50/bicycle and marginal costs are $50/bicycle. Therefore, ATC is at a minimum. The minimum efficient scale is the lowest production level associated with the minimum average total cost. Hence, 3,000 bicycles is the correct answer. You did not need to interpolate to check the points not shown on the table because when MC = ATC, you know that ATC is at an extreme value, in this case a minimum. Answers A, C and D are incorrect because they are not the lowest production level associated with the minimum average total cost. Answer E is wrong because answer B is correct. A is correct. Since the bicycle industry is constant cost, the long run supply curve is perfectly elastic at the minimum ATC. Using the cost functions from the previous two questions, this implies that the equilibrium price is $50 in the long run. Evaluating the demand curve at this price gives 750, 000 = 1,000,000 – 5,000 x 50. So, long run quantity demanded = quantity supplied = 750,000 at P = $50. Each firm operates at minimum efficient scale of 3,000 bicycles. So, the total number of firms is 250 = 750,000/3,000. 8 9 B is correct (false). You don’t have to solve for the short‐run equilibrium to answer this question correctly. Answer A is true, it is the short run equilibrium price when there is no entry. Here’s how you check that. Calculate the quantity demanded at P = $90: 1,000,000 = 1,450,000 – 5,000 x 90. So, 1,000,000 bicycles are demanded at P = $90. Now, use the short run supply function from the answer to the previous question. There are 250 firms in operation. At MC = 90, they will each produce 4,000 bicycles. The quantity supplied in the short run is 1,000,000 at P = $90. The market is in short run equilibrium (no entry has occurred yet). At P = $90, each firm makes 4,000 bikes and the ATC is $55/bike. So, answer D is true. Short‐run economic profits are $140,000 = (90 – 55) x 4,000. Answer B is therefore false. Now for the long run. The long run supply curve does not change. Answer E is therefore true. Hence, we need to evaluate the long run demand curve at P = $50, which gives 1,200,000 = 1,450,000 – 5,000 x 50. If the long run equilibrium quantity is 1,200,000, then there must be 400 bicycle firms each producing 3,000 bikes in long run equilibrium. Answer C is therefore true because 150 = 400 – 250 (new firms = total firms – existing firms). A is correct. Increasing returns to scale occur when output increases proportionally more than the increase in all inputs. If output increases by 10% when all inputs increase by 8%, then we must be in a region of increasing returns to scale. Answer B is wrong because decreasing returns to scale would imply that output increased by less than 8% when inputs increase by exactly 8%. Answer C is wrong because constant returns to scale would imply that output increased by exactly 8% when inputs increase by exactly 8%. Answers D and E are wrong because the problem concerns internal economies of scale, not external economies of scale, which are the result of factors not related to the firm’s production function. B is correct. For a given price change, the quantity change in the long run is greater than in the short run. Thus, the own price elasticity of supply will be greater in the long run than in the short run, regardless of the direction of the price change. Answers A, C, and D are wrong because they are inconsistent with answer B. Answer E is wrong because answer B is correct. B is correct. Marginal cost is equal to average total cost where the average total cost is minimized. This occurs at a quantity of 3. Answers A, C, and D are wrong because ATC is not at its minimum for those quantities. Answer E is wrong because the quantity at which ATC is minimized can be read directly off the graph. B is correct. Each unit costs $80,000. We can determine ATC directly from the graph at Q = 4. TC = ATC x Q = $80,000 x 4 = $320,000. TR = P x Q = $120,000 x 4 = $480,000. Economic profit = TR – TC = $160,000. Economic profit also can be determined from (P – ATC) x Q = $40,000 x 4. Answer A is wrong because it is the per unit profit. Answer C is wrong because it is total cost. Answer D is wrong because it is total revenue. Answer E is wrong because answer B is correct. E is correct. If accounting profits are positive then economic profits = accounting profits‐ opportunity costs of owned factors. The economic profits may be either positive, negative, or zero when the accounting profits are positive. In this case opportunity costs are represented by owner’s managerial time. Hence, answers A, B and C are all false. Long run economic profits must be zero in a competitive market if short run economic profits are zero because there will be neither entry nor exit in this case. Short and long run accounting profits have no such relationship. So, answer D is false. 15 C is correct. The minimum efficient scale is the smallest quantity at which the ATC is minimized, considering all technologies together. Technology Beta is has the lowest ATC, and this occurs at a production level of 7. Therefore, the minimum efficient scale in this industry is 7. Answer A is wrong because at Q = 3 technology Gamma is at its minimum ATC but it is dominated by either technology Alpha or Beta at that output; so, 3 cannot be the minimum efficient scale. Answer B is wrong because technology Alpha has a greater minimum ATC than technology Beta; hence, at Q = 5, it is cheaper to produce using technology Alpha but since the market is much bigger than this, firms that use technology Beta and produce 7 will have lower ATC and will dominate the industry. Answer D is wrong because answer B is wrong. Answer E is wrong because answer C is correct. B is correct (false). Answer A is true because the long run supply curve of a constant cost industry is perfectly elastic at the minimum ATC associated with the minimum efficient scale. Answer B is false (therefore correct) because technology Beta dominates technology Alpha; hence long run supply response is to have 50 firms of type Beta each supplying 7 units. Answer C is true; technology Gamma is dominated by either technology Alpha or Beta. Answer D is true because 20 firms of type Beta producing 7 units each is the correct long run supply if demand is 140. D is correct. The long run supply curve is upward sloping when there are external diseconomies of scale. External diseconomies of scale mean that as the industry increases in size every firm’s costs increase either through rising factor prices or congestion that makes the technology less efficient. Statement I is false; it describes external economies of scale. Statement II is false; it describes internal diseconomies of scale (decreasing returns to scale). Statement III is true; it is the direct implication of external diseconomies of scale. A is correct. The budget constraint is the total amount of money an individual can spend on goods and services per period of time. Answer B is incorrect because the total amount of utility an individual can receive from goods and services per period of time describes preferences. Preferences are the other part of consumer demand theory. Budget constraints describe opportunities. Utility functions describe preferences. Answer C is wrong because the combined price of all goods and services an individual can consume isn’t meaningful. The budget constraint says that the combined prices and quantities of all goods consumed cannot exceed one's income. This answer ignores quantities, so answer A is better. (One point for answer C.) Answer D is incorrect because it is the definition of non‐labor income, not a budget constraint. Answer E is wrong because it is wishful thinking. B is correct. MRS = MU(coffee)/MU(tea) = P(coffee)/P(tea) = ERS. Substituting we get 3 = 6/P(tea) or 1/3 = P(tea)/6 or 2 = P(tea). Answer A is wrong because you put the wrong good in the numerator of the MRS. Answer C is wrong because if the 10 16 17 11 12 18 13 14 19 price of tea is $6.00, then ERS = 1, which is different from MRS; so, Brian can’t be at an optimum. Answer D is wrong because you put the wrong price in the numerator of the ERS. Answer E is wrong because answer B is correct. 20 E is correct. The consumer’s initial position is the point C associated with the tangency of the budget line with a slope of −1 and intercepting the food axis at 16. The substitution effect of the increase in the price of food associated with the tax is, therefore, the point B, which is on the same indifference curve but tangent to the budget line with the slope of ‐1/2 (reflecting the increased price of food in its denominator). Substitution effects are always measured on the original indifference curve. After imposing the tax on food but before taking account of the subsidy (transfer payment), the consumer’s optimal point is A, which is on the indifference curve tangent to the budget line with a slope of −1/2 and food intercept of 8. This is the consumer’s optimal choice when the price of food is increased by the tax (but before we transfer any subsidy). So the movement from C to A is the total effect of the increase in the price of food. Since the movement from C to B is the substitution effect, the movement from B to A must be the income effect. Hence, answer E is true. Answer A is false because the initial position is point C, not point A. Answer B is false because point A is the optimal position after imposing the tax on food but before accounting for the subsidy. Answer C is false because it is backwards; shelter got relatively cheaper, so shelter should increase and food should decrease in the substitution effect—the movement is from point C to point B. Answer D is false because the effect of the subsidy (transfer payment) is to increase consumer income by the full amount of the subsidy ($8), which allows for the purchase of 4 additional units of food, not $4. A is correct. MRS = MU(Wine)/MU(Cheese) = 9/3 = 3. ERS = P(Wine)/P(Cheese) = 10/5 =2. MRS > ERS. To increase utility increase the consumption of the numerator good (wine) and decrease the consumption of the denominator good (cheese). D is correct. More of both is preferred to less; so we don’t need to use price ratio at all. Answer D specifies at least as much milk and eggs as answers A, B and C. In addition, answer D specifies more of at least one of the goods than in answers A, B and C. By the axiom of more being preferred to less, we know that Anita prefers 20 glasses of milk and 20 eggs to all of the other bundles. Answer E is wrong because answer D is correct. A is correct See the graph below. The three budget lines are plotted for the three different prices of video games. The dots on the graph show the optimal choices: 16, 10, and 7 for prices 3, 6, and 12, respectively. Answer B is incorrect; it’s the demand for movies as the price of video games changes (movies are a substitute). Answer C is incorrect; it’s approximately what you would get if you drew the budget lines varying the price of movies instead of the price of video games. Answer D is incorrect; it’s answer B backwards (with a slight variation in one tangency). Answer E is incorrect; it’s answer A backwards. 10 9 8 7 6 Movies 5 4 3 2 1 0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 Video games 24 25 21 D is correct. ERS = P(Y)/P(Z) = 50/200 = 0.25. So MRS = ERS implies that Y = 6 and Z = 1 given the data in the figure. B is correct. See the graph below. When demand is perfectly inelastic, there is no deadweight loss (because the before and after tax equilibrium quantities are identical). The incidence of the tax is entirely on the buyers even though the sellers must collect the tax payment and remit it to the government. The buyers’ after tax 22 23 price rises by the full amount of the tax. P P including tax P without tax Demand Q 26 E is correct. The point that Thompson’s analysis makes is that the true bubble must be measured using transaction prices (spot or futures prices) not unexercised option prices. No buyer actually paid an index value of 200 on February 3, 1637. The buyer held the option to buy tulip bulbs at that price but since the market collapsed, the option expired unexercised. Buyers actually paid the much lower spot or futures price. So, answer E is the only false statement on the list. ...
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