Econ101_W10_Quiz2_solutions

Econ101_W10_Quiz2_solutions -...

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Unformatted text preview: Economics
101
Section
400
 Winter
2010
 
 Quiz
2

 Solutions
 For
discussion
in
section,
February
4th
and
5th
 Name:______________________________________

Section:________________
 Consider
the
market
for
gasoline
in
Michigan.

Assume
that
the
marginal
value
of
 gasoline
decreases
as
the
quantity
of
gasoline
consumed
increases,
and
that
the
 opportunity
cost
of
supplying
the
marginal
gallon
of
gasoline
increases
as
more
gasoline
 is
supplied.

In
each
of
the
following
questions,
assume
that
the
gasoline
market
initially
 attains
equilibrium
at
a
price
of
$2.60/gallon.
 
 (a) Draw
a
diagram
showing
the
shape
of
the
demand
curve
for
gasoline
(measured
 in
gallons/day)
and
the
shape
of
the
supply
curve
for
gasoline
(also
measured
in
 gallons/day).

Identify
the
equilibrium
market
price
on
your
diagram.
 
 
 
 (b) Ethanol
is
derived
from
corn
syrup
and
is
used
as
an
additive
in
regular
gasoline.

 Suppose
the
price
of
ethanol
rises.

Will
this
generate
an
excess
supply
or
excess
 demand
for
gasoline
at
the
price
of
$2.60/gallon?

Explain
why.

How
do
you
 think
the
price
of
gasoline
will
adjust?

What
will
happen
to
the
quantity
of
 gasoline
sold
each
day?
 
 Since
ethanol
is
an
input
into
gasoline,
an
increase
in
its
price
will
increase
the
marginal
 opportunity
cost
associated
with
the
production
of
each
unit
of
gasoline,
thereby
 implying
a
leftward
shift
in
the
supply
curve.

At
the
previous
equilibrium
price
of
 $2.60/gallon,
this
will
lead
to
excess
demand
for
gasoline
since
suppliers
are
willing
to
 supply
less
gasoline
at
any
given
price
and
demand
is
unchanged.

Excess
demand
will
 cause
consumers
to
bid
up
the
price
of
gasoline
until
the
new
equilibrium
is
reached
 where
quantity
demanded
and
supplied
are
equal.

At
this
higher
price,
quantity
 demanded
and
supplied
will
be
less
than
when
the
price
was
$2.60/gallon.
 
 
 A
decrease
in
the
price
of
cars
leads
naturally
to
an
increase
in
quantity
demanded
of
 cars.

Since
cars
and
gasoline
are
complements,
this
also
leads
to
an
increase
in
 consumers’
marginal
valuation
of
gasoline
and
the
demand
curve
for
gasoline
shifts
 right.

At
the
previous
equilibrium
price,
this
produces
excess
demand
for
gasoline.

 Consumers
will
consequently
bid
up
its
price
until
a
new
higher
equilibrium
price
is
 reached
at
a
larger
equilibrium
quantity.
 
 (d) Petroleum
corporations
refine
crude
oil
into
a
range
of
products,
including
both
 gasoline
and
jet
fuel.

If
the
price
of
jet
fuel
changes,
then,
we
expect
to
observe
 changes
in
the
quantities
of
gasoline
and
jet
fuel
produced.

In
addition,
we
 expect
that
the
price
of
air
travel
will
be
affected
by
the
price
of
jet
fuel,
and
that
 air
travel
and
gasoline
are
substitutes
in
consumption.

If
the
prices
of
jet
fuel
 and
air
travel
rise,
would
we
observe
an
excess
supply
or
excess
demand
for
 gasoline
at
the
price
of
$2.60/gallon?

Why?


How
do
you
think
the
price
of
 gasoline
will
adjust?


What
will
happen
to
the
quantity
of
gasoline
sold
each
 day?
 
 An
increase
in
the
price
of
jet
fuel
will
raise
the
marginal
OC
of
producing
gasoline
for
 passenger
cars,
thereby
implying
a
leftward
shift
in
the
supply
curve
for
gasoline.

By
 itself,
this
creates
a
shortage
of
gasoline
at
the
previous
equilibrium
price
(i.e.
excess
 demand).

Moreover,
if
increased
jet
fuel
prices
increase
the
cost
of
air
travel,
this
will
 reduce
demand
for
air
travel
as
consumers
substitute
toward
travelling
by
car,
which
in
 turn
raises
consumers’
marginal
valuation
of
gasoline.

Hence,
the
demand
curve
for
 gasoline
will
shift
right
and
aggravate
the
excess
demand
situation
at
the
former
 equilibrium
price.


Both
effects
will
unambiguously
lead
to
a
higher
market
price
for
 gasoline
as
consumers
bid
for
the
scarce
good.

Whether
the
equilibrium
quantity
 transacted
in
the
market
rises
or
falls
will
depend
on
the
relative
magnitude
of
the
two
 effects.
 
 
 
 
 
 
 
 
 
 (c) Suppose
that
cars
and
gasoline
are
complements.

Following
a
spate
of
 embarrassing
recalls,
prices
of
cars
produced
by
the
major
manufacturers
begin
 to
fall
in
Michigan.

Will
this
generate
an
excess
supply
or
excess
demand
for
 gasoline
at
the
price
of
$2.60/gallon?

How
do
you
think
the
price
of
gasoline
will
 adjust?


What
will
happen
to
the
quantity
of
gasoline
sold
each
day?
 ...
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