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Practice Midterm 1 - ‘3""I:= |" A 1T”"...

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Unformatted text preview: ‘3 " "I ::=.:- |" A 1T”. " NAME AND L. MW UTEID \ Md Q$gj 3 ECONOMICS 304K, FALL 2007 D. Ha ermesh MID'I‘ERM EXAM #1 Answer the questions in the space provided on the test sheet or on the reverse side. write gear name and UTEID on each page. You have 80 minutes for the exam, and there are 36 total points. tests will be handed back and gone over in class next Tuesday. Please read Chapter 7 in the text for next Tuesday’s lecture. I. (6 points)1. TexaMioh is known for the production of rice and cars. The possible combinations of rice and cars that can be produced are given in the followin table: ~ g (3 ”(go a. What is the opportunity cost of the first 300,000 cars? r fig 330 What is the opportunity cost of increasing oar production {90z, filoc) from 600, 000 to 900, 000? Explain the reasoning behind the changing opportunity cost of cars. %4JK [OD 02"” ”Q” 6 360 'Msmroas We; amt? MGPZMO‘C” is ”it”??? ' dijfikg ' - owl—Lee; a (Jeac‘x b. Graph the production possibility frontier in TexaMioh.% {AA/W47Lb’ 349%, ”Kb - I Q50 o. Explain the result and show in your graph the effect of an inflow of foreign a or' E WEI" Wm Wow 1 flmwtef ”M d. Now do the same thing for the development of a new variety of high yield rice. ‘Eow VPF’ II. a. (2 points) Briefly describe and show graphioally what will happen (if anything) to outcomes in the market for iPhones in response to Googie {one of the most successful internet service providers) beginning to market its own phone, the gshone. M%m W \/ QW/ Qxl/ b. (2 points) The FDA institutes stringent new testing requirements for contact ienses, resulting in a 300% increase in the price of contacts. How does this affect the market for laser vision correction surgery? Max/01 New/Eng @(W QRM' (Wm M c. (2 points) Corn is the main input for both ethanol and high—fructose corn syrup. If the demand for ethanol increases, how will this affect the market for gummy bears (which are made almost entirely of corn syrup)? [is LK Zéfé PPPX‘LW III. {6 points) WSéc/QA} we. Graduate students at UT are offering tutoring services in economics to undergraduates. The demand for and supply of these services are'summarized i'n the follow1ng table. Hours supplied per Hours demanded per. Eprioe ($) week aDrawthe‘fléié'afidwafid """s'uspig?‘stress"“‘f‘6£“"'£a't6uai' services. Indicate specifically the equil'briumtprice a d quantity. é Us b. Suppose that toward the end of the semester the graduate students have to study to take their exams, leaving them with less time to_provide tutoriai services. Indicate on the diagram you drew how this might affect Supply or demand (or both). What happens to the equilibrium price and quantity in the economics tutorial market? 3W c. Suppose the UT administration decides that extra economics help has become too expensive, and that the undergraduate students are being exploited. It implements a price control so that any graduate student charging more than $10 per hour will be suspended. Indicate this on a new graph and discuss how it affects the market for tutoring by grad students. \x wee/3 5L, €ng 1M IV. (4 points) A story in the Austin American-Statesman of September 13 headlined, “Itaiians have fill of high pasta prices." It says, “The price of pasta is being driven by rising wheat prices worldwide.” An analyst says, “Markets tend to correct themselves, as higher prices lead farmers to plant more wheat.” Show what rising wheat prices have done in the pasta Xmarket. Then show andfidescribe what the analyst means about the wheat M s marsket. "D. s S f w % ‘mmws 5"?ij W “HMS Q §vholg MWK‘L’CS GLWK Wig/is 1% free moms, CW 97 9M, momeéf/ ‘M W V. {6 points) Peter sells pretzels on the streets of New York. He charges $2 per pretzel, and each day, Paul buys 6 at lunch. Qm a. Peter raises the price to $3. New Paul only buys 4 pretzels. What is Paul’s price elasticity of demand for pretzels? fl 3—; we 82% Sis—Zr ,L 7’." . \ / 25 ”Ewes ’5” b. if other consumers have the same price elasticity as Paul, what happens to Peter's total revenue from selling pretzels when he raises the price? c. The City of New York realizes that street pretzels are a necessity for consumers. As a result it decides to subsidize their consumption. Discuss how this subsidy benefits consumers at different income levels.. Production Possibility Frontier for TexaMich {.0 01 D 2 “a? l: g I... O In I: .2 E, 00 3 35150‘ Gairs (thousands) c. Explain the result and Show in your graph the effect of an inflow of foreign labor. An inflow of foreign labor reduces the price of labor. This should reduce the costs of producing both goods. This should shift the production possibility frontier outward along both the rice and car axes. Production Possibility Frontier for Texafiflich Rice (miiiions of tons} 606 Cars (thousands) w—Production before foreign {abor --—m-—- Production afler foreign iaborj The choice of points is arbitrary. The production possibility frontier just needs to shift outward on both axes. d. Now do the same thing for the development of a new variety of high yield rice. The development of a new variety of high yield rice should rotate the production possibility frontier outward along the rice axis. The point 900,000 cars and 0 millions of tons of rice must: be on the new production possibili ty frontier. Production posaibifityfronfier for TexaMich 717 a .3 “5 m s: .9. E w E 0 300 600 Cars (thousands) —e——-Rice - old variety ——m-—- Rice - new variety I1.a. (2 points) Briefly describe and show graphically what will happen {if anything) to outcomes in the market for iPhones in response to Googie (one of the most successful internet service providers) beginning to market its own phone, the gPhone. Since the cell phone consumers will have another alternative, the demand for iPhone will decrease after Google begins to market the gEhone. So the demand curve will shift to the left. Therefbre, the equilibrium price will decrease and quantity sold will also go down. fhe extent of the shift may depend on the price of gfhones, the functional similarity of the two products, and so on. Supply (~11 'V‘TTQ Demand curve before emand cur b. (2 points) The FDA institutes stringent new testing requirements for contact lenses, resulting in a 300% increase in the price of contacts. How does this affect the market for laser vision correction surgery? In the market for laser surgery, demand will increase because people will substitute correction surgery for contact lenses. Equilibrium price and quantity will increase. Laser Vision Correction Surgery 8 pric ’2’ x” quantity c. (2 points) Corn is the main input for both ethanol and high—fructose corn syrup. If the demand for ethanol increases, how will this affect the market for gummy bears (which are made almost entirely of corn syrup)? An increase in the demand for ethanol will lead to an increase in equilibrium price and quantity in the market for ethanol. The increased price of ethanol will cause an increased demand for corn, so equilibrium price and quantity of corn will rise as well. The higher price of corn will lead to a decrease in the supply of gummy bears because the cost of producing them will rise. Equilibrium price rises, and equilibrium quantity falls. III. (6 points) Graduate students at UT are offering tutoring services in economics to undergraduates. The demand for and supply of these services are summarized in the following table. ‘"issues“éafibiigawgsifisaaegM“aéeafiaea““gasg Eweek Eweek : I jPrice ($) “a? BESW the usages sea Efifipi§ EGE§E§ ESE Efitéiiéi EEEGices. Indicate specifically the equilibrium price and quantity. Market for Tutoring Services 20 WWWm.WMmmm.w...im___m-w_w_m__..__.____ ......................... MW; 18 ———-—-—~———-——-— m-—--— 1 6 4O 50 60 70 80 Hours of Tutoa'ing Service - -¢- ~0emnd —fl—-Supply The equilibrium price is $14 and the equilibrium quantity is 60 hours of tutoring service. The equilibrium is the intersection of supply and demand. b. Suppose that toward the end of the semester the graduate students have to study to take their exams, leaving them with less time to provide tutorial services. Indicate on the diagram you drew how this might affect supply or demand (or both}. What happens to the equilibrium price and quantity in the economics tutorial market? Graduate students taking time to study for exams will reduce the supply of tutoring services in the market. The reduction in supply (shift leftward) causes an increase in equilibrium price and a reduction in the equilibrium quantity. The graph below illustrates this with the price changing to $15.00 and the quantity changing to 50 hours. Market forTutoring Services Price {$3 40 50 60 70 80 Hours of Tutoring Services .. “em .- Supply After WDemsnd memsupply Before] J c. Suppose the U? administration decides that extra economics help has become too expensive, and that the undergraduate students are being exploited. It implements a price control so that any graduate student charging more than $10 per hour will be suspended. Indicate this on a new graph and discuss how it affects the market for tutoring by grad students. Market for Tutoring Services . "mm...“ ......_ ....__.__ .. ...A__.__.‘...__. ..._.,_..‘.____._..._._‘ ....._.. __ H._._......‘...._.,_...._._.....» _._... ..V._.._....._.._..._........_._.._.._._‘..~.._.._..._ _......t..um.».m.» Awmmwwwmur try..,..._..rm_.ms__uWA“: Shortage in the market after pn'ce floor 4O 50 60 7’0 80 90 100 Hours of Tutoring Service This causes a shortage in the market for tutoring services. There is excess demand in the market at the price of $10.00 an hour. The students will want to have 100 hours of tutoring service and the tutors will only supply 40 hours of tutoring service. Students and tutors will arrange for illegal ways of generating the services at a price above $10. IV. (4 points) A story in the Austin American-Statesman of September 13 headlined, “Italians have fill of high pasta prices.” It says, “The price of paste is being driven by rising wheat prices worldwide.” An analyst says, “Markets tend to correct themselves, as higher prices lead farmers to plant more wheat.” Show what rising wheat prices have done in the pasta market. Then Show and describe what the analyst means about the wheat market. The increase in the cost of production of pasta causes the supply curve to shift to the left, and therefCIe create a new equilibrium point with a higher price. Pasta Market 8} 3 price quantity Rising prices in the wheat market cause farmers to plant more wheat. This is a shift along the suppiy'curve in the wheat market, as shown below. Wheat Market , , Quantity This extra wheat in the mark t Will eventually drive down the cost of production or'pasta and thus return us to the original equilibrium point in the pasta market. V. {6 points) Peter sells pretzels on the streets of New York. He charges $2 per pretzel, and each day, Paul buys 6 at lunch. a. Peter raises the price to $3. Now Paul only buys 4 pretzels. What is ?aul’s price elasticity of demand for pretzels? The formula for price elasticity of demand is percent change in quantity demanded divided by percent change in price. Using the midpoint formula to calculate the elasticity: — (2—3)/(2.5) X (6w4)/(5) = 1.0. b. If Eeul is a typical consumer, what happens to Peter’s total revenue from selling pretzels? With a unit elasticity of demand, the percentage price rise equals the percentage quantity decline, so total revenue remains unchanged. c. The City of New York realizes that street pretzels are a necessity for all consumers- As a result it decides to subsidize their consumption. Discuss how this subsidy affects spending on street pretzels by consumers at different income levels. Pretzels being a necessity means that the income elasticity is less than 1. Therefore, the pretzel subsidy will be paid especially to lower—income people, because higher—income people will spend proportionately less and get a lesser share of the subsidy. The subsidy will thus benefit lowerw income people proportionately more. VI. (6 points) Grenada has a budget of $160 million. It can build prisons or schools. Building a prison costs $40 million, building a school costs $20 million. The government believes that society’s total utility from prisons and schools is given by the following table: d) Draw the budget constraint for Grenada. Budget constraint of Grenada mm, , I "r 1 l ! e) How many schools and how many prisons should Grenada build? Explain your answer. Show your work, deriving the Marginal Utility of each additional prison, and each additional school. The easiest way to do this is to add the utilities for all points on the budget line in a table: I!--_—_ ___—_- ___-__ ___—— utility 3 2 The highest total utility is attained at the point 1 prison M 6 schools. This is the feasible point where the MU of‘prisons is nearest to twice the MU of schools. Going to 7 schools is only possible if no prisons are built, and the utility is then only 91. f) Show in the graph you drew in your answer to (a) what happens to the budget constraint aftex a teachers’ strike raises the price per school to $40 million. New b.c. of Grenada 5 WW WW'WWW etc: w W m new :1 J VII. (2 points) Comment on the following statement; “It’s always a better deal to pay a flat fee, like a monthly charge for local telephone service, or a daily admission ticket at Sea World, than to have to pay for each unit of the serviceweach phone call or each ride.” This depends entirely on the flat fee charged. If the fee is set appropriately, consumers will be worse ofthhe seller will be able to capture the entire consumer surplus. math a fee for service some people will be priced out of the market, but others who desire the product a lot will enjoy some consumer surplus. ...
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