Download Answer - Leah Brooks

Midterm
Intermediate Microeconomics
Fall 2016
October 11, 2016
Name:
Instructions
1. Answer all questions.
2. The exam will be graded out of 100 points. Points for each section and points for each
question are indicated on the exam.
3. Write legibly. Illegible exams cannot be graded.
4. Do your best to fit all your answers on the front side of the exam. If you need to use
the back of a page, indicate that clearly.
5. Label all figures as needed.
6. Make sure you explain your answers as needed. When appropriate, you should also
explain any assumptions that you make to arrive at your answer. Explanations may
yield partial credit.
7. Be concise.
8. The final page is intentionally left blank for extra work. If you do extra work on this
page (or in any other non-standard location) that you would like to be counted, you
must note it clearly near the question you are answering.
9. Write your name on each page.
For marking purposes only
Part A
Part B
Part C
total
1
A. Ripped From the Headlines (8 points)
Read the article from the Wall Street Journal at the end of the exam.
1 (3). Has this recent scare changed the supply of clowns or the demand for clowns? Draw
a picture of the original equilibrium and the new post-scare equilibrium.
Demand for clowns has shifted inward. See picture at end.
You could also argue from evidence in the article that supply has shifted inwards – the article
mentions clowns canceling bookings – and I accepted answers that gave this answer with
evidence and also cited a decrease in demand for clowns.
2 (3). What are some inputs complementary to clown production that are described in this
article? What do you anticipate will happen to the prices of these goods after the scare?
Some complementary inputs include clown make-up, balloons, and clown clothes (and surely
others I’ve missed).
There are two reasonable expectation for prices of inputs complementary to clown production. The first is that the complementary good sees no change in price because clowns make
up only a very small portion of the demanders – too small to appreciably change prices. This
is probably true for the balloon market.
An alternative answer is that the decreased demand for clowns will lower the price of goods
complementary to clown production since demand by clowns for these goods will fall substantially. This is probably most true for goods such as clown make-up.
A complete answer here requires both a description of inputs and some discussion of the
impact on input prices.
One very good answer: “Complements: fact paint, balloons, clown noses.
“I would anticipate the demand curve will shift to the left due to a change in consumer
tastes. This will cause a new equilibrium farther down the supply curve leading to what I
would expect to be a lower price for clowns.
“I would then expect a similar shift for the demand curve for the complements expecting
them to have new, lower prices as well.”
3 (2). Imagine that the output of clowns is enjoyment. Describe the change in the marginal
) from this
product of enjoyment with respect to clown make-up (M Pmake-up = ∆enjoyment
∆make-up
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recent scare.
Any reasonably argued answer is acceptable. I suggest that the marginal product of enjoyment with respect to clown make-up declines, because it takes more clown inputs (or better
clown inputs) to produce enjoyment than before.
This question is quite nuanced. For an answer to receive full credit it must have both an
understanding of the marginal product of enjoyment with respect to make-up, and an explanation for why it should decline.
One very good answer: “The marginal product of enjoyment with respect to clown make-up
has decreased due to this scare, meaning that for every additional unit of clown make-up
used, the amount of public enjoyment produced is smaller than the amount of enjoyment
produced per unit of make-up before the scare.”
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B. Short Answer Questions (40 points, 5 points each question)
1. Give two examples of things that could shift your demand for apples, and explain which
way each shifts shifts the demand curve and why.
We discussed a variety of potential factors that can shift the demand curve:
• number of consumers
• consumer wealth or income
• consumer tastes
• prices of other goods
New information/tastes: I learn that apples rot my teeth. This causes a decline in the price
that I am willing to pay for any quantity of apples, shifting my demand curve inward.
Presence of substitutes: I learn that price of peaches falls. For me, peaches and apples are
somewhat substitutable. Therefore my willingness to pay for apples decreases for any quantity, shifting my demand curve inward.
Price is not a correct answer to this question, as changes in price move you along the demand
curve.
2. Why do we generally expect an isoquant to flatten (be more parallel to the axis) as a
firm’s consumption of labor becomes very large?
When a firm consumes a lot of labor, it is willing to give up a lot of labor to get a little bit
of capital. This is true because there is complementarity between labor and capital.
To receive full credit here, your answer must discuss the complementarity of labor and capital.
3. Suppose that we are interested in the cross price elasticity of goods X and Y . If goods
X and Y are substitutes, what should the sign of the cross-price elasticity be? Explain your
logic.
The cross-price elasticity between X and Y is the percentage change in the quantity of Y
demanded with respect to a percentage change in the price of X. In math, this is
E=
%∆QY
%∆PX
If X and Y are substitutes, an increase in the price of X leads to an increase in the quantity
of Y consumed. In other words, the denominator is positive and the numerator is negative,
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yielding a negative sign, or E > 0, when X and Y are substitutable.
The right answer here requires both a formula (or the equivalent words) and an explanation.
4. Suppose that both the equilibrium price and quantity of yams increases. Assume that
only supply or demand changed. Which changed? Explain your answer.
Demand shifted outward. We know this because there are only four possible pairs of outcomes:
• If S increased → prices fall, and Q increases. Not possible
• If D increased → prices increase, and Q increases. Possible.
• If S decreased → prices increase, and Q decreases. Not possible.
• If D decreased → prices fall, and Q decreases. Not possible.
5. If the market price for pluots is $3 per pound and a consumer would be willing to pay $4
per pound, does the consumer receive any surplus? Explain, using the definition of consumer
surplus.
Consumer surplus is the benefit a consumer receives above and beyond the market price.
Here the consumer is willing to pay $1 more per pound for pluots and therefore receives a
consumer surplus equal to her quantity of pluots consumer multiplied by $1.
To receive full credit, you must provide an intuitive definition for consumer surplus.
6. Draw a supply curve where the government allows production of no more than 200 doctors
per year. Explain why your supply curve looks the way it does.
This is a supply curve with a quota. See the picture at the end; the curve becomes vertical
at Q = 200, because there is no price for which the market will provide more than 200 doctors.
Full credit requires some intuition and a labeled picture.
7. Suppose that you can spend your income I on only two goods: bread and water. The
price of bread if Pb and the price of water is Pw . Now suppose that the price of water falls
and the price of bread is unchanged. Draw both the new and old budget constraints, labeling
axes and points of intersection and putting bread on the horizontal axis. Explain why the
change is as you’ve drawn it.
The budget constraint should have two intercepts. On the y-axis, the intercept is I/Pw ; on
the x-axis, the intercept is I/Pb . After the price of water falls, the intercept on the bread
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axis is unchanged, and the intercept on the water axis moves higher. See picture at end.
8. Define the income elasticity of demand, and give the limits of its size for inferior goods.
Explain your answer.
The income elasticity of demand is the percentage change in quantity demanded for a given
percentage change in income:
E=
%∆Q
%∆I
You consume less of inferior goods as your income increases. This means that the denominator is positive (an increase in income) and the numerator is negative, so E < 0.
You need an intuitive explanation to receive full credit.
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C. Medium Answer Questions (52 points, each sub-point worth 4 points)
1. Consumer Optimization
Suppose that Fred’s utility function is U = XY , and that, therefore, M UX = Y , and
M UY = X. Also suppose that Fred’s income is $200, and the price of X is 4, and the price
of Y is 2.
(a) Give two combinations of X and Y that are on the same indifference curve for Fred.
If two baskets of goods are on the same indifference curve, they must give the same utility. Suppose that U = 10. Fred can get this level of utility from (X = 5, Y = 2) or
(X = 2, Y = 5) (as well as from (1,10), (10,1) and other combinations).
To receive partial credit, you need some intuition or information about indifference curves.
(b) Draw the budget constraint, labeling axes and intercepts. Put good X on the horizontal
axis.
See picture at end.
(c) What is Fred’s optimal consumption?
If Fred is consuming optimally, it must be the case that
PX
M UX
=
M UY
PY
Plugging in,
Y
4
= ,
X
2
or, simplifying, Y = 2X.
We also know that Fred’s budget constraint holds: 200 = 4X + 2Y .
Combining these two, we can write 200 = 4X + 2(2X), which simplifies to X = 25. Since
Y = 2X, it must be the case that Y = 50.
We give substantial partial credit to answers with the right formula and wrong math, and
less partial credit to answers with the wrong formula and right math.
(d) Give some intuition for Fred’s relative consumption of X and Y in part (c).
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Fred gets utility from both X and Y – they are complementary. Their marginal utility are
the same in a per unit sense, but X costs twice as much as Y . Therefore, Fred prefers to
consume twice as much Y relative to X.
To receive full credit, you need describe how prices and marginal utilities both play a role.
2. Supply, Demand and Surplus
The supply and demand for almonds are QD = 80 − 10P and QS = 10P , where P is price
per bag and Q measures bags per day.
(a) What are the equilibrium price and quantity?
Find equilibrium P and Q by setting the demand and supply equations equal.
80 − 10P = 10P
80 = 20P
P =4
Plug into either the supply or demand equation to find the equilibrium quantity: Q =
80 − 10P = 80 − 10(4) = 40.
(b) Calculate consumer and producer surplus, drawing a graph and labeling all relevant
points. You will need this graph for the remaining parts of this question.
See the picture at the end.
Consumer surplus is a triangle above the market price and below the demand curve, so
CS = 21 (40)(4) = 80. Producer surplus is a triangle above the supply curve and below the
market price, so P S = 12 (40)(4) = 80.
To receive full credit, you must both draw a labeled picture and calculate the amounts.
(c) Suppose the government imposes a price floor of $7 per bag. Is there a shortage or surplus
of almonds and, if either, what size?
If the government imposes a price floor of $7, this is a price above the market price. At this
price, producers would like to make a lot, and consumers would like to buy a little. In other
words, there is a surplus.
We can find the number of units of surplus by finding both the supply and demand at this
price. Plugging P = 7 into the supply curve gets the amount suppliers would like to sell:
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Q = 10(P ) = 10(7) = 70.
We can find the number of units of consumers would like to purchase by plugging into the
demand curve: Q = 80 − 10(7) = 10.
The difference between this two figures is 60 units, or a 60-bag surplus.
We give some partial credit for saying that there is a surplus, but without the right amount.
(d) Calculate consumer and producer surplus with the price floor.
Consumer surplus when the price is 7 is the triangle above the price and below the demand
curve: CS = 21 (10)(1) = 5.
Producer surplus is the area above the supply curve and below the price of seven: P S =
(6)(10) + 21 (10)(1) = 60 + 5 = 65.
(e) What is the size of the deadweight loss?
There are (at least) two ways to find the deadweight loss. This first is to calculate the area
directly. It is the triangle made by the supply and demand curves to the right of the quantity
10, until the old equilibrium price: DW L = 12 (6)(30) = 90.
Alternatively, you could subtract the new CS and P S from the original total to find the
DW L. In this way, DW L = CSold + P Sold − (CSnew = P Snew ) = 80 + 80 − (65 + 5) =
160 − 70 = 90.
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3 (15). Income and substitution effects
(a) What is the size of the income effect and substitution effect of each good due to the price
change in scallops?
For scallops, the size of the total effect is A to B, or 2 − 6 = −4. The substitution effect is
from A to A0 , or 5 − 6 = −1. The income effect is A0 to B, or 2 − 5 = −3.
For beef jerky, the size of the total effect is A to B, or 12 − 8 = 4. The substitution effect is
from A to A0 , or 10.44 − 8 = 2.44. The income effect is A0 to B, or 12 − 10.44 = 1.56.
Note that you cannot add the substitution effects for the two goods to get some sort of
“total” substitution effect. The answer for scallops is in terms of number of scallops. The
answer for beef jerky is in terms of numbers of beef jerky (or whatever the correct plural for
this is). Adding them up yields some nonsensical units.
We give one point for each correct answer of the 4 parts.
(b) Are scallops a normal good or an inferior good?
Note that the price of scallops increased, and that the person is therefore poorer in terms of
purchasing power.
This decrease in purchasing power caused the consumer to buy fewer scallops; they are therefore a normal good.
(c) Is beef jerky a normal good or an inferior good?
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With a decrease in purchasing power, the person buys more beef jerky. Beef jerky is therefore
an inferior good.
(d) If the government could subsidize the consumption of one of these two goods, which
subsidy would likely yield a greater percentage change in consumption? Why?
A subsidy to scallops should yield a greater increase in scallop consumption since, all else
equal, we’d expect more scallop consumption relative to beef jerky consumption as income
increases. This is because scallops are a normal good, which beef jerky is an inferior good,
and its consumption should not keep pace as income increases.
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