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Economics 172 Spring 2004 Name__________________ Exam 1 Answer all questions on this exam. Label all important and relevant points, lines, and axes on any graph. Point values are noted next to each question (78 points total). Budget your time wisely. 1. (15) Suppose a National Institutes of Health study finds that using battery powered toys is bad for children's intellectual and emotional development. Show the impacts on the following markets. Be sure to label all relevant points and graphs and clearly show what happens to equilibrium price and quantity. a. (5) The market for battery powered toys. b. (5) The market for batteries used in toys. c. (5) The market for yo-yos (the ones without batteries). 1 2. (13) Business Week magazine (February 16, 2004) reported that when JetBlue Airlines entered the New York City to Buffalo market, the average fare between the two cities fell by 40% and the number of passengers traveling by air between the two cities rose by 94%. a. (3) What was the price elasticity of demand for air travel between these two cities? b. (2) Is air travel demand between New York and Buffalo elastic or inelastic. Briefly (1 sentence) explain why. c. (3) Business Week also reported that when JetBlue entered the New York to Los Angeles market, average fares fell by 26% and the number of passengers traveling rose by 2%. What was the price elasticity of demand for air travel between these two cities? d. (2) Is air travel demand between New York and Los Angeles elastic or inelastic. Briefly (1 sentence) explain why. e. (3) Why are your answers different or the same for these two city pairs? 3. (5) Your income is $10 per week. You can purchase cookies for $1 each. The store you buy them from has a “frequent cookie” program. If you buy more than 5 cookies a week, you can buy them at 50 cents each. Draw your budget line between cookies and all other goods. 2 4. (19) In 2002 roses cost $4 each and Gertrude bought 100 roses over the course of the year. a. (4) Draw an indifference curve and budget line for Gertrude in 2002 and label the budget line BL2002 and label all relevant points and curves. Put the composite good on the y axis and roses on the x axis. In 2003, roses cost $3 each and Gertrude earned the same income she did last year. She gave her retired mother a gift of $100 in 2003. b. (2) Is her 2003 budget line flatter or steeper than the 2002 budget line? c. (4) After Gertrude gives her mother the $100 gift in 2003, will her 2003 budget line be above, below, or go through her 2002 equilibrium (optimum) point? Carefully explain why. d. (3) Based on your answer to part c, draw her new budget line for 2003 (on your original graph) and label it BL2003. e. (2) Draw her new indifference curve for 2003 (on the original graph) and label it I2003. f. (4) In 2003, can Gertrude be better off, worse off, or have just the same amount of satisfaction as she had in 2002? Briefly explain. 3 5. (10) Homer buys only Duff Beer and nuclear power plant tools. Duff Beer is an inferior good for Homer. One day the price of Duff Beer goes down. a. (5) Show Homer’s old and new optimum points and show the income and substitution effects of the price change. Explain how you derived the income and substitution effects and the direction of change of them. b. (5) Can you say for certain whether the substitution effect causes Homer to buy more or fewer tools than before? Can you say for certain whether the income effect causes Homer to buy more or fewer tools than before? If you can, use the graph to explain why. If you cannot, explain on what the answer would depend. (Note that the price of Duff Beer changed and this part asks about tools.) 4 6. (16) Suppose there are two countries, East and West. The only two goods these countries can produce are food and clothing and the only inputs required are labor. The amount of hours of labor required to produce these products in each country are as follows: 1 unit of food 1 unit of clothing East 2 hours 8 hours West 7 hours 14 hours a.(3) What is the cost of producing 1 unit of clothing in East? b.(3) What is the cost of producing 1 unit of clothing in West? c.(2) Which country should produce clothing? d. (2) Which country should produce food? e. (3) Suppose West offers to give East 1 unit of clothing in exchange for 5 bushels of food. Why won't East accept this offer? f. (3) Suppose East offers to give West 1 unit of food in exchange for 1 unit of clothing. Why won't West accept this offer? g. (3) Provide one feasible trading exchange rate that will be agreeable to both countries. 5