Download Exam 1 Spring 2004

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