Midterm 1

Question 1

Complements

Answer 1

Things that go hand in hand (use together with)
Ex: Corn and butter go hand in hand.

Price goes UP then Quantity demanded goes DOWN.
Vice versa (opposites).

Question 2

Substitutes

Answer 2

Things that you use in place of something.
Ex: Margarine is a substitute for butter.

A decrease in the price of a
substitute shifts demand down and to the left.

Price goes UP then Quantity demanded goes UP.
(P and Q will always be in the same direction)

Question 3

Inferior Goods

Answer 3

Inferior goods have a negative income elasticity.
Ex: People will buy better things when their income goes up. iPhone 1 demand will go down, because people have more money to buy better phones.

Income decrease -> Price goes UP and Quantity demanded goes UP
(vice versa)

Question 4

Increase in supply/production

Answer 4

Increases in productivity means suppliers can produce more at lower costs.

Price goes DOWN, and Quantity demanded goes UP

Question 5

The increase in price of smidgets.
The increase in labor productivity.
Combining the two, what would happen?

Answer 5

The INCREASE in price of smidgets causes both the quantity and price of widgets both
FALL. The increase in labor productivity would cause the price of widgets to go DOWN and
its quantity to go UP. Combining the two, prices will go DOWN, but the effect on quantity
would be ambiguous.

Question 6

Normal Goods

Answer 6

Income increase means quantity demanded goes UP.

Ex: When your income goes UP the quantity demanded for iPhones goes UP.

Question 7

Qfigget remains unchanged while Pfigget increases

Answer 7

Since there is no change in quantity, either supply or demand will be perfectly
inelastic or both. In this case, It cannot be both, however, since price increased. Income is one of the
shifters of demand curve so the demand curve must have shifted. Price will increase
when the demand curve shifts to the right which means quantity demanded goes up
when income increases. This fits into the definition of normal goods.

Question 8

Pareto Efficiency

Answer 8

An allocation is possible/easy and no other way to make someone better off without making someone worse off. Total surplus is maximized (Pie is as big as it can be)

In a free market, there must be no externalities and perfect competition.

Question 9

Rules of Pareto Efficient

Answer 9

General Principal #1: Efficient Allocation of Consumption
In any efficient allocation, consumers with highest willingness to pay get to consume.

General Principal #2 : Efficient Allocation of Production
Producers with the lowest cost produce

General Principal #3: Efficient Quantity Marginal reservation value of the last buyer should be equal to
marginal cost of last seller.

Question 10

Perfectly inelastic supply

Answer 10

eS =0

Supply curve is vertical and doesn’t change

Question 11

Perfectly elastic demand

Answer 11

eD = infinity

Line is horizontal

Question 12

Perfectly inelastic demand

Answer 12

eD = 0
Examples: 700 students buying 1101 book in Spring 2018 at $112
Same number of students will still buy if price is $50 or $130
Theoretically ideal concept: if price raised to $1 million, students will drop out.
Demand curve is vertical; stays the same no matter what

Question 13

Clearing the Market

Answer 13

To “clear the market,” the quantity supplied and quantity demanded must be the same.

Question 14

Total tax revenue

Answer 14

The total tax revenue is the quantity

consumed (1) times the amount of the tax ($8). Thus, the total tax revenue is $8.

Question 15

Subsidy of $2 (look at graph)

Answer 15

With a subsidy, the wedge is placed to the right of the free market equilibrium. Quantity times by the Supply price. This gives us (6*6)/2=18.

Question 16

The equilibrium price of a unit of taxi quota

Answer 16

The quota is set such that the quantity is 2. Then we take the equilibrium price of a unit of tax,
is the price between Supply Price at Q=2 (2) and the Demand Price at Q=2 (8). Thus,
the answer is 8-2=6.

Question 17

Inelastic demand

Answer 17

Price > Quantity

Quantity demanded will not change as much as price will.

Question 18

Elastic Demand

Answer 18

Price < Quantity

Price will not change as much as quantity demanded will change.

Question 19

Elasticity depending on short/long run

Answer 19

Elasticity in the long run is greater than in the short run.

Question 20

Cap and trade

Answer 20

Cap and trade is a mechanism through which the amount of milk sold is reduced relative to the quantity of free market and the price is above the price of free market. A subsidy increases the quantity relative to the free market quantity. Consumers end up paying more in the cap and trade system.

Question 21

Income elasticity

Answer 21

income elasticity:
(1) For inferior goods, income elasticity is negative.
(2) For necessity goods, income elasticity is between zero and one.
(3) When income elasticity for a good is greater than one, the share of income spent on the good
is higher with higher income.

Question 22

Factors that determine Demand

Answer 22

• Price of a related good (complement or substitute)
• Income of consumers
• Tastes of consumers
• Number of consumers
• Expectations of consumers

Question 23

Factors affecting supply

Answer 23

• Price of inputs
• Production technology
• Number of producers
• Expectations of producers

Question 24

Supply shifts down and to the right

Answer 24

Increase in equilibrium Quantity and decrease in equilibrium Price.

Question 25

Unit elastic

Answer 25

Unit elastic is a change in price that causes a proportional change in the quantity demanded.

Question 26

Tax burden

Answer 26

The more inelastic part of the market bears the burden.
For consumers to bear the whole tax burden, demand should be perfectly inelastic.
If producers were to bear the whole tax burden, supply should be perfectly inelastic.

Question 27

In any Pareto efficient allocation

Answer 27

Producer surplus does not have to equal consumer surplus.

Question 28

In the unregulated market equilibrium, excess demand must be zero.

Answer 28

In the unregulated market, the equilibrium price is such that QD=QS , hence Excess Demand = QD – QS= 0.

Question 29

Subsidy of $6. What is the equilibrium quantity with the subsidy?

Answer 29

PD = Tax + PS. In this case we have a subsidy of $6 hence
Tax = -$6. This implies that the equilibrium quantity is where PD = -6+ PS. This happens when Q=8, because in this case PD = 2 and PS = 8.

Question 30

Total government expenditure

Answer 30

Subsidy x quantity supplied by gov = Total gov expenditure

Question 31

Change in total surplus ($6 subsidy)

Answer 31

In the graph, the deadweight loss corresponds to the area in which the supply curve is above the demand. The area of the triangle corresponding to the deadweight loss is (1/2)x(8 - 2)x(8 - 5) = 9. Since it is a loss, - 9.

Question 32

Price ceiling of $2, Excess demand =

Answer 32

With price ceiling of $2, excess demand is Quantity demanded - Quantity supplied . ( 8 - 2 = 6 )

Question 33

Perfectly inefficient rationing

Answer 33

Buyers with the lowest reservation value will acquire the
widget.
Start from right to left. (Quantity 8 with price ceiling of $2.)
So (1/2) * (8-6) * (4-2)

Question 34

When price floor is below equilibrium

Answer 34

A price floor establishes the minimum price in the market. A price floor of $2 is below the equilibrium and it is not a binding constraint. That is, it does not affect market allocation. The consumer surplus is calculated as usual, CS = (1/2)x(5 - 0)X(10 - 5) = 12.5

Question 35

The policy caps the total amount of quota at 4 units. The equilibrium price of one unit of quota at the quota exchange equals

Answer 35

The policy caps the total amount of quota at 4 units. So the owner of a quota face the following
decisions If produce, profit for selling the good are given by $2 = $6-$4 => Pd - Ps. If he sells the
quota, he gets the Price of the quota, Pq. Hence in equilibrium it must be the case that the Price of
the quota equals the profits that the firm makes by producing.

Question 36

Head tax that has not have an impact/change on quantity or number of people that live there

Answer 36

There will be no deadweight loss if there the head tax does not have an impact on anything.