Problem Set 2. PART I Multiple Choice Figure 1. The figure illustrates the market for roses in a country.

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1 PART I Multiple Choice Figure 1 Problem Set 2 The figure illustrates the market for roses in a country. 1. Refer to Figure 1. The amount of revenue collected by the government from the tariff is a. $200. b. $400. c. $500. d. $600. ANSWER: A 2. Refer to Figure 1. When a tariff is imposed in the market, domestic producers a. gain $100 of producer surplus. b. gain $150 of producer surplus. c. gain $200 of producer surplus. d. gain $300 of producer surplus. ANSWER:B 3. Refer to Figure 1 The amount of deadweight loss caused by the tariff equals a. $100. b. $200. c. $400. d. $500. ANSWER:A

2 4. The following diagram shows two budget lines: A and B. Which of the following could explain the change in the budget line from A to B? a. a decrease in income and a decrease in the price of X ANSWER:D Figure 2 b. a decrease in income and an increase in the price of X c. an increase in income and a decrease in the price of X d. an increase in income and an increase in the price of X 5. Refer to Figure 2. The price of X is $20, the price of Y is $5, and the consumer s income is $40. Which point represents the consumer s optimal choice? a. A b. B c. C d. D ANSWER:A

3 Figure 3 6. Refer to Figure 3. It would be possible for the consumer to reach I2 if a. the price of Y decreases. b. the price of X decreases. c. income increases. d. All of the above would be correct. 7. Refer to Figure 3. Bundle B represents a point where a. MRSxy > Py/Px. b. MRSxy = Px/Py. c. MRSxy < Px/Py. d. MRSxy > Px/Py. 8. Consider the indifference curve map and budget constraint for two goods, X and Y. Suppose the good on the horizontal axis, X, is normal. When the price of X increases, the substitution effect a. and income effect both cause an increase in the consumption of X. b. causes a decrease in the consumption of X, and the income effect causes an increase in the consumption of X. However, the substitution effect is greater than the income effect. c. causes an increase in the consumption of X, and the income effect causes a decrease in the consumption of X. However, the substitution effect is greater than the income effect. d. and income effect both cause a decrease in the consumption of X.

4 9. When the price of an inferior good increases, a. both the income and substitution effects encourage the consumer to purchase more of the good. b. both the income and substitution effects encourage the consumer to purchase less of the good. c. the income effect encourages the consumer to purchase more of the good, and the substitution effect encourages the consumer to purchase less of the good. d. the income effect encourages the consumer to purchase less of the good, and the substitution effect encourages the consumer to purchase more of the good. ANSWER:C 10. Assume that a college student purchases only Ramen noodles and textbooks. If Ramen noodles are an inferior good and textbooks are a normal good, then the income effect associated with a decrease in the price of a textbook will result in a. a decrease in the consumption of textbooks and a decrease in the consumption of b. a decrease in the consumption of textbooks and an increase in the consumption of c. an increase in the consumption of textbooks and an increase in the consumption of d. an increase in the consumption of textbooks and a decrease in the consumption of!

5 PART II Short Answer 1. Chp 9, question 11 a. Figure 11 shows the market for jelly beans in Kawmin if trade is not allowed. The market equilibrium price is $4 and the equilibrium quantity is 4. Consumer surplus is $8, producer surplus is $8, and total surplus is $16. Figure 11 b. Since the world price is $1, kawmin will become an importer of jelly beans. Figure 12 shows that the domestic quantity supplied will be 1, quantity demanded will be 7, and 6 bags will be imported. Consumer surplus is $24.50, producer surplus is $0.50, so total surplus is $25. Figure 12 c. The tariff raises the world price to $2. This reduces domestic consumption to 6 bags and raises domestic production to 2 bags. Imports fall to 4 bags (see Figure 12). Consumer surplus is now $18, producer surplus is $2, government revenue is $4, and total surplus is $24. d. When trade was opened, total surplus increases from $16 to $25. The deadweight loss of the tariff is $1 ($25! $24)

6 2. Chp 9, question 13 a. When a technological advance lowers the world price of televisions, the effect on the United States, an importer of televisions, is shown in Figure 13. Initially the world price of televisions is P 1, consumer surplus is A + B, producer surplus is C + G, total surplus is A + B + C + G, and the amount of imports is shown as Imports 1. After the improvement in technology, the world price of televisions declines to P 2 (which is P 1 100), consumer surplus increases by D + E + F, producer surplus declines by C, total surplus rises by D + E + F, and the amount of imports rises to Imports 2. Figure 13 P 1 P 2 CHANGE Consumer Surplus A + B A + B + C + D + E + F C + D + E + F Producer Surplus C + G G C Total Surplus A + B + C + G A + B + C + D + E + F + G D + E + F b. The areas are calculated as follows: Area C = 200,000($100) + (0.5)(200,000)($100) = $30 million. Area D = (0.5)(200,000)($100) = $10 million. Area E = (600,000)($100) = $60 million. Area F = (0.5)(200,000)($100) = $10 million. Therefore, the change in consumer surplus is $110 million. The change in producer surplus is -$30 million. Total surplus rises by $80 million. c. If the government places a $100 tariff on imported televisions, consumer and producer surplus would return to their initial values. That is, consumer surplus would fall by areas C + D + E + F (a decline of $110 million). Producer surplus would rise by $30 million. The government would gain tariff revenue equal to ($100)(600,000) = $60 million. The deadweight loss from the tariff would be areas D and F (a value of $20 million). This is not a good policy from the standpoint of U.S. welfare because total surplus is reduced after the tariff is introduced. However, domestic producers will be happier as they benefit from the tariff.

7 d. It makes no difference why the world price dropped in terms of our analysis. The drop in the world price benefits domestic consumers more than it harms domestic producers and total welfare improves. 3. Chp 21, question 5 Figure a. Figure 14 shows Jim's budget constraint. The vertical intercept is 50 quarts of milk, because if Jim spent all his money on milk he would buy $100/$2 = 50 quarts of it. The horizontal intercept is 25 dozen cookies, because if Jim spent all his money on cookies he would buy $100/$4 = 25 dozen cookies. b. If Jim's salary rises by 10 percent to $110 and the prices of milk and cookies rise by 10 percent to $2.20 and $4.40, Jim's budget constraint would be unchanged. Note that $110/$2.20 = 50 and $110/$4.40 = 25, so the intercepts of the new budget constraint would be the same as the old budget constraint. Because the budget constraint is unchanged, Jim's optimal consumption is unchanged.