Write your name: UNIVERSITY OF WASHINGTON Department of Economics

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1 Write your name: UNIVERSITY OF WASHINGTON Department of Economics Economics 200, Fall 2008 Instructor: Scott First Hour Examination ***Use Brief Answers (making the key points) & Label All Graphs Completely and Carefully*** 1. (4 points) Consumer Equilibrium. A consumer has $50 per week to spend as she wishes on two goods vanilla lattes and pastries. The prices of those goods, the quantities she now buys, and her evaluation of the utility provided by these quantities are as follows: P Units Bought Total Utility Marginal Utility A) vanilla lattes B) cheese Danish For maximum satisfaction, this consumer should: a. Buy less of A and more of B. b. Buy the same quantity of A and more of B. c. Buy more of A and less of B. d. Buy more of A and the same quantity of B. e. Do nothing, being already at the best possible position. To justify your answer, state the utility-maximizing condition for consumer equilibrium and briefly explain (you do NOT need to provide a graph).

2 Economics Scott 2. (4 points) Elasticity of Supply. State whether the following statement is true, false, or uncertain and explain your answer: In the diagram below, the supply curve S2 is more elastic than the supply curve S1. That is, the elasticity of supply is greater for S2 than for S1. P S 1 S 2 Q 3. (4 points) Incidence of a Sales Tax. Assume that the demand for fish is perfectly elastic, and the supply curve is rising. The current equilibrium price is $8.00 per pound. If the government imposes a sales tax of $2 per pound (requiring that producers send the government $2 for each pound of fish sold) what will the new equilibrium price of fish be? How much of the tax will consumers bear? How much of the tax will producers bear? Illustrate your answer with an appropriate graph of supply and demand.

3 Economics Scott 4. Agriculture Policy, Supply and Demand, Demand Elasticity, Pareto Efficiency. The diagram below shows the supply and demand for an agricultural commodity, say grain. Quantity is measured in thousands of bushels per week, price in $ per bushel. P S D Q a. (4 points) If the market clears, what is the equilibrium price of grain? What would it cost an individual farmer to produce one additional bushel of grain per week? Explain why the answers to these two questions are the same. b. (4 points) The government sets a target price of 9 but then lets the market determine the price. Consider the new equilibrium price and quantity. What would a feedlot (which produces beef) now pay for a bushel of grain to feed its cattle? What would it now cost an individual farmer to produce one additional bushel of grain per week? In light of your answers, is the new equilibrium quantity of grain efficient? EXPLAIN. (Remember that with a target price policy the government pays the farmers the difference between the target price and the market price.)

4 Economics Scott c. (4 points) How will the target price policy affect the price of beef (grain is used in the production of beef)? Illustrate your answer with a diagram showing the supply and demand for beef. Is the new equilibrium quantity of beef efficient? EXPLAIN. d. (4 points) What is the elasticity of demand over the stretch of the demand curve from the point (Q=3, P=9) to the point (Q=10, P=2)? Explain simply by showing the appropriate formula and your work to get the numerical answer. e. (4 points) Does your calculation in part d accurately predict the change in total revenue? Explain.

5 Economics Scott 5. Consumer Equilibrium, Pareto Efficiency. Two consumers (A and B) each have an income of 100. Each spends all of her income on two goods, X and Y. Each consumer maximizes utility subject to her budget constraint. The price of good X is 10 and the price of good Y is 5. At these prices, Consumer A consumes 4 units of X, and Consumer B consumes 8 units of X in equilibrium. a. (4 points) Draw two diagrams, one for Consumer A and one for Consumer B, showing the equilibrium (budget lines and indifference curves) for each consumer. b. (4 points) In equilibrium, how many units of Y does Consumer A consume? How many units of Y does Consumer B consume? Show your work. c. (4 points) In equilibrium, what is Consumer A s marginal rate of substitution (MU X /MU Y )? What is Consumer B s marginal rate of substitution? Briefly explain how you arrive at your answer (you do NOT need to provide intuition here). d. (4 points) Consumer B obtains a coupon for good X, which allows her to buy as much as she wants for HALF PRICE. In your diagram for Consumer B, draw her new budget constraint and indifference curve, assuming that she now buys 14 units of X. What is Consumer B s marginal rate of substitution now? (Consumer A does not have the coupon, so she still buys the same quantities of X and Y). e. (4 points) Consider the distribution of goods X and Y between consumers A and B under the assumptions of part d. Is this distribution Pareto efficient? EXPLAIN.

6 Economics Scott 6. Production Possibilities, Opportunity Costs, and Gains from Trade. The diagrams below show the production possibilities frontier (PPF) for Country A and for Country B. The outcome with autarky (no trade) for each country is shown as point Z on each country's PPF. Good Y 4000 PPF for Country A with Z = (500, 2000) 2000 Z Good X Good Y 2000 PPF for Country B with Z = (1000, 1000) 1000 Z Good X ***SHORT ANSWERS ONLY NO NEED TO WRITE EXPLANATION*** a. (1 point) Country A has an absolute advantage in the production of good. b. (1 point) Country A has a comparative advantage in the production of good. c. (1 point) Country B has an absolute advantage in the production of good. d. (1 point) Country B has a comparative advantage in the production of good. e. (4 points) Suppose that after free trade that causes gains from trade, Country A produces 100 more of one of the goods, while Country B produces 75 more of the other good. After the trade, the total output of good Y is how much, while the total output of good X is how much?