1. D The pollution your car puts into the air is a cost that is absorbed by society as a whole.

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1 ECON 102 Kagundu Exam 2 Practice Exam Solutions 1. D The pollution your car puts into the air is a cost that is absorbed by society as a whole. 2. A Price elasticity of demand. This problem is simply putting the price elasticity of demand equation into words. Ep = % ΔQd % ΔP 3. B Decrease price by 2%. We can use the price elasticity of demand equation to solve this problem. Ep = % ΔQd % ΔP 2.5 = 5% % ΔP % ΔP = 2% 4. E All of the above 5. B Sell more at a lower price because when demand is elastic a small decrease in price will cause a large increase in quantity demanded. 6. A Unit elastic, not change 7. B Perfectly price inelastic demand is when the demand curve is completely horizontal. 8. A Fall, elastic

2 9. D Consumer demand becomes less price elastic as departure dates approach. This means that airlines believe that consumers are less sensitive to changes in price as the date of travel gets closer. 10. C Selling less at a higher price. Inelastic demand means that a large increase in price will only cause a small decrease in quantity demanded. 11. C Tax goods with inelastic demand because the increase in price will only cause a small decrease in quantity demanded when demand is inelastic. 12. D As the time horizon increases, the elasticity of supply will become more elastic. Since elasticity of supply was 0.80 when supplier had a month to adjust, we know that the answer must be a number larger than D This problem is putting the cross-price elasticity equation into words. E xy = % ΔQd for good x % ΔP for good y 14. C Long run demand curve because demand become more elastic as consumers are given more time to adjust to changes in price. 15. C Is the most inelastic. As demand curves become more vertical, they become more inelastic. We also know that consumer demand becomes more inelastic as prices go down. Point C related to the lowest price on the most vertical demand curve. 16. A You should disagree with your friend because lowering price will only increase revenues when demand is inelastic. 17. A You can tell they are substitutes because the cross-price elasticity of demand is positive. 18. D The cost of repairing damage to the highway caused by its delivery trucks because this is a cost that is absorbed by society as a whole. 19. C Free-riding problems are when individuals are incentivized not to work because they know that if they don t do it someone else will do it for them.

3 20. A They can reduce the number of cars on the highway. 21. D All of the above 22. C A natural disaster warning system is non-rival and non-excludable 23. C Look at the graphs from this section of the packet. You will see that the supply curve shifts inward to the left which causes quantity to go down and price to go up. 24. C The area under the demand curve but above the equilibrium price. 25. A When demand for a good increases, the demand curve shifts outward to the right. As you can see in the graphs below, both CS and PS will increase. 26. A Relatively elastic because your friend is sensitive to changes in price due to a limited budget. 27. B Upperclassmen have inelastic demand because they are already most of the way through their degree so at that point they are going to do what is needed to complete the program. When you have customers with inelastic demand and you increase price, revenue will increase. 28. B It is inelastic because total revenue increased when price increased.

4 29. B Demand is inelastic when there are no substitutes available. 30. A Demand becomes more elastic as time passes. 31. A Inelastic because we are generally not sensitive to changes in prices of goods that make up a small percent of our income. 32. C Inelastic because there are few substitutes. 33. B The cost of someone s rent or mortgage is typically a large percent of their overall income so people will be sensitive to changes in the cost of housing. 34. D Negative 5 EP = EP = Qd2 Qd1 P2 P1 (Qd1+Qd2)/2 (P1+P2)/ = 5 (10+0)/2 (4+6)/2 35. B It will always be negative because of the law of demand. 36. A Elastic 37. C Inelastic because there a few substitutes 38. B You will be more sensitive to price changes in items that are a large percent of your budget 39. B Demand is perfectly inelastic 40. B Relatively elastic. Perfectly elastic would be completely horizontal. 41. D Relatively inelastic. Perfectly inelastic would be completely vertical. 42. C Positive You know the goods are substitutes because the cross price elasticity is positive. E xy = % ΔQd for good x % ΔP for good y = 30% 40% = 0.75

5 43. D Additional satisfaction gained from consuming one more unit of a good. 44. D All of the above 45. B 6 Marginal utility = (Change in total utility) (Change in number of units consumed) = = B 0 because there was not change in total utility when you go from 3 hour to 4 hours of watching Netflix 47. A After the first hour because you are getting less and less marginal utility from each additional hour of watching Netflix after the first hour. 48. D Py(MUx) = Px(MUy). This is kind of a tricky question because the answer choice algebraically manipulates the standard form of the equal marginal principle equation; however, answer D is the same thing as the equation below. Answer D takes the equation below one step further by cross multiplying. (MU of good X) (Price of good X) = (MU of good Y) (Price of good Y) (MU of good X)(Price of good Y) = (MU of good Y)(Price of good X) 49. A The marginal utility of diamonds exceeds the marginal utility of water but the total utility of water exceeds the total utility of diamonds. 50. A Total satisfaction gained from all units of a good 51. C You can tell he began to experience negative marginal utility because he ate so much that his total utility started to decrease when he got sick. 52. C The marginal utility of good A divided by the price of good A should equal the marginal utility of good B divided by the price of good B. 53. A 10 Marginal utility from 6 th beet = Total utility from 6 beets Total utility from 5 beets = = 10

6 54. C 15 For this problem you need to use the equation the following equation to solve for the marginal utility of ice cream. (MU of good A) (Price of good A) 10 $2 = MU ice cream $3 MU ice cream = 15 = (MU of good B) (Price of good B) 55. B We should buy less of good X and more of good Y Bang for the buck X = 10 / $5 = 2 utils per dollar Bang for the buck Y = 8 / $2 = 4 utils per dollar 56. A We should buy more of good X and less of good Y Bang for the buck X = 4 / $10 = 0.4 utils per dollar spent Bang for the buck Y = 5 / $25 = 0.2 utils per dollar spent 57. D We should keep our spending the way it is. Bang for the buck X = 150 / $75 = 2 utils per dollar Bang for the buck Y = 250 / $125 = 2 utils per dollar 58. B Offering high marginal utility 59. A Customers have an opportunity cost associated with giving up their time to be on the phone, which is a form of diminishing marginal utility. 60. A There are plenty of substitutes

7 61. C The rate of diminishing marginal utility is greater for newspapers than candy. 62. C 2 Gatorades and 3 ice creams Bang for the buck of 1 st Gatorade = 40/4 = 10 Bang for the buck of 1 st ice cream = 60/2 = 30 Bang for the buck of 1 st Gatorade = 40/4 = 10 Bang for the buck of 2 nd ice cream = 40/2 = 20 Bang for the buck of 1 st Gatorade = 40/4 = 10 Bang for the buck of 3 rd ice cream = 24/2 = 12 Bang for the buck of 1 st Gatorade = 40/4 = 10 Bang for the buck of 4 th ice cream = 8/2 = 4 Bang for the buck of 2 nd Gatorade = 32/4 = 8 Bang for the buck of 4 th ice cream = 8/2 = 4 * Since Gatorade costs $4 and ice cream costs $2 we have used our full $14 budget at this point 63. B A very large percent of their earnings comes from economic rent 64. C The actual expenditures a firm must make. 65. C The opportunity cost of using factors of production that a producer does not buy or hire but already owns. 66. D Only economic profits take opportunity cost into account.

8 Short Answer Elastic EP = = 1.5 (100+60)/2 (5+7)/ Inelastic EP = = 0.15 ( )/2 ( )/ Unit elastic EP = 2,000 1, = 1 (2, ,000)/2 (25+50)/2 4. Rival Non-rival Excludable Private goods: Food, furniture Club goods: Cable TV, education Non-excludable Common pool goods: Hunting Public goods: Light house, fireworks 5. 1/7, Inelastic Qd1 = 15 Qd2 = 13 P1 = $1 P2 = $3 EP = $3 $1 ( )/2 ($1 + $3)/2 EP = 2 14 $2 2 EP = 2 = The price elasticity of demand is inelastic because it is between 0 and 1.

9 6. 1, Unit Elastic Qs1 = 2 Qs2 = 6 P1 = $1 P2 = $3 Es = 6 2 $3 $1 (2 + 6)/2 ($1 + $3)/2 Es = 4 4 $2 2 Es = 1 The price elasticity of supply is unit elastic because it is equal to /23, Inelastic Qd1 = 12 Qd2 = 11 P1 = $4 P2 = $5 EP = $5 $4 ( )/2 ($4 + $5)/2 EP = $1 4.5 EP = 4.5 = The price elasticity of demand is inelastic because it is between 0 and 1.

10 8. 1, Unit elastic Qs1 = 8 Qs2 = 10 P1 = $4 P2 = $5 Es = 10 8 $5 $4 (8 + 10)/2 ($4 + $5)/2 Es = 2 9 $1 4.5 Es = 1 The price elasticity of supply is unit elastic because it is equal to The increased price of football tickets will cause us to consume fewer football tickets. However, it is ambiguous if we will consume more or less tacos. Income effect Since the price of football tickets has increased, it is as if your income decreased. The increased price of football tickets has made you poorer so you will consume less of both tacos and football tickets. Income effect = Less tacos and Less football tickets Substitution effect The increased price of the football tickets has caused tacos to become relatively cheaper than football tickets. This means you will consume more tacos and less football tickets. Substitution effect = More tacos and Less football tickets We can see that the increased price of football tickets will cause us to consume fewer football tickets. However, it is ambiguous if we will consume more or less tacos.

11 10. 3 Gatorade and 2 Ice Cream The first decision that you need to make is if you want your first purchase to be Gatorade or ice cream. You can use the equal marginal principle equation to determine which will give you more utility per dollar spent. 1 st Gatorade = 40 / $2 = 20 1 st ice cream = 66 / $3 = 22 Your first purchase will be ice cream because ice cream gives you 22 utility points per dollar spent and Gatorade only gives you 20 utility points per dollar spent. You have a total budget of $12 and you just spent $3 on ice cream so you still have $9 to spend. The next step of the problem is the spot where people most commonly make mistakes. You can now either buy your 1 st Gatorade or your 2 nd ice cream. Often people will jump to comparing the 2 nd Gatorade to the 2 nd ice cream; however, you have not purchase your 1 st Gatorade yet so you need to decide if you want to purchase your 1 st Gatorade or your second ice cream. 1 st Gatorade = 40 / $2 = 20 2 nd ice cream = 42 / 3 = 14 You will purchase your 1 st Gatorade because your 1 st Gatorade gives you 20 utility points per dollar and your second ice cream only gives you 14 utility points per dollar. You just spent $2 on Gatorade so you have $7 left to spend ($9 - $2 = $7). 2 nd Gatorade = 32 / $2 = 16 2 nd ice cream = 42 / 3 = 14 In this step you are comparing purchasing your 2 nd Gatorade to purchasing your 2 nd ice cream because you have purchased 1 Gatorade and 1 ice cream at this point. Your 2 nd Gatorade gives you more utility per dollar spent so you will purchase a 2 nd Gatorade for $2 so you have $5 left to spend ($7 - $2 = $5). 3 rd Gatorade = 24 / $2 = 12 2 nd ice cream = 42 / 3 = 14 You purchased a 2 nd ice cream because your second ice cream gave you more utility per dollar than your 3 rd Gatorade. You just spent $3 on ice cream so you have $2 left to spend ($5 - $3 = $2). 3 rd Gatorade = 24 / $2 = 12 3 rd ice cream = 24 / $3 = 8 You will use your last $2 to purchase your 3 rd Gatorade. Your third Gatorade gives you more utility per dollar than your 3 rd ice cream. Additionally, you knew your last purchase would have to be on Gatorade because you only had $2 left so you couldn t afford to purchase a 3 rd ice cream anyways. You spent your last $2 on your third Gatorade so you have now spent your entire budget. You will purchase 3 Gatorade and 2 ice creams with your budget of $12.

12 11. To find the equilibrium price and quantity you need to Qd = Qs P = P 300 = 30P P = 10 Now you can plug P back into either the Qd or Qs equation to find the equilibrium quantity. Since $10 is the price that makes Qd and Qs equal is doesn t matter which equation you plug $10 back into. However, a good way to check that you got this problem correct is to plug the value you found for P back into both equations. If both equations give you the same Q it is very likely you have the correct answer. Qd = (10) = 300 Qs = (10) = 300

13 12. Price Increase; Quantity Cannot be determined The trick to solving these problems is drawing 2 graphs. In the 1 st graph you shift demand a little bit and supply a lot. When you do this you can see that Price is increasing while Quantity is decreasing. In the 2 nd graph you will shift demand a lot and quantity only a little. In this graph you can see that both price and quantity are increasing. Since price is increasing in both graphs you know that price will increase. Since quantity decreases in the first graph and increases in the 2 nd graph quantity cannot be determined based on the information you have been given.

14 13. To find the equilibrium price and quantity, you need to set Qd = Qs P = P 300 = 30P P = 10 Now you can plug P back into either the Qd or Qs equation to find the equilibrium quantity. Since $10 is the price that makes Qd and Qs equal, it doesn t matter which equation you plug $10 back into. However, a good way to check that you got this problem correct is to plug the value you found for P back into both equations. If both equations give you the same Q, it is very likely you have the correct answer. Qd = (10) = 300 Qs = (10) = 300 Will there be a shortage or a surplus if the price of this good is $7? Will the price of the good rise or fall over time? Qd = (P) Qd = (7) = 330 Qs = (P) Qs = (7) = 240 There is a shortage of 90 units ( = 90) because Qd is greater than Qs. We expect the price of the good to rise over time. Will there be a shortage or a surplus if the price of this good is $12? Will the price of the good rise or fall over time? Qd = (12) = 280 Qs = (12) = 340 There is a surplus of 60 units ( = 60) because Qs is greater than Qd. We expect the price of the good to fall over time.

15 14. A relatively elastic demand curve will have a shallow slope because consumers are sensitive to changes in price. A relatively inelastic demand curve will have a steep slope because consumers are not sensitive to changes in price.