Midterm II with Answers

Economics 101 Student Name :

Answers to Second Midterm Section #
:
June 13, 2011 TA Name
:


Second Midterm





DO NOT BEGIN WORKING UNTIL THE INSTRUCTOR TELLS YOU TO DO SO. READ THESE
INSTRUCTIONS FIRST.


You have 75 minutes to complete the exam. The exam consists of 3 problems
worth 20 points each and 20 multiple choice questions worth 2 points each
for a total of 100 points.

PLEASE WRITE NEATLY AND LEGIBLY AND PLEASE MAKE SURE IT IS EASY TO SEE
WHERE YOUR ANSWER IS FOR A QUESTION.

If there is an error on the exam or you do not understand something, make a
note on your exam booklet and the issue will be addressed AFTER the
examination is complete. No questions regarding the exam can be addressed
while the exam is being administered.

When you are finished, please get up quietly and bring this exam booklet to
the place indicated by the instructors.

NO CALCULATORS OR FORMULA SHEETS ARE ALLOWED.

PICK THE BEST ANSWER FOR EACH QUESTION.

GOOD LUCK!





I, ______________________________, understand that giving answers to
another student or taking answers from another student on this exam
constitutes academic misconduct and can result in my receiving a zero on
this exam. I also understand that the use of a calculator on this exam is
prohibited and that such use will result in my receiving a zero on this
exam.


____________________________________ (signed)
Problems (3 problems each worth 20 points for a total of 60 points)
1. You are given the following information about the market for
motorcycles.
Market Demand: P = 400 - 4Q
Market Supply: P = 4Q
a. (2 points) Find the equilibrium price and quantity in this market.
400 - 4Q = 4Q
8Q = 400
Q = 50 motorcycles
P = 4(50) = $200 per motorcycle
b. (2 points) What is the value of consumer surplus in this market?
CS = (1/2)($400/motorcycle - $200/motorcycle)(50 motorcycles) = $5000

c. (2 points) What is the value of producer surplus in this market?
PS = (1/2)($200/motorcycle - $0/motorcycle)(50 motorcycles) = $5000

d. (2 points) Suppose that the government decides to impose an excise tax
of $80 per motorcycle on producers in this market. What will be the number
of motorcycles sold in this market once this tax is imposed?
The new supply curve with the excise tax will be P = 80 + 4Q. Using this
equation and the demand equation we can solve for the new quantity of
motorcycles sold once the excise tax is imposed. Thus, 80 + 4Q = 400 - 4Q
or 8Q = 320 and Q = 40 motorcycles.
e. (3 points) Given the tax described in part (d), what will be the tax
incidence on consumers?
To find the tax incidence we must first find the price consumers pay once
the excise tax is imposed. When Q = 40 motorcycles, the price consumers pay
is P = 400 - 4Q or P = 400 - 4(40) = $240/motorcycle. The excise tax raises
the price to consumers from $200 to $240. Thus, the consumer tax incidence
can be calculated as the change in price times the number of motorcycles
sold once the tax is imposed. Thus, CTI = ($240/motorcycle
-$200/motorcycle)(40 motorcycles) = $1600.

f. (3 points) Given the tax described in part (d), what is the value of the
deadweight loss from the tax?
DWL = (1/2)($240/motorcycles - $160/motorcycles)(10 motorcycles) = $400
g. (3 points) What is the loss in producer surplus from the imposition of
the excise tax described in part (d)?
The loss is producer surplus is equal to the area of a rectangle and the
area of a triangle. The producer loses some of their surplus when the
government captures it as tax revenue. The producer also loses some of
their surplus due to the part of the deadweight loss from the tax that
falls on producers. Thus, the loss is producer surplus is equal to
($200/unit - $160/unit)(40 units) + (1/2)($200/unit - $160/unit)(50 units -
40 units) = $1600 + $200 = $1800.
h. (3 points) Suppose the government would like motorcycle consumption to
fall to 20 units. Relative to the initial situation before there was any
excise tax, how big an excise tax would the government need to place on
motorcycles in order for consumption to fall to 20 units?
From the demand curve we know that if Q = 20 motorcycles, then the price
demanders must pay is equal to P = 400 - 4Q or P = 400 - 4(20) =
$320/motorcycle. From the supply curve we know that if Q = 20 motorcycles,
then the price suppliers must receive in order to be willing to supply 20
units is P = 4Q or P = 4(20) = $80/motorcycle. The difference between the
price demanders are willing to pay for 20 units and the price suppliers
must receive in order to produce 20 units is $320 - $80 or $240. The excise
tax would need to equal $240/motorcycle in order for consumption to fall to
20 units.

2. Suppose there is a small, closed economy that produces bananas. The
domestic demand and domestic supply curves for bananas in this small,
closed economy are given as:
Domestic demand: P = 20 - (1/2)Q
Domestic supply: P = 2 + (1/10)Q
a. (2 points) What is the equilibrium price and quantity of bananas in this
small, closed economy?
To find the equilibrium price and quantity simply use the demand and supply
curves. Thus, 20 - (1/2)Q = 2 + (1/10)Q and solving for Q, we get Q = 30
units. Using this quantity in either the demand or the supply equations we
can find the price: P = $5.
b. (2 points) Suppose that the world price of bananas is $8 per unit of
bananas and this economy opens to trade. Provide a numerical measure of
this country's imports or exports of bananas once the market is open to
trade.
If the world price is $8 per unit of bananas and this economy opens to
trade, then at $8 domestic demanders will demand 24 units of bananas. At
$8, domestic suppliers will supply 60 units of bananas. The excess supply
of 36 units of bananas will be exported.
c. (2 points) If this closed economy opens its banana market to trade with
the world price of bananas equal to $8 per unit of bananas, what will be
the change in consumer surplus due to this decision?
CS when the banana market was closed to trade was equal to (1/2)($20/unit
of bananas - $5/unit of bananas)(30 units of bananas) = $225. CS when the
banana market is open to trade is equal to (1/2)($20/unit of bananas -
$8/unit of bananas)(24 units of bananas) = $144. The loss is consumer
surplus when the banana market opens to trade is equal to $81.
d. (2 points) Suppose that the world price of bananas is $2.50 per unit of
bananas. If this market opens to trade, what will be the level of imports
or exports of bananas?
When the world price is $2.50 per unit of bananas domestic demanders will
demand 35 units of bananas while domestic suppliers will supply 5 unit of
bananas. The excess demand for bananas of 30 units will be met by importing
30 units of bananas into this small economy.
e. (2 points) Given the scenario in part (d), what will be the change in
consumer surplus when this economy goes from being a closed economy with
regard to the banana market to being an open economy with regard to the
banana market?
CS when the banana market was closed to trade was equal to (1/2)($20/unit
of bananas - $5/unit of bananas)(30 units of bananas) = $225. CS when the
banana market is open to trade is equal to (1/2)($20/unit of bananas -
$2.5/unit of bananas)(35 units of bananas) = $306.25. The gain in CS from
opening the market to trade: the gain in CS = $81.25
f. (4 points) Suppose that the world price of bananas is $2.50 per unit of
bananas and that this economy is open to trade. Suppose the government
implements a tariff of $1.00 per unit of bananas. Calculate the tariff
revenue from the implementation of this policy and the deadweight loss from
the tariff.
With the tariff the price of bananas rises to $3.50. At this price 15 units
of bananas will be supplied domestically and 33 units of bananas will be
demanded domestically. The small country will therefore import 18 units of
bananas and collect a tariff of $1/unit of bananas on these imports. Tariff
revenue is therefore equal to ($1.00/unit of bananas)(18 units of bananas)
= $18. Deadweight loss is equal to (1/2)($3.50/unit of bananas - $2.50/unit
of bananas)(15 units of bananas - 5 unit of bananas) + (1/2)($3.50/unit of
bananas - $2.50/unit of bananas)(35 units of bananas - 33 units of bananas)
= $6.
g. (2 points) Suppose the government wishes to replace the tariff described
in part (h) with a quota that results in the same consumer surplus as the
consumer surplus with the tariff, the same producer surplus as the producer
surplus with the tariff, and the same deadweight loss as the deadweight
loss with the tariff. How many units of bananas should the quota equal for
this result? Explain your answer.
With the tariff the small economy imported 4 units of bananas. If the quota
was set at 18 units of bananas then the quota would have the same impact as
a tariff of $1.00/unit of bananas on consumer surplus, producer surplus,
and deadweight loss.
h. (4 points) Trade has distributional consequences. Briefly summarize who
wins and who loses when an economy opens to trade. Be specific in your
answer.
When an economy opens to trade in a market typically either the world price
is greater than or less than the domestic equilibrium price. If the world
price is greater than the domestic equilibrium price then the economy that
has opened its market to trade will export the good: domestic producers
will benefit while domestic consumers will be hurt from this trade. If the
world price is less than the domestic equilibrium price then the economy
that has opened its market to trade will import the good: domestic
producers will be hurt while domestic consumers will benefit from this
trade.
3. Use the following information to answer this question. Joe's income is
$100 a day and he currently buys two good