Northwestern University - ECON 201

Econ 201 — Midterm #1 — Winter 2008 Name: SOLUTIONS

1          Multiple Choice (26 points)

1. What does trade allow a country to do that it cannot do by itself? (a) produce inside its production possibilities frontier.

2. produce outside its production possibilities frontier.
3. consume inside its production possibilities frontier.

(d) consume outside its production possibilities frontier.

(e) shift its production possibilities frontier outward.

2. The lecture suggested that the rate of return of higher education
   1. Decreased over the past 30 years
   2. Increased over the past 30 years
   3.  Did not change over the past 30 years

d.  Is higher in the U. S. than in the United Kingdom

3. The course packet reading Capitalist Punishment is a book review of a book related to
   1. The invention of the concept of opportunity cost
   2. The invention of supply and demand curves
   3. The invention of the production possibility frontier
   4. The invention of the concept of the invisible hand
      
      For questions 4-6, please refer to figure 1 and the statements below.

Statements:

1. 1. 1. Infeasible without trade
      2. Feasible without trade
      3. Feasible only with trade

    V. Efficient

4. Which statements apply to point A?

6. Which statements apply to point C?
   1. I only                (b) II only           (c) III only         (d) I and III
7. The lecture talked about the equilibrium price as explained by the textbook in Chapter 3. The lecture claimed:
   1. The price for a given commodity is always the same at all times and locations
   2. The price for a given commodity is always higher at all locations on the weekend
   3. The price for a given commodity is always higher at all locations on weekdays

d. The price for a given commodity differs across locations

8. The course packet reading on Iran has the following explanation for long lines of cars waiting for gasoline

a.  Price ceiling on gasoline

2. Price ceiling on oil
3. Shortage of oil
4. High tax on gasoline

9. A government subsidy will have which of the following effects on a market equilibrium?

(a) An increase in price and increase in quantity

(b) An increase in price and decrease in quantity

(c) A decrease in price and increase in quantity

(d) A decrease in price and decrease in quantity

10. Economists know that a particular good can be classified as an inferior good if a(n) in buyers’ income causes a(n) .

1. increase; increase in demand
2. increase; increase in quantity demanded

(c) increase; decrease in demand

(d) decrease; decrease in demand

11. If demand and supply are linear functions with the usual slopes, then a decrease in the price of a good will result in:

1. an increase in demand.
2. an increase in supply.

c.  an increase in the quantity demanded.

d.  an increase in the quantity supplied.

12. Suppose demand and supply are linear functions with the usual slopes. If a price ceiling prevents an equilibrium then there is:

a.  Excess demand and thus a shortage.

2. Excess demand and thus a surplus.
3. Excess supply and thus a shortage.
4.  Excess supply and thus a surplus.13. The lecture argued that the best policy to prevent global warming is

a.  Congestion tax on auto and truck traffic

b.  Carbon tax

3. Regulations on average fuel economy of cars and trucks
4. Raise tax on gasoline to European levels

For questions 14-15, please refer to figure 2 below

FIGURE 2 14. Suppose that demand decreases. In equilibrium,

16. When the United States and Mexico trade:

1. the United States will be worse off because wages in Mexico are so low.
2. Mexico will be worse off because the United States is a stronger economic power.

c.  both Mexico and the United States will be better off.

d.  both Mexico and the United States will be worse off.

17. Which of the following statements is true?

(a) The concept of equilibrium requires that all individuals have an equal amount of income.

(b) If equilibrium in a market exists, then the price in that market will not fluctuate by more than 5 %.

(c) If equilibrium in a market exists, then there will be no remaining opportunities through trade for individuals to make themselves better off.

(d) Equilibrium in a market will exist when the number of buyers is equal to the number of sellers.

For questions 18-20 you may assume that demand and supply are linear functions with the usual slopes. Please fill in all the empty cells in the table below with one of the following four options: (a) increases (b) decreases (c) doesn’t change (d) cannot be determined

(We filled in the first row for you as an example.)

21. The gini coefficient is

(a) 1.0 when one person in the population gets all the income

(b) 1.0 when income is distributed equally with everyone getting the same income

(c) 0.5 when one person in the population gets all the income

(d) 0.5 when income is distributed equally with everyone getting the same income

22. Consider the gini coefficient diagram. Area A is the area between the line of complete equality and the line showing the actual distribution for a given country. Area B is the area between the actual distribution line and the line of complete inequality. The gini coefficient is calculated as:

1. A divided by B
2. B divided by A
3. A divided by A+B
4.  B divided by A+B

23. The Great Compression hypothesis attempts to explain

a.  Why income inequality was lower in the 1950s than 1990 s

2. Why income inequality was lower in the 1920s than 1990 s
3. Why income inequality was lower in the 1990s than the 1950 s
4. Why income inequality was lower in the 1920s than the 1950 s

24. Which of the following interpretations of relatively low female/male earnings ratios was supported in lecture
    1. Many women do not work full-time during their child-bearing years
    2. More women than ever are choosing full-time careers
    3. More women than men choose to major in the humanities instead of in computer science and engineering
    4.  (a) and ( c )

(e) (a) and ( b )

25. A deadweight loss occurs as the result of which set of scenarios?

a.  excise tax, quota, subsidy, monopoly

2. excise tax, quota, subsidy, increase in demand
3. excise tax, subsidy, decrease in supply, price floor
4. excise tax, quota, price ceiling, change in price of a complementary good

26. In the 1990s the income share of the top 1 percent increased to the highest level seen since the 1920s. Among the sources of income of the top 1 percent, was a larger share in the 1990s and was a larger share in the 1920 s

a. capital gains income; labor income

b.  labor income; capital income

3. capital gains income; capital income
4. capital income; capital gains income

2          Short Answer (34 points)

1. (13 pts) In this problem we will consider the market for S.U.V.s. The supply curve for S.U.V.s is a straight line and the supply schedule is given by the following table:

Price (in thousands of dollars)           54           48            42          36

Quantity (in thousands of cars) 28    24            20          16

The demand for S.U.V.s is dependent on two factors: the price of   the S.U.V. (P_SUV ) and the price of gasoline (P_g). The demand can be represented by the following equation:

PSUV = 48 − QDSUV /2 − 4Pg

where the price of gasoline is determined somewhere else.

1. (2 pts) From the supply schedule derive a formula representing the supply for S.U.V.s.

(It should be of the form P_SUV = a + bQ^S_SUV where a and b are some numbers.)

b. (1 pt) Plot the supply and demand curves for P_g = $3.

c. (4 pts) Calculate the equilibrium price and quantity for S.U.V.s when P_g = $3. Label this point on your graph in the previous part.

d. (5 pts) Now suppose the price of gas increases to P_g = $4. What is the new equilibrium price and quantity of S.U.V.s? Are gas and S.U.V.s substitutes or complements?

e. (3 pts) Return to the case where P_g = $3 and suppose that the government implements a price floor of 32 (thousand dollars). Is there a shortage, surplus, or equilibrium? If there is an equilibrium, what is the equilibrium price and quantity? If there is a shortage or surplus, what is the magnitude?

2. (16 pts) Consider the market for plasma televisions. The supply and demand equations are given by the following two equations:

P = 60Q^S + 200  P = 2700 − 40Q^D

One can calculate that the equilibrium values are P^∗ = $1700 and Q^∗ = 25.

1. (4 pts) Calculate the consumer surplus, the producer surplus, and the total surplus.

2. (10 pts) Now suppose the government levies a $400 per unit tax on plasma televisions to help fund the transition from analog to digital broadcast. (1 pt) What is the new quantity produced?

(1 pt) How much do consumers now pay?

(1 pt) How much do producers now receive (net of taxes)?

(1 pt) What is the government’s revenue from this tax?

(2 pts) What is the incidence of the tax? (I.e., what percent of the tax burden does the consumer bear, what percent does the producer bear?

.

(2 pts) What is the deadweight loss of the tax?

(1 pt) Suppose that the supply curve was more elastic. Will deadweight loss be higher or lower?

(1 pt) What equivalent quota (restricting production) would generate the same amount of deadweight loss?

(c) (2 pts) Now suppose the government levies a $400 per unit tax on plasma television consumers (instead of the tax on the suppliers) to help fund the transition from analog to digital broadcast.

What is the deadweight loss of this tax?

3. In this problem we’re considering production possibilities for sail boats and chocolate in Belgium and the Netherlands. You may assume that the production possibility frontier is a straight line for both countries.

1. (1 pt) Sketch the two production possibility frontiers. (Please put chocolate on the xaxis and sail boats on the y-axis and be sure to label your axes.
2. (1 pt) Does either country have an absolute advantage? Which one?

c. (2 pts) For Belgium, what is the opportunity cost of producing one more ton of chocolate in terms of sailboats?

d. (1 pt) Does either country have a comparative advantage in the production of sail boats?

Which one?