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Department of Economics
ECON 201 Section B
Fall 2012
Instructor: Ivan Tchinkov
Exam duration: 60 min.
MIDTERM EXAMINATION WITH ANSWERS
Version 2
Last Name: ______________________
ID #: ___________________________
Multiple Choice Questions (3 marks each).
1. If the government wishes to discourage smoking by tax increases the policy will be more effective if:
A)
demand is price inelastic.
B)
supply is price elastic.
C)
demand is income elastic.
D)
demand is price elastic.
2. If a per unit tax is imposed, the more elastic demand is,
A)
less likely the deadweight loss will be affected.
B)
smaller the deadweight loss.
C)
larger the loss in consumer surplus.
D)
larger the deadweight loss.
3. All of the following statements are incorrect except:
A)
demand is more elastic in the short run than in the long run.
B)
the time period available for adjustment to changes in a good's price does not affect the
elasticity of demand for the good.
C)
the longer the time period consumers have to adjust to price changes, the more elastic
will be demand.
D)
the long-run demand curve for a good is steeper than the good's short-run demand curve.
4. Suppose that an increase in consumer income of 5% causes the consumption of a good to fall from 10
to 7 units, then using the initial quantity as the reference quantity, the income elasticity is:
A)
-10.
B)
-7.
C)
-5.
D)
-6.
5. Which of the following statements is false?
A)
When a market is in equilibrium, excess demand is zero.
B)
When a market is in equilibrium, quantity demanded equals quantity supplied.
C)
When a market is in equilibrium, a price is established that clears the market.
D)
Draw the demand and supply equilibrium graph and label the consumer and producer surplus areas.
Also find the value of consumer surplus, producer surplus and total surplus.
The consumer surplus is height times base divided by 2. The height of the triangle is the
vertical intercept 1000 less equilibrium price $800. So the height is 200. The base of the
triangle is 200. The value of consumer surplus is then $20,000. The value of producer surplus
is also height times base divided by 2. The height is 800, the base is 200, so the value of
producer surplus is $80,000. Total surplus is $100,000
Now suppose that the mayor of Vancouver creates an energy saving program. Therefore, it imposes a tax
of $100/machine on the consumers.
(iii) Find the equilibrium quantity and price after the tax and depict these new results graphically.
Equilibrium quantity is solve by setting 1000-100 (=t)-Qd=4Qs, Q=180, Consumers pay
P=$720 before tax, but P=$820 after tax.
(iv)
Find the tax revenue collected by a city of Vancouver, the new consumer and producer surpluses
and the deadweight loss of this tax program.
Tax revenue is $100 each machine, multiplied by 180 machines, so tax revenue is $18,000.
New consumer surplus is 1000-820=180 multiplied by 180 divided by 2. So consumer surplus
is $16,200 and producer surplus is 720 multiplied by 180 divided by 2, which is equal to
$64,800.
Deadweight loss is $100 multiplied by 20 units divided by 2, which is $1,000.
2. (20 marks) Developed countries often intervene in their agricultural industries, using price
floors, production subsidies or quotas (supply management). As an economist in the Department
of Agriculture you have estimated the demand to be P = 250 Qd and supply to be P = 100 + 2Qs
for the wheat industry. You have been asked to evaluate three policy choices. Quantities are in
tons.
(i)
Find the initial equilibrium P and Q. What is the total revenue (TR) of the suppliers.
Q=50, P= 200, TR=10000.
(ii)
Option 1: Price floor = $220, the government buys up any surplus (excess supply). Find Qd,
Qs, surplus (Excess Supply), TR of the suppliers, and the cost to the government.
Qd=30, Qs=60, ES=30, TR=13200, Cost to government=6600.
What is the private market equilibrium price and quantity if the externality is not corrected for in
this market?
5
The unregulated market equilibrium is characterized by the intersection of the private cost
curve and the demand curve. Thus, 150 Q = 10 + Q. The market equilibrium quantity is Q =
70. The market equilibrium price is P = $80
(ii)
(iii) Suppose that the government wants to achieve the socially optimal quantity by imposing a tax on
the producers. What would be the size of the tax in dollars on per unit of paper?
We know that we want the output to be 56 units. To sell 56 units, we know that the consumers
are willing to pay $94. To produce 56 units, we know that the firms only need to receive a
price equal to P = 10 + Q (=56) or P = $66. This means that if the government charges a tax of
$94 - $66 = $28 per unit, the firms will produce only 56 units. We can always check, using our
knowledge from Chapter 3. Let demand be unaffected at P = 150 - Q, while supply is P = (10 +
28) + Q. We will find Q = 56 and P = $94 for consumers, and P = $94 - $28 = $66 for the firms
after they have paid the tax.
(iv)
Calculate the changes in CS, PS, Social Cost (SC), government tax revenue (TR) and Total Surplus
(changes in CS, PS, SC and TR taken together) as a result of the tax (assume the supply curve with
the tax from (iii) is the socially responsible one with equation P=10+1.5Q).
Change in CS= (70+56)*14/2= 882 (loss)
Change in PS= (70+56)*14/2= 882 (loss)
Change in GR= 28*56= 1568 (gain)
Change in SC= 35*14/2+28*14/2= 441 (gain)
Change in TS= -882-882+1568+441= 245 (gain)
(v)
Which TS (before or after the tax) is bigger, by how much and why?
TS after the tax is bigger by $245, because the tax has moved the economy from an inefficient
allocation to an efficient one, by internalizing the cost of negative externality