ECON 101: Principles of Microeconomics - Midterm 1 Exam Questions and Answers | Exams Microeconomics

ECON 101: Principles of Microeconomics (Fall 2012-13)

Some explanation for Midterm 1 (Afternoon Exam)1

Use the following information to answer the next three questions.

Milvan is a small, closed economy that produces tires. The domestic demand and domestic supply of tires in

Milvan is given by the following equations where Pis the price per unit and Qis the quantity of tires:

Domestic Demand: P= 1000 (5/1000) Q

Domestic Supply: P= 200 + (1/600) Q

You a re a ls o to ld t ha t th e wo rl d pr ic e fo r ti re s is $ 30 0 pe r ti re .

QUESTION 11 Suppose Milvan is considering opening its tire market to international trade. Holding

everything else constant, which of the following statements is true?

a. Milvan will import 80,000 tires and domestic producers in Milvan will favor this policy change.

b. Milvan will import 140,000 tires and domestic consumers in Milvan will favor this policy change.

c. Milvan will export 100,000 tires and domestic consumers in Milvan will favor this policy change.

d. None of the above answers is correct.

ANSWER: d.

EXPLANATION:

This question concerns the application of international trade to demand-supply framework. If you solve this

question from the beginning, you will have the domestic equilibrium as Pdom = $400 and Qdom = 120000

tires. Then you will have the equilibrium with international trade as Pe= $300 and Qe= 140000 tires, of

which, to satisfy the quantity demanded of Qe= 140000, domestic producer is willing to supply on Q= 60000

tires and the rest must be imported, so the quantity imported is 80000 tires. Unfortunately, producer will

not favor this policy change since it loses producer surplus. (Draw the demand-supply curve with world price

line to yourself.)

QUESTION 12 Suppose Milvan opens its tire market to international trade while simultaneously the

government of Milvan implements a tariﬀthat raises the price per tire to $400. Holding everything else

constant and comparing the situation of the tire market in Milvan being open to trade versus this same

market having the described tariﬀ, the change in domestic consumer surplus on tires with the tariﬀis

a. An increase of $72 million relative to the level of consumer surplus on tires when the Milvan market was

open to trade but had no tariﬀ.

b. A decrease of $72 million relative to the level of consumer surplus on tires when the Milvan market was

open to trade but had no tariﬀ.

c. A decrease of $13 million relative to the level of consumer surplus on tires when the Milvan market was

open to trade but had no tariﬀ.

d. An increase of $13 million relative to the level of consumer surplus on tires when the Milvan market was

open to trade but had no tariﬀ.

ANSWER: c. (But there is a problem in the exam where the choices turned out to be a., e., b. and c.)

EXPLANATION:

This question concerns the tariﬀinstituted in the international trade. Clearly tariﬀraises the world price

perceived by importers, read the question carefully and you will find that the tariﬀis not $400 but the tariﬀ

makes the price to $400. This is a case of prohibitive tariﬀwhere no tires are being imported to Milvan.

Hence, we are back to the domestic equilibrium with Pdom = $400 and Qdom = 120000 tires. The con-

sumer surplus would decrease by the trapezoid area above $300 and under $400 as the quantity consumed

reduces. The decrease in consumer surplus is 1/2⇥(140000 + 120000) ⇥(400 300) = $13 million. (Draw

the demand-supply curve with the world price line, and world price after tariﬀ, you will see that the supply

curve with international trade and tariﬀcuts exactly through the domestic equilibrium.)

1Prepared by Kanit Kuevibulvanich. Disclaimer: This note does not constitute as the oﬃcial solution guidelines, comments

welcomed.

Partial preview of the text

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ECON 101: Principles of Microeconomics (Fall 2012-13)

Some explanation for Midterm 1 (Afternoon Exam) 1

Use the following information to answer the next three questions. Milvan is a small, closed economy that produces tires. The domestic demand and domestic supply of tires in Milvan is given by the following equations where P is the price per unit and Q is the quantity of tires: Domestic Demand: P = 1000 (5/1000) Q Domestic Supply: P = 200 + (1/600) Q You are also told that the world price for tires is $300 per tire.

QUESTION 11 Suppose Milvan is considering opening its tire market to international trade. Holding everything else constant, which of the following statements is true? a. Milvan will import 80,000 tires and domestic producers in Milvan will favor this policy change. b. Milvan will import 140,000 tires and domestic consumers in Milvan will favor this policy change. c. Milvan will export 100,000 tires and domestic consumers in Milvan will favor this policy change. d. None of the above answers is correct. ANSWER: d. EXPLANATION: This question concerns the application of international trade to demand-supply framework. If you solve this question from the beginning, you will have the domestic equilibrium as P (^) dom = $400 and Q (^) dom = 120000 tires. Then you will have the equilibrium with international trade as P e^ = $300 and Q e^ = 140000 tires, of which, to satisfy the quantity demanded of Q e^ = 140000, domestic producer is willing to supply on Q = 60000 tires and the rest must be imported, so the quantity imported is 80000 tires. Unfortunately, producer will not favor this policy change since it loses producer surplus. (Draw the demand-supply curve with world price line to yourself.)

QUESTION 12 Suppose Milvan opens its tire market to international trade while simultaneously the government of Milvan implements a tariff that raises the price per tire to $400. Holding everything else constant and comparing the situation of the tire market in Milvan being open to trade versus this same market having the described tariff, the change in domestic consumer surplus on tires with the tariff is a. An increase of $72 million relative to the level of consumer surplus on tires when the Milvan market was open to trade but had no tariff. b. A decrease of $72 million relative to the level of consumer surplus on tires when the Milvan market was open to trade but had no tariff. c. A decrease of $13 million relative to the level of consumer surplus on tires when the Milvan market was open to trade but had no tariff. d. An increase of $13 million relative to the level of consumer surplus on tires when the Milvan market was open to trade but had no tariff. ANSWER: c. (But there is a problem in the exam where the choices turned out to be a., e., b. and c.) EXPLANATION: This question concerns the tariff instituted in the international trade. Clearly tariff raises the world price perceived by importers, read the question carefully and you will find that the tariff is not $400 but the tariff makes the price to $400. This is a case of prohibitive tariff where no tires are being imported to Milvan. Hence, we are back to the domestic equilibrium with P (^) dom = $400 and Q (^) dom = 120000 tires. The con- sumer surplus would decrease by the trapezoid area above $300 and under $400 as the quantity consumed reduces. The decrease in consumer surplus is 1 / 2 ⇥ (140000 + 120000) ⇥ (400 300) = $13 million. (Draw the demand-supply curve with the world price line, and world price after tariff, you will see that the supply curve with international trade and tariff cuts exactly through the domestic equilibrium.)

(^1) Prepared by Kanit Kuevibulvanich. Disclaimer: This note does not constitute as the official solution guidelines, comments welcomed.

QUESTION 13 Suppose that Milvan institutes the tariff described in the previous question. Which of the following statements is true? a. The tariff will definitely increase domestic producer surplus compared to domestic producer surplus if the market is simply open to trade and no tariff is in place. b. The tariff will likely increase domestic consumer surplus compared to if this market is closed to trade. c. The tariff will decrease government revenue compared to the revenue the government receives when this market is open to trade and no tariff is in place. d. The government will always prefer a market open to trade to one in which a tariff has been imposed. ANSWER: a. EXPLANATION: This question checks your intuition after solving Question 11 and 12. You can see clearly that producer surplus increases after the tariff, i.e. the level of producer surplus increases back to the case of domestic equilibrium. Choice b. obviously follows from Question 12 that consumer surplus decreases. Choice c. – clearly the government has not collected any tax revenue before or after tariff as there is no import after tariff. Choice d. – undoubtedly follows from choice c. that there is no difference in tax revenue before or after tariff.

QUESTION 23 Suppose Tyrion has a fixed income to spend on beer and bread. When both beer and bread cost $3 each, Tyrion buys five beers. When the price of beer rises to $5 and the price of bread rises to $20, Tyrion still buys five beers. You also know that Tyrion’s demand for beer is downward sloping. Holding everything else constant, which of the following statements is true? a. For Tyrion, beer and bread are substitutes. b. For Tyrion, beer and bread are complements. c. For Tyrion, beer and bread are normal goods. d. For Tyrion, bread and beer are inferior goods. ANSWER: a. EXPLANATION: This question asks about the concept of substitutes and complements in demand, the income is held constant so you can delete choice c. and d. The trick here is to know how much is being spent in initial situation. At first, we have P (^) beer = 3 and P (^) bread = 3, and Q (^) beer = 5, but we don’t know the quantity demanded for bread, call it x, so Q (^) bread = x. Thus, the total spending is I = 15 + 3x. Notice that at this point price of beer and price of bread is the same, so one beer is one bread, i.e. P (^) beer /Pbread = 1. With the same income I, prices change to P (^) beer^0 = 5 and P (^) bread^0 = 20, and we know that Q (^0) beer = 5, we still don’t know the quantity demanded for bread, here call it y, so Q (^0) bread = y. Hence, the total spending is I = 25 + 20y. Notice now that the price of bread is 4 times the price of beer, so one beer is 1/4 bread, i.e. P (^) bread /P (^) beer = 1/ 4. Clearly with the same income, you have already spent more money on beer, then it must be the case that y < x, so we know that Q (^) bread decreases in the second situation. Further, beer is relatively cheaper than bread since the price of beer per bread is lower. Hence, by the properties of substitute goods, when price of beer is (relatively) lower and quantity demanded for bread decreases, it must be the case that bread and beer are substitutes.

ECON 101: Principles of Microeconomics - Midterm 1 Exam Questions and Answers, Exams of Microeconomics

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