Eco 201
Test 2
Name______________________________
25 June 2008
Please write answers in ink. You may use a pencil to draw graphs.
Questions 1-4 are 17 points each, 5-6 are 16 points each. Allocate your time efficiently.
Good Luck.
1. Suppose the weekly demand and supply curves for used DVDs in Lincoln, Nebraska, are as
shown in the diagram. Calculate
a. The weekly consumer surplus.
Consumer surplus is the triangular area between the demand curve and the price line. Its area is
equal to 0.5bh, where b is the base of the triangle and h is the height. The base is 6 units and the
height is 1.5 units, measured in dollars. Therefore, consumer surplus is 0.5($1.50/unit)(6
units/wk), or $4.50 per week.
b. The weekly producer surplus.
Producer surplus is the triangular area between the supply curve and the price line. Using the
base-height formula, it is (0.5)($4.50/unit)(6 units/wk), or $13.50 per week.
c. The maximum weekly amount that producers and consumers in Lincoln would be willing to
pay to be able to buy and sell used DVDs in any given week.
The maximum weekly amount that consumers and producers together would be willing to pay to
trade in used DVDs is the sum of gains from trading in used DVDs—namely, the total economic
surplus generated per week, which is $18 per week.
2. The Kubak crystal caves are renowned for their stalactites and stalagmites. The warden
of the caves offers a tour each afternoon at 2 p.m. sharp. The caves can be shown to only
four people per day without disturbing their fragile ecology. Occasionally, however, more
than four people want to see the caves on the same day. The following table lists the people
who wanted to see the caves on September 24, 2003, together with their respective times of
arrival and reservation prices for taking the tour that day.
Herman
Jon
Kate
Jack
Penny
Fran
Faith
Arrival time
Reservation price ($)
1:48
1:50
1:53
1:56
1:57
1:59
2:00
20
14
30
15
40
12
17
a. If the tour is "free" and the warden operates it on a first-come, first-served basis, what will
the total consumer surplus be for the four people who get to go on the tour on that day?
When there is no charge for the tour, the surplus enjoyed by someone who takes it equals
his or her reservation price for the tour. If the warden operates the tour on a firstcome-first served basis, Faith, Penny, and Fran will be turned away. The combined
consumer surplus when the four who arrive first take the tour is $20 + $14 + $30 + $15 =
$79.
b. Suppose the warden solicits volunteers to postpone their tour by offering increasing amounts of
cash compensation until only four people still wish to see the caves that day. If he gives each
volunteer the same compensation payment, how much money will he have to offer to generate
the required number of volunteers? What is the total economic surplus under this policy?
An offer of $15 compensation generates 3 volunteers to return another day: Fran, Jack,
and Jon. The four who go on the tour receive a total consumer surplus of $40 + $30 + $20
+ $17=$107. The warden pays $45 in compensation payments to the three volunteers,
which causes him a loss in economic surplus of $45 that is exactly offset by the gain in
economic surplus to the three volunteers. Total economic surplus from the tour operation
is now $107, or $28 higher than before.
c. Why is the compensation policy more efficient than the first-come, first-served policy?
The compensation policy is more efficient than the first-come-first-served policy because
it establishes a market for a scarce resource that would otherwise be allocated by nonmarket means. People who choose not to miss the tour that day are paying an opportunity
cost of $15 not to miss it. Therefore, only those people to whom the tour is worth more
than $15 will actually take it.
3. In Charlotte, North Carolina, citizens can get their electric power from two sources: a
hydroelectric generator and a coal-fired steam generator. The hydroelectric generator can supply
up to 100 units of power per day at a constant marginal cost of 1 cent per unit. The steam
generator can supply any additional power that is needed at a constant marginal cost of 10 cents
per unit. When electricity costs 10 cents per unit, residents of Charlotte demand 200 units per day.
a. Draw the marginal cost curve of electric power production in Charlotte.
Price (cents/unit)
10
Marginal cost of power
1
Units of power per day
100
b. How much should the city charge for electric power? Explain. Should it charge the same price
for a family whose power comes from the hydroelectric generator as it does for a family
whose power comes from the steam generator?
The city should charge 10 cents per unit since that is the marginal cost when residents use
at least 100 units/day, which they will if the city charges 10 cents or less. It should
charge 10 cents per unit to all users, even those who are receiving their power from the
hydroelectric facility, since if those users were to cut their consumption, they would free
up hydroelectric capacity, which could then be used to serve others who are currently
receiving their power from the more costly steam generator.
4. A price-taking firm makes air conditioners. The market price of one of their new air
conditioners is $120. Its total cost information is given in the table below:
Air conditioners per day
1
2
3
4
5
6
7
8
Total cost ($ per day)
100
150
220
310
405
510
650
800
How many air conditioners should the firm produce per day if its goal is to maximize its profit?
What is the firm’s profit?
The marginal cost of each of the first 6 air conditioners produced each day is less than
$120, but the marginal cost of the 7th air conditioner is $140. So the company should
produce 6 air conditioners per day. Profit = TR − TC. Profit = $720 – $510 = $210.
5. Ann lives in Princeton and commutes by train each day to her job in New York City (20 round
trips per month). When the price of a round trip goes up from $10 to $20, she responds by
consuming exactly the same number of trips as before, while spending $200 per month less on
restaurant meals.
a. Does the fact that her quantity of train travel is completely unresponsive to the price increase
imply that Ann is not a rational consumer?
Even at twice the original price, the marginal utility per dollar of the 20th train trip may be
higher than the corresponding ratio for any other good that Ann might consume, in which
case she would be perfectly rational not to alter the number of trips she takes. After all,
missing a trip would be to miss a whole day’s work.
b. Explain why an increase in train travel might affect the amount she spends on restaurant
meals.
The higher price of train tickets makes Ann poorer. The income effect of the price
increase is what leads to the reduction in the number of restaurant meals she eats.
6. The schedule below shows the number of packs of bagels bought in Davis, California, each
day at a variety of prices.
Price of bagels Number of packs
($/pack)
purchased/day
6
0
5
3,000
4
6,000
3
9,000
2
12,000
1
15,000
0
18,000
a. Graph the daily demand curve for packs of bagels in Davis.
P
($/pack)
6
3
9
Q
18 (1000s of packs/day
b. Calculate the price elasticity of demand at the point on the demand curve at which
the price of bagels is $3 per pack.
Use the formula: elasticity = (P/Q) (1/slope). When P = 3, Q = 9 and 1/slope is 3. So
elasticity = 3(3/9) = 1.0.
c. If all bagel shops increased the price of bagels from $3 per pack to $4 per pack, what
would happen to total revenues?
If the price increases from $3 to $4, revenue will fall from $27,000 to $24,000.
d. Calculate the price elasticity of demand at a point on the demand curve where the
price of bagels is $2 per pack,
Using the same formula as in b, elasticity = (2/12)x(3) = 0.5.
e. If bagel shops increased the price of bagels from $2 per pack to $3 per pack, what
would happen to total revenues?
If the price increases from $2 to $3, revenue will rise from $24,000 to $27,000.