Total Time—60 minutes
Reading Period—10 minutes
Writing Period—50 minutes
Directions: You are advised to spend the first 10 minutes reading all of the questions and planning your answers. You will then have 50 minutes to answer all three of the following questions. You may begin writing your responses before the reading period is over. It is suggested that you spend approximately half your time on the first question and divide the remaining time equally between the next two questions. Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. Use a pen with black or dark blue ink.
1. The markets for bananas, muffins, and coffee are interrelated, and each market is perfectly competitive.
(a) In the market for bananas, the equilibrium price is $1.00 per pound, and the equilibrium quantity is 1,000 pounds per week. Suppose the government imposes a price floor on bananas at $1.20 per pound, causing the quantity supplied to increase to 1,500 pounds per week.
(i) Would the price floor result in a shortage, a surplus, or neither? Explain.
(ii) Calculate the price elasticity of supply if the price increases from $1 to $1.20. Show your work.
(iii) Between $1 and $1.20, is the supply elastic, unit elastic, or inelastic? Explain.
(b) Bananas are an input for muffins.
(i) Draw a correctly labeled graph of the market for muffins indicating the equilibrium price and quantity,labeled Po and Qo, respectively.
(ii) On the graph drawn in part (b)(i), show the impact of an increase in the price of bananas on the muffin market, labeling the new equilibrium price and quantity P1 and Q1, respectively.
(iii) On the same graph, completely shade the area that represents the change in the consumer surplus caused by the increase in the price of bananas.
(c) In the market for coffee, the equilibrium price is $3.00 per cup and the equilibrium quantity is 100 cups per week. The cross-price elasticity of coffee with respect to muffins is negative two
(i) Are coffee and muffins normal goods, inferior goods, complementary goods, or substitute goods?
(ii) Assume the supply of coffee is perfectly elastic. Using the equilibrium price and quantity given above, draw a correctly labeled graph for the coffee market, and show the impact of an increase in the price of muffins on the coffee market.
(iii) Given the original quantity of 100 cups of coffee per week, if the increase in the price of muffins is 10%, calculate the new equilibrium quantity in the coffee market. Show your work.
2. Martha has a fixed budget of $20, and she spends it all on two goods, X and Y. The price of X is $4 per unit, and the price of Y is $2 per unit. The table below shows the total benefit, measured in dollars, Martha receives from the consumption of each good.
(a) What is Martha’s marginal benefit of the fifth unit of good X?
(b) Calculate the total consumer surplus if Martha consumes 5 units of X. Show your work.
(c) Martha is currently consuming 4 units of X and 2 units of Y. Use marginal analysis to explain why this combination is not optimal for Martha.
(d) What is Martha’s optimal combination of goods X and Y?
(e) Indicate whether each of the following will cause the optimal quantity of good Y to increase, decrease, or stay the same.
(i) The price of good Y doubles.
(ii) Martha’s income falls to $10 with no changes in prices.
(iii) Martha’s income doubles, and the price of both goods double.
3. Camden’s Cakery is one of many dessert cafés serving a local community. Each café produces a slightly differentiated product, there are no barriers to entry or exit, and the firm is in long-run equilibrium.
(a) Draw a correctly labeled graph showing Camden’s demand curve, marginal revenue curve, marginal cost
curve, and long-run average total cost curve. Label Camden’s profit-maximizing output Qm and its price Pm.
(b) On your graph in part (a), label the output at which total revenue is maximized Qr
(c) Do firms in this market experience economies of scale, diseconomies of scale, or neither in long-run equilibrium? Explain.