Economics 201 Midterm #1 Answer Key

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Economics 1102 Homework #1

Define or explain briefly. Five points each.

(1) perfect market

(2) efficient resource allocation

(3) Externality.

(4) Marginal Rate of Transformation (MRT)

1 Part II. True or false. Explain (be sure to). Ten points.

(5) If a resource allocation is efficient, then it is desirable.

(6) If the relationship between a variable in a model and one of its influences, i.e., a parameter, is elastic, then if there is a change in the parameter’s value, ceteris paribus, the value of the variable will not change very much.

Part III. Quantitative Problems.

(7) 15 points. Prior to the destruction of the World Trade Center, air travel in the United States was forecast for the year 2013 at 1515 billion seat miles at a price of $165 million per billion seat miles. The (arc) price elasticity of demand for air travel is estimated to be -.75. Even if the demand for air travel is fully restored, i.e., the confidence in air travel returns to its pre-disaster level, the price of air travel is expected to increase by over 40% due to the implementation of new security procedures. Given this, and the price elasticity of demand of -.75, what would be the projected number of seat miles of air travel in the United States in the year 2012? Provide your answer in the table below. Note, the elasticity formula to be used in solving the problem is given by, %DQuantityDemanded骣 Q 2 - Q 1 骣 P 2 + P 1 =E = -.75 = 琪琪 . %D Pr ice桫P 2 - P 1 桫 Q 2 + Q 1 Projected Air Travel And Costs for 2013 Case Billion Seat Miles (BSM) Price ($Billion/BSM)

Projection-Pre 9/11/01 Q1 = 1515 P1 = 165

Projection Post-9/11/01 Q2 = ? P2 = 235

Note: In the above, Seat Miles is the variable and price is the parameter. 2 (8) 30 points. Below is a roster of production possibilities for CD’s and LD’s. In the table below, S = the price of CD’s and R = the price of LD’s. For the prices given in each row of the table, find the revenue maximizing production possibility and place the associated quantities of CD’s and LD’s in the table in the appropriate places. For these data, compute the elasticity of supply of CD’s and LD’s to each of S and R. Place your answers in the last table using our standard notation. For each elasticity, indicate the cases used.

CD’s LD’s MRT 36749 0 n/a 36491 350 -0.74 36067 700 -1.21 35476 1050 -1.69 34719 1400 -2.16 33796 1750 -2.64 32707 2100 -3.11 31451 2450 -3.59 30029 2800 -4.06 28441 3150 -4.54 26687 3500 -5.01 24766 3850 -5.49 22679 4200 -5.96 20426 4550 -6.44 18007 4900 -6.91 15421 5250 -7.39 12669 5600 -7.86 9751 5950 -8.34 6667 6300 -8.81 3416 6650 -9.29 0 7000 -9.76

Case S R CD’s LD’s R/S

A 10 30

B 10 50

C 15 70

D 20 30

E 25 55

F 30 75

3 Variable Parameter Sensitivities Parameter: S R Variable:

CD’s

LD’s

(9) (15 points) Assume that two refineries produce both motor gasoline and distillate fuel oil (used to heat homes). Both refineries are constrained in terms of capacity and technology so that production choices at both refineries are made from rosters of production possibilities. In each refinery, production decisions are efficient. Data for production in 2012 are given below. Quantities are in thousands of barrels per day.

. Refinery #1 Refinery #2 Total

Gasoline (y) 350 530 880

Distillate(x) 75 135 210

MRT = y/x -5 -3

These data depict efficient production by the two refineries taken together if it is not possible to change the production decisions so as to produce more of either gasoline or distillate, or both, but not less of either. Otherwise, the production choices are inefficient.

Are the choices efficient? Explain. Be sure to demonstrate why, or why not.