EEP 1 Midterm Exam
Answer all the questions. Exam totals 25 points.
1. (7 points: c counts double) A consumer has an income of $1,000 per month, which she spends
entirely on Wine and Bread.
(a) What are the prices of the two goods on each of the two budget constraints?
(b) What consumption bundle will be chosen when the consumer is faced with “Budget 1?”
(c) Why will that bundle be chosen?
(d) Give the coordinates of two points on this consumer’s demand curve for bread.
(e) Briefly describe how you would find two points on a demand curve for this consumer
when the prices are the same as in part (a), but income has increased to $1,200. How
would these new points relate to the previous demand curve? (You may assume that
both goods are normal goods.)
60
50
Budget 2
40
Wine
Budget 1
30
20
10
0
0
10
Bread
20
30
2
(6 points) Are the following statements true, false or uncertain? Why?
(a) Two indifference curves can intersect only when one of the goods being studied is a highpriced item.
(b) If a consumer’s income rises, the consumer will buy more of every good.
(c) The shape of a consumer’s indifference curve is generally assumed to be unaffected by
price changes.
(d) If the price of coffee goes up, it is likely that the market supply curve for tea will shift to
the right.
(e) If a 3 percent increase in price leads to a 2 percent decrease in demand, then the
elasticity of demand is –1.5 and demand is elastic.
(f) In a target price deficiency payment program, the imposition of a set aside program
would make no difference to consumers.
3
(12 points ) A Firm with Pollution: A firm pollutes, but does not pay any costs for its disposal of its
pollutants.
(a) (2 pts)Draw a U-shaped cost curve diagram including MC, AC, AVC.
(b) (1 pt)Choose a price for which profits will be positive and show the profit-maximizing output and
label it q*.
(c) (1 pt)Show profits at q*.
(d) (2 pts)Explain why this firm will choose to operate where P = MC.
(e) (1 pt)In long-run competitive equilibrium, what will the price be?
(f) (2 pts) Now assume that the firm is charged for its disposal costs for a pollutant. The charge
amounts to T/unit of output. Including disposal costs, what is its new MC? New AC? New AVC?
Answer with respect to MC, AC and AVC before the firm was charged for its disposal costs.
(g) (2 pts )When the firm is charged for its disposal costs, and assuming that any number of firms can
enter or leave this industry in the long run, what will happen to the long-run supply curve for this
industry?
(h) (1 pt)Will the price to consumers go up by the full amount of the disposal fee or will the fee be
partially incident upon the firms?