Answer to Exam I 04

EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004
A couple general grading notes…
To minimize the potential for arithmetic errors, we graded each question out of 10
points. The resulting total (out of 40) was divided by 2 to arrive at the final score. This
number is circled on the inside cover of your quiz. The point values listed below are
relative to the 40 point scale.
In many cases, students had the correct answer but added unnecessary incorrect
information. We took off 0.5 pts each time this occurred.
Answer all four of the following questions in your blue book. Each of the four questions is
worth five points for a total of 20 points.
1. Define
a. Complements (2 pts.)
Goods are complements if a rise in the price of one causes consumption of the
other to fall.
Goods are complements if a fall in the price of one causes consumption of the
other to increase.
Many students said that goods are complements if a rise in the demand for one
causes a rise in the demand for the other. This may usually be true, but it is not
how complements are technically defined. Answers of this nature were given half
b. Elasticity (2 pts)
Elasticity measures the percentage change in quantity due to 1% change in price
(or income).
If accompanied by a formula, any of the following were also acceptable. Without a
formula, these type of answers received partial credit.
A measure of the sensitivity of quantity to price or income.
How much quantity changes due to price changes.
c. Indifference Curves (2 pts)
Indifference curves connect bundles that give a consumer the same amount of
To receive full credit on this question, students had to explain what defined a given
curve. Many described indifference curves in general, receiving various amounts of
partial credit depending on how complete the answers were. Many students tried to
incorporate budget constraints into the definition. This is incorrect and points were
taken off as a result. (A few people had correct definitions and then added a correct
EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004
statement about the relationship between indifference curves and budget
constraints. This was unnecessary, but if all the statements were correct, full credit
was still given.)
d. Name and in one sentence each explain two agricultural policies that are not price
support policies (i.e., not loan rate or target price – deficiency payment) (2 pts
per policy)
To receive credit, students had to describe two policies discussed in class. Points
were taken off if policies were identified incorrectly or only barely described.
2. (10pts) Use the diagram to answer the following questions. Assume PW = 1.
a. What is income on budget constraint II?
b. What is the price of bread on each of the three budget constraints? (4pts)
First, find out the y associated with each BC
For BCI and BCII, y=5*Pw=5
For BCIII, y=6*Pw=6
Second, get the price:
formula and plugging in right numbers.
Correct results---1pt.
c. What are two points on the demand curve for bread? --------------(2pt)
The two tangency points on I and II. Need clear labels to get the point. 1pt for
each point.
If draw a demand curve with with the coordinates (Pb,B) be (2,1.5) and (1,2) are
also good.
d. What happens to the demand curve for bread as income increases – why?
EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004
The demand curve shifts in as income increases. Because the chosen bundle on a
higher budget constraint with the same price of bread (demonstrated by the
slope of BC II and BCIII) contains less bread. ----If the answer “shifts in” but
gave the wrong reason, then no credit would be granted. Can say “because bread
is an inferior good”, the inferiority is the consequence of the shift, not the cause.
3. Draw a diagram and use it to explain the “loan rate” agricultural price support program.
Be sure to show quantities produced and consumed and government purchases. (3.5pts)
Gov’t Purchases
In the loan rate program, the government effectively sets the price of the commodity
at PL. This induces farmers to produce QS. At the price of PL, consumers purchase
only QD . Therefore to support the price, the government must purchase the
quantity QS - QD.
A correct diagram with clear labels and no explanation was given 6/7. The question
asked you to draw a diagram and use it to explain the loan rate policy, so some sort of
explanation was necessary.
Drawing PL above the original equilibrium – 1 pt
QS – 2 pt
QD – 2 pt
Gov’t purchases – 2 pt
Many students confused the loan rate and target price/deficiency payment policies or
tried to combine them in one picture. Usually these answers had the price floor drawn
correctly and identified quantity supplied and therefore received 3 pts.
A set aside program takes land out of production. What does it do to the supply curve? To
the amount of money government pays to support the price? Explain your answer in a
few sentences. (3 pts)
EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004
The program causes the supply curve to shift inward, therefore reducing the
amount of the commodity produced at the price PL . Since the demand curve is
unaffected, there is less excess for the government to purchase. The amount the
government spends to support the price is reduced from the entire shaded region to
only the diagonally shaded region.
Diagrams were not necessary. Grading:
Supply shifts inward – 1 pt
Government expenditures fall – 1 pt
Including some type of correct explanation – 1 pt
A lot of people said that consumers would be paying more due to the reduction in
supply. As you can see from the diagram, this is not necessarily true. In fact, it only
happens if farmers take so much land out of production that the price floor is no
longer binding. We took off 1 pt for saying this unless you noted that either the gov’t
doesn’t have to support the price anymore or that the price floor is no longer binding.
Also, many people did not connect the government expenditures to purchasing the
excess with the loan rate, but instead talked about the amount the government spends
on the set aside policy. These answers were incorrect because the set aside is not a
price support policy and hence the expenditures students referred to were not
expenditures to support the price. Moreover, the set aside policy was discussed in class
as a policy designed to do exactly what is shown in the picture.
4. (10 pts) Draw a picture showing how a tax results in a decreased quantity supplied. For
the after tax equilibrium, label price paid by consumers and price received by producers.
Show the before and after-tax quantity. (This part---5pts)
EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004
Notation: D is the original demand curve. Dt is the after-tax demand curve from a
producer’s point of view. Pnt is the before-tax equilibrium price while Qnt is the
corresponding before tax equilibrium quantity. Pd is the price paid by consumers
and Ps is the price received by suppliers. Qt is the after-tax equilibrium quantity.
Correct diagram----meaning correct slope of D and S curves, the orientation of axis,
and an inward shift of the D curve to demonstrate the tax effect ---gets 1 point.
Alternatively, could illustrate the tax with an inward shift of S curve.
Correct labeling of Pd, Ps, Qnt, and Qt gets 1 pts each.
How can a tax be used to reduce pollution? (1pt) Compare the use of a tax and a quantity
restriction (quota) that have the same effect on output (diagram—1pt, explanation-1pt).
Which does a firm prefer? Why? (1 pt for each if correct reason is given , but none if
reason is wrong.)
When output is positively related with total pollution, an imposition of tax will
result in a reduction in output produced as shown in the above diagram. A tax leads
to either an increase in consumer’s price or an increase in the producer’s cost (or
both), therefore reducing equilibrium quantity. (1pts. As long as referring to the
diagram you drew and talk about reduction in equilibrium quantity it is fine.)
For comparison between quota and tax, please see the diagram below. If one can
draw a diagram, then she gets 2 pts. Alternatively, one can answer verbally the
effects of both in terms of the equilibrium price and quantity. The main point is that
with a quota, the equilibrium price, which is also the price received by the
producers, is equal to the price paid by consumer. And from the diagram we know
EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004
that in the case of tax, the price received by the producers is t below price paid by
the consumers. Therefore, a producer would prefer a quota instead of a tax because
he’s selling same amount of output with a higher price.
EnvEcon 1 / Econ 3
Quiz 1
P. Berck
Fall 2004