PART 1

A - Opportunity Costs (5 points)

Opportunity cost = $15 (direct cost to purchase the book) +

= 20x$25 (indirect cost to read it) = $515.

B - Maximizing Net Benefits (5 points)

1: MB = TB’ = 100 – 2N;

MC = TC’ = 040 + 4N.

2: max NB wrt. N ⟺ NB’ = 0. Thus, TB’ – TC’ = 0 ⟺ MB = MC.

Replacing MB and MC:

100 – 2N = 40 + 4N,
60 = 6N
N* = 10.

C - Price Elasticity of Demand (10 points)

1: The price elasticity of demand PED = dQD/dP * P/Q.

Replacing Q1 = 20 in QD = 60 – 2P, we have 20 = 60 – 2P, and thus P1 = 20.

Thus, at (Q1, P1) = (20,20), we have dQD/dP * P1/Q1 = –2 * 20/20 = –2 (or |-2| in abs value).

Replacing Q2 = 05 in QD = 60 – 2P, we have 05 = 60 – 2P, and thus P2 = 27.5.

Thus, at (Q2, P2) = (5,27.5), we have dQD/dP * P2/Q2 = –2 * 27.5/5 = -11 (or |-11| in abs val).

2: Since |-02| > 1, demand is elastic at point (Q1, P1).

Since |-11| > 1, demand is elastic at point (Q2, P2).

3: TR = P*Q. Thus,
- at (Q1, P1) = (20,20): TR = 20*20 = 400;
- at (Q2, P2) = (5,27.5): TR = 27.5*5 = 137.5.

4: No, it is not. Only when PED is |1| is the total revenue maximized.

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PART 2

A - Closed Economy (10 points)

1: 2:
P
To find the equilibrium, set

QD = Qs
60 – 2P = 38P 30
60 = 40P è PCE = 1.5$ D
QCE= 57kg

PCE= 1.5
S
3: Q
(a) P QCE= 57 60

D
Sa
Pa
S
PCE
Q
Qa QCE
A hailstorm leads to a decline in supply, which shifts the supply up from S to Sa, and:
o the equilibrium price increases from PCE to Pa, (PCE < Pa), and
o the equilibrium quantity decreases from QCE to Qa, (QCE > Qa).

(b) P

S Sb
PCE
Pb Q
QCE Qb
The new manure leads to an increase in supply, which shifts the supply from S to Sb, and:
o the equilibrium price decreases from PCE to Pb, (PCE > Pb), and
o the equilibrium quantity increases from QCE to Qb, (QCE < Qb).

(c)

The hailstorm damage shifts the supply up, from S to Sa.

The availability of new manure shifts the supply down, from S to Sb.

Thus, the hailstorm damage and the availability of new manure act in opposite directions. Since we do
not have enough information to determine which one of the two shifts is larger in magnitude, we
cannot say more about their combined impact.

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 B - Open Economy

4 – Free trade (7 points)

(a)
P

30

S
PCE= 1.5
PFT= PW= 0.5
Q
QFTlocal QCE QFT 60
= 57
Show/identify that the world price is PW. Show the new equilibrium quantity QFT, out of which QFTlocal is
produced by Veganstan’s suppliers, and QFT - QFTlocal is imported from Beefland.

(b)

With free trade, we have that

o the equilibrium price decreases from PCE to PFT, (PCE > PFT), and
o the equilibrium quantity increases from QCE to QFT, (QCE < QFT).

(c)
P P

30 30
D D

S
S
PCE= 1.5
PFT= PW= 0.5 !
! "!

QCE QCE QFT

60
= 57 = 57
The graph on the left depicts the initial closed economy; the graph on the right depicts the free-trade
economy. We now discuss the welfare implication of free trade by comparing the two graphs, and we
observe (by comparing the coloured areas) that free—trade leads to the following changes in
Veganstan:

- a larger consumer surplus;

- a smaller producer surplus; and
- an overall increase in welfare (and there is no deadweight loss).

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 5 – Tariff (7 points)

(a)
P

30

S
PCE= 1.5
PT= PW +0.5=1
PFT= PW= 0.5
Q
QFTlocal QCE QFT 60
= 57
QTlocal QT

Show/identify that the new equilibrium price, which includes the tariff is, PT = PW + 0.5.
Show that the new equilibrium quantity is QT, out of which QTlocal is produced by Veganstan’s
producers, and QT – QTlocal is imported from Beefland. The quantity QT – QTlocal that is being imported
when a tariff is in place is smaller than the quantity QFT - QFTlocal that is imported under free trade.

(b)

With a tariff, we have that

o the equilibrium price increases from PFT to PT, (PFT < PT), and
o the equilibrium quantity decreases from QFT to QT, (QFT > QT).

(c)
P P

30 30
D D

S S
PT = 1
PFT= PW= 0.5 PFT= PW= 0.5
Q Q
QFTlocal QFT 60 QFTlocal QFT
QTlocal QT
The graph on the left depicts the initial free—trade; the graph on the right depicts the tariff economy.
We discuss the welfare implication of the tariff as by comparing the coloured areas in the two graphs.

The tariff leads to the following changes in Veganstan:

- a smaller consumer surplus;
- a larger producer surplus;
- a tariff revenue;
- an overall decrease in welfare (deadweight loss).

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6—Subsidy (14 points)

(a)
P

30

S SS
P+SubsSlrs
PS=PFT= 0.5 Q
QFTlocal QSlocal QS=QFT 60

The subsidy shifts the local supply to SS, but the world supply remains at PFT = 0.5. The equilibrium
quantity QS remains at QFT, where the local suppliers sell up to QSlocal, and the quantity QS - QSlocal is
being imported. The “effective” supply, which combines the local and world one, is shown in yellow.

(b)

With a subsidy, we have that

o the equilibrium price, paid by consumers, remains at PFT, (PFT = PS), while the price
received by Veganstan’s sellers is P+SubsSlrs
o the equilibrium quantity remains QFT (QFT = QS).

(c)

The effect of the subsidy is that the quantity of brocollo that is:
o domestically supplied in Vegastan, increases from QFTlocal to QSlocal.
o imported from Beefland, decreases from (QFT – QFTlocal) to (QFT – QSlocal).

(d)
P P

30 30

D D
S S
SS

#
PS=PFT= 0.5

Q
QFTlocal QS=QFT 60 QFTlocal QSlocal QS=Q60
FT

$%
The graph on the left depicts the initial free—trade; the graph on the right depicts the economy with a
subsidy for producers. We discuss the welfare implication of the subsidy by comparing the coloured
areas in the two pictures.

The subsidy leads to the following changes in Veganstan:

- the consumer surplus remains unchanged;
- a larger producer surplus;
- (thus we have an overall increase in joint consumer and producer surplus);
- it creates a subsidy cost for the government;
- it creates a deadweight loss (because the subsidy cost exceeds the increase in PS+CS).

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7- (7 points)

Beefland’s broccoli is cheaper than Vegastan’s, so a tariff on it will increase the price in Vegastan
(see question 5). The increase in price means that some of Vegastanian’s will be priced out from
consuming broccoli, and they might substitute towards cauliflower instead; thus, Vegastan’s demand
for cauliflower would be expected to increase.

However, note that since Beefland’s cauliflower supply is cheaper than Vegastan’s, all of the
additional cauliflower demand from Vegastan will be exclusively served by imported cauliflower from
Beefland (for which the price does not change: as Beefland can produce unlimited quantities at the
world price, the increase in demand from Vegastan does not move the price at all).

Thus, Vegastan’s own cauliflower price plays no direct role and remains unchanged.

PART 3

A - Initial Economy (4 points)

1: To find the equilibrium, set

QD = Qs
9 – 0.25P = 2P
9 = 2.25P

PE = 4
QE = 8

2:
P

36

PE=4

Q
QE=8 9
Be sure to label the axes as P and Q and to show the intersections with D at 36 and 9. Also, show the
equilibrium point.

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 B - Tax on Consumption (14 points)

3:

(a)

36

DT
PD = 12.889

PE
PS = 2.889

Q
QT QE 9
= 5.778
Shift the demand downwards to QT, and plot PD and PS.

(b)

The tax is imposed on buyers, so PD = PS + 10.

Setting QD=QS, we have

9 – 0.25 (PS + 10) = 2PS
9 – 0.25 PS – 2.5 = 2PS
6.5 = 2.25 Ps
PS = 2.889

PD = PS + 10 = 12.889

QD = QS
QD = 9 – 0.25(12.889) = 5.778 and QS = 2*2.889 = 5.778, as expected.

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 P P
(c)

36
36

D
D

DT
PD = 12.889

S S

PE=4
PE
PS = 2.889

Q
QE=8 Q
QT QE
9 = 5.778 9

The graph on the left depicts the initial economy; the graph on the right depicts the post tax-on-
consumption economy. Discuss the welfare implication of the tax by comparing the two graphs (note:
as a bonus, the areas could have been computed as well).

The tax leads to a decline welfare, driven by:

- a smaller consumer surplus;
- a smaller producer surplus;
- a tax revenue;
- the emergence of a deadweight loss.

(d)

Consumers bear most of the cost, given the inelastic demand.

Moreover, the increase in PD (relative to PE) is higher than the decrease in PS (relative to PE).

4:

Since we are told that chicken meat is a substitute for pork meat, and there is now a tax on pork meat
consumptions, we should expect an increase in the demand for chicken, i.e. a shift to the right of
demand for chicken which (given that the supply stays unchanged; short run implicit) would lead to a
higher equilibrium price and a higher equilibrium quantity in the market for chicken meat.

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 C - Tax on Sales (12 points)

5:

a) P

36

D
ST

PD = 12.889

PE=4
PS = 2.889

Q
QT QE=8
= 5.778

Shift the supply upwards to S and plot PD and PS.

(b)

The tax is imposed on sellers, so PS = PD – t

Setting QD=QS, we have

9 – 0.25PD = 2(PD – 10)
9 – 0.25PD = 2PD – 20
29 = 2.25PD
PD = 12.889

PS =12.889 –10 = 2.889

QD=QS
QD = 9 – 0.25(12.889) = 5.778 and QS = 2(PS) = 2*2.889 = 5.778, as expected

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(c) P
P
36
36

D D

ST

PD = 12.889

S S

PE=4 PE=4
PS = 2.889

Q Q
QE=8 9 QT QE=8
= 5.778

The graph on the left depicts the initial economy; the graph on the right depicts the post tax-on-
consumption economy. We discuss the welfare implication of the tax by comparing the two pictures.

The tax leads to a decline welfare, driven by:

- a smaller consumer surplus;
- a smaller producer surplus;
- a tax revenue; and
- the emergence of a deadweight loss.

(d)

Consumers bear most of the cost, given the inelastic demand.

Moreover, the increase in PD (relative to PE) is higher than the decrease in PS (relative to PE).

D - Comparing the two Taxes (5 points)

6.

Neither policy is efficient, they both lead to a welfare loss.

The same amount of total surplus is foregone (as shown with the graphs, or computed).

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