Exam 1 Review
Exam 1 · Friday, September 18
In class, on paper
50 minutes. Arrive on time; late arrival does not add testing time.
Multiple choice, 1 point each
Bring to the exam
One 4×6 index card
Handwritten, front and back. Put graphs and worked examples on it; exam questions focus on applying the concepts.
You keep your card after the exam. Take a photo of it anyway, so you can reuse your notes when preparing for the final.
A basic calculator
No scientific or graphing calculators. Phones, watches, and printed notes are not allowed during the exam.
Every choice uses scarce resources
Scarcity
One greenhouse can grow herbs or seedlings. Its space cannot satisfy every possible use.
Opportunity
cost
You choose to study. Your next-best option is a shift paying $54 with $14 in extra travel costs.
Incentives
A payment for installing drip irrigation makes adoption more attractive to farms.
Could evidence test the statement?
Positive
A claim about what happens.
Evidence could support or reject it.
Testable does not mean true.
Normative
A claim about what should happen.
It includes a value judgment.
“Fair,” “should,” and “deserve” are clues.
Answer: B. It makes a testable prediction; it does not have to be correct to be positive.
Classify the claim and explain why
For each statement, decide whether it is positive or normative. Do not decide whether you agree with it.
1. A $0.50-per-pack cigarette tax will cut teenage smoking by 12%.
2. The government should spend more on AI research.
3. Rising paper prices will increase textbook prices.
4. The price of housing in China is too high.
Read the endpoints before calculating
A farm can produce 48 crates of berries or 24 crates of beans, with a constant trade-off.
Both axes measure crates. Resources and technology are fixed.
What is the OC of one more crate of berries?
If the farm produces 10 crates of beans, what is its maximum berry output?
Is point I feasible? Is it productively efficient?
Berries = 48 − 2(10) = 28. Point I is feasible but inefficient: resources are idle or poorly used.
What changed: use, capacity, or cost?
The frontier stays fixed when existing capacity is put back to work.
Reopen an idle greenhouse
With the same resources and technology, move from inside the PPF toward the frontier.
Beyond the frontier: production is currently unattainable.
Specialize where opportunity cost is lower
Each farm has the same growing season. All resources go to one crop or the other.
| Maximum output | Strawberries | Beans |
|---|---|---|
| Farm A | 72 crates | 36 crates |
| Farm B | 24 crates | 48 crates |
Absolute advantage
Who produces more with the same resources?
A → strawberries. B → beans.
Comparative advantage
Who gives up less of the other good?
A → strawberries. B → beans.
| Opportunity cost | 1 strawberry crate | 1 bean crate |
|---|---|---|
| A | 36/72 = 0.5 bean | 72/36 = 2 strawberries |
| B | 48/24 = 2 beans | 24/48 = 0.5 strawberry |
Even if one producer is better at both goods, specialization still depends on relative opportunity cost.
Use each farm’s comparative advantage
Start with each farm splitting its resources 50–50 between strawberries and beans.
| Allocation | Farm A strawberries, beans | Farm B strawberries, beans | Combined strawberries, beans |
|---|---|---|---|
| 50–50 split | (36, 18) | (12, 24) | (48, 42) |
| Specialize | (72, 0) | (0, 48) | (72, 48) |
Strawberries
Crates produced by both farms
Beans
Crates produced by both farms
Both outputs rise with the same resources and technology. Report each good separately; their sum is not a measure of total value.
Trade expands consumption possibilities
After specialization, A trades 22 strawberry crates for 22 bean crates from B.
Farm A
Farm B
Trading rate: 0.5 < 1 bean per strawberry < 2. Both gain because the rate lies between their OCs.
Trade changes consumption. Each PPF stays fixed; combined production remains (72, 48).
A curve is a relationship; Q is one point
Own price changes
Move to a different point on the same curve, other things equal.
Another determinant changes
If buyers or sellers choose a different Q at the same price, the curve shifts.
1 · Oat-milk market: the price of oat milk falls.
2 · Oat-milk market: dairy milk becomes more expensive; the two are substitutes.
3 · Oat-milk market: the price of oats used in production rises.
First name the market. Then ask whose decision changes: buyers or sellers?
What changes demand at every price?
Hold this good’s price fixed while you identify the change.
| Determinant | Change in the market | Demand |
|---|---|---|
| Number of buyers | More students move near a coffee shop. | Right → |
| Income | Income falls; dining out is a normal good. | ← Left |
| Income | Income falls; canned soup is an inferior good. | Right → |
| Related prices | Cheaper tea (a substitute for coffee). Consider coffee. | ← Left |
| Related prices | Costlier printers (a complement to ink). Consider ink. | ← Left |
| Tastes | A new preference for fresh fruit develops. | Right → |
Substitutes / complements: classify the response to the other good’s price.
Translate the event into cost or capacity
| Event | Mechanism and supply shift |
|---|---|
| Packaging material becomes cheaper. | Cost falls → S right |
| A sorting machine reduces wasted produce. | Productivity rises → S right |
| A frost destroys part of the harvest. | Capacity falls → S left |
| A cost-reducing payment makes each unit cheaper to produce. | Effective cost falls → S right |
| Apple sellers expect a higher price next month and store more apples now. | Less offered today → S left |
Expected future price ↑ can reduce current supply of a storable good.
A higher current selling price instead raises quantity supplied along S, with other determinants fixed.
A supply shift changes the market price
Cucumbers · quantities in crates
| Price | Qd | Qs |
|---|---|---|
| $4 | 80 | 40 |
| $6 | 60 | 60 |
| $8 | 40 | 80 |
Read the market condition
At $4: shortage or surplus?
At $8: which way does price move?
$4: shortage = 40; P rises.
$8: surplus = 40; P falls.
Equilibrium: P* = $6, Q* = 60.
Qd = 120 − 10P Qs = 10P
Higher input costs reduce supply by 20 crates at every price. Demand stays fixed. Find the new equilibrium.
120 − 10P = 10P − 20 → P* = $7, Q* = 50.
The 20-crate supply shift reduces Q* by 10, because price adjusts.
Which outcome is certain?
Case A · Frozen yogurt
Consumers lose interest in frozen yogurt.
Milk used to make it becomes costlier.
D left: P ↓, Q ↓
S left: P ↑, Q ↓
Case B · Fish
Chicken becomes costlier; fish is a substitute.
Fuel costs for fishing boats rise.
D right: P ↑, Q ↑
S left: P ↑, Q ↓
| Combine the shifts | S increases | S decreases |
|---|---|---|
| D increases | Q ↑; P ambiguous | P ↑; Q ambiguous |
| D decreases | P ↓; Q ambiguous | Q ↓; P ambiguous |
The direction depends on the relative sizes of the shifts.
For Case B, trace the linked market first: chicken price ↑ → demand for fish ↑.
Two shocks can push supply opposite ways
New greenhouses add 30 crates at every price. Disease removes some output. Demand stays fixed.
Dashed gray: original supply. Green: supply after both shocks.
+30 − 10 = +20 crates
Supply right
P ↓ · Q ↑
P: $6 → $5
Q: 60 → 70 crates
Do not force one event onto demand just because the story contains two events.
Follow developers into both markets
Tighter borrowing restrictions raise developers’ financing costs and reduce their planned home-building projects.
Hold home demand and land supply fixed. Draw both markets.
1 · Newly built homes
Identify developers’ role, the curve shift, and the changes in P* and Q*.
Developers supply homes.
Higher financing costs shift S left.
2 · Buildable land
Identify developers’ role, the curve shift, and the changes in P* and Q*.
Developers demand land.
Fewer planned projects shift D left.
Add the surplus of those who trade
CS = willingness to pay − P
| Buyer | WTP | CS |
|---|---|---|
| A | $32 | $16 |
| B | $26 | $10 |
| C | $18 | $2 |
| D | $10 | $0 · no trade |
PS = P − opportunity cost
| Seller | Cost | PS |
|---|---|---|
| W | $4 | $12 |
| X | $9 | $7 |
| Y | $14 | $2 |
| Z | $20 | $0 · no trade |
A nonparticipant’s surplus is zero. The demand curve records buyers’ WTP; supply records sellers’ costs.
Find the price, then measure the areas
Qd = 72 − 2P Qs = 2P
Price in dollars; quantity in units.
Calculate P* and Q*.
Find market consumer surplus.
Find market producer surplus.
72 − 2P = 2P
P* = $18; Q* = 36.
= $324
= $324
Does a lower price mean more surplus?
Demand falls by 12 units at every price; supply stays Qs = 2P.
Find the new equilibrium, CS, PS, and TS. Then explain the effect on consumers.
Qd′ = 60 − 2P → P* = $15, Q* = 30
New demand intercept: $30. CS = ½(30)(30 − 15); PS = ½(30)(15 − 0).
| Market | P* | Q* | CS | PS | TS |
|---|---|---|---|---|---|
| Original demand | $18 | 36 | $324 | $324 | $648 |
| Lower demand | $15 | 30 | $225 | $225 | $450 |
Check whether the control binds
Demand: P = 30 − 2Q Supply: P = 6 + Q
Equilibrium: 30 − 2Q = 6 + Q → Q* = 8, P* = $14.
| Policy | Binding? | Effect on private trade |
|---|---|---|
| Maximum price of $18 | No · ceiling above P* | No change: P = $14, Q = 8 |
| Minimum price of $10 | No · floor below P* | No change: P = $14, Q = 8 |
| Maximum price of $10 | Yes · binding ceiling | Qs = 4, Qd = 10 → Q = 4 |
| Minimum price of $18 | Yes · binding floor | Qd = 6, Qs = 12 → Q = 6 |
A legal price limit by itself does not shift D or S.
Assume no government purchase of unsold output. Government buying the surplus changes the calculation.
Calculate surplus over actual sales
D: P = 30 − 2Q · S: P = 6 + Q · Floor: $18 · Lowest-cost sellers trade.
1 · Find actual sales
Qd = (30 − 18)/2 = 6
Qs = 18 − 6 = 12
Only 6 units trade.
2 · Consumer surplus
CS = ½ × 6 × (30 − 18)
= $36
3 · Producer surplus
Cost at Q = 6 is $12.
PS = ½ × [(18 − 6) + (18 − 12)] × 6
= $54 · a trapezoid
4 · Deadweight loss
DWL = ½ × (8 − 6) × (18 − 12)
= $6
A transfer is not a deadweight loss
Same market: P = 30 − 2Q and P = 6 + Q. No government purchases.
| Outcome | Q traded | CS | PS | TS | DWL |
|---|---|---|---|---|---|
| Free market · P = $14 | 8 | $64 | $32 | $96 | $0 |
| Ceiling · P = $10 | 4 | $64 | $8 | $72 | $24 |
| Floor · P = $18 | 6 | $36 | $54 | $90 | $6 |
Transfer
A different price redistributes the gains on units that still trade.
One side’s gain is the other’s loss.
Lost trade
A buyer values a unit more than it costs, but the transaction no longer occurs.
The potential total gain disappears.
A higher floor helps some sellers who sell, but excludes others.
A ceiling helps some buyers but excludes others. Lines or lotteries may ration access.
Areas assume the highest-WTP buyers and lowest-cost sellers trade. Other rationing can reduce surplus further.
The same model explains new settings
A minimum wage
Suppose a required wage is $20 while the market-clearing wage is $16.
| Vertical axis | Wage |
|---|---|
| Demand for labor | Employers hiring |
| Supply of labor | Workers offering work |
Classify the policy and predict employment.
Binding price floor.
Labor demanded falls; labor supplied rises. Employment is Ld.
Ls − Ld is a labor surplus.
Water after a storm
A storm raises demand for bottled water and disrupts deliveries.
What can a higher price encourage?
Buyers conserve water.
Stores and outside suppliers have a stronger reason to bring in more.
A binding cap can create a shortage and shift rationing to waiting or purchase limits.
Use the basic competitive model and the stated assumptions. The policy’s name does not tell you which curve or market to draw.
Count the workers who actually get jobs
Labor demand: Ld = 400 − W
Labor supply: Ls = 3W
Stylized market: W is dollars per work period; L is the number of workers.
1 · Free market
Find the equilibrium wage and the number employed.
400 − W = 3W
W* = $100
Employment = 300
2 · Wage-floor follow-up
A minimum wage is set at $120.
Find Ld, Ls, employment, and the labor surplus.
Ld = 280; Ls = 360
Employment = 280
Labor surplus = 80
Can you explain every step?
1 · Trade: Farm C can produce 40 apples or 20 pears; D can produce 30 apples or 10 pears. Who has comparative advantage in pears?
2 · Markets: Cheaper pasta reduces demand for substitute rice. At the same time, higher fuel costs reduce rice supply. What happens to P and Q?
3 · Price floor: Qd = 36 − 2P and Qs = P. A floor sets P = $15. How many units trade, and how much excess supply is there?
Name the market → identify the constraint or shift → calculate → check units and actual trade → explain the result.