# Question 1

1. In the mythical nation of Oz, gasoline used to sell for \$3.25 a gallon, and the natives purchased 100,000 gallons a week. Four years ago, the price rose to

\$3.85 a gallon, and the natives reduced their quantity demanded to 80,000 gallons a week. (See “Work it Out” at the end of Section 6.1 in the text for an example.)

1. Calculate the price elasticity for this change. Show formula and math! (4 pts.)
• Today, gas again sells for \$3.25 a gallon in Oz, but instead of again being willing and able to purchase 100,000 gallons a week, the natives are only willing and able to buy 90,000 gallons a week. Why not 100,000 gallons a week again? What is responsible for this buying change? Explain. (5 pts.)

# Question 2

• Suppose that a Starbucks store raises the price of its premium coffee from

\$2.35 to \$2.65 per cup, and as a result, the quantity sold per day decreased from 550 to 470 cups.

1. Calculate the price elasticity for this change. Show formula and math? (4 pts.)
• Is this change in price going to successfully increase Starbucks’ profits? Explain making references to additional concepts in this chapter. (5 pts.)
• 3.    If the question is whether a shift in demand will have a greater effect on equilibrium price or quantity, the answer lies not with the elasticity of demand, but with the elasticity of supply. Why is this? Explain fully. You may provide a graph(s) as part of your explanation. (6 pts.)
• 4.    The supply and demand conditions facing a firm that makes widgets and generates a negative externality by dumping a highly toxic sludge in a nearby river is given in the table below.
1. What is the equilibrium price and quantity when only private costs are taken into account? Explain your thinking. (2 points)
• What is the equilibrium price and quantity when social costs are taken into account? Explain your thinking. (2 points)
• 5.    Suppose a city releases 16 million gallons of raw sewage into a nearby lake. The table below shows the total costs and marginal costs of cleaning up the sewage to different levels, together with the total benefits of doing so. (Benefits include environmental, recreational, health, and industrial benefits.)
1. What is the optimal level of sewage for this city? Explain making references to economic concepts. (3 points)
• Why not just pass a law that firms can emit zero sewage? After all, the total benefits of zero emissions exceed the total costs. Explain making references to economic concepts. (5 points)
• 6.    Would most environmentalists favor command-and-control policies over market orientated policies reduce pollution? Yes or No? Explain fully making references to economic concepts. (5 points)
• The Prisoners’ Dilemma Model (Payoff Matrix) of Chapter 8 is used in a variety of economic situations including business decision making between rival companies. Coke and Pepsi are rivals. Their commercials are usually not designed to convey new information about their products. Instead, they are designed to capture each other’s customers. Assume the following hypothetical information as expressed in the following Payoff Matrix:
1. What will be the outcome of this Prisoners’ Dilemma situation? What will each company choose to do? Explain fully (be sure to watch the video in Chapter 8.3 and perhaps another from another context provider linked from Students Resources) making specific references to the material in the chapter. Is the outcome you’ve found efficient? Explain fully. (5 points)
• 8.    Your neighbor has a large dog that barks often.
• Describe a situation when your neighbor’s barking dog is creating a negative externality on you. Be detailed, specific, and clear. (2 points)
• Describe a situation when your neighbor’s barking dog is creating a positive externality on you. Be detailed, specific, and clear. (2 points)

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