The Hong Kong University of Science and Technology

Economics 2113: Microeconomics

Midterm Exam Solutions
Fall 2020

Problem 1. Comparative Advantage (30 points)

Solution a (8 points)
According to the PPF’s, Chris’ opportunity cost of producing one suit is 2 ties, and Bob’s op-
portunity cost of producing one suit is 1 tie. Because 2 > 1, Bob has comparative advantage in
producing suits. Meanwhile, Chris’ opportunity cost of producing one tie is 1/2 suit, and Bob’s
opportunity cost of producing one tie is 1 suit. Because 1/2 < 1, Chris has comparative advantage
in producing ties.

Solution b (8 points)

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Solution c (4 points)
Both Chris and Bob will produce on their PPF when they’re working together (the region outside
each one’s PPF is always unattainable).

Solution d (4 points)
If one suit and one tie must be paired together for sale, then the number of suits must be equal to
the number of ties in production. At the “kink" point A, the number of suits (9) is smaller than the
number of ties (12), so the tailor shop needs to increase their production of suits at the cost of ties.
If the number of suits is increased by 1, the number of ties must be decreased by 2 according to the
PPF, and both the number of suits and the number of ties will be 10 units.

Solution e (4 points)
Chris can make $2000 revenue for each suit, but only $1600 if he instead produces two ties. Bob
can make $2000 revenue for each suit, but only $800 if he instead produces one tie. Since producing
suits is more profitable for both Chris and Bob, both Chris and Bob will produce suits, and they
will produce 15 suits in total per day.

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Problem 2. Elasticity (20 points)
Solution a (6 points)
The equilibrium is at price of 32 and quantity of 200. The point is the midpoint between (0, 48)
and (400, 16). Therefore the elasticity can be computed as:

∆Q/Q̄ (400 − 0)/200

= = −2
∆P/P̄ (16 − 48)/32

Solution b (6 points)
The 4 dollar discount reduces price to $28, which is still larger than the midpoint of the demand
curve (the price at the midpoint is $24. Therefore the elasticity is larger than 1 and total revenue
will increase with the discount.

Solution c (4 points)
The effect on the total revenue from Cappuccino is undetermined. The price change of coffee beans
will have effects on both demand & supply for Cappuccino. The supply will decrease because the
input price increases. As the change happens above the midpoint of the demand curve, it will drive
down the revenue. On the other hand, supply for other beverages such as Latte also decreases and
drives up the price of Latte. Because Latte is a substitute of Cappuccino, the change will affect the
demand for Cappuccino as well. Because it is uncertain how large each effect is, the direction of
the combined effect is undetermined.

Solution d (4 points)
The price of Cappuccino will decrease by 20%. Notice that the supply curve is unit elastic as it
passes through the origin, so %∆P = %∆Q = 20%.

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Problem 3. Government in Action (30 points)
Question a (10 points)

Note: Only males will smoke when the price is higher than 50 HKD. Therefore the “kink" point
on the demand curve is when the price is 50 HKD and the quantity is 40 thousand packs. It can
also be directly observed from the schedules, that the equilibrium point is the point when the price
is 20 HKD and the quantity is 130 thousand packs.

Question b (8 points)

CS = (70 − 50) × 40/2 + (40 + 130) × (50 − 20)/2 = 2950 thousand HKD
P S = (20 − 7) × 130/2 = 845 thousand HKD
T S = 2950 + 845 = 3795 thousand HKD

Question c (4 points)
The minimum price level such that female consumers do not smoke is at 50 HKD, and the quantity
is 40 thousand packs. If a sales tax is implemented such that the equilibrium quantity is 40 thousand
packs, then the producer price is 11 HKD. Therefore the sales tax is 50 − 11 = 39 HKD.

Question d (4 points)
The tax burden on producers is 20 − 11 = 9 HKD.

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Question e (4 points)
The change in total surplus is exactly the deadweight loss, which is

39 × (130 − 40)/2 = 1755 thousand HKD

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Problem 4. Case: Covid-19 Vaccine (20 points)
Question a (10 points)
The Indian government will implement a price ceiling policy, and the ceiling price will be $3 a
dose.
The price ceiling will crate a DWL. However, in this case, the supply of vaccine is very inelastic,
which means the DWL could be really small.

Question b (10 points)

Vaccines will be free in UK and Australia, but we can think it as a subsidy policy: the amount of
subsidy is the unregulated price of vaccines.
A subsidy will create a DWL to the society. However, it will also create a huge positive external-
ity because the coverage of vaccines will effectively contain the spread of COVID-19 and create
tremendous benefits to the public health. Therefore in the end the policy should improve the social
welfare.