Free response 25 out of 50 pts. (2 qns., 12 pts.

each + 1)
Answer these questions on your exam paper in the space provided. Show your work and intermediate steps
for partial credit. You will not be given credit for correct answers without any work or explanation. Points
are split equally across all sub-parts. You will receive 1 extra point for correctly writing your name, perm
number, and TAs name in the appropriate place on the first page of the exam paper.
1. The demand for iClickers at UCSB is p = 15 q and the supply is p = 2q..
(a) What is the equilibrium price and quantity?
Answer: (p, q) = (10, 5)
(b) The UCSB administration thinks that UCSB students are paying too much and decides to subsidize iClickers enough so that the students end up paying $2 less than the price you found in
part (a). How large must the per-unit subsidy be? What is the new quantity sold? What is the
deadweight-loss (DWL) of this policy?
Answer: s = 6, q = 7, and DW L = 6
(c) Suppose the government wants to achieve the same price for consumers as in part (b), but it uses
a price ceiling instead. What is the new quantity sold? What is the DWL of this policy?
Answer: q = 4 and DW L = 3/2
(d) State which policythe subsidy from part (b) or the price ceiling from part (c)has a bigger
DWL (and by how much) or whether the DWL is the same. Which policy, if any, do consumers
prefer? Which policy, if any, do producers prefer?
Answer: The subsidy has a higher DWL, by 6 3/2 = 9/2 = 4.5. Even if you hadnt calculated
the DWL in parts (b) and (c) already, you could tell that this would be the case from the fact that
the subsidy distorts the quantity more than the price ceiling does. Consumers prefer the subsidy.
Although they pay the same price either way, the consumer a greater quantity with the subsidy.
Producers prefer the subsidy as well because under it they earn a higher price on a larger quantity.
So even though it is better for both consumers and producers, the subsidy is worse for society.
Its benefits to consumers and producers come at the expense of those outside of the market from
whom the subsidy expenditures were generated.

2. Consider an exchange economy consisting of two people, A and B, endowed with two goods, 1 and
2. Person A is initially endowed with A = (12, 0) and person B is initially endowed with B =
(6, 18). Person As preferences are given by U A (x1 , x2 ) = x1 x2 and Person Bs preferences are given
by U B (x1 , x2 ) = x21 x2 .
A
(a) Write the equation of the contract curve (express xA
2 as a function of x1 ).

Answer : xA
2 =

36xA
1
18+xA
1

A
(b) Let p2 = 1. Find the competitive equilibrium price, p1 , and allocations, xA = (xA
1 , x2 ) and
B
B
B
x = (x1 , x2 ).

Answer : p1 = 3/2 , xA = (6, 9), and xB = (12, 9)

(c) Now suppose that U A (x1 , x2 ) = min{x1 , x2 }. If the initial endowments and U B are still the same
as in part (a), write down the new equation of the contract curve.
A
Answer : xA
2 = x1
A
B
(d) Find the new competitive equilibrium price, p1 , and allocations, xA = (xA
=
1 , x2 ) and x
B
B
(x1 , x2 ).

Answer : p1 = 2 , xA = (8, 8), and xB = (10, 10)