4 pt. 1. Draw and label a market with a perfectly elastic ... · ... the sum of the costs for two units and the fine incurred. ... Output Total Variable Fixed Marginal Total Variable

4 pt. 1. Draw and label a market with a perfectly elastic supply and a perfectly inelastic demand. P� � � � � � � � � � � � � � � ������������������������������� Q

3 pt.

2

2. (Short answer) Suppose that, at a price of $10, there are twice as many apples demanded as supplied. How does the price adjustment eliminate the shortage? At $10, some consumers fail to obtain apples. Sellers can raise prices and still make sales. Increasing prices reduce quantity demanded and increase quantity supplied, eliminating the shortage.

3 pt. 3. (Short answer) Is electricity a normal good? Why or why not? Yes, for richer consumers will buy more electricity. Thus electricity demand rises as income rises, the definition of a normal good.

3

10 pt. 4. (Short answer) Red shirts and blue shirts are substitutes in production. (i) If the demand for red shirts falls, but the demand for blue

shirts is unchanged, what will happen to the prices of red shirts and blue shirts?

Both prices fall. The price of red shirts falls because of the demand decrease, and the price of blue shirts falls because sellers substitute to the more profitable blue shirts, increasing supply. (ii) Illustrate your answer with supply and demand diagrams: P� P � � � � � � � � � � � � � � � � � � � � � � � � � � � � � ���������������������Q �������������������Q Red Shirt Market Blue Shirt Market

3 pt.

4

5. (Short answer) Provide two examples of by-products of the production of goods. What does the increase in price of a by-product do to the other good's supply? Why? Gold and silver, beef and hides, lumber and wood chips (for paper), oil and natural gas. An increase in the price of the byproduct makes the first good more profitable, increasing the supply.

5

10 pt. 6. Suppose the elasticity of demand for shirts is 2. A 10% tax is imposed, which reduces supply in the following way: for any given quantity on the old supply curve, the required price to obtain the same quantity on the new supply curve is 10% higher. (i) Using one diagram, illustrate the supply shift, and find the

maximum that the equilibrium quantity can fall.

6

(ii) Now assume that the supply elasticity is 3. Using a second diagram, estimate the percentage change in the equilibrium price and quantity.

7

6 pt. 7. (No diagrams are necessary for the answer to this question) Tylenol is a substitute (in demand) for aspirin. (i) What does the introduction of Tylenol do to the supply and

demand for aspirin? Tylenol, a substitute in demand for aspirin, will reduce demand for aspirin without affecting supply. (ii) What happens to the price of aspirin when Tylenol is

introduced? The price of aspirin should fall due to the demand reduction. (iii) A bottle of poisoned Tylenol causes the company to

withdraw Tylenol from the market. What happens to the price and quantity of aspirin traded?

The price and quantity traded should increase, and return to their pre-Tylenol level.

8 pt. 8. Consider the market for controlled substances (experiment 4). (i) Some sellers chose not to sell. Why did they do this? What

was the predicted price? (Recall that half the units were confiscated, each unit cost «10, and there was a «5 fine for confiscation.)

The predicted price was «25 - the sum of the costs for two units and the fine incurred. Sellers chose not to sell because there was insufficient demand to permit all sellers to sell at this price. An additional seller would not have earned enough to make selling profitable.

8

(ii) The prices and quantity traded were roughly the same, whether the police resold confiscated units or not. Using a supply and demand diagram, illustrate why this might occur.

9

10 pt. 9. Consider the sales tax imposed in experiment 3. Using a supply and demand diagram (you may draw this with smooth curves), show how the tax on suppliers reduces quantity, raises the price paid by consumers by an amount less than the tax, and lowers the price paid to suppliers. On the same diagram, illustrate the dwad weight loss, and outline the area corresponding to the total tax revenue collected.

10

5 pt. 10. Consider the imposition of rent control, holding the maximum legal rents below the market equilibrium price. Using a supply and demand diagram, illustrate the dead weight loss, the number of apartments lost, and the size of the shortage in both the long and short run. What illegal activities would you expect to arise to circumvent the rent controls?

11

10 pt. 11. Suppose that employers have the following total revenue. Number of Total Marginal Average workers Revenue Revenue Revenue

0 -10

1 20 30 20

2 45 25 22.5

3 65 20 21.67

4 80 15 20

5 90 10 18

(i) Fill in the marginal and average revenue from the table. (ii) Suppose there are ten such employers. Draw the market

demand curve, carefully labelling every wage and quantity demanded.

(iii) Suppose there are 25 workers who will work for 22 (that is,

they get 22 if they are unemployed), and another 25 who will work for 18. Add the supply curve to the diagram. What is the equilibrium market price and quantity employed? Illustrate in the diagram.

Equilibrium Price: Quantity: (iv) Suppose a minimum wage of 20 is imposed. What is the

level of employment and involuntary unemployment? Illustrate in the diagram.

12

Voluntary Unemployment: Involuntary Unem.

13

8 pt. 12. Consider experiment 2, where the fishers sometimes caught one, two or three fish. (i) Explain how an increase in the number of fish caught can

reduce the total earnings of fishers. An increase in the number of fish reduces price, so revenue, which is price times quantity, can fall. (ii) How does the elasticity of demand affect the earnings of

fishers when the number of fish caught increases? Revenue falls when the quantity increases if demand is inelastic. (iii) Fishers paid «10 to run their boats. If prices fall to «1,

these fishers lose money. How many would you expect them to exit the industry? What should happen to prices?

Enough should exit so that prices increases to the level that makes fishing profitable. Since some are exiting, the price should equal average cost.

14

5 pt. 13. Using supply and demand diagrams, show that the effect of a «15 per unit sales tax on buyers and sellers is the same when the buyer pays the tax as when the seller pays the tax. How does this claim accord with your experimental findings? Did it matter who paid the tax?

15

10 pt. 14. Suppose the government offers a price support above the equilibrium price. (announced in class that the government doesn't redistribute the surplus). (i) What is an example of a price support that is actually used in

the United States? Cheese, peanuts, tobacco. (ii) Using a supply and demand diagram, illustrate the dead

weight loss and the expenditure for the price support.

16

5 pt. 15. (i) Why does demand give marginal value of the good? Consumers are willing to pay up to their value for the good. Thus, the marginal consumer values the good at the price. (ii) What is consumer surplus? Illustrate with a demand diagram. Consumer surplus is the net gains from trade earned by consumers.

17

Second Exam 1. (10 points) Fill in the following table. Ignore XXXX spaces. Average Average Average Output Total Variable Fixed Marginal Total Variable Fixed Cost Cost Cost Cost Cost Cost Cost 0 18 0 XXXX XXXX XXXX XXXX 1 9 2 21 3 15 4 90 5 33

18

2. (10 points) Most farmers earn very little money. Increases in subsidies to farmers, such as low interest loans, appear to provide short-term increases in farm income, but over time the earnings fall back to earlier levels. Why might this be the case? No diagrams are necessary to answer this question.

19

3. (10 points) Suppose Coca-Cola, which accounts for 10% of U.S. sugar demand, stops purchasing sugar and purchases an alternative sweetener. If sugar is a competitive industry, trace out the short and long run effects (on quantity, price, the number of suppliers and supplier's profits) of this demand decrease. You will need two diagrams, one for the market and one for the firm.

20

4. (10 points) Because of a perceived shortage of day-care facilities, the government decides to subsidize day-care facilities, providing suppliers with a $2,000 check each year for every child served. Suppose that day-care providers are a competitive industry. What effects, in the short and long run, does this subsidy have on the price of day-care, quantity of children in day-care, and the earnings of day-care facility owners? Use diagrams to illustrate your answer.

21

5. (10 points) The internet is clogged. Because of the high level of downloads, users may wait five or ten minutes to download from a site. There is an external effect of anyone's use - it slows the system down for all. Using a diagram or two, illustrate the private and social cost of internet use, and the benefits. Identify the unregulated equilibrium and the deadweight loss associated with this outcome. Identify the social optimum quantity, and the level of taxation necessary to achieve this optimum.

22

6. (10 points) California sells the right to pollute some effluents. Consider the right to release S02 into the atmosphere. Suppose the quantity of S02 has been fixed at a level below equilibrium that would prevail without regulation, but above the socially optimal quantity. Using a diagram, illustrate the social gain to the reduction in S02 below the unregulated quantity, and identify the price of a permit to produce one unit. Without using a diagram, identify the advantages of creating a market for pollution permits, rather than having a government agency choose who gets to pollute?

23

7. (10 points) Roaches in apartment buildings easily move from apartment to apartment. Thus, if your neighbor leaves a lot of food around, and never sprays, you are more likely to get roaches in your apartment. Identify the problem faced by the society of apartment dwellers, and suggest two fixes for this problem. No diagrams are necessary.

24

8. (10 points) How do coupons permit manufacturers to price discriminate?

25

9. (5 points) Consider a monopoly seller of computer software. This seller sells only over the internet, and pays a fixed charge for the creation of a web page, but has no variable costs. Explain why the seller will set a price so that the elasticity of demand equals one.

26

10. (5 points) In experiment 7, non-students valued the good at «21, and _ of the students valued the good at «16, with the other _ valuing the good at «21. Seller costs were «10. What prices (for students and non-students) maximize the seller's profit? You may assume that a buyer will buy if the buyer gets zero profits.

27

11. (10 points) Suppose non-students value a good supplied by a monopoly at «10, _ of students value the good at «10 and the other _ value the good at «6, and costs are «0. Half the population are students. Is society better off if price discrimination is forbidden?