of Department Economics University of California, Berkeley
Professor Kenneth Train Spring 2006
ECONOMICS 1 SECOND MIDTERM EXAMINATION
April 19, 2006 INSTRUCTIONS 1. Please fill in the information below:
Your Name: ______________________________________________
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2. The exam ends at 11:57 am. 3. If you finish early, please remain in your seat so that you do not disturb others. 4. When time is called, stop writing and pass your exam to the aisle. Please stay in your seat until all of the exams are collected. 5. There are a total of 100 points, 6 questions, and 9 pages, including this cover sheet. Points for each question are in parentheses. 6. Answer the questions in the space provided. (NO BLUE BOOKS.) If you need extra room to answer questions, use the backs of the pages. 7. Calculators are not permitted.
Do not turn the page until you are told to begin the exam.
Question 1: (20 points, 10 minutes) True, False, Uncertain: Decide whether the following are true, false, or uncertain. Your grade is determined by your explanation; an answer without an explanation receives no credit. a) (10 points) Expansionary monetary policy increases both aggregate output and the interest rate.
b) (10 points) Suppose a person's von Neumann-Morgenstern utility function exhibits diminishing marginal utility of income. This person is willing to pay some amount to reduce uncertainty about his/her income.
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Question 2: (14 points, 7 minutes) When an individual gets vaccinated for the flu, that person benefits from increased immunity, but the community at large also benefits because there are fewer possible flu carriers to infect others. Thus, the marginal social benefit (MSB) to vaccine consumption is larger than the marginal private benefit (MPB). P S
MSB
MPB Q
a) (3 points) Label the quantity that will be produced in the free market with QM. b) (3 points) What is the socially optimal level of production? Label it with QSO. c) (3 points) Label the area of deadweight loss that will arise in the free market. d) (5 points) Suppose that the government decides to subsize vaccinations in order to encourage the socially optimal level of production. Indicate the per-vaccine amount of the appropriate subsidy on the graph.
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Question 3: (22 points, 11 minutes) Consider closed a economy with fixed prices and interest rates that is described by the following equations: C = 200 + 0.8(Y-T) I = 100 G = 200 T=200
a) (4 points) Solve for the value of equilibrium income. Show your work.
b) (3 points) Suppose that government spending falls to 100, but government taxation stays the same. What is the new value of equilibrium income? Show your work.
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c) (5 points) Why is the fall in equilibrium income larger than the fall in government spending? Explain very briefly in words.
d) (10 points) Suppose that consumers begin to save less, increasing the marginal propensity to consume. Does this increase or decrease the government spending multiplier? Explain, using intuition and economic concepts, not math.
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Question 4: 10 points, 5 minutes As financial services firms improve their technology, it becomes easier and less expensive for individuals to quickly move their wealth between liquid and illiquid forms. a) (3 points) How will this affect the transactions demand for money and the interest rate? Show the effect on the money market graph and explain very briefly. r MS
MD M
b) (7 points) What effect does this change in the money market have on aggregate output? Explain very briefly in words.
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Question 5: 16 points, 6 minutes The city of Ravenna is considering building a subway system, expected to cost $500,000. A measure is placed on the ballot that would finance the construction with a flat fee assessed on each of the 25,000 residents of the town. a) (8 points) If the median willingness to pay for the subway system is $35, will the ballot measure pass? Why or why not?
b) (8 points) Explain the condition required for the construction of the subway to be socially optimal. Is it satisfied in this case?
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Question 6: (18 points, 8 minutes) Suppose that there is a government-mandated minimum wage, w , that is above the equilibrium wage in a particular labor market. w SL
w
DL 200 300 400 L
a) (2 points) Calculate the unemployment rate in this market at the wage w .
b) (6 points) Does the existence of the minimum wage mean that firms are paying workers more than the marginal revenue product of the last worker hired? Explain.
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c) (10 points) Suppose that there is an increase in marginal product for each worker. How will this affect the demand and/or supply of labor, the wage, and the unemployment rate? Indicate on the graph and explain.
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