14.01Fa08Exam2

14.01Fa08Exam2 - 14.01 Fall 2008 Exam #2 Solutions November...

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14.01 Fall 2008 Exam #2 Solutions November 4th, 2008 1. (Total: 20 Points) True/False Questions: In this section write whether each claim is True or False. Please fully explain your answer, using a diagram if appropriate. No credit will be awarded to solutions without clear explanations. (a) (5 Points) The magnitude of the elasticity of the supply of hamburgers is less than 1, and the government imposes a $1 tax on hamburgers. increase less than 50 cents. (Support your argument with a sketch.) False, if j E D j < j E S j the price of hamburgers will increase more than 50 cents regardless of the elasticity of supply. 1
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(b) (5 Points) Claim: Any government intervention in a goods market that increases consumer surplus and generates dead- weight loss in that market must then also reduce producer surplus in that market. (Support your argument with a sketch.) False: a subsidy makes both producers and consumer better o/, but there is deadweight loss since the government expenditure is greater than the sum of the gains in surplus. In the diagram: CS = ECGF > 0 PS = ABCE > 0 Govt:Expenditure = ABGF DWL = j CS CS Govt:Expenditure j = CBG (c) (5 Points) Suppose that there are only two goods in the world, cars and wheat. In country X it takes 500 labor hours to produce a car and 0.25 labor hours to produce a pound of wheat. In country Y it takes 600 labor hours to produce a car and 0.35 labor hours to produce a pound of 2
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wheat. These per-unit costs are independent of the quan- tity produced. Claim: Country X has a comparative advantage over coun- try Y in the production of cars. (Make explicit any calcu- lations.) False. Opportunity cost of a car in terms of wheat in country X is 500 hr car : 25 hr lb = 2000 : 0 lb car > 600 0 : 35 = 1714 : 3 lb car =opportunity cost of a car in terms of wheat in country Y : This means Y has a comparative ad- vantage over X in the production of cars since has lower opportunity cost. (Even though X has absolute advantage). (d) (5 Points) A &rm with a production technology that re- quires a constant ratio of inputs faces constant input prices. Claim: If the &rm exhibits economies of scale in produc- tion over some range of output, then it must also exhibit increasing returns to scale. (Make explicit any calcula- tions.) True. Intuitively, let q 0 = F ( K o ;L o ) ! C ( q o ) = wL o + rK o : Consider increasing inputs by a scalar a > 1 . We know by Economies of Scale: C ( aq o ) < aC ( q 0 ) ;a > 1 Let q 1 = F ( aK o ;aL o ) . By constant ratio of inputs we know cost increases by a . If q 1 = aq 0 then increasing output by a is a times the initial cost, but we know the cost is strictly less. Therefore it must be that q 1 > aq o and we have increasing returns to scale. F
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This note was uploaded on 04/20/2010 for the course ECON 14.01 taught by Professor Pindyck during the Spring '08 term at MIT.

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14.01Fa08Exam2 - 14.01 Fall 2008 Exam #2 Solutions November...

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