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Unformatted text preview: ECONOMICS 211
FINAL EXAMINATION
Spring 2004
(3 hours, 200 points) Circle the name of your instructor: Han, Leroux, Ma, Soligo. NAME:
W PLEDGE; W
W
W PART 1: MULTIPLE CHOICE (Circle the correct answer) [4 POJNTS EACH, 32 POINTS
TOTAL] 1. One reason why the quantity demanded of a normal good tends to fall as its price rises is
a) people are poorer and cut down on their use of that good.
b) demand has to fall to restore equilibrium after a price rise.
0) at higher prices suppliers are willing to supply less. d) the increase in price shifts the demand curve upwards. 2. A Giffen good is all of the following except a) an inferior good.
b) a good for which an individual's demand curve slopes upward. c) a good for which the income effect of a price change dominates the
substitution effect. d) a good for which the income effect and the substitution effect have the same
direction. 3. For which of the following is demand likely to be most elastic?
a) Corn ﬂakes.
b) "Kellog’s" corn ﬂakes. 0) Cold breakfast cereals. (1) Breakfast cereals. 4. When the Rolling Stones give a concert, scalpers can be seen selling tickets outside the
gate at higher prices than at the box ofﬁce. What would be the best explanation for this? a) There is an excess supply of Rolling Stones tickets.
b) The box ofﬁce price for Rolling Stones tickets is set too high to clear the market.
c) The box ofﬁce price for Rolling Stones tickets is set too low to clear the market. d) There is a need for government price supports for RolIing Stones tickets. 5. The graph below shows demand and supply curves in a candy bar market. Suppose
that the government sets a quota on production at 10 units of output, and as a result the price rises to $7. In comparison to a competitive market, the consumer surplus would fall by
P
8
6
5
4. ......................... ..
10 2:0 30 Q
a) $0. b) $10.
0) $15. (1)520. 6. As the market price declines, competitive supply will decline for what two reasons? (a) Each ﬁrm wants to charge a higher price and some ﬁrms will leave the
industry. (b) Each ﬁrm will supply less and some ﬁrms will leave the industry. (c) Marginal revenue exceeds marginal cost and total cost exceeds total revenue. (d) Fixed costs and sunk costs both decrease. 7. Which of the following is NOT TRUE. In monopolistic competition ﬁrms
(3) face downward—sloping demand curves.
(b) make zero proﬁts in the long run. (0) produce differentiated products. ((1) produce at minimum average cost in the long run. 8. A public good in economics is best deﬁned as a good:
3. produced by a publiclyowned corporation and distributed at a zero price.
b. produced by a public utility whose prices are government controlled. 0. that entails zero production costs and thus should be allocated to the public at a zero
price. d. for which the extent of consumption by one person does not reduce the amount
available for other people. PART 2: TRUE/FALSE (Explain) [5 POINTS EACH, 15 POINTS TOTAOL] 9. The marginal rate of substitution between perfect substitutes decreases along any
indifference curve. 10. Competitive markets achieve exchange efﬁciency because the marginal rate of
substitution of all consumers is the same in equilibrium. 11. In the short—run when a competitive ﬁrm has only one variable input, labor, the proﬁt
maximizing condition (setting output where price is equal to marginal cost) is
equivalent to the condition that labor should be hired up to the point where the value
of the marginal product of labor is equal to the wage rate. PART 3: SHORT PROBLEMS 12. (5 points) You want to buy a room air conditioner. The price of one machine is $200. It
costs $20 a year to operate. The price of the other air conditioner is $300, but it costs only
$10 a year to operate. Assuming that both machines last 10 years, which is a better deal?
Explain. The interest rate is 10%. (Set up the equation but don’t solve.) l3. (8 points) The following diagram shows the capital and labor input combinations that a ﬁrm needs to produce the given levels of output. Assume the ﬁrm faces a constant
returns to scale production technology. Capital 100 200 Labor Currently the ﬁrm produces 100 units of output using the capitalwlabor inputs given by point A. The price of labor is $5 per unit of labor and the price of capital is $10 per unit
of capital. a) (2 points) Show, on the diagram, the least cost input combination of producing
100 units of output. Label this point B. b) (2 points) What is the marginal rate of substitution of labor in terms of capital
at point B? c) (2 points) Suppose the cost of producing 100 units of output at point B is $800.
What is the minimum cost of producing 200 units of output? Label this point C. d) (2 points) Draw the ﬁrm’s longrun average cost curve in the following graph. LAC 100 200 300 Q 14. (8 points) Answer the following six questions by referring to the diagram below. (Note. the 14 2 3Q/T a. If price is P1, the average economic proﬁt per unit is represented by line segment
(i) FE. (ii) BC. (iii) FL. (iv) EK. (v) GH. b. There will be economic proﬁts, if price is above what value? (Note. your answer
should indicate the lowest price above which there will be economic proﬁts.) (i) P]. (a) P2. (iii) P3. (iv) P4. (v) Q4. c. The ﬁrm will close down when price falls below (1') P1. (ii) P2. (iii) P3. (iv) P4. (v) 0. d. If the ﬁrm wanted to maximize output (not proﬁts), without incurring losses, and if
price were P1, then output would be (i) 0. (10 Q1. (iii) Q2. (iv) Q3. (v) Q4. 15. (8 points) Consider the decision to advertise in the market for athletic shoes with two
companies: Nike and Reebok. The matrix below gives the payoffs for these two
companies in terms of proﬁts made when they advertise or do not advertise. Reebok Advertise Not advertise Advertise Nike makes $10 mil Nike makes $20 mil Reebok makes $10 mil Reebok makes $5 mil
Nike Not advertise Nike makes $5 mil Nike makes $15 mil
Reebok makes $20 mil Reebok makes $15 mil 3. (5 points) What is the Nash equilibrium for this game? Explain precisely how
you arrived at your conclusion. b. (3 points) If the two ﬁrms play this game indeﬁnitely, what outcome is likely to
emerge over time? Explain your answer. 16. (10 points) Suppose that initially there are two individuals  A and B  whose demand curves for national defense are: PA z 30  QD Demand curve for A P3 = 20  QD Demand curve for B Where QD are units of national defense. The cost of providing national defense is
constant at $20 per unit. a. (4 points) If the price is equal to marginal cost, what quantity of national defense will each person buy if they act independently? What is the total amount of
purchase? Draw the graph below. Q b. (4 points) Draw the social demand curve for national defense on the graph above.
What is the optimum level of production of national defense? c. (2 points) Are total amount of purchase in part (a) and (b) same? If so, why? If
not, why not? l7. (8 points) There are two types of people, Pales and Rosys. The number of each type is 5,000.
The numbers of Pales and Rosys who will get sick during a oneyear period are 400 and
200, respectively. No one will get sick more than once per year. The medical cost for each
sick person is $1,000. (There are no other costs associated with sickness.) A Pale is willing to pay $100 for a full—coverage health insurance policy, while a Rosy is willing to pay $50
for a full—coverage health insurance policy. Suppose that only fullcoverage insurance
contracts are available. a. (4 points) In general, the price of an insurance policy (or the money which a
person who purchases the policy pays to the insurance company in advance) is called a "premium". What would be the numbers of people demanding insurance
at the following insurance premiums? b. (4 points) Is there a premium at which the insurance industry can cover both
types of people and break even (that makes zero proﬁts)? Explain why. PART 4: LONG PROBLEMS 18. (10 points) Lisa just inherited a Vineyard from a distant relative. In good years (when there
is no rain or frost during harvest season), she earns $100,000 from the sale of grapes from the vineyard. If the weather is poor, she loses $20,000. Lisa’s estimate of the probability
of good weather is 60%. a. (3 points) Calculate the expected value of Lisa’s income from the vineyard. b. (4 points) Lisa is risk averse. Ethan, a grape buyer, offers Lisa a guaranteed payment of
$52,000 each year in exchange for her entire harvest. Will Lisa accept this offer? Explain. b. (3 points) Suppose that Ethan is risk preferring. Draw the shape of his utility function
over income. Is he willing to pay Lisa more than $52,000 each year for her entire
harvest? 19. (15 points) At the current price P, there is an insufﬁcient number of landing slots
available to supply all needed landings at peak hours at Washington National Airport.
The supply of these landing slots is assumed perfectly inelastic. There is some price
elasticity in demand. a. (4 points) Use a graph to illustrate the problem of excess demand. Explain the slopes
of your demand and supply curve. b. (4 points) In your diagram label the price that would prevail if the landing slots were
auctioned off by the airport authority to the highest bidder as P'. 10 c. (4 points) Suppose that the landing slots Were allocated by lottery to the airlines but
the winners would be allowed to resell them in an open market. What would be the
market price for the landing slots (label the price P")? Explain. d. (3 points) Since higher prices do not change the quantity supplied, why should the
government allow the price to rise above P? 20. (12 points) The demand and supply for milk in NYC are drawn in the graphs below. The
leaders of NYC consider 3 different plans to help local dairy farmers. The ﬁrst is a quota
on total production, the second is a perunit subsidy, and the third is to allow milk
producers to form a legal cartel. In the graphs below, clearly indicate the areas for consumer surplus, producer surplus and deadweight efﬁciency loss after each plan is
implemented. (a) (3 points) Quota of 3 units of milk. Quantity of
Milk lI (b) (3 points) Per—unit subsidy of $2.00. .,..s::ia§i§§;:EéQuantityof
2468101214 Milk (0) (3 points) Gate
33 14 10 77777 n .:s...s..=i:§sasasQuantityof
2468 1214 Milk ((1) (3 points) Rank the three plans in terms of their efﬁciency. 12 21. (12 points) The ﬁgure below shows the demand for the daily services of a bridge. These
services can be provided at zero marginal cost. (Dollars) IIIIllllllll
6 IIIIEIII # of crossings a. (2 points) What toll would a nondiscriminatory, proﬁt maximizing monopolist charge per crossing? How many crossings would be made? b. (2 points) What toll should be charged to be consistent with allocative efﬁciency? 13 c. (4 points) Suppose that ﬁxed costs are $400 a day. Will a nondiscriminating, proﬁt
maximizing monopolist continue to operate the bridge in the long run? Explain. d. (4 points) If the bridge owner could perfectly price discriminate how much revenue
would he collect? With ﬁxed costs of $400 per day would he continue to operate the bridge in the long run? Explain. 22. (18 points) Suppose that currently, all of the handmade sweaters in Alaska are supplied by
only two ﬁrms, Granny's Handknits and A Stitch in Time. The demand curve for sweaters in
this market is given by P = 350  Q, where P is market price and Q is quantity. The marginal
cost (for knitter‘s labor and yarn) is constant and equal to $50 per sweater, and the ﬁxed cost
is $0. a. (10 points) Assume that this market operates under the assumptions of the
Cournot model. What is the Cournot duopoly level of output and associated price? 14 b. (4 points) Suppose now that the two ﬁrms form a cartel and maximize their joint proﬁt. The costs of production are unchanged. Find the market price and
quantity. c. (4 points) Compare the Cournot equilibrium with the cartel equilibrium in
terms of market output, price and total proﬁt. 23. (12 points) Mr. Alfred Newman, owns a mill which is the ONLY employer in a rural county.
Here, the curve MB is marginal expenditure. a. (2 points) Show on the diagram below the proﬁt maximizing level of employment and
wage rate for Mr. Newman‘s Mill. Wage
Rate Quantity of Labor 15 b. (2 points) How many workers would be employed if the labor market were
perfectly competitive? C. (2 points) On the graph above, indicate the dead weight loss under case (a). Assume that the United Textile Workers won a representation election and negotiated
$3.00 as the minimum wage in the mill. d. (2 points) On the same diagram draw the new marginal expenditure curve with
the minimum wage. How many people will be hired with the minimum wage? e. (2 points) What is the dead weight loss under case (d)? f. (2 points) Assume that the union gets a further raise; at what level will it reduce
employment below the level which prevailed in part (a)? 16 24. (17 points.) CHEMICALS UNLIMITED produces sulfuric acid in its plant in Texas City. However, it dumps its toxic wastes in a river which is the main source of water
for the city. The external cost of its toxic waste is constant at $2 per unit of acid
produced. The firm’s marginal cost of sulfuric acid is P=2+Q. The demand function
for sulfuric acid is P=IOQ. Suppose that the sulfuric acid market is competitiVe. a. (3points) What are output and price in the competitive market equilibrium? (give numerical answers) Draw the corresponding graph below and label the
competitive equilibrium on the graph as cc, b, (2 points) Draw the social marginal cost curve on the graph above. c. (3 points) What is the socially optimal level of acid production and price?
(give numerical answers) Label the social optimum on the graph as es. (:1. (3 points) What per unit tax will lead to the socially optimum level of output? 17 3 (3 points) Now assume that CHEMICALS UNLIMITED is a monopoly.
What are output and price in the monopoly? (give numerical answers) Label the monopoly equilibrium on the graph as em f. (1 points) Compute the dead weight loss under perfect competition. g. (1 points) Compute the dead weight loss under monopoly. h. (1 points) Is monopoly less efﬁcient than perfect competition here? 25. (10 points) Consider a factory where smoke causes damage to the laundry hung
outdoors by ﬁve nearby residents. In the absence of any corrective action each
resident would suffer $75.00 in damages, a total of $375.00. The smoke damage can
be eliminated in either of two ways: a smoke screen can be installed on the factory’s
chimney at a cost of $150.00, or each resident can be provided an electric dryer, at a
cost of $50.00 per resident. a. (4 points) Assuming no transaction costs what would happen if: (i) Residents have a right to clean air? 18 (ii) Factory has a right to pollute? b. (4 points) Suppose now that there are transactions costs such that it costs each resident $60.00 to get together with others (e.g. value of their time and
transportation costs) what would happen if: (i) Residents have a right to clean air? (ii) Factory has a right to pollute? (c) (2 points) How do your answers to parts (a) and (b) illustrate the Coase
theorem? 19 ...
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