Economics Final Exam 2019

ECON Spring 2019 Final Exam May 10, 2019 Time Limit: 120 Minutes Name (Print): Recitation Section: Name of TA: • This exam contains 10 pages (including this cover page) and 17 questions. Check to see if any pages are missing. • The exam is scheduled for 2 hours. • This is a closed-book, closed-note exam, no calculator exam. • Answer each multiple choice question by writing the correct answer on the line at the right margin of the corresponding question. Make sure that your answer is clearly written or it will be marked incorrect. • Write your answers to the short answer questions in the spaces provided below them. If you don’t have enough space, continue on the back of the page and state clearly that you have done so. • Do not remove any pages or add any pages. No additional paper is supplied • Show your work when applicable. Use diagrams where appropriate and label all diagrams carefully. • You must use a pen instead of a pencil to be eligible for remarking. • This exam is given under the rules of Penn’s Honor system. My signature certifies that I have complied with the University of Pennsylvania’s Code of Academic Integrity in completing this examination. Please sign here Date Question Maximum MC (Q1-14) 39 1st SA (Q15) 20 2nd SA (Q16) 21 3rd SA (Q17) 20 Total 100 Grade Name: Section: TA: Page 2 of 10 Multiple Choice Questions (best 13 out of 14: 39 points) 1. (3 points) The price of flour, an ingredient used in making baguettes, increases. At the same time, the price of croissants, a substitute for baguettes, decreases. What is the impact on the price of baguettes? A. B. C. D. The price of baguettes increases The price of baguettes decreases The price of baguettes stays the same Not enough information to determine 1. D 2. (3 points) Alice has $6 to spend on ice cream or chocolate. One ice cream costs $2 and one chocolate costs $1. Ice cream and chocolate are perfect substitutes to her: she is indifferent between one ice cream and three chocolates. How many ice creams and chocolates does he optimally consume? A. B. C. D. E. 3 ice creams and 0 chocolates 2 ice creams and 2 chocolates 0 ice creams and 6 chocolates 1 ice cream and 4 chocolates Not enough information 2. A 3. (3 points) Which of the following is always true in the short-run equilibrium under perfect competition? A. B. C. D. At the equilibrium quantity, demand is unit-elastic Each firm produces the quantity such that its marginal costs equals its marginal revenue A firm shuts down whenever the market price falls below its average total costs The firm earns positive profits 3. B 4. (3 points) Consider the perfectly competitive market for oranges, with market demand P = 10 − Q and market supply P = Q. Consumers currently buy 2 units at a price of $8 per unit. Which of the following could be true? I. A per unit tax of $6 is imposed on sellers II. A price floor of $8 is imposed on the market III. Due to a hurricane the supply equation has become P = Q + 4 A. Only I F. II and III B. Only II C. Only III G. All of the above D. I and II E. I and III H. None of the above 4. D 5. (3 points) Suppose home-owners listing their homes on AirBnB are more responsive to prices compared to tourists looking for a place to stay. Consider an upward sloping supply and downward sloping demand. Upon imposing a $10 tax on home-owners: A. B. C. D. The price received by listers drops by $10 The price paid by tourists rises by $10 The tax falls more on tourists The tax is split equally between tourists and listers Name: Section: TA: Page 3 of 10 E. The tax falls more on listers F. None of the above 5. C 6. (3 points) Wakanda is a small nation producing both shields and Vibranium in the world economy. Following recent changes in the world price of shields, it specializes in Vibranium production. What must have happened in the world market for shields? Assume world market for Vibranium is unaffected. I. Demand for shields in the world market increased II. Supply of shields in the world market decreased A. I only B. II only C. I and II D. Neither I nor II 6. D 7. (3 points) Consider the perfectly competitive market for dry cleaning. Suppose the market demand is perfectly inelastic and the market supply is upward sloping. In addition, suppose the dry cleaning process yields air pollution. Which of the following statements must be true? A. B. C. D. E. The government can increase the social surplus by imposing a per unit tax. If the government imposes a per unit tax, the producer surplus will decrease. If the government imposes a per unit tax, the consumer surplus will increase. All of the above statements in A,B, and C are correct. None of the above statements in A,B, and C are correct. 7. E 8. (3 points) Consider a single price monopolist facing a downward sloping demand and positive marginal cost. Suppose it raises the price a little bit. Which of the following statements must be true? A. B. C. D. Both revenue and profit will increase. Both revenue and profit will decrease. The revenue will increase, but the profit will decrease. The revenue will decrease, but the profit will increase. 8. B 9. (3 points) The market for cereal is monopolistically competitive. Which of the following is true in long-run equilibrium? A. B. C. D. Firms maintain a positive profit through product differentiation. Firms choose to produce the quantity at which their marginal cost equals the market price. A firm’s demand curve is tangent to its average total cost curve. As firms producing imperfect substitutes enter the market, a firm’s demand becomes more inelastic. 9. C 10. (3 points) Consider a single price monopolist in the market for Portland cement, facing market demand P = 12 − QD , and marginal costs M C = Q. Producing Portland cement generates pollution amounting to a marginal external cost of $2. If the government wants to restore social efficiency, which of the following is true? A. The monopolist is overproducing and should be taxed to account for the pollution B. The monopolist is overproducing and should be subsidized to account for the pollution Name: Section: TA: Page 4 of 10 C. The monopolist is underproducing and should be subsidized to account for the pollution D. The monopolist is underproducing and should be taxed to account for the pollution E. No government intervention is needed as the monopolist is already producing the efficient quantity 10. C 11. (3 points) Kellogg’s and General Mills are currently each charging a low price, pL , for their cereals. The CEOs of Kellogg’s and General Mills meet to discuss colluding on a higher price, pH . If both firms cooperate and charge pH , each firm gains $4 million in profits. If one firm charges pL while the other charges pH , the low-pricing firm gains $8 million in profits and the high-pricing firm loses $1 million in profits. If both firms continue charging pL , there is no change in their profits. Which of the following is true? I. The pricing game is a prisoner’s dilemma II. There is a unique Pareto efficient Nash equilibrium III. Each firm’s dominant strategy is to charge the high price, pH A. Only I B. Only II C. Only III D. I and II E. I and III F. II and III G. I, II and III 11. A 12. (3 points) Amy, Bob, and Carl, are the only citizens of Econville and are considering building a bridge to Econtropolis. Amy values the bridge at $1, Bob at $2, and Carl at $3. They all value no bridge being built at $0. Suppose the bridge costs $3 to build. Which of the following is a Pareto efficient outcome? I. All citizens pay $1 and the bridge is built II. Carl pays $3 and the bridge is built III. Amy and Bob pay $1.50 and the bridge is built A. Only I B. Only II C. Only III D. I and II E. I and III F. None of the above 12. D 13. (3 points) Econ-Mart, a firm that produces economics lectures, is a monopsonist facing an upward sloping labor supply curve for economists. In an effort to protect economists, the government had imposed a minimum wage that restored market efficiency. Recently, demand for economics lectures has slightly increased as more people want to understand trade policy. Which of the following is now true about equilibrium wages and labor quantity, as well as market efficiency? A. B. C. D. Wages have risen, labor has risen, the market is efficient Wages have risen, labor has risen, the market is inefficient Wages are unchanged, labor has risen, the market is efficient Wages are unchanged, labor is unchanged, the market is inefficient 13. D 14. C 14. (3 points) Which of the following is not a policy that reduces economic inequality? A. B. C. D. Progressive income tax Unemployment insurance Sales tax Public school system Name: Section: TA: Page 5 of 10 Short Answer Questions (61 points total) To get any point you must show your work. 15. Suppose the market for coffee in Philadelphia is characterized by demand Qd = 1000 − 10P . Individual coffee shops are identical with total costs T C = 5 + 5q 2 and marginal costs M C = 10q. (a) What is the individual short-run supply curve equation for a coffee shop? Show your work. Solution: The short-run supply curve is the firm’s marginal cost curve above the shut-down price. The shut down price is equal to the minimum of AV C, which is reached at q = 0 so the shut down P price is 0. Therefore, the firm’s short-run supply is P = 10q ⇔ q(p) = 10 (b) Suppose the market for coffee is in a long-run equilibrium. What is the market price, firm output, number of firms, and market output? Show your work. Solution: In a LR equilibrium with perfect competition, each firm produces at min AT C, i.e. such that M C = AT C. So 10q = 5q + 5q which implies that the firm ouptu is q ∗ = 1, the market price is P ∗ = 10, the market output is Q∗ = 900, and the number of firms is N = 900 (c) What is the market supply equation? Is supply elastic, inelastic, or unit-elastic? Show your work. Solution: Using the individual supply equation, we have P = 10q = 10(Q/N ). Since N = 900, the market supply equation is P = Q/90 ⇔ Q = 90P . It begins at the origin so supply is unit-elastic. (d) What are consumer surplus, producer surplus, and total surplus? Show your work. Solution: CS = (100 − P ∗ ) ∗ Q∗ ∗ 0.5 = (100 − 10) ∗ 900 ∗ 0.5 = 40, 500; P S = P ∗ ∗ Q∗ ∗ 0.5 = 10 ∗ 900 ∗ 0.5 = 4, 500, T S = CS + P S = 45, 000 (e) Suppose the government has introduced a tax on coffee of $5 per cup. Now what are the equilibrium prices (price paid by buyers and price kept by sellers), quantity, and deadweight loss? Show your work. Solution: Seller’s price ps = 9.50, buyer’s price pb = 14.50, and DWL= 12 (900 − 855) ∗ 5 = 112.5 (f) What effect will this policy have in the long-run? Explain. Solution: Firms are operating at a loss, so in the long-run firms will exit and supply will decrease, such that each firm breaks-even, i.e. such that the sellers’ price is equal to min AT C = 10 – which implies that the burden of the tax will fall entirely on buyers in the long run. Name: Section: TA: Page 6 of 10 16. Amy and Ben are the only citizens of the small town of Econville. They have asked the government to build a park in the town. Their individual marginal benefits (M B) are given by: • Amy : M BA = 60 − 2Q • Ben : M BB = 40 − 0.5Q where Q is the square footage of the park (ft2 ). The cost of building the park is constant at M C = $20 per square foot, and there is no fixed cost. Note that we assume the park is a public good. (a) State the problem that arises in the market provision of a public good. What is the characteristic of public goods that is associated with this problem? Solution: The market underprovides pubic goods because of the free rider problem. This is because public good is non-excludable. (b) On the graph below, draw the marginal cost (M C), as well as Amy’s and Ben’s marginal benefits. Label Amy’s M BA and Ben’s M BB . Make sure to label all intercepts. Solution: $ 100 SM B 60 40 25 20 MC M BA 0 M BB 30 80 Q (c) Find the social marginal benefit (you should write down the exact equation) and draw it on the graph above. Label it SM B and make sure to label all necessary points. Solution: SM B = 100 − 2.5Q if Q ≤ 30 and SM B = 40 − 0.5Q if Q ≥ 30. See part (b). (d) Suppose the government has no budget to build the park, so it imposes an equal contribution of $10 per square foot on both Amy and Ben. What is the size of the park each person wants under this policy? Show your work. Name: Section: TA: Page 7 of 10 Solution: Since each pays $10 per square foot, M CA = M CB = $10. Therefore, Amy wants 25 square feet (M BA = M CA ⇔ 60 − 2QA = 10 ⇔ QA = 25) and Ben wants 60 square feet (M BB = M CB ⇔ 40 − 0.5QB = 10 ⇔ QB = 60) (e) What is the socially efficient size of the park QE ? Show your work. Solution: Since M C < 25, SM B = M C ⇔ 40 − 0.5QE = 20 ⇔ QE = 40ft2 . (f) Find the total willingness to pay of each person for the efficient size QE . Show your work. Solution: The total willingness to pay of each person is each person’s total benefit. For each of them, the total benefit from QE = 40 is the area below their marginal benefit curve, up to the quantity QE = 40. Therefore, Amy’s total benefit from QE is $900 (= 0.5 × 60 × 30) and Ben’s total benefit is $1, 200 (= 0.5 × (40 − 20) × 40 + 20 × 40). (g) Suppose now that each of them should pay a proportion x of his/her total benefit to finance the park. What is the minimum proportion x necessary to finance the efficient quantity? If you could not solve part (e), express it as a function of the efficient size QE , Amy’s total benefit T BA and Ben’s total benefit T BB . Solution: x(T BA + T BB ) = 20QE ⇔ x = 20QE T BA +T BB = 20×40 1,200+900 = 8 21 Name: Section: TA: Page 8 of 10 17. Suppose that the market for electric car workers is characterized by a downward-sloping labor demand curve and an upward-sloping labor supply curve. (a) On the graphs below, draw the labor supply and demand at the market level on the left hand side and at the firm level on the right hand side. Label the equilibrium market wage w∗ and market employment L∗ , the individual firm’s employment l∗ and the unemployment level. Solution: w w SL w∗ w∗ DL 0 L ∗ l 0 l ∗ M RPl L There is no unemployement. (b) Environmentally conscious consumers lobby the government to make electric cars more affordable, so the government decides to impose a binding price ceiling in the market for electric cars. What is the impact of this price control on the market for electric cars, and on the market for electric car workers? Show the first and second round effect (i.e. the “feedback effect”) on the graphs below, assuming the price ceiling always remains binding. Solution: The binding price ceiling decreases the price of electric cars below the initial equilibrium price. So the demand for electric car workers rotates counterclockwise (keeping the same X-intercept). As a result their wage decreases and employment decreases. The lower wage decreases the cost of producing electric cars so the supply of electric cars shifts out, such that the price ceiling is still binding. The effects stop at this point since the price of electric cars does not change any further and remains at the price ceiling. The equilibrium quantity of electric cars can go up or down, depending on the magnitude of the increase in supply (in the graph it increases). Name: Section: P TA: Page 9 of 10 w S S0 SL P∗ Price ceiling P0 w∗ w0 D 0 ∗ Q 0 Q Q 0 0 L ∗ L 0 DL DL L (c) Worried about the impact of the price ceiling on wages of electric car workers, the government decides to impose a binding minimum wage in the market for electric car workers. Describe (in words) how this minimum wage regulation affects the wage and levels of employment and unemployment of electric car workers. Solution: The binding minimum wage will increase the wage (compared to w0 ), decrease employment (to the quantity of labor demanded at the minimum wage), and generate unemployement (excess supply of labor, equal to the difference between quantity of labor supplied and demanded at the minimum wage). (d) Suppose the electric car producers unite into an employers’ organization and coordinate their actions in the labor market so that now they behave as a single employer. The government asks its chief economist to analyze the effect of the minimum wage in this new situation. i. To begin with, draw the employer’s individual labor supply and demand and marginal cost curves below, in the absence of a minimum wage. Label the monopsony wage and level of employment. Is there unemployment, and why? Solution: Name: Section: TA: Page 10 of 10 w M CL SL wmin wm DL 0 Lm L There is no unemployment in the monopsony equilibrium because the quantity of labor demanded is equal to the quantity of labor supplied. ii. Suppose the chief economist concludes that the minimum wage will actually increase employment, and at the same time generate unemployment. In your graph above, show the level of the minimum wage that confirms this conclusion. Solution: To increase employment, the minimum wage must be above the monospony wage but below the wage level such that M CL intersects DL . Moreover, to generate unemployment, it must be above the competitive wage w∗ . Therefore, the minimum wage is above w∗ and below the intersection of M CL and DL . See graph above. (e) Suppose the minimum wage is removed. Moreover, the employers’ organization of electric car producers is dismantled by the government, so that the market for electric car workers is back to perfect competition. To retaliate, electric car producers decide to collude and behave like a monopoly in the market for electric cars. How does this affect the equilibrium wage and employment of electric car workers? Explain. Solution: There is now a monopoly in the market for electric cars so the output quantity decreases. As a result, employment decreases and wage also decreases. Formally: in the output market the marginal revenue is below the market demand. At the profit maximizing quantity, the marginal revenue is below the perfectly competitive price, so the marginal revenue product of labor M RPL = M R ∗ M PL decreases compared to when the market was perfectly competitive. Therefore, the demand for labor decreases, and yields a lower wage and lower level of employment.