econ 202: principle of microeconomics name: fall 2005...

ECON 202 Third Midterm Fall 2005

ECON 202: Principle of Microeconomics Name:________________ Fall 2005 Bellas Third Midterm You have two hours and twenty minutes to complete this exam. Answer all questions, explain your answers, label axes and curves on graphs and do your own work. Fifty points total, points per part indicated in parentheses. 1. Consider a firm with the following technology that sells its output for $6 per unit:

Labor Total Physical Product (TPP)

Marginal Physical Product (MPP)

Marginal Revenue Product (MRP)

1 8 8 $48 2 15 7 $42 3 21 6 $36 4 25 5 $30 5 29 4 $24 6 32 3 $18 7 34 2 $12 8 35 1 $ 6 9 35 0 $ 0

A. Calculate MPP and MRP. (2) B. How many units of labor will be demanded if the wage is $20? (1) 5 units of labor because you hire more as long as the MRP > wage. C. How many units of labor will be demanded if the wage is $17? (1) 6 units of labor for the same reason. D. How many units of labor will be demanded if the wage is $14? (1) Again, six units of labor.

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2. Taxes are important issues in microeconomics. A. Draw a supply and demand diagram showing a tax on a supplier. Be sure to include:

the pre-tax quantity (1) the post-tax quantity (1) the dead weight loss from the tax (1) the burden on consumers (1) the burden on suppliers (1)

B. Consider a tax on economics textbooks. Are consumers likely to bear most of the burden or are producers likely to bear most of the burden of this tax. Explain. (2) Consumers are probably more likely to bear most of the burden because they have little choice as to whether to buy a textbook or which textbook to purchase. C. Why is the Social Security tax evenly split between employers and employees? (2) There’s no good economic reason for this, because it doesn’t matter who pays the tax. This was probably done for political reasons.

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3. Diagram a negative externality that occurs in production. Be sure to show: the supply curve (1) the social marginal cost curve (1) the market quantity (1) the efficient quantity (1) the dead weight loss at the market quantity (1)

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4. Bob is the owner and manager of a business you’d really rather not know anything about. Suffice to say he is a ruthless profit maximizer. A. One day, Bob tries putting large doses of caffeine into the food in the employee cafeteria and discovers that this increases employee productivity. What impact does this have on Bob’s demand for labor? (2) It increases the demand for labor. Anything that increases productivity increases the demand for labor. B. A couple of months later, Bob discovers that he can use his hypnotic powers of suggestion and his crafty logical abilities to convince banks to loan him money at an interest rate well below what he could have borrowed at before. What impact does this have on his level of investment? (2) Because he faces a lower rate of interest, he will borrow more and will invest more, so his level of investment will increase. C. How does the change in Bob’s level of investment from part B affect his demand for labor? (2) This will increase his demand for labor because it will increase his capital stock and an increased capital stock increases the productivity of labor, which, as per part A, will increase the demand for labor.

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5. Consider a firm selling a good with a price of $13 with the indicated marginal cost schedule and the indicated marginal external cost schedule.

Quantity

Marginal Private Cost

Marginal External Cost

Marginal Social Cost (MSC = MPC + MEC)

1 $ 5 $ 4 $ 9 2 $ 7 $ 5 $12 3 $ 9 $ 6 $15 4 $11 $ 7 $18 5 $13 $ 8 $21 6 $15 $ 9 $24 7 $17 $10 $27

A. Complete the marginal social cost schedule. (1) B. What is the profit maximizing quantity to produce? (1) A quantity of either 4 of 5, because this is where the MPC is less than or equal to the price. C. What is the efficient quantity to produce? (1) A quantity of 2, because this is where the MSC is less than or equal to the price. D. Calculate the dead weight loss from the profit maximizing quantity. (1) This is the sum of the difference between MSC and price for the additional units produced at the market quantity, which may be either 4 or 5. (15-13) + (18-13) = 2 + 5 = 7 or (15-13) + (18-13) + (21-13) = 2 + 5 + 8 = 15 E. Calculate the total damage from the efficient quantity. (1) This is the sum of the marginal external costs of the first two units, or 4 + 5 = 9.

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6. Consider this example in which there are two firms, each emitting ten tons of a pollutant, who have the following marginal abatement costs (MAC) or marginal cost schedules for reducing their pollution: Tons of Pollution Abated

MACA

MACB

1 $ 3 $ 5 2 $ 6 $ 6 3 $ 9 $ 7 4 $12 $ 8 5 $15 $ 9 6 $18 $10 7 $21 $11 8 $24 $12 9 $27 $13 10 $30 $14 Imagine that the goal of the pollution control authority is to reduce pollution by eight tons. A. If each firm does four tons of abatement (that is, if they both reduce their pollution by four tons) what will be the total cost? (2) 3+6+9+12 + 5+6+7+8 = 56. B. What is the lowest cost way to reduce pollution by eight tons? How much abatement does each firm do? (2) A does 3, B does 5. Cost is 3+6+9 + 5+6+7+8+9 = 53. This is a savings of $3 over the result in part A. C. What per ton emission fee will result in a reduction of eight tons of pollution? (2) Anything between $9 and $10 per ton.

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7. There are federal and state taxes on gasoline. The federal tax is 18.4 cents per gallon and the Minnesota state tax is 20.0 cents per gallon (Source: American Petroleum Institute web page, http://api-ec.api.org, November 30, 2005). Discuss briefly whether it is appropriate to characterize these taxes on gasoline as Pigouvian taxes. (2) It may be, because the consumption of gasoline does generate negative externalities and some of these negative externalities, such as contributions to global warming, occur regardless of the conditions under which the gasoline is consumed. However, some of the externalities associated with gasoline consumption vary greatly depending where and when the gasoline is consumed, suggesting that if the tax were really intended to address externalities, it should vary according to where and when and under what conditions the gasoline is consumed. So, perhaps it should not be considered a Pigouvian tax.

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http://api-ec.api.org/


8. Find the equilibria for the following games. Each game may have zero, one or multiple equilibria. (1 each)

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9. Opportunity cost is one of the most important concepts in economics. Imagine that a firm has some profits left after paying its expenses and paying its taxes. The firm does not pay dividends to its stockholders. The firm could invest the profits in a financial instrument that would pay an interest rate of 7% but which will involve an initial fee of 2%. Instead, the firm’s managers decide to invest the profits in a project within the firm that will yield a rate of return of 8% annually. What is the opportunity cost of using the firm’s own profits for this internal project? (2) The opportunity cost is the net return that could have been earned elsewhere, or 7% - 2% = 5%.

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10. The principle of comparative advantage is important in economics, and especially in international trade. Consider the example of two farmers, Angus from Scotland and Malcolm from Australia, who are growing oats and cane. In one year, they have the following production possibilities: Oats Cane Cost of 1 O Cost of 1 C Angus 16 8 8/16 = 0.5C 16/8 = 2O Malcolm 4 12 12/4 = 3C 4/12 = 0.33O That is, Angus can grow 16 units of oats or raise 8 units of cane or any linear combination of the two. A. Calculate the opportunity cost of each activity for each person. (1) This is shown above. Each person requires four units of oats to stay alive and, after that, would like to have as much cane as possible. B. If they do not trade, how much cane can each person have? (1) Angus has 4O and 6C Malcolm has 4O and 0C C. If they specialize and trade, what is the total gain in terms of units of cane? (1) Angus specializes in the production of O and makes 8 O and 4C. Malcolm makes only C and produces 12 C. They have a total of 16C, a gain of 10C over the previous outcome. D. Who are these Angus and Malcolm guys anyway? (0) They are Angus and Malcolm Young, two of the founding members of the rock band AC/DC.

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11. Imagine that there is a monopolist producing a good and that the production of that good generates some external damage. Will there necessarily be dead weight loss in this market? Explain why or why not. (3) Not necessarily, because the presence of a negative externality means that a market will generally produce too much of something. However, a monopolist, as long as she is not price discriminating, will produce less than a competitive market would produce, so the monopolist may wind up producing the efficient quantity in the presence of a negative externality. Here’s a sample diagram:

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econ 202: principle of microeconomics name: fall 2005...

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