Final ExamProfessor Peter Berck

EEP1/ECON3Ruth Uwaifo, TA

Fall 2003Emma Aisbett, TA

Time allowed: 3 hours

The Exam is a total of 50 points. Answer all questions.

Question 1 (10 points)

Briefly define each of the following (1pt each)

Make your answers as brief and to the point as possible. Where appropriate, an equation or diagram with letters labeled (e.g. “Where P1 is the price of good 1”) is sufficient.

a) A target price deficiency program

b) Long run equilibrium in a competitive market

c) Economic profit vs Business Profit

d) Shut down point

e) Public good

f) Elasticity of demand with respect to price

g) Free rider

h) TBES

i) Coase Theorem

j) Marginal revenue

Question 2 (11 points)

a) Draw a diagram for a monopolist. Carefully label all necessary curves. Show:

i. The quantity the monopolist chooses to produce. (1 point)

ii. The price the monopolist will charge. (1 point)

iii. The quantity that would be produced if the firm were acting competitively. (1 point)

iv. The price if the firm were acting competitively. (1 point)

v. The profit box for the monopolist. (1point)

b) Redraw the monopoly diagram (you do not need to include and label all the items required in part (a)).

i. On the new diagram, show the dead weight loss caused by the monopoly. (2 points)

ii. Suppose that the production of the good that the monopolist makes causes social costs that are not paid for by the firm (i.e. has an externality). The value of the externality is $t per unit. Illustrate this situation on your diagram. Also show the total deadweight loss from the monopoly's operations. (Hint: Deadweight loss always compares the welfare achieved to the welfare in the socially optimal outcome) (2 points)

c) Give an example of a monopolist whose actions cause substantial environmental externalities. (Historic examples are acceptable; if you can’t think of a monopolist, an oligopoly with significant market power will be acceptable). Two sentences should be sufficient. (2 points)

Question 3 (8 points)

WaterGray

bread bread

X

Arnold

Water

The Edgeworth box above shows the economy of Arnold and Gray. In this economy there are 40 gallons of water and 15 loaves of bread. All the economy's supply is allocated between both Gray and Arnold. Use the following information to answer the questions below. (Note all the labeled points are either at intersections of indifference curves, corners or at tangents of indifference curves)

a) At point A how much of bread and Water has Arnold and Gray. (1 point)

b) Which of the indicated points are Pareto optimal, if any (2 points)

c) If at point M, Gray has 13 gallons of water and 7 loafs of bread how much of bread and water has Arnold (1point)

d) Say whether this statement is true or false or indeterminate and why –

  1. Point M is Pareto preferred to B (1 point)
  2. Point B is Pareto preferred to point C (1point)
  3. Point X is a Pareto optimal point that makes both Arnold and Gray better of compared to point B (1point)
  4. A move from point C to point X indicates a move to a Pareto preferred point at which both Arnold and Gray are better off. (1point)

Question 4 (7 points)

Assume that there are two goods whose prices are P1 = 6, P2 =4. Income is 24.

a) Draw a diagram with this budget constraint and indifference curves for a consumer who would choose the bundle x1= 2 and x2 = 3. (2 points)

b) Explain why this consumer would make this choice of bundle. (2 points)

c) What bundle would the consumer choose if all prices and income were doubled? (1 point)

d) Now suppose income increased to 36 and prices are back to P1 = 6 and P2 = 4, and that the consumer still buys 3 of good X 2. Draw the new budget constraint and an indifference curve showing the new chosen bundle. (2 points)

Question 5 (8 points)

Assume that the supply function for ethanol, used as a gas additive, is positively sloped and has the form qs = -6 + p where p > 6

and the demand for ethanol is qd = 21 – 0.5p. (Prices are in $)

a) What is the equilibrium price and quantity given the demand and supply functions above (2 points)

b) State the demand-price function and the supply-price function corresponding to the given demand and supply functions (1 point)

c) Assume that a subsidy (a subsidy is a negative tax, so t = -6) of $6 per unit is imposed by the government. (2 points)

i) What is the new price paid by the consumer?

ii) What is the new price received by the producer?

d) Assuming that the use of ethanol in gasoline has no environmental benefit, what is the deadweight loss caused by the subsidy? (1 point)

e) Explain why such a subsidy could exist, even if it had a large deadweight loss. (2 points)

Question 6 (6 points)

The government is concerned about the environmental damage being caused by consumption of a particular good. Having studied EEP1, they are considering placing a tax on the good that is equal to the marginal cost of the environmental damaged caused by production of the good. They know, however, that demand for this good is completely inelastic.

a) Draw a diagram illustrating what would happen if the government did impose a specific tax on this good. (2 points)

b) Who would bear all the burden of the tax? (1 point)

c) Would any environmental benefit be obtained? (1 point)

d) The government also knows that the damage caused in the production of the good is actually all caused by the use of one input. Suggest one alternative way that the government could reduce the environmental damage associated with the production of the good. (2 points)

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