ECO 5520/6520 Exam 2Page 1 of 4

ECO 5520/6520 Exam 2Page 1 of 4

ECO 5520/6520 – Exam 2Page 1 of 4

Name______

ID ______

Midterm Exam 2 – ECO5520/6520

Instructions

This examination has five questions and you are to do all five in a bluebook that you provide, or on the exam sheet. Please number your answers clearly. Each question will be worth 20 points, and each part of each question will be weighted as indicated, so allocate your time accordingly. The exam is “closed book – closed notes.” You may use a calculator.

You will have until from 12:50 until 2:40 to complete the exam. Latecomers will not be given extra time to finish the exam. If you are unsure of a question, indicate what assumptions you are making and go forward.

  1. Suppose that there are 50 houses in the community with 2,000 square feet (ordinarily renting for $8,000 per year), and another 150 houses in the community with 3,000 square feet (ordinarily renting for $12,000 per year). The interest rate is 4% and with proper maintenance all of the houses are expected to last forever. In an election the population decides that they want public services worth $8,000 per year.
  1. (5 points) What property tax rate will be necessary to fund these public services?
  2. (5 points) How much money will be raised by the property tax rate?
  3. (5 points) Calculate the value of the big houses after the tax is imposed?
  4. (5 points) Calculate the value of the small houses after the tax is imposed?

ANSWER

  1. Small houses $200,000; Big houses $300,000. Base = 0.75*300 + 0.25* 200 = 275; Tax rate = t = 8000/275,000 = 2.91%
  2. $1,600,000
  3. [(25*12)+(25*8)]/(1+25*0.0291) = 289.43
  4. [(25*8)+(25*8)]/(1+25*0.0291) = 231.55

  1. Consider the demand and supply of smart phones. They are given by the following equations.

PD = 800 – 12 QD

PS = 100 + 8 QS

  1. (5 points) Calculate the equilibrium levels of price and quantity in this market.
  2. (5 points) If a 10% tax is placed on the smart phonesellers, what will happen to the equilibrium price and quantity, and tax revenues? Be specific with your answers.
  3. (5 points) How much of the tax will be borne by buyers, and how much by sellers? Why?
  4. (5 points) Calculate the “dead-weight” loss of the tax. Explain why this is a loss to society.

ANSWER

  1. P* = 380 ; Q* = 35
  2. Price will rise; Quantity will fall. P* = 401.92; Q = 33.17; tax = $36.53/phone; Total tax = 1212.09
  3. Buyers will pay 401.92 – 380 of tax = 21.92; Sellers will pay $14.61
  4. DW = 0.5* 36.56 * (35 – 33.17) = 33.38

  1. Mr. Paravano presented a discussion of fixing Michigan’s roads. Use the accompanying diagram for your answer.
  1. (5 points) What principle determines the optimal quantity of roads?
  2. (5 points) Show the equilibrium with Michigan’s current roads. Indicate costs to the drivers, and the consumer surplus.
  3. (5 points) Show what happens with road improvements. Indicate the new equilibrium, and the new level of consumer surplus.
  4. (5 points) This diagram has been drawn without any road congestion. Show what happens to costs when there is traffic congestion and explain why.

ANSWER

  1. MB = MC
  2. See graph
  3. MC falls. CS increases
  4. See graph. Increasing numbers of cars slow each other down.

  1. Consider a municipality with particular preferences for Education and for Pizza. Both are measured in dollars.

a. (5 points) What is the slope

of the budget constraint, and why?

b. (5 points) Draw a graph showing

the impact of a grant of $E that can

be spent only on education.?

c. (5 points) Suppose, instead

that the state matches every $1 that

the municipality spends with $3.

In this case, what is the cost of the

grant?

d. (5 points) Suppose that as a

condition for receiving the grant

in part c, that the state requires

that the municipality spend

at least half of its funds on

education.Draw this condition and

explain how it may (or may not)

change your answer to part c.

ANSWERS

  1. -1. Output is measured in dollars. You use a dollar on one or the other.
  2. See graph – Horizontal line.
  3. Slope -4.0. 1:1 + a 3 dollar match
  4. See graph – Decrease in utility


5.

  1. Please answer the following questions about public goods.
  1. (5 points) Suppose that Adam and Steve both want tenniscourts in their suburb. Adam’s demand curve is DA, and Steve’sdemand curve is DS. Draw the appropriate marginal benefit curve that summarizes the demand for a public goodfor the two of them on the graph above. Discuss briefly how you did it.
  2. (5 points) What principle would you use to estimate the optimum amount of this local public good? Is it the same or different as that used for private goods?
  3. (5 points) If the marginal cost per unit of a tennis court is 40, show the optimal number of tennis courts, based on your answers to parts (a) and(b). Give your best estimate, either geometrically or algebraically.
  4. (5 points) Steve has a twin sister Rosamunde, who has identical demand as Steve. What will happen to your answers to parts a, b, and c, if Rosamunde moves into the town and expresses her demands. Why?

ANSWERS

  1. Draw and explain.
  2. Sum of MB = MC
  3. Looks like 10 – 11 tennis courts. Algebraically:

30 – 2.5Q + 60 – 2.5Q = 40

90 – 5Q = 40 ; Q* = 10

  1. Shift up again by 60 – 2.5Q. Up to 12, it is 150 – 7.5Q = 40. Past 12, it is

120 – 5Q = 40; Q* = 16.

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