Introductory Microeconomics - EC155C and D

October 19, 2006 

FIRST EXAMINATION - ANSWERS

 

I.  Thinking like an economist (36 points)

 

ANSWER SIX OUT OF THE SEVEN QUESTIONS IN THIS SECTION:
THERE IS NO EXTRA CREDIT FOR ANSWERING ALL SEVEN.

 

A.              The following table shows the ‘production possibilities’ for six different workers (A-F) in typing (pages per hour) and in biking (miles per hour). 

Worker

Pages per hour

Miles per hour

A

5

2

B

8

4

C

12

18

D

18

18

E

9

18

F

2

20

 

Which worker has a comparative advantage in typing?  Which worker has a comparative advantage in biking?  Justify your answers.

By calculating the ratios, as we did in class, you can see that worker F has the CA in biking, whereas worker A has the CA in typing.  These reflect the opportunity costs …

Worker

Pages per hour

Miles per hour

RATIO

A

5

2

0.4

B

8

4

0.5

C

12

18

1.5

D

18

18

1.0

E

9

18

2.0

F

2

20

10.0

 

B.              Based on the data above, plot the production possibilities curve for typing and biking.  Use your graph to illustrate how the concept of opportunity cost is related to the concept of comparative advantage.

This is exactly like the exercise we did in class.  Start with all biking, and the shift the workers, one a time, based on their CAs: F, E, C, D, B, A.  IF you did this, you got a PPF like this

 

 

C.              The following table shows ‘willingness to accept’ data for six different travel agents (A – F).  Each of them is willing to sell one, and only one, travel package to Bermuda for the price that it listed.  For example, travel agent A will sell one package as long as she receives at least $300.

Travel agent

WTA

A

 $   300

B

 $   400

C

 $   500

D

 $   600

E

 $   700

F

 $   800

 

Plot the supply curve for travel packages in this market of six suppliers.

 

The key to this problem was to set up a market supply schedule, based on these data.  The schedule would look like this:

P

Q

$300

1

$400

2

$500

3

$600

4

$700

5

$800

6

 

So the graph then looks like this:

   

 

D.              In class, we talked about producer surplus at the ‘extra money in the wallets’ of suppliers after a market transaction.  Explain this idea.  In the example above, what would be the producer surplus in the travel package market if the equilibrium price were $650?  Justify your answer. 

It’s extra money in their pocket because, say in the case of Travel Agent A, they would be willing to accept $300, but get $650.  The difference is like extra money in their pockets. 

The producer surplus would be $800, the sum of the PS’s for Travel Agents A – D.

$650 – $300 = $350

$650 – $400 = $250

$650 – $500 = $150

$650 – $600 = $50

E.              The following table shows the demand for donuts for four different Middlebury students (A – D).

 

Quantity demanded

Price of a donut

Student A

Student B

Student C

Student D

 $    0.50

3

1

2

0

 $    1.00

3

1

2

0

 $    1.50

2

1

2

0

 $    2.00

2

1

2

0

 $    2.50

1

0

2

1

 $    3.00

1

0

2

1

 $    3.50

0

0

2

1

 $    4.00

0

0

2

1

 

Do all of the students follow the ‘law of demand’?  If not, why might this be the case?

Students C and D don’t.  Demand is inelastic for C: maybe she just can’t be without two donuts, no matter the price!  And maybe D is a snob: thinks that the only good donuts are expensive donuts!

F.              Plot the demand curve for donuts in this market of four consumers.  If supply in this market is characterized by the following equation:

Qs = -2 + 2P 

what will be the equilibrium price and quantity in this market?  Justify your answer.

Summing the individual demands yields:

Q

P

6

$0.50

6

$1.00

5

$1.50

5

$2.00

4

$2.50

4

$3.00

3

$3.50

3

$4.00

 

You can use the supply equation to get the following supply schedule:

Q

P

-1

$0.50

0

$1.00

1

$1.50

2

$2.00

3

$2.50

4

$3.00

5

$3.50

6

$4.00

 

By inspection, Qd = Qs = 4 when P = $3

 

G.              The following table shows market demand for coffee, with two different prices of a donut: $1.00 and $2.00

 

Quantity demanded

Price of coffee

Price of a donut  - $1.00

Price of a donut  - $2.00

 $    0.50

10

8

 $    1.00

8

6

 $    1.50

6

4

 $    2.00

4

2

 $    2.50

2

0

 $    3.00

0

0

. 

When the price of a donut goes from $1.00 to $2.00, what is the cross-price elasticity for coffee when the price of coffee is $1.50?  Are these goods complements or substitutes?  Why are they complements/substitutes?  Justify your answers.

Calculate the cross-price elasticity when the price of coffee is $1.50:

E =  (4-6)/5//(2-1)/1.5 = -0.6.  The sign is negative, they are compliments.  Why?  Coffee and donuts go together!

 

II.  Economic growth, markets and well-being (36 points)

ANSWER ALL SIX QUESTIONS IN THIS SECTION:

 

A.              What are the advantages and disadvantages of the conceptualization of “well-being” from Amartya Sen and Partha Dasgupta?  What are the advantages and disadvantages of other conceptualizations of well-beings?  Justify your answers. 

Sen and Dasgupta:  WB = f(Consumption, Health, Education, Freedom).  A top answer would talk about the Bhutan article and compare and contrast various approaches to well-being, and note that other factors (eg, the environmental, connection to others) should be in there.

B.              Has the remarkable harnessing of energy in the 20th century shifted out production possibilities?  If so, how? Has the dramatic increase of the world’s population in the 20th century shifted out production possibilities?  If so, how? Have each of these phenomena – the harnessing of energy and the increase of global population – increased well-being worldwide?  Why or why not?  Justify your answers. 

A top answer will illustrate how technology and population will shift out the PPF, and discuss why.

C.              In our class, we have discussed the provision of clean water in the developing world.  Under what circumstances will clean water be a normal good?  Under what circumstances will the (own-price) elasticity of demand for clean water be close to infinity?  Will the cross-price elasticity of demand for dirty water (say from a polluted river) with respect to clean water be negative or positive?  Justify your answers.

·        A normal good if folks want more water as their income goes up.  True in most cases.

·        Close to infinity if lots of substitutes, and/or if folks are using a large share of their (limited) income to purchase a small amount of water

·        Positive: they will be substitutes.

D.              One set of economists (group A) in Indonesia is proposing that the Indonesian government reimburse poor households in rural areas by 1000 Rupias (about ten cents) for every liter of clean water that they consume.  Another set of Indonesian economists (group B) is proposing that the Indonesian government reimburse sellers of clean water by 1000 Rupias for every liter of clean water that they sell to poor households.  Do you think that the government of Indonesia should adopt the recommendation of group A?  Alternatively, do you think that the government of Indonesia should adopt the recommendation of group B?  Justify your answers.

It won’t matter: this is the equivalent of the tax situation we looked at graphically and algebraically.  Good to show this graphically.

E.              In his visit to our class, Jason Scorse of the Monterey Institute summarized two results of his research on labor markets in Indonesia:

·        When Nike improved working conditions in their shoe factories in Indonesia, this caused a very small increase in unemployment among the workers in these factories;

·        When the government of Indonesia increased the minimum wage nationwide, this caused a significant increase in unemployment among Indonesian workers.

Can the characteristics of demand and/or supply elasticities in Indonesian and global markets explain these results?  Would either of these policies – improving working conditions and raising the minimum wage -- have created a large deadweight loss?  Were these good policies?  Justify your answers. 

It’s likely that the supply of labor, for Nike, will be relatively inelastic.  So a shift in of demand for labor, as costs go up, will create little DWL.  And the goodwill about Nike goods might, in the long run, shift demand back out, further reducing the DWL

In Indonesia, by contrast, a minimum wage might lead to a high DWL, as demand for labor might be elastic (factories can go elsewhere), leading to a high DWL. 

F.              In the Invisible Heart, we learned that Sam Gordon has two notable beliefs:

·        Private charity, in many conditions, will replace government programs that are intended to improve the well-being of the poor. 

·        Governments should impose a pollution tax on companies that are major sources of pollution

Under what conditions would Sam Gordon be right about each of these beliefs?  Under what conditions would he be wrong?  Justify your answers.     

A good answer would discuss the government/charities tradeoff, as Gordon discussed them.  Likewise for externalities and the pollution tax