Econ 206

Continued from previous question). There are 110 coffee drinkers in Jitterville, each of whom will purchase one cup of coffee from a coffee shop if the price is right. Sixty are willing to buy a cup for $3 or less (that is, they have a buyer value of $3), 30 are willing to buy a cup for $2 or less, and 20 are willing to by a cup for $1 or less. In a long-run equilibrium in the coffee market in Jitterville, how many coffee shops are open and what is the price of a cup of coffee? a. Three shops are open, and the equilibrium price is $2.00. b. Three shops are open, and the equilibrium price is $1.50. c. Two shops are open, and the equilibrium price is $2.00. d. Two shops are open, and the equilibrium price is $2.50. e. One shop is open, and the equilibrium price is $2.50.

Answer: A

Ricardo's Island is occupied by two individuals: Ms. Rich and Mr. Poor. Both Ms. Rich and Mr. Poor have 30 hours per week to catch fish and bake bread, and both eat only fish sandwiches, which consist of one fish and one loaf of bread. Ms. Rich must spend 1 hour to catch a fish and 1.5 hours to bake a loaf of bread. Mr. Poor must spend 3 hours to catch a fish and 2 hours to bake a loaf of bread. If Ms. Rich and Mr. Poor coordinate to create the most number of fish sandwiches possible, how many could they make in a week? a. 21 b. 20 c. 19 d. 18 e. 22

Answer: A First, how many sandwiches could each produce per week if they didn't trade (not necessary, but interesting nonetheless). It takes Ms. Rich 2.5 hours to produce a sandwich, 1 hour for the fish and 1.5 hour for the bread. She has 30 hours per week, so she could produce 12 sandwiches. It takes Mr. Poor 5 hours to produce a sandwich, so he could produce 6 in 30 hours. In total, they would produce 18 sandwiches. Now suppose each specialized in their comparative advantage and traded with the other. Who has a comparative advantage in bread? In one hour, Ms. Rich can produce 2/3 loaf of bread and 1 fish. If Ms. Rich spent more time baking bread and less fishing, she would get (2/3)/(1)=2/3 loaves of bread for every fish she gave up. For Mr. Poor, that tradeoff is (1/2)/(1/3)=3/2 loaves of bread for every fish he gives up. Ms. Rich has a comparative advantage in fishing, and Mr. Poor has a comparative advantage in baking. Suppose each only produced their comparative advantage. Mr. Poor would bake 15 loaves of bread, and Ms. Rich would catch 30 fish. Too much fish, and not enough bread. Let's have Mr. Poor specialize and Ms. Rich produce some bread and some fish. Mr. Poor will produce 15 loaves of bread. We would then want Ms. Rich to produce 15 more fish than loaves of bread. That is, for her, F=B+15. Her production possibility set is 1.5B+F=30. Substituting F=B+15 for F, this equation becomes 1.5B+B+15=30 or B=15/2.5=6. She would bake 6 loaves of bread and Page 8 of 12 catch 21 fish. In total, they would have 21 loaves and 21 fish, which makes 21 sandwiches, three more than if they did not specialize and trade.

A firm knows that its total value product (revenue) per hour will be $12 if it hires one worker, $20 if it hires two workers, $26 if it hires 3 workers, and $31 if it hires 4 workers. The wage rate is $7 per hour. In order to maximize its profits, how many workers should this firm hire? a. 2 workers b. 3 workers c. 4 workers d. 1 worker

Answer: A It will be profitable to continue to hire as long as the marginal value product of each worker is greater than the market wage. The table below shows the total and marginal value product of each worker.

Suppose that the demand curve for umbrellas slopes downward and the supply curve slopes upward. If El Niño (a weather system) brings a large increase in the number of rainy days, we would expect: a. the demand curve for umbrellas to shift right (more at every price), and the price and quantity of umbrellas to increase. b. the supply curve for umbrellas to shift left (less at every price), and the price of umbrellas to rise, and the number of umbrellas sold to fall. c. the demand curve for umbrellas to shift left (less at every price), and the price and quantity of umbrellas to decrease. d. the supply curve for umbrellas to shift right (more at every price), and the price of umbrellas to fall, and the number of umbrellas sold to rise.

Answer: A This would lead to an increase in the demand for umbrellas (and prompt a movement along the supply curve), increasing price and quantity.

Given the market fundamentals two questions ago, consider an arrangement of trades in which 400 buyers with a buyer value of $100 buy from 400 sellers with a seller cost of $75 and 200 buyers with a buyer value of $50 buy from 200 sellers with a seller cost of $25. This arrangement of trades a. is not efficient but maximizes the number of profitable trades b. is efficient and maximizes the number of profitable trades c. is not efficient and does not maximize the number of profitable trades d. is efficient but does not maximize the number of possible trades

Answer: A We know that a competitive equilibrium (CE) is efficient and since this arrangement of trades is not the same as in a CE, this arrangement cannot be efficient, eliminating answers B and D. Does it maximize the number of possible trades? There are 800 buyers and 600 sellers, so there are at most 600 transactions, which this arrangement achieves.

(Use the market fundamentals in this question to answer the next 2 questions). The 100 people who live in the town of Fairhaven each own a house and they love to drive around and see holiday lights on houses throughout the town. 25 people are willing to pay up to $500 to put up holiday lights on their own houses and 75 are willing to pay up to $300. It costs $400 to put up holiday lights. However, each house that has holiday lights creates a positive externality of $2 for each person in Fairhaven. Without any government intervention, how many people would choose to put up lights in a competitive equilibrium? a. 0 b. 25 c. 75 d. 100

Answer: B

The 100 residents of Sprawlville can either walk or drive to work. Fifty residents would pay as much as $30 per day to drive instead of walk. The other fifty residents are willing to pay as much as $10 per day to drive. The cost of driving to work is $20 per day. Driving also pollutes the atmosphere imposing external costs on all residents of Sprawlville. Assume that each driver imposes a cost of $0.10 on each resident of Sprawlville. Without government intervention in the form of taxes, what is the total social profit that Sprawlville residents derive from the benefits and costs (including external costs) of driving to work? a. $500 b. $0 c. $250 d. -$250 e. -$500

Answer: B

A cool and wet growing season has led many orange trees to become infected with a disease called brown rot, drastically reducing the supply of oranges. Orange prices increase throughout the world, but the revenue made by orange farmers declines. From this we can conclude that a. the demand curve for oranges is inelastic. b. the demand curve for oranges is elastic.

Answer: B The effect of a supply change on revenues depends on the elasticity of demand. Specifically, a supply decrease will decrease revenues if demand is elastic (responsive). Thus, the fact that the revenue from oranges falls when supply falls indicates that demand is elastic.

Given the market fundamentals from the previous question, suppose now the town leaders of Fairhaven propose creating a subsidy that internalizes the external benefit created by holiday lights for every house that puts up holiday lights. To maximize social profits, the subsidy will be set to the marginal external benefit of lights and financed by a tax on all community members. How much should this subsidy be and how would it change social profits in the town compared to a competitive equilibrium with no subsidy? a. Subsidy = $2. The proposal would increase social profits by $2,500. b. Subsidy = $200. The proposal would increase social profits by $7,500. c. Subsidy = $2. The proposal would not change social profits. d. Subsidy = $200. The proposal would increase social profits by $2,500. e. Subsidy = $200. The proposal would increase social profits by $15,000.

Answer: B Without the subsidy, only the 25 people who value holiday lights at $500 put up lights. Holiday lights produce $2 of external benefit for each of the 100 people, so each house that has lights produces $2 × 100 = $200 worth of external benefit (the marginal external benefit). If we set the subsidy equal to the marginal external benefit of $200, then the 75 residents with a private value of $300 would now decide to put up lights since their new benefit from putting up lights is $500 ($300 + $200) while the cost is only $400. The net benefit to is $100 per house that now decides to put up lights, or in total 100 × $75 = $7,500 since there are 75 residents who now put up lights.

Because of recent tuition increases, the 50 students attending WWU are more interested in working than they used to be. Some students are better at juggling work and study than are others, a difference reflected in their reservation wages for working. Ten students have a reservation wage of $8 per hour, 10 have a reservation wage of $10 per hour, 10 have a reservation wage of $12 per hour, 10 have a reservation wage of $14 per hour, and 10 have a reservation wage of $16 per hour. If the equilibrium wage in the labor market for WWU students is $13, how many of these students will be voluntarily unemployed? a. 0 b. 10 c. 20 d. 30 e. 40

Answer: C A person's reservation wage is the lowest wage for which he or she is willing to accept a job. The wage is $13, so students with a reservation wages of $14 and $16 would not be willing to work at the market wage. These 20 students are voluntarily unemployed.

Compared with last year, the price of grapes fell and more grapes have been sold. What is the most plausible explanation of this change? a. Consumer income has fallen. b. The Surgeon General announced that grapes are the healthiest fruit and should be eaten daily. c. Warm weather came at just the right time for growing grapes producing an unusually large harvest this year. d. An unusually cold Fall season led to an unusually small harvest. e. An unusually cold Fall season reduced the appeal of grapes for consumers.

Answer: C Compared with last year, the price fell and quantity sold rose. The competitive equilibrium is moving along the demand curve as depicted below.

(Use the market fundamentals in this question to answer the next 2 questions). Every coffee shop in Jitterville has a fixed cost of $25, a capacity of 25 cups of coffee, and a variable cost of $0.50 per cup of coffee. What is the average cost of a cup of coffee when a coffee shop is producing at full capacity? Put another way, what is the break-even price of the a coffee shop when making 25 cups? a. $0.50 b. $1.00 c. $1.50 d. $2.00

Answer: C If coffee shops are operating at full capacity, the average fixed cost of a cup of coffee is $1 ($25/25), the average variable cost is $0.50, and the average cost is $1.50.

An excise tax levied on a good will have a relatively small deadweight loss if a. the good is a luxury causing its demand curve to be very price elastic. b. the good has many substitutes, causing its demand to respond greatly to changes in price. c. the supply of the good is not very responsive to changes in its price. d. the supply of the good has a very high price elasticity.

Answer: C P Q Dashed lines are supply when 1, 2, 3, and 4 firms enter $3 $2 25 80 60 $1.50 50 75 110 $0.50 100 Page 12 of 12 The excess burden (deadweight loss) of a tax will be relatively small if either the demand or supply curves are relatively inelastic. The extreme case is the perfectly inelastic supply curve, in which case the excess burden is zero. The answer to this question comes down to determining which of the options implies either a relatively inelastic demand or supply. Option C fits the bill because "not very responsive to changes in price" is equivalent to relatively inelastic. Option A doesn't work because the demand for luxuries is usually quite elastic. Option B doesn't work for the same reason. Goods with many substitutes tend to have elastic demand curves. Option D doesn't work because the supply curve should be inelastic, not elastic.

In "Is Divorce Underrated?," Tim Harford describes a simple model of marriage, the Marriage Supermarket. What is the key insight from that model? a. A shortage of men makes unmarried men worse off. b. A shortage of men makes married women better off. c. A shortage of men makes married women worse off. d. A shortage of men makes married men worse off. e. A shortage of men makes both men and women worse off.

Answer: C See Harford, page 67-70.

Given the market fundamentals in the previous question, what is the total profit (buyers' profit plus sellers' profit) in the competitive equilibrium? a. $5,000 b. $10,000 c. $15,000 d. $20,000

Answer: D $ per ham hams Supply Demand $75 200 $50 $100 $25 400 600 800 Page 10 of 12 We know that a competitive equilibrium (depicted in the previous answer) is efficient. What is the profit from those transactions? Buyers have a profit of $10,000 and sellers have a profit of $10,000. The total profit is $20000

In "Is Divorce Underrated?," Tim Harford argues that contraceptive pills had all of the following effects except: a. Caused women to invest in longer-training careers such as law and medicine. b. Reduced women's bargaining power in the marriage market relative to men. c. Caused more women to enter college relative to men. d. Reduced the rate of divorce by reducing unwanted pregnancies. e. Directly increased the desirability of women as employees.

Answer: D The article argues that the pill probably had the opposite effect on divorce rates (actually causing them to rise)

Given the market fundamentals from the previous question, if the city of Bellingham levies a tax of $50,000 on each person who buys a lot, how will the tax affect the price that sellers receive for lots in Bellingham? a. Sellers' price will increase by $50,000 b. Sellers' price will decrease by $25,000 c. Sellers' price will increase by $25,000 d. Sellers' price will decrease by $50,000 e. Sellers' price will not change

Answer: D The supply and demand curves are depicted below. The original equilibrium price is $750,000. A tax of $50,000 on buyers shifts the demand curve down by $50,000. This new demand curve is illustrated by the dashed line. Since demand shifted, we know the new price in equilibrium is the price that sellers receive, which is $700,000 (or $50,000 less than the original price before the tax).

(Use the market fundamentals in this question to answer the next 2 questions). There are 50 vacant lots in Bellingham. The owner of each lot is willing to sell that lot if he or she receives a price of at least $500,000. There are 200 retirees from Seattle who would like to buy a lot in Bellingham on which they could build their retirement homes. 75 of those retirees are willing to pay as much as $750,000 for a lot, and 125 of those retirees are willing to pay as much as $375,000 for a lot. In a competitive equilibrium, what is the price of a lot? a. $375,000 b. $500,000 c. $625,000 d. $700,000 e. $750,000

Answer: E

Olivia bought her son a toy train for $100 at the toy store last month, planning to give it to him as a gift. However, the train carrying the next shipment of toy trains has derailed creating a mass shortage. Olivia can now sell her son's present to another parent for $500! What is Olivia's opportunity cost of giving her son the toy train for a present? a. $600 b. $0 c. $100 d. $400 e. $500

Answer: E Olivia's original expenditure on the train of $100 is sunk, so Olivia's opportunity cost of giving her son the train is determined by the price Olivia could get from the train's best alternative use - in this case, selling it for $500.

(Use the market fundamentals in this question to answer the next 3 questions). In the market for protective-mask bundles (a box of many protective masks), there are 800 buyers and 600 sellers. Each buyer can buy one bundle at most, and each seller can sell one bundle. 400 buyers have a buyer value of $100 for a bundle, and 400 buyers have a buyer value of $50 for a bundle. 200 sellers have a seller cost of $25 for a bundle, and 400 sellers have a seller cost of $75 for a bundle. What is the competitive equilibrium price for a bundle of masks? a. $100 b. $70 c. $50 d. $25 e. $75

Answer: E The competitive equilibrium is depicted below with a price of $75 and quantity of 400.

T/F If Janelle gives Jada a free ticket to an upcoming concert by the ViQueens, a hot new band whose tickets command a high resale price, Jada's opportunity cost of attending the concert is zero.

Answer: False Jada must still use time to attend the concert which must be valued at its next highest value (which is certainly greater than 0). Also, Jada gives up the opportunity to re-sell the ticket if she attends the concert.

t/f A profit-maximizing firm will continue to hire more labor as long as the average value of output (product) per worker is greater than the wage.

Answer: False The firm should hire workers until the marginal value product of labor is equal to the equilibrium wage. This rule is distinctly different than the one stated in the question and will generally produce a different outcome!

t/f The imposition of a minimum wage in a competitive labor market always creates involuntary unemployment.

Answer: False Think back to the minimum wage experiment. A minimum wage that is set above the competitive equilibrium will likely create involuntary unemployment (as it did in Session 2), but a minimum wage that is set below the competitive equilibrium wage has no effect (as in Session 3).

t/f A $10 excise tax levied on sellers will decrease the price sellers receive by $10.

Answer: False This is possible, but not guaranteed to be true. Tax incidence depends on the relative elasticities of supply and demand, not who the tax is levied on. For example, if demand is very inelastic (like the soda tax example), the tax may be entirely passed on to buyers such that the price that sellers receive does not change after the tax is implemented.

t/f The free rider problem in the provision of a public good is caused by the fact that public goods are non-excludable.

Answer: True A good is nonexcludable if we can't exclude people from enjoying the benefits of the good. This leads to the free rider problem because people can enjoy the benefits of a public good regardless of whether they contribute to providing that good. As a consequence, no one will have an incentive to voluntarily contribute to producing the good. That's the free rider problem.

t/f In a long-run equilibrium, a profit-maximizing firm in a perfectly competitive market with free entry and exit should produce the quantity that minimizes its average cost.

Answer: True In the long-run a firm will produce the quantity which minimizes its average cost because if it does not, another firm can produce at minimum average cost, charge a lower price, and still be profitable (and consequently run the higher average cost firm out of business).

T/F The Law of Supply states that a decrease in the price of a good will decrease the quantity of the good supplied, and an increase in the price will increase the quantity of the good supplied.

Answer: True The Law of Supply states that a higher price is associated with a greater quantity supplied. If an increase in prices increases the quantity supplied, a decrease in price decreases that quantity. In other words, the Law of Supply states that the supply curve is upward sloping.

t/f Because the use of coal produces negative externalities through pollution, market competition typically encourages firms to use too much coal in production from society's point-of-view.

Answer: True The social cost of producing a good the private cost to the producer plus the external cost the producer creates for others. Private firms will ignore these negative externalities and thus produce too much of the good. The Isle of Effluvia example in lecture illustrated this point.

t/f If there are no externalities, a competitive equilibrium for a private good maximizes total profits.

Answer: True This is the invisible hand theorem in action, which says (and we proved) that a competitive equilibrium is efficient (that is, maximizes total profits).

t/f If a public good has been provided to one consumer, the marginal cost of providing it to another consumer is zero.

Answer: True. See the definition of a public good in R&T on p. 300.

A small tropical island's banana market has 35 banana growers and 45 banana consumers. Each banana grower can sell at most one sack of bananas. Each consumer can consume either 0 or 1 sack of bananas. There are 10 low-cost banana producers, each of whom can produce bananas at a cost of $15 per sack and 25 high-cost banana producers, each of whom can produce bananas at a cost of $30 per sack. There are 30 consumers who are willing to pay up to $40 a sack and 15 consumers who are willing to pay up to $20 a sack for bananas. What is the competitive equilibrium price of bananas on this island? (a) $20 (b) $30 (c) $15 (d) $35 (e) $40

B

What is the competitive equilibrium number of sacks of bananas sold on this island? (a) 10 (b) 25 (c) 30 (d) 15 (e) 50

C

In competitive equilibrium, the total amount of profit made by banana growers will be: (a) $285 (b) $100 (c) $250 (d) $200 (e) $150

E

In competitive equilibrium, the total amount of profit made by banana growers will be: (a) $335 (b) $125 (c) $275 (d) $225 (e) $175

E

A tax of $1 per unit on sellers will increase the price buyer's pay by $1.

False: could be true but is not necessarily true who pays the tax is dependent on tax incidence

If a series of trades has made each buyer and seller better off and there are no further trades that would make both a buyer and seller better off, the outcome of these trades is efficient.

False: efficiency is not just about getting everyone to trade it is also about getting the most profit from the trades

If Jessica gives Joan a free ticket to an upcoming concert by the ViQueens, a hot new band who always sells out its concerts, Joan's opportunity cost of attending the concert is zero.

False: opportunity cost is almost never zero-- Joan has to give up time which can cost money

In order to maximize its profits, a monopolist will choose the output that maximizes its marginal revenue.

False: produce quantity until MR=MC

If a private good does not produce externalities, a competitive equilibrium for that good is efficient.

True

If the demand curve is downward sloping, a shift out (to the right) in the supply curve will decrease the competitive equilibrium price.

True: however if the supply curve is perfectly elastic (horizontal line) then it would be false as it would not change

Because the use of coal produces negative externalities through pollution, market competition encourages private firms to use too much coal in production (from society's point-of-view).

True: people producing coal do not care

Loyalty cards (ex: coffee cards buy 9 cups get the 10th free) are an example of price discrimination.

true

In a long-run equilibrium, all firms are making at least $0 economic profit.

true 2 conditions for LR Equilibrium: 1. no negative (Econ) profits 2. one more firm pushes all profits negative

If the demand curve is downward sloping, a shift in (to the left) in the supply curve will decrease the competitive equilibrium price.

false

Suppose the US government caps the price of gas nationwide at $3 per gallon. This would likely result in:

less gas purchased since few gas stations would find it profitable to sell at this price putting a price control on gas would cause the supply to go down

A small tropical island's banana market has 60 banana grower and 40 banana consumers. Each banana grower can sell at most one sack of bananas. Each consumer can consume either 0 or 1 sack of bananas. There are 35 low-cost banana producers, each of whom can produce bananas at a cost of $15 per sack and 25 high-cost banana producers, each of whom can produce bananas at a cost of $30 per sack. There are 20 consumers who are willing to pay up to $40 a sack and 20 consumers who are willing to pay up to $20 a sack for bananas. What is the competitive equilibrium price of bananas on this island? (a) $20 (b) $30 (c) $15 (d) $35 (e) $40

A

What is the competitive equilibrium number of sacks of bananas sold on this island? (a) 35 (b) 25 (c) 20 (d) 15 (e) 50

A