ECON Midterm Quiz 3

Consider a specific example of the special-interest effect and the collective-action problem. In 2012, it was estimated that the total value of all corn production subsidies in the United States was about $3 billion. The population of the United States was approximately 300 million people that year. a. On average, how much did corn subsidies cost per person in the United States in 2012? (Hint: A billion is a 1 followed by nine zeros. A million is a 1 followed by six zeros.)

$10 a. $10.00 (= $3 billion divided by 300 million).

Consider a corrupt provincial government in which each housing inspector examines two newly built structures each week. All the builders in the province are unethical and want to increase their profits by using substandard construction materials, but they can't do that unless they can bribe a housing inspector into approving a substandard building. a. If bribes cost $1,000 each, how much will a housing inspector make each year in bribes? (Assume that each inspector works 52 weeks a year and gets bribed for every house he inspects.)

$104,000 a. $104,000 (= 52 weeks times 2 bribes per week times $1,000 per bribe).

b. If each person in the United States is only willing to spend $0.50 to support efforts to overturn the corn subsidy, and if antisubsidy advocates can only raise funds from 10 percent of the population, how much money will they be able to raise for their lobbying efforts?

$15,000,000 b. $15 million: To find the answer to this question, we first calculate the number of individuals willing to fund the antisubsidy advocates. Since only 10 percent of 300 million are willing to provide funding, we have 30 million people providing funding (= 0.10 × 300 million). Each of these individuals is only willing to provide $0.50. This results in a total funding of $15 million (= $0.50 × 30 million).

d. By how many dollars does the amount raised by the recipients of the corn subsidy exceed the amount raised by the opponents of the corn subsidy?

$15,000,000 d. $15 million (= $30 million - $15 million).

c. If the recipients of corn subsidies donate just one percent of the total amount that they receive in subsidies, how much could they raise to support lobbying efforts to continue the corn subsidy?

$30,000,000 c. $30 million: Since the recipients of corn subsidies receive a total of $3 billion from the government, 1 percent of this amount is $30 million (= 0.01 × $3 billion).

c. If you count the 1 million workers at the bottom as the first layer of the federal bureaucracy, how many total layers are there, including the president?

7 c. 7 total layers corresponding to the 1 million workers at the bottom and then six layers of supervisors above them (the 100,000, then the 10,000, then the 1,000, then the 100, then the 10, then the president).

Suppose that Omar's marginal utility for cups of coffee is constant at 5.5 utils per cup no matter how many cups he drinks. On the other hand, his marginal utility per doughnut is 11 for the first doughnut he eats, 10 for the second he eats, 9 for the third he eats, and so on (that is, declining by 1 util per additional doughnut). In addition, suppose that coffee costs $1 per cup, doughnuts cost $1 each, and Omar has a budget that he can spend only on doughnuts, coffee, or both. How big would that budget have to be before he would spend a dollar buying a first cup of coffee?

7 To answer this question, we first need to calculate the marginal utility per dollar for doughnuts. Recall that the marginal utility per dollar for a good is the marginal utility divided by the price of the good (= MU/P). For the first doughnut, we have 11 (= 11/$1). The second doughnut is 10 (= 10/$1). For the third 9, fourth 8, fifth 7, sixth 6, seventh 5, eighth 4, ninth 3, and tenth 2. The marginal utility per dollar for every cup of coffee is 5.5 (= 5.5/$1). To determine how big the budget would have to be before Omar would spend a dollar buying his first cup of coffee, we compare the marginal utility per dollar values. Omar will purchase the first doughnut before he buys a cup of coffee because the marginal utility per dollar for the doughnut is greater than the marginal utility per dollar for the cup of coffee (11 > 5.5). The same is true for the second. This process is repeated until the marginal utility per dollar of coffee becomes greater than that of the doughnut. This implies Omar will buy 6 doughnuts at a price of $1 each before he buys his first cup of coffee. Therefore, his budget will need to be $7 before he buys his first cup of coffee, $6 for doughnuts and $1 for the cup of coffee.

b. What total utility will you realize?

96

d. Who is the median voter here? Who will the two other voters be attempting to persuade?

Benson Benson Benson is the median voter whose preference is "in the middle" and whose vote will decide the outcome. Thus, Adams and Conrad will put their efforts toward persuading Benson to vote for their respective positions.

a. In the graph below, identify the areas of consumer surplus and producer surplus.

CS top PS bottom

John likes Coca-Cola. After consuming one Coke, John has a total utility of 10 utils. After two Cokes, he has a total utility of 40 utils. After three Cokes, he has a total utility of 90 utils. a. Complete the table below to show John's marginal utility for each Coke.

Coke Marginal Utility First Coke 10 Second Coke 30 Third Coke 50

Suppose that there are 1 million federal workers at the lowest level of the federal bureaucracy and that above them there are multiple layers of supervisors and supervisors-of-supervisors. Assume that each higher level is one-tenth the size of the one below it because the government is using a 10:1 ratio of supervisees to supervisors. That is, for every 10 workers at the bottom, there is 1 supervisor; for every 10 of those supervisors, there is 1 supervisor-of-supervisors; for every one of those supervisors-of-supervisors, there is a supervisor-of-supervisors-of-supervisors; and so on, all the way up the bureaucratic pyramid to the president. a.How many supervisors will there be in each supervisory layer of the federal bureaucracy? Start with the layer of supervisors directly above the 1 million workers at the bottom.

First Level of Bureaucracy --------> President 100,000 10,000 1,000 100 10 1

b. Does John show diminishing marginal utility for Coke, or does he show increasing marginal utility for Coke?

Increasing marginal utility

d. Using the two prices and quantities for X, derive a demand schedule (a table showing prices and quantities demanded) for X.

Price Quantity Demanded $2 2 1 4

b. Which of the following statements is true?

Producing less than equilibrium leaves unrealized producer and consumer surplus, and producing more than equilibrium reduces total surplus.

Mylie's total utility from singing the same song over and over is as shown in the table below. a. Write down her marginal utility for each repetition.

Repetitions Total Utility Marginal Utility 1 80 80 2 120 40 3 150 30 4 170 20 5 130 -40 6 70 -60

d. Is the U.S. border patrol a public or private good? How about satellite TV?

The U.S. border patrol is a public good, but satellite TV is a private good.

How to find optimal quantity.

The optimal quantity can be found by finding the price where the willingness to pay equals the price required by the firm to supply that last unit (basically, the price that clears the market). In this case, the optimal quantity is 2 units.

Refer to the table below. If the six people listed in the table are the only producers in the market and the equilibrium price is $6, how much producer surplus will the market generate? Person Minimum Acceptable Price Actual Price (Equilibrium Price) Carlos $3 $6 Courtney 4 6 Chuck 5 6 Cindy 6 6 Craig 7 6 Chad 8 6

Total producer surplus = $6

c. Corrupt officials may have an incentive to reduce the provision of government services to help line their own pockets. Suppose that the provincial construction supervisor decides to cut the total number of housing inspectors from 20 to 10 in order to decrease the supply of new housing permits. This decrease in the supply of permits raises the equilibrium bribe from $1,000 to $2,500. How much per year will the construction supervisor now receive if he is still getting half of all the bribes collected by the 10 inspectors? Will he personally be happy with the reduction in government services?

$1,300,000 Yes

b. There is a provincial construction supervisor who gets to hire all of the housing inspectors. He himself is corrupt and expects his housing inspectors to share their bribes with him. Suppose that 20 inspectors work for him and that each passes along half the bribes collected from builders. How much will the construction supervisor collect each year?

$1,040,000 b. $1,040,000 (= 20 inspectors times one half times each inspector's annual total bribe amount of $104,000).

For each item, decide if it describes a moral hazard problem or an adverse selection problem. a. A person with a terminal illness buys several life insurance policies through the mail: b. A person drives carelessly because she has automobile insurance: c. A person who intends to torch his warehouse takes out a large fire insurance policy: d. A professional athlete who has a guaranteed contract fails to stay in shape during the off season: e. A woman who anticipates having a large family takes a job with a firm that offers exceptional childcare benefits:

a. adverse selection b. moral hazard c. adverse selection d. moral hazard e. adverse selection

Mrs. Simpson buys loaves of bread and quarts of milk each week at prices of $1 and 80 cents, respectively. At present she is buying these products in amounts such that the marginal utilities from the last units purchased of the two products are 80 and 70 utils, respectively. a. Mrs. Simpson should buy b. Mrs. Simpson

a. more milk and less bread b. is not buying the utility-maximizing combination of bread and milk since the marginal utility per cent spent on bread is 0.80 and the marginal utility per cent spent on milk is 0.875.

A "mathematically fair bet" is one in which a gambler bets, say, $100 for a 10 percent chance to win $1,000 ($100 = 0.10 × $1,000). a. Assuming diminishing marginal utility of dollars, this is not a fair bet in terms of utility because b. When the "house" takes a cut of each dollar bet, the bet is

a. the utility of the $100 used to make the bet is greater than the $900 that you might gain if you win the bet. b. less fair, because the winnings are reduced.

Rent seeking is

an appeal to the government for special benefits at the taxpayers' or someone else's expense.

An apple grower's orchard provides nectar to a neighbor's bees, while the beekeeper's bees help the apple grower by pollinating his apple blossoms. Consider the figure below to answer the questions that follow. b. This misallocation can be resolved via the means suggested by the Coase theorem because

apple growers and beekeepers can benefit from the other, so they will negotiate an optimal solution.

Rent seeking is different from profit maximization because rent seeking

attempts to increase profit by influencing the political process.

a. The theory of consumer behavior accounts for time

because time can be used to earn money.

An apple grower's orchard provides nectar to a neighbor's bees, while the beekeeper's bees help the apple grower by pollinating his apple blossoms. Consider the figure below to answer the questions that follow. a. This situation of dual positive externalities might lead to an underallocation of resources to both apple growing and beekeeping because there are spillover

benefits for both the apple growers and beekeepers.

a. Economists say competitive markets are efficient because

by producing up to the point where MB = MC, the maximum potential consumer surplus and producer surplus are generated

b. A tax can correct for a negative externality and a subsidy to producers can correct for a positive externality because the tax shifts the cost onto firms producing the product, which ______ output, while the subsidy ________ and _________ output.

decreases, increases supply, increases

a. When negative externalities exist in a market,

equilibrium output will be greater than the efficient output.

b. If the supply curve shifts outward (to the right), consumer surplus will _____ and price will _____.

increase, decrease

b. Once Mylie's total utility begins to decrease, does each additional singing of the song hurt more than the previous one or less than the previous one?

more than the previous one

Looking at the figures below, which show the costs and benefits to voters Adams, Benson, and Conrad of two different public goods that the government will produce if a majority of Adams, Benson, and Conrad support them. Suppose that Adams, Benson, and Conrad have decided to have one single vote at which the funding for both of those public goods will be decided simultaneously. a. Given the $300 cost per person of each public good, what are Adams' net benefits for each public good individually? Net benefit of first public good: Net benefit of second public good: For the two combined? Will he want to vote yes or no on the proposal to fund both projects simultaneously?

$400 -$200 $200 Yes Adams' net benefit for the good in 5.1a is $400 (= $700 of benefit − $300 of cost). His net benefit for the public good in 5.1b is - $200 (= $100 of benefit − $300 of cost). Thus, his combined net benefit for both public goods is $200 (= $400 from the first public good - $200 from the second public good), and he will want to vote yes on funding both projects simultaneously.

Given the following diagrams: Q1 = 20 bags. Q2 = 15 bags. Q3 = 27 bags. The market equilibrium price is $25 per bag. The price at point a is $85 per bag. The price at point c is $5 per bag. The price at point d is $40 per bag. The price at point e is $20 per bag. The price at point f is $32 per bag. The price at point g is $4 per bag. Apply the formula for the area of a triangle (Area = ½ × Base × Height) to answer the following questions. b. What is the dollar value of the deadweight loss when output level Q2 is being produced? What is the total surplus when output level Q2 is being produced?

$50.0 $750.0

d. What if reducing the number of inspectors from 20 to 10 only increased the equilibrium bribe from $1,000 to $1,500? In this case, how much per year would the construction supervisor collect from his 10 inspectors? In this case, will the construction supervisor be happy with the reduction in government services?

$780,000 No d. $780,000 (= 10 inspectors times one half times each inspector's new annual total bribe amount of $156,000). The construction supervisor will not be happy with this reduction in government services. He will want to go back to using 20 inspectors because he personally received a higher income from bribes when there were 20 inspectors.

Given the following diagrams: Q1 = 20 bags. Q2 = 15 bags. Q3 = 27 bags. The market equilibrium price is $25 per bag. The price at point a is $85 per bag. The price at point c is $5 per bag. The price at point d is $40 per bag. The price at point e is $20 per bag. The price at point f is $32 per bag. The price at point g is $4 per bag. Apply the formula for the area of a triangle (Area = ½ × Base × Height) to answer the following questions. a. What is the dollar value of the total surplus (producer surplus plus consumer surplus) when the allocatively efficient output level Q1 is being produced? How large is the dollar value of the consumer surplus at the output level Q1?

$800.0 $600.0

Given the following diagrams: Q1 = 20 bags. Q2 = 15 bags. Q3 = 27 bags. The market equilibrium price is $25 per bag. The price at point a is $85 per bag. The price at point c is $5 per bag. The price at point d is $40 per bag. The price at point e is $20 per bag. The price at point f is $32 per bag. The price at point g is $4 per bag. Apply the formula for the area of a triangle (Area = ½ × Base × Height) to answer the following questions. c. What is the dollar value of the deadweight loss when output level Q3 is produced? What is the dollar value of the total surplus when output level Q3 is produced?

$98 $702

b. What are Conrad's net benefits for each public good individually? Net benefit of first public good: Net benefit of second public good: For the two combined? Will he want to vote yes or no on the proposal to fund both projects simultaneously?

-$100 $50 -$50 No Conrad's net benefit for the public good in 5.1a is - $100 (= $200 of benefit − $300 of cost). His net benefit for the public good in 5.1b is $50 (= $350 of benefit − $300 of cost). Thus, his combined net benefit for both public goods is - $50 (= - $100 from the first project + $50 from the second project), and he will want to vote no on funding both projects simultaneously.

c. What are Benson's net benefits for each public good individually? Net benefit of first public good: Net benefit of second public good: For the two combined? Will he want to vote yes or no on the proposal to fund both projects simultaneously—or will he be indifferent?

-$50 $50 $0 Indifferent Benson's net benefit for the public good in 5.1a is - $50 (= $250 of benefit − $300 of cost). His net benefit for the public good in 5.1b is $50 (= $350 of benefit − $300 of cost). Thus, his combined net benefit for both public goods is $0 (= - $50 from the first project + $50 from the second project), and he will be indifferent.

b. What if, instead of bags of oranges, the data in the two tables dealt with a public good like fireworks displays? If all the buyers free ride, what will be the quantity supplied by private sellers?

0 bags

d. How many federal employees are there in total at all layers, including the president?

1,111,111 d. There are 1,111,111 total federal employees (= 1 million workers at the bottom + 111,111 supervisors, including the president).

e. What fraction of all federal employees are supervisory, including the president?

10% e. 9.999 percent (which can be rounded up to 10 percent) of all federal employees, including the president, are supervisory.

b. How many supervisors are there in total at all levels of the federal bureaucratic pyramid, including the president?

111,111 b. 111,111 (= 100,000 + 10,000 + 1,000 + 100 + 10 + 1)

c. Assume that we are back to talking about bags of oranges (a private good), but that the government has decided that tossed orange peels impose a negative externality on the public that must be rectified by imposing a $4-per-bag tax on sellers. What is the new equilibrium price?

12

If the new equilibrium quantity is the optimal quantity, by how many bags were oranges being overproduced before?

2 bags

What is the new equilibrium quantity?

4 bags

Look at the tables below, which show, respectively, the willingness to pay and willingness to accept of buyers and sellers of individual bags of oranges. For the following questions, assume that the equilibrium price and quantity will depend on the indicated changes in supply and demand. Assume that the only market participants are those listed by name in the two tables. Bob $17 $10 Carlos $5 Barb 14 10 Courtney 6 Bill 13 10 Chuck 7 Bart 12 10 Cindy 8 Brent 11 10 Craig 9 Betty 10 10 Chad 10 a. Given the equilibrium price of $10, what is the equilibrium quantity given the data above?

6 bags

You are choosing between two goods, X and Y, and your marginal utility from each is as shown below. Units of X MUx Units of Y MUy 1 20 1 16 2 16 2 14 3 12 3 12 4 8 4 10 5 6 5 8 6 4 6 6 a. If your income is $9.00 and the prices of X and Y are $2.00 and $1.00, respectively, what quantities of each will you purchase to maximize utility?

X=2 Y=5

c. Assume that, other things remaining unchanged, the price of X falls to $1.00. What quantities of X and Y will you now purchase?

X=4 Y=5

c. Suppose that John has $6 in his pocket. If Cokes cost $2 each and John is willing to spend the money to purchase the first can of Coke, would he spend the money to purchase the second can of Coke, too?

Yes

d. What about the third can?

Yes

e. If John's marginal utility for Coke keeps on increasing no matter how many Cokes he drinks, would it be fair to say that he is addicted to Coke?

Yes

Demand curves slope downward because, other things held equal,

a decrease in a product's price raises MU per dollar and makes consumers wish to purchase more units.

An example of rent seeking is

a domestic industry group using resources to try to block imports.

Given the following: zA = 12 − 1x zB = 15 − 2y, where z is the marginal utility per dollar measured in utils (zA = MUA/PA, zB = MUB/PB), x is the amount spent on product A, and y is the amount spent on product B. Assume that the consumer has $9 to spend on A and B—that is, x + y = $9. a. How is the $9 best allocated between A and B? b. How much utility will the marginal dollar yield?

a. $5 on A $4 on B We know from our optimization rule that MUA /PA= MUB/PB, which implies (12 - 1x) = (15 - 2y). By rearranging, we can solve for x. Combining this equation with our budget constraint, x + y = 9, we have two equations and two unknowns (x and y). Use the x that we find from our optimality equation in the budget constraint of x + y = 9 to solve for y. Thus, we spend $4 on good B. Using our budget constraint x + y = 9, this implies we spend $5 on good A. b. 7 utils To check our answer, substitute these values into the marginal utility equations: MUA /PA = 12 - 1x, or 12 - (1 × 5) = MUA /PA = 7 and MUB /PB= 15 - 2y, or 15 - (2× 4) = MUB /PB = 7. Thus, MUA /PA= MUB/PB, and the marginal dollar will yield 7 utils.

On the basis of the three individual demand schedules below, and assuming these three people are the only ones in the society, determine (a) the market demand schedule on the assumption that the good is a private good and (b) the collective demand schedule on the assumption that the good is a public good.

a. 2, 5, 8, 11, 14, 17, 20, 23 b. 23, 20, 17, 14, 11, 8, 5, 2

Suppose that with a budget of $100, Deborah spends $60 on sushi and $40 on bagels when sushi costs $2 per piece and bagels cost $2 per bagel. But then, the price of bagels falls to $1 per bagel. a. How many pieces of sushi and how many bagels did Deborah consume before the price change? b. At the new prices, how much money would it have cost Deborah to buy those same quantities (the ones that she consumed before the price change)? c. Given that it used to take Deborah's entire $100 to buy those quantities, how big is the income effect caused by the reduction in the price of bagels?

a. 30 pieces of sushi 20 bagels This implies that Deborah bought 30 pieces of sushi (= $60/$2) and she bought 20 bagels (= $40/$2) before the price change. b. $80 If Deborah purchased the same quantities of sushi and bagels with the new prices, it would only cost her $80. She still spends $60 on sushi because the price hasn't changed (still $2) and she was consuming 30 pieces. However, the cost of the 20 bagels has fallen to $20 because the price of a bagel is only $1 now ($1 × 20). c. $20 This implies Deborah has an additional $20 to spend as a result of the price decrease on bagels (= $100 (original cost) - $80 (new cost)).

a. A public good is

nonrival and nonexcludable.

c. The free-rider problem occurs when

people benefit from the public good without contributing to the cost.

b. The government could correct the difference between the equilibrium output level and the efficient output level by

regulations that force firms to internalize external costs

c. An example of an external benefit is

safety provided by motion-detector lights.

Elected officials often accommodate rent-seeking behavior, particularly by firms, unions, and professional groups located in their home states, because these groups

support the elected officials with financial and nonfinancial resources.

a. Spillover costs and spillover benefits are also called negative and positive externalities because

the unintended spillover costs have a negative impact on third parties and the unintended spillover benefits have a positive impact on third parties.

b. Consider the following comment: "Want to make millions of dollars? Devise a product that saves Americans lots of time." This statement recognizes that

time can be used to earn money.

b. Public goods are not privately provided because

when goods are nonexcludable, those people purchasing the good could simply allow others the use without requiring compensation.