ECONOMICS 108

Fall, 1997

Second Midterm with answers

 

There are 60 points on this exam; the number of points appears in parentheses after each question.

Print your name AND sign your name in the spaces provided below. Also write your social security (University ID) number.

 

PRINT NAME _______________________________________________

SIGN NAME _______________________________________________

 

Soc. Sec. # __________________________________________________

 

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1. Suppose the demand curve for a product is Qd = 400 - 3p where Qd is the quantity demanded and p is the price. Suppose the supply curve for the product, with Qs representing the quantity supplied, is Qs = 2p - 100.

  1. (2 points) Find the equilibrium price and quantity.

400-3p= -100+2p so 5p=500 or p=100 and Q = 100.

 

 

 

(b) (5 points) Suppose a $10 per-unit tax is placed on the product. Find the

400-3pb=-100+2ps and pb =ps +10, so 500-3pb = 2(pb-10) or 5pb =520 or pb = 104; then ps =94 and Q = 88. The government collects (88)(10) = 880; the deadweight social loss is (12)(10)/2 = 60

 

 

 

 

 

 

 

 

 

 

(c ) (5 points) Suppose a $15 per-unit subsidy is placed on the product. Find the

400-3pb=-100+2ps and pb = ps -15, so 500-3pb =2(pb+15) or 5pb =470 or pb =$94; then ps =$109 and Q = 118.

The government spends (118)(15) = 1180+590 = $1770 on this subsidy and the deadweight social loss from the subsidy is (18)(15)/2 = $135.

2. (3 points) Use a graph to show how a 50-cent-per-gallon tax on gasoline would affect (i) the quantity sold, (ii) the price that buyers pay including tax, and (iii) the price sellers receive net of tax, if the supply of gasoline is perfectly inelastic.

 

 

 

 

 

 

 

 

 

 

With a 50-cent per-gallon tax, the price that buyers pay (including tax) stays at $1.40, the price that sellers receive (net of tax) falls to $0.90, and the equilibrium quantity stays at 10 million.

 

  1. (6 points) Use graphs to explain how much various groups of people would win or lose if the United States made it illegal to import Japanese products.

 

 

 

 

 

 

 

 

 

 

 

 

4. (4 points) Comment: "Economists say that taxes cause a deadweight social loss, but this is misleading. Obviously, when one person pays money in taxes, another person collects money in taxes, so there is no loss to society as a whole."

 

 

 

5. (3 points) Explain why not every potential Pareto improvement is a Pareto improvement.

 

 

 

 

 

 

 

  1. (3 points) Under what conditions should a firm continue to produce at a loss rather than go out of business?

 

 

 

 

 

 

 

  1. (3 points) Comment: "The perfect competition model says that equilibrium profits are zero, but real life corporate profits are often high, proving that we do not have perfect competition in real life."

 

 

 

 

 

 

  1. (4 points) Complete the following discounted-present-value calculations. You may skip the arithmetic if you have the correct formula with the correct numbers filled in.
  1. If the interest rate is 20 percent per year, what is the discounted present value of $600 to be paid 1 year from now?
  2. If the interest rate is 10 percent per year, what is the discounted present value of $500,000 to be paid 2 years from now.
  3. If the interest rate is 5 percent per year, what is the discounted present value of $1,000 to be paid 1 year from now along with $1,000 two years from now?
  4. If the interest rate is 12.5 percent per year, what is the discounted present value of $1,000 per year paid each year, forever?

9. (5 points) Explain moral hazard and give an example.

 

A principal is a person who hires someone else, an agent, to do something. Moral hazard occurs when the agent does not have an incentive to do what the principal wants him to. One example is that people give little effort to a job, and then blame bad results on bad luck. Another example involves insurance: a person who insures a car has less incentive to take care of it. The same is true of products with guarantees or service contracts (another example); see the text for other examples.

 

 

 

 

 

 

 

  1. (3 points) Use a graph to show why an increase in the tax rate can reduce the government’s tax revenue.

 

 

 

 

 

 

 

 

 

 

 

 

11. (5points) (a) Draw a diagram to show the output and price charged by a monopoly, and the deadweight social loss from the monopoly. (b) How does your answer to part (a) change if the monopolist can perfectly price discriminate?

 

 

 

 

 

 

 

 

 

  1. (3 points) True or false? Explain with a graph. If the shoe industry is perfectly competitive and the marginal cost of producing shoes rises by one dollar per pair, then the price of a pair of shoes will rise by one dollar per pair.

 

False in general. A $1 increase in the MC of producing shoes raises the supply curve vertically by $1, which typically raises the price by less than $1 (Unless the supply curve is perfectly elastic or the demand curve is perfectly inelastic).

 

 

  1. (6points) Gwendolyn can produce gourmet lemonade for $3 per gallon. (Her marginal cost and average cost are both $3 per gallon, and she has no fixed costs.) She faces the demand schedule in the table below.
  1. How much should she produce and what price should she charge to maximize her profit?
  2. How big is her profit?
  3. How much consumer surplus do her customers get?
  4. How big is the deadweight social loss from this monopoly?
  5. If Gwendolyn could perfectly price discriminate, how much would she produce?

price quantity demanded

$9 1

$8 2

$7 3

$6 4

$5 5

$4 6

$3 7

$2 8

$1 9

She should produce 4 gallons, and charge a price of $6 per gallon. Her profit is then $12. Her customers get $3+$2+$1 = $6 in consumer surplus. The deadweight social loss from her monopoly is $2 + $1 = $3. If she could perfectly price discriminate then she would produce 7 gallons.

price

quantity demanded

TR

MR

MC

profit

$9

1

9

9

3

6

$8

2

16

7

3

10

$7

3

21

5

3

12

$6

4

24

3

3

12

$5

5

25

3

3

10

$4

6

24

-3

3

6

$3

7

23

-3

3

  

$2

8

36

-5

3

  

$3

9

9

-7

3