1. Consider a firm with the following technology that sells its output for $8 per unit:

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1 ECON 202: Principle of Microeconomics Name: Fall 2005 Bellas Practice Third Midterm You have two hours and twenty minutes to complete this exam. Answer all questions, explain your answers, label axes and curves on graphs and do your own work. Fifty points total, points per part indicated in parentheses. 1. Consider a firm with the following technology that sells its output for $8 per unit: Labor Total Physical Product (TPP) Marginal Physical Product (MPP) Marginal Revenue Product (MRP) $ $ $ $ $ $ $ $ $16 A. Calculate MPP and MRP. (2) B. How many units of labor will be demanded if the wage is $33? (1) Six units. This is where MRP > wage C. How many units of labor will be demanded if the wage is $25? (1) Seven units. This is where MRP > wage D. How many units of labor will be demanded if the wage is $17? (1) Eight units. This is where MRP > wage Page 1 of 11

2 2. Taxes are important issues in microeconomics. A. Draw a supply and demand diagram showing a tax on a consumer. Be sure to include: the pre-tax quantity (1) the post-tax quantity (1) the dead weight loss from the tax (1) the burden on consumers (1) the burden on suppliers (1) B. Consider a tax on kashkaval, a little known but very tasty variety of cheese. Are consumers likely to bear most of the burden or are producers likely to bear most of the burden of this tax. Explain. (2) It depends. If kashkaval producers can easily switch to production of other cheeses, then consumers might bear most of the burden. If producers cannot easily change to production of other products, then producers will likely bear most of the burden. If consumers of kashkaval don t believe that other cheeses are good substitutes then consumers will bear most of the burden, but if other cheeses are good substitutes then producers might bear most of the burden. C. What difference does it make if the kashkaval tax is put on suppliers or on consumers? (2) None really, except if the costs of administering the tax are higher for one group or the other. Page 2 of 11

3 3. Diagram a positive externality that occurs in consumption. Be sure to show: the demand curve (1) the social marginal value curve (1) the market quantity (1) the efficient quantity (1) the dead weight loss at the market quantity (1) Page 3 of 11

4 4. Aaron and Derek operate a pirate business. They are ruthless profit maximizers. A. One day, Derek reorganizes the deck of the pirate ship and discovers that this increases the crew s productivity. What impact does this have on their demand for labor? (2) The increase in the marginal physical productivity of labor will increase the marginal revenue product and will increase their demand for labor on their pirate ship. B. Aaron discovers that he can use his hypnotic powers of suggestion to convince people to loan him money at an interest rate well below what he could have borrowed at before. What impact does this have on their level of investment? (2) At a lower rate of interest, Aaron and Derek will choose to invest more. C. How does the change in Aaron and Derek s level of investment affect the marginal productivity of labor? (2) Greater investment will lead to a higher level of capital, which will make labor more productive. Page 4 of 11

5 5. Consider a firm selling a good with a price of $16 with the indicated marginal cost schedule and the indicated marginal external cost schedule. Quantity Marginal Private Cost Marginal External Cost Marginal Social Cost (MSC = MPC + MEC) 1 $ 5 $ 6 $11 2 $ 7 $ 6 $13 3 $ 9 $ 6 $15 4 $11 $ 6 $17 5 $13 $ 6 $19 6 $15 $ 6 $21 7 $17 $ 6 $23 A. Complete the marginal social cost schedule. (1) B. What is the profit maximizing quantity to produce? (1) Six, this is where the MPC is less than the price. C. What is the efficient quantity to produce? (1) Three, this is where the MSC is less than the price. D. Calculate the dead weight loss from the profit maximizing quantity. (1) Calculate the difference between price and MSC for units four, five and six: (17-16) + (19-16) + (21-16) = = $9 E. What per unit Pigouvian tax will result in the efficient quantity being produced? (1) This should be equal to the MEC at the efficient quantity, or $6. Page 5 of 11

6 6. Consider this example in which there are three firms, each emitting ten tons of a pollutant, who have the following marginal abatement costs (MAC) or marginal cost schedules for reducing their pollution: Tons of Pollution Abated MAC A MAC B MAC C 1 $ 3 $ 5 $ 4 2 $ 6 $ 6 $ 8 3 $ 9 $ 7 $12 4 $12 $ 8 $16 5 $15 $ 9 $20 6 $18 $10 $24 7 $21 $11 $28 8 $24 $12 $32 9 $27 $13 $36 10 $30 $14 $40 Imagine that the goal of the pollution control authority is to reduce pollution by twelve tons. A. If each firm does four tons of abatement (that is, if they both reduce their pollution by four tons) what will be the total cost? (2) = 96 B. What is the lowest cost way to reduce pollution by twelve tons? How much abatement does each firm do? (2) A does three, B does seven, C does 2. C. What per ton emission fee will result in a reduction of twelve tons of pollution? (2) A fee of between $11 and $12. Page 6 of 11

7 7. One approach to dealing with externalities is through the use of a Pigouvian tax. A. Briefly explain what a Pigouvian tax is. (1) A Pigouvian tax is a tax on a good that is intended to make producers and consumers internalize the marginal external damage done by either the production or consumption of that good. B. Briefly describe the advantages and disadvantages of a Pigouvian tax for dealing with pollution problems. (1) A Pigouvian tax can result in the efficient quantity being exchanged in the market. However, a Pigouvain tax doesn t reward innovations that reduce the marginal external damages of production or consumption. Also, a Pigouvain tax doesn t usually change if the consumption of the good is under circumstances that reduce or increase the level of external damage. For example, if there was a Pigouvain tax on cigarettes, it should be lower for cigarettes consumed when a person is alone, as this will not result in external damages from second hand smoke. Page 7 of 11

8 8. Find the equilibria for the following games. Each game may have zero, one or multiple equilibria. (1 each) Page 8 of 11

9 9. Opportunity cost is one of the most important concepts in economics. You win a free ticket to a hockey game and, for various reasons, you cannot re-sell the ticket. The band The Real McKenzies is performing at the same time and is your next-best alternative activity. Tickets to see The Real McKenzies cost $30. On any given day, you would be willing to pay up to $55 to see them perform. They do an excellent cover of Auld Lang Syne on their CD Clash of the Tartans. Assume there are no other costs of attending either event. Based on this information, what is the opportunity cost of going to the hockey game? (3) The opportunity cost of attending the hockey game is the consumer surplus you would get from attending the show, which is $55 - $30 = $25. Page 9 of 11

10 10. The principle of comparative advantage is important in economics, and especially in international trade. Consider the example of two farmers, Angus from Scotland and Malcolm from Australia, who are growing oats and cane. In one year, they have the following production possibilities: Oats Cane Angus 18 6 Malcolm 4 16 That is, Angus can grow 20 units of oats or raise 8 units of cane or any linear combination of the two. A. Calculate the opportunity cost of each activity for each person. (1) Angus Opp Cost of 1 O = C, Opp Cost of 1 C = 3 O Malcolm Opp Cost of 1 O = 4 C, Opp Cost of 1 C = 0.25 O Each person requires three units of oats to stay alive and, after that, would like to have as much cane as possible. B. If they do not trade, how much cane can each person have? (1) Angus Malcolm 3O, 5C 3O, 4C A total of 9C If Angus makes 3O, he is using 3/18 = 1/6 of his time making O and has 5/6 of his time left over, so he can make 5/6 x 6 = 5C. If Malcolm makes 3O, he is using 3/4 of his time making O and has 1/4 of his time left over in which he can make 1/4 x 16 = 4C. The total is 5C + 4C = 9C. C. If they specialize and trade, what is the total gain in terms of units of cane? (1) Have Angus produce 6O and 4C Malcolm produces 16 C A total of 20C, a gain of 11C. If they specialize and trade, Angus produces all 6O which requires 6/18 = 1/3 of his time. In the remaining 2/3 of his time he can produce 2/3 x 18 = 12 C. Malcolm produces only C and can make 16C. The total is 12C + 16C = 28C, a gain of 19C. Page 10 of 11

11 11. Two of the market imperfections we considered were monopoly and negative externalities. A. Draw the standard picture of a monopolist s profit maximizing output decision, showing both the efficient quantity and the profit maximizing quantity and the dead weight loss from the profit maximizing quantity. You can find this in the lecture notes. B. Draw the standard picture of a negative externality resulting from production, showing both the efficient quantity and the market quantity and the dead weight loss from the market quantity. You can find this in the lecture notes. Page 11 of 11