Principles of Microeconomics Review Questions #1 (Chapters 1-3)

Transcription

1 Principles of Microeconomics Review Questions #1 (Chapters 1-3) 1. Explain if each of the following government policy is motivated by Efficiency or Equity? a. Regulating cable TV prices. b. Providing free prescription drugs to people on welfare. c. Prohibiting smoking in public areas. d. Preventing mergers between two banks. 2. The Old Age Security Program provides income for people over age 65. How does this program affect people s incentives to save while working? 3. Production Possibility A B C D E Truck Corn Draw a PPF and explain if this production technology exhibits diminishing marginal returns/productivity for Truck/Corn. 4. Ivan spends his entire allowance on two goods: ice cream cones (which cost $1 each) and tickets to the movies (which cost $5 each). What is the opportunity cost of one movie and the opportunity cost of one ice cream cone? 5. The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your sales people report that the competition from other products has reduced the expected sales of your product to $3 million. If it costs you one million to complete your development, would you go ahead and do so? 6. You have a choice between spending $100 you have now or put in a bank account that earns 5% interest. What is the opportunity cost of spending now? If inflation rate is 3%, would you buy something with that $100 now or keep it in the bank? 7. AIDS has become an acute problem in Africa. a. How has the spread of AIDS influenced the PPF of the economies of Africa? b. How has this affected the opportunity cost of health care services? (assume diminishing marginal productivity)

2 8. Production Table Hours required to produce 1 unit Cheese Bread England 10 5 Spain 8 2 Find opportunity cost of Cheese production in England and Spain. What should England export?

3 Review Questions #2 (Chapters 4-6) University of British Columbia Department of Economics Principles of Microeconomics 1. A technological breakthrough reduces the cost of producing computer chips. Using supply and demand diagrams, show the effect of this breakthrough on the equilibrium price and quantity in the following markets: a. the market for computers. b. the market for software. 2. Consider public policy aimed at smoking. a. Studies indicate that the price elasticity of cigarette demand is about If a pack of cigarette currently costs $3 and the government wants to reduce smoking by 20%, by how much should it increase the price? b. If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking one year from now or five years from now? 3. Explain why the following might be true. A drought around the world raises the total revenue that farmers receive from the sales of grain, but a drought only in Manitoba reduces the total revenue that Manitoba farmers receive. 4. A subsidy is opposite of tax. a. Show the effect of a $0.50/cone subsidy on the demand curve for icecream cones, the price paid by consumers, price received by sellers, and the quantity sold. b. Do consumers and producers gain or lose from this policy? (Ch. 7) 5. The Canadian government administers two programs that affect the market for cigarettes. Media campaigns and labeling requirements are aimed at making the public aware of the dangers of smoking. At the same time, Agriculture Canada imposes production quota on tobacco (which is an input for cigarette production), which raises the price of tobacco. a) How do these two programs affect cigarette consumption? b) What is the combined effect of these two programs on cigarette price?

4 6. The Canadian government aims to reduce smoking among Canadians by (a) media campaigns that makes the public aware of the dangers of smoking and/or (b) imposing tax on tobacco, which is an input of cigarette production. Answer the following questions using S-D diagrams. (a) Show the effects of media campaign. When will the media campaigns be more effective? (b) Show the effects of the tax on tobacco. When will this tax be more effective? 7. The government of Canada is contemplating to use media campaign as a way to make people aware of the adverse health effects of cigarette smoking. Draw a graph illustrating a situation when this media campaign will be most effective. 8. The government of Canada is contemplating to decrease the tax rate on cigarette (from say t 1 to t 2 ). Draw a graph illustrating the situation when this decrease will increase the tax revenue. 9. The demand of Housing in Vancouver is given by Q d = 200 2P. Due to Zoning laws, the supply is fixed at 100 units. (a) Find equilibrium P and Q. (b) What is the price elasticity of demand at the market equilibrium? Is demand elastic or inelastic? (c) What is the price elasticity of supply at the market equilibrium point? Interpret your result. (d) Vancouver City thinks that the equilibrium market price is too high for the lowincome families. If the City council imposes a price ceiling of $20, what is the likely effect of this policy on the market (calculate the magnitude of the effect)? (e) Calculate the changes in CS and PS caused by city s policy. 10. The supply and Demand of Housing in Vancouver is given by Q d = 22 2 P Q S = P a) Find equilibrium P and Q. b) Vancouver City thinks that the equilibrium market price is too high for the lowincome families. If the City council imposes a price ceiling of $ 4, what is the likely effect of this policy on the market? c) Calculate the changes in consumer and producer surpluses caused by city s policy (chapter 7)

5 11. Suppose that your demand schedule for CD, Q, is as follows Price ($) Q when Q when Income = $10, 000 Income = $12, a) Calculate (and also interpret) your price elasticity of demand as the price of CD increases from $8 to $10 if your income is $ 10,000. b) Calculate income elasticity when I increases from 10,000 to 12,000 and when P= $ Ketchup is a complement (as well as a condiment) for hot dogs. If the price of hot dogs rises, what happens to the market for ketchup? 13. Explain each of the following statements using S and D diagrams. a. When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout Canada. b. When the weather turns warm in Quebec every summer, the prices of hotel rooms in Caribbean resorts plummet. c. When a war breaks out in the Middle East, the price of gasoline rises, while the price of a used SUV falls. 14. Draw the S and D diagrams to illustrate the following two situations: a. When a cold snap hits Florida, the price of orange juice rises in Canada substantially. b. When the weather turns warm in Quebec, the price of hotel rooms in Hawaii plummet. 15. The government has decided that the free-market price of cheese is too low. a) If the government imposes a binding price floor in the cheese market, what will be the effect of this price floor? b) Farmers complain that the price floor has reduced their total revenue. Is this possible? Explain with a diagram. c) In response to farmers complaints, the government agrees to purchase all of the surplus cheese at the price floor. Compared to the basic price floor of (a), who benefits from this new policy? Who loses? 16. Parliament decides that Canada should reduce air pollution by reducing its use of gasoline. It imposes a $0.50 tax for each liter of gasoline sold. a) Should it impose this tax on producers or consumers? Explain carefully, using a supply-and-demand diagram.

6 b) If the demand for gasoline were more elastic, would this tax be more effective or less effective in reducing the quantity of gasoline consumed? Explain with both words and a diagram. c) Are consumers of gasoline helped or hurt by this tax? Why d) Are workers in the oil industry helped or hurt by this tax? Why? 17. Government of Canada thinks that the current equilibrium wage of $10 for unskilled workers is too low and decides to help the unskilled workers by setting minimum wage at $15. Will this minimum wage legislation help the unskilled workers? Show in your diagram a situation in which the workers (in total) will in fact lose rather than gain from this legislation. 18. Classify each of the following statements as positive or normative. Explain. a) Society faces a short-run tradeoff between inflation and unemployment. b) A reduction in the rate of growth of money will reduce the rate of inflation. c) The Bank of Canada should reduce the rate of growth of money. d) Society ought to require welfare recipients to look for jobs. e) Lower tax rates encourage more work and more saving. 19. Pat and Kris are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Pat takes 4 hours to brew 5 L of root beer and 2 hours to make a pizza. Kris takes 6 hours to brew 5L of root beer and 4 hours to make a pizza. a) What is each roommate s opportunity cost of making a pizza? Who has the absolute advantage in making pizza? Who has the comparative advantage in making pizza? b) If Pat and Kris trade foods with each other, who will trade away pizza in exchange for root beer? c) The price of pizza can be expressed in liters of root beer. What is the highest price at which pizza can be traded that would make both roommates better off? What is the lowest price? Explain. 20. Consider the market for minivans. For each of the events listed below, identify which of the determinants of supply or demand are affected. Also indicate whether demand or supply is increased or decreased. Then show the effect on price and quantity of minivans. a) People decide to have more children. b) A strike by steelworkers raises steel prices. c) Engineers develop new automated machinery for the production of minivans. d) The price of SUVs rises. e) A stock market crash lowers people s wealth.

7 Practice Problems # 3 (Chapters 7-9) University of British Columbia Department of Economics Principles of Microeconomics 1. Market research has revealed that demand for labor in Vancouver is given by W = 200 5L and the supply is given by W = 5 + L, where W = wage rate and L = Labor hour. a. Calculate the equilibrium W and L of this market. b. The government thinks that the equilibrium wage is too low and wants to protect the workers by setting minimum wage at $50/hr. What is the effect of this government policy? c. Will the workers (as a whole) lose or gain from this policy? What could be the reason behind your result? 2. Suppose a technological advance reduces the cost of making computers. a. Use supply and demand diagram to show what happens to price, quantity, and producer surplus and consumer surplus in the market for computers. b. Computers and software are complements. What happens in the market for software due to the technological advance in computer production technology? 3. Suppose that a market is described by the following supply and demand equations: Q S = 2P and Q D = 300 P a. Solve for the equilibrium P and Q. b. Suppose that a tax of T is placed on buyers, so the new demand equation is: Q D = 300 (P+T) Solve for the new equilibrium Prices (both Ps) and Q. c. If T = 100, find the deadweight loss caused by this tax. 4. To conserve the use of heating oil, Canadian government imposes a tax on it. a. Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year? b. Would the revenue collected from this tax likely be greater in the first year or fifth year? 1

8 5. Show graphically a. How will the burden of tax on land (which is fixed in supply) sales be distributed between landowners and land buyers. b. How will the burden of tax on a good with a perfectly elastic demand be distributed between sellers and consumers. 6. Imagine that winemakers in BC petitioned the provincial government to tax wines imported from Ontario. They argued that this tax would both raise tax revenue and raise employment in BC. Do your agree or disagree? Support your claims with diagram(s). 7. Suppose that a technological advance in Japan lowers the world price of TVs. a. If Canada is an importer of TV, how will such drop in price affect the welfare of Canadian consumers and producers of TV? b. Suppose now that the Canadian government thinks that this import will hurt Canadian TV producers and impose a tariff of t per TV imported. How will this affect Canadian producers and consumers? 8. When does a country become an exporter or importer of a good? Show this with the help of diagrams. 9. Consider a country that imports a good from abroad. For each of the following statements, say whether it is true or false. Explain your answer. a. The greater the elasticity of demand, the greater the gains from trade. b. If demand is perfectly inelastic, there are no gains from trade. c. If demand is perfectly inelastic, consumers do not benefit from trade. 10. Consider a merger in a market in which the supply is perfectly elastic at a price of 10 dollars. Demand is given by Q = Q a. Suppose that the evidence shows that the merger is forecast to raise prices by 15 percent. What will be the dead-weight loss from the merger? b. Suppose that additional evidence shows that the pre-merger price is already 10 percent above the competitive level. Accepting that the forecast price increase from the merger remains at 15 percent, what is the deadweight loss associated with the merger? 2

9 UBC Department of Economics Principles of Microeconomics Review Questions Set # 4 (Ch and 17) Chapter (easy) Your aunt is thinking about opening a hardware store. She estimates that it would cost $ 500,000/year to rent the location and buy the stock. In addition she would have to quit her $50, 000/year job as an accountant. What is your aunt s opportunity cost of running a hardware store per year. If she thought she could sell $ 510,000 worth of merchandise in a year, should she open the store? 2. (moderate) A commercial fisher notices the following relationship: Hours Quantity of Fish in Kg a) What is the MP of each hour spent fishing? b) Draw the fisher s production function and explain your result. c) The fisher has a fixed cost of $10. The opportunity cost of fisher's time is $5/hr. Draw the fisher s total cost curve. 3. (easy) Bob s lawn-mowing service is a profit maximizing competitive firm. His mows lawns for $ 27 each. His total cost each day is $280, of which $30 is a fixed cost. He mows 10 lawns a day. What can you say about his short-run decision regarding shut down and long run decision on exit? 4. You are thinking about setting up a lemonade stand. The stand itself costs $200. The ingredients for each cup of lemonade cost $0.50. a) What is your fixed cost of doing business? b) Construct a table showing your total cost, average total cost, and marginal cost for output levels varying from 0 to 45 L. (HINT: There are 4 cups in a litre.) Draw the three cost curves. 5. A firm in a competitive market receives $500 in total revenue and has marginal revenue of $10. What is the average revenue, and how many units were sold?

10 Chapter (very hard) Suppose that the Canadian Textile Industry is competitive, and there is no international trade in textile. In long-run equilibrium, the price per unit of cloth is $30. a) Describe the equilibrium using graphs for the entire market and for an individual producer. Now suppose that textile producers in other countries are willing to sell large quantities of cloth in Canada for only $25 per unit. b) Assuming that Canadian textile producers have large fixed costs, what is the short-run effect of these imports on the quantity produced by an individual producer and on profits? Explain with graph(s). c) What is the long-run effect on the number of Canadian firms in the industry? 7. (hard) Assume that the gold-mining industry is competitive. a) Illustrate a long-run equilibrium using diagrams for the gold market and for the representative gold mine. b) Suppose that an increase in jewelry demand induces a large surge in the demand for gold. Using your diagrams, show what happens in the short run to the gold market and to each gold mine? c) If the demand for gold remains high, what would happen to price over time (i.e., in long run)? 8. Analyze the two following situations for firms in competitive markets: a) Suppose that TC = Q, where TC is total cost and Q is the quantity produced. What is the minimum price necessary for this firm to produce any output in the short run? b) Suppose that MC = 4Q, where MC is marginal cost. The perfectly competitive firm maximizes profits by producing 10 units of output. At what price does it sell these units? Chapters 15 and (moderate) The Best Computer Company just developed a new computer chip on which it acquires a patent. a) Draw a diagram that shows the CS and PS in the market for this chip. b) What happens to CS and PS and the total surplus if the firm can perfectly price discriminate?

11 10. (easy) Larry, Curly and Moe run a only drink store in town. Larry wants to sell as many drinks as possible without losing money. Curly wants to maximize revenue and Moe wants to maximize profits. Using a single diagram of the store s demand and cost curves, show the price and quantity combinations favored by each of these partners. 11. (easy) A small town is served by many competing supermarkets, each of which has a constant MC. a) Using a diagram of the market for groceries, show PS and CS. b) Now suppose that all of these supermarkets combine into one giant superstore. Use a new diagram to show new PS and CS. Relative to your answers in (a) what happens to PS and CS and the total surplus? 12. (moderate) Consider a trade relation between Canada and Mexico with the following payoffs. Mexico s Decision Canada s Decision Low Tariffs High Tariffs Low Tariff 25, 25 10, 30 High Tariff 30, 10 20,20 a) What is the dominant strategy for Canada? For Mexico? Explain. b) Find the Nash equilibrium of the above game. 13. (moderate) Suppose each of the two airline companies (Air Canada and West Jet) can charge either high or low price for its tickets. If one airline charges $100, it earns low profits provided the other airline also charges $100 but earns higher profits if the other airline charges $200. On the other hand, if the airline charges $200, it earns very low profits if the other airline charges $100, and the medium profits if the other company charges $200 also. a) Draw the decision box of the game (payoff matrix). b) What is the Nash equilibrium in this game? c) Is there an outcome that would be better than the Nash equilibrium? 14. (moderate) Assume the following profile for three consumers and one firm selling both Widgets and Gadgets where MC=2 for each item. Reservation prices Widgets Gadgets Bart Lisa 3 3 Homer 1 4.5

12 a) If the firm chooses the strategy of pure bundling, what should be the profitmaximizing price of the bundle? b) Calculate the maximum profits under pure bundling strategy. c) Calculate the maximum profits possible when the firms sells those two items individually. 15. Consider the relationship between monopoly pricing and price elasticity of demand. a) Explain why a monopolist will never produce a quantity at which the demand curve is inelastic. (HINT: If demand is inelastic and the firm raises its price, what happens to total revenue and total costs?). b) Draw a diagram for a monopolist, precisely labelling the portion of the demand curve that is inelastic. (HINT: The answer is related to the marginalrevenue curve).

13 UBC Department of Economics Principles of Microeconomics Review Questions #5 (chapters 10, 21) 1. (moderate) There are three industrial firms in a Happy Valley. Firm Initial Pollution Level Cost of Reducing Pollution by 1 Unit A 70 units $20 B 80 units $25 C 50 units $10 The government wants to reduce pollution to 120 units so it gives each firm 40 permits. a. If trade is not allowed what is the total cost of pollution control? b. If trade is allowed, who sells and who buys permits and how many do they sell or buy? What is the total cost of pollution control with trade? 2. (moderate) It is well known that we can use either Pigouvian Tax or Tradable Pollution Permits to control pollution. As shown in the diagram, both the policy instruments lead to the same result. a. Now suppose there is a sharp improvement in the technology for pollution control. How will this improvement in technology affect the level of pollution under the Pigouvian tax? b. How will this improvement affect the level of pollution under the Tradable Pollution Permits? 3. (easy) Greater consumption of alcohol leads to more motor vehicle accidents and, thus imposes costs on people who do not drink and drive. a. Illustrate the market for alcohol. How will the market equilibrium level of alcohol consumption differ from that of optimal consumption level? b. On your diagram show the deadweight loss caused by over-consumption of alcohol. c. What is the level of Pigouvian tax that can induce alcohol consumers to reduce consumption to optimal level? 4. (hard) UBC has $100 million dollars that it can spend for cancer research or other educational activities. If it gets $10 million grant from the provincial government for cancer research (Note this $10 million can be used only for cancer research),

14 a. How will UBC s new budget line look like? b. Show the situation whereby this conditional grant provides UBC with lower utility than when it gets the grant without any conditions (i.e. it can use the grant as it wishes). 5. (moderate) Jennifer divides her income between coffee and croissants. An early frost in Brazil causes a large increase in the price of coffee in Canada. a. Show the effect of the frost on Jennifer s budget constraint. b. Show the effect of frost on Jennifer s optimal consumption assuming that the substitution effect outweighs the income effect for croissants. 6. (tricky) Keyboards and Computers are perfect complements. With the help of a diagram, show the effect of an increase in the price of Keyboards on the consumption of both Keyboards and Computers (show both income and substitution effects). 7. Jim buys only milk and cookies. a. In 2004, Jim earns $100, milk costs $2 per litre, and cookies cost $4 per dozen. Draw Jim s budget constraint. b. Now suppose that all prices increase by 10% in 2005 and that Jim s salary increase by 10% as well. Draw Jim s new budget constraint. How would Jim s optimal combination of milk and cookies in 2005 compare to his optimal combination in 2004? 8. Consider your decision about how many hours to work. a. Draw your budget constraint assuming that you pay no taxes on your income. On the same diagram, draw another budget constraint assuming that you pay a 15% tax. b. Show how the tax might lead to more hours of work, fewer hours, or the same number of hours. Explain. 9. Suppose you take a job that pays $30,000 and set some of this income aside in a saving account pays annual interest of 5%. Use a diagram that to show how your consumption changes in each of the following situation. a. Your salary increases to $40,000. b. The interest on your account rises to 8%.