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Page 1 of 24
Page 2 of 24
Page 3 of 24
Graph 2
5. In which panel(s) in Graph 2 would there be a shortage for a good at the market price?
A.
panel a
B.
panel b
C.
panel a and panel b
D.
neither panel a nor panel b
Graph 3
6. Graph 3 represents a market before and after a per unit tax is introduced According to Graph 3, on
which side of the market is the tax imposed?
A.
Buyers
B.
Sellers
C.
Producers
D.
None
7. According to Graph 3, the amount of the tax imposed in this market is:
A.
$1.00
B.
$1.50
C.
$2.50
D.
$3.00
Page 4 of 24
8. According to Graph 3, the equilibrium price in the market before the tax is imposed is:
A.
$8.00
B.
$6.00
C.
$5.00
D.
$3.50
9. An increase in efficiency suggests that an economy:
A.
is using more costly production techniques
B.
has decided to produce more luxury goods
C.
is able to get less goods and services from a given amount of resources
D.
is able to get more goods and services from a given amount of resources
10. For economists, positive statements are:
A.
descriptive, making a claim about how the world is
B.
optimistic, putting the best possible interpretation on things
C.
affirmative, justifying existing economic policy
D.
prescriptive, making a claim about how the world ought to be
Graph 4
11. Refer to Graph 4. What is the opportunity cost to society of the movement from point C to point B,
given the production possibilities frontier shown?
A.
650 pretzels
B.
500 pretzels
C.
300 pretzels
D.
150 pretzels
12. Refer to Graph 4. In the production possibilities frontier shown, what is the opportunity cost to
society of moving from point C to point E?
A.
150 pretzels
B.
300 potato chips
C.
both A and B
D.
zero
13. Refer to Graph 4. In the production possibilities frontier shown, the movement from point C to point
E was most likely caused by:
A.
an increase in societys preference for pretzels
B.
a decrease in societys preference for potato chips
C.
unemployment
D.
both A and B
Sample Mid Semester Autumn 2014
Page 5 of 24
Cost ($)
1500
1200
1000
750
500
15. Refer to Table 1. If the market price is $1000, the producer surplus in the market will be:
A.
$700
B.
$750
C.
$2250
D.
$3700
16. Donald produces nails at a cost of $200 per ton. If he sells the nails for $500 per ton, his producer
surplus is:
A.
$200 per ton
B.
$300 per ton
C.
$500 per ton
D.
$700 per ton
Page 6 of 24
Graph 5
Page 7 of 24
Graph 6
20. According to Graph 6, producer surplus before the tax is represented by area:
A.
A
B.
A+B+C
C.
D+E+F
D.
F
21. According to Graph 6, after the tax is levied, consumer surplus is represented by area:
A.
A
B.
A+B+C
C.
D+E+F
D.
F
22. A positive consumption externality occurs when:
A.
Jack receives personal benefits from his own consumption of a certain good
B.
Jack receives a benefit from Johns consumption of a certain good
C.
Jacks benefit exceeds Johns benefit when they each consume the same good
D.
Jacks consumption is not beneficial to John
23. Internalising a positive production externality through a government subsidy will cause the
industrys supply curve to:
A.
remain unchanged
B.
shift down by an amount less than the subsidy
C.
shift down by an amount equal to the subsidy
D.
shift down by an amount greater than the subsidy
24. Internalising a positive production externality will cause the demand curve faced by an industry to:
A.
shift to the right
B.
shift to the left
C.
become more elastic
D.
remain unchanged
Page 8 of 24
25. Paul owns a mushroom farm. The smell from the farm reduces the value of adjacent houses by a
total of $30 000. Suppose that the benefit of the mushroom farm to Paul is $20 000. Assuming that Paul
has the legal right to own the farm, a possible private solution to this problem is that:
A.
adjacent property owners pay $20 000 to Paul to stop farming mushrooms
B.
Paul pays the adjacent property-owners $25 000 for their loss in house-values
C.
adjacent property owners pay $25 000 to Paul to stop farming mushrooms
D.
there is no private solution that would improve this situation
26. To determine whether a good is a common resource or a public good, we need to know:
A.
if the good is provided by the government
B.
if my use of the good reduces its availability to you
C.
if the good can be patented
D.
if the good is very expensive to produce
27. Because the benefit that each citizen receives from having an educated community is a public good:
A.
the private market would undersupply education to the community
B.
the government can potentially help the market reach a socially optimal level of
education
C.
a tax increase to pay for education could potentially make the community better
off
D.
all of the above are true
28. Due to the externalities associated with public goods and common resources:
A.
private markets will lead to an efficient allocation of resources
B.
government intervention can potentially raise economic wellbeing
C.
private markets will correct for the gain or loss to consumer surplus
D.
all of the above are true
29. Basic research is a public good because it:
A.
is difficult to exclude those who might benefit from it
B.
is used to develop public goods
C.
always benefits developed countries at the expense of developing countries
D.
is a rival good
30. Frank was willing to contribute $40 this year to his local public television station. However, after
learning that the television station had already met its goal of raising $400,000, he decided not to
contribute because he knew he could watch public television without contributing. This is an example
of:
A.
An external cost
B.
A deadweight loss
C.
An opportunity cost
D.
The free-rider problem associated with public goods
Page 9 of 24
Using the graph above, explain how you would measure the opportunity cost of producing more
computers? Is the opportunity cost constant or increasing, as the number of computers gets larger?
Explain why.
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___________________________________________________________________________________
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2. Suppose that the equilibrium price in a market is $100. Explain what will happen in the market if the
existing market price were $120 (and show it in the graph below). Represent this situation using a
Demand-Supply graph (carefully label each axis, curve, and the equilibrium point).
Page 10 of 24
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3. You are an economist working for the telephone company. You discover that demand for phone calls
during business hours is inelastic and demand for phone calls during evening hours is elastic. How could
your company use this information to increase its total revenue?
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
4. Suppose the government was trying to redistribute income from the richer Australians to the poorer
ones. Would a high tax on luxury cars, compared to other cars, be an effective way to achieve such
redistribution?
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
Page 11 of 24
5. Suppose the price of good X decreases. Assuming that nothing else changes, explain what happens to
producer surplus and illustrate your answer using a supply curve.
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
__________________________________________________________________________________
6. Using demandsupply diagrams, show the difference in deadweight loss (as a result of a tax) between
a market where the supply is more elastic than the demand and a market where the supply is less elastic
than the demand. In each graph, indicate clearly who bears the majority of the tax burden.
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
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Page 12 of 24
Identify the social optimum and explain how Pigovian taxes could be used to achieve this outcome.
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
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___________________________________________________________________________________
8. What are the two necessary characteristics that a good must satisfy in order for the good to be
classified as a common resource? Explain the meaning of each of these two characteristics.
___________________________________________________________________________________
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___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
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Page 13 of 24
Consider the following article by The Sydney Morning Herald (Note, in the actual midsemester exam you fill find an article that is part of the News Analysis.)
More
hard
toil
needed
on
our
'labour
market'
By
Ross
Gittins
The
world
is
full
of
economists
who,
though
they
know
little
of
the
specifics
of
labour
economics,
confidently
propose
policies
for
managing
the
labour
market
based
on
their
general
knowledge
of
the
neo-classical
model.
All
markets
are
much
the
same,
aren't
they?
I
fear
this
is
the
best
we'll
get
from
the
Productivity
Commission's
inquiry
into
regulation
of
the
labour
market.
So
a
test
of
the
commission's
report
will
be
whether
it
displays
knowledge
of
advanced
thinking
on
how
labour
markets
actually
work
or
is
just
another
neo-liberal
rant
about
free
markets.
In
their
efforts
to
bone
up
on
the
topic,
the
commissioners
could
do
worse
than
start
with
a
quick
read
of
Nobel
Laureate
Robert
Solow's
90-page
classic,
The
Labor
Market
as
a
Social
Institution.
Since
the
book
was
published
in
1990,
it
should
be
old
hat
to
economists,
but
I
doubt
it
is.
If
so,
it
shows
how
little
effort
most
economists
-
even
academic
economists
-
have
put
into
studying
the
labour
market.
Solow
starts
by
reminding
economists
of
a
glaring
problem
they
prefer
not
to
think
about:
if
the
market
for
labour
is
just
a
market
like
any
other
market,
and
so
is
capable
of
being
adequately
analysed
by
the
economists'
standard
tool
kit
of
demand
and
supply
-
prices
adjust
until
demand
and
supply
are
equal
and
the
market
''clears''
-
how
come
the
labour
market
never
clears?
How
come
we
always
have
high
unemployment,
which
shoots
up
during
downturns
and
stays
very
high
for
years
before
falling
only
slowly?
To
put
it
another
way,
if
the
labour
market
works
like
any
other
market,
making
wages
just
a
price
like
any
other
price,
why
don't
wages
fall
and
keep
falling
as
long
as
the
supply
of
labour
exceeds
the
demand
for
it?
Why
do
nominal
wages
almost
never
fall?
Why
is
it
the
closest
we
ever
get
is
nominal
wages
not
rising
as
fast
as
ordinary
prices,
so
wages
fall
a
bit
in
''real
terms''?
In
a
country
with
Australia's
history
of
many
minimum
wages,
carefully
specified
in
awards
and
agreements,
it's
easy
for
economists
to
claim
wages
can't
fall
because
they're
being
held
up
by
legal
minimums.
But
this
doesn't
wash.
In
reality,
many
if
not
most
wages
are
well
above
the
legal
minimum,
meaning
the
minimum
isn't
''binding''
and
so
isn't
stopping
actual
nominal
wages
from
falling
back
to
the
minimum.
But
they
don't
-
and
nor
do
they
in
America,
where
the
minimum
wage
is
kept
so
low
it's
almost
never
binding.
Overseas,
some
extreme
neo-classical
economists
have
tried
to
escape
this
problem
by
arguing
most
unemployment
is
voluntary
rather
than
involuntary.
It
just
so
happens
that,
when
economies
turn
down,
a
lot
of
people
decide
now's
the
time
to
take
unpaid
holidays
and
stay
on
them
for
many
months.
Yeah,
right.
Solow
says
a
more
credible
line
of
explanation
is
to
admit
the
obvious:
there
must
be
something
about
labour
markets
hat
makes
them
different
from
other
markets
(such
as
the
market
for
cars,
or
the
market
for
bank
loans)
and
so
renders
economists'
usual
analytical
tools
inadequate.
And
it's
not
hard
to
think
of
what
that
something
could
be.
Other
markets
are
for
the
purchase
and
Page 14 of 24
sale
of
inanimate
objects,
whereas
every
unit
of
labour
bought
or
sold
comes
with
a
real
live
human
attached.
Every
human
is
different
-
some
are
smart,
some
aren't;
some
work
hard,
some
don't;
some
are
co-operative,
some
aren't
-
and
bosses
turn
out
to
be
humans,
too.
The
thing
about
humans
is
they
have
egos
and
feelings
and
moods.
One
apple
doesn't
care
about
the
other
apples
in
the
barrel,
but
a
human
cares
about
how
they're
being
treated
by
their
human
boss,
as
well
about
how
they're
being
treated
relative
to
all
the
other
humans
working
for
the
boss.
Hence
the
title
of
Solow's
book.
Unlike
other
markets,
the
labour
market
is
also
a
social
institution.
Only
an
economist
could
imagine
you
could
analyse
the
labour
market
successfully
without
taking
account
of
the
human
factor.
So
maybe
it's
the
social
dimension
of
labour
that
explains
why
wages
are
inflexible
and
the
labour
market
doesn't
clear.
Solow
uses
the
work
of
some
woman
whose
name
seems
vaguely
familiar,
a
Janet
Yellen,
and
her
Noble
prize-winning
husband,
George
Akerlof,
to
outline
a
possible
explanation
of
the
conundrum,
''the
fair-wage-effort
hypothesis''.
The
''efficiency-wage
theory''
says
that
in
the
modern
economy
workers
often
have
some
control
over
their
own
productivity.
They
produce
more
when
they
are
strongly
motivated
to
do
so.
''One
way
for
an
employer
to
provide
more
motivation
is
by
paying
more
than
other
employers
do;
another
is
to
threaten
to
fire
the
excessively
unproductive
if
and
when
they
are
detected,''
Solow
says.
If
that
sounds
obvious,
note
the
radical
implication:
a
firm's
physical
productivity
depends
not
just
on
how
much
labour
(and
capital)
it
uses,
but
also
on
how
well
the
labour
is
paid.
If
so,
wages
won't
fall
just
because
unemployment
rises.
Yellen
and
Akerlof's
version
of
efficient-wage
theory
says
workers
who
believe
they're
being
paid
''a
fair
day's
wage''
feel
a
social
obligation
to
deliver
''a
fair
day's
work''
in
return.
A
different
approach
is
''insider-outsider
theory''.
This
says
the
people
already
working
for
a
firm
(insiders)
are
likely
to
be
more
productive
than
those
who
aren't
(outsiders)
because
they
understand
the
peculiarities
of
how
the
firm
works.
If
so,
the
insiders
are
helping
to
generate
''economic
rent''
for
the
firm
and
thus
are
able
to
share
this
rent
by
negotiating
higher
wages.
An
outsider
may
be
prepared
to
work
for
the
firm
for
a
smaller
wage,
but
the
boss
won't
want
to
risk
reducing
his
productivity
by
switching
from
insiders
to
outsiders.
Whichever
of
those
theories
you
find
more
persuasive,
the
point
is
the
workings
of
real-world
labour
markets
are
far
more
complicated
than
most
economists
realise.
Let's
hope
the
Productivity
Commission
does.
Questions
on
next
page
Page 15 of 24
9. Using demandsupply diagrams in the labour market, show what it means that the market clears.
Label the axes carefully.
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___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
10. Using demandsupply diagrams in the labour market, show what it means that there is a minimum
wage but it is not binding. Should we have unemployment if it is not binding?
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Page 16 of 24
Page 17 of 24
Page 18 of 24
SOLUTIONS
PART A - Multiple Choice (15 marks)
1. D
2. C
3. B
4. A
5. B
6. A
7. D
8. B
9. D
10. A
11. D
12. C
13. C
14. D
15. B
16. B
17. D
18. C
19. C
20. C
21. A
22. B
23. C
24. D
25. C
26. B
27. D
28. B
29. A
30. D
Page 19 of 24
Using the graph above, explain how you would measure the opportunity cost of producing more
computers? Is the opportunity cost constant or increasing, as the number of computers gets larger?
Explain why.
ANS:
The opportunity cost of obtaining more computers is the number of snowboards that have to be
given up to get those computers. In the graph above, this can be seen when moving from Point A to
B as well as when moving from point C to D. For instance, as the production and consumption of
computers increases from 2 to 4 units, the opportunity cost (the number of snowboards which must
be given up) is 1 snowboard. However, to increase the production of computers from 15 to 17 units,
the opportunity cost is 5 snowboards. This is because the resources best suited to making
snowboards are now actually used to computers instead. Please note that numbers have been
added to the graph above to illustrate the increasing opportunity cost as more computers are
produced. Students are welcome to come up with their own figures, so long as it can be shown
that the opportunity cost is increasing.
Page 20 of 24
2. Suppose that the equilibrium price in a market is $100. Explain what will happen in the market if
the existing market price were $120 (and show it in the graph below). Represent this situation using
a Demand-Supply graph (carefully label each axis, curve, and the equilibrium point).
ANS:
A market price of $120 is above the equilibrium price. Accordingly, there will be a surplus of the
good (i.e. quantity supplied exceeds quantity demanded). This will put downward pressure on the
market price: as producers see less and less people demanding their goods, they will have an
incentive to decrease the price of the good. As the market price decreases, quantity demanded
increases and quantity supplied decrease, thereby eliminating the surplus progressively. The
decrease in price will occur until the price reaches its equilibrium level at $100. At $100, quantity
demanded equals quantity supplied, the market clears and thus no force will make the price change
further.
3. You are an economist working for the telephone company. You discover that demand for phone
calls during business hours is inelastic and demand for phone calls during evening hours is elastic.
How could your company use this information to increase its total revenue?
ANS:
In order to increase total revenue, the telephone company should increase the cost of phone calls
during business hours and decrease the cost of phone calls during evening hours. Since the demand
during business hours is inelastic, a price increase by X% will lead to a quantity decrease but by
less than X%, causing an increase in revenue. Similarly, since demand during evening hours is
elastic, a price decrease by Y% will lead to a quantity increase but by more than Y%, also causing
to an increase in revenue.
4. Suppose the government was trying to redistribute income from the richer Australians to the
poorer ones. Would a high tax on luxury cars, compared to other cars, be an effective way to
achieve such redistribution?
ANS:
The price elasticity of demand for luxury goods, like these cars, is high relative to the price
elasticity of supply. Hence, when a tax is imposed on luxury cars, there will be a significant
reduction in the quantity demanded and only a slight increase in the equilibrium market price. The
burden of the tax falls mostly on the suppliers, who suffer substantial reductions in the prices they
receive and substantial reductions in the quantities sold and in total revenue. The rich end up
bearing little of the tax burden.
Page 21 of 24
5. Suppose there is a price decrease. Assuming that nothing else changes, explain what happens to
producer surplus and illustrate your answer using a supply curve.
ANS:
When the price of a good decreases, producer surplus decreases for two reasons. First, those
sellers who were already selling the good suffer a decrease in producer surplus because the price
they receive is lower (area A). Second, some sellers will exit the market because the price of the
good is now lower than their willingness to sell (area B). The graph should show that as price
decreases from P2 to P1 to P2, producer surplus decreases from area A+B+C to area C.
6. Using demandsupply diagrams, show the difference in deadweight loss (as a result of a tax)
between a market where the supply is more elastic than the demand and a market where the supply is
less elastic than the demand. In each graph, indicate clearly who bears the majority of the tax burden.
ANS:
Page 22 of 24
Area A + B represents the total tax revenue made by the government. Area A represents how much
of the tax burden is carried by buyers and Area B represents how much of the tax burden is carried
by sellers. Holding the demand curve constant in Graph (a), when supply is elastic (then demand is
inelastic relative to this curve) buyers will carry the majority of the tax burden. When supply is
inelastic in Graph (b), suppliers will carry the majority of the tax burden. Both parties will share
the tax, but the party that is most inelastic takes on the majority of the tax burden. For a given tax,
the DWL is smaller when the supply is less elastic. Thats because there is a smaller change in the
equilibrium quantity.
7. Consider the following negative production externality as depicted:
Identify the social optimum and explain how Pigovian taxes could be used to achieve this outcome.
ANS:
The social optimum would be for Q1 to be produced and consumed. The market equilibrium means
that too much of the good is being produced at too low a price. If a Pigovian tax, equal in size to the
cost of the externality, was imposed on producers then their new private cost function would equal
the social cost function and they would produce at the social optimum. This way the private incentive
would be aligned to the social incentive.
8. What are the two necessary characteristics that a good must satisfy in order for the good to be
classified as a common resource? Explain the meaning of each of these two characteristics.
ANS:
A common resource is both non excludable and rival. That is, since it is non excludable, it is
available free of charge to anyone that wishes to use it. Since it is also rival, one persons use of the
common resource reduces other peoples use. Examples of a common resource are natural resources
(e.g. clean air, wildlife such as fish, whales and so on) and a less obvious example would be
congested roads (if not congested, it is a public good).
9. Using demandsupply diagrams in the labour market, show what it means that the market clears.
Label the axis carefully.
ANS:
Page 23 of 24
Note that here the price is given by the wage. The market will clear at the equilibrium point where
the quantity of labour supplied (by workers) is exactly equal to the quantity of labour demanded (by
firms). The market-clearing wage is the equilibrium wage and the market clearing quantity of labour
is the equilibrium quantity. At the equilibrium point, there is no unemployment (surplus) or
underemployment (shortage).
10. Using demandsupply diagrams in the labour market, show what it means that there is a
minimum wage but it is not binding. Should we have unemployment if it is not binding?
ANS:
The graph above shows an example of where the minimum wage (which is also a price floor) is not
binding, since it lies below the market equilibrium point. The market naturally would clear at the
equilibrium point where the quantity of labour supplied is equal to the quantity of labour demanded
and this is easily achieved because this point lies below the market equilibrium. Because the market
is not affected (it can naturally gravitate to the equilibrium, therefore its not binding), the market
can clear. There is no unemployment (surplus) or underemployment (shortage).
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