University of the Philippines

SCHOOL OF ECONOMICS

Economics 100.2: Fundamentals of Microeconomics

2nd Semester, AY 2018–2019
Problem Set #3
ANSWER KEY

Chapters 12 and 13 – How Markets Determine Income & The Labor Market (24 pts)

1. (5 pts) Identify if the statement is True or False. If it is False, modify the whole statement to make
it correct.
a. The theory of income distribution studies how incomes are determined in a market
economy.
True
b. Wealth consists of the net dollar value of assets owned at a given pt in time.
True
c. Transfer payments are payments by governments to individuals that are not made in
return for current goods or services.
True
d. The amount of labor hired by a producer depends not only on the price of labor, but also
on the price of machinery and other outputs.
True
e. Marginal revenue product is the extra revenue you get by the additional output.
False. MRP is the additional revenue per additional input

2. (6 pts) Suppose that the president proposes a new law aiming to reduce healthcare costs
requiring all Filipinos to eat one mango a day.
a. (2 pts) How would this mango-a-day law affect the demand and equilibrium price of
mangoes? Explain and show using a graph.
b. (2 pts) How would the law affect the marginal product and the marginal revenue
product of mango farm workers?
c. (2 pts) How would the law affect the demand and equilibrium wage for mango farm
workers? Assume that the wage elasticity of supply is not perfectly inelastic. Explain and
show using a graph.

Answers:

a. The law requiring people to eat one mango a day increases the demand for mangoes. As
shown below, demand shifts from D1 to D2, increasing the price from P1 to P2, and increasing
quantity from Q1 to Q2.
 Price of Mangoes Quantity of Mangoes

b. Because the price of mangoes increases, the MRP increases for any given quantity of
labor. There is no change in the marginal product of labor for any given quantity of labor.
[Additional answer but not necessary: However, firms will choose to hire more workers
and thus the marginal product of labor at the profit-maximizing level of labor will be
lower.]

c. As the figure below shows, the increase in the value of marginal product of labor shifts
the demand curve of labor from D1 to D2. The equilibrium quantity of labor rises from L1
to L2, and the wage rises from w1 to w2.

3. (6 pts) Concisely explain and show in a graph the effect of each of the following events on the
market for labor in the computer manufacturing industry. (6 pts)
a. (2 pts) DepEd allocates Php 500,000 per school to purchase personal computers for all
senior high school students.
b. (2 pts) More college students enroll in programs under the fields of computer
engineering and computer science.
c. (2 pts) Several computer manufacturing firms build new local plants in the Philippines
(show only the effect on the demand side of the market).
 Answers:

a. If DepEd were to buy personal computers for all senior high schools, the demand for
computers would increase, raising the price of computers and thus increasing the MRPL of
workers who produce computers. This is shown in the figure below as a shift in the demand
curve for labor from D1 to D2. The result is an increase in the wage from w1 to w2 and an
increase in the quantity of labor from L1 to L2.

b. If more college students enroll in programs major under fields of computer

engineering and computer science, the supply of labor in the computer industry rises.
This is shown in the figure below as a shift in the supply curve from S1 to S2. The result is
a decrease in the wage from w1 to w2 and an increase in the quantity of labor from L1 to L2.

c. If computer firms build new manufacturing plants, this increases the marginal product of
labor and the MRPL for any given quantity of labor. This is shown in the figure below as
a shift in the demand curve for labor from D1 to D2. The result is an increase in the wage
from w1 to w2 and an increase in the quantity of labor from L1 to L2.
 4. (7 pts) Wilkis Water can sell all the drinking water that it wants for Php 15 a bottle, and it can rent
all the machines it wants for production at a capital rental price of Php 450/machine per day. Its
production schedule is tabulated below.

Number of Machines Total Product

0 0
1 50
2 85
3 115
4 140
5 150
6 155

a. (1 pt) In what kind of market structure does Wilkis Water sell its bottled water? How can you
tell?
b. (1 pt) In what kind of market structure does Wilkis Water rent machines? How can you tell?
c. (2 pts) Calculate the marginal product of capital and the marginal revenue product of capital for
each additional machine.
d. (2 pts) Using a graph, draw the demand curve for machines.
e. (1 pt) How many robots should the firm rent? Briefly explain.

Answers:

a. PC; same price for any quantity so P=MR=Demand curve for bottled water
b. PC; same price for any quantity so P=MR=Demand curve for machines
c. See table:
Number of Machines Total Product MPK MRPK
0 0
1 50 50 750
2 85 35 525
 3 115 30 450
4 140 25 375
5 150 10 150
6 155 5 75
d.

e. Rent 3 robots or find the quantity of capital where capital price = MRPK.

Chapter 14 - Land, Natural Resources, and the Environment (17 pts)

1. (2 pts) In Economics, why is it important to make a distinction between renewable resources and
nonrenewable resources? Briefly explain.
We differentiate since there are differences in approach for policy design. With renewable
resources, we are concerned with sustainability management; for nonrenewable resources, we
look at the timing of extraction to allocate across generations.
5. (3 pts) What is the definition of an ‘inappropriable natural resource’? Provide an example and
explain why the market allocation of this resource is inefficient. What is one solution to improve
the market outcome?
‘Inappropriable resources’ means that some of the costs and benefits associated with the use of
the commodity do not accrue to its owner (i.e. involves externalities). Example must be a form of
externality, which results in the inefficiency of underproduction or underconsumption. Solution
to externality should be convincing.
2. (6 pts) Briefly explain the possible externalities existing in the following scenarios.
a. Chinese poachers extracting clams in the Scarborough Shoal in the West Philippine Sea.
b. People freely smoking in restaurants in Baguio City.
c. John, Yoko and Paul always gossip loudly during their big lecture class in Math 17.

Answers:

a. This activity destroys the coral reefs in the Scarborough Shoal, which degrades other
marine resources existing in this body of water. This cost is not paid by the Chinese.
b. Other people harmed by the smoking is not paid by the smokers.
 c. They distract other students from focusing in class, and this ‘cost’ is not paid by the
talkative classmates.

3. (6 pts) There are several firms who are operators of coal-fueled powerplants in the Philippines.
Suppose that these firms make up half of the country’s power generation mix. However, they
also account for 65% of the electric power sector CO2 emissions. Using economic principles,
answer the following questions:
a. (4 pts) What are two (2) possible policies that can solve the externality brought by the
coal powerplant operators? What are the limitations of each solution? Briefly explain.
Possible answers:
• Pollution standards; limitation: pollution regulations are often set without
comparisons of marginal costs and marginal benefits, and without such
comparisons there is no way to determine the most efficient level of pollution
control. Also, one cannot collect monetary compensation from pollution
standards.
• Emission fees/Pigouvian tax; limitation: producers may pass the cost to the
consumers, resulting in higher price of electricity for households.
• Tradable permits; limitation: the industry has no incentive to lower emissions
below the level prescribed by the total permits.
b. (2 pts) Why can’t we simply ban the existence of coal powerplants in the short run?
Briefly explain.
This will limit the source of electricity, which would either result in a shortage or a very
high price of electricity for households. Hence, we can’t just stop the generation of coal
powerplants without cleaner alternatives in place.

Chapter 16 - Government Taxation and Expenditure (16 pts)

1. (10 pts) Suppose that the Philippine tax schedule given below is being implemented this year.

Annual Income Tax Payment Effective tax rate (%)

P 10,000 P 1,000 10
30,000 4,500 15
70,000 14,000 20
140,000 35,000 25
250,000 75,000 30
500,000 160,000 32

a. (6 pts) Calculate the effective tax rate at each level of income. (Hint: effective tax rate =
percentage of income paid in taxes)
b. (2 pts) Plot the relationship between income earned and the effective tax rate.
 c. (2 pts) Based from the schedule above, the tax is (regressive / proportional / progressive).
Explain your answer.
Ans: Progressive. Because the tax RATE increases as the annual income increases.

2. (6 pts) Consider two individuals, Eugene and Alfred facing two types of taxes: 1) a proportionate
income tax rate of 10% and 2) Value-added tax rate (VAT) of 12%. Answer the following.
a. (1 pt) What is the total tax payment of Eugene if he earns P100,000 and spends P50,000?
Ans: P16,000
b. (1 pt) What is the total tax payment of Alfred is he earns P20,000 but spends P35,000?
Ans: P6,200
c. (1 pt) Compute for the proportion of their tax payment with respect to their income.
Ans: Eugene 16% and Alfred 31%
d. (1 pt) If the government plans to decrease the income tax rate to 5% and compensate the
decrease by increasing VAT to 15%, what would be the new total tax payment of Eugene
and Alfred given the same income and spending?
Ans: Eugene P12,500 and Alfred P6,250
e. (2 pts) Does the tax reform from (d) promote equity? Explain why or why not.
Ans: No since Alfred, a low-income earner, suffers while Eugene, a high-income earner,
benefits from the tax reform.

Chapter 17 - Efficiency Vs. Equality: The Big Tradeoff (18 pts)

1. (12 pts) In a country called Econoland, there are 10 people whose incomes (in hundred
thousands) are ₱3, ₱6, ₱2, ₱8, ₱4, ₱9, ₱1, ₱5, ₱7, and ₱5, respectively.
a. (2 pts for the solution; 6 pts total for the table) Complete the table of income quintiles
below. Show your solution

Income Class of Percentage of total Percentage Percentage of Income Received by

Households income received of This Class and Lower Ones
 by households in households
this class in this
Actual Distribution
class and
lower ones
Lowest Fifth 6 20 6
Second Fifth 14 40 20
Third Fifth 20 60 40
Fourth Fifth 26 80 66
Highest Fifth 34 100 100

b. (1 pt) Briefly explain the use of a Lorenz curve.

It is a tool for measuring and analyzing income and wealth inequality.
c. (3 pts) Using the table in above, plot a Lorenz curve. (3 pts – 1 pt for the Equality line
and 2 pts for the Lorenz curve)

Lorenz Curve
100

80
Percent of Income

60

Equality
40
Lorenz Curve
20

0
0 20 40 60 80 100
Percent of Households

2. (6 pts) What effect would the following have on the Lorenz curve of after-tax incomes? (Assume
that the taxes are spent by the government on a representative slice of GDP.) Explain. (2 pts per
letter - 1 pt for the answer and 1 pt for the explanation)
a. (2 pts) A proportional income tax (i.e., one taxing all incomes at the same rate)
i. No change. All income classes will be reduced by the same proportion of their
income. Thus, the relative income level of each class does not change.
b. (2 pts) A progressive income tax (i.e., one taxing high incomes more heavily than low
incomes)
i. The Lorenz curve will be flatter and closer to that of the equality line. This will
imply relatively less income for the higher income classes compared to that of the
lower income classes.
c. (2 pts) A sharp increase in taxes on cigarettes and food which are considered necessities
by low income groups.
 i. The Lorenz curve will be farther from the equality line. This will imply relatively
less income for the lower income classes compared to that of the higher income
classes.

Chapter 18 - International Trade (26 pts)

1. (12 pts) Assume that USA and Japan are trading partners and that they can switch between
producing wheat and producing meat at a constant rate in their respective economies. Assume
further that each of them work 8 hours per day.

Labor minutes needed to produce 1 kilogram of:

Meat Potatoes
Japan 60 15
USA 20 10

a. (1 pt) What is the maximum amount of meat Japan can produce daily? of potatoes?
Ans: 8 kg of meat and 32 kg of potatoes
b. (1 pt) What is the maximum amount of meat USA can produce daily? of potatoes?
Ans: 24 kg of meat and 48 kg of potatoes
c. (2 pts) Draw the PPF of the American and Japanese economies.
 d. (1 pt) What is the opportunity cost to produce meat in Japan? To produce potato?
Ans: 4 units of potatoes; ¼ units of meat
e. (1 pt) Which country has an absolute advantage in both?
Ans: USA
f. (2 pts) Which country has a comparative advantage in producing meat? In producing potato?
Ans: Meat – USA; Potato - Japan
g. (2 pts) Without trade, if four hours of one country’s time is used to produce meat and the rest
to produce potato, how much meat and potato will each country produce?
Japan: 4 kg of meat, 16 kg of potatoes USA: 12 kg of meat, 24 kg of potatoes
h. (2 pts) Briefly explain how ‘comparative advantage’ is different from ‘absolute advantage’.
Why do we still need to know who has comparative advantage for each good?
Ans: Absolute Advantage characterizes the country to have an advantage based on the
principle of least ABSOLUTE COST while Comparative Advantage is based on the least
OPPORTUNITY COST. For economies or country to specialize on the good/s they have
comparative advantage in (implies lowest cost) and then trade those goods for other goods
foreign countries specializes in.

2. (7 pts) The values in the table represent the amounts of meat and potato that Japan and USA can
produce with and without specialization. Given the international price ratio of 1/3 (meat to
potatoes), what are Japan’s and USA’s gains from specialization and trade? Complete the table.

Japan USA
Meat Potatoes Meat Potatoes
Without Trade
Production & Consumption 4 16 12 24

With Trade
Production 0 32 18 12
Trade (a) 15 (b) (c)
Consumption ___ 17 ___ ___

Gains from trade +1 +1 +1 +3

a. (1 pt) How many kilograms of meat would Japan import? 5 kgs of meat
b. (1 pt) How many kilograms of meat would USA export? 5 kgs of meat
c. (1 pt) How many kilograms of potato would USA import? 15 kgs of potato
d. (4 pts) How much are the gains from trade? (see values above)
3. (7 pts) Consider the following graph:

a. (1 pt) Briefly explain what a tariff is. What incentivizes the government to set a tariff for
carnations?
Ans: Tariff are taxes imposed on imported goods, To protect the domestic producers
b. (1 pt) Without trade, what is the equilibrium price and quantity?
Ans: P = 8, Q = 300
c. (1 pt) With trade and without tariff, what is the domestic price and quantity of import?
Ans: P = 4, Imports = 400
d. (1 pt) How much is the tariff per unit?
Ans: $2 per unit
e. (1 pt) What is the effect of tariff on imports?
Ans: Decrease imports by 200
f. (1 pt) How much is the amount of revenue collected by the government from the tariff?
Revenue = 400
g. (1 pt) When a tariff is imposed, what is the increase in producer’s surplus?
Increase in PS = 300
h. (1 pt) When a tariff is imposed in the market, what is the decrease in consumer’s surplus?
Decrease in CS = 900