Midterm (answers) 80 possible points ECNS 432 February 25, 2016 Name

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1 Midterm (answers) 80 possible points ECNS 432 February 25, 2016 Name 1.) (15 points total) Suppose the output of jumbo shrimp from a shrimp bed is given by the following production function, where L represents the labor input and TP represents total product, or output, in shrimp. Labor TP or more 32 Assume the market price for shrimp is $10 each and all shrimp gatherers can earn $40 per day in their next best alternative. a.) (8 points) Suppose the shrimp bed is common property, no one owns it and anyone who wishes can work the shrimp bed and share equally in the output. That is, the value of the total product is split evenly amongst however many workers decide to work the shrimp bed. How many workers will harvest shrimp in this case? Explain why common property is inefficient. People will join the common property shrimp bed to farm it up to the point where VAP = w. As a result, 8 workers farm the shrimp bed under common property This is NOT socially efficient because workers 6, 7, and 8 could be reallocated elsewhere to be producing more output for society. b.) (7 points) Suppose the shrimp bed is privately held by a profit maximizing owner. How many workers would the owner hire, and would it be an efficient allocation of resources? Profit maximizing owner will hire up to the point where VMP = w. As a result, 5 workers will be hired to farm the shrimp bed. This is socially efficient because these workers could not be reallocated elsewhere to be producing more output for society.

2 2.) (15 points total) The initial cost of constructing a temporary dam that is expected to last for 3 years is $100 million. The expected net benefits for each year are as follows: yr. 1: $28 million yr. 2: $34 million yr. 3: $42 million Under which of the following scenarios should we construct the dam? (make sure to show your work) a.) (5 points) Benefits accrue at the end of each year and the real discount rate is 5%. PV of Net Benefits = [$28/ $34/ $42/ ] - $100 < 0 Don t construct the dam b.) (5 points) Benefits accrue at the beginning of each year and the real discount rate is 5%. PV of Net Benefits = [$28/ + $34/ $42/ ] - $100 < 0 Don t construct the dam c.) (5 points) Benefits accrue at mid-year and the real discount rate is 2%. PV of Net Benefits = [$28/ $34/ $42/ ] - $100 > 0 Build it!

3 3.) (15 points total) Consider a low-wage labor market. Workers in this market are not presently covered by the minimum wage, but the government is considering implementing such legislation. If implemented, this law would require employers to pay workers a $5 hourly wage. Suppose all workers in the market are equally productive, the current market-clearing wage is $4 per hour, and that at this market-clearing wage there are 600 employed workers. Further suppose that under the minimum wage legislation, only 500 workers would be employed and 200 workers would be unemployed. Finally, assume that the market demand and supply curves are linear and that the market reservation wage, the lowest wage at which any worker in the market would be willing to work, is $1 per hour. The graph below depicts this situation. wage h Labor Supply $5 a b Min. Wage $4 e g c d $1 f Labor Demand Q L a.) (3 points) Which area in the graph represents the change in employer surplus due to the minimum wage? Calculate this change in employer surplus (making sure to indicate whether it is positive or negative). abce is a loss in employer surplus. This amount is equal to [($5- $4)*500 + (1/2)*100*($5-$4)] = - $550

4 b.) (3 points) Which area represents the new employee surplus? (i.e., employee surplus after the minimum wage has been implemented) Is the change in employee surplus positive or negative? abdf is the new employee surface. The gain in employee surplus of abge clearly outweighs the loss in employee surplus of gcd. c.) (3 points) Which area represents a transfer from employers to employees? abge is a transfer from employers to employees d.) (3 points) Which area represents the total impact of the minimum wage on employers and employees as a whole? Is this amount positive or negative? The DWL is bcd and this is clearly negative. e.) (3 points) Finally, 100 workers are induced by the higher wage to enter the market. Do these workers experience a change in surplus that should be counted in a welfare analysis? Why or why not? Because these individuals neither had a job before or after the min. wage policy, they see no change in surplus.

5 4.) (10 points) Suppose the City of Bozeman is trying to decide how to use a piece of land. One option is to build an ice climbing tower with an expected life of 2 years. Another option is to build a dirt bike track with an expected life of 6 years. The ice climbing tower would cost $100,000 to construct and would yield net benefits of $56,000 per year for each of the 2 years. The dirt bike track would cost $750,000 and would yield net benefits of $150,000 for each of the 6 years. Each project is assumed to have zero salvage value at the end of its life. Using a real discount rate of 6 percent, which project offers larger net benefits? For both projects, assume the benefits accrue at mid-year. Also, notice that the proposed project lengths are not the same. As only one of these projects can be built on the site, they are mutually exclusive. The comparison is complicated because the dirt bike track has an expected life two times longer than the ice climbing tower. Consider first the NPV of each project separately: NPVice tower = -$100,000 + $56,000/(1.06^.5) + $56,000/(1.06^1.5) = $5, NPVdirt bike track = -$750,000 + $150,000/(1.06^.5) + $150,000/(1.06^1.5) + $150,000/(1.06^2.5) + $150,000/(1.06^3.5) + $150,000/(1.06^4.5) + $150,000/(1.06^5.5) = $9, If we chose on the basis of this comparison, then the dirt bike track has a larger present value of net benefits. However, this is not appropriate as the projects are of different lengths. One possible correct approach is the following: One could choose between one dirt bike track and three successive ice climbing tower projects so that the site would be used in each case for the same length of time. NPVthree successive ice towers = $5, $5,705.22/(1.06^2) + $5,705.22/(1.06^4) = $15, Thus, three successive ice tower projects offer a higher present value of net benefits than one dirt bike track project. The City of Bozeman should build the ice tower.

6 5.) (15 points total) Suppose we have an efficiently operating market for good X. Also, suppose the government adds a sufficiently large quantity of good X to the market such that the price of good X decreases (as shown in the graph below). Use the graph below to answer the following: a.) (3 points) The gain in consumer surplus is given by what area on the graph? P0abP1 b.) (2 points) Which supply curve do private sector suppliers operate on, S or S? S c.) (3 points) The loss in producer surplus is given by what area on the graph? P0acP1 d.) (2 points) What area on the graph represents the net surplus among producers and consumers? Is this net surplus positive or negative? abc, and this amount is positive e.) (3 points) Government surplus is given by what area on the graph? Q2cbQ1 f.) (2 points) The overall gain in social surplus is given by what area on the graph? Q2cabQ1 Px S f S P 0 a P 1 c b e d D Q 2 Q 0 Q 1 Qx

7 6.) (10 points) A recent publication in the American Journal of Epidemiology entitled "Trends in Alcohol and Other Drugs Detected in Fatally Injured Drivers in the United States, " assessed trends in alcohol and other drugs detected in drivers who were killed in motor vehicle crashes in 6 U.S. states. During the study period, the prevalence of positive results for marijuana increased from 4.2% in 1999 to 12.2% in The authors conclude that their results suggest that driving under the influence of marijuana is playing an increasing role in fatal motor vehicle crashes. To control the ongoing "epidemic of drugged driving", their recommendation is to strengthen and expand drug testing and intervention programs for drivers. Based on these findings, is there enough evidence to conclude that increases in marijuana use have caused more traffic fatalities? Why or why not? Stay short and concise in your answer...i don't want to read anything more than a few sentences. This may simply represent an increase in marijuana consumption in the United States. It does not necessarily imply that marijuana increases the risk of fatal motor vehicle crashes.