3. Suppose the following data represent the market demand for college education: a. If tuition is set at $5,000, how many students will enroll?

Transcription

1 PS 4: 38 points Government Intervention: Chapter 9 problems 3. Suppose the following data represent the market demand for college education: a. If tuition is set at $5,000, how many students will enroll? Now suppose that society gets an external benefit of $1,000 for every enrolled student (for, say, more informed voting). Tuition $1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 (per year) Enrollment Demanded (in millions) b. Draw the social and market demand curves for this situation. c. What is the optimal level of enrollments at the tuition price of $5,000? d. How can this optimal enrollment level be achieved? 1

2 a. At a tuition price of $5,000, four million students would enroll in college. 1 pt b. Social and Market Demand Tution (per year) $10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 Social Demand Market Demand Enrollment (in millions) 1 pt each curve (2 pts) c. The optimal level of enrollments at the tuition price of $5,000 is five million students. 1 pt d. This optimal level could be achieved by offering students a tuition subsidy of $1, pt Doing so shifts the Market Demand curve vertically upward by $1,000 at every level of enrollment so that it is coincident with the Social Demand curve. Note that this is different from an increase in demand, i.e., rightward shift in the demand curve, that would be caused by a change in a ceteris paribus condition. 2

3 4. Assume the market demand for cigarettes is as follows: Price Per pack Quantity (Packs per day) $ Suppose further that smoking creates external costs valued at 25 cents per pack. a. Draw the social and market demand curves. b. At $2 per pack what quantity is demanded in the market? c. What is the socially optimal quantity at that price? d. How can the optimal quantity be attained? a. Social and Market Demand $3.00 Price per pack $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 Market Demand Social Demand Quantity (packs per day) 1 pt each (2 pts) b. At $2 per pack, consumers would purchase 30 packs per day. 1 pt c. The socially optimal quantity at a $2 per pack is 20 packs. 1 pt d. The socially optimal quantity can be achieved by placing a 25 cents per pack tax on cigarettes. 1 pt This would shift the Market Demand curve vertically downward by 25 cents at every level of output so that it coincides with the Social Demand curve. 3

4 5. Suppose in the previous problem that a tax of 50 per pack is imposed. a. How many packs will be consumed? b. Is this the socially optimal rate of consumption? If not, is the rate of smoking too high or too low? a. At $2.50 per pack, 10 packs per day will be consumed. 1 pt b. This is not the socially optimal rate of consumption. 1 pt Since the socially optimal quantity is 20, the rate of smoking at a tax rate of 50 per pack is too low. 1 pt 4

5 Business Cycle: Chapter 10 problems 1. How much more output will the average American have next year if the $12 trillion U.S. economy grows by: a. 2 percent? b. 5 percent? c percent? (Assume a population of 300 million): a) $800 1 pt b) $ pt c) - $400 1 pt To calculate the change in GDP per capita, multiply the GDP by the percent change and divide by the population. 2. Suppose the following data describe a nation s population Year 1 Year 2 Population 200 million 203 million Labor Force 120 million 125 million Unemployed 7.2 million 7.5 million a. What is the unemployment rate in each year? b. How has the number of unemployed changed from Year 1 to Year 2? c. How is the apparent discrepancy between (a) and (b) explained? a. The unemployment rate is calculated as the number of unemployed divided by the labor force. Using this formula, the unemployment rate in year 1 is 7.2 million/120 million = 0.06 or 6 percent. The unemployment rate in year 2 is 7.5/125 million = 0.06 percent or 6 percent. 1 pt b. The number of unemployed increases by.3 million or 300,000 workers. 1 pt c. The unemployment rate is determined by both the number of unemployed and the size of the labor force. Even though the number of people who were counted as unemployed increased by 300,000, the size of the labor force also increased by the same proportion, resulting in no change in the unemployment rate. 1 pt 5

6 3. If the average worker produces $70,000 of GDP, by how much will GDP increase if there are 140 million labor force participants and the unemployment rate drops from 5.2 to 4.5 percent? If the labor force consists of 140 million participants, and there is a drop of the unemployment rate from 5.2 (140 million x = 7,280,000 unemployed) to 4.5 (140 million x.045 = 6,300,000 unemployed), there will be an additional 980,000 people employed. If each person produces $70,000 in additional GDP, then GDP will increase by $68.6 billion. 1 pt 4. What would the real value be in ten years of $500 you hid under your mattress if the inflation rate is: a. 4 percent. b. 8 percent. To answer this question, one simply needs to calculate the compounded impact of the annual inflation and divide the $500 by that number. (a) (b) $500 after 10 years of 4% inflation is determined by dividing the $500 by 1.48, which is 1.04 n and n is 10. The value after 10 years is approximately $ pt $500 after 10 years of 8% inflation is, by the same formula, approximately $ pt 5. According to the data below, a. How did nominal wages change between 1990 and 1992? b. How did real wages change between 1990 and 1992? c. How did nominal wages change between 1990 and 1999? d. How did real wages change between 1990 and 1999? Compute percentage changes for each answer Average Weekly Wage $345 $364 $457 CPI a. Nominal wages, the stated dollar wage for the given time period increased from $345 to $364, a change of 5.5%. This is calculated as ($364-$345)/$345= or 5.5%. 1 pt b. To calculate real wages, it is necessary to adjust for inflation using the CPI numbers provided. Note: a CPI of 131 indicates prices are 1.31 times larger than in the base period. Real wages in 1990 were $345/1.31= $ Real wages in 1992 were $364/1.40=$260. Thus, real wages declined between 1990 and This is a 1.28 percent decline in real wages (($ $260)/$263.36)) 1 pt c. Nominal wages increased from $345 to $457, a 32.5 percent increase. 1 pt 6

7 d. As stated in part b, real wages in 1990 were $ Using the same method of calculation, real wages in 1999 were $ Thus, real wages increased by $10.29 per week, a 3.9 percent increase. 1 pt 7. The following table lists the prices of a small market basket purchased in both 2000 and Assuming that this basket of goods is representative of all goods and services a. Compute the cost of the market basket in pt b. Compute the cost of the market basket in pt c. By how much has the average price level risen between 2000 and 2006? 1 pt d. The average household s nominal income increased from $45,000 to $60,000 between 2000 and What happened to its real income? 1 pt Price (per unit) Item Quantity Coffee 20 pounds $ 3 $ 4 Tuition 1 year $4,000 $7,000 Pizza 100 pizzas $ 8 $ 10 VCR Rental 75 days $ 15 $ 10 Vacation 2 weeks $ 300 $ 500 (a), (b) The market basket's total cost is as follows Coffee $ 60 $ 80 Tuition 4,000 7,000 Pizza 800 1,000 VCR Rental 1, Vacation 600 1,000 TOTAL $6,585 $9,830 (c) (d) The average price level rose by 49.28% between 2000 and This was calculated by dividing 2006 cost by 2000 cost. Looked at another way, the average price level for 2006 is % of its 2000 level. Using the index and dividing the $60,000 salary by it and then multiplying by 100, we get a real income of $40,193 for The real income of this average household decreased by approximately $4,800 (11%) in this period--it fell because the nominal wage grew more slowly than the price level. 7

8 Aggregate Supply and Demand: Chapter Illustrate these events with AS and AD shifts: a. Government increases defense spending. b. The Headline story on p c. Imported raw materials get cheaper. d. Congress cuts corporate income tax. AS A Price Level AS B AD A AD B Real Output a. An increase in government spending would shift AD from AD A to AD B. 1 pt b. The Headline story on p. 263 would result in a shift from AD B to AD A. A decline in wealth results in shifting AD from AD B to AD A. 1 pt c. Imported raw materials are a factor of production and thus affect AS. A decrease in the price of imported raw materials will result in shifting AS from AS A to AS B. 1 pt d. A cut in corporate income taxes is a supply side cut and would result in shifting AS from AS A to AS B. 1 pt (ok if said increase in AD) 8

9 2. Based on the Headline on p. 264: a. Illustrate the AS shift that occurs. 1 pt b. Identify the old (E o ) and the new (E 1 ) macro equilibrium. 1 pt c. What macro ailments result? 1 pt d. How can the economy stay healthy in this case? 1 pt a. and b. Price Level AS 2 AS AD E 1 E 0 Real Output c. The macro ailment that results is recession. d. Government intervention to promote investment will help the economy stay healthy. Any supply side policy (education, tax cuts, etc.) 9