Exam 2. Revenue. Figure The total economic profits of the monopolist in Figure 1 would be approximately: (P-AC) x Q (cross hatched area)

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1 ECONOMICS Exam 2 Dr. John Stewart November 11, 2003 Instructions: Mark the letter for the best answer for each question on the computer readable answer sheet. Please note that some questions have four choices, others have five choices. On the answer sheet make sure that you have written your name and coded in your student ID number and the number of the recitation section you attend (A list of recitations shown on the screen will help you identify your section number). All questions are weighted equally. Information for Questions 1-5: Figure 1 shows the market demand, marginal revenue curve and the marginal and average cost curves for a monopoly firm in the market. 1. In Figure 1, profit-maximization would occur when: a) P=10 and Q=10 point where MR=MC (red lines) b) P=5 and Q=10 c) P=9 and Q=12 d) P=8 and Q=14 e) P=7 and Q=16 $ Revenue Profits MC ATC Demand 2. The total revenue of the profit-maximizing monopolist in Figure 1would be a) 50 b) 72 c) 100 P x Q (Gray rectangle) d) 108 e) 112 Figure Q MR 3. The total economic profits of the monopolist in Figure 1 would be approximately: (P-AC) x Q (cross hatched area) a) 0 b) 15 c) 25 d) 37 e) If the monopoly could be persuaded to lower its price by enough to sell one unit more than the profit maximizing quantity, net social welfare would be a) unchanged b) increased by about $9.50 c) increased by about $8.00 d) increased by about $3.40 When output increase, consumer benefits expand by P and social cost increases by MC. With P a little less than 10 and MC greater than 5 this is the only possible answer that is not clearly wrong. (The purple bar in the figure) e) decreased by about $ In Public Utility regulation, the regulator sets a price and then the utility must produce all of the quantity demanded at that price. A regulator who wished to ensure that the monopolist in Figure 1 made zero economic profits would likely: a) set the price at 9 b) set the price at 8 c) set the price at 7 Econ Exam 2 - Page 1 of 11

2 d) set the price at 6 e) set the price at 5 6. Section 2 of the Sherman Act prohibits a) price discrimination that creates monopoly power. b) competing firms from collusively setting price. c) mergers that create monopoly power. d) firms from monopolizing a market. e) all of the above. 7. Which of the following characteristics of perfect competition does not apply in monopolistic competition? a) free entry and exit b) homogeneous products c) numerous participants d) perfect information 8. In the long run the prices charged by a firm in monopolistic competition will be a) equal to average cost, including the opportunity cost of capital. b) so low that many firms will drop out of the industry. c) equal to marginal cost. d) high enough to provide profits to the firm. Information for Questions 9-12: Consider a competitive market where consumption of the good produces a positive externality. (Example: vaccinations) Figure 2 shows the marginal private benefits function (the market demand; D), the marginal social benefits function (MSB), and the market marginal cost curve (MC) You may assume that there are no production externalities so marginal social cost and marginal private cost are the same. Various points on the diagram are labeled a, b, c, d, e, and f. $ MSB (Margina Social Benefits) f e a b c d MC MSC 9. In the absence of any intervention in the market, the market equilibrium price and output would be at point and the socially optimal outcome would be at point. a) a; c b) b; c point where supply equals demand, point where marginal social cost equals marginal social benefits c) a; d d) b; d e) c; b Figure 2 D (Margina Private Benefits) Quantity 10. With no intervention in the market, the welfare loss (compared to the social optimal) can be shown by the area a) abc b) bef c) abf d) abef e) abef 11. The welfare loss caused by the externality shown in figure 2 could be eliminated if the government would each unit of output produced in the market by an amount shown by the distance. Econ Exam 2 - Page 2 of 11

3 a) tax; ab b) subsidize; ab c) tax; de d) subsidize; de e) tax cd A subsidy can be thought of as either a downward shift in the supply curve (at any give quantity the net cost of producing one more unit is reduced by the subsidy) or an upward shift of the demand curve (at any given quantity the net price the consumer has to pay is less) no matter whether we subsidize the consumer or the producer by ab we can get to the optimal point c. 12. Consider a perfectly competitive market for a good that generates a negative production externality (e.g. a production process that generates pollution) In such a market, the equilibrium price will be and an equilibrium quantity will be to be socially optimal. a) Too low, too low b) Too high, too high c) Too high, too low d) Too low, too high 13. A public good is a good a) that can only be produced by government. b) that once it is produced, all consumers can consume equal quantities whether they have paid or not. c) that will be over produced by a free market. d) both b) and c) 14. In any competitive factor market, the marginal revenue product of the last unit of the factor purchased will equal: a) the price of the factor b) the average cost of the product c) average product of the factor d) the price of the product Information for Question 15-16: The table shown below shows information about Pepper s Pizza. Pepper has the following estimates on the production and the price he would have to charge to sell each quantity of output he could produce by hiring different numbers of servers. Assume that servers are the only variable input. # of servers Pizza sold per hour Price of pizza Total revenue per MRP L hour Suppose that servers are paid a wage rate of $7.50 per hour, then how many servers does Pepper want to hire? a) 2 b) 3 c) 4 d) 5 Will hire additional labor so long as MRP L >P L 16. Now suppose that the new minimum wage law is enacted that says that the servers should be paid by at least $15 per hour. How many servers will Pepper lay off as a result of the new law? a) 3 b) 2 c) 1 d) 0 Same logic as 15 Econ Exam 2 - Page 3 of 11

4 Information for Questions 17-20: The table below shows the price of food and clothing in the years 1999, 2000 and 2001 and the quantity of those goods that are purchased by a typical consumer in You may assume that these are the only goods in the economy. Use the information from this table to answer questions 16 to 19. Good Quantity 1999 Price 1999 Price 2000 Price 2001 Work Space Spending in each year Clothing 200 $1.00 $1.10 $ Food 100 $1.50 $1.65 $ If we use 1999 as the base year, the Consumer price index for this economy in 2001 is a) 140 b) 125 c) 120 d) 110 e) 100 CPI 99 = (490/350) x 100 = Between the years 1999 and 2000 the price level experienced a total a) deflation of 20% b) inflation of 10% c) inflation of 25% d) inflation of 40% e) no change in the price level CPI 99 = (385/350) x 100 = 110; the CPI went from 100 to 110, that is a 10% increase in the general price level. 19. In 2000 the typical consumer in this economy had a nominal income of $330. In 2001 the typical consumer had a nominal income of $392. Compared to 2000, the typical consumer s real income (measured in 1999 dollars) had shown by 2001 a) a gain of $20. b) a loss of $20. c) a gain of $62 d) a loss of$ 62 e) no change. Real income t = 100 (Nominal income t /CPI t ), Real income 2000 = 100(330/110) = $300; Real income 2000 = 100(392/140) = $280. Thus real income declined by $ From the information provide we can conclude that over the time period 1999 to 2001 a) the rate of inflation slowed b) the rate of inflation accelerated. CPI grew by more 2000 to 2001 than it did 1999 to c) the rate of inflation was constant. d) nothing. There is not enough information to draw a conclusion on the rate of inflation. 21. The population of an economy is 24 million. Of this total, 19 million people currently have jobs, 1 million do not currently have jobs but are actively looking for work, and the remaining 4 million do not currently have jobs but they are not looking for employment. Calculate the current unemployment rate is a) 4.2% b) 5.0% c) 16.7% d) 20.8% Unemployment rate is the (total unemployed)/(total labor force). Unemployed are those without a job that are currently looking for work = 1 million. Labor force is all those with jobs + those without a job that are currently looking for work = 19 million + 1 million = 20 million. Unemployment rate is thus 1/(19+1) =.05 Econ Exam 2 - Page 4 of 11

5 22. Which of the following groups would most benefit the most from an unanticipated inflation? a) borrowers b) lenders c) pensioners on fixed incomes d) both b) and c) 23. Cyclical unemployment a) is unemployment that is due to normal turnover in the labor market. b) refers to unemployed workers whose skills don't match the jobs available. c) is the part of unemployment that is attributable to a decline in the economy's total production. d) is all of the above. 24. Which of the following would not be included in the calculation of GDP a) the value of a used car I sell to my neighbor. b) my purchase of 1,000 shares of General Motors stock. c) the value of the time I volunteer to PTA to serve as treasurer d) none of the items a), b), or c) count in GDP calculations e) all of the items a), b), or c) count in GDP calculations 25. Consider an economy where for the current year national income is $2,000,000. The total amount of taxes collected by the government in the current is $600,000 and the government pays out $200,000 in social security payments to citizens. Given this information, disposable income for the economy is a) $2,00,000 b) $1,600,000 c) $1,400,000 d) $1,200,000 DI = Y - T where T is NET taxes = (Total taxes - transfers) = 2,000,000 - (600, ,000) = $1,600, The current inflation rate is 2.0% per year. The nominal interest rate on a passbook savings account is 1% per year. The real interest rate on passbook savings in a bank is a) 2.0% b) 1.0% c) 0% d) -1% Real interest rate = nomianl rate - inflation rate Information for questions Consider a simple macro economy with no foreign trade (you can ignore exports and imports, so total expenditure = C + I + G ). You may also assume that the price level is fixed. The consumption function can be described by the equation C = (Y-T), where Y is income and T is the net amount of tax payments the government collects from consumers. Assume initially that government taxes (T) total $ 100 million and that taxes are autonomous "lump sum" taxes), government spending is autonomous (G) and is equal to $ 120 million and autonomous investment (I) is $ 130 million. You may use the blank table below to help answer the questions that follow. (Numbers are in current dollars per year.) 27. In the economy described above, the marginal propensity to consume is a).75 b).8 c).9 slope of consumption function d) can t be determined 28. Given the numbers above, the equilibrium GDP for this economy will be. a) 250 b) 1200 c) 2000 d) 2400 e) 2600 Model TE = C + I + G = (Y-100) , and TE = Y at equilibrium Y* = (1/(1-.9)) ( (100) = Given the numbers above, the investment expenditure multiplier is a).8 b) 5.0 c) 9.0 d) 10.0 e) 12.0 Multiplier is Y*/ I = (1/(1-.9)) =10 Econ Exam 2 - Page 5 of 11

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7 30. Given the numbers above, the autonomous tax multiplier is a).8 b) 9.0 c) -9.0 d) 10.0 e) 12.0 Multiplier is Y*/ T = (-.9/(1-.9)) = In this model, a one dollar decrease in taxes will a) have the same effect on equilibrium GDP as would a one dollar increase in government spending. b) have a larger effect on equilibrium GDP than would a one dollar increase in government spending. c) have a smaller effect on equilibrium GDP than would a one dollar increase in government spending. d) have a larger effect on equilibrium GDP than would a one dollar increase in investment spending. 32. If the potential GDP for this economy is 2800 and assuming taxes and investment do not change, the government could achieve full employment by a) increasing government spending by 20 The recessionary gap is 200 (difference between Potential GDP and actual GDP. The Government expenditure multiplier is 10 so if we add 20 of additional G will get 10 x 20 =200 additional equilibrium income. b) increasing government spending by 200 c) increasing government spending by 100 d) decreasing government spending by 50 e) there is no level of government spending that will achieve full employment. 33. If the government replaces the lump sum tax with a 4% tax on income (T =.04Y) a) equilibrium income will increase and the government expenditure multiplier will rise. b) equilibrium income will increase and the government expenditure multiplier will fall. c) equilibrium income will fall and the government expenditure multiplier will rise. d) equilibrium income will fall and the government expenditure multiplier will fall. e) equilibrium income will stay the same and the government expenditure multiplier will fall. 34. If the government replaces the lump sum tax with a 4% income tax as described in question 33, the government expenditure multiplier will be approximately a) 6.4 b) 7.4 c) 9.2 d) 9.6 e) 10.0 The multiplier with a proportional income tax is 1/(1-.9(1-.04)) = Consider a government program that had no other effect but to transfer income from the poor to the rich (e.g. cut welfare payments to the poor and decrease taxes to the rich by an equal amount). In a macro model such as the one used in the above questions, such a program would a) Increase equilibrium GDP if rich and poor people have the same marginal propensity to consume. b) Increase equilibrium GDP if rich people have a higher marginal propensity to consume than do poor people. c) Increase equilibrium GDP if rich people have a lower marginal propensity to consume than do poor people. d) Increase equilibrium GDP now matter what the relative sizes of poor and rich peoples marginal propensities to consume. e) Decrease equilibrium GDP in all cases. 36. A change in which of the following would not lead to a shift in the aggregate supply curve? a) output prices b) the wage rate c) technology and productivity d) an increase in the quantity of available labor and capital Econ Exam 2 - Page 7 of 11

8 37. The aggregate demand curve shifts downward (to the left) when a) There is an decrease in the tax rate b) There is an decrease in government expenditure c) There is an increase in autonomous investment spending d) There is an decrease in income e) both b) and d) Questions Consider the economy shown in Figure 3. For simplicity you may ignore the foreign sector. The graphs show the total expenditure function (TE) the aggregate supply and demand curves (AS, AD) and the economy s potential GDP. The current equilibrium for the economy is shown at Real GDP = Y 0 and price level P 0. Total Expenditure (TE) Potential GDP 45 0 TE=C + I + G 38. The economy shown in Figure 3 is currently a) experiencing an inflationary gap. b) experiencing a recessionary gap. c) experiencing both unemployment and inflation. d) in full employment equilibrium. 39. The government in this economy decides to decrease taxes and increase government spending. What will happen to the curves in Figure 3 in the short run as a result of these changes? a) The aggregate supply curve (AS) with shift to the right b) The aggregate demand curve (AD) will shift to the right. c) The total expenditure curve (TE) will shift up. d) The total expenditure curve (TE) will shift down. e) both b) and c) P0 Price Level AD Real GDP (Y) AS Figure 3 Y 0 Real GDP (Y) Econ Exam 2 - Page 8 of 11

9 40. What will be the effect on the economy of the changes suggested in question 39? a) the unemployment rate and the price level will fall. b) the unemployment rate will fall but the price level will rise. c) the unemployment rate will increase but prices will fall. d) both the unemployment rate and the price level will increase. 41. If the government devises a program to stimulate investment spending, what will happen in this economy a) In the short run, aggregate demand and Total expenditure will shift up. b) In the short run, aggregate demand will not shift, but aggregate supply will shift out (to the right). c) In the long run, aggregate supply will remain unchanged. d) In the long run, aggregate supply will shift out (to the right). e) both a) and d). Econ Exam 2 - Page 9 of 11

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11 When you have completed your exam: Print your Name Write your Student ID number (PID) Print your recitation section number (A list of recitation will be on the screen) Section Sign the honor Pledge affirming that you have neither given nor received aid on this exam and have complied with all of the rules of this exam. Signature Tear this form off the back of you exam and turn it in with your answer sheet. You may keep the rest of the exam. Econ Exam 2 - Page 11 of 11