Transcription of Exam 2 Review Problems (Hints and Answers) …
1 Exam 2 Review Problems (Hints and answers ) ECNS 204 1.) Mutt and Jeff find themselves on a deserted island. The only two activities available are fishing and hunting rabbits. In a full day, Mutt can catch 6 rabbits or 10 fish; in the same time, Jeff can catch 6 rabbits or 3 fish. Activities can be divided with no loss of efficiency. When left to their own devices, Mutt consumes 3 rabbits and 5 fish, and Jeff consumes 2 rabbits and 2 fish. Explain how Mutt and Jeff can improve their standard of living through specialization. If they decide to continue to consume their original amount of fish each, what are their gains from specialization and trade?
2 What role, if any, does one person s absolute advantage play in your analysis? First we must solve for the MCs of production: For Mutt: MC of 1 rabbit = 5/3 fish MC of 1 fish = 3/5 of a rabbit For Jeff: MC of 1 rabbit = fish MC of 1 fish = 2 rabbits So, we see that Mutt is the low cost producer ( has a comparative advantage) in catching fish and Jeff is the low cost producer in hunting rabbits. When they specialize Mutt will only fish and Jeff will only hunt. In doing so, the bundle of goods produced in the economy is (10 fish, 6 rabbits). Without specialization we were told that Mutt catches 3 rabbits and 5 fish while Jeff catches 2 rabbits and 2 fish.
3 So, via specialization we see that the gains are 3 fish and 1 rabbit. Absolute advantage plays no role in this analysis. 2.) In China, the wages are about 20 cents per hour. (In the US, the average wage is about $20/hour). It seems like China could produce virtually everything cheaper than could America, and yet China imports various goods from the , such as office machines. Why do they do this? They do this because they have a comparative advantage in some products, while the has a comparative advantage in other products ( office machines). Through specialization and trade both can be made better off.
4 3.) The government maintains price supports on both corn and wheat, , the government maintains a price for each of these grains above what would otherwise exist with a free market. a.) Explain, with a diagram, why we have surpluses in these grains. Simply two standard supply and demand graphs for corn and wheat where a price support is shown in both markets. There is a surplus for each good because Qs > Qd. b.) Suppose the price floor for corn was abandoned, so there was a free market for corn, but the price support was maintained for wheat. Explain the effects of this on the markets for corn and wheat.
5 When the price floor for corn is abandoned, the market price for corn will fall to the market clearing equilibrium. Given these two goods are likely substitutes, this will have an impact on the wheat market. In particular, the demand for wheat will decrease (as shown by a shift in the demand curve). But, because the price floor still exists in the wheat market, the price stays the same. The quantity of wheat demanded decreases and the surplus gets bigger. 4.) Suppose the state of Washington decided to increase the sales tax on fast food restaurants, McDonalds. The standard sales tax graph from class and your text should be used when answering this question.
6 A.) Provide an estimate for the elasticity of demand for fast food restaurants, and justify your answer. You could go either way on this as long as you justify your answer. Do you think substitutes for fast food exist? b.) How will the increased tax affect the total amount consumers in this state spend on all the fast food restaurant meals they purchase? Your answer will depend upon your estimate of the elasticity of demand. If you think demand is inelastic, then TEs will go up. c.) Who will likely pay the bulk of the sales tax, consumers or restaurant owners? Be sure to use a diagram to justify your answer.
7 Again, this depends on your estimate of the elasticity of demand. If demand is inelastic, then sellers are able to pass the majority of the tax onto consumers. 5.) The state of WA would like to raise more tax revenue. They consider an increase in the property tax on view properties ( nice houses) and extending the sale tax on fast food. a.) Explain who will pay most of the new taxes in each instance. For view properties, suppose we are only focused on the very short-term. As a result, the supply is fixed ( vertical). Also, assume the producer is the one responsible for sending the tax receipts to the government (this was the simplifying assumption made in class).
8 You answered the part on fast food above. For the property tax, we know that owners (can think of as land lords too) will pay the entire tax because supply is fixed in the short run. We went through this in class when discussing a tax on fixed resources. b.) Which tax will have a greater effect on economic efficiency? (hint: remember how we defined economic efficiency). DWL exists in fast food market under a sales tax. Thus, market is inefficient. No, DWL in view property market. Thus, market remains efficient. You will need to show both of these graphically. 6.) Assume that peanut butter and jelly are compliments.
9 Also, suppose that the government maintains a price floor in the market for peanut butter and the market for jelly is unrestricted. Now, suppose that the government gets rid of the price floor for peanut butter. What happens to the price of jelly? You need to support your answer with diagrams for both markets. When the price floor is abandoned, the price of peanut butter will fall to the market clearing level. Because the two goods are compliments, then we know that the demand for jelly will go , price of jelly increases and so does the quantity exchanged. 7.) Suppose Chuck owns a coal mining firm and his marginal cost schedule (in tons of coal) is given as follows Q(tons) MC 1 50 2 100 3 150 4 200 5 250 6 300 Also, suppose the market price for a ton of coal is $200.
10 How many tons of coal will Chuck s firm produce? Graphically illustrate his marginal cost curve and show on your graph the total costs of production when the market price is $200. How much are the total costs? Simply plot the points above to illustrate Chuck s MC curve ( supply curve). He will produce up to the point where P = , he produces 4 tons. The total production costs are represented by the area under the MC curve up to Q = 4 sure to calculate this amount. 8.) Suppose the output of wheat is given by the following production function where L represents the labor input and TP represents the total product, or output (per day), in bushels.
