Economics 001, General Honors

First Midterm Exam

October 8, 1998

Please read all the questions carefully before answering them. If you need to assume anything in answering a question, state your assumption clearly, and proceed. Allocate your time judiciously.

GOOD LUCK!

 

QUESTION 1 [40 points]

This question concerns the housing rental market in West Philadelphia. Use your intuition as well as the theories you have learned in class.

Houses in West Philly are all identical, except that different houses have different maintenance costs that must be paid to keep them on the market (maintenance costs range from the very low to the extremely high.) Assume that the market is perfectly competitive.

As well as living off-campus in West Philly, students can choose to live in Center City or in the university dormitories.

(a) Using the above information, graph the demand and supply curves for housing in West Philly, and explain why they might slope the way you have drawn them. Indicate the equilibrium price and quantity, as well as producer and consumer surplus. [15]

(b) Draw a similar graph, and label it "Center City". Suppose that a large number of yuppies move from the suburbs into Center City (although they don't go to West Philly). Show on your graph the effect this will have on the equilibrium price of housing in Center City. [5]

(c) How do you think this will affect the housing market in West Philly? Why? Represent this change on your graph. Also indicate what happens to the producer surplus in West Philly (you may draw another graph if you think it will be clearer.) [10]

(d) Suppose that the university demolishes the Superblock. Show on your graphs what you expect this will do to the housing markets in West Philly and Center City. (Again, draw new graphs if you think this will help.) [10]

 

Question 2 [60 points]

(In answering this question, you may want to use the fact: Area of a triangle = ½ * base * height)

The demand for bread and wine is given by:

Bd = 15 – Pb; Wd = 40 – 2Pw

where Bd and Wd are the quantity demanded of bread (100’s of loaves) and wine (10’s of bottles) respectively, and Pb and Pw are the prices of bread and of wine.

The supply functions are given as follows:

Bs = Pb – 5; Ws = 2Pw - 20

where Bs and Ws are the quantity supplied of bread and wine respectively

The government would like to increase its budget surplus (due to pressure from Congress). It decides to tax both bread and wine. It imposes a tax of $2 per 100 loaves of bread and $2 per 10 bottles of wine.

  1. Compute the equilibrium price and quantity in both markets. [12]
  2. Compute government revenue (please specify a number) from bread and from wine. What is total government revenue? [5]
  3. Define deadweight loss. Indicate any deadweight loss in both markets, and its extent (once again specify numbers). Total deadweight loss = Deadweight loss in the bread market + deadweight loss in the wine market. [12]
  4. Define price elasticity of demand. Comment on how the deadweight loss in each market may depend on the elasticity of the good. [5]
  5. Congress protests (once again!) that by taxing bread the government hurts the poor. As a result the government removes the tax on bread and raises the tax to $4 per 10 bottles of wine. Compute the new equilibrium in the wine market only. Compute the government’s tax revenue in this case. Has the total tax revenue of the government changed (refer to your answer in part (b))? [10]
  6. Compute the new deadweight loss in the wine market. Has the total deadweight loss changed (refer to your answer in part (c)) [8]
  7. Which of the above tax regimes would you support? Argue why. [8]