Part I (24 points)

Answer the first question and five out of the remaining six. Explain whether the statement is true, false or

partially true. The grade will be based on the quality of your explanation.

1. In the article, "Sex, Booze, and Drugs", Miller et al argue that law enforcement activities have the unintended consequence of lowering the price of, and thus increasing the demand for, illegal goods.

2. Take-out pizza and home-rental videos are complimentary goods. Therefore, a reduction in the price of video rentals should lead to an increase in the price of pizza.

3. The Law of Diminishing Marginal Product says that at some point Total Product will be falling.

4. An increase in average household income will lead to an increase in the demand for all goods and services.

5. Suppose a utility-maximizing household consumes only guns and butter. If the marginal rate of substitution (guns for butter) is greater than the ratio of prices for guns and butter, the household will consume more guns.

6. Consider a firm that owns a building where it produces output. If the value of the building does not change over time (i.e. it does not depreciate), the economic cost of the building is effectively zero. 

7. If the long-run supply of rental housing is highly elastic, then the imposition of effective rent controls will lead to a housing shortage that will increase over time.

Part II (14 points)

Assume a simple world with two commodities, x and y. The typical consumer's income is given by 1=20, and the prices of the goods are given by PX=2 and Py=4

(1) (5 points) Suppose the optimum solution of a typical consumer is given by the bundle x=4, y=3. Now suppose the price of y drops to Py=1. Does the typical consumer become better off? Explain graphically.

(2) (5 points) The government is considering imposing taxes to finance an important public project. There are two alternative tax schemes: (a) An income tax which will cut incomes in half (i.e. a flat income tax rate of 50%) (b) A sales tax which will double the price of each good

A financial analyst argues that both tax schemes yield the same result. Do you agree with this conclusion? Why or why not?

(3) (4 points) Suppose that the typical consumer's preference relation is numerically represented by the following linear utility function: U(x,y) = x + y. That is, the utility derived from the bundle x=4, y=3 is 7. Assume that the prevailing prices are Px=2 and Py=4. Find the optimal bundle of the typical consumer (the one which maximizes utility subject to the budget constraint).

(Hint: draw a typical indifference curve, say U(x,y)=x+y=7)

Section-Specific Econ 1-003 

Part III (Total 12 points, 3 points each question)

Suppose the market demand and supply for cola drinks is given by

where Q is quantity in millions per day and P is price in cents per can. 

(i) Graph the supply and demand curves for Q=l to 10. Identify the equilibrium price and quantity.

(ii) Define and calculate consumer surplus.

(iii) If a tax of $0.20 cents per can of cola is introduced, what happens to the equilibrium price and quantity of cola?

(iv) How much tax does the government collect? What share do consumers (producers) pay? <Show your work!>

Part III (Total 12 points)

In the market for apples there are two consumers (denoted by 1 and 2 respectively). The demand of the first consumer is infinitely inelastic and is given by- Q1=5, whereas the demand of the second consumer is given by the following linear equation- P=10-Q2 (Note, that the maximal price the second consumer is willing to pay for an apple is 10).

(I) Derive the market demand for apples (5 points).

(II) Suppose the market supply of apples is given by- Q=P. Calculate the equilibrium (quantity and price). Show the graphs! (4 points).

(III) Suppose the government is interested in reducing the consumption of apples to 5 units. The government is considering the imposition of per unit flat tax, for this purpose. Calculate the minimum per unit flat tax that the government should levy to realize this goal. Support your calculations with graphical illustration (3 points).

(Hint: the consumer price after tax should be sufficiently high!)

Section-Specific Econ 1-001 

A farmer who rents land at a cost of $1,000 per acre per year and hires workers for $10/hour observes the following. When she rents ten acres of land, nine workers are able to produce 180 bushels of product per hour, while ten workers are able to produce 196 bushels. Furthermore, with ten acres worked by nine workers her yield is 10,000 bushels per year, while she can obtain 11,400 bushels per year if she rents one additional acre. Suppose the farmer decides to hire nine workers and rent ten acres of land.

1) What is the marginal product of labor?

2) What is the marginal product of land?

3) Is the farmer minimizing her costs? If not, which input should she use in larger relative quantity? Explain your answer.

Part III (12 points)

Consider the following short-run Total Cost curve for the production of widgets:

(l)What are the fixed costs for producing widgets?

(2) When the firm produces 5 widgets, what are Total Variable Costs?

(3)At what output is Total Average Cost minimized?

(4) When the firm is producing 7 widgets will the Marginal Cost be higher or lower than the Average Cost? Explain.

(5) Suppose that Widgets are produced using Capital and Labor and that Capital is a fixed Input. If the price of labor doubles- what will happen to the Total Cost curve in the short run? Show this change graphically.