Final EXAM AEC2713

Economics is the study of how society manages its

unlimited wants and limited resources

An economic model is

a simplified representation of some aspect of the economy

The principle that “people face tradeoffs” applies to

individuals, families, societies

At any point on an indifference curve, the slope of the curve measures the consumer’s

willingness to trade one good for another

Marge buys a pizza for $10 and a soft drink for $2. She has an income of $200 that she has allocated to the purchase of pizza and soft drinks. Her budget constraint will experience a parallel outward shift if

her income allocated to the two products increases to $225

Concisely explain the concept of comparative advantage.

The entity that has the comparative advantage in producing the good or service can produce that good or service at a lower cost than the other entities

Evaluate the following statement as being either a positive economics statement or a normative economics statement.

“It will hopefully save me on substitute teacher costs and wasting instructional time and the time of assistant teachers — not to mention the loss of instruction,” Biloxi Superintendent Marcus Boudreaux said.

Normative – this statement expresses a belief without any supporting statistics or data

The “Trade and Prosperity in the States: The Case of Mississippi” report provided insight on the state of
international trade for the state. Discuss why international trade is a benefit for the state of Mississippi using the trade concepts that we used in our examples of the production possibilities frontier.

We (Mississippi) can produce goods for which we have a lower opportunity cost and trade them for goods for which we have a higher opportunity cost. This enables us to consume outside the production possibilities frontier.

Define the concept of a normal good.

A normal good is a good whose consumption increases as the consumer’s income increases.

If the price elasticity of demand for a good is calculated as -1.28, then a decrease in the price of the good will cause revenue for the good to

Decrease

If two goods are related and an increase in the price of one good causes a decrease in demand for the other good, then these two goods can be classified as

Complements

In 1972, long lines at gas stations in the United States were primarily a result of the fact that

The U.S. government maintained a binding price ceiling on gasoline

Putting a binding price floor on the price of U.S. produced corn and wheat will

Result in surpluses of corn and wheat

Suppose that airplane tires has a cross-price elasticity of demand of -1.23. The best explanation of this elasticity is:

Jet fuel is a complement to airplane tires; a one percent increase in the price of jet fuel will cause the
quantity demanded of airplane tires to decrease by 1.23 percent.

What is the total amount of the tax per unit of product?

$63 = $98 - $35

How much total tax will be collected by the government?

Total tax = $63 x 175 = $11,025

What is the tax incidence and tax burden on consumers?

Consumer tax incidence = $98 - $70 = $28 per unit
Consumer tax burden = $28 x 175 = $4,900

What is the tax incidence and tax burden on producers (sellers)?

Producer tax incidence = $70 - $35 = $35 per unit
Producer tax burden = $35 x 175 = $6,125

Who has the highest tax burden (producers or consumers)? Why is this the case?

Producers have the highest tax burden because the supply is more inelastic than demand

Concisely define producer surplus

Producer surplus is the difference between the price that producers receive for their product as shown
by the equilibrium price and the price that producers are willing to take for the product as shown by the
supply curve

Concisely define consumer surplus

Consumer surplus is the difference between the price that consumers are willing to pay as shown by the demand curve and the price that they have to pay as shown by the equilibrium price

Calculate the amount of consumer surplus in the market shown in the graphic.

Consumer surplus = ($250 - $100) x 600 x ½ = $150 x 600 x ½ - $45,000

Calculate the amount of producer surplus in the market shown in the graphic.

Producer surplus = ($100 - $50) x 600 x ½ = $50 x 600 x ½ = $15,000

Demonstrate on the graphic what likely happened to the market when the events described in the
newspaper article “Income tax cut begins today” occurred. Provide a concise verbal explanation of this effect on the market.

An income tax cut would cause the level of consumer disposable income to increase. This would cause the demand curve for tennis shoes to shift out if the shoes were a normal good or a luxury good. It would cause the demand curve to shift inward if tennis shoes were considered an inferior good.

Given the following graphic, calculate the price elasticity of demand for apples for the range of the demand curve between a price of $3.50 and a price of $4.00.

-3.008

How would you classify the price elasticity of demand for apples along this range of the demand curve?

Apples would be classified as having an elastic demand because |EP| = |-3.008| = 3.008 > 1.0

Assume that the government
imposes a tax of $1.00 per unit on the
sale of pizzas. What would happen to the
level of producer surplus?

Decrease from $4,000 to $2,250

With the imposition of the tax,
what would be the level of revenue
collected by the government?

$3,000

What is the level of the deadweight loss after the tax and why does the deadweight loss exist?

$500; the quantity of pizzas sold in the market decreased

Who would lose the greatest amount of surplus after the imposition of the tax – consumers or producers?

The amount of surplus after the imposition of the tax would be the same for producers and consumers because the price elasticity of supply equals the absolute value of the price elasticity of demand.

What is the Coase theorem? What would make it not apply to a particular situation?

Private parties can reach agreement to solve the problem of externalities without governmental involvement.

The Coase theorem does not apply if

Transaction costs make negotiation difficult.

Describe the Laffer curve. What is its importance regarding the relationship between tax rates and the total tax revenue accruing to the government?

The Laffer curve plots the level of tax revenue collected by the government against tax rates (in other words, how much revenue is collected by the government at different tax rates). The premise behind
Laffer’s argument is that at some point, higher tax rates actually result in less revenue for the government because the higher tax rates discourage work and depress incomes.

Is there be an externality associated with education? If so, what type of externality would exist?

Education has been shown to have positive externalities such as higher wages, lower crime, etc.

If an externality exists, what should happen to the quantity demanded and supplied in the market (should it increase or decrease) to reach a socially optimal point? If needed, would you use a tax or subsidy to reach this point of production/consumption?

The quantity supplied and demanded should increase. You would use a Pigouvian subsidy.

Consumer surplus before the tax or subsidy

AB

Consumer surplus after the tax or subsidy

ABDEF

Producer surplus before the tax or subsidy

DH

Producer surplus after the tax or subsidy

BCDH

In the newspaper article “Mississippi economist refutes politicians’ claim that the state cannot afford Medicaid expansion,” Mississippi House Speaker Phillip Gunn made the statement “I just don’t think the taxpayers can afford it. That is what it boils down to is the taxpayers. It is their money. I just don’t have taxpayers calling saying we want you to raise taxes so we can expand Medicaid.” Is this statement reflective of positive or normative economics and why?

Normative – states a belief or position with no facts

Given these production possibilities frontiers, which country has the comparative advantage in the production of wheat?

Brazil has the comparative advantage in producing wheat

In the newspaper article “State lotteries transfer wealth out of needy communities,” the authors made the assertion “Standifer – and millions of players like her – lose about 35 cents for every dollar they spend.” Is this statement reflective of positive or normative economics and why?

Positive economics – states the way things are without a statement of position or beliefs

If two goods are related and an increase in the price of one good causes an increase in the demand for the other good, then these goods can be classified as

Substitutes

If the price elasticity of demand for a good is calculated as -1.28, then a decrease in the price of the good will cause revenue for the good to

Increase

An increase in advertising for a particular good will likely cause the demand curve for that good to
shift ________________ due to a change in __________________.

outward; tastes and preferences

If the price of a good is $10, then the quantity purchased of that good is 120 units. If the price of the good increases to $13, then the quantity purchased falls to 100 units. Calculate the price elasticity of demand.

-0.697

If a consumer’s income increases by 3% and the consumption of a particular good increases by 5%,
then this good would be classified as

Luxury

If two goods are related and an increase in the price of one good causes a decrease in demand for the other good, then these two goods can be classified as

Complements

If the cross-price elasticity of demand for two goods is 1.07, then these goods can be classified as

Substitutes

Given a market with a price elasticity of supply of 1.28 and a price elasticity of demand of -0.73, choose the best answer.

Supply is elastic and demand is inelastic. A tax on this market will result in the majority of the tax incidence and burden to fall on consumers.

A tax on a good

gives buyers an incentive to buy less of the good than they otherwise would buy.

If an aluminum manufacturer does not bear the entire cost of the smoke it emits, it will

emit a higher level of smoke than is socially efficient.

A negative externality exists if

The marginal social cost of producing a good or service exceeds the private cost.

The loss in total surplus resulting from a tax is called

deadweight loss

In a market with a positive externality

producers will tend to underproduce the level of the good that is socially optimal.

What are property rights?

The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it.

Diseconomies of scale occur when a firm’s

Long-run average total costs are increasing as output increases.

A company sells traditional Native American rugs. The production of rugs for one year is 500 rugs. The average total cost of production per rung is $100. Each rug sells for $250 and the total fixed costs for the firm is $5,000. The average variable cost for each unit of output is

$90

Given the following information, calculate the price elasticity of demand:
Quantity1 = 10,000 units
Price1 = $7.50 per unit
Quantity2 = 12,000 units
Price2 = $6.50 per unit

-1.273

If the price falls from $7.50 per unit to $6.50 per unit, what happens to the total revenue generated from the sales of this product?

Increases

Charles purchases 20 basketball tickets when his annual income is $50,000 and 25 basketball tickets
when his income is $60,000. Charles’ income elasticity of demand is

1.22, and basketball tickets are a luxury good

When her income increased from $10,000 to $20,000, Heather’s consumption of macaroni decreased from 10 pounds to 5 pounds and her consumption of hamburger meat increased from 2 pounds to 4
pounds. We can conclude for Heather that

macaroni is an inferior good with an income elasticity of -1 and hamburger meat is a normal good with an income elasticity of 1

Suppose that when the price of good X falls from $6 to $4, the quantity demanded of good Y rises from 30 units to 40 units. The cross-price elasticity of demand is

1.40 and X and Y are complements

Suppose that the cross-price elasticity of demand between hot dogs and mustard is -2.0. This implies that a 20 percent increase in the price of hot dogs will cause the quantity of mustard purchased to

fall by 40 percent; hot dogs and mustard are complements

What conditions govern the relative size of producer and consumer surplus?

The relative elasticities of the supply and demand curves; if demand is more inelastic than supply, then consumers will have the largest share of total surplus

Given a market with a price elasticity of supply of 1.28 and a price elasticity of demand of -0.73.

Supply is elastic and demand is inelastic. A tax on this market will result in the majority of the tax incidence and burden to fall on consumers.

Given a market with a price elasticity of supply of 1.28 and a price elasticity of demand of -0.73.

Producer surplus will be greater than consumer surplus.

Market failure can be caused by

externalities

In a market economy, government intervention

may improve market outcomes in the presence of externalities.

An externality is

a benefit or cost experienced by someone who is not a producer or consuer of a good or service

Which of the following is a source of market failure?

incomplete property rights or an inability to enforce property rights

What is the "social cost" of production?

The sum of all costs to individuals in society, regardless of whether the costs are borne by those who produce the products or consume the products.

It would always be a mistake to view

national defense as a common resource.

Goods that are not rival in consumption include both

club goods and public goods.

Bob owns 5 acres of land. Bob sells the land to a real estate developer who builds a subdivision with 10 houses. The land is an example of a good that is

both rival in consumption and excludable

For private goods allocated in markets,

prices guide the decisions of buyers and sellers and these decisions lead to an efficient allocation of resources.

An example of a private good would be

a sleeping bag.

An example of a club good would be

an internet radio subscription.

An example of a common resource would be

a library book.

An example of a public good would be

an interstate highway.

Economists normally assume that the goal of a firm is to earn
(i) profits as large as possible, even if it means reducing output.
(ii) profits as large as possible, even if it means incurring a higher cost.
(iii) revenues as large as possible, even if it reduces profits.

(i) and (ii) only

The amount of money that a firm receives from the sale of its output is called

total revenue

Carol Anne makes candles. If she charges $20 for each candle, her total revenue will be

$500 if she sells 25 candles

The value of a business owner's time is an example of

an opportunity cost

A difference between explicit and implicit costs is that

implicit costs do not require a direct monetary outlay by the firm, whereas explicit costs do

Pete owns a shoe-shine business. His accountant most likely includes which of the following costs on his
financial statements?
(i) shoe polish
(ii) rent on the shoe stand
(iii) wages Pete could earn delivering newspapers
(iv) interest that Pete's money was earning before he spent his savings to set up the shoe-shine

(i) and (ii) only

Foregone investment opportunities are an example of

an implicit cost

Farmer McDonald gives banjo lessons for $20 per hour. One day, he spends 10 hours planting $100 worth of seeds on his farm. What total cost has he incurred?

$300

Farmer Greene faces diminishing marginal product. If she plans no seeds on her farm, she gets no harvest. If she plants 1 bag of seeds, she gets 3 bushels of wheat. If she plants 2 bags of seed, she gets 5
bushels of wheat. If she plants 3 bags of seed, how many bushels of wheat does she get?

6 bushels

Diminishing marginal product explains why, as a firm's output increases,

The production function gets flatter, while the total-cost curve gets steeper.

The government imposes a $1,000 per year license fee on all pizza restaurants. As a result, which cost curves shift?

average total cost and average fixed cost

If Boeing produces 9 jets per month, its long-run total cost is $9 million per month. If it produces 10 jets per month, its long-run total cost is $11 million per month. Boeing exhibits

diseconomies of scale.

A perfectly competitive firm

takes its price as given by market conditions.

A competitive firm maximizes profit by choosing the quantity at which

marginal cost equals the price.

If a profit maximizing, competitive firm is producing a quantity at which marginal cost is between
average variable cost and average total cost, it will

keep producing in the short run, but exit the market in the long run.

A competitive market is in long-run equilibrium. If demand decreases, we can be certain that price will

fall in the short run. All, some, or no firms will shut down and some of them will exit the industry. Price will then rise to reach the new long-run equilibrium.

The accountants hired by Forever Fitness have determined total fixed cost to be $75,000, total variable cost to be $130,000, and total revenue to be $125,000. Because of this information, in the short run, Forever Fitness should

shut down because staying open would be more expensive.

Whenever a perfectly competitive firm chooses to change its level of output, its marginal revenue

does not change.

Which of the following goods are not likely to be sold in monopolistically competitive markets?

tap water

Which of the following is not a characteristic of monopolistic competition?

firms are price takers