2020 Resources

Question 9 [40 marks]

Assume the following. King Bob’s kingdom consists of two places: Boblandia—the densely populated city, and Gazzalestan—the countryside which is not densely populated. The firms that employ people are located in the city. It is easier to maintain social distance in the countryside. Residents of the Kingdom choose to live in either. Tourists from outside the Kingdom can choose to visit either. The owner of a home can either live in it; rent it to tourists; or leave it empty. All markets are perfectly competitive.

Here is what happened in March:

1.     For all human beings, the benefits of maintaining social distance from others increased.

2.     An increasing number of firms have decided that workers can work from wherever they live.

 [30 Marks] As a result of what happened in March, what are your predictions for the price and quantity of home purchases in Boblandia? Provide your answers in sections labelled

Initial Impact on Demand (individual and market)

At an individual (i.e., household) level, this decreases the value of living in the city, thus decreasing MWTP for a house. (I think it is okay to just assume that each household demands 1 and only one house.)

Houses can also be used to as rentals to tourists. Social distancing concerns decrease demand for rentals, leading to lower rental prices and fewer rentals. This too decreases the value of owning a city house in order to rent to tourists, thus decreasing MWTP for a house.

At a market level, this is a decrease in demand (i.e., a shift in/down of the demand curve). For full marks, you need to explain why, either in terms of “down” or in terms of “in”. In terms of in, at any given price, there fewer households who are willing to pay that price or more. In terms of down, the demand curve is an ordering, from highest to lowest, of MWTP. Because each individual’s MWTP has decreased, this means that the “Q highest” MWTP has decreased for all Q.

Initial Impact on Supply (individual and market)

For this individual with a house in the city, this decreases the cost of selling your house. Opportunity cost is the cost of what you give up: city living. As the benefits of city living has gone down, so has the cost of selling your house. 

Likewise, for those already renting out their city houses, this decreases the cost of selling your rental property. Opportunity cost is the cost of what you give up: rental income. As the rental income has gone down, so has the cost of selling your house. 

At a market level, this is an increase in supply (a shift out and down of the supply curve).  For full marks, you need to explain why, either in terms of “down” or in terms of “out”. In terms of out, at any given market price, there are now more sellers whose cost is less than that price.  In terms of down, the supply curve is an ordering, from lowest to highest, of marginal cost. Because each individual’s MC has decreased, this means that the “Q lowest” MC has decreased for all Q.

Initial Impact on Market (i.e., price and quantity) Price decreases, the effect on quantity is uncertain.

The equilibrium price occurs where quantity supplied equals quantity demanded. Before the shift, at the equilibrium price, quantity supplied equal quantity demanded. With the shifts in supply and demand, there is excess supply. From above, at any price (like the original equilibrium price), more units are supplied at this price and fewer units are demanded. This puts downward pressure on prices.

Quantity is uncertain: the shift in of the demand curve puts pushes quantity lower, the shift out in supply pushes quantities higher. It is uncertain which effect will be larger.

[10 Marks] What happened in March also changed the price of purchasing a home in

Gazzalestan. If the price change in Gazzalestan was larger than expected, how would this affect the predictions you just made for purchasing a home in Boblandia? Provide your answer in a section labelled

Revised Market Prediction (i.e., price and quantity)

The price in the countryside increases, as the effects are supply and demand are the exact opposite of what happens in the city: supply shifts in and up; demand shifts out and up.

Learning that the price of a home in the countryside is higher than expected will moderate the shift in and down of the demand curve. Starting from our previously shifted demand curve, the higher countryside price decreases the implicit cost of purchasing a

city home as it decreases the value of the next best alternative. This increases MWTP. 

Likewise, learning that the price of a home in the countryside is higher than expected will moderate the shift out and down of the supply curve. The next best alternative (moving to the countryside) has become less valuable, decreasing the cost of staying (i.e., increasing the cost of selling.)

So, the shift down and in of the demand curve is not as big, nor is the shift down and out of the supply curve. We still get a decrease in price, but not as large. The effect on quantity is still ambiguous.

Question 9 [40 marks].

Assume the following. King Bob’s kingdom consists of two places: Gazzalestan—the densely populated city, and Boblandia—the countryside which is not densely populated. The firms that employ people are located in the city. It is easier to maintain social distance in the countryside.

Residents of the Kingdom choose to live in either. Tourists from outside the Kingdom can choose to visit either. The owner of a home can either live in it; rent it to tourists; or leave it empty. All markets are perfectly competitive.

Here is what happened in March:

1.     For all human beings, the benefits of maintaining social distance from others increased.

2.     An increasing number of firms have decided that workers can work from wherever they live.

[30 Marks] As a result of what happened in March, what are your predictions for the price and quantity of home purchases in Boblandia? Provide your answers in sections labelled

Initial Impact on Demand (individual and market)

At an individual (i.e., household) level, both an ability to work from home and an increase in the value of social distancing increases the value of living in the country, thus increasing MWTP for a house. (I think it is okay to just assume that each household demands 1 and only one house.)

Houses can also be used to as rentals to tourists. Social distancing concerns increase demand for country rentals, leading to higher rental prices and more rentals. This too increases the value of owning a city house in order to rent to tourists, thus increasing MWTP for a house.

At a market level, this is an increase in demand (i.e., a shift out/up of the demand curve). For full marks, you need to explain why, either in terms of “up” or in terms of “out”. In terms of out, at any given price, there more households who are willing to pay that price or more. In terms of up, the demand curve is an ordering, from highest to lowest, of MWTP. Because each individual’s MWTP has increased, this means that the “Q highest” MWTP has increased for all Q.

Initial Impact on Supply (individual and market)

For an individual with a house in the country, this increases the cost of selling your house. Opportunity cost is the cost of what you give up: country living. As the benefits of country living has gone up, so has the cost of selling your house. 

Likewise, for those already renting out their country houses, this increases the cost of selling your rental property. Opportunity cost is the cost of what you give up: rental income. As the rental income has gone up, so has the cost of selling your house. 

At a market level, this is a decrease in supply (a shift in and up of the supply curve). For full marks, you need to explain why, either in terms of “up” or in terms of “in”.  In terms of in, at any given market price, there are now fewer sellers whose cost is less than that price.  In terms of up, the supply curve is an ordering, from lowest to highest, of marginal cost. Because each individual’s MC has increased, this means that the “Q lowest” MC has increased for all Q.

Initial Impact on Market (i.e., price and quantity) Price increases, the effect on quantity is uncertain.

The equilibrium price occurs where quantity supplied equals quantity demanded. Before the shifts, at the equilibrium price, quantity supplied equal quantity demanded. With the shifts in supply and demand, there is excess demand at the original market price. From above, at any price (like the original equilibrium price), more units are demanded at this price and fewer units are supplied. This puts upward pressure on prices.

Quantity is uncertain: the shift in of the supply curve puts pushes quantity lower, the shift out in demand pushes quantities higher. It is uncertain which effect will be larger.

[10 Marks] What happened in March also changed the price of purchasing a home in

Gazzalestan. If the price change in Gazzalestan was larger than expected, how would this affect the predictions you just made for purchasing a home in Boblandia? Provide your answer in a section labelled

Revised Market Prediction (i.e., price and quantity)

The price in the city decreases, as the effects are supply and demand are the exact opposite of what happens in the countryside: supply shifts out and down; demand shifts in and down.

Learning that the price of a home in the city is lower than expected will moderate the shift out and up of the demand curve. Starting from our previously shifted demand curve, the lower city price increases the implicit cost of purchasing a country home as it increases the value of the next best alternative. This decreases MWTP.

Likewise, learning that the price of a home in the city is lower than expected will moderate the shift in and up of the supply curve. The next best alternative (moving to the city) has become more valuable, increasing the cost of staying (i.e., decreasing the cost of selling.)

So, the shift up and out of the demand curve is not as big, nor is the shift up and in of the supply curve. We still get an increase in price, but not as large. The effect on quantity is still ambiguous.

Question 5 [40 Marks]

You have seven mornings per week. On each morning, you can either study, go to the rockclimbing wall, or read. If you rock climb, you must be a member of the club. The membership fee is 100 Bobos each week, charged at the beginning of the week. As member, you pay 10 Bobos each morning you climb. You do not pay for the books you read as you borrow them from the library.

[15 Marks] Your economics professor has asked you to produce a table showing your marginal cost for each of 7 mornings you may climb during a week. Your uncle, who has never taken economics, has asked you to explain the table and why the values you wrote down make sense. Provide your answers in sections labelled The Table

Note that you can make the case for MC(1) being 150. If you have already paid your membership fee, then MC(1)=50. If not, then MC(1)=150.

The Explanation

So, the table lists, for each day I climb, how much my total climbing costs increase. I have depicted the costs from the perspective of having already paid my membership fee. 

Now, I am sure you are little confused, because I pay only 10 bobos each time I climb. But what I learned in my studies with Prof. Gazzale is that the true cost of an doing something—what economists call opportunity cost—is the value of what I have to give up to do it. So, when I climb, I have to give up doing something else that morning, which means I have to give up either studying or reading, which I value. I also have to give up spending 10 Bobos on something else, and I know the value of this something else has to be at least 10 Bobos or I would not have purchased it had the climbing wall been closed.

Oh, you want to know why the marginal cost is increasing. Well, that is the due to the principle of increasing opportunity cost, another really important concept that I learned from my studies with Prof. Gazzale. So, just to make things simple, let’s ignore reading for the moment. If I don’t climb, I study 7 mornings. If I climb one morning, I give up whatever morning of studying was the least valuable. If I climb a second morning, I give up whichever of the six remaining mornings is least valuable, but value of this second morning has to be higher than the first because I did not give it up originally. Of course, by the time we get to the 7^th morning of climbing, I would have to give up that really valuable morning of studying that I wouldn’t give up any of the other times I could have.

And yes, the same holds true for the 10-bobo daily fee. I always choose the least valuable 10 bobo purchase to give up, meaning that each successive 10 bobos is more costly than the last.

[10 Marks] Assume that in October, you rationally climbed four times per week. At the end of

October, you learned that you are not doing well in your courses. You also learned that for November, weekly fee is 50 Bobos per week if you are a member. Your economics professor has been asked to predict and explain what this new information will mean for your weekly climbing In November. What might your professor have written? Provide your answer in a section labelled

November

If you are not doing well in your courses, this likely increases the marginal benefits of studying. By increasing the value of the next best alternative, we increase value of what you give up by climbing: an increase in the marginal cost of climbing.

First, let me assume that you do pay my membership fee. In this case the number of days I climb will likely decrease. You follow the behavioural rule “keep doing something as long as the marginal benefit is at least as large as the marginal cost.” No change in marginal benefits, increase in marginal cost, this means climbing likely decreases. (It is possible that it does not change. If the benefit of the fourth day of climbing was 89 bobos, then if MC(4) increases from 80 to 89, you still climb.)

Now, the interesting question is whether you climb at all. Your net benefit (total benefit minus total cost) of being a member has decreased. The marginal cost of each day of climbing has increased, and the number of days you climb has decreased (or remained the same). We know that your net benefit was at least 100 before, and we know it has decreased, but it may it still be greater than 50. (Heck, it may still be greater than 100.)

EXTRA: The most plausible assumption is that the value of studying has decreased. It is generally hard to come up with a compelling story where the marginal benefit of studying has decreased except in the case where marginal benefit equals zero. If you are going to fail anyway, what’s the point of studying. You do not have to mention this case to receive full marks, but you cannot receive full marks by only looking at the case where marginal benefit goes to zero.

[9 Marks] Assume that in March, you rationally climbed four times per week. In April membership fee increased to 200 Bobos and you chose to be a member. If your economics professor believes that you wisely chose to be a member. What does your economics professor

predict about your April climbing? Explain. Provide your answer in a section labelled April

The number of days that you climb is determined by you following the rule “keep doing something as long as the benefit is at least as large as the cost”. The membership fee, whether 100 or 200, affects neither your marginal costs nor your marginal benefits. Therefore, no change in the number of days you climb.

[6 Marks] On April 1, you inform your economics professor that if you had not missed the feeincrease notification from the club, you would not have renewed for April. What does your economics professor predict about your April climbing? Explain. Provide your answer in a section labelled April redux

The number of days that you climb is determined by you following the rule “keep doing something as long as the benefit is at least as large as the cost”. In this decision, the membership fee is a sunk cost: as far as we know, this cost is entirely unrecoverable.

Looking forward, it affects neither your marginal costs nor your marginal benefits. Therefore, no change in the number of days you climb.

Question 4 [40 Marks]

You have seven mornings per week. On each morning, you can either study, go to the rockclimbing wall, or sculpt (i.e., make sculptures). If you rock climb, you must be a member of the club. The membership fee is 100 Bobos each week. And, as member, you pay 10 Bobos for each morning of climbing. If you sculpt, you must rent a studio which costs 100 Bobos per month. Each morning you sculp, you use 10 Bobos worth of material.

[15 Marks] Your economics professor has asked you to produce a table showing your marginal cost for each of 7 mornings you might sculpt during a normal week. Your uncle, who has never taken economics, has asked you to explain the table and why the values you wrote down make sense. Provide your answers in sections labelled

The Table

Note that you can make the case for MC(1) being 150. If you have already paid rented your studio for the week, then MC(1)=50. If not, then MC(1)=150.

The Explanation See previous question.

[10 Marks] Assume that in October, you rationally climbed two times per week and sculpted three times per week. In November, you know that the daily climbing price will be 5 bobo per morning. Explain, using the costs and benefits of sculping, how you will decide whether to rent a studio in November. Provide your answer in a section labelled

November

I figure out how many days I will sculpt if I rent a studio, and then figure out, given this number of days, whether renting a studio makes sense. 

Well, the benefit of sculpting has not changed. The marginal cost likely has. Think about that third day of sculpting. If I was not able to sculpt that third day, I would climb (i.e., climbing is the next best alternative). The decrease in the price of climbing increases the net value of this day of climbing, so when I do have a choice between a third day of climbing and a third day of sculping I may or may not climb that third day. Of course, if I would not sculpt a third day, I would want to check whether I even want to sculpt 2 days if I had a studio, etc.

Because the net value of the next best alternative for at least one day almost certainly has increased—and I may not want to sculpt as many days as I did in October—I have to see whether renting a studio makes sense. So, for each day I would sculpt, I take the net benefit (benefit -opportunity cost) and add up across all days. If this is at least 100, I rent. 

An aside, and not required for full marks: It is possible that this price decrease is irrelevant. If it is the case that reading is the next best alternative for each of the days you sculpt even at the reduced climbing fee, then the reduction in the daily climbing fee is irrelevant. One example is that after 3 days of climbing, any further day has a really low— and possibly negative—value.

[9 Marks] Assume that in March you rationally climbed two times per week and sculpted three times per week. A climber from out of town is willing to pay you 50 Bobos per week for your April membership. If you sell, you cannot climb. If this is the only change the professor is aware of, what does your economics professor predict about how often you sculp in April? Explain. Provide your answer in a section labelled

April

If this is the only change, then it does not matter. You still climb and sculpt twice a week. We know that a week of climbing is worth at least 100 bobos to you. You are not going to give up something you value at over 100 bobos in exchange for a 50-bobo benefit.

[6 Marks] Assume that the following March, you rationally climbed two times per week and sculpted three times per week. In April the membership fee for the climbing club will increase 150 bobos per week. If this is the only change the professor is aware of, what does your economics professor predict about how often you sculp in April? Explain. Provide your answer in a section labelled April, redux

Importantly, as this affects neither the marginal cost nor the marginal benefit, assuming that you become a member you still climb twice a week and sculpt three times per week.

You might not choose to pay your membership fee if the net benefit from 3 days of climbing is greater than 100 but less than 150. In this case, you do not renew. Now you start from 2 days of sculpting and 2 days of reading. Because you would have climbed on day 5 had you renewed, the cost of an extra day of sculpting has decreased meaning you may potentially increase the number of days you sculpt. (The opportunity cost of reading has decreased as well, so yes, it is possible that you read on all three of these extra days.)

An aside, and not required for full marks: Actually, it is possible that you renew your membership and decrease your sculpting. Because you have paid an extra 50 for your climbing wall the value to you of that last 10 you spend on climbing has increased. (Perhaps when thinking about sculpting that last day you would have had 100 Bobos in your pocket. You now only have 50. With only 50, maybe you are not so willing to spend 10 sculpting.)

Question 2 [40 Marks]

You are going to model households consisting of two adults—a man and a woman—and some kids. (While families are increasingly diverse, we are just going to focus on these households.) 

The adults split their time however they like between home production and the formal labour market (i.e., working for pay). Let’s assume that households care only about efficiency. (This is a really bad assumption as it means we are ignoring a lot of really important factors like the role of gender norms. We make the assumption anyway for this test.)

Many places have restrictions on all sorts of gatherings. As a result, whether we are talking about educating children or feeding families, we are seeing an increase in home production. We are also seeing a large exodus of women from the formal labour market (either leaving a forpay jobs or not seeking another for-pay job after the loss of a for-pay job). 

 [25 Marks] If, in fact this exodus is the efficiency-seeking response of households, what does this say about productivity, opportunity costs and PPFs for men and women in these households? Provide your answer in a section labelled

Exodus

A side note: In our baseline model we had two individuals, each having a linear PPF. When we found the joint PPF for an economy consisting of these two individuals, we had two linear segments. Along this joint PPF, we never had both of the individuals producing both items. In a household where both heads-of-households work, assuming one of them is not a total lout, both are producing both goods: money and home production. That being said, let's look at what our model has to say.

Our model: There are two individuals, each splits their labour between the formal labour market (i.e., a for-pay job) and home production (i.e., an unpaid job). Time in the formal labour market creates income, while time on home production creates "tasks". Before Covid, the household was on their joint PPF with each individual spending time on both activities. With the closing of schools and restaurants, households “needed to” increase time allocated to home production. (Especially at first, it was hard to get prepared food. And someone had to watch the kids during what was once school hours.) 

This is a lot like the Andreas and Katya example. If we need more beer, we are going to ask the person with the lower opportunity cost to produce it. If we need more home production, we are going to ask the person with the lower opportunity cost to produce it. Therefore, if this decrease in female labour force participation is driven solely by efficiency considerations (a rather debatable if, by the way), then this is telling thus that women have a lower opportunity cost of household production than men.

Now if we are going to talk about PPFs, then we need to specify what is being measured on each axis. With household production on the horizontal axis and household income on the vertical, then the slope of the PPF is the opportunity cost of household production.

Our model thus tells us that for an average household, the man has a steeper PPF than the woman.

Note that while we have information about opportunity cost (income given up per household task completed), we have no information about absolute levels of productivity: income created per hour or tasks created per hour. And no, contrary to what some of you asserted, it is not widely known that women are better at household production that men.

If we are looking to really impress the TA: Particularly for some tasks, such as literally watching the kids to make sure they don't burn the house down, it is probably the case that men and women are equally productive: an hour is an hour. If this is the case, then the model is telling us that men make more per hour than women. While this is becoming less true in most economies, it is still true. The model also tells us that the more productive women are at producing household tasks relative to men (e.g., can watch the kids AND fold laundry), the more women need to make relative to men outside of the household in order for it to be efficient to ask the man cut back his hours on his for-pay job. (As someone is who is far better at laundry folding than his partner, I find this last assumption rather objectionable.)

 [15 marks] King Bob, the King of Boblandia, decides to subsidize childcare. King Bob will pay half of whatever the family owes to a childcare provider who is not a member of the household. Explain how this affects opportunity costs and how these changes will affect how household adults allocate their time. Provide your answer in a section labelled

King Bob

The initial instinct is that this will increase female labour supply to the formal market. Thinking only about whether a woman works for pay (and the family purchases the childcare) or the woman provides the childcare, clearly we have decreased the cost of the working for pay.

However, our model suggests that if the aim of subsidizing childcare was to stem the flow of working women from the for-pay labour force, it may not be a successful as hoped. We can think of two reasons.

The exit of women from the workforce when they "needed" to increase home production (e.g., schools were closed) tells us that the purchase of this of this home production was too expensive. It might still be too expensive at half off.

The second reason is that it does not change comparative advantage. Let us say that initially 1 hour of male labour purchases 3 hours of childcare whereas 1 hour of female labour purchases 2 hours of childcare. The spouse earning the higher wage can still needs to work fewer minutes to “produce” and hour of childcare purchased on the market