ECON 504 ECONOMIC THEORY FOR NON-ECONOMISTS
MID-TERM EXAMINATION OCTOBER 10, 1995
ANSWER SHEET
A. Multiple Choice Questions:
1. (b) Opportunity cost question. The income they could receive from renting the offices is the opportunity cost of doing nothing. This should be weighed against the cost of building outside the city.
2. (d) What counts is that MB>MC.
3. (c) Price discrimination as incentive-- raise prices to discourage diners from 12 to 1 and lower them to encourage diners at other hours.
4. (a) Elasticity question. With inelastic demand, % P>% QD; thus, as prohibition shifts the supply curve up a steep demand curve, TR=PxQ will increase.
5. (b) Supply elasticity question-- a good way to increase housing for the poor is provide a voucher subsidy to renters.
6. (d) Free rider question. Public goods are ones that are nonexclusionary and nonrivalous. Since you cannot be excluded from consuming the service you can free ride.
7. (b) Application of opportunity cost.
8. (c) Allocating your resources by MB, MC-- put each dollar spent where it returns the most, indescending order, until you have used up your resources.
B. Essay Questions:
9.Standing in line has an opportunity cost of $30; hence the full price of the ticket is the $25 cost of the ticket plus the $30 (5 hrsx$6) opportunity cost for a total of $55. If the concert becomes more popular so that 8 hours must be spent in line, the full cost becomes $73 [$25 plus $48 (8hrsx$6)].
10. The reasoning is correct until it reaches the point where it suggests that as "consumers switch to other grains, the demand for wheat falls." The error here is in the assertion that the demand for wheat falls, since this means that the demand for wheat shifts to the left. As a S&D diagram illustrates, the demand for wheat does not shift; only the supply of wheat shifts. The increase in price of wheat reduces the quantity demanded of wheat-- but it does not shift the demand curve. Hence, the plague of locusts raises the equilibrium price of wheat.
11. It is unlikely that rent controls will help low-income tenants. Once the controls are imposed landlords may forsake upkeep and the condition of rental units will deteriorate. Further, potential tenants may have problems finding units as some landlords may remove rental units from the market. Finally, the excess demand created by the rent controls may lead to illegal activities such as under-the-counter payments. In this event tenants are likely to pay an even higher price under rent control than they did in its absence.
12. In order to raise the maximum revenue, the government should tax products with an inelastic demand. Taxing a product raises its price and reduces the amount sold. If the demand for it is inelastic, the reduction in the amount sold is smaller than if the demand is elastic. Moreover, the price increase is greater if the demand is inelastic. Hence, the government raises more tax revenues when it taxes commodities with an inelastic demand.
13. The discussion should center on the fact that in the case of owning the only station in Smallyton, Ms Rich has market power and therefore is able to charge a price above the competitive one. When she owns one of several stations she must act as a price taker, charging the lower, competitive price.
14. The key characteristic of a public good is that consumption of the good or service by one person does not deprive another person from consuming precisely the same good or service. Thus, if the student eats an apple, no one else is able to eat that particular apple. Therefore, apples are not a public good. Rather, they are (like most products) a private good.
15. The cost of giving a party can be divided into costs incurred by the part-giver and external costs. The costs paid by the person giving the party include the cost of refreshments, cleaning, and so forth. These are included in the MPC curve that underlies the S curve that includes only private costs. The external costs-- born by a neighboring third party-- include the value of lost sleep and/or quiet study time. These would be added to obtain the MSC curve which underlies the true S curve.
16.        a) Yes, if their time has a high opportunity cost. b) No, you still have the free rider problem.
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