Economics 8100
Applied Microeconomics
Sample Exam
Bruce A. Seaman
102 total points
Name _____________________________________
This is a take-home exam due at the beginning of class, Wednesday, October 14 , 1998. You may independently use any course materials, but you are forbidden to work in cooperation with any other individual. Your signature on this exam indicates your compliance with these Georgia State University regulations regarding academic honesty. Violations of these regulations are punished severely. There are no strict length requirements; just remember that partial credit is given for the quality of the economic argumentation. If there are three good arguments to be made, do not limit yourself to only one. When you begin guessing and making things up - stop.
Remember that the optimization decision rule for maximizing point totals given
a time constraint is to equalize the marginal points across all questions (for
extra credit, prove this proposition using mathematical and graphical techniques).
Part I. Indicate whether the following statements are true, false or
uncertain, and most importantly, defend your answers using complete and coherent
economic argumentation as to the principles involved. Choose 6 of 9; Each worth
9 points; 54 total.
1. At an average price of $100 per train trip, you had been planning to take
4 trips between various cities while traveling in Europe. Then a friend informs
you that you can purchase a "Eurail Pass" that allows you to take
unlimited trips at a fixed price of $500. You would be irrational to buy the
Eurail Pass under these circumstances.
2. If the government places a per unit excise tax on the production of a good,
the price of the product will increase and the quantity supplied by producers
will increase because the producers will receive a higher price.
3. A student spends 8 hours per day listening to music, with M hours devoted to Mozart, and B hours devoted to Beethoven. The student's utility function is given by U = M 1/4 B 3/4 . ..
The utility maximizing listening pattern of this student will generate four
times as much listening to Beethoven as listening to Mozart.
4. Each week, Jon divides $200 between renting video games and purchasing all other goods. When the price per game is $4.00, Jon rents 10 games per week, and spends $160 on other goods. The local store then institutes a new "two-part pricing policy" - that is, Jon must pay a weekly membership fee of $30 , but then he can rent games at a price of $1.00 per game. This new policy makes Jon better off than the original pricing policy.
..
5. When in Norway, Robert spends his $500 income per month as follows: 50 units
of X at $2.00 per unit and 100 of Y at $4.00 per unit. When in Kenya, he spends
his $450 per month income as follows: 42 units of X at $4.00 per unit and 141
units of Y at $2.00 per unit. These consumption patterns suggest that he changes
his tastes when he moves, or else he must be behaving irrationally.
6. One proposal in the United States for reforming the welfare system has been a "negative income tax." Under this proposal, each person is entitled to a grant of G dollars per month (assume equal to $150), but for every dollar the person earns, the grant is reduced by t dollars (assume equal to $.25). For a person initially earning, say, $5.00 per hour, this proposal will (1)
increase this person's supply of labor hours per month compared to having no program in place; but (2) reduce this person's supply of labor hours per month when compared to an alternative program with the rate t = 0.
7. Economic theory indicates that the following approaches to subsidizing poor
people (when designed to be "comparable") can be ranked from "most
efficient," i.e. (1), to "least efficient" in this particular
order: (1) lump sum cash transfers; (2) vouchers limited to spending on particular
goods; (3) price subsidies that lower the relative prices of particular goods;
(4) in-kind transfers whereby recipients are simply given a certain quantity
of particular goods.
8. Assume that there is a higher interest rate applicable to borrowing than
is applicable to saving and investment. Now assume that the entire "structure"
of interest rates increases, making all interest rates 1.5% points higher than
before. Individuals who were net savers when the interest rate structure was
lower are more likely to reduce their savings after the interest rate increases
when contrasted to the cases of either those who were previously net borrowers
or those who neither borrowed nor saved before the interest rate increases.
9. If it is known that the cross price elasticity of demand for X with respect
to the price of Y is negative, and that the pure substitution effect between
the two goods is positive, then the income elasticity of demand for good X must
be positive.
Part II. Problems. Do 3 of 4 of the following problems. Each worth 16 points;
48 points total.
1. In the 17th and 18th centuries, the Royal Shipyards in England conceded
the rights of workers to take pieces of waste wood (call wood chips) and sell
them. Earlier efforts to stop this practice by punishing workers had not been
successful. While this practice continued, only one sixth of the wood bought
for the construction of ships actually was used to produce ships - the rest
left the shipyards in the form of wood chips. Explain your answers to the following
questions:
a. Were the workers made better off by being able to take the wood chips?
b. Would both workers and the Shipyard employers be better off if workers were paid exclusively in money, and workers were not allowed to take wood chips?
c. If all scrap lumber could be burned by the Shipyard, would the "problem" be eliminated?
d. If the people burning the scrap lumber were able to be bribed with money, would the problem facing the Shipyard employers return?
2. Gideon's utility function for packages of doughnuts x, and popcorn, y, is
U = X 1/2 Y 1/2 . The price per doughnut is $9 per large
package, and the price per large package of popcorn is $16.
a. Consider any arbitrary level of utility, U(0). Find the minimum level of expenditures on x and y that can attain this level of utility.
b. What are the actual amounts of x and y corresponding to your answer in (a)?
c. If the price of x increases from $9 to $25, what is the Hicks compensating variation in income? What is the Slutsky compensating variation in income? What accounts for the difference in these two measures?
d. Generalize your answer to part (b) by letting the price of x be p(x) and the price of y be p(y). Write x and y as functions of p(x), p(y) and U(0).
e. Why are your answers to (d) the equivalent of the "compensated demand curves for x and y?"
3. Assume there is a grant program at Georgia State University that gives $4.00
to the College of Business for every dollar donated by a recent graduate. For
all other alumni of the CBA, the grant program will give $2.00 for each additional
dollar donated over and above the graduate's most recent annual donation
to the CBA.
a. Consider a 1998 graduate whose income is spent on other goods and on a donation to the College of Business. How does the graduate's budget constraint change with the new "challenge grant program?"
b. Is this any different than the constraint change facing a graduate from the class of 1988? Demonstrate.
c. Will each graduate increase the amount donated compared to what would have been donated without the challenge grant? Will any graduate decrease the amount donated? Explain your answers.
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