Government intervention

Give some reasonable objectives for a centrally planned economy in a democratic state; state the grounds of your selection of objectives; indicate and discuss possible lines of procedure for realizing them through price control.

Show graphically the effect of lowering the tariff on sugar. (Assumed domestic and foreign demand and supply curves given, and neglect any disturbances in the balance of international payments.)

Discuss the theoretical short-comings involved in a policy on the part of our federal government of progressively bidding up the price of gold in foreign markets.

In an article on the British tobacco industry, the Economist remarked:

“Since 1938 the industry has had to contend with a sixfold rise in the standard rate of tobacco duty, and a three- to fourfold increase in the average cost of its principal raw material—this includes the higher cost of dollar leaf bought since sterling devaluation. All eight duty increases have been automatically passed on to the smoker, but if duty is left out of account the increase in cigarette prices since 1938 has been no more than about 85 per cent.”

What do you take “passed on” to mean in this sentence? What is its relation to the economic concept of “incidence”? What inference, if any, would you draw about the latter?

Suppose the tax on capital income (dividends, interest) is increased. What will be the effect on the demand for cash if the tax proceeds are spent on: (a) aid to foreign countries; (b) federal contribution to medical aid in the United States.

With reference to federal legislation assuring to every resident in the U.S.A. medical care by the physician and hospital of his choice, free and with no special taxation: Appraise the proposal as to effects upon general welfare, assuming that the alternative is the sale of medical insurance, not subsidized, but with the same distribution of personal income effected by cash “relief”.

It is a common view today that an equal reduction of both taxes and governmental expenditure would contribute to an increase of the national income or counteract a tendency to depression. State your position and discuss carefully.

Fair trade is now rapidly disappearing. However, a few firms (Sunbeam, Schaeffer) are actively trying to enforce fair trade pricing.

(a) Are these firms just misguided or are there circumstances in which fair trade would help them?

(b) If fair trade were generally observed, what would be the effect on return on capital and entrepreneurial effort engaged in retailing?

Indicate whether each of the following statements is true (T), false (F), or uncertain (U). Explain briefly the basis for your answer.

_____. If the market elasticity of demand for peaches is -2, a peach producer whose output accounts for 1/20th of the total supply of peaches will be faced by a demand function of elasticity -40.

_____. If a constant amount of carpenters’ services is required per unit of housing constructed, and the elasticity of demand for housing is -1, the elasticity of demand for carpenters’ services used in housing must be less (in absolute value) than unity.

_____. If the production possibilities for wire can be represented by a Cobb-Douglas production function, and the wire industry is competitive, a rise of 10 per cent in the wages of wire-workers will lead to a reduction of 10 per cent in their employment.

_____. The elasticity of demand for a group of commodities with respect to the average price of the group can never be larger in absolute value than the largest of the individual price elasticities of the commodities which comprise the group.

_____. If total consumer expenditures are the same before and after a tax, then an excise tax on a consumer good of elastic demand will lead to an increase in consumer spending on other consumer goods, while an excise tax on a consumer good of inelastic demand will lead to a decline in consumer spending on other consumer goods.

_____. A tax of 10 per cent per year on the rental value (actual or imputed) of all land will in the long run lead to a lowering of the marginal productivity of labor in agriculture.

_____. A technological advance opening up widespread possibilities for new investment in the electronics industry at very high rates of return will tend to lower the real value of the existing stock of residential housing in the United States.

_____. A supply curve passing through the origin has an elasticity equal to unity.

_____. Given certainty, no firm would hold inventories.

_____. A negatively sloping supply curve of labor implies a positively sloping demand curve for leisure.

_____. It is impossible to derive a supply function for a monopolist.

_____. A legally enforced minimum wage for a particular occupation may increase employment in that occupation.

_____. Wage rates rise while interest rates remain the same. It follows that the ratio of capital to labor will increase.

_____. Engel’s laws are due to Friedrich Engels.

The U.S. government currently guarantees a large fraction of mortgages on newly-constructed houses through the Federal Housing Administration and the Veteran’s Administration. The government guarantee naturally makes these more attractive than non-guaranteed mortgages and so leads to their being available at a lower rate of interest. Recently there has been a decline in residential building. Representatives of the industry have suggested that one means of stimulating building would be to extend the government guarantee to mortgages on existing houses. They claim that the higher cost of mortgages on such houses inhibits their sale and thus prevents individuals currently owning houses from coming into the market for new houses.

Analyze the effect that the enactment of this proposal would have on the rate of construction of residential housing. Do not discuss the desirability as a matter of public policy of either the existing guarantees or the proposed extension.

Indicate whether each of the following statements is true (T), false (F), or uncertain (U). Explain briefly the basis for your answer.

A tax on a product whose supply is of zero elasticity will have no effect on resource allocation.

If factors of production are used in absolutely fixed proportion in the production of a particular product, the demand for each of the factors by the producers of the product will be completely inelastic with respect to price.

Since 1951 interest rates have risen by about 50 percent whereas real wages have risen only by approximately 24 percent. This implies that firms are and will be using more labor per unit of capital than they did in 1950.

An income tax has no resource misallocating effects.

A competitive firm will increase its demand for factor A as a result of a fall in the price of factor B.

“A monopolist has no supply curve.” Hence it is impossible to predict his response to a shift in the demand curve facing him.

Budget studies have yielded an income elasticity of demand for food of .5 for urban families and of . 35 for farm families. This implies that farm families have substantially different tastes or consumption habits.

Price stabilization at the mean of fluctuating prices would harm consumers.

Product A is one of the major inputs used in the production of product B. Price control is imposed on product A, but not on product B, at a level below the equilibrium price of A. This will result in a fall of the price of B.

A tax of 50% of the gross sale price of all new automobiles in the U. S. will in the short run tend to double the market value of used automobiles, and in the long run tend to double the gross market price of new automobiles as well.

Suppose the armed forces want to raise a fixed number of men. One way to do this would be to set a price at which the number of volunteers would equal the number wanted. Another way would be to set a lower price and draft the difference between the number wanted and the number volunteering. Assume that each person receiving a draft notice would be permitted not only to enter as a draftee but also either to buy a substitute or to be a substitute for someone else.

Contrast the two schemes in terms of the personnel secured, the pay received, and the source of this pay.

Producers in one area of goods that are also produced elsewhere often claim that the distant producers keep their high quality product at home and sell only their low quality goods elsewhere. On the other hand, consumers often complain that local producers ship all their high quality products elsewhere and sell only the poor quality material locally (as in the standard California complaint that you can’t but a decent orange in retail markets in California). Obviously, either group might be right in some special case. But can you think of any general factors that would on the average tend to produce the one result or the other? I.e., in any particular case, what indirect information would you consider relevant in forming a judgment about which was right?

Answer whether the statement is true, false, or uncertain. In each case, write a few sentences explaining your answer. Your grade will depend heavily on your explanation.

The elasticity of a linear supply function that passes through the origin is always unity.

If a firm is producing in the region of rising marginal costs, the firm is realizing profits.

An effective price ceiling on cotton, i.e., one that holds its price below the free market level, will decrease the price of textiles.

Steel prices and output usually move together during business cycles. This means that the income effect of a rise in price is greater than the substitution effect.

Firms try to minimize unit costs; at the point where unit costs are at a minimum, they equal marginal costs; therefore, firms tend to operate where their unit and marginal costs are equal.

Marginal productivity theory does not apply if factors are always used in fixed proportion.

Since all firms in competitive industry have the same marginal costs, it is meaningless to speak of more or less efficient firms.

If a Paasche price index is higher than the Laspeyres' index, tastes must have changed.

The demand for a product at the market price is inelastic. It follows that the product must be produced under conditions of net internal diseconomies.

“Commodities with higher, income elasticities have higher demand (price) elasticities.” (Stigler, 1952 ed., p. 45)

If X and Y are substitutes, a decline in the price of X can increase the amount of Y demanded only if Y is an inferior good.

The elasticity of demand for a group of commodities with respect to the average price of the group can never be larger in absolute value than the largest of the individual price elasticities of the commodities which comprise the group.

A rational consumer is insatiable.

I. Indicate whether each of the following statements is true (T), false (F), or uncertain (U) and state briefly (on this paper) the reason for your answer.

The elasticity of a straight line demand curve varies from point to point.

In the long run, demand has no influence on the price of the product of a competitive industry that uses no specialized resources.

Marginal revenue is always greater than average revenue when average revenue is rising as quantity increases.

[4. and 5.] Assume that the government is going to purchase a predetermined quantity of rice for foreign relief and that it is considering making its purchases (a) directly from the growers of rice, or (b) through the regular dealer on the grain exchange. Assume also that there are no other governmental actions affecting rise growing or marketing.

The price to the domestic consumer of rice that remains will be higher in case (a) than in case (b).

The price received by the farmer for the rice that remains will be higher in case (a) than in case (b).

An “inferior” good is one such that a larger quantity is demanded at a high than at a low price.

If the quantity of Y increases and the quantity of X decreases in such a way as to keep total utility constant, then the rate of substitution of Y for X is independent of the quantity of X.

The income of the farmers raising corn increases when the price of corn rises. The rise in income is the “income effect of the rise in price.”

[9., 10., 11.] The Gimcrack Company is a monopoly, selling in two distinct markets. Transportation costs between the two markets can be neglected.

The company will always charge the same price for gimcracks in the two markets.

The company will sell such quantities in the two markets as will make the elasticities of demand the same in the two markets.

The company will sell such quantities in the two markets as will make marginal revenue the same in the two markets.

IV. Consider two alternative taxes imposed on a commodity: (a) a specific tax of T dollars per unit sold: (b) an ad valorem tax of t per cent of the price of the product.

Assume that the commodity is produced and sold under strictly competitive conditions and that the price inclusive of tax when the tax of T is imposed is $P_0$. (i) Prove graphically that an ad valorem tax of $t-T/P_0$ will result in the same equilibrium price. (ii) Suppose a tax rate slightly greater than $t-T/P_0$ is imposed. Under what conditions, if any, is it certain that the revenue will increase? (iii) Decrease?

Assume alternatively that the commodity is produced and sold by a monopoly. Suppose that, when a specific tax of T is imposed, the monopolist chose to sell at a price (inclusive of tax) of $P_1$. Suppose now, an ad valorem tax of $t-T/P_1$ is imposed. (iv) Will the monopolist’s optimum price be $P_1$? If not, will it be higher? or lower? Prove your answer.

I. Indicate which alternatives, if any, are correct or fill in the indicated blanks. Where you think it required, briefly justify your answer.

Marginal revenue (a) cannot (b) may (c) must rise as output increases.

A monopolized product initially sells for $1. A tax is imposed on the product. A tax of t cents per unit will reduce marginal revenue at the pre-tax output (a) more, (b) less, (c) the same amount, (d) sometimes more sometimes less than a tax of t per cent.

In the preceding example, the imposition of a tax of t cents will lead the monopolist to reduce output (a) more, (b) less, (c) the same amount, (d) sometimes more sometimes less than a tax of t per cent.

A reduction in demand for a product is followed by a rise in quantity sold despite no change in conditions of supply. It follows that the product is being produced (a) in a competitive industry with increasing returns, (b) in a competitive industry with external diseconomies, (c) by a monopolist, (d) this result is impossible under any of the preceding conditions.

Assume that the government has been supporting the price of wheat by buying any wheat offered to it at its support price. Suppose it abandons the program. In the new position of long period equilibrium the total amount received by producers will rise (a) only if the market demand for wheat is inelastic in the range between the support and new price, (b) only if the market demand for wheat is elastic in this range, (c) whatever the demand elasticity, (d) under no circumstances.

An individual buys four commodities, W, X, Y, and Z, currently spending one-quarter of his income on each. The income elasticity of W and X are 2; of Y, 1. The income elasticity of Z is _________?

Consider three demand curves for commodity X: A, for given money income and other prices; B for given apparent real income in Slutsky's sense; C, for given real income in Hicks' sense. Let all three curves go through the point $(p_o,x_o)$. If X is a superior good, then for a price higher than $p_o$, the quantity demanded will be larger for ____ than for ____ than for ____ (Insert A, B, C, in correct spaces).

Suppose p_o = \2$,$x_o = 40$,thecorrespondingmoneyincomeis$200, and the income elasticity of demand for x is unity. Suppose that at a price of $2.50, the quantity demanded on Curve A is 20. Then the income compensation required to pass from A to B is $ _____ (be sure to indicate sign of change) and the quantity demanded on curve B is _____.

If long run average cost (LRAC) equals short run average cost (SRAC) at an output on the falling segment of the LRAC curve then short run marginal cost (SRMC) (a) exceeds, (b) equals, (c) is less than long run marginal cost (LRMC) at that output.

If LRAC is rising and less than SRAC, then SRMC is (a) rising, (b) falling, (c) greater than SRAC, (d) less than SRAC.

In a discussion of the World Series last fall, Jones offered to take either side of a bet with Smith involving a payment of $2 by one party if the Pirates won, of $1 if the Yankees did. It follows that Jones' estimate of the probability that the Yankees would win is _____ and that his utility function of income is (a) concave upward, (b) linear, (c) concave downward, (d) not concave upward, (e) not concave downward.

Alternatively, Jones refuses to take either side of the preceding bet but offered to take either side of a bet involving a payment of $200 by one party if the Pirates won or of $100 if the Yankees did. This behavior (a) contradicts or (b) is consistent with the expected utility hypothesis.

A monopolist is faced with the following stable demand schedule for his patented machines:

Price per machine (thousand dollars) / Quantity per month / TR / MR / TC / MC 40 / 1 35 / 2 30 / 3 25 / 4 20 / 5 15 / 6 10 / 8 5 / 10

The Costs of production are $5000 per machine, and the fixed costs are $16000 per month.

1.) Compute total and marginal revenue and total and marginal costs in the table above.

2.) Find the equilibrium price, quantity and profits of this firm.

3.) A tax of $60,000 per month is imposed on the firm. Find the new price, quantity and profits.

4.) Instead, a tax of 60% of the market price is imposed on the machines. What will be the monopolist price, output, profits? The tax revenues?

5.) Alternatively, a tax of $24000 per machine is levied. What are the equilibrium price, quantity, profits and tax revenues? What will be the long-run equilibrium quantity?

6.) If no tax is imposed, but a maximum price of $10,000 is enforced, what will be the quantity sold? The Profits?

7.) State your preference among the 5 alternatives ((2) – (6)) above, and justify your choice briefly.

True, False, or Uncertain. In each case write a few sentences explaining your answer. Your grade will depend heavily on your explanation.

If the United States exports one tenth of its coal, the elasticity of supply of domestic coal being unity, the elasticity of supply of U.S. coal exports must be at least 10.

If the price of X rises while the price of X stays constant, the amount of Y demanded will always increase, so long as X and Y are substitutes. (Assume money income and other prices remain unchanged.)

The own-price elasticity of demand for a commodity must always equal or exceed, in absolute value, the cross elasticity of demand for that commodity with respect to the price of any other commodity.

The own-price elasticity of demand for a commodity must always equal or exceed, in absolute value, the marginal propensity to consume that commodity.

When the production function is such that factors of production combine with each other in fixed proportions to produce a product, the own price elasticity of demand for the use of any of the factors in the production of the product must be less than the price elasticity of demand for the product. (Assume that the production of the product in question is competitive.)

The income elasticity of demand for a commodity is the marginal propensity to consume that commodity divided by the average propensity to consume that commodity.

The elasticity of demand for labor in the production of automobiles will be lower in the case in which the quantities of other factors are given than in the case in which the prices of other factors are taken as given.

The elasticity of demand facing a monopolist will be lower than the elasticity of demand facing the same industry if it were competitive.

The welfare cost of a 5 percent tax on automobiles is the same as the welfare cost of a 5 percent subsidy on all goods and services other than automobiles.

The welfare cost per dollar of tax receipts of a 5 percent tax on automobiles is the same as the welfare cost per dollar of tax receipts of a 5 percent tax on all goods and services other than automobiles.

If, at a point in a production function which is homogeneous (of degree 1), the marginal product of factor B is negative, the marginal product of factor A will be rising (in the sense that the marginal product of A will be higher when the proportion of factor A to factor B is slightly increased). Assume that A and B are the only two factors.

The supply curve of labor can be backward bending only if leisure is an inferior good.

The demand for the services of a factor of production in a particular industry will be more elastic, the larger is the share of that factor in the total costs of the industry in question.

All short run average cost curves are tangent at (at least) one point to the long run average cost curve.

Indicate, using supply and demand diagrams, what is the welfare cost of a tariff. Assume that the tariff is on a product (woolen cloth) in which the domestic demand is partly met by domestic supplies and partly met by imports. The tariff, of course, is a tax only on the imports. Assume that the imported product and the domestic product are for all relevant purposes homogeneous. What role does the elasticity of domestic demand for woolen cloth play in your measure of welfare cost? The elasticity of domestic supply of woolen cloth? The ratio of domestic supply to domestic demand?

State whether each of the following statements about the U. S. economy is true, false, or uncertain, and explain your answers briefly.

Consumers decide what will be produced.

All consumers participate equally in determining what will be produced.

The government influences the composition of output in the private consumer goods sector.

The government determines the level of investment for the economy as a whole.

By means of appropriate diagrams and/or explanations, show the short-run effect of each of the following taxes on the output and profits of a monopolist.

An excise tax of 10 cents per unit of product.

An excise tax of 10 percent of the price of the product.

A corporate profit tax equal to 50 percent of net profits.

The Edgeworth Box Company is the only employer in the town of Yarmouth. Its supply schedule of labor is given by $W=40+\frac{1}{4}q$, where $W$ is the wage in cents per hour and $q$ is the number of manhours supplied per week. The company sells boxes in a competitive market. The value of the marginal product of labor is given by

$V=100-\frac{1}{2}q$ for values of $q$ greater than zero.

How many man-hours of labor will the company employ, and at what wage?

Show diagramatically for part (a) first, the wage bill and second, the sum of monopoly profits and the return to factors of production other than labor.

What will be the effect on employment of a legal minimum wage of 60 cents an hour? of 80 cents an hour?

This problem may be solved algebraically or graphically. The following table gives numerically some points on the schedules whose equations are given above:

Supply [q (Man-hours), W (cents)] / Marginal Product [q (man-hours), W (cents)]: 1, 40.25 / 1, 99.5 2, 40.50 / 2, 99.0 3, 40.75 / 3, 98.5 4, 41.00 / 4, 98.0 etc. / etc.

The difference between the price of foreign crude oil and the price of domestic crude oil (landed at the same U.S. port) times the quantity of oil consumed in the U.S. is roughly $5 billion. This has been cited as an estimate of the cost to the U.S., in terms of wasted resources, of the whole set of governmental measures special to oil (oil import quotas, percentage depletion allowances, prorationing of oil, etc.). Indicate as specifically as you can the defects, if any, in this measure, and the information needed to set a dollar value on each defect.

“The orthodox tools of supply and demand assume that sellers and buyers are free to buy or sell any quantities they wish at the price determined by the market. This assumption cannot validly be made when price controls or rations are imposed by government. It follows that these tools are useless in analyzing the effects of such governmental actions. Economists should free themselves from slavish adherence to outmoded concepts and fashion new tools for the new problems raised by the modern Leviathan.” Discuss.

Indicate whether each of the following statements is true or false and explain briefly why.

1. An “inferior” good is one for which the marginal utility is negative.

2. The short-run marginal cost curves cross the long-run marginal cost curve from below (proceeding from left to right) at the quantities corresponding to the points of tangency of their respective average curves.

3. For a homogeneous production function of degree one, and, for given relative factor prices but varying output, both of the following are true:

a. The ratios of the quantities of the various inputs are constant at all levels of outputs.

b. The average productivities for each factor are constant at all levels of output.

4. Suppose you have the following budget data for two periods for a consistent consumer (i.e., a consumer who, in those situations where the same two commodity bundles are within his budget and he chooses one of them, will never choose the other one): prices of all goods in only the first period $p_{i1}$ for $i=1,2,\dots ,n$) and quantities purchased of all goods ($q_{i1}$ and $q_{i2}$ for $i=1,2,\dots ,n$).

Then it is true that implies that the consumer is “better off” in the first period than in the second.

5. Consider an individual’s demand functions for two goods, $x_k$ and $x_j$. Then the cross elasticity of demand for $x_k$ with respect to $p_{ik}$ is equal to the cross elasticity of demand for $x_j$ with respect to $p_k$ when only the substitution terms are considered.

6. “The more the merrier” is a denial of the law of diminishing marginal utility.

7. “The increment of product resulting from adding one more worker to a firm should not be attributed exclusively to labor because it results partly from the more intensive working of the other productive factors.”

8. A tax of 20 per cent on all wages and salaries will decrease the supply of labor by more than a tax of 20 per cent on overtime pay alone.

9. Carpenters would not receive a wage equal to the value of their marginal product if they were a “specific factor of production” in the industry using their services.

10. The demand function for labor on the part of a competitive industry can in some cases be more elastic in the neighborhood of a given point if the quantities of other factors are taken as given than if the prices of other factors are taken as given.

President Johnson has recently sent to Congress a bill that would require certain industries to pay double the standard wage-rate for overtime. Assuming competitive conditions, what can you say about the effect on (a) prices of products (b) output (c) number of man hours, (d) number of persons employed in (1) the industries affected and (2) other industries?

Currently, the number of taxicabs permitted to operate in the city of Chicago is limited by licensure, no new licenses are being issued, and existing licenses which can be transferred sell for substantial sums. In addition, the price which taxicabs charge is fixed by the city. (A) Suppose restrictions on licensure were lifted but prices continued to be fixed at present levels. What would be the effect on (a) number of cabs, (b) incomes of non-driving owners of cabs, (c) wages of non-owning (i.e., hired) cab drivers?

(B) Suppose the price restrictions were lifted, so cabs could charge whatever they wanted. What would you expect to happen to prices for taxicab rides, both with respect to level and structure?

It is sometimes alleged that periods of economic depression are more conducive to the growth of economic regulation than prosperity. Develop a theory which elaborates the link between the level of economic activity and the propensity to regulate. Include a discussion of whether the goals of regulatory agencies (old as well as new) are likely to differ with the level of economic activity.

There has recently been renewed interest in the social optimality of various devices for the public regulation of pollution. Among popular proposals to deal with the problem: emission taxes, subsidies for pollution control, transferable rights to emit pollutants, maximum limits on pollution discharges from each source. Assume that the optimality conditions for public regulation have been met. Evaluate the relative efficiency of these four devices and any others you wish to add to the list.

An excise tax affects the allocation of resources among different uses, whereas an income tax does not.

An effective price ceiling on cotton, i.e., one that holds its price below the free market level, will decrease the market price of textiles.

A subsidy of a fixed number of dollars per unit of output might be used as part of a program to control a monopoly in the public interest.

Assume that if the prices of farm products fall farmers will expend more effort in an attempt to maintain their income. Under these circumstances, a reduction in effective farm price supports will increase the volume of farm surpluses.

Take it as a fact that grade one cocoa commands a premium on world markets over inferior grades; that the Nigerian Cocoa Marketing Board (which is the sole purchaser from producers) has set a differential between grades in prices paid to producers wider than the world market differential; and that they have succeeded in this way in raising sharply the proportion of Nigerian production which is grade one. By so doing, they have greatly improved the efficiency of the Nigerian economy.

III. (40 points)

Some prominent manufacturers such as Sunbeam, Eastman Kodak, and Bayer Aspirin, set minimum prices below which retailers may not resell their products. In most states an agreement to this effect between a manufacturer and some retailers is legally enforceable on all retailers.

(a) What is the probable effect of this practice on the net rate of return on factors of production used in retailing?

(b) What is the probable effect of this practice on the net profits of the manufacturers concerned?

Explain your answers fully.

It is argued in connection with the development of underdeveloped countries that basic industries such as steel should be developed by the government, since private investors will neglect the external economies brought to other industries by low-cost steel, and therefore will underinvest. Evaluate this argument. For what general class or classes of cases is the argument correct?

III. (40 minutes)

It has often been suggested that the demand for a durable good could be increased if “something were done about the large number of used items on the market” The practical suggestions usually are (1) a government regulation forbidding the use of items older than some specified age, e.g. declaring all pre-1950 cars as “unsafe” and withholding license plates from them or (2) “the manufacturers should buy up the used items and destroy them or export them at a loss. Discuss the consequences of these two types of policies on (a) the demand for new durable equipment and (b) the profitability to the industry of the two policies.

IV. (40 minutes)

“The first impact of this policy (tight money) is the higher interest rate. Plainly the impact of this will be very different on a firm that has control over its prices and hence can pass along this higher cost as compared with the firm whose prices are given and which, accordingly, must bear the cost itself. The point need not be labored.

“The U.S. Steel Corporation justified its price increase of 2 weeks ago by the contention that its cost had risen. In doing so it not only conceded its ability to pass higher costs, including higher interest charges, to the consumer but based its policy on the need to do so. But no such opportunity is open to the farmer or to the smaller businessman. They cannot raise their prices, for they are market-determined. They shoulder themselves the costs of this policy.”

Analyze and evaluate this statement. Disregard the peculiar problems of monetary policy. Treat it as a question about the differential impact of a change in any factor price on a competitive firm or industry as against the impact on a monopolistic firm. Does a change in factor cost “hurt” less in one case than in the other? What do you understand by “passing the cost on to the consumer” and how does the distinction between a monopoly and a competitive industry affect this? Assume the same cost curves and the same shifts in both cases.

(60 points) Indicate whether you believe each of the following statements to be true, false, or uncertain. In each case write a few sentences explaining your answer. Your grade will depend heavily on your explanation.

If the rate of obsolescence is constant over time for each type of capital equipment, a rise in the rate of interest will shorten the optimal life of capital equipment.

If oranges are substitutes for apples, apples are complementary to cheese, and cheese is a substitute for butter, oranges and butter are complements.

If a certain commodity is rationed and subject to price control, and there is a black market price for it, the black market price is the equilibrium price of the commodity in the absence of price control.

Let ${\sum }_i{p}_{i1}{x}_{i1}$ and ${\sum }_i{p}_{i2}{x}_{i2}$ be the expenditure of a firm on factors of production per unit of output at two points in time. If ${\sum }_i{p}_{i1}{x}_{i2}>{\sum }_i{p}_{i1}{x}_{i1}$ and ${\sum }_i{p}_{i2}{x}_{i1}<{\sum }_i{p}_{i2}{x}_{i2}$, the production function of the firm has changed between the two points of time.

A company cannot have a monopoly if its shareholders receive only the normal rate of earnings on their stock in it.

If the production function of an Industry is subject to constant returns to scale, the industry supply curve will be horizontal.

If it were possible to travel backwards as well as forwards in time, everyone would be a millionaire.

The development of better fertilizer will increase the value of farm land.

Manufacturers frequently advertise that their products contain extra ingredients, and they generally succeed in selling “extra-ingredient” products (e.g. Bufferin) at higher prices than “similar” single-ingredient products (e.g. aspirin). This implies that consumers have a diminishing marginal rate of substitution between the ingredients.

The removal of a barrier to competition anywhere in the economy must make society better off.

Given:

a three-product world,

the cross-elasticity of demand of x with respect to the price of z is zero,

the own-price elasticity of demand for x is -1,

y and z are substitutes,

expenditures on X occupy half of consumers’ budgets, expenditures on Y one quarter of consumers’ budgets in the initial situation,

it follows that the own-price elasticity of demand for y is greater than 1.5 in absolute value. (For this question consider all price-elasticities defined to include the substitution effect only.)

The price-elasticity of demand on the part of a competitive industry for a factor of production will be greater, the smaller is the share of that factor of production in the total costs of the industry in question.

If production in industry X (assumed to be competitive) is governed by a Cobb-Douglas production function, then no wage set by the trade union in that industry will produce greater total labor income than any other wage.

A tax of a fixed amount per unit of output, placed upon the product of an industry with constant costs, will necessarily result in a smaller rise in price if that industry is organized (and behaves) as a monopoly than if the industry is competitive.

In an industry employing just two factors of production, the elasticity of demand on the part of that industry for either factor must be less in absolute value than the elasticity of substitution between the two factors in that industry.

Discuss the following quotations:

(from a newspaper story) “The Sun Rose Bar and Grill…advertised ‘the largest glass of beer in the city for five cents’ and did a tremendous business in eight-ounce glasses of beer as soon as the public realized it was no April Fool proposition…

‘If enough of us do this’ said…one of the proprietors, ‘the brewers will have to cut prices!’”.

(from a newspaper story) “Domestic producers of oil contend that unrestricted imports hurt them not only because they swell the supply, but because a barrel of foreign crude costs about $1 less than a comparable barrel of U.S. crude.”

“All of this is to say, of course, that in practice what we have to reckon with is not a unique marginal cost for a given level of output, but a complex of marginal costs, each of which is pertinent to a particular period of time. As a longer period of time is considered, more of the ‘fixed factors’ become variable. Because of this greater flexibility in the production process, long-run marginal cost will generally be less than short-run marginal costs.” A. Bergson in A Survey of Contemporary Economics.

Indicate whether statement is true, false, or uncertain, and briefly give your reason.

A firm has a monopoly in its home market and also sells in a perfectly competitive world market; if its home-market price is 50% above the world market price, the elasticity of demand in the home market must be 3.

If a multiplant firm has to produce a given quantity of output, it will never pay it to produce in more than one of its plants if that plant has decreasing marginal costs.

The development of more rapid urban transport will inevitably raise the aggregate rental value of urban residential property.

If the number of acceptable applicants for admission to medical schools is less than the number that could be accepted, the medical profession cannot be raising its earnings by artificially restricting entry.

The rate of interest is determined by the marginal productivity of capital.

If a particular commodity is subject to a special tax not imposed on other commodities, removal of that tax will always increase economic welfare.

If the supply curve of a competitive industry has a positive slope, it means that the industry is subject to decreasing returns to scale.

If wage rates, on the average, increase at the same rate as average product per worker, this means that the marginal return on investment declines over time.

Entrepreneurs in a competitive industry may realize short term gains or profit as a result of an increase in the price of an input (due to a shift in the supply function for the input), even if the demand curve for the industry remains unchanged.

A. A drug manufacturer stated that the prices of drugs sold in England were priced at about one half the price of similar drugs in the United States. The reason given for the price difference was that per capita incomes were much lower in England than in the United States and the English could not afford to pay as much for the drugs.

Accept the factual statements as valid. Discuss the statement in terms of:

Demand functions for drugs in the two countries (income and price elasticities).

Whether the manufacturer could be maximizing his profits.

International trade restrictions on drugs in the two countries.

B. In a given competitive industry, both price and output increase between two time periods. Indicate why each of the following statements is consistent or inconsistent with the observed changes in price and output or is simply irrelevant:

The industry has a perfectly elastic supply curve.

The demand curve has shifted to the right.

The factor supply curves are upward sloping.

The industry is subject to diminishing returns.

Total revenue has increased because the price elasticity of demand is greater than unity.

Rents and quasi-rents have increased.

A. In the effect of union-produced wage increases on prices, one economist says,

“A competitive industry (with a horizontal long run supply curve] will eventually pass all of a wage increase on to consumers in higher product prices” but “a monopolized industry, if it maximizes profits both before and after the wage increase, will not pass on the full amount of the wage increase in prices.”

Assume that the monopolized industry, like the competitive, operates under long-run constant costs.

Explain precisely what “pass all of a wage increase on to consumers in higher prices” means.

Is the statement for the monopolized industry correct? If so, prove it. If not, state why not and indicate any additional conditions required to make it true.

B. This economist also says that the competitive industry “will regain its normal rate of profit”, whereas, in the monopolized industry, “the wage increase will lower monopoly profits”

What does the word “profit” mean in these statements? in the phrase “maximizes profits” of the preceding question?

Do the two statements imply a difference in results in the sense that the monopolized industry will not regain “its normal rate of profit”?

Indicate briefly what other meaning or meanings, if any, does the term “profit” have in economic theory.

(40 minutes) It appears that the Federal Communications Commission will be given the power to compel manufacturers of television sets to build them in such a way that they will receive ultra-high frequency broadcasts (at an additional cost of about $25 per set). Then every community can have (say) a dozen channels. Will consumers be benefitted?

A flat sum tax on the firms in an industry will never have an effect upon output in the short-run.

A tax on American citizens who go abroad will reduce tourist expenditures and hence improve the U.S. balance of payments only if the demand for foreign trips is elastic.

“Exploration for natural gas or oil is a form of investment. As such, like all investments, it depends on the expected level of future output (demand). Thus, a rise in the governmentally fixed (regulated) price of natural gas will decrease consumption and hence curb exploration. Conversely, lowering the price of gas will stimulate both consumption and exploration.” Appraise.

Assume that a comprehensive system of point rationing is superimposed on a money price system. Each consumer is given an equal number of points although money incomes are very unequal. Point prices exist for every commodity for which a money price exists, and a consumer must pay over both points and money to purchase a commodity. To simplify the analysis, assume throughout (1) that the points are dated, (that is, can be used only during a specific period), (2) that fixed and known quantities of various commodities are available each period.

(a) Indicate (on an indifference diagram or in any other manner) how to determine the quantity of each good that an individual would purchase, given money prices, point prices, his money income, and his point income (i) if it is illegal to transfer points from one person to another and consumers conform to this requirement, and (ii) if points may legally be bought and sold for money. In this case, take as given to the individual consumer also the price of points in terms of money.

(b) If the only thing the government fixed were the number of points each individual receives, and it were to allow the money prices, point prices, and price of points in terms of money to be determined on the market, there would not be a unique set of values of these variables that would establish equilibrium, because the number of variables would be greater than the number of conditions. Explain this statement. Suppose the government tries to remove the indeterminacy by assigning values to some variables on the basis of criteria other than clearing the market. How many variables could the government so set and still have a determinate equilibrium? Does it matter which variables the government sets?

(c) It has been argues that every consumer will gain if non-transferable points, case (a) (i), were made freely transferable into money, case (a) (ii). Do you think this correct? Discuss.

(20 points) Define briefly:

Indifference curve

Income effect of a change in price

Equilibrium price

Marshallian demand curve

Marginal rate of substitution

(40 points) Indicate whether each of the following statements is true (T), false (F), or uncertain (U), and state briefly the reason for your answer.

A government subsidy of $100 per year to each grower of potatoes enacted after the end of a particular planting season and expected to be continued indefinitely will lower the price of potatoes (which it is assumed cannot be stored)

_____ a. for that season's crop.

_____ b. in the long run.

During period when general business is improving, both the price and output of steel rise. This means

_____ a. that the income effect of the rise in price is greater than the substitution effect.

_____ b. that the demand for steel is inelastic.

_____ c. that the demand for steel increases with income.

Removal of rent control would

_____ a. reduce the money wages of maids.

_____ b. reduce the price of trailers.

_____ If the removal of rent controls were to lead to a rise in rents, then the total amount paid in rents would decline if the demand for rental housing were elastic and rise if the demand for rental housing were inelastic.

_____ "Since elasticity measures variation in quantity (demanded or offered) divided by variations in a price, the elasticity of demand for anything will be seven times as large for seven similar demanders as it is for one." (A. C. Pigou)

_____ A rise in the price of coal will reduce the number of "Okies" trying to go to California.

(40 points) Assume that a system of point rationing is superimposed on a price system. Each consumer is given a specified total number of points, point prices are set on various commodities, and a consumer must pay over both points and money to purchase a commodity. For simplicity, assume that there are only two commodities in the system. Indicate (on an indifference diagram or in any other manner), how to determine the quantity of each of the two commodities an individual would purchase, given money prices, point prices, his money income, and his point income.

(a) If it is illegal to transfer points from one person to another and consumers conform to this requirement. In your explanation, distinguish among the various special cases that may arise.

(b) If points may legally be bought and sold for money. In this case, take as given also the price of points in terms of money.

(c) Suppose that a fixed total quantity of each of the two goods is available; that point prices are fixed by the government, money prices are freely determined so as to clear the market; and that in case (a) some consumers are left with points which they cannot spend because they do not have enough money. The legal prohibition against transferring points is now removed, the point prices and the total number of points issued are unchanged, and the price of points in terms of money is determined in the open market. What, if anything, can be said about the price of points in terms of money under these conditions?

2. Indicate which of the following statements are true (T) and which false (F):

[T] If a one per cent increase in price will cause more than a one per cent reduction in amount demanded, the demand for the commodity is elastic.

[F] Cost of production affects price only through its effect on the rate of production.

[F] If production of a commodity is completely monopolized, and if the monopolist takes full advantage of his position, no changes in the cost of production will have any effect upon price.

[F] A fixed tax (say, a license tax of $10,000) would operate to increase the price at which a monopolist would make the largest net return (or largest net earnings).

[blank] An individual firm will undertake to equalize marginal revenue and marginal cost.

[F] An excise tax is likely to increase the price of a competitively produced commodity by the full amount of the tax.

[T] If price exceeds the competitive producer’s average expense it will therefore be advantageous for him to increase his rate of production.

[T] A monopoly will never operate at a price at which the demand of its product is inelastic.

Suppose that legislative hearings were to be held on the following (a) A national bill to make the minimum wage rate very regionally, so it would be lower in the South than in the North; (b) A bill in a particular state to make it legal for manufacturers to enforce a minimum retail price on their products (a so-called “fair-trade” law).

Indicate what groups you would expect to be testifying for and against each bill, and why you would expect them to do so.

In most states it is illegal for drug stores to advertise the prices of prescription drugs. A customer can find out the price of a prescription drug only by asking the pharmacist in person. In addition only pharmacists licensed by the state are allowed to dispense drugs and every drug store must employ at least one licensed pharmacist. One can become a licensed pharmacist by passing an examination administered by the state and written by a board of pharmacists. Finally, a pharmacist must fill a prescription exactly as it is written by the physician and may not substitute a generically equivalent drug.

What would happen if pharmacists were allowed to advertise the prices of prescription drugs?

What would happen to the price of drugs if pharmacists were allowed to substitute any drug from a specified list in place of the prescribed drug?

We are presently importing considerable oil at the $10 barrel price, and producing domestically at a free price from new wells and a $5 price from “old” wells (on amounts they produced before the oil price rises).

What would be the effect on domestic price of a higher tariff on imports? On what would the magnitude of the price rise depend?

What would be the effect on domestic price of a removal of the price ceiling on “old” oil? On what would the magnitude of this price effect depend?

Ontario imposes a tax of 30 percent on the sale or bequest of any land to non-Canadians. What are the effects of such a tax on:

Landowners, Canadian and non-Canadian;

Non-landowners, Canadian and non-Canadian.

What will the effect be if leases are not regulated?

(a) Appraise: “Recent studies of domestic consumption in low-cost municipalities demonstrate that the demand for electric current is highly elastic, expanding rapidly as the cost declines. The national average consumption of the United States was 604 kilowatt-hours in 1933. The average charge to consumers on October 1, 1934, for the whole country is reported as 5.4 cents per kilowatt-hour. In Seattle where the average cost is 2.58 cents, the average consumption is 1,098 kilowatt-hours. In Tacoma, the charge is 1.726 cents and the consumption 1,550. In 26 cities of Ontario, the average charge is 1.45 cents and the consumption 1,780. Finally, in Winnipeg, where the average net charge is only 8 mills per kilowatt-hour the average per capita consumption exceeds 4,000 kilowatt-hours.” (Report of the National Resources Board, December 1, 1934, Government Printing Office, 1934, p. 39.)

(b) Will a specific tax (a tax of a specified number of dollars per physical unit) on a commodity raise its price more or less than an equivalent ad valoremtax (a tax of a specified percentage of the price)? Assume that the commodity is produced and sold under competitive conditions.

The accompanying diagram showing a set of indifference curves between income and work is part of a diagram given by Boulding in Economic Analysis in his discussion of the effects of various types of direct taxation, and reproduced by Schwartz and Moore in the March 1951 American Economic Review. The latter write, “Given O Q2Q5 as a rate of pay, the equilibrium position is P1 where the rate of pay is equal to the MRS between leisure and income. Let us assume that we are to collect a tax from this individual equal to OL. One method of collecting the tax would be to levy a poll tax, leaving the rate of pay unaltered, as LP5. Another direct tax would be a proportional income tax represented by OSP2 which would have the effect of lowering (flattening) the rate of ‘take-home’ pay. To extract the same amount of revenue as the poll tax does, this rate of pay must be tangent to an indifference curve at an intersection with LP5. Thus P2Q2 = OL. Since the rate of ‘take-home’ pay is flatter, P2 must lie below and to the left of P5; i.e. less effort is expended and the worker enjoys a smaller net income. More important, his welfare is diminished because he must be on a lower indifference curve…Given the premises of the conventional indifference curve pattern, this must necessarily be true.”

(a):

(1) Why do the indifference curves in the diagram slope positively?

(2) How can you justify their being drawn concave upwards?

(3) The statement that OQ2Q5 is “a rate of pay” is of course wrong. OQ2Q5 is a line. Reword the statement so it is accurate.

(4) What do the authors mean by MRS?

(b) If we suppose the diagram to stand for a “representative” individual, or one of a society of identical individuals all to be taxed alike, the last sentence in the quotation is false: the authors' welfare conclusion does not follow from their premises and arguments. Point out the fallacy in the proof.

(c) Under what conditions is the authors' welfare conclusion valid? Can you give a proof of your statement?

Indicate whether each of the following statements is true (T), false (F), or uncertain (U), and state briefly the reason for your answer. It is to be understood that in each question the appropriate “other things” are to be held constant.

1. The imposition of a minimum wage for labor of type X higher than the preceding wage leads to an increase in the number of laborers of type X employed. It follows that labor of type X is hired under monopsonistic conditions.

2. Under both competition and monopoly in the product market, marginal value product of a factor to a firm is equal to marginal physical product of the firm times marginal revenue to the firm from the sale of the product.

3. Marginal productivity analysis shows that, in the absence of monopsony, a laborer gets as a wage his marginal value product. If this analysis is correct, it follows that unions can raise wages in the absence of monopsony only if they either make each worker more efficient, or increase demand for the product, or make the demand for the product more elastic.

4. The law of variable proportions (or diminishing returns) is contradicted by the fact that agricultural output of this country has increased tremendously despite a decrease in the proportion of the working population on farms.

5. The rate of interest is equal to the rate of time preference of consumers.

6. At present levels of operation, three quarters of the total cost of the XYZ railroad is overhead cost that does not vary with traffic, only one quarter is variable cost. It follows that marginal cost is much less than average cost.

7. The demand curve of an individual firm for a factor of production is identical with its marginal value productivity curve for the same factor of production.

8. The demand curve of a firm for a factor of production is a meaningless concept if the firm is a monopsonistic purchaser of that factor.

9. A declining long run supply curve is impossible in a competitive industry.

10. Marginal factor cost is equal to the price per unit of a factor whenever the product market is competitive.

11. According to the theory of joint demand, the absolute value of the elasticity of derived demand for a factor of production will be smaller the more inelastic the supply of that factor.

12. The fact that individuals do not choose occupations solely on the basis of their pecuniary attractiveness helps explain why the supply curve of labor for a particular occupation has an elasticity greater than zero.

13. If all types of services were used only in fixed proportions, a marginal-productivity theory would be neither necessary nor possible.

14. Our society is often described as a “profit” economy or “profit-maximizing” economy. The word “profit” is here used in the same sense as in the uncertainty theory of “profit.”

15. “Profit” as defined in the uncertainty theory of profit is the expected return to any factor assuming uncertainty over and above the guaranteed expected income it can obtain if it assumes no uncertainty.

16. If one income is higher than another before income tax it will also be higher after a progressive income tax, provided only that the marginal tax never exceeds 100%. It follows that if one accepts the theory that individuals act as if they sought to maximize their income, he must also accept the conclusion that such taxes do not alter individual's actions and hence are not shifted.

17 and 18. A minimum wage law is repealed. The wage rate of a class of workers hired under competitive conditions was equal to the minimum before repeal and falls after repeal. It follows that:

17. The total wage bill for this class of labor will rise, remain constant, or fall, according as the elasticity of demand for labor of this class is greater than, equal to, or less than unity in absolute value.

18. The quantity of labor of this class employed will fall, remain constant, or rise according as the elasticity of supply of labor of this class is positive, zero, or negative.

19. The great technological improvements in the past few decades in the production of synthetic fibers (rayon, nylon, etc.) and associated decline in their relative price has, among other effects, tended to raise the price of meat in general, especially of lamb and mutton.

20. At the same time, stringent rationing of meat consumption in Great Britain, by tending to offset this effect, has improved the competitive position of the synthetic fiber industry, and so enabled it to expand more than otherwise.

It is frequently argued that a tax on a product imposed at the manufacturing level involves a greater burden on consumers than a tax yielding the same revenue imposed at the retail level because the tax is “pyramided,” i.e., the “margins” of wholesalers and retailers are viewed as given percentages of purchase price and so, it is argued, price will tend to rise not only by the tax but also by the “margins” on the tax.

Evaluate this argument.

A subsidy of $X is paid per acre of land devoted to growing soy beans. Will this lead to a rise or to a decline in the yield per acre on land devoted to growing soy beans prior to the introduction of the subsidy? Justify your answer.

Indicate in each box whether the change in the indicated variable would, under the specified conditions, tend to be an increase (+), decrease (-), no change (0), or is uncertain (?). In each case, of course, assume other relevant variables unchanged.

Make usual assumptions about behavior functions.

The table columns are organized under two conditions — Underemployment / Rigid Wages, and Full Employment / Flexible Wages — with the following variables for each: Employment, Interest rate, Real stock of money, Consumption (Underemployment, Rigid Wages); and Price level, Interest rate, Real stock of money, Consumption (Full Employment, Flexible Wages).

Assumed change:

(1) Rise in tariff

(2) Increase in government taxes, no change in government expenditures

(3) Reduction in legal reserve requirements of member banks

(4) Discovery of vast oilfields

(5) Substitution of tax on land values for tax on wages, no change in revenue

(6) Emergence of widespread fear of civil disturbances

Consider a hypothetical economy in which initially, government expenditures (G) are 100, private investment (I) is 50, and private consumption (C) is 350, so that national product (Y) is 100 + 50 + 350 = 500, and tax receipts (T) are 90. Assume that G and T are both reduced by 10 to 90 and 80 respectively, and that wage rates are rigid.

If you neglect any effects on the rate of interest, what would be the resulting values of C, I, and Y? Prove your answer in general by a simple algebraic analysis.

Would you expect any effects on the interest rate if nominal quantity of money is constant? If so, what effect? How would this in turn affect I, C, and Y? Give hypothetical numbers that might correspond to final outcome.

Again, prove your answer.

What additional complications, if any, are relevant in generalizing these effects of a balanced budget change to actual circumstances?

MONETARY vs. FISCAL POLICY

Define fiscal policy as deliberate changes in the government tax structure or expenditure structure for a given behavior of the quantity of money; monetary policy as a change in the rate of change of the quantity of money for a given tax and expenditure structure.

Using the standard income-expenditure model, and assuming prices are rigid, analyze the effect on real income and interest rates of an increase in taxes which would raise the full-employment surplus (or lower the full-employment deficit) by X billion dollars. Specify the parameters on which the result depends and indicate limiting cases.

Using the same model, indicate how to determine the change in monetary policy that would have the same effect on real income. How would other effects of the two policies differ?

The standard model is in terms of comparative statics, so (1) and (2) would be analyzed in terms of a comparison of two alternative positions at a single date. In addition, the only stock variable in the standard model is the quantity of money. Modify the analysis in (1) in both respects. That is, indicate the time path of adjustment you might expect and why, taking into account any effects on such stock variables as total holdings of government and private securities.

Similarly, analyze the time path of the effect of a decline in the rate of monetary growth by, say, X percentage points, again allowing for effect on stocks.

Answer each of the following as true, false or uncertain and justify your answer in the space provided.

Over time in the U.S. since 1929 output of the service industries rose at about the same rate as that of goods. Since the price of services rose at least as rapidly as that of goods, the income elasticity of demand for services would be greater than that for goods.

A weighted average of all price elasticities must add up to one.

Suppose the excise tax on bus travel was reduced and not on plane, train or other travel. This would reduce the use of buses if such travel was a sufficiently strong inferior good relative to other kinds of travel.

The ability of firms of very different sizes to survive in an industry means that the long run marginal cost curve is horizontal over the range of firm sizes that survive.

If an increase in the output of any firm lowered the marginal cost curves of other firms in the same industry (external economies) a competitive industry as a whole might show increasing returns; i.e., have a negatively inclined supply curve.

Short run marginal costs can never be below long run marginal costs.

Suppose that a competitive firm maximizes not income but its sales subject to the constraint that it does not make any losses. Then reduction in the demand for its product might not lead it to reduce output.

Goods X and Y are either substitutes, complements, or independent if an increase in the amount of X either reduces, raises or leaves unchanged the marginal utility of Y.

If the price of a good competitively produced was free to vary and yet did not change much between a seasonal low and a seasonal high in demand, this means that the industry’s long run marginal cost curve was very elastic.

An ad valorem tax, with a tax rate proportional to producer’s price, on a competitive industry that yielded the same revenue at the initial output as a specific tax, fixed amount per unit, would reduce output less than the specific tax.

Treat charitable contributions as a commodity entering the utility functions or indifference curves systems of the contributor. Assume, as is largely true, that contributions can be deducted from income in arriving at taxable income. Assume a proportional tax rate equal to t.

What would be the effect of an increase in the tax rate for any one person alone on his contributions? How does your analysis compare with the traditional analysis for commodities?

Is he more likely to increase or decrease his contributions?

Suppose now the tax rate increased for everyone. Would your answers to a. and b. be significantly different?

Suppose the traffic department would like to enforce parking regulations in an efficient way. Assume that each person has the choice of parking illegally or legally; the latter costs X dollars per “day” and the former, if one is caught, causes a fine equal to F dollars per time caught.

Assume first that the sole aim of the traffic department is to discourage illegal parking at minimum cost. Assume also that all drivers simply try to maximize expected money income. How frequently should the traffic department inspect parking in order to achieve its aim?

If all drivers maximized expected utility and had diminishing marginal utility of income, (but there is no utility or disutility from disobeying the law), how would this affect your answer? If they had increasing marginal utility of income?

Suppose the traffic department received all the fines and desired just to maximize its expected income. How would your answer to 1. be affected?

How does your answer to a. and c. depend on F, the size of the fine, and X, the cost of legal parking?

Suppose the earnings of military personnel were set below the price that would make the number of volunteers equal to the demand by the military, and that draft calls were sent out strictly at random to males aged 18-26 to bring the number entering up to demand

a.

1. How would the composition of drafted personnel compare with those that would enter if military earnings were raised sufficiently to make the number of volunteers equal to demand?

2. How would the total tax burden and its distribution among the population compare?

b. Assume now that drafted personnel could buy a substitute or substitute for someone else (as during the Civil War) instead of entering as a draftee. Assuming the capital market for substitutes works well, in equilibrium

1. How would the composition of men entering and the tax burden compare with that under a drafted and a fully voluntary system?

2. What determines the price that substitutes can get?

In the present real world we seldom observe “market clearing” prices. Sometimes we even observe zero prices. How can you account for these two phenomena that appear to contradict economic theory?

A number of techniques are available to cope with increased scarcity and higher world prices of petroleum. Analyze the following in terms of supply-demand responses in the short run and long run:

(a) Price freeze and “rationing by queue” (waiting lines for gasoline).

(b) Price freeze and rationing by coupon (non-salable).

(c) Rationing by coupon (non-salable) without a price freeze.

(d) A tax on all petroleum used.

(e) A tariff on imports of petroleum.

Most cities and towns that allow the sale of alcoholic beverages require all seller of liquor to have a license. Not only is the number of licenses strictly limited, but the prices of such a procedure on: (a) liquor prices; (b) the profits to sellers of liquor at the retail level? What would happen to prices and profits if cities and towns limited the number of licenses and auctioned them to the highest bidder? What are the effects on the distribution of wealth of the price-regulated method versus the market method of allotting licenses?

Discuss the following statement: “In a competitive market the least cost production techniques are revealed through entry and exit, while in public utility regulation they are revealed by commission rate hearing. It is easier to fool the commission than the market. Therefore, whenever possible competition should be permitted.”

“If the minimum wage law is eliminated, it will only shift the burden of unemployment from sons to fathers.” Evaluate.

Write a very short comment on each of the following questions:

(a) “Fishing in the ocean leads to too many resources being devoted to fishing.” First explain what is meant by “too many.”

(b) Tourists in foreign countries pay higher prices for a given item than do the indigenous residents.

(c) Mechanics tend to charge women higher prices for a given emergency repair than that charged men.

(d) Why might it be legal for anyone to give free medical advice but if he is going to charge for medical advice he needs a license.

(e) “Thou shalt not plow with an ox and an ass together.”

Using elementary economic theory, write short explanations to the following statements:

(a) Tourists must be more careful buying Maine lobsters in Maine than buying Maine lobsters in Philadelphia.

(b) There are proportionally fewer members of minority groups employed in regulated industries than in unregulated industries.

(c) Fishing in the ocean leads to too many resources being devoted to fishing. (First explain what is meant by too many.)

Gasoline price “wars” have induced many gasoline-station owners to propose a regulatory agency to establish orderly marketing conditions in gasoline markets. Also they proposed that no service station be allowed to charge a price loss than cost, and further that no new stations be opened unless the convenience and necessity of the area warrants more stations.

(a) Who would benefit and who would be hurt by these proposals, if carried out?

(b) If the proposals were carried out, how should the commission decide who got to open a new station?

(c) Is it possible that a gentleman’s agreement could be formed among gasoline station owners in lieu of statutes? Explain why or why not.

(a) In a competitive (atomistic) industry, suppose that a maximum wage law lower than the equilibrium wage is imposed and enforced. Indicate graphically the implication for employment in the industry, the areas representing distributive transfer(s) and those areas representing social gains or losses.

(b) Do the same, but assume now that the industry is empowered to conscript laborers at the specified maximum wage.

Explain what is meant by “Pareto optimal.” Why is it used so widely? (Do not state all the conditions that must hold for it to exist.) Is it consistent with compulsory licensing of doctors, prescriptions for drugs, approval by the Securities and Exchange Commission before securities are sold, tariffs, franchises for public transportation, minimum wage laws, non-exchangeable rights to be a U.S. citizen, anti-discrimination laws and anti-murder laws? Explain.

Briefly analyze the following:

(a) The price of cheese falls relative to the price of milk. What is implied about the rate of interest? Why?

(b) Usually there are cheaper prices for matinee performances than evening performances. Why?

(c) “Allowing the price of goods to rise in period when none of the good is being produced is immoral, because the higher prices do not induce a larger output. They merely give unwarranted profits to those who are lucky enough to own the goods. Either prices should be prevented from rising, or the government should take over ownership in order to prevent unjust enrichment.” Evaluate this statement using economic analysis.

(d) Give the definition of interest rates.

Discuss the following statement: “In a competitive market the least-cost production techniques are revealed by entry and exit, while in public utility regulation they are revealed by commission rate hearings. It is easier to fool the commission than the market. Therefore whenever possible, competition should be permitted.”

“Debtors are exploited by creditors because a person who has to borrow is usually in distress and is willing to pay a very high price to get the loan. Unless laws were passed controlling the rate of interest, debtors would be forced to pay unreasonable rates of interest.” Is the analysis correct? Explain why or why not.

Taxi fares in New York recently were increased by nearly 50%. Predict the effect on the price of taxicab medallions, the earnings of taxicab drivers and congestion in New York streets.

In the interest of conservation it has often been argued there must be government regulation of the extraction of natural resources such as timber and government regulation to protect endangered wildlife. Explain why and how, in a free market economy, these resources are already regulated and comment on the pitfalls to either form of regulation.

Give brief analysis to each of the following:

(a) Evidence of sex discrimination lies in the fact that the median annual earnings of women are only 59 percent of male earnings.

(b) Professor of Economics, Betty J. Watson, of the College of Notre Dame in Baltimore said, in reference to the minimum wage, “It’s more important to focus on creating jobs. Black youth have to deal with racism, and lowering the wage isn’t going to help them find jobs.” ( The Cincinnati Enquirer, November 23, 1986).

(c) Evaluate: A jet plane can fly from New York to Los Angeles three hours faster than a propeller driven plane. Which is the more efficient? Why?

Evaluate the following quote from USA Today, March 22, 1988:

“Raising the minimum wage wouldn’t result in fewer jobs because businesses would absorb the costs as they have absorbed other costs, according to Robert McGlotten, director of legislation for the AFL-CIO.”

‘Business doesn’t hire people on the basis of wage,’ he says, ‘but on the basis of need.’

‘If an individual with a particular kind of occupation is needed, then that occupation and the skill levels of the individuals would be matched with a wage rate,’ he says.

And the lost-job claim? McGlotten says critics made that argument when the minimum wage was 25 cents an hour. And ‘that’s never been true at all.’”

Why might the existing firms in a cartelized industry prefer to be regulated by the government?

“Public policy is necessary to protect the average citizen from the power of vested interest groups. In the absence of government intervention, regulated industries, such as airlines, railroads, and trucking, would charge excessive prices. Products would be unsafe, and the rich would oppress the poor. Government curbs the power of special interest groups.” Comment saying why you agree or disagree with the accuracy of that statement.

Suppose a frost kills a large portion of an orange crop, with a resulting higher price of oranges. It has been said that such an increase in price benefits no one since it cannot elicit a supply response; the higher price, it is said, simply “lines the pockets of profiteers.” Analyze this proposition. (Hint: be sure to focus on the rationing function of market price.)