Final ExamIntermediate MicroeconomicsFall 2015December 15, 2015

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Instructions

1. Write your name or initials on each page. Please do this first.

2. Answer all questions.

3. The exam will be graded out of 100 points. Points for each section and points for eachquestion are indicated on the exam.

4. Write legibly. Illegible exams cannot be graded.

5. Do your best to fit all your answers on the front side of the exam. If you need to usethe back of a page, indicate that clearly.

6. Label all figures as needed.

7. Make sure you explain your answers as needed. When appropriate, you should alsoexplain any assumptions that you make to arrive at your answer. Explanations mayyield partial credit.

8. Be concise.

9. The final page is intentionally left blank for extra work. If you do extra work on thispage (or in any other non-standard location) that you would like to be counted, youmust note it clearly near the question you are answering.

10. You are allowed a calculator and no other aids. Please leave everything else in yourbag for the duration of the exam.

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A. Ripped From the Headlines (9 points, 3 each part)

Read the article from the Wall Street Journal at the end of the exam.

1. What impact would an economist expect professional licensing to have on the wages ofpersonal trainers? Use economic logic to explain why.

2. Using economic logic, explain why physical therapists in DC might be interested in regu-lating personal trainers in DC.

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3. Explain which assumption of the perfectly competitive market is violated with the exis-tence of professional licensing.

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B. Short Answer Questions (40 points)

1. Give an example of a positive externality. Explain why (and to whom) this is a positiveexternality.

2. Define marginal revenue. In a perfectly competitive market, what is a firm’s marginalrevenue?

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3. Why does the long run marginal cost curve intersect the long-run average total cost curveat its minimum?

4. Give an example of a moral hazard problem caused by insurance coverage, explain whyit is a moral hazard problem.

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5. Suppose that the US considers a drastic change to drug policy: legalization and taxation.How do we expect the incidence of this tax (which is levied on producers) to differ acrossproducers and consumers if the policy is implemented in one state relative to if the policy isimplemented nationally?

6. Does market power create deadweight loss? Draw a picture illustrating why or why not(assuming constant marginal cost), and give some intuition about why there is or isn’t adeadweight loss.

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7. Suppose that company X would like to sell insurance to cover loss or damage to cellphones, which occurs at a rate of 2% per year in the population. If the customer’s phone islost or damaged, the insurance company will pay $600 per year. The potential size of themarket is 100,000 people. What is an actuarially fair premium? And what dollar value ofactuarially fair premium should firm X charge in this market?

8. Suppose that a firm operates with marginal product of capital is MPK = 5K, andmarginal product of labor is MPL = 3L. The firm faces a wage rate of 3 and a capital rentalrate of 2. The firm is currently consuming 2 units of capital, and 3 units of labor. Is the firmoptimizing its purchases of capital and labor? If it is not, which should it purchase more of:capital or labor?

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C. Medium Answer Questions (51 points)

1 (18: 2 for (a), 4 for (b)-(e)). Tax Incidence

Suppose that the demand for Meyer lemons is given by QD = 100 − 4P , and the supply ofMeyer lemons is given by QS = 2P − 5.

(a) What is the initial equilibrium P and Q in the market for Meyer lemons? Draw thesupply and demand curves, labeling the curves and intercepts.

(b) Suppose that the government believes that Meyer lemons have addictive qualities andwants to curb their consumption. To do so, the government levies a $2 tax per lemon, andputs the statutory incidence for this tax on consumers. How do the supply and demandcurves change (or not) to reflect this new tax? Write the equation for the new curve(s), anddraw the new curve(s) in your picture, labeling curves and intercepts.

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(c) What is the new equilibrium P and Q with the tax?

(d) How much of the tax burden do producers and consumers each bear?

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(e) Which party bears more of the burden (or, on whom does the incidence fall more heavily)and why?

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2 (18: 3 (a)-(c), 4 for (d), 5 for (e)). Public and Private Goods

Imagine that there are two people in the world, Mr. 1 and Mr. 2. Mr. 1’s demand curve isgiven by Q1 = 200 − 20P , and Mr. 2’s demand curve is Q2 = 100 − 10P .

(a) Draw Mr. 1 and Mr. 2’s demand in one chart, labeling curves and intercepts.

(b) Suppose that the curves express demand for private goods, such as french fries or ham-burgers. Write an equation, and draw the chart, for total market demand. Note the valuesof any kinks.

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(c) Suppose instead that these demand curves represent demand for a public good, such asfireworks. Write an equation, and draw the chart, for total market demand. Note the valuesof any kinks.

(d) Explain why you add up the demand curves differently for the two cases.

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(e) Give an example of a good with at least some public good aspects (and that is not na-tional defense, lighthouses or fireworks). Explain why the good is a public good, and anyreasons it is not a public good.

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3 (15: 3 each, (a)-(e)). Market Power

A monopoly is considering spending fixed costs of $100,000 to develop a new drug in period1 that will be sold in period 2. The demand curve in period 2 is Q = 100 − P and marginalcost is constant at $4.

(a) What is the equilibrium price and quantity in the second period if the drug will begranted patent protection in period 2, and there are no fixed costs of production in period2? Draw a picture of the relevant curves and label the intercepts and key intersections.

(b) Will the monopoly spend $100,000 developing the drug during period 1 to sell it duringperiod 2? (Hint: think about producer surplus.)

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(c) What is consumer surplus in period 2?

(d) Now suppose that in period 2 the price of the drug will be regulated by the govern-ment and set equal to marginal cost, and there are no fixed costs of production in period 2.Will the monopoly spend $100,000 developing the drug in period 1 to sell it in period 2 atmarginal cost?

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(e) What is the level of consumer surplus in period 2?

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Blank – for extra work

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http://www.wsj.com/articles/anti-licencing-movement-scores-a-victory-1447433906

Tom Brose, co-owner of CrossFit DC, says the people trying to push fitness-trainer licensing ‘are doing it to

support their rapidly diminishing place in the market.’ Here, Mr. Brose leads a class on a recent day. PHOTO: T.J.

KIRKPATRICK FOR THE WALL STREET JOURNAL

Anti-Licensing Movement Scores a Victory - WSJ http://www.wsj.com/articles/anti-licencing-movement-scores-a-victory-...

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Anti-Licensing Movement Scores a Victory - WSJ http://www.wsj.com/articles/anti-licencing-movement-scores-a-victory-...

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Anti-Licensing Movement Scores a Victory - WSJ http://www.wsj.com/articles/anti-licencing-movement-scores-a-victory-...

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