Practice Final SOLUTION V2

May 16 Name__________________________ Practice Final • You have 110 minutes to complete this test. • No outside paper/materials are allowed except a non-graphing calculator. • You can tear off the last two pages of the test to use as scratch paper. • Good luck! Key

Part 1: True/False • For each question in this section determine whether the statement is True or False. • Clearly write “True” or “False” on the line next to the question number. • Below each question, write a short (one sentence or less) explanation of your answer. • Answers without explanation will be worth no credit. _________ Question 1.1: The complete markets assumption is required to ensure that a market equilibrium maximizes producer surplus. _________ Question 1.2: Oligopoly is a preferable market structure to monopoly because it always results in more consumer surplus. _________ Question 1.3: In game theory, an economic game may have zero, one, or more than one Nash Equilibrium. _________ Question 1.4: Economic theory requires that maximizing total surplus should be the only objective of economic policy makers. F The complete markets assumption is one of the assumptions needed for the Fert which E implies EQ maximizes Total Surplus. Oligopoly can have more or less as than monopoly T F The objective of maximizing total surplus is a value judgement not from theory

Part 2: Multiple Choice • In this section you must determine which of the corresponding lettered options best answers each question. • Clearly write the letter of the most correct answer on the line next to the question number. • Only what’s written on the line next to each question number will be graded! _________ Question 2.5: A study surveys a large number of individuals and finds that people who eat kale at least 3 times a week are much less likely to develop heart disease. Without more information, we can say this relationship is: A. Both a correlation and a causal relationship B. A correlation but not causal relationship C. Not a correlation but a causal relationship D. None of the above _________ Question 2.16: Which axioms do we typically assume about preference relations? A. Transitivity, completeness, rational expectations B. Rational expectations, transitivity, indifference C. Monotonicity, completeness, transitivity D. None of the above ________ Question 2.18: Which of the following is true about both the marginal rate of transformation (MRT) and the marginal rate of substation (MRS)? A. MRS depends on physical constraints, MRT depends on preferences B. MRT captures how much an agent must give up of one good to get more of a second good, MRS captures how much of a good the agents is willing to give up in exchange for one unit of a second good C. MRS captures how much an agent must give up of one good to get more of a second good, MRT captures how much of a good the agents is willing to give up in exchange for one unit of a second good D. None of the above are correct B C B

_________ Question 2.23: An agent is choosing how much of good X and good Y to consume. The two goods are normal. If the price of good X goes up, what can we say about the agent’s new optimal consumption bundle? A. Consumption of Y will go up B. Consumption of X will go up C. Consumption of X and Y will go down D. None of the above _________ Question 2.33: A firm uses two inputs X and Y to produce an output good. X and Y and perfect complements in the firm’s production function. If the price of X increases, what will happen to the firm’s optimal input mix of X and Y? A. The amount of X will go down and the amount of Y will go up B. The amount of X and Y may decrease and may stay the same C. The amount of X and Y will both decrease D. None of the above ________ Question 2.39: A price-taking firm has a marginal cost curve that crosses their average variable cost curve at q=10 and p=$3. If the market price for their output good is $2 and the marginal cost curve passes through the point q=5, p=$2, what is the optimal quantity for this firm to produce in the sort-run? A. 0 B. 5 C. 10 D. Not enough information to know ________ Question 2.42: If a new firm enters a market and chooses to produce a positive amount of output at the equilibrium price, what happens to the market-level supply curve (potentially by a very small amount)? A. The supply curve shifts to the right B. The supply curve shifts to the left C. The supply curve will become steeper D. We don’t have enough information to know D C A A

_________ Question 2.54: The First welfare Theorem can best be described as saying that: A. If a market satisfies the complete markets assumption then the equilibrium allocation will be socially optimal B. A market equilibrium will always be the socially optimal way to allocate resources C. Under the complete and competitive markets assumptions, a market equilibrium will maximize total surplus D. None of the above _________ Question 2.56: Market power may arise due to all of the following EXCEPT: A. Intellectual property B. Price taking firms C. Network effects D. None of the above _________ Question 2.60: Which of the following is NOT a setting where asymmetric information may lead to a market failure? A. Moral hazard B. Adverse selection C. X-inefficiency D. None of the above ________ Question 2.62: Credence goods may not have efficient markets because what competitive market assumption is unlikely to hold? A. Complete markets B. Full information C. Price taking agents D. Homogenous goods _________ Question 2.64: Which of the following is NOT an example of an externality? A. The noise of jackhammers from road repairs B. Manicured lawns and local property values C. The increased price of oranges after a cold-snap in Florida D. All of the above are examples of externalities 2 B C B C

_________ Question 2.69: Which of the following policies would NOT be likely improve total surplus from a public good? A. Governments directly providing the good B. Individual agents collectively organizing to provide the public good C. A government imposed price ceiling on the good D. None of the above _________ Question 2.71: Even though a Pigouvian tax/subsidy may be able to reduce the deadweight loss of an externality, we may not want to impose such a tax because: A. Using the incorrect tax/subsidy rate could do more harm than good B. It’s often not clear if a tax or a subsidy would be the appropriate policy C. Taxes always reduce total surplus D. None of the above _________ Question 2.75: Skill biased technological change is a theory which can help to explain: A. How mature economies can continue to maintain high growth rates B. Widening income inequality C. Why historically the returns to capital has been higher than wage growth D. None of the above _________ Question 2.73: In general, we see that income inequality is: A. Decreasing over time in the United States B. Less than wealth inequality in most nations C. Higher in higher income countries D. None of the above C A B B

Part 3: Short Response • In this section you must answer each question with a short response. • All questions can be correctly answered in a few sentences or less. • If the question asks for a specific number/answer please circle your final answer. • Please show all your work. If you don’t show your work you may not receive full credit. Question 3.1: A study finds that people who live in neighborhoods with poor air quality have lower wages. Provide two different narratives that could explain this relationship, one that explains the relationship as a simple correlation and one that is based on a causal effect. X

Question 3.2: Anna and Daniel are deciding to go to dinner at a sushi restaurant or to a pub. They decide they will say which place they prefer simultaneously and then decide where to go. They decide that if they disagree on where they initially want to go, they’ll just stay home and eat salads. Table 3.1 below shows the value they place on different outcomes of this game where a pair (X,Y) means Anna values the outcome at X and Daniel values the outcome at Y. Table 3.1: Student Poker Payouts Daniel Sushi Pub Anna Sushi (10, 6) (2, 3) Pub (2, 3) (1, 12) What is (are) the Nash Equilibrium (Equilibria) of this simultaneous move game? If instead of going at the same time the two decided that Daniel will move first and then Anna will respond, what is the Equilibrium (Equilibria) outcome of the resulting sequential move game? (hint: use backwards induction) op 0 0 Sushi is a dominant strat of Anna, So (Sushi, Sushil is the only NE. S (10,6) - wis) ④ The EQ is the same. (Sushi, Sushil

Question 3.4 Figure 3.1 shows the cost curves associated with a firm’s production function. If the firm is price-taking, determine the optimal short- and long-run quantities to produce at the following market prices (round the nearest ¼ of a unit). P Short-Run Supply Long-Run Supply 3 5 6 8 Figure 3.1: A firm’s cost curves O 0 5 O 6.25 0 10 10 O O 0 &

Question 3.5 Figure 2.3 shows the supply and demand curves for ferry services around Manhattan. Imagine that the ferry market is competitive. You can also imagine the quantities are in 1,000s of trips per day. However, to keep things simple solve everything in terms of the units of the figure (so leave all answers in terms of 1,000s of rides per day). Figure 3.2: Supply and Demand for Manhattan Ferry Rides a) What are the equilibrium quantity and price in the ferry service market? , / $ 11.5 - - - - - ⊥ pEY * = 8 ②

e) Why might your friends’ suggestion of a price ceiling be problematic? f) What are the consumer and producer surplus under the price ceiling you proposed in part e? For this question you can assume there are no transaction costs for consumers to re- sell ferry tickets. g) The mayor prefers to impose a tax on the ferry market instead. What is the socially optimal per-ride tax rate on Manhattan ferries? What are the consumer and producer surplus under this tax rate? A price ceiling would lead to a shortage of ferry rides, which could significantly reduce 25 if the lowest WTP consumers get the scare ferry tickets. (3: 105x7 + Yz()(12 - 5) 10.5 + 24.5 = 55 DS: Y() (3.5) = x2(24.5) = 225 I = $ 105 ps: Y2()(3.5) - 23: Yz(T) (12 - 5) -5

Question 3.6 A firm is solving their optimal input mix problem. They can either produce with AI technology and/or skilled labor. Figure 3.3 shows the feasible set from the firm’s output maximization (for a specific cost level) under prices in 2020. a) What other type of problem could the firm have used to solve their optimal input mix problem? b) If the price of skilled labor (per unit displayed in Figure 3.3) is $2, what is the price of AI (per unit in Figure 3.3) in 2020? c) Assume AI and skilled labor are complements in the firm’s production function and the optimal bundle under 2020 prices is 2 units of each type of input. On Figure 3.3 draw and label an isoquant curve that is consistent with this optimal choice of inputs. d) If the price of AI Falls by ½ from 2020 to 2023, draw and label the new boundary of the firm’s feasible set for their output maximization problem at the same cost level as the curve in Figure 3. cost minimization $ 2

Figure 3.3: Firm’s production mix decision ↑ ⊥ ⊥ ⊥ Esoquant ↑ I Isoquant