Final

Question 1

Define elasticity of demand

Answer 1

The elasticity of demand measures how sensitive the quantity demanded of a good is to changes in other economic variables, most commonly its price. It’s a numerical value that shows how a change in price affects the quantity demanded, calculated as the percentage change in quantity demanded divided by the percentage change in price.

Question 2

Elastic

Answer 2

e>1
quantity demanded more responsive to changes in prices
flatter curve

Question 3

Inelastic

Answer 3

e<1
quantity demanded is relatively less responsive to changes in price

Question 4

True or false: if the elasticity of demand for a good is greater than 1, the total revenue from sale of the good will go up when the price goes up. State why your answer is correct.

Answer 4

False. When the elasticity of demand for a good is greater than 1 (elastic demand), an increase in price will lead to quantity demanded going down faster than price, which will cause total revenue to fall.

Question 5

State the three basic categories of rationing mechanism and give an example of each one. (It is okay if you give one example that covers more than one of the mechanisms.)

Answer 5

1. Ration by Price
2. Ration by Queue
3. Ration by Centralized plan

Question 6

Ration by Price
w/ example

Answer 6

goods and services are distributed based on the willingness and ability of consumers to pay

EX: buying tickets for a concert. The price determines who can afford to attend, effectively rationing access to the event based on consumers’ willingness to pay.

Question 7

Ration by Queue
w/ example

Answer 7

(First-come, first-served) - goods are distributed to those who are first in line.

EX: parking meters

Question 8

Ration by Centralized plan
w/ Example

Answer 8

authorities distribute ration coupons that entitle the holder to purchase a certain amount of a resource

EX: food during shortages, or gasoline

Question 9

True or false: When a worker’s wage goes up, the worker’s budget constraint becomes steeper, creating a motivation for the worker to increase their labor supply, because of the substitution effect. State why your answer is correct. (This may not be the only effect of the wage increase on the worker’s labor supply, but restrict your answer to the substitution effect. State why your answer is correct.

Answer 9

True.

When a worker’s wage goes up, the worker’s budget constraint indeed becomes steeper due to the increase in the wage rate, which represents the rate at which leisure can be substituted for additional income. This change illustrates the substitution effect, where higher wages make leisure relatively more expensive in terms of forgone earnings.

Question 10

Substitution Effect & wage increases

Answer 10

substitution effect, which is the change in labor supply resulting from the relative change in the returns to working versus leisure.

predicts that as wages rise, workers are motivated to work more hours (i.e., increase their labor supply) because the opportunity cost of not working (i.e., enjoying leisure) is higher.

Question 11

When a tax is placed on the market for a good, the side of the market (supply or demand) that is less elastic will bear the larger share of the burden of the tax. Explain what this means, and why it is true. (Use a diagram if it is helpful, but make sure that you also provide a complete answer in words.)

Answer 11

Tax creates a wedge between supply and demand (what consumers are willing to pay and the production cost). The side of the market that is less elastic can absorb price changes more readily without a proportionate change in the quantity traded. Therefore, that side will bear a greater portion of the tax burden because it adjusts less in response to the tax-induced price change.

If Demand is Less Elastic than Supply:

Consumers less responsive to price changes. Therefore, even when the price they pay rises due to the tax, they decrease their quantity demanded only slightly.

So, consumers end up paying a larger share of the tax because they continue to buy the product despite higher prices.

Question 12

Explain how non-excludability causes a missing-market problem, and how that leads to the tragedy of the commons. (If it is helpful to use an example while answering the question, feel free to do so, but make sure that it is clear how your answer applies to other cases in general.)

Answer 12

non-excludable goods are goods that use cannot be confined only to paying customers, which leads to missing market problem because the transaction costs involved in coordinating and enforcing trades make it impossible for the basic components of a market to function, which means there is no price signal, and since many of natural resources are non excludable goods and limited, they become overused and depleted, which is the essence of the tragedy of the commons.

For example, multiple shepherds using the same common pasture to graze their sheep, and they all will graze as much as possible, for the greatest personal gain, which leads to the sheep grazing all the grass in the commons.

Question 13

Non-excludability

Answer 13

Goods that are non-excludable are typically public goods or common resources where the use cannot be confined only to paying customers. Examples include public parks, clean air, or fish stocks in international waters.

Question 14

Missing-Market Problem

Answer 14

Since producers cannot prevent non-payers from consuming the good, they often find it unprofitable to provide the good at an adequate level through the market. As a result, the market may fail to supply these goods at all, or supply them in suboptimal quantities. This is referred to as a missing-market problem.

Question 15

Transition to Tragedy of the Commons

Question 16

Explain how a system of tradeable rationing coupons can result in a good being allocated to consumers who get the most benefit out of the good, and explain how differences in income can reduce the effectiveness of the system. (Use a diagram if it is helpful, but make sure that you provide a complete answer in words.)

Answer 16

each consumer receives a set number of rationing coupons that can be used to purchase a specific good.
Consumers who value the good more highly are willing to pay more for additional coupons to obtain more of the good. and , those who value it less are willing to sell their coupons, gaining monetary benefits without consuming the good.

Market Equilibrium: Through trading, the coupons and the goods move to those who value them the most. This is because the willingness to pay for extra coupons reflects the consumer’s utility from the good.

High-income individuals can afford to buy more coupons, allowing them to outbid others who might value the good more but have less financial capability.

Marginal Utility of Money: For lower-income individuals, the marginal utility of money is higher.

Question 17

Define a Pigouvian tax

Answer 17

tax imposed on any market activity that generates negative externalities,
The purpose of the Pigouvian tax is to correct the market outcome by internalizing the externality, essentially adjusting the price to reflect the true social cost of production or consumption

Question 18

Explain how a Pigouvian tax can “fix” the problem of a missing price signal caused by a missing market. Explain why it does not give firms any incentive to reduce the per-unit negative externality of their production. (If it is helpful to use the example of a Pigouvian tax on electricity from coal-burning power plants, feel free to use it, but make sure it is clear how your answer applies to other cases general. Use a diagram if it is helpful, but make sure that you also provide a complete answer in words.)

Answer 18

1. Internalizes externalities: When a market fails to account for all costs associated with a product—such as pollution from a factory, which affects air quality and public health—the price signal is missing because the price of producing or consuming that product is lower than its true societal cost. A Pigouvian tax is set equal to the estimated cost of the negative externality fixing this price signal

It does not incentivize a reduction in negative externalities because the tax is applied to all units produced, so the only way the tax could be lower is if they produce less. Still, they are not incentivized to produce more because that will increase their tax burden.

EX: pigouvian tax on electricity, even if firms are able to find a less polluting from of energy to use they would be charged the same tax on the units produced.

Question 19

Example of the example of a Pigouvian tax

Answer 19

Example: In the case of electricity generated from coal-burning power plants, these facilities emit pollutants like sulfur dioxide and carbon, which have various harmful environmental and health effects. A Pigouvian tax could be levied per unit of coal burned, making it more expensive to produce electricity this way. This would ideally lead power producers to reduce their output of coal-generated electricity or switch to cleaner energy sources, aligning the cost of electricity with its true environmental impact.

Question 20

Explain why the Pigouvian tax does not give firms any incentive to reduce the per-unit negative externality of their production

Answer 20

Fixed Tax Rate Per Unit: charges a fixed amount for each unit of the good produced or each unit of pollution emitted. This means that once the tax is in place, there is no additional financial incentive for a firm to reduce the negative externality per unit of output below the level that triggers the tax. The tax only incentivizes firms to reduce their overall level of the taxed activity, not to make each unit less harmful.

Question 21

This is a labor-market problem, based on some of the issues that led to the creation and expansion of the Earned Income Tax Credit (EITC) in the United States.

Consider a policy of providing a per-hour wage subsidy to low-wage workers. Assume that the worker will receive the wage subsidy for any number of hours they choose to work. (In other words there is no earnings threshold beyond which the subsidy is cut off.)

a. Using the model of individual worker choice (budget constraints and indifference curves) learned in class, draw a diagram of how the policy will affect the worker’s budget constraint compared to no policy.

Answer 21

Pre-Policy World (No Subsidy)
Budget Constraint: This is a straight line from the origin with a slope equal to the wage rate ww. The x-axis represents hours of leisure, and the y-axis represents income. As the worker foregoes leisure (thus working more hours), their income increases linearly.

Indifference Curves: These curves illustrate combinations of leisure and income that give the worker the same level of utility. Typically, these curves are convex to the origin, indicating that as workers give up more leisure, they need increasingly more income to maintain the same utility level.
Post-Policy World (With Subsidy)
Modified Budget Constraint: Introducing a wage subsidy ss per hour shifts the budget constraint upwards without changing its slope if the subsidy is added to every hour worked. The new wage rate becomes w+sw+s, and the line shifts upward because the worker earns more at every point of labor supplied.

This shift would not alter the origin point (0 income at 0 hours worked) but ensures higher income for any positive number of hours worked, represented by a steeper slope from the origin.

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Question 22

What effect will the policy have on the number of people who choose to work at all? In other words, what adjustments will there be, if any, along the extensive margin of labor supply, aka labor-force participation?

Answer 22

Increased Incentive to Work: A wage subsidy effectively increases the hourly wage for workers. This higher effective wage can make employment more attractive compared to not working, particularly for those who might have been marginally dissuaded from working due to low wages. This increased incentive can lead to higher labor-force participation as more people decide that working is financially worthwhile. The reservation wage is the minimum wage at which a person is willing to accept a particular type of job. A subsidy lowers this threshold because the actual income received from work would be higher due to the subsidy.

Question 23

Consider a policy of providing a per-hour wage subsidy to low-wage workers. Assume that the worker will receive the wage subsidy for any number of hours they choose to work

What effect will the policy have on the number of hours that people who were already working will choose to work (aka the intensive margin of labor supply)?

Answer 23

depends on the shape of their indifference curve. Different preferences have different indifference curves which will have different behaviors. In the graph pictures time and stuff are substitutes so labor goes up.

Question 24

Now imagine that in addition to the wage subsidy, the government chooses to provide a cash income benefit to all individuals, whether or not they choose to work, and regardless of how much they choose to work. (This can be thought of as non-labor income, and again there is no threshold beyond which workers become ineligible for the benefit. It is simply given to all workers.)

Draw a diagram of how the cash benefit will affect the worker’s budget constraint, compared to the diagram you drew in part (a)

Answer 24

Question 25

Now imagine that in addition to the wage subsidy, the government chooses to provide a cash income benefit to all individuals, whether or not they choose to work, and regardless of how much they choose to work. (This can be thought of as non-labor income, and again there is no threshold beyond which workers become ineligible for the benefit. It is simply given to all workers.)

What effect will the addition of the cash benefit have on the number of people who choose to work at all (labor-force participation), compared to the policy in part (a)?

Answer 25

Income effect: cash income benefit increases income for everyone regardless of whether they work so it reduces the financial necessity to work for people who find work less rewarding or more taxing than their free time. While in part the labor force was impacted by the substitution effect, the cash income benefit is influenced by the income effect.

Question 26

Now imagine that in addition to the wage subsidy, the government chooses to provide a cash income benefit to all individuals, whether or not they choose to work, and regardless of how much they choose to work. (This can be thought of as non-labor income, and again there is no threshold beyond which workers become ineligible for the benefit. It is simply given to all workers.)

What effect will the policy have on the number of hours of work for people who were already choosing to work under the wage-subsidy policy in part (a)?

Answer 26

decrease in the number of hours they choose to work as long time is not an inferior good.

Question 27

Now imagine that the government receives a large number of complaints about giving a cash benefit to workers who are also eligible for a wage subsidy, because many people feel those workers should be able to support themselves with the subsidy. In response, the government changed the rules of the cash-benefit program so that once a worker reaches a threshold level of earnings, they are no longer eligible for the cash benefit.
Draw a diagram of how this change to the policy will affect the worker’s budget constraint, compared to the diagram you drew in part (b).

Answer 27

Question 28

Now imagine that the government receives a large number of complaints about giving a cash benefit to workers who are also eligible for a wage subsidy, because many people feel those workers should be able to support themselves with the subsidy. In response, the government changed the rules of the cash-benefit program so that once a worker reaches a threshold level of earnings, they are no longer eligible for the cash benefit.

What effect will the policy have on the number of people who choose to work at all, compared to the policy in part (b)?

Answer 28

Income effect: For people marginally attached to the workforce they may choose leisure time or non wage earning activities and leave the labor market

Question 29

Now imagine that the government receives a large number of complaints about giving a cash benefit to workers who are also eligible for a wage subsidy, because many people feel those workers should be able to support themselves with the subsidy. In response, the government changed the rules of the cash-benefit program so that once a worker reaches a threshold level of earnings, they are no longer eligible for the cash benefit.

What effect will the policy have on the number of hours of work for people who were already choosing to work under the policy in part (b)?

Answer 29

For those workers that are below the threshold level of earning that cuts them off from basic cash income payment the hours worked will decrease, but once they pass the threshold the hours worked will be determined by their individual indifference curves

Question 30

This problem is an extension of the Tragedy of the Commons situation we worked on in class, in which there was a developer and a neighborhood of households. In this case, there is an area of undeveloped land that is currently occupied by a large number of independent individuals and households who live and farm on the land, but do not have any formal ownership or rights to the land, in the eyes of the law. In addition, there is a large number of entrepreneurs that would like to develop sites on the land for small businesses, such as restaurants, retail shops, computer repair stores, etc. (Each site will consist of a building and parking lot.) The amount of land that gets developed depends on how many entrepreneurs choose to pay the cost of developing a site. The more sites get developed, the less land is available for the people who live there. Let’s assume that as the land gets developed, the residents will not leave, but will simply share a smaller and smaller amount of land.

First imagine that there is no government policy at all. Answer the following questions. (You don’t have to use bullet points or separate your answers from one another, but make sure that you have answered each question.)
Who owns the rights to the land?

Answer 30

Entrepreneurs→ because the government has not regulated the land and therefore allowed entrepreneurs to use it as the see fit without payment, the rights to the land are owned by the entrepreneurs.

Question 31

This problem is an extension of the Tragedy of the Commons situation we worked on in class, in which there was a developer and a neighborhood of households. In this case, there is an area of undeveloped land that is currently occupied by a large number of independent individuals and households who live and farm on the land, but do not have any formal ownership or rights to the land, in the eyes of the law. In addition, there is a large number of entrepreneurs that would like to develop sites on the land for small businesses, such as restaurants, retail shops, computer repair stores, etc. (Each site will consist of a building and parking lot.) The amount of land that gets developed depends on how many entrepreneurs choose to pay the cost of developing a site. The more sites get developed, the less land is available for the people who live there. Let’s assume that as the land gets developed, the residents will not leave, but will simply share a smaller and smaller amount of land.

First imagine that there is no government policy at all. Answer the following questions. (You don’t have to use bullet points or separate your answers from one another, but make sure that you have answered each question.)

Assuming that the number of entrepreneurs who are willing to pay to develop a site is greater than the amount of available land, what will be the final allocation of land?

Answer 31

The final allocation of land will be determined by queueing or first come first serve.

Question 32

This problem is an extension of the Tragedy of the Commons situation we worked on in class, in which there was a developer and a neighborhood of households. In this case, there is an area of undeveloped land that is currently occupied by a large number of independent individuals and households who live and farm on the land, but do not have any formal ownership or rights to the land, in the eyes of the law. In addition, there is a large number of entrepreneurs that would like to develop sites on the land for small businesses, such as restaurants, retail shops, computer repair stores, etc. (Each site will consist of a building and parking lot.) The amount of land that gets developed depends on how many entrepreneurs choose to pay the cost of developing a site. The more sites get developed, the less land is available for the people who live there. Let’s assume that as the land gets developed, the residents will not leave, but will simply share a smaller and smaller amount of land.

First imagine that there is no government policy at all. Answer the following questions. (You don’t have to use bullet points or separate your answers from one another, but make sure that you have answered each question.)Will the allocation of land be either efficient, or fair, either in terms of how much goes to the residents versus the small-business owners, or in terms of which small-businesses get parcels of land?

Will the allocation of land be either efficient, or fair, either in terms of how much goes to the residents versus the small-business owners, or in terms of which small-businesses get parcels of land?

Answer 32

It will not be efficient because the land will not be going to the entrepreneur or individual that would value the land greatest, it is not fair because the land is just going to the entrepreneur that gets their first and the residents who also gain value from the land have no rights to the land.

Question 33

This problem is an extension of the Tragedy of the Commons situation we worked on in class, Suppose that the government decides to use a system of tradable land-use permits. First the government decides how many plots of land, in total, can be developed. (Based on some criteria known only to the government. It doesn’t matter how they decide.) Then the government creates a number of permits equal to that number of parcels, and makes it legal to trade them for money, and illegal to develop a site without owning a permit. Answer each of the following questions separately.

Explain why it won’t matter, in terms of the final allocation of land, whether the government assigns the permits to the individual residents of the land or to the entrepreneurs, or, for that matter, which entrepreneurs they assign the permits to.

Answer 33

Since the permits are tradable they can be allocated by the free market, so no matter who the government assigns the permits to, they will go to the entrepreneur or individuals that value them the most.

Question 34

Suppose that the government decides to use a system of tradable land-use permits. First the government decides how many plots of land, in total, can be developed. (Based on some criteria known only to the government. It doesn’t matter how they decide.) Then the government creates a number of permits equal to that number of parcels, and makes it legal to trade them for money, and illegal to develop a site without owning a permit. Answer each of the following questions separately.

Explain how this system will automatically result in the most profitable businesses getting the sites. (Unlike in part (a) above.)

Answer 34

Theoretically, the entrepreneurs who expect their business to make the greatest profit will value the permits higher than those who expect lower profits, therefore the most profitable businesses will purchase the permits from less profitable businesses who stand to gain more by selling their permits.

Question 35

This problem is an extension of the Tragedy of the Commons situation we worked on in class, Suppose that the government decides to use a system of tradable land-use permits. First the government decides how many plots of land, in total, can be developed. (Based on some criteria known only to the government. It doesn’t matter how they decide.) Then the government creates a number of permits equal to that number of parcels, and makes it legal to trade them for money, and illegal to develop a site without owning a permit. Answer each of the following questions separately.
What type of rationing system is this? [Note: It could be more than one.]

Answer 35

Price allocation

Question 36

This problem is an extension of the Tragedy of the Commons situation we worked on in class, Suppose that the government decides to use a system of tradable land-use permits. First the government decides how many plots of land, in total, can be developed. (Based on some criteria known only to the government. It doesn’t matter how they decide.) Then the government creates a number of permits equal to that number of parcels, and makes it legal to trade them for money, and illegal to develop a site without owning a permit. Answer each of the following questions separately.

Is the system in part (b) fair to the residents? What about the small-business owners? If the answer is ambiguous, what does it depend upon.

Answer 36

Residents: ambiguous whether it is fair to residents. The initial assignment of permits, if residents are given permits that they are able to sell, could allow them to benefit financially for the loss of land, if they are not given permits, then they just lose access to the land and get none of the benefits.
small business owners: Ambiguous whether its fair to small business owners because it depends if they are able to access the permits, if they are too expensive or hoarded by larger companies.