Name Eco200: Practice Test 1 Covering Chapters 10 through 15

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1 Name Eco200: Practice Test 1 Covering Chapters 10 through Many observers believe that the levels of pollution in our society are too high. a. If society wishes to reduce overall pollution by a certain amount, why is it efficient to have different amounts of reduction at different firms? b. Command-and-control approaches often rely on uniform reductions among firms. Why are these approaches generally unable to target the firms that should undertake bigger reductions? c. Economists argue that appropriate corrective taxes or tradable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should undertake bigger reductions? Solution: A Chapter 10 problem, externalities a. It is efficient to have different amounts of pollution reduction at different firms because the costs of reducing pollution differ across firms. If they were all made to reduce pollution by the same amount, the costs would be low at some firms and prohibitive at others, imposing a greater burden overall. b. Command-and-control approaches that rely on uniform pollution reduction among firms give the firms no incentive to reduce pollution beyond the mandated amount. Instead, every firm will reduce pollution by just the amount required and no more. c. Corrective taxes or tradable pollution rights give firms greater incentives to reduce pollution. Firms are rewarded by paying lower taxes or spending less on permits if they find methods to reduce pollution, so they have the incentive to engage in research on pollution control. The government does not have to figure out which firms can reduce pollution the most it lets the market give firms the incentive to reduce pollution on their own.

2 2. An industry currently has 100 firms, all of which have fixed costs of $16 and average variable cost as follows: Quantity Average Variable 1 $ a. Compute marginal cost and average total cost. b. The price is currently $10. What is the total quantity supplied in the market? c. As this market makes the transition to its long-run equilibrium, will the price rise or fall? Will the quantity demanded rise or fall? Will the quantity supplied by each firm rise or fall? d. Graph the long-run supply curve for this market. Solution: Chapter 14 problem, MC, VC, ATC, long-run supply curve a. The firms' variable cost (VC), total cost (TC), marginal cost (MC), and average total cost (ATC) are shown in the table below: Quantity Variable Total Marginal Average Total b. If the price is $10, each firm will produce five units, so there will be = 500 units supplied in the market. c. At a price of $10 and a quantity supplied of five, each firm is earning a positive profit because price is greater than average total cost. Thus, entry will occur and the price will fall. As price falls, quantity demanded will rise and the quantity supplied by each firm will fall. d. Figure 10 shows the long-run industry supply curve, which will be horizontal at minimum average total cost. Firm Industry MC Price Price and ATC and s s P 1 S Quantity Quantity Figure 10

3 3. Federal and State Expenditures: a. Social Security payments have increased dramatically. Explain why this is a problem and what is causing the increase? b. What is the single-most largest expenditure for state governments? c. What is the single-most largest expenditure for the federal government? Solution: Chapter 12, Social Security a. Increasing in life expectancy, Baby Boom generation retiring, health care costs have risen more rapidly than the cost of other goods and services produced in the economy b. State governments usually possess the largest expenditures in Education c. This is somewhat of a trick question because the federal government spends about the same for National Defense and Social Security Payments, 456 billion (in 2004) on National Defense and 496 (in 2004) on Social Security Payments. Many people believe that National Defense is the largest expenditure for the federal government, which is a common misperception.

4 4. Excessive fishing occurs because each individual fisherman has little incentive to maintain the species for the following year. a. The fish in the ocean can be considered which type of good, private, public, common resources, or natural monopoly. When describing which type of good, be sure to specify if fish are rival and/or excludable. b. Why is there a problem with fish while there is no problem with cows? c. How can governments solve this problem? d. Give some reasons why this solution sometimes fails? Solution: Chapter 11 problem a. Fish in the ocean are common resources, rival and not excludable. Fish are rival in that every time a fisherman catches one it prevents someone from catching that same fish. Fish are not excludable because you cannot prevent people from fishing unless the government takes action, say restrictions, corrective taxes, or tradable permits. b. Cows are private property while fish in the ocean are common resources, as long as there are no permits sold for fish. If the government chooses to sell permits for the fish, then the fish become a private good. c. Tradable permits or corrective taxes will help alleviate the problem since the quantity of fish caught depends on some form of fee through taxation or permits. d. Many countries have access to the ocean. It is difficult to get international cooperation among countries that hold different values. The oceans are so vast that enforcing any agreement would be difficult.

5 5. Consider the following demand and cost information for a monopoly. Quantity Price Total 0 $30 $ a. What is the marginal revenue for the second unit? b. What is the marginal cost for the fourth unit? c. What is the maximum profit this monopolist can earn? d. What price does the monopolist set? Solution: a. $15 b. $7 c. $28 d. $20 Q P TR MR TC MC Profit (TR TC) 0 $ $

6 6. Adrian's Premium Chocolates produces boxes of chocolates for its mail order catalogue business. She rents a small room for $150 a week in the downtown business district that serves as her factory. She can hire workers for $275 a week. There are no implicit costs. Number of Workers Boxes of Chocolates Produced per Week Marginal Product of Labor of Factory of Workers Total of Inputs a. What is the marginal product of the second worker? b. What is the total cost associated with making 890 boxes of premium chocolates per week? c. During the week of July 4th, Adrian doesn't box any chocolates. What are her costs during the week? d. Adrian has received an order for 3,000 boxes of chocolates for next week. If she expects that the trend in the marginal product of labor will continue in the same direction, what should Adrian do? Solutions: Chapter 13 problem a In order to figure this out, calculate the # of boxes of chocolates produced per Week at the level of one worker, which would be 330 boxes. Now, if you add a second worker, the # of boxes increases from 330 to 630. The difference between 630 and 330 is 300, which is the marginal product of the second worker. b. $1,250. Looking at the row of 3 Numbers of workers. The total cost of workers is $825. Thus, add another worker at $275, which adds up to $1100. The remaining is the fixed cost of the factory or $150. This gives a grand total of $1250 c. $150. Just the fixed cost of the factory d. She should not commit to meeting the order until she can move to a larger room and hire more workers to box the chocolates.

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