S. Klepper, Economics 73-100, Fall 2010

Exam II

There are a total of three major questions, each weighted according to the points listed to the left of the question. These are the points apportioned to each question. They sum to 100

Each of the major questions has a series of subsidiary questions. Each of these subsidiary questions is a true-false question. To answer the question, indicate in your exam booklet whether the answer is true or false and provide a brief explanation for your answer. Correct answers with insufficient explanations will get no points. When you finish, hand in only your exam booklet.

The exam is open-book and open-notes. If you have any questions at all, then ask the proctor to help you. Do not introduce any assumptions (beyond those introduced in class) without consulting the proctor.

[30] 1. Bangladesh relies heavily on its garment industry to generate foreign currency through exports of its products. In the last year, the world price of garments has fallen off, which has led some Bangladeshi garment producers to shut down their operations. Producers have not been able to sell off their garment manufacturing plants or convert them to other uses, so those that shut down continue to own their plants. To stimulate the industry, the Bangladesh government is considering a program that would train garment workers to become more productive. Suppose such a training program enabled producers to produce garments using 10% less labor than before the institution of the program. Assume that Bangladeshi garment producers can sell as many units of garments as they like without affecting the world price and labor is the only variable input of production in the short run.

Which of the following statements about the effects of this program in the short run are correct? Mark true for a correct statement and false for an incorrect one.

_____1. For each plant, the marginal cost of production of every level of output will be 10% lower after the program.

______2. For each plant, the average total cost of production of every level of output will be 10% lower after the program.

_____3. Some producers that previously shut down might reopen.

_____4. All firms that previously were producing (a positive level of output) will increase their production of garments by 10%.

_____5. All firms that were previously producing (a positive level of output) will employ more labor than before the institution of the program.

_____6. For all firms that previously were producing (a positive level of output), the marginal cost of production (of the marginal unit of output) will be the same as before the institution of the program.

[44] 2. Consider the fourth experiment conducted in class on supply. Suppose the government was considering raising money by imposing a payroll tax on producers. In order to minimize opposition to the tax, the government would impose the tax only when producers choose to produce an output of five units or greater. The tax would be based on the producer’s total payroll—i.e., the total amount paid to labor. Producers of five or more units of output would pay a tax equal to some percentage of their total payroll. Congress is considering a tax rate of between 5% and 10%--for example, if the tax rate is 7%, then producers of five or more units of output would pay a tax equal to 7% of the total amount they pay to labor whereas producers would pay no tax if they chose to produce less than five units of output. Suppose that all other aspects of the experiment were the same—in each round the price of labor, the price of output, and the $20 cost to play were all the same.

If producers were subject to this payroll tax, which of the following statements concerning the effects of the tax (relative to before the tax) are correct assuming that producers make choices to maximize their profits? Assume the payroll tax will be equal to a percentage of the total cost of labor between 5% to 10% (including 5% and 10%). Mark true for correct statements and false for incorrect ones.

_____7. In each round there will be no change in the marginal cost of production of the first four units of output.

_____8. In each round the tax will cause the marginal cost of production of the fifth and higher units of output to rise on a percentage basis by the (percentage) tax rate.

_____9. In each round the tax will cause the average variable cost of production of the fifth and higher units of output to rise on a percentage basis by the (percentage) tax rate.

_____10. In each round the average total cost of production at every level of output will either not rise at all or rise by less than 10%.

_____11. In each round the minimum price at which producers will supply a positive level of output will rise.

_____12. In every round in which producers produced a positive level of output before the tax, they will incur a higher cost for labor, where the cost of labor includes the payroll tax.

_____13. Producers will continue to produce the same level of output in each round regardless of the size of the percentage tax rate (i.e., regardless of how big it is within the range of 5% to 10%).

_____14. In every round producers will earn lower profits.

[26] 3. The world price of oil denominated in Euros rose by 98% between 2002 and 2006. In class we analyzed the extent to which this would be explained by a 40% rise in income in China, India, and the Middle East. Various assumptions were made in the analysis. The income elasticity of demand for gasoline in China, India, and the Middle East was assumed to be 1, the price elasticity of demand for gasoline in all countries was assumed to be 0.25, income and hence world demand for gasoline outside China, India, and the Middle East was assumed not to have changed between 2002 and 2006, the world supply of oil was assumed not to have changed between 2002 and 2006, and oil was assumed to account for 40% of the price of gasoline between 2002 and 2006. Under these assumptions, it was shown how the 40% growth in income in China, India, and the Middle East between 2002 and 2006 could have accounted for a 64% increase in the world price of oil. This still leaves an additional rise of 34% in the world price of oil to be explained.

Which of the following, in addition to the rise of 40% in the income of China, India, and the Middle East, could explain why the world price rose by 98% rather than the predicted 64% rise? Mark true for an answer if it (along with the 40% rise in the income of China, India, and the Middle East) implies an increase in the world price of oil of at least 98% and false for answer that implies an increase in the world price of less than 98%.

_____15. As gasoline prices increased from 2002 to 2006, consumers began to take various steps to economize on their use of gasoline, resulting in a price elasticity of demand for gasoline of 0.4 rather than 0.25.

_____16. A study of the habits of Chinese, Indian, and Middle Eastern consumers suggested that the income elasticity of demand for gasoline in these countries during the period 2002 to 2006 was actually 1.4 rather than 1.

_____17. National taxes on gasoline were higher in other countries than in the United States, so that over the period 2002 to 2006 oil only accounted for 30% of the price of gasoline throughout the world rather than 40%.

_____18. World income outside of China, India, and the Middle East actually rose by 4% from 2002 to 2006 rather than stayed constant and the income elasticity of demand for gasoline outside China, India, and the Middle East was 0.5.

_____19. The world supply of oil did not remain constant over the period 2002 to 2006 but was 3% less in 2006 than 2002.

_____20. In 2002, speculators started purchasing oil and storing it in tanks. This caused the world demand for oil to be 4% greater per year than it had been at the beginning of 2002.