Midterm Practice Exam Problems
Question 1. True or False
A. A Rawlsian Social Welfare function is a function that maximizes the total utility in
society, without preference toward any individual’s relative position.
B. A pure public good is one that is non-excludable goods are non-rivalrous.
C. A positive consumption externality occurs when the production of a good creates a positive benefit to a 3rd party.
Question 2. Edgeworth boxes
Josh and Elanna go on a picnic together. When they arrive at the park Josh has 10 glasses of wine and 2 pieces of cheese. Elanna has 8 pieces of cheese and 2 glasses of wine. They can trade wine for cheese to improve both of their picnicking experiences (utility). Below is an Edgeworth box displaying some information about their preferences. UJ=Josh’s utility, Ue= Elanna’s utility.
10 Wine 8
Ue =2
Ue = 6
Ue = 10
Ue = 18
Elanna
Josh 4 UJ =4
UJ =32 UJ =8
Cheese
A. Label the endowment point.
B. Would Josh be willing to trade 2 glasses of wine for 6 pieces of cheese? Would Elanna accept this trade? Label the point of the hypothetical trade on the Edgeworth box
C. Would Elanna be willing to trade 1 piece of cheese for 4 glasses of wine? Would Josh accept this trade. Label the point of the hypothetical trade on the Edgeworth box.
UJ =16
Question 3. Public vs. Private Demand
Aron’s demand for books in his apartment (a private good) is Q = 100 – 3P and Tamar’s demand
for books in her apartment is Q = 50 – P.
A. Write down an equation for the social marginal benefit of the consumption of privately- owned books (i.e., books are a private good).
B. If the price of a books was $10 and they were a private good, how many books would be consumed?
C. Now assume that instead of books being privately-owned, they are all kept in a shared library (a public pood). Write down the social marginal benefit of library book consumption.
D. Now find the socially efficient number of library books if the price per book is $10.
Question 4. Externalities (Cost-Effectiveness, Fees, & Tradeable Permits)
On an island in Scotland there are two sweater factories (Firm 1 & Firm 2). They both make lovely sweaters, but the yarn dying process causes pollution. Firm 1 currently produces 100 units of pollution and Firm 2 produces 250 units of pollution. The firms have different costs for reducing pollution. The marginal cost of firm 1 to reducing pollution is MC1 = 40X1, and the marginal cost for firm 2 of reducing pollution is MC2 = 10X2, where X1 is the number of units of pollution reduction for firm 1 and X2 is the number of units of pollution reduction for firm 2.
A. Suppose the island’s government decided they needed to reduce pollution by 50% (175 units) in order to keep the scenery attractive and attract tourists. How much should each firm reduce pollution in order to be cost effective.
B. One method of reducing pollution is imposing fees on firms that pollute. What per unit fee should be the island’s government impose per unit of pollution to achieve the cost- effective outcome?
C. How much would each firm pay in taxes?
D. An alternate way to decrease pollution is to issue a set number of tradeable permits that allow firms to pollute 1 unit each. If the government issues 75 permits to Firm #1 and 100 permits to Firm #2 (a total 175), how many permits will be traded between the two of them.
Question 5. Education
The Elijah family lives in Edutopia. They make a combined income of $30,000 per year to spend on private goods and education and have one child. Currently, all education in Edutopia is privately provided.
(a) Draw the Elijah family’s budget constraint. Assume that the family prefers to spend $6,000 on their child’s education: draw an “X” at point. How much does the family spend on other goods?
(b) Suppose now that the government of Edutopia decided to provide free public education with spending of $5,000 per pupil. However, to fund this policy change, each family will now be taxed $3,000. Draw this new budget constraint on the same graph you completed part (a).
(c) Will the Elijah family enroll their child in public or private education? Explain your answer below.
Question 6. Cash Transfers
In Pennsylvania, a welfare recipient can earn $600 per month without having her benefits reduced. Beyond $600, benefits are reduced by 50 cents for every dollar earned. If a beneficiary does not work at all, he receives welfare benefits of $1,000. Suppose Jada earns an hourly wage of $12 and can work up to 1,000 hours a year.
a) After Jada works a certain number of hours, she no longer receives benefits. What is that number of hours? (Round to two decimal places.)
b) Draw Jada’s budget constraint (labeling axes, intercepts, and slopes) and draw a set of indifference curves consistent with her participating in the labor market and receiving a partially-reduced welfare benefit.
Question 7. Benefit linkage: Cash Transfers + In-kind Transfers
a) Draw the budget constraint of a person working at No Doze Coffee Co. which pays a wage of $10 per hour. Suppose that there are 2,000 possible working hours per year (T=2000).
b) The government of Caffeineland runs a welfare system that gives income benefits of $5,000 per year for individuals with no income. An individual can earn up to $500 in income before their benefits are reduced; after that point, they are reduced by $1 for every $2 in earned income. Currently, the government also provides free health care for individuals with less than $15,000 in income. Each individual values this benefit at $2,000 per year. On the same graph, draw this new budget constraint.
c) Draw a set of indifference curves depicting a Caffeineland resident working fewer hours after receiving both healthcare and partially-reduced welfare benefits. Explain using economic concepts what “effects” lead to this decrease in work.
