QUESTION 1.
Congratulations! After 35 years working as a practicing economist, you decide to retire. To stay somewhat productive during retirement, you agree to teach an economics course at the University of Freedmania. Remarkably, Freemania continues to produce and consume only two goods: tequila and medicine.
To produce one bottle of tequila per day, one worker and one machine must be used. That is, there is no substitutability between inputs. But, to produce one bottle of medicine per day, there is perfect substitutability between inputs. That is, there are three ways to produce a bottle of medicine:
1. One worker and one machine
2. Two workers and no machines
3. Two machines and no workers
All markets in Freedmania are perfectly competitive. Furthermore, all workers and all machines are capable of working in either industry. Workers and machines are both paid $10 per bottle produced.
Regardless of price, Freedmania always consumes 10 bottles of tequila per day. But, regardless of how many bottles of medicine Freedmanian consumes, marginal value (marginal benefit) is always $20 per bottle. (Assume initially that Freedmania consumes 10 bottles of medicine per day.)
Task 1: You decide that for your first lecture you will explain to your students what the shape of the isoquant and isocost curve looks like in each industry. For each industry provide a graph. Place machines on the vertical axis and labor on the horizontal axis. Label how many machines and workers are employed in each industry (For tequila this is straight forward, but for medicine there are different ways to produce. Pick one).
QUESTION 2.
Task 2: Students fascinated with your explanation and eager to learn more, ask about the shape of the demand and supply curve in each industry. Provide a demand and supply graph for each industry to explain. Label equilibrium price and quantity.
QUESTION 3.
The semester progresses smoothly. You are preparing a lecture on the impact of a per unit tax on efficiency and on consumer and producer surplus.
Task 4: Discuss using a supply and demand graph.
QUESTION 4.
Freedmania is a small society that produces and consumes just two goods: tequila and medicine. The price of tequila and medicine are both $1 per unit, but the marginal utility of medicine is less than the marginal utility of tequila. All consumers have identical Cobb-Douglass preferences.
Task 1:Your job is to explain how equilibrium is achieved. Provide a graph with your explanation. Place medicine on the horizontal axis and tequila on the vertical axis. Clearly label the budget line and the indifference curves before and after equilibrium.
QUESTION 5.
Part 2 (15 Points):
Good for you! You passed round two with flying colors. You negotiated a great employment contract and you are sitting at your desk waiting for a project to successfully complete. As it turns out, the Freedmanian Congress has decided to place a per unit tax on Medicine. Your supervisor needs you to provide an economic analysis. He provides you with the following information:
All consumers have the same incomes and preferences.
Utility for a typical consumer is given by: U(tequila, Medicine) = 1(tequila) + 1(medicine).
Income for a typical consumer is $200
Before the tax the price of both goods is $1 per unit.
Per unit tax on medicine is $1
After the tax, the price of tequila remains $1, but the price of medicine rises to $2.
Currently, a typical consumer purchases both goods.
You are quick to observe that tequila and medicine are perfect substitutes for each other.
Task 2: How much tax revenue will the Freedmanian government collect from a typical consumer? Use a graph with medicine on the horizontal axis and tequila on the vertical axis to explain. Clearly label budget lines and indifference curves.
QUESTION 6.
Hold the press! Congress is upset with your findings. They are demanding a re-evaluation. Your bonus depends on it. Congress is convinced that the utility function you are using is all wrong, but that the other information is correct. Congress insists that tequila and medicine are consumed in equal proportions. No choice, you must re-evaluate using Congresses fixed proportion utility function.
Task 3: Answer task 2 using the utility function provided to you by the Freedmanian Congress.
QUESTION 7.
Part 4 (15 Points):
Congress must be happy with your findings. You are sitting at your desk starring at your very first bonus. Your bonus will be provided to you in two parts: 50% this year and 50% next year. You are dreaming about what to do with the money. Should you spend 50% this year and the other 50% next year, should you borrow against next year's portion to spend more of the bonus this year, or should you save a portion of this year's bonus to spend more of it next year.
Task 4: What did you end up doing? Explain using a two time period budget equation.
QUESTION 8.
Part 5 (15 Points):
Years have passed. You are now working with a prestigious think tank on K-Street. Early one morning, you find yourself in a heated discussion with one of your brightest colleagues. He gets very upset with you, because you are trying to make the point that, ceteris paribus, it is possible for a decrease in price to result in a decrease in quantity demanded. He argues that you are simply wrong.
Task 5: Using budget lines and indifference curves, prove to your colleague that he is wrong.
Decompose the change in price into two components: pure substitution effect, and income effect.
QUESTION 9.
Part 6 (15 Points):
You are at the tail end of your career, working as a high priced consultant for a firm that you are partner in. The Freedmanian Congress is in the process of overhauling the Freedmanian Health Care system and they have hired you to assist them. They would like you to analyze the impact of expanding the demand for health care services while at the same time reducing payments to health care providers.
Task 6: Using supply and demand curves, provide your analysis.
QUESTION 10.
8.7. A firm's long-run total cost curve is TC(Q)=1000Q. Derive the equation for the corresponding long-run average cost curve, AC(Q). Given the equation of the long-
run average cost curve, which of the following statementsis true?
a) The long-run marginal cost curve MC(Q) lies belowAC(Q) for all positive quantities Q.
b) The long-run marginal cost curve MC(Q) is the sameas the AC(Q) for all positive quantities Q.
c) The long-run marginal cost curve MC(Q) lies abovethe AC(Q) for all positive quantities Q.
d) The long-run marginal cost curve MC(Q) lies belowAC(Q) for some positive quantities Q and above theAC(Q) for some positive quantities Q.
QUESTION 11.
National Hospital is the only employer of nursesin the country of Castoria, and it acts as a profit-maximizing monopsonist in the market for nursing labor.The marginal revenue product for nurses is W=50-2N, where w is the wage rate and N is the number ofnurses employed (measured in hundreds of nurses).Nursing services are provided according to the supplyschedule w=14+2n
a) How many nurses does National Hospital employ, andwhat wage will National pay its nurses?
b) What is the deadweight loss arising from monopsony?