I. Thinking like an economist

ANSWER FIVE OUT OF THE SIX QUESTIONS IN THIS SECTION: (AMONG QUESTIONS 1A – 1F) THERE IS NO EXTRA CREDIT FOR ANSWERING ALL SIX)

A. On October 12^th, 2001, BBC Radio reported on “Queue for You,” a new business in London that will stand in line for you! For example, if you need to renew your driver’s license, a “Queue for You” employee will go to the Department of Motor Vehicles and stand in line. The employee will call you when he is almost at the front of the line so that you can then replace him in line, get your photo taken, and sign for your new license!

Explain how “Queue for You” is taking advantage of the concept of opportunity cost. What decision rule would a potential client follow as she decides whether to pay for the services of “Queue for You”?

B. Over Family Weekend for Middlebury College, how do you think that the demand for pizza changes in downtown Middlebury? If you sold pizza in Middlebury, how would you react to this change in order to maximize your revenues over Family Weekend? Justify your answers.

C. As a pro-consumer lobbyist in Washington, you are trying to make consumers better off in the energy market. You could push for one of two policy changes: switch the current gasoline tax on consumers to a similarly-sized gasoline tax on producers; or remove tariffs on oil from overseas producers (so that more foreign oil would be sold in the United States). For consumers of gasoline, which of these two possible changes would be better? Justify your answer.

D. On October 5^th, 2001, the Associate Press reported that teen-agers are now less likely to become cigarette smokers. Since 1997, the number of new teen smokers has decreased by a third – and the average price of a pack of cigarettes has gone from $1.85 to $2.92. Would it be correct for a researcher to use this data to calculate the own-price elasticity of demand for cigarettes among young smokers? Justify your answer.

E. Two drivers -- Ben and Jerry -- each drive up to a full-service gas station. Before looking at the price, each places an order. Ben says, “I’ll take 10 gallons of gasoline.” Jerry says, “I’ll take $10 worth of gasoline.” What is each driver’s own-price elasticity of demand for gasoline?

F. The following data are from a student in an economics class who was asked about their willingness to pay for CDs and DVDs under two different scenarios (A and B).

	*Scenario A*	*Scenario B*
	*DVD price = $20*	*DVD price = $30*
*Price of a Compact Disk*	Number of compact disks demanded	Number of compact disks demanded
$ 20	10	15
$ 18	12	18
$ 16	14	21
$ 14	16	24
$ 12	18	27

Based on these results, what is the cross price elasticity of demand for CDs with respect to DVDs for this student when the price of a CD is $14? Based on the logic of consumer choice (and assuming that this student always tries to be as happy as possible), in which of the two cells in this row (16 and 24, respectively) is the marginal rate of substitution (MU_CD /MU_DVD) higher? Justify your answer.

II. Using supply and demand

The commodity markets for some goods (like wheat) often have the following characteristics: supply shifts frequently; prices fluctuate wildly and frequently; the quantity sold per year doesn’t change much; and the per capita consumption of the good increases – but not by much -- as (most) countries grows economically.

A. Is the own-price elasticity of demand for such a commodity likely to be relatively elastic or inelastic? Justify your answer.

B. Is the elasticity of supply for such a commodity likely to be relatively elastic or inelastic? Justify your answer.

C. Is such a commodity likely to be an inferior good, a normal good, and/or a luxury good? Justify your answer.

D. Under these conditions, why would established suppliers of such a commodity try to persuade their governments to impose a price floor on the commodity and/or to restrict imports of the commodity?

E. If you were a lobbyist for a company that was trying to establish a price floor, how would you argue that society would not be very hurt by such a policy? Under what conditions would society be more hurt by the imposition of a price floor?

III. The logic of consumer choice

In Kenya, a family with two children in primary school has $24 to spend on two goods: textbooks and clothing for the school year. The price of each textbook is $3; the price of each school uniform is $4.

A. Using the axes below, plot the relevant income constraint for this family, with textbooks on the vertical axis and uniforms on the horizontal axis. What is the slope of this line?

B. The government orders that all uniforms must be bought from a single, state- owned supplier -- who will now charge $6. On the same graph above, show what this does to the income constraint. What is the slope of this new line?

C. Soon after the government declares this policy, the woman in this household finds new income-generating activities, supported by a small loan from a local development agency. The family is soon able to afford spending $30 on textbooks and clothing. On the same graph above, show what this does to the income constraint. What is the slope of this new line?

D. Is the family going to be better off, in terms of the utility that they derive from textbooks and uniforms, with the first income constraint and the first set of prices ($24, $3, and $4, as in question A) -- or with the second income constraint and the second set of prices ($30, $3, and $6, as in question C)? Justify your answer.

E. Researchers at a development agency estimate that the own-price elasticity of demand for textbooks in Tanzania is about 0.1, the income elasticity for textbooks is about 2.0; and that only 20% of poor families regularly purchase textbooks. Based on these research results, which policy (or combination of policies) would you recommend to the government of Tanzania if its objective were to ensure that children of most poor families have access to textbooks in their homes?

· Lower prices of textbooks from $3.00 to $1.50.

· Rent the books for $3.00 -- and give the family back it’s $3.00 at the end of the school year.

· Give away the books.

· Teach parents about the importance of textbooks for their children’s education.

Justify your answer.

IV. Putting microeconomic reasoning to work

You are a member of the Town Council in Middlebury, which voted last year to increase the local tax on the sale of real estate by 10%. You and you colleagues are trying to decide how to use the new tax revenues. You could increase downtown parking (this would help local residents and businesses); expand the facilities at Project Independence (an elderly care program); or do a combination of both (some parking and some elderly facilities).

A. At the Middlebury Town Meeting, a voter gets up and declares: “This tax increase is really making us worse off: less houses are now being sold because of the tax, and these tax revenues represent money out of the pockets of buyers and sellers. In other words,” (it turns out that this guy is an economics teacher!) “our community has been made worse off in two ways: we are losing the ‘deadweight loss,’ and we are losing all of these tax revenues.” Is this voter’s logic correct? Justify your answer.

B. Based on the material in our class, what ‘role of government’ would the Town Council be playing if it decided to increase downtown parking? What ‘role of government’ would the Town Council be playing if it decided to expand the facilities at Project Independence? Justify your answers.

C. To help you and your colleagues to decide how to use these tax revenues, the town manager gives you the following production possibilities, based on his studies of local input prices and consultations with local contractors.

*Resources devoted to parking lot construction*	*Square feet of parking lot*	*Resources devoted to elderly services expansion*	*Square feet of elderly services*
100%	20,000	0%	0
80%	19,000	20%	2,000
60%	17,000	40%	3,600
40%	14,000	60%	4,800
20%	10,000	80%	5,600
0%	5,000	100%	6,000

Using the space below, plot the production possibilities frontier for these allocations.

D. One of your colleagues states: “It’s obvious which one of these possibilities is best. If we allocate 80% of our resources to parking lot construction and 20% to elderly services, we get the most square feet: a total of 21,000. Since more is always better, this is what we should do.” Is your colleague right? Justify your answer.

E. Based on our discussion of the logic of consumer choice, how can you relate the concepts of utility and indifference curves to this decision making process? Use your graph to illustrate your answer.