Microeconomics Midterm Question -

Q1) Let the annual demand for cars in the United States be D(p) = 600 × (40,000 - p) and let the annual supply be S(p) = 2,400 × (P - 21,250).

a) What is the price of cars? What is annual production?

b) Suppose there is a fire at a General Motors factory that normally produces at its full capacity of 300,000 cars per year. What is the new price of cars? How much does production decline because of the fire?

c) Discuss why production falls by less than 300,000 cars per year, and how the elasticity of supply relates to the decrease in production (one or two sentences).

Q2) Suppose that the market for palladium has monthly demand of D(p) = (2,000 - p) ounces and monthly supply of S(p) = 2 × (p - 500) ounces.

a) What is the price of palladium? What are consumer and producer surplus?

b) Suppose that every ounce of palladium produced creates one thousand gallons of water pollution. Nearby residents would be willing to pay $0.30 per gallon to clean the water. What is the optimal tax per gallon of water polluted? With this tax, how much palladium is produced? How much water is polluted?

c) Suppose that the government does not want to tax pollution, but instead wants to cap it. Suppose the government will sell permits to companies that allow them to pollute. Each permit allows one gallon of water pollution. How many permits per month should the government sell? What will be the price of a permit?

d) Suppose demand for palladium increases to D(p) = (2,300 - p) ounces per month. No new permits are issued. How much will the price of a permit increase? How much does the quantity of palladium produced increase?

Q3) Yan is an analyst at Commerce-Merc and Co. He is tasked with preparing senior traders with reports on expected price movements resulting from news that has been released since the previous trading day. In each case below, determine whether Yan should tell the traders to expect higher or lower prices and, when possible, how much higher or lower.

a) The US Government has announced a new "industrial pollutant impact fee" of $1 per pound of copper produced. The fee will apply to all US firms and imports. The elasticity of supply of copper is 0.2 and the elasticity of demand is -0.8. How much will the consumer price of copper increase? (circle one)

$0   $0.20  $0.25  $0.50  $0.75  $0.80  $1.00

b) The long run supply elasticity of copper is 1, and the long run elasticity of demand for copper is -1. In the long run, how much will the consumer price of copper increase? (circle one)

$0   $0.20  $0.25  $0.50  $0.75  $0.80  $1.00

c) The government has announced an increase in the mandatory quantity of ethanol contained in gasoline. The price of oil is likely to go: HIGHER or LOWER

d) The government has announced an increase in the mandatory quantity of ethanol contained in gasoline. The price of pork is likely to go: HIGHER or LOWER

e) A severe increase in piracy has made shipping to and from Hawaii very expensive. The US navy will respond eventually, but it may be a year before the problem is under control. The price of pineapples in Hawaii is likely to go: HIGHER or LOWER

f) The US Energy Information Administration has announced that gasoline inventories unexpectedly dropped last week. The price of gasoline futures is likely to go: HIGHER or LOWER

Q4) Read the article "New mileage standards would double fuel efficiency" at the end of this exam, and then return to this question.

a) According to administration estimates, the new regulations will cost the auto industry $135 billion from 2017 to 2025 (a nine year period). They will increase the cost [price] of a new car by $2,800 by 2025. Assuming that the average new car sales will be approximately 15 million per year over that range, and that this increase in the cost of a new car occurs by 2017, and is constant from 2017 to 2025, approximately what fraction of the total cost of the regulation is being passed to consumers?

b) The administration has a political incentive to downplay the cost for consumers relative to producers. Therefore, we should probably take their estimate from (a) as a lower bound on the true fraction borne by consumers. Given your answer in (a), discuss how elastic supply must be in the car industry, relative to demand. Does the ratio from (a) make intuitive sense?

c) Consider a simple model of the car industry in 2025. The effective fuel efficiency requirement for General Motors's (GM) fleet is 40 miles per gallon. Suppose that GM produces only two types of automobile: cars get about 50 miles per gallon, and light trucks get 25 miles per gallon. Suppose that when prices are set without reference to the fuel economy requirement, GM sells about equal numbers of cars and light trucks. How should GM change its prices to achieve the required fuel economy standard (one sentence)? Who benefits from these changes (one sentence)?

d) Continuing with the model in (c), is there a way that the government could achieve the same average fuel economy for cars sold in the US without fuel economy standards (one or two sentences)? Hint: the policy would change effective consumer prices in the same way as in (c). Politically speaking, why might the administration prefer these rules rather than the alternative you discuss here (one or two sentences)?

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