Answer appropriately.

Final Exam (A) You have 2h to complete the exam and the final consists of 6 questions (15+10+25+15+20+15=100). Problem 1. (Consumer Choice) Jeremy's favorite flowers are tulips z , and daffodils zz. Suppose pi = 2, pa = 4 and m = 10. a) Write down Jeremy's budget constraint (a formula) and plot all Jeremy's affordable bundles in the graph (his budget set). Find the slope of a budget line (number). Give an economic interpretation for the slope of the budget line (one sentence). b) Jeremy's utility function is given by U (m.) = \\(In +izz) +7 Propose a simpler utility function that represents the same preferences (give a formula). Explain why your utility represents the same preferences (one sentence). c)' Plot Jeremy's indifference curve map (graph), find MRS analytically (give a formula) and find its value at bundle (2, 4) (one number). Give economic interpretation of this number (one sentence). Mark its value in the graph. d) Write down two secrets of happiness (two equalities) that allow determining the optimal bundle. Pro- vide their geometric interpretation (one sentence for each). Find the optimal bundle (2s.z2) (two numbers). Is your solution interior? (a yes -no answer) e) Hard: Find the optimal bundle given pr = 2. p2 = 4 and m = 10 assuming U (21, 12) = 221 + 3x2 (two numbers). Is your solution interior? (a yes -no answer) Problem 2. (Producers) Consider production function given by F(K, 1) = 3utzt. a) Using the A argument demonstrate that production function exhibits decreasing returns to scale. b) Derive the cost function given ax = wy = 9. c) Derive a supply function of a competitive firm, assuming the cost function from b) and fixed cost F = 2 (give a formula for p(p)). Plot the supply function in a graph, marking the threshold price below which a firm chooses inaction. Problem 3. (Competitive Equilibrium) Consider an economy with apples and oranges. Dustin's endowment of two commodities is given by - (8, 2) and Kate's endowment is w" = (2,8). The utility functions of Dustin and Kate are the same and given by where i = D, K. a) Plot the Edgeworth box and mark the point corresponding to the initial endowments. b) Give a general definition of Pareto efficient allocation z (one sentence) and state its equivalent con- dition in terms of MIS (one sentence, you do not need to prove the equivalence). c) Using the "MRS" condition verify that the initial endowments are not Pareto efficient, d) Find a competitive equilibrium (six numbers). Provide an example of a competitive equilibrium with some other prices (six numbers). e) Using MRS condition verify that the competitive allocation is Pareto efficient, () Hard: Find prices pi, p, in a competitive equilibrium for identical preferences of two agents U (21. 12) = 2r1 +3r2 (two numbers, no calculations). Explain why any two prices that give rise to a relative price higher than pa/pa cannot be equilibrium prices (which condition of equilibrium fails?) 'If you do not know the answer to b), to get partial credit in points cle) your can assume (21.x2) = 2142. Problem 4. (Short Questions) a) Uncertainty: Find the certainty equivalent of a lottery which, in two equally likely states, pays (0, 9). Bernoulli utility function is a(c) = ve (one number). Is the certainty equivalent smaller or bigger than the expected value of a lottery 45. Why? (one sentence) b) Market for lemons: In a market for racing horses one can find two types of animals: champions (Plums) and ordinary recreational horses (Lemons). Buyers can distinguish between the two types only long after they buy a house. The values of the two types of horses for buyers and sellers are summarized in the table Lemon Plum Seller Buyer 2 Are champions (Plums) going to be traded if probability of Lemons is ]. (yes-no). Why? (a one sentence argument that involves the expected value of a horse to a buyer c) Signaling: The productivity of high ability workers (and hence the competitive wage rate) is 1000 while productivity of low ability workers is only 400. To determine the type, employer can, first offer an internship program with the length of a months, during which a worker has to demonstrate her high productivity, A low ability worker by putting extra effort can mimic high ability performance, which costs him c(z) = 200r. Find the minimal length z be which the internship becomes a credible signal of high ability. (one number) d) PV of Perpetuity: You can rent an apartment paying 1000 per month (starting next month, till the "end of the world" ) or you can buy the apartment for 100.000. Which option are you going to chose if monthly interest rate is r = 2%? (find the PV of rent and compare two numbers) Problem 5. (Market Power) Consider a monopoly facing the inverse demand p (y) = 25 -y, and with total cost TC() = 5p. a) Find the marginal revenue of a monopoly, MR (y) and depict it in a graph together with the demand (formula +graph). Which is bigger: price or marginal revenue? Why? (one sentence) b) Find the optimal level of production and price (two numbers). Illustrate the optimal choice in a graph, depicting Consumer and Producer Surplus, and DWL (three numbers + graph). c) Find equilibrium markup (one number). d) First Degree Price Discrimination: Find Total Surplus, Consumer, Producer Surplus and DWL if monopoly can perfectly discriminate among buyers and quantities. (four numbers +graph) e) Hard: find the individual level of production and price in a Cournot-Nash equilibrium with N identical17. Which of the following contributed to rising unemployment and increased inflation in the 1970s? a Declining profits of U.S. firms due to increased competition from other industrialized nations b. Decline in wages c. High expenditures by the government d. (a) and (c) only e. (a) and (b) only 18. Which of the following is not one of the ideas associated with monetarist economics? a. Free-market economy drives out inefficiencies in the economic system. b. A smaller government is good for the economy as it encourages private initiatives. c. Efforts by the government to push unemployment too low could lead to inflation. d. Governments should keep the money supply stable. e. There are times when the government should take an active role by changing its spending policies. 19. According to the text, which of the following issues, not previously a major concern of macroeconomics, must macroeconomics confront in the 21* century? a. The ecological sustainability of our reliance on fossil-fuel based economic growth b. The social sustainability of the traditional model of economic development with the persistence of global poverty. c. The problem of business cycle fluctuations in unemployment and inflation. d. (a) and (b) only e. None of the above. 20. Which of the following characterizes the environmental challenges of the 21" century? a. The impressive growth of global GDP in the 20" century was accompanied by a dramatic increase in CO, emissions. b. There are limits to the capacity of the environment to absorb the by-products of economic growth. c. It is becoming more difficult for technological advancements to keep problems of resource depletion and pollution at bay. d. If continued at the current rate, the emissions of CO, and other greenhouse gasses may lead to dramatic disturbances to our environment and economy. e. All of the above. Chapter 1 - Economic Activity in Context 8 Answers to Active Review Questions I. microeconomics, macroeconomics 2. positive, normative 3. living standards growth, stability and security, sustainability 4. economic development 5. economic, living standards 6. the business cycle 7. sustainability 8. classical economics 9. John Maynard Keynes 10. monetarist economics 1 1. False. They are studied in Macroeconomics. 12. False. Economic growth, not living standards growth, is defined as increases in the level of production in a country or region.Fill in the Blank 1. While the study of economic activities of individuals, households, and business at the sub-national level is the concern of , the study of economic activities of the national and global level is the concern of 2. Questions about facts or "how things are" are questions, while questions about values and "how things should be" are questions. 3. The three main macroeconomic goals identified in this chapter are , and 4. The process of moving from a situation of poverty and deprivation to a situation of increased production and plenty is referred to as 5. The increase in the level of production in a country or region is called growth while improvements in diet, housing, medical attention, education, working conditions, access to care, transportation, communication, entertainment, etc. is called growth. 6. The fluctuations in the level of production, including recessions on the one hand and booms on the other hand, is called 7. The goal that recognizes a serious responsibility to future generations is the goal of 8. The school of economics that is associated with the idea that individual self-interest is a positive force and that governments should let markets function without interference is called 9. The economist who argued that the market mechanism can fail by leaving insufficient demand and that governments could intervene by increasing aggregate demand was named 10. The school of thought that argued that governments should aim for steadiness in the money supply rather than play an active role is called True or False 11. Economic phenomena such as the rate of unemployment and inflation are studied in microeconomics. Chapter 1 - Economic Activity in Context 12. Living standards growth is defined as increases in the level of production in a country or region. 13. During a recession, the economy often has higher rates of unemployment, whereas during a boom, the economy often has higher rates of inflation. 14. Monetarists believe the government should change money supply to boost aggregate demand during a recession. 15. According to the Keynesians, the government can reduce unemployment through changes in its spending and taxation policies.6. En oil executive states he is not concerned about the eventual depletion of fossil fuel resources. \"When we run out of oil," he says, \"we'll just switch to nucleon\" The oil executive is basing his argummt on the notion of T. The activity of consumption and the activity of investment are linked by the activity of ,which is the re'aining from consumption today in order to gain benets in the future. 3. in one year a country adds to the capital stock with new investments, but during that year some of its capital stock is reduced through depreciation. The resulting amount of investment is called investment. 9. The graph that is used to depict income inequality, showing the percent of households along one axis and the percent of income along the other, is known as the curve. 10. If income were perfectly equally distributed within a country, the vaJue of the II{'_'iini ratio for that country would be I]. If someone enjoys the benefit of a well-paved highway but refuses to pay for it, they would be considered a . 12. You decide to buy a used car. You discover that it is hard to get informeion on the quality of the used cars that are available. You have trouble communicating with the car dealer. It takes a considerable amount of time to get the informmion you need to successfully get the car you had in mind. In other words, buying a used cartums out to be an activity with high costs. IS. A new factory begins discharging pollutants into a previously pristine river. Fish in the river begin to die, and people who make their living through shing have trouble maintaining their catch. This factory is generating negative M. A professional musician practices piano every afternoon. Her neighbor listens to the music and enjoys it. Through her activity, the musician is creating a positive 15. In a sustainable socioeconomic system, flows of goods and services come largely from judicious use of renewable capital stocks, 16. The number of fish sold per day at Big City Fish Shop is an example of a stock. 17. Planting new trees in a forest is an example of making an investment. 18. The distribution of wealth in the U.S. tends to be more equal than the distribution of income. 19. A public good is a good that is consumed by the public. Short Answer 20. Identify the four essential economic activities. 21. Name the five types of capital. 22. Explain the difference between a stock and a flow. 23. What are the two main forms of economic distribution? What is the difference between them? 24. How does the approach of someone who has adopted the precautionary principle differ from someone with a blind faith in substitutability, when it comes to a non- renewable resource like fossil fuels? 25. What are the two types of government cash transfer programs in the U.S., used to help households achieve income security? Provide examples of each. 26. What is the distinguishes a progressive income tax, from a proportional income tax, or a regressive income tax? Chapter 3 - What Economies Do 27. What is a Lorenz curve? Explain how the Gini ratio uses the Lorenz curve to measure the level of inequality in a nation's income distribution. 28. The US Census Bureau has experimented with a variety of possible definitions of personal income. The Gini ratio in the US varies somewhat, depending which definition of personal income is used. If the Census Bureau starts with a measure of pre-tax money income and then adds the value of health insurance fringe benefits paid by businesses for their employees, as well as the value of net capital gains, how does the Gini ratio change? 29. Provide an example of a market that fits the first meaning of markets (as a physical place), and an example of a market that fits the second definition (as an institution). 30. List two advantages of markets identified by the authors of the text. 31. Identify the four institutional requirements of markets. 32. Identify six disadvantages of markets (i.e, cases of market failures)