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Consider the following open economy. The real exchange rate is fixed and equal to one. Consumption, investment, government spending, and taxes are given by:

C = 8 + 0.6(Y - T), I = G = T = 0.

Imports/ exports are given by:

Q = 0.4Y, X = 0.4Y*,

where an asterisk denotes a foreign variable.

A/ Suppose that the domestic country takes foreign income Y* as given. The equilibrium output in the domestic economy is 10 + 0.5Y*.

B/ Following a, if the domestic government increases spending by 6 units (i.e., G increases from 0 to 6), the equilibrium output in the domestic country will increase by 7.5 units and the trade balance will increase by 3 units.

C/ Assume the foreign economy has the same equations as the domestic economy. Both governments consider the impact of the other country on the domestic economy. If G=0, then the equilibrium output in both countries is ( ) and the trade balance is ( )

D/ Following c, if the domestic government increases spending by 6 units as in b) and G=0 in the foreign country, the equilibrium output in the domestic country increases by ( ) units, and the trade balance in equilibrium is ( )

E/ Please compare your answer in b) and d) regarding the equilibrium output and explain the difference.

1. Two firms are developing new technology to allow consumers to taste food online. Given the risks and the relatively small anticipated size of this market, compatibility of technologies is very important. "La Brasa Roja" is firmly advancing in developing its technology, RemoteTaste. "Kokoriko" has been developing its technology, BitterWeb. If both adopt the same technology, each can earn a total of $200 million. If they adopt different technologies, consumers will not buy any products, leading to a profit of $0. Reconditioning the factory to implement a technology different from its own would cost "Kokoriko" $100 million and "La Brasa Roja" $200 million. The decision about which technology to adopt must be made simultaneously. (a) 0.2 points Represent the game in normal form. (b) 0.2 points Represent the game in the extensive form. (c) 0.3 points Find the Nash equilibria in pure strategies. (d) 0.3 points Find the Nash equilibria in mixed strategies.

2. Subway has a monopoly on sandwiches and makes an annual profit of $100,000. Metro, a newly formed Canadian company, is contemplating entering the market, incurring costs of $25,000 and splitting annual profits 50-50 with Subway. Subway threatens to sell at cost, if necessary, to maintain its monopoly position. In which case neither firm would make a profit. Remember that: Metro still incurred some fixed costs of entering a new market. Metro can choose between "enter the market" and "don't enter the market" and Subway, once it sees if Metro enters, can decide between "Sell at cost" and "Welcome the new competitor".

(a) 0.2 points Draw the game extensively, including payoffs (b) 0.2 points Write the normal representation of the game. (c) 0.2 points Shows that Subway's threat is not credible. (d) 0.2 points What is the subgame perfect equilibrium? (e) 0.2 points Is there a Nash equilibrium that is not a subgame perfect equilibrium? justify and if it exists, say why this balance does not make sense.

Suppose there are 25 potential used-car buyers, each of whom is willing to pay $1200 for a good used car and $400 for a lemon. Potential buyers want to buy at most one car. Before they purchase a used car, buyers are not able to tell whether it is a good used car or a lemon. The current owners of good used cars have a reservation price of $700 for their cars, and the current owners of lemons have a reservation price of $200. In this market, there are 5 good used cars and 15 lemons.

a. Draw the resulting supply curve.

Suppose that all of the potential buyers believe that all used cars will be offered for sale.

b. What is the average quality of cars sold? c. Draw the demand curve. d. What is the market equilibrium (price, quantity and quality)?

Suppose now that all consumers believe that the only lemons will reach the market:

e. Does the market equilibrium change? If so, how?

1. Assume that peaches are grown in a perfectly competitive market and that peach farms

have cost curves that look like those in this chapter. Draw a graph for a peach farm that

earns a profit. Label the axes, as well as the curves for demand, marginal revenue, average

total cost, and marginal cost. Label the prices of peaches "P" and the quantity of peaches

the farm will produce "Q". Shade and label the farm's profit.

2. Suppose the firms in a perfectly competitive market earn profits in the short run. Explain

how this market will reach a long-run equilibrium. Illustrate your answer with side-by-side

graphs of the market and a representative firm.

3. True, false or uncertain: After some firms leave a market in which they were experiencing loses, the remaining firms will produce the same quantity of output as before the other firms left. Explain your answer using side-by-side graphs of the market and a representative firm.

4. True, False or uncertain: A firm maximizes its profit by producing the quantity at which the marginal cost is as far below the price as possible. Explain your answer.

5. What characteristic does hamburger market in your area share with a perfectly competitive industry? What conditions for the perfect competition does it violate?

Suppose the Earned Income Tax Credit gives workers 40% of their earnings for earnings up to a maximum tax credit of $4800, then begins to reduce the credit by 20% for every dollar of earnings above $21,000. For an individual who earns $15 an hour and can work a maximum of 4000 hours in a year.

1a. Draw the budget constraints before and after this EITC goes into effect. Label the number of hours of work and the income for each kink in the budget constraint.

1b. Draw indifference curves before and after the EITC goes into effect for 4 people. Alex does not work at all before the EITC goes into effect. Brandon works 1200 hours. Chris works 2000 hours. David works 3500 hours.

1c. Explain the income and substitution effects of the EITC on these 4 people.

1d. State how hours of work and money income will change (more, less, no change). Explain.

At the beginning of each year, Larry chooses how many weeks he will work. Factoring out holidays, Larry's total time endowment T is 50 weeks. He earns a wage w of $400 per week, the price of consumption p is $10 per unit of consumption, and he has no nonlabor income V . Throughout this question we will build and graph Larry's budget line.

3a. Normalize the prices in this question. What are they now? (NOTE: If you cannot or are unsure, feel free to use the listed numbers in the rest of the problem).

3b. What is Larry's real wage? Explain what this means in words. (HINT: Think about interpreting ratios.)

3c. Suppose Larry doesn't work at all. What would his consumption and leisure bundle be? On the graph, label this point E.

3d. Now suppose Larry is a workaholic and works all 50 weeks. What would his consumption and leisure bundle be now? On the graph, label this point F.

3e. Draw Larry's budget line. Shade in the pairs (z, c) that Larry can afford. What is this shaded in area called? Now let us introduce a flat/proportional tax on labor income with a tax rate of t.

3f. What is the expression that represents Larry's after-tax wage?

3g. Suppose the flat tax is 10%. What is the effect on Larry's real wage?

3h. Now uppose the flat tax is 25%. What is the effect on Larry's real wage?

3i. What happens to Larry's budget line as the tax increases from 0% to 10% to 25%? Illustrate these changes on the graph.