Eco 101, Davis, Final Exam, p.

Final Exam A: Name Time:

Note: Please feel free to use the abbreviations we use in class: AC for average cost, AD for aggregate demand.
Good luck!

1. Grapes are used to produce Wine, which is a substitute for Beer. Suppose grape pickers unionize and
successfully demand higher wages. In the graphs below, show how this affects the markets for Wine and Beer.
(5 pts)
Wine Beer
P P

S S

D D

Q Q

2. Rising food prices in Venezuela have made it increasingly difficult for the poor to feed their families. In
response, the Venezuelan government has recently put limits on what grocery stores can charge for food. Draw
a graph of the Venezuelan market for food and use it to explain why this policy may not be very effective. (5
pts)

3. A report on the oil market contains an error in that it gives the price elasticity of demand for oil as both 0.2 and
2.0.
A. Which number is likely to be correct? (1 pt)

B. Given you answer to A), suppose the price of oil rises by 20%. Find the percentage change in the quantity
of oil demanded. (2 pts)

C. Would you expect total revenue in the oil market to rise or fall? Explain. (2 pts)
 Eco 101, Davis, Final Exam, p. 2

P
4. Suppose oil consumption creates a negative
externality of $20 per barrel by reducing air quality S
and contributing to global warming.
90
A. On the graph, indicate the equilibrium price and 80
quantity, the social cost curve (SCC) and the
efficient level of output, Q*. (2 pts) 70
60
B. Compute the economic surplus from the last
barrel of oil produced when the market is in 50
equilibrium. (1 pts) 40
D
Barrels of Oil,
C. Pigou would suggest that we tax oil by $______ 40 60 80 100 120 140 160 millions
per barrel. (1 pt)

D. Show the new supply curve, S’, that would result from this tax. (1 pt)

5. The graph to the right shows a firm in the short Cost

run.

A. Show the firm’s profit maximizing level of MC AC

output, profits or losses, and fixed cost: q,
, and FC. (3 pts) AVC

B. Should the firm shut down in the short run?

Explain. (2 pts)

Output

C. On the graph above, draw the firm’s LR demand curve and output: D’ and q’. (2 pts)

D. Explain how the industry adjusts to its long run equilibrium. (3 pts)
 Eco 101, Davis, Final Exam, p. 3

6. Suppose two airlines, United and Delta, are considering whether or not to lobby congress for subsidies for the
airline industry. If the lobbying effort is successful, the subsidies will be available to both airlines. Each airline
has a choice of strategies: “L” = Lobby, or “D = Don’t Lobby,” resulting in the following payoff matrix:

Delta (Player 2)
D L
| | |
United D | (0, 0) | (5, -2) |
(Player 1) | | |
L | (-2, 5) | (3, 3) |

A. Circle United’s dominant strategy: D L neither (1 pt)

B. If the game is played only once, the Nash equilibrium is { , }. (1 pt)

C. Suppose the game above is played repeatedly. Describe a trigger strategy for Delta. (3 pts)

7. What is a “natural monopoly”? Is it a good idea to break up a natural monopoly? Explain. (5 pts)

8. Is real GDP per person a good measure of material wellbeing? Explain. (5 pts)
 Eco 101, Davis, Final Exam, p. 4

9. For each transaction below, indicate which component (or components) of GDP are affected. The components
of GDP are C, I, G and NX. If none are affected write “None.” (5 pts)

Transaction Component(s)
I mow my own lawn.
I buy $1000 IBM stock.
I increase the inventory at my hardware store by 20 hammers.
The government sends me a social security check.
GE purchases $1000 of German lab equipment

10. The adjacent table shows the Consumer Price Index for January 1 of various years. Year CPI
A. If I made $20,000 in 2004. What’s that worth in 2008 dollars?
2004 563.2
(2 pts)
2005 582.9
2006 603.5
2007 619.1
2008 643.5
B. Compute the inflation rate for 2005, i.e. from 2005 to 2006. (2 pts)

C. Suppose I took out a loan at an interest rate of 8.5% at the beginning of 2005 and pay it back at the
beginning of 2006. What was the real interest rate on that loan? (1 pt)

11. Suppose inflation is 5%. Does this mean that, on average, everyone’s purchasing power falls by 5%? Explain.
(5 pts)

12. The financial crisis has reduced the amount of tax revenues collected by the State of NY, resulting in a large
deficit for the state government. Given that we’re in a recession, is it a good idea to try to balance the state
government budget? Explain. (5 pts)
 Eco 101, Davis, Final Exam, p. 5

13. During the financial crisis last spring, the value of the US$ rose relative to other currencies, such that it took
more Yen or Euros or Pesos to buy $1.
A. Explain how this affects aggregate demand in the US. (3 pts)

B. Use the AS-AD graph below to show how this affects US real GDP and the price level in the SR. How did
this change affect the unemployment rate? (2 pts)

C. Assuming that the government does nothing to P

LR AS
intervene, explain how the economy adjusts to its long
run equilibrium. Show this on the graph. (5 pts)
AS

AD

real GDP
Y*

14. Explain how you could change the level of taxes to offset the SR change in AD described above. Which would
be more effective, a $1000 change in taxes on the rich or a $1000 change in taxes on the poor? (5 pts)
 Eco 101, Davis, Final Exam, p. 6

15. Suppose the reserve ratio is 5%, and the Fed decides to buy $1000 of bonds in the open market.
A. Suppose the money from the bond sale is deposited in the First National Bank. Use the table below to
show what happens to the bank’s deposits, reserves and loans. (3 pts)
First National Bank
Assets Liabilities

B. Suppose banks hold no excess reserves. Find the change in the money supply. (2 pts)

16. Use graphs or equations to explain the argument that expansionary fiscal policy “crowds out” business
investment. (5 pts)

17. Suppose the Fed sells bonds in the open market. Draw graphs to explain how this will impact the money
supply, the real interest rate, the level of private investment, real GDP, and the price level. (10 pts)