Please, start your answer for each question on a separate page.

EXAM IN MICROECONOMICS

(April, 2009)

MOCK

SOLUTIONS AND MARKING SCHEME

Section 2. Free response questions.

You will have a total of 60 minutes for this section of the exam. It is strongly recommended that you spend the first 10 minutes reading the exam carefully, and the next 50 minutes working on the questions.

Please, start your answer for each question on a separate page.

1. (30 points) The Russian Dolls Factory makes matreshka sets out of wood supplied to it by the Souvenir and Lumber Company, which pays the Russian Dolls Factory $10 for each finished matreshka set. The Russian Dolls Factory’s only factors of production are artists and a small construction facility. The number of matreshka sets per day it produces depends on the number of employee – hours per day, as shown in the table below:

Number of matreshka sets per day	Number of employee – hours per day

A. (10 points) If the wage is $15 per hour and the Russian Dolls Factory’s daily fixed costs are $60, what is the profit-maximizing quantity of matreshka sets? Show your work.

Answer:

Number of matreshka sets per day	Number of employee – hours per day	Total costs	Marginal cost per matreshka set
		60+15*0=60	-
		60+15*1=75	(75-60)/5=3
			(90-75)/5=3

The marginal revenue per matreshka set is equal to $10. From the table we find that the firm should produce 20 matreshka sets and use 7 employee-hours per day. (Also check that the total cost ($165) is below total revenue ($10*20=$200)).

Marking Scheme:

6 points for the answer, 4 points for the explanation (table is sufficient).

B. (10 points) How would the Russian Dolls Factory’s profit-maximizing level of output be affected if the government imposed a tax of $10 per day on the company? Explain your answer.

Answer: The tax is equivalent to an increase in the fixed cost to 60+10=70 $. Since the MC per matreshka set is the same, the profit-maximizing output remains the same at 20 matreshka sets per day. The total cost now is $175 and total revenue is $200.

Marking Scheme:

6 points for the answer (stays the same), 4 points for the explanation (marginal cost is not affected by the tax).

C. (10 points) What would the Russian Dolls Factory’s profit-maximizing level of output be if the government imposed a tax of $2 per matreshka set? Explain your answer.

Answer: The tax is equivalent to a $2 increase in the marginal cost per matreshka set.

Number of matreshka sets per day	Number of employee – hours per day	Marginal cost per matreshka set, no tax	Marginal cost per matreshka set with tax
		-	-

With tax, the profit-maximizing level of output is lower at 15 matreshka sets per day.

Marking Scheme:

6 points for the answer, 4 points for the explanation (correct table is sufficient or any other reasonable explanation of work).

2. (40 points) The demand function for Japanese cars in Russia is such that annual sales of cars (in thousands of cars) are equal to 250 − 2 P, where P is the price of Japanese cars in thousands of dollars. The supply schedule of Japanese cars is horizontal at a price of $10,000.

A. (12 points) Draw a diagram of the market for Japanese cars in Russia. What are the equilibrium price and quantity?

Answer: See graph below.

thousand dollars, thousand cars.

Marking Scheme:

7 points for the graph;

5 points for price and quantity:

2 points for the price; 3 points for quantity.

Subtract 1 point if the answers are not in thousands.

Suppose that in response to pressure from Russian car manufacturers, Russian government imposes an import duty on Japanese cars in such a way that for every car exported to Russia the Japanese manufacturers must pay a tax to the Russian government of $5,000.

B. (8 points) Use your diagram to show how this tax would affect the price and quantity of Japanese cars sold in Russia. Find the new equilibrium price and quantity.

Answer: thousand dollars, thousand cars.

Marking Scheme:

3 points for the diagram: 2 points the shift of supply by tax amount, 1 points labeling.

5 points for the calculation: 2 points for the price; 3 points for quantity.

Subtract 1 point if the answers are not in thousands.

C. (6 points) How much revenue will the Russian government collect with this tariff? Show it on your graph.

Answer: 220*5=1100 million $.

Marking Scheme:

2 points for the diagram, 4 points for calculations. Subtract 1 point if the answer is not in millions.

D. (6 points) Compute the deadweight loss from this policy and show it on your graph.

Answer: million $.

Marking Scheme:

2 points for the diagram, 4 points for calculations. Subtract 1 point if the answer is not in millions.

E. (8 points) What are the respective losses in consumer and producer surpluses?

Answer: Loss in CS is 1100+25=1125 million $, loss in PS is 0.

Marking Scheme:

4 points for CS, 4 points for PS. Subtract 1 point if the answers are not in millions.

3. (30 points) Sasha and Kolya are neighbors in an apartment complex in Moscow. Sasha is a concert pianist, and Kolya is an economics student working on his diploma thesis. Sasha rehearses his concert pieces on the piano in his room, which is directly above Kolya’s study. The following matrix shows the monthly payoffs to Shasha and Kolya when Sasha’s room is and is not soundproofed. The soundproofing will be effective only if installed in Sasha’s apartment.

	Soundproofed	Not soundproofed
Gains to Sasha	$ 100 / month	$ 150 / month
Gains to Kolya	$ 120 / month	$ 80 / month

A. (15 points) If Sasha has the legal right to make any amount of noise he wants and he and Kolya can negotiate with one another at no cost, will Sasha install and maintain soundproofing? Explain. Is his choice socially efficient?

Answer: Kolya would be willing to pay up to $40 (120 – 80) in order for Sasha to soundproof his apartment. But the not-soundproofed apartment is worth $50 to Sasha, he would not be willing to accept a smaller amount. Thus, Sasha’s apartment will not be soundproofed. This outcome is socially efficient, since the total monthly benefit from soundproofing ($100 + $120 = $220) is lower than that from not soundproofing ($150 + $80=$230).

Marking Scheme:

5 points answer (No), 5 points explanation, 5 points answer to the efficiency part of the question (3 points the actual answer + 2 points if explain).

B. (10 points) If Kolya has the legal right to piece and quiet and can negotiate with Sasha at no cost, will Sasha install and maintain soundproofing? Explain. Is his choice socially efficient?

Answer: Sasha would be willing to pay Kolya up to $50 not to install soundproofing. Kolya would be willing to accept any amount greater than or equal to $40 for having to put up with noise. Thus, they can reach an agreement and the apartment will not be soundproofed. This outcome is socially efficient for the same reasons as above.

Marking Scheme:

4 points answer (No), 4 points explanation, 2 points answer to the efficiency part of the question.

C. (5 points) Does the attainment of an efficient outcome depend on whether Sasha has the legal right to make noise, or Kolya the legal right to piece and quiet?

Answer: No. This is an illustration of the famous Coase Theorem at work.

Marking Scheme:

5 points answer (Yes). Explanation is not necessary.

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