QUESTION 1.

Congratulations! After 35 years working as a practicing

economist, you decide to retire. To stay

somewhat productive during retirement, you agree to teach an economics course

at the University of Freedmania. Remarkably, Freemania continues to produce and

consume only two goods: tequila and medicine.

To produce one bottle of tequila per day,

one worker and one machine must be used.

That is, there is no substitutability between inputs. But, to produce one bottle of medicine per

day, there is perfect substitutability between inputs. That is, there are three

ways to produce a bottle of medicine:

1.

One worker and one machine

2.

Two workers and no machines

3.

Two machines and no workers

All markets in Freedmania are perfectly

competitive. Furthermore, all workers and all machines are capable of working

in either industry. Workers and machines

are both paid $10 per bottle produced.

Regardless of price, Freedmania always

consumes 10 bottles of tequila per day.

But, regardless of how many bottles of medicine Freedmanian consumes,

marginal value (marginal benefit) is always $20 per bottle. (Assume initially

that Freedmania consumes 10 bottles of medicine per day.)

Task

1: You decide that for your first lecture you will

explain to your students what the shape of the isoquant and isocost curve looks

like in each industry. For each industry

provide a graph. Place machines on the vertical axis and labor on the

horizontal axis. Label how many machines

and workers are employed in each industry (For tequila this is straight

forward, but for medicine there are different ways to produce. Pick one).

QUESTION 2.

Task

2: Students fascinated with your explanation and

eager to learn more, ask about the shape of the demand and supply curve in each

industry. Provide a demand and supply

graph for each industry to explain.

Label equilibrium price and quantity.

QUESTION 3.

The semester progresses smoothly. You are

preparing a lecture on the impact of a per unit tax on efficiency and on

consumer and producer surplus.

Task

4: Discuss using a supply and demand graph.

QUESTION 4.

Freedmania is a small society that

produces and consumes just two goods: tequila and medicine. The price of

tequila and medicine are both $1 per unit, but the marginal utility of medicine

is less than the marginal utility of tequila.

All consumers have identical Cobb-Douglass preferences.

Task

1:Your job is to explain how equilibrium is

achieved. Provide a graph with your explanation. Place medicine on the horizontal axis and tequila on the

vertical axis. Clearly label the budget line and the indifference curves before

and after equilibrium.

QUESTION 5.

Part 2 (15 Points):

Good for you! You passed round two with

flying colors. You negotiated a great employment contract and you are sitting

at your desk waiting for a project to successfully complete. As it turns out, the Freedmanian Congress

has decided to place a per unit tax on Medicine. Your supervisor needs you to

provide an economic analysis. He

provides you with the following information:

All consumers have the same incomes and

preferences.

Utility for a typical consumer is given

by: U(tequila, Medicine) = 1(tequila) +

1(medicine).

Income for a typical consumer is $200

Before the tax the price of both goods

is $1 per unit.

Per unit tax on medicine is $1

After the tax, the price of tequila

remains $1, but the price of medicine rises to $2.

Currently, a typical consumer purchases

both goods.

You are quick to observe that tequila

and medicine are perfect substitutes for each other.

Task

2: How much tax revenue will the Freedmanian

government collect from a typical consumer?

Use a graph with medicine on the horizontal axis and tequila on the

vertical axis to explain. Clearly label budget lines and indifference curves.

QUESTION 6.

Hold the press! Congress is upset with

your findings. They are demanding a re-evaluation. Your bonus depends on it.

Congress is convinced that the utility function you are using is all wrong, but

that the other information is correct. Congress insists that tequila and

medicine are consumed in equal proportions.

No choice, you must re-evaluate using Congresses fixed proportion

utility function.

Task

3: Answer task 2 using the utility function

provided to you by the Freedmanian Congress.

QUESTION 7.

Part 4 (15 Points):

Congress must be happy with your

findings. You are sitting at your desk starring at your very first bonus. Your bonus will be provided to you in two

parts: 50% this year and 50% next year.

You are dreaming about what to do with the money. Should you spend 50% this year and the other

50% next year, should you borrow against next year’s portion to spend more of

the bonus this year, or should you save a portion of this year’s bonus to spend

more of it next year.

Task 4:What did you end up doing?

Explain using a two time period budget equation.

QUESTION 8.

Part 5 (15 Points):

Years have passed. You are now working

with a prestigious think tank on K-Street.

Early one morning, you find yourself in a heated discussion with one of

your brightest colleagues. He gets very

upset with you, because you are trying to make the point that, ceteris paribus,

it is possible for a decrease in price to result in a decrease in quantity

demanded. He argues that you are simply

wrong.

Task 5:Using budget lines and indifference curves, prove to your colleague

that he is wrong.

Decompose the change in price into two components: pure substitution

effect, and income effect.

QUESTION 9.

Part 6 (15 Points):

You are at the tail end of your career,

working as a high priced consultant for a firm that you are partner in. The Freedmanian Congress is in the process of

overhauling the Freedmanian Health Care system and they have hired you to

assist them. They would like you to

analyze the impact of expanding the demand for health care services while at

the same time reducing payments to health care providers.

Task 6:Using supply and demand curves, provide your analysis.

QUESTION 10.

8.7.

A firm’s long-run total cost curve is TC(Q)=1000Q. Derive the equation for the

corresponding long-run average cost curve, AC(Q). Given the equation of the

long-

run

average cost curve, which of the following statements is true?

a)

The long-run marginal cost curve MC(Q) lies below AC(Q) for all positive

quantities Q.

b)

The long-run marginal cost curve MC(Q) is the same as the AC(Q) for all

positive quantities Q.

c)

The long-run marginal cost curve MC(Q) lies above the AC(Q) for all positive

quantities Q.

d)

The long-run marginal cost curve MC(Q) lies below AC(Q) for some positive

quantities Q and above the AC(Q) for some positive quantities Q.

QUESTION 11.

National

Hospital is the only employer of nurses in the country of Castoria, and it acts

as a profit-maximizing monopsonist in the market for nursing labor. The

marginal revenue product for nurses is W=50-2N, where w is the wage rate and N

is the number of nurses employed (measured in hundreds of nurses). Nursing

services are provided according to the supply schedule w=14+2n

a)

How many nurses does National Hospital employ, and what wage will National pay

its nurses?

b) What is the deadweight loss arising from monopsony?