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Briefly describe the difference between an economic profit and an economic rent.
economic profit is the difference between a firm's total revenues and its total economic costs. economic costs is the amount required to keep an input in its present use; the amount that it would be worth in its next best alternative use.
economic rent is long run profits earned by owners of low cost firms. May be capitalized into the prices of these firms' inputs.
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Describe briefly why the principal of setting quantity produced and consumed where
marginal social benefit equals marginal social cost results in an outcome that
is socially efficient.
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Describe the private costs of a commuter crossing the George Washington
Bridge during the morning
rush hour.
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Explain the idea of a congestion externality (i.e., why private costs don’t equal
social costs).
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Explain how a flexible toll schedule reduces the congestion externality (i.e., flexible
with respect to time of day).
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The cost and quality of cell phones has dropped dramatically over the past 6 years.
Using ideas from class, predict the effect cell phones have had on waiting
times to cross the bridge into New
York during the morning rush hour.
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Briefly compare and contrast the following three mechanisms for treating pollution
externalities when the costs and benefits of abatement are uncertain: (a) an
emissions fee, (b) an emissions standard, and (c) a system of transferable
emissions permits.
an emissions fee,
an emissions standard
a system of transferableemissions permits.
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Explain the difference between systematic and unsystematic risk. Why do investors who
hold well diversified portfolios of assets not need to be concerned with
unsystematic risk?
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Farm State Insurance Company offers flood
insurance that fully reimburses claimants for all flood-related losses.
a. Explain
the concept of adverse selection and give an example relevant to this
situation.
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Explain the concept of moral hazard and give an example relevant to this situation.v
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Suppose Farm State offers policies that only cover 80% of flood-related losses. Is the moral hazard problem solved?
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Suppose Farm State now offers two policies: one that covers 50% of losses and has a low price and one that covers 90% of losses but has a
high price. Explain why this may help solve the adverse selection problem.
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It is often alleged that firms could produce
infinitely-lived light bulbs if they wanted to.
The fact that they do not is simply evidence that consumers are at
firms' mercy, and they produce short-lived light bulbs to keep us coming
back. Suppose markets are competitive
with no externalities, etc.
a. Explain briefly what it means for a firm to be a price-taker.
price-taker a firm or individual whose decisions regarding buying or selling have no effect on the prevailing market price of a good.
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Explain why it might not be efficient to produce
infinitely-lived light bulbs versus a lightbulb that lasts, say, exactly two
years.
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Develop a simple theory that predicts how a
competitive market will choose the most efficient lifespan of a lightbulb.
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What should happen to lightbulb life if the
interest rate falls and stays at its new, lower level forever?
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Who should demand light bulbs with the longest
life: New Yorkers, five of whom it takes
to change a lightbulb, or Pennsylvanians, only three of whom it takes to change
a lightbulb? Assume that the price of a
lightbulb is identical in both states.
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Assume that Liechtenstein and Andorra, with
equal (and very few) resources, can produce the following (in addition to
postage stamps):
Wine
OR Navajo
blankets
Leichtenstein 100,000 cases 100,000 blankets
Andorra 50,000 cases 100,000 blankets
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Define comparative and absolute advantage.
comparative is when one country or firm has an advantage over another in producing a good because the cost of producing the good in 1, relative to the cost of producing other goods in 1, is lower than the cost of producing the good in 2, relative to the cost of producing other goods in 2.
absolute advantage is when one country or firm has an advantage over the second in producing a good because the cost of producing the good in 1 is lower than the cost of producing it in 2.
trade in comparative advantage allows firms/countries to consume outside of its production possibilities frontier.
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Who has the comparative advantage in producing grapes? wool?
Wine OR Navajo blankets
Leichtenstein 100,000 cases 100,000 blankets
Andorra 50,000 cases 100,000 blankets
Liechtenstein has the comparative advantage in grapes. No one has the comparative advantage in wool.
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Before trade, Liechtenstein produces 50,000 cases of wine and 50,000 blankets, and Andorra
produces 25,000 cases of wine and 50,000 blankets. Show that trade between Liechtenstein
and Andorra has the potential of increasing total consumption for the two countries.
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After the trauma of Micro, you
decide to pursue a PhD in Sociology and need to invest in a good pair of
sandals. Let the demand and supply
curves for sandals be given by Qd = 20 - P and Qs = P. As a good Sociologist, you believe the market
is oppressive and advocate a price cap of $5 on each pair.
a. (3
points) Graph supply and demand and solve for equilibrium price and quantity
before the price cap.
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What is the price and quantity after the price cap is
imposed? How big is the shortage?
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Explain the concept of consumer surplus. Calculate consumer surplus before and after
the price cap, and illustrate using a graph.
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Calculate the total welfare change to society of this
policy. Illustrate its components on a
graph.
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Are there any transfers involved
with this new policy? What are they and
how much are they?
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Briefly, what are the advantages to
diversification? Mention the relative benefits if the two
stocks have positive, negative, or zero covariance.
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Calculate the expected return and the standard
deviation (sometimes called the volatility) for each security.
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Calculate
the covariance of the two securities.
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Your investment advisor tells you to put all of your savings into Stock A because it
has less risk than Stock B and offers and the same return as Stock B. Do you agree?
Prove your advisor wrong by constructing a portfolio in which you put
80% of your wealth into Stock A and the remainder into Stock B.
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