Question

Question 1 ( 10  marks)
Evaluate the following statements   (your  answer for all three parts  should be no more than
200 words ):
a)   Since I own my own home , housing costs  me  nothing . (3 marks)
b)   These lectures are boring and useless, but since I have paid for them, I am going to
attend all of them.   (4 marks)
c)   Petrol is essential for people who own motor vehicles, therefore  the demand curve
for petrol is perfectly inelastic.   (3 marks)
Question 2 ( 2 0   marks)
The table below shows the production possibilities for two countries , Australia and Canada.
These countries each produce only two goods, cheese’ and wine’:
Australia’s production
per day
Canada’s production
per  day
Cheese
Wine
1600
OR
3200
800
OR
2400
a)   On separate diagrams draw the production possibility frontier (PPF) for
each country, putting cheese on the x axis and wine on the y axis.  Assume constant
opportunity cost.
b)   Use the information in the table to explain the meaning of absolute advantage.
c)   Which country has the comparative advantage in wine production?
Which country has a comparative advantage in cheese production?
Make sure you fully  explain your answers.
d)   Assume   a terms of trade of 1  unit of cheese = 2.5 units of wine.  Explain why each
country would find these terms of trade acceptable.  Draw  the  consumption possibility
frontier (CPF) in the PPF diagram from a)  for each country. Explain how you
constructed  the CPF.
e)   Use the diagram from d) to demonstrate the gains from trade’. Explain   your answer.
4
Question 3 (25   marks)
Assume that the retail price of petrol in Australia is $1.50 per litre. This price includes a per
unit  tax of 38 cents per litre. Assume that the supply of petrol is perfectly elastic. At the
price of $1.50 the quantity traded per year is 18 billion litres. It has been proposed to cut the
tax by 5 cents to 33 cents per litre. Answer the following questions.
a)   What is the effect of the reduction of the tax on the retail price?
b)   Assume the demand curve is linear and that the reduction in price causes the
quantity of petrol traded to increase by 61.02 million litres. Calculate the elasticity of
demand at the  mid-point between the original and new price.
c)   What is the tax revenue collected before and after the tax is cut by 5 cents per litre?
d)   What is the change in the deadweight loss from the petrol tax when it is cut by 5
cents per litre?
e)   Calculate the ratio of the change in deadweight loss from part (d) to the change in
tax revenue in part (c). What does this ratio tell you?
Question 4 (25   marks)
The first two columns of the table below show the market demand schedule for  an industrial
chemical. The   production of this chemical generates a negativ e externality in the form of
atmospheric pollution. The   third column shows  the  marginal private cost (MC)  of producing
this chemical in   this market.
Price ( dollars per  tonne )  Quantity (tonnes per
day )
Marginal Cost (dollars
per tonne)
0   6000  120
4 0  500 0  1 0 0
8 0  400 0  8 0
1 2 0  300 0  6 0
1 6 0  200 0  4 0
2 0 0  100 0  2 0
The marginal external cost (MEC) of the pollution created is equal to the MC  at every level
of output produced:    that is, MC=MEC and therefore marginal social cost (MSC)  = 2 x MC.
a)   With no pollution control, what is the quantity of chemical  produced, the price of  the
chemical per tonne, and the marginal external cost of the pollution generated?
b)   With no pollution control, what is the marginal social cost of the chemicals produced
and the deadweight loss?
5
c)   Suppose that the government levies a tax  on the producers, such that the  market
produces the efficient quantity. What is   the price of the chemic al per tonne,  the tax
per tonne, and the tax revenue per day?
d)   Draw a diagram to illustrate all of the above.
e)   Assuming there are a small number of parties involved in this chemical market, and
that transactions costs are low, outline another way (apart  from the tax) that the
externality issue could be dealt with.
Question 5 ( 20  marks)
In many major cities around the world the  taxi ride market is regulated by the government.
A common form of regulation is the requirement that taxi operators must hold a government
issued taxi licence. Assume the following holds in one such city. Only 500 licences are
issued and each taxi can only offer six taxi rides per day. Assume there are no government
controls on the price that can be charged per ride. Assume that  the demand curve for taxi
rides  is linear and  obeys the law of demand. Assume that in an unregulated market (that is
in  a  market  with  no  licenc e  requirements)  the  supply  curve  for  taxi  rides  would  be  an
upward sloping straight line starting at the origin.  Answer the following questions.
a)   Draw a diagram representing the unregulated taxi ride market. Put price per ride on
the vertical axis and taxi rides per day on the horizontal axis. Assume that the
unregulated equilibrium quantity transacted is 5000 rides per day.
b)   Indicate the areas of consumer surplus and producer surplus in the unregulated
market. Explain briefly what is meant by consumer  surplus and producer surplus.
c)   Now draw the supply curve representing the regulated taxi ride market. Explain the
shape of this curve.
d)   Will the regulated equilibrium price and quantity be higher or lower than the
unregulated equilibrium price and quantity? Show the regulated equilibrium price and
quantity on the diagram.
e)   Indicate the areas of consumer surplus, prod ucer surplus under the regulated
market. Is there a deadweight loss in the regulated market? If so indicate the area of
deadweight loss on the diagram.