Total 20 points.
1) (4 points) Rights and markets.
“We hold these truths to be self-evident that all men are created equal, that they are endowed by their Creator with certain unalienable Rights that among these are Life, Liberty and the pursuit of Happiness.”
Thomas Jefferson, 1776.
a) (1 point) Give examples of how we recognize people as having rights to Life, to Liberty, and to the pursuit of Happiness. Give examples of how we do not recognize people as having these rights but make them conditional on success in the marketplace.
b) (1 point) Does your answer mean that we, as a nation, are insincere in our commitment to democracy and equality? How does Arthur Okun resolve this seeming contradiction?
c) (2 points) Evaluate the evidence relating income inequality and efficiency. Is Okun right? Consider the arguments in Chris Tilly, “Geese, Golden Eggs, and Traps” (article 7.1 in Real World Micro), and Gar Alperovitz and Lew Daly, “The Undeserving Rich” (1.6): do we need inequality to maintain an efficient economy?
2) (4 points) Equilibrium discrimination and crowding. Suppose there are two occupations, chefs and truck drivers.
a) (2 points). Draw hypothetical supply and demand graphs for men and women to both occupations assuming that some of each gender prefers each job. Now, assume that discriminatory actions take place in the restaurant business preventing men from becoming chefs. Show the effects of discrimination on your graph.
b) (1 point) Who benefits and who loses from this discrimination? Show the effect of discrimination on wages and employment in both occupations and on total output in each. (Hint: have one graph for chefs, and a separate for truck drivers)
c) (1 point) Angry about the discrimination, aspiring male chefs’ successfully lobby Washington to crack down on discrimination practices in the restaurant business. If discrimination is eliminated through this process, show the changes that will take place in the labor markets for chefs and truck drivers. Who benefits and who loses from the ban on discrimination?
3) (6 points) Long-run competition. Much of the cost of a new smart phone is in the research and development and in building manufacturing facilities. By contrast, the marginal cost of producing another phone is relatively low.
a) (2 points) You have been hired by Apple to recommend pricing and marketing strategies for their next phone. On one graph: draw a hypothetical Average Total Cost (ATC) curve, the Marginal Cost curve, and a Demand (MU) curve for iPhones. (Hint: The point where Demand intersects MC should be below the ATC curve.)
b) (2 points) Show the area of net profit (or loss) under perfect competition as the difference between average total cost and the average revenue (or the price). (Note that profit is the number of phones sold times the price minus ATC.) What will happen to the industry and the number of companies under competitive conditions? Why?
c) (1 points) Duplicate the ATC, MC, & MU graph from part b, but this time, show what happens if they can charge a monopoly price. Show the area of net profit as the difference between average total cost and the price multiplied by the number of phones sold (Profit = (P – ATC)*Q). How does this change consumer, producer, and total surplus?
d) (1 point) What can Apple do to maintain a monopoly pricing strategy? Would their success depend on having very low fixed costs?
4) (4 points) Insurance and social policy. You have been hired by an insurance company to help them launch a new product which would pay for long-term care in a nursing home for people at an average cost of $150,000/year. Among 90% of the population, there is a 1% chance of going into a nursing home in the next year but for 10% of the population, people with chronic conditions or over age 80, there is a 10% chance of going into a home. Assume that people live two years, the current year and the next, and you buy the policy this year and either use it or not next year.
a) (1 point) If you were able to sell this to the entire population, what is the fair market value of this policy? (That is to say, what is the expected value of the policy to the average person?) What is the fair market price if you marketed the policy exclusively to people with chronic conditions and those over age 80.
b) (1 point) Who would you expect would buy your policy if you offered it at the fair market price for the whole population? Will you be able to make profits offering it at this price to anyone who wants the policy?
c) (2 points) What alternative strategies could you offer the company to make profits selling long-term insurance market? Think about moral hazard and adverse selection and how these affect your markets. Would you expect markets with moral hazard and adverse selection to provide the optimal amount of long-term care insurance at an efficient price?
5) (2 points) future and our children’s. Frank Ackerman (Real World Micro, 11.7) makes four arguments for aggressive action to stop global warming. Evaluate each of his arguments from the perspective of a young person, an elderly person without children, and a middle-aged person with children. Which arguments might each find persuasive? Which arguments might each dismiss?