Mid term 2 review questions
1. Circle all of the following statements that are true for Pareto efficiency in a perfect market
according to neoclassical economic theory. Note that some of the questions may be true, but
are not considered relevant to Pareto efficiency. (10 points, partial credit possible.)
a. The richest 5% of the citizens cannot own 90% of the nation’s wealth.
b. Resources must be allocated in a way that maximizes total national well-being.
c. Prices will always be stable.
d. If price and quantity take any other than their equilibrium values, a transaction that will make
at least some people better off without harming others can always be found.
e. There is a different Pareto efficient outcome for every initial distribution of wealth and
f. Wealth should be distributed from the rich to the poor, because the poor have a higher
marginal utility for each additional dollar.
g. Unemployment is minimized.
h. Consumer surplus is greater than producer surplus.
i. Economic surplus is maximized subject to the constraint that no one is made worse off.
2. In a country where it is easy to hire and fire workers, labor is considered what type of cost?
3. Which of the following can a firm vary in the long-run?
a. no factors of production
b. all factors of production
c. all but one factor of production
d. only one factor of production
e. more information about the firm is needed to answer this question
4. Total economic surplus is
a. the sum of all the individual economic surpluses gained by buyers and sellers in a market.
b. the sum of producer and consumer surplus in a market.
c. maximized at market equilibrium.
d. a measure that can be used to determine economic efficiency.
e. All of the above
5. You use $5,000 of your own money to start a security business. During the first year you earn a 5%
return on your investment. If the current interest rate is 10% (consider this the opportunity
cost on your investment), you earn an economic profit of
6. If a firm in a perfectly competitive industry raises price above market price, in theory
a. its total revenue will increase.
b. its profit will increase.
c. its sales will drop to zero.
d. its demand curve will become downward sloping.
e. Other firms will raise prices as well.
7. As it relates to oil, which of the following best demonstrates the law of increasing marginal
a. The marginal cost of producing the previous barrel of oil will be more than the marginal cost
of producing the next.
b. As oil production increases, sources of oil become harder to locate and the oil itself becomes
harder and more expensive to extract.
c. The marginal cost of oil was higher in 1950 than it is now.
d. While the price of oil remains constant, the marginal cost of producing it decreases each year.
e. Oil prices remained constant for much of the 20th century, disproving the law of increasing
8. Which of the following is not a characteristic of perfectly competitive markets?
a. Firms are price takers
b. A downward sloping market demand curve
c. An upward sloping supply curve for each firm
d. A downward sloping demand curve for each firm
e. There are a large number of buyers for each product
9. Purchasing goods such that the ratio of marginal utility to price is equal across all goods
results in the
a. greatest total utility, subject to income constraints and existing distribution.
b. lowest expenditure on goods.
c. greatest average utility, subject to income constraints and existing distribution.
d. greatest expenditure on goods.
e. expenditures for all goods being the same.
Table for question 10-15
Rival A B
Non-rival but congestible C D
Non-rival E F
Categorize each of resources below according to where it falls in the table. Explain what market
failures affect allocation of the resource, and what policies could help correct the problem. When
thinking about what policies to apply, remember that ecosystem structure generates function.
10. Timber from forests
11. Flood protection provided by forested watersheds
12. Climate stability
13. Atmospheric waste absorption capacity for CO2
14. Information on how to make non-ozone depleting compounds
15. A centralized sewage system with high fixed costs and negligible marginal costs,
currently operation below capacity
16. If rent controls were implemented for the Burlington market such that a 2 bedroom apartment
can rent for no more than $700, which of the following is likely to result:
a. The quantity supplied would increase
b. The quantity demanded would decrease
c. The quality of apartments provided would decrease.
d. The quality of apartments provided would increase
17. Of the following pairs, choose all the ones that are likely to be complements:
a. Coffee and Tea
b. Cable TV and Dish Network
c. Hiking boots and hiking trails
d. Climate stability and sustainable agriculture
e. Coca Cola and Fruit Juice
f. Computers and Microsoft Word software packages
18. You graduate from college, get a high paying job, and start eating less macaroni and cheese.
Mac and cheese in this case is an example of:
a. A normal good
b. A luxury good
c. An inferior good
d. A substitute good.
The following quotes are from Utilities plan coal-fired power plants: Shift reflects jump
in price of natural gas, By Dan D'Ambrosio / Associated Press March 30, 2004.
“DENVER — Coal, spurned for decades by power plant builders, is enjoying something
of a renaissance as natural gas prices drive up the cost of generating electricity…
Nationwide, as many as 90 new coal-fired plants are being considered with a combined
capacity of 50,000 megawatts, McIlvaine said.
That equals about 7 percent of the total power generation available in the United States
and carries a price tag of about $75 billion.
One megawatt supplies the amount of electricity used by 400 to 900 homes in one year.
In Colorado, Xcel Energy is planning a 750-megawatt coal-fired plant near Pueblo, Colo.,
for $1.3 billion while a comparable gas-fired plant would cost about $533 million.
Xcel had seen a 13 percent increase in per capita demand for power in the last decade,
thanks to a proliferation of household appliances from big screen televisions to cell phone
chargers, Roalstad said.
Over the next 10 years, the United States will need about 140,000 megawatts of increased
power, with about one-half or more to come from coal plants, McIlvaine said.”
Based on information from this article, and a little creative number crunching, I came up with the
following table of production costs and revenues for a coal fired power plant (500 MW). If a firm
decides to invest in this plant, the only fixed costs will be interest payments of $25 million per
year on a $500 million loan. The plant will sell electricity for $70 million per 100 megawatts.
Variable costs are given in the table.
Note the table lists costs in millions, and output in 100 megawatts, so you don't have to deal with
all the zeros. You will need to fill in the remainder of this table in order to answer some of the
Output (100 Fixed total total variable Total Marginal Costs
megawatts) Costs revenue costs (millions) Costs (millions)
0 0 0 ---------------------
1 100 ---------------------
2 130 ---------------------
3 170 ---------------------
4 230 ---------------------
5 320 ---------------------
19. What is the minimum price for electricity that would induce the firm to build this
a. $50 million per 100 MW
b. $56 million per 100 MW
c. $64 million per 100 MW
d. $70 million per 100 MW
e. $75 million per 100 MW
20. At a price of $70 million per 100 MW, how much electricity would the firm produce
(measured in 100 MW)?
21. At the profit maximizing level of production the firm would be making total profits of:
a. $60 million
b. $25 million
c. $230 million
d. $-3 million
e. $10 million
“The downside for coal-fired plants is that they are a major source of carbon dioxide emissions,
the leading cause of global warming. Coal plants emit sulfur dioxide, which creates acid rain;
nitrogen oxide, which turns to ozone creating smog; and mercury, a neurotoxin especially
dangerous to children.”
Many people argue that the current administration’s Clear Skies initiative will allow the emission
of far too much NO, SO2 and mercury. Assume the firm decides to invest in the plant on the
assumption that the next administration will continue to favor business over the environment, but
instead a pro-environment administration takes over. This new administration imposes strict
regulations on the emissions of these pollutants, and complying with them increases the cost of
electricity generation for the firm by $7 million per 100 megawatts.
22. Would the firm have built this power plant if it had known these regulations would be
c. There is not enough information to tell
d. All of the above
e. $25 million
23. If this power plant was already under construction w hen the regulations were imposed, so
that all fixed costs had already been incurred, how much electricity (in 100 MW) would it
a. None. Construction would be halted
24. What would profits be in the presence of the regulations?
b. -$25 million
c. $25 million
d. -$3 million
e. $10 million
25. Which of the following is a tenet or goal of both ecological and neoclassical economics?
a. Socially just distribution
c. efficient allocation
d. The economy is a subset of the ecosystem.
e. Continuous physical growth of the economy
26. A good with price inelastic demand is unlikely to exhibit which of the following
a. It is essential to our well-being
b. It has few if any substitutes
c. A high proportion of individual income is spent on the good
d. A small change in quantity supplied will lead to a large change in price
e. A large change in price leads to a small change in quantity demanded
27. Your current marginal utility from consuming soda is 4 utils per ounce and your current marginal
utility from consuming milk is 6 utils per ounce.
a. If the price of soda is $.07 per ounce and the price of milk is $.25 per ounce, are you
maximizing your total utility from milk and soda? Explain
b. What would happen to your total utility from milk and soda if you increased your
consumption of milk and decreased your consumption of soda? Explain.
28. Explain how the supply of natural resources responds to price increases in the short run and in the long
run. Consider positive feedback loops when prices begin to rise rapidly.
Figure 2: Graphs depicting market supply and demand for cheap plastic crap, as well as firm costs
for supplying it.
29. In figure 2, the rectangle labeled A depicts:
a. Negative economic profit
b. Normal profit
c. Positive economic profit
d. Total costs
e. Total Revenue
30. The shift in the supply curve from S to S1 can best be explained by
a. An increase in supply in response to a shift in the demand curve
b. New firms entering the market in pursuit of economic profit
c. A decrease in price, leading firms to produce less
d. A change in supply in response to higher prices
e. A decrease in the elasticity of demand for cheap plastic crap
31. What is the level of economic profit depicted in the lower right-hand corner? Would
the firm depicted have entered the market had it known it would earn this? Will the
firm leave the industry in response to this level of profit?
U.S. Government To Discontinue Long-Term, Low-Yield Investment In Nation's
September 24, 2003 | Issue 39•37
WASHINGTON, DC—In an effort to streamline federal financial holdings and spur growth,
Treasury Secretary John Snow announced Monday that the federal government will discontinue its long-
term, low-yield investment in the nation's youth.
"For generations, we've viewed spending on our nation's young people as an investment in the
future," Snow said. "Unfortunately, investments of this type take a minimum of 18 years to mature, and
even then, there's no guarantee of a profit. It's just not good business."
32. According to this passage, educated 20 year olds are a __________ to the government while the
education of young children represents a___________
a. variable cost, variable cost
b. fixed cost, fixed cost
c. variable cost, fixed cost
d. fixed cost, variable cost
Snow compared funneling money into public schools, youth programs, and child health-care
clinics to letting the nation's money languish in a low-interest savings account.
"This is taxpayer money we're talking about," Snow said. "We can't keep pouring it into slow-
growth ventures, speculating on a minuscule payout some time in the future."
"Federal expenditures are recouped when a child grows up and becomes a productive, taxpaying
member of society," Snow said. "But we don't see a sizable return on our investment unless a child invents
something profitable, or cures a costly disease, like cancer. The wisdom of making such long-range, long-
shot investments is questionable at best, especially when you consider inflation. America would do better to
invest in profitable business ventures. It's just that simple."
In the first quarter of 2004, the U.S. will scale back such youth-market investments as Head Start,
a federal preschool program for the poor, and D.A.R.E., a drug-use prevention program for minors. Snow
said such programs focus on preparing tomorrow's leaders at the expense of turning a profit today. The
extensive federal public-education system will also experience major cutbacks.
"With the economy showing signs of recovery, now is the time to cut away the dead wood," Snow
said. "As the stock market turns around, we have a real opportunity to make some money. But that's only if
we shift the nation's funds into high-yield, short-term investments."
Snow said he plans to support the private sector with corporate subsidies, and to invest overseas.
"This nation needs something really big to turn it around, something like the '90s tech bubble,"
Snow said. "We need a winning business model, something that after-school art workshops and inner-city
basketball programs simply do not offer."
Federal Reserve Chairman Alan Greenspan expressed cautious support for the divestments.
"Investments in our nation's young people have never yielded very impressive gains," Greenspan
said. "On the other hand, as the market improves, disinflation is a major concern for future quarters. The
education system is a huge employer in this country, and consumer spending could be affected."
33. Circle all that apply. This passage is an example of:
a. The rationing function of prices
b. The invisible hand in action, which allocates resources away from those sectors of the
economy that perform poorly and towards those sectors that generate economic profits
c. Compassionate conservatism
d. The allocative function of prices
Jack Carpenter, a financial consultant for Deloitte Touche Tohmatsu, said he is excited by the
prospects for the nation's financial future.
"In such tough markets, the federal government should be putting its money in fliers, but instead,
it's wasting it all on crawlers," Carpenter said. "Right now, we should focus on high-growth industries.
Professional and technical services, finance and insurance, and information management are hot right now.
Inner-city community youth programs—not so much."
Carpenter noted that not all investments in America's youth are low-yield, pointing to several
youth-targeted efforts in the private sector that have generated immense returns.
"Coca-Cola and Microsoft," Carpenter said. "Both organizations have done very well in the youth
market. Coke markets their beverages largely to children and young adults, showing steady gains. And
Microsoft, maker of the X-Box, has increased profits and beat earnings expectations in each of the past
eight quarters. The federal government has a lot to learn from these businesses."
In spite of an outcry from teachers and union leaders, Snow insisted that the divestment will be a
boon for all Americans.
"Taking a student through high school costs the federal government nearly $100,000 in taxpayer
money," Snow said. "If that figure upsets you, then think about the times that we invest in a child and then
he pulls out of the program before he matures."
Secretary of Education Rod Paige, whose post has historically been strongly committed to
investment in youth and the bridges from one century to the next, surprised many when he came out in
favor of the controversial plan. Paige said data collected over the past five years shows that there is reason
to divest our stake in the nation's youth.
"Look at our recent graduates," Paige said. "So many recipients of years of federal investments are
laying around in a state of unemployment. It's just not reasonable to continue to invest billions of dollars in
such risky ventures."
Paige was quick to add that the new investment strategy doesn't involve dismantling the public
school system, just restructuring it.
"The proposed plan actually includes increased investments in vouchers for private schools,"
Paige said. "Through the years, we've seen consistent returns from blue-chip schools."
In addition, Paige said Republican leaders are investing record levels of federal money in support
of President Bush's No Child Left Behind program, which calls for expanded testing, higher-quality
teachers, and greater achievement among students, particularly those in poor districts.
"Testing is exactly the sort of research the government should do before making spending
decisions," Paige said. "How else will we know which individuals are sound investments and which are
likely to waste our time and money?"
34. "Resource wars" ignite around the world by Fred Pearce, from New Scientist, January 02
A favourite prediction of environmentalism has bitten the dust - too many natural resources, rather than too
few, are the cause of an increasing numbers of wars in the 21st century.
Many greens had predicted that the new century would see a rash of wars in countries where
natural resources such as timber, water, minerals and fertile soils are running out. But far from it, says the
2002 State of the World report from the prestigious Washington-based think-tank, the Worldwatch
In fact, says the report's co-author Michael Renner, there are "numerous places in the developing
world where abundant natural resources help fuel conflicts". More than a quarter of current conflicts are
either being fought over, or are funded by, some lucrative natural resource. Examples cited by the
Worldwatch Institute include:
• Diamond mines in Sierra Leone and Angola making the two African nations ripe for plunder by warlords
• Profits from sapphires, rubies and timber arming the Khmer Rouge in their interminable jungle war in
• Guerillas using the threat of sabotage to extort hundreds of millions of dollars from oil companies
prospecting in Colombia
• Opium funding 20 years of war in Afghanistan
• The Congo's continuing civil war subsisting on the proceeds of elephant tusks and coltan, a vital mineral
in the manufacture of mobile phones
With the end of the cold war, superpowers no longer fund civil wars for their own geopolitical
ends, says Renner. Their place has been taken by the market - in the form of the plunder and sale of natural
"Nature's bounty attracts groups that may claim they are driven by grievance, but [which] initiate
violence not to overthrow a government but to gain and maintain control of lucrative resources," says
Renner. Such resource wars are being fought because of "greed rather than need".
According to David Keen at the London School of Economics: "We tend to regard conflict as
simply a breakdown in a particular system, rather than as the emergence of another, alternative system of
profit and power", i.e. a "conflict economy" with the looting of natural resources at its heart.
Renner warns that warlords in such conflicts have no interest in winning the war, because its
continuance is more profitable. And he says too many Western governments are happy to turn a blind eye
as their own corporations reap the benefits in cheap no-questions-asked raw materials.
Renner argues the issue of resource conflicts should be added to the agenda of the forthcoming
World Summit on Sustainable Development to be held in Johannesburg in August 2002.
35. This article claims that the problem is too many natural resources, not too few. Analyze this claim
from the viewpoint of neoclassical economics. The price of the resource is set by market supply and
demand. Think of each group that wants to control the resources as a firm that faces rising marginal
costs and rising average total costs. Think of the costs of fighting for control of the resource as a
production cost. Whoever controls the resource captures rent, the value of the resource in the ground,
which generates economic profits. Show what is likely to happen to the number of resource wars as
resources grow scarcer. (I gave an example in class of an irrigation project in India in which landless
farmers kept offering higher rent until their economic profit returned to zero. In this example, think of
more expenditures on war effort as the equivalent of paying rent).
36. Provide an analysis of resource wars as negative externalities of cell-phone manufacturing.
37. In Liberia there were serious conflicts over timber as well. Since no single group is able to effectively
control the resource, it is basically the same as having no owner. Explain the logic of the open access
regime as it applied to Liberia's timber (Liberia recently had what appears to be fair elections, so things
may be changing).
38. Describe peace as a public good.