ECON 51D – Economic Principles

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					                           ECON 202 – Economics II
                     Fall 2005 – Homework Assignment 3

Professor: Maria Pia Olivero

NAME: _______________________________________________

(24 points, 2 points each)

   1) Lines, ration coupons and black markets are all signs of a:
         a. price floor below the equilibrium
         b. price ceiling below the equilibrium
         c. price floor above equilibrium
         d. price ceiling above equilibrium

   2) Why do price floors tend to cause persistent imbalances in the market?
       a.    Quantity demanded exceeds quantity supplied but price cannot rise to
             remove the shortage
       b.    Quantity demanded exceeds quantity supplied but price cannot fall to
             remove the surplus
       c.    Quantity supplied exceeds quantity demanded but price cannot rise to
             remove the shortage
       d.    Quantity supplied exceeds quantity demanded but price cannot fall to
             remove the surplus

Use the following info to answer the next two questions: Stellios pizzeria has been
experimenting with the price of its Supreme pizza. At a price of $12, quantity demanded
is 100. At $10, 120. At $8, 140.

   3) Using the midpoint formula, the price elasticity of demand between 10 and 12 is:
                 a. Elastic with an elasticity value of –2
                 b. Unitary elastic with an elasticity value of –1
                 c. Elastic with an elasticity value of –10
                 d. Inelastic with an elasticity value of –0.1
4) Total revenue will decrease if price ---- and demand is----
          a. increases; inelastic
          b. increases; unitary elastic
          c. decreases; inelastic
          d. decreases; elastic

5) The cross-price elasticity of demand between Exxon gas and Havoline oil is –0.7.
Exxon gas and Havoline oil are----. The cross price elasticity of demand between Exxon
gas and Texaco gas is-----
         a. substitutes; positive
         b. substitutes; negative
         c. complements; positive
         d. complements; negative

6) The price elasticity of labor supply is 0.7. Labor supply is ----- and ----.
         a. elastic; upward sloping
         b. elastic; downward sloping
         c. inelastic; upward sloping
         d. inelastic; downward sloping

7) The price of canned salmon increases; total spending on canned salmon remains
unchanged. Canned salmon has a(n)------ demand.
         a. Perfectly elastic
         b. Perfectly inelastic
         c. Unitary elastic
         d. Inelastic

       8) If the minimum reserve requirement for all bank deposits is 5%, then the
       maximum multiple creation of deposits by the banking system as a whole
       following a cash deposit of $2,000 would be:
                   a) 100
                   b) 2100
                   c) 4000
                   d) 40,000

       9) If the reserve requirement is 10%, then the maximum multiple creation would
                    a) smaller than in question 1
                    b) larger
                    c) the same
10) I) The primary benefit of the medium of exchange function of money is that it
reduces transaction costs and is therefore more efficient.
II) The primary benefit of the store of value function of money is that it allows the public
to save, causing more potential for business investment.
                     a) I is true, II is false
                     b) I is false, II is true
                     c) Both I and II are true
                     d) Both I and II are false

11) Excess reserves make banks less vulnerable to runs, but bankers don’t like to hold
excess reserves because:
              a) Holding excess reserves means lower profits for banks
              b) Holding excess reserves is frowned on by bank examiners
              c) Holding excess reserves is indefensible to the bank’s stockholders if
                  the economy is turning down
              d) All of the above are correct

12) If a bank’s total reserve holdings are $35 million and it has $12 million of excess
reserves, then its required reserves are:
                a) $ 12 million
                b) $ 23 million
                c) $ 35 million
                d) $ 47 million

Question 1 (graded, 20 points)
The labor market is depicted in the following graph:


           300      450

S denotes the supply of labor by workers and D denotes the demand by firms. The
equilibrium price determined in this case is the wage rate.

   a) How many workers become unemployed if the wage rate is set at a minimum of
      6? (6 pts)
   b) How does the graph change if more women decide to join the labor force? (14

Question 2 (optional)
For each of the following pair of goods, which good would you expect to have more
elastic demand and why?

   a) Required college textbooks or novels – necessity argument
   b) Heating oil during the next 6 months or heating oil during the next 5 years – time
      to adjust consumption argument
   c) Root beer or water – necessity argument
   d) Ice cream or vanilla ice cream – quantity/availability of substitutes argument

Question 3 (graded, 18 points)
Science has proven that consumption of gasoline for transportation purposes is a key
cause of air pollution. Economists have shown that the demand for gasoline is very
inelastic. Use this information to graphically and verbally explain how government uses
economic means to deal with this problem. Be sure to include an analysis of how the
burden of the solution is distributed between producers and consumers (10 pts., 5 pts for
correct verbal explanation, 5 pts for correct graphic).

Is there an excess burden associated with the solution above? (2 pt.)
If so, how does it occur? (4 pts.).
If so, is it large or small? Why? (2 pts.).

Question 4 (graded, 18 points)
New property tax assessments are arriving soon. For many property owners, this will
imply a rise of 20% in their taxes. They would love to see some other tax replace the
property tax. In response to such complaints many states have increased their sales tax
and cut their property tax rates. However, a general sales tax is regressive (it taxes lower
income people proportionally more because lower income people consume almost all of
their income). Equity in taxation has fallen in those states as a result. So, why do
governments don’t solve this problem by replacing property, income and sales tax with
taxes on diamond rings, yachts, Mercedes-Benz and Jaguar cars?

Question 5 (optional)
Suppose the supply and demand schedules for gasoline are the following:
Price                       Qd                             Qs
$3                          360                            160
$ 3.25                      330                            180
$ 3.5                       300                            200
$ 3.75                      270                            220
$4                          240                            240
$ 4.25                      210                            260
$ 4.5                       180                            280
$ 4.75                      150                            300
$5                          120                            320

a) What are the equilibrium price and quantity?
b) Now the government levies a $1.25 tax on gasoline. What are the new equilibrium
   price paid by consumers, the price received by producers and the quantity?
c) Will there be any excess burden from this tax? Why?

Question 6 (graded, 6 points, 2 each)
What may limit the size of money supply expansion to an amount less than that indicated
by the oversimplified money multiplier (1/rr)? Name three things.
Question 7 (graded, 14 points)
Consider the following bank’s balance sheet in a banking system with a required reserve
requirement of 20%

Assets                              Liabilities
Cash: $5000                         Demand deposits: $50000
Deposits with the Fed: $15000

Loans : $20000
Securities: $10000

   a) What are the legal, required and excess (if any) reserves? (7 pts)
   b) Starting with the initial balance sheet suppose John walks into her bank and
      deposits $1000. If nothing inhibits the money creation process, how much will the
      money supply change based solely on her deposit? (7 pts)

Question 8 (optional)
The Arbezani money demand is given by the following equation:

Md = 5,000 – 10,000 r + 0.5 Y

Md is money demand, r is the real interest rate and Y is aggregate income. Money supply
(Ms) is fixed at Ms = 4,500.

           a. Suppose that aggregate income is 3,000. Graph the money demand curve.
              Why does the equation have a negative slope?
           b. Calculate money demand at an r = 0.1
           c. Income rises from Y = 3,000 to Y = 5,000. Ms is 4,500. At the previous
              equilibrium interest rate, there is an excess ------- (supply/demand) of
              money, By how much? What will happen to the interest rate?
           d. The new equilibrium interest rate is ------
           e. How much must the money supply increase to restore the original interest
Reading 2 (for section III): “Is It Time to Abolish the Minimum Wage?”, in
Swartz and Bonello, Taking Sides: Clashing Views on Controversial
Economic Issues, Issue 11, Part 2.

   1) How do the effects of a minimum wage differ between the covered and the
      uncovered sectors? (30%)

   2) Discuss the impact on labor productivity of the imposition of minimum wages.
      Think about the kind of incentives that minimum wages put on workers. (30%)

   3) What is the main distortion to the market process imposed by minimum wages