ECO 3660: Exam 1 Study Questions

Last update: September 29, 2008 08:48 AM

1. The goal of benefit cost analysis is to identify where government policy can be used to reallocate resources and improve upon market failure. Using one of the market failures described in the texbook, (a) describe a policy to correct this market failure, (b) qualitatively describe the benefits and costs of your policy and define (b) allocative efficiency, (c) Pareto improvement, and (d) potential Pareto improvement.
2. The theoretically correct measures of benefits and costs are changes in consumer surplus and producer surplus. Define (a) consumer surplus and (b) producer surplus. Graphically illustrate the change in consumer surplus that results from (c) a price increase and (d) a price decrease. Graphically illustrate the change in producer surplus that results from (e) a price increase and (f) a price decrease.
3. There are two competing decision rules for a benefit cost analysis. Describe and provide a formula for the (a) net benefits and (b) benefit cost ratio criteria. (c) Do the two criteria provide the same answers? Construct numerical examples to explain your answer considering (d) varying scopes.
4. Suppose the marginal cost of a product is MC = 100 + 5Q. (a) Graph the supply curve. (b) What is the level of output if government pays the firm $500 per unit? (c) Compute the costs to the firm generated by the subsidy. (d) Compute the producer surplus generated by the subsidy.
5. Linear demand and supply are often good approximations of nonlinear demand and supply. Suppose the equilibrium price of a product is 10, equilibrium quantity is 50 and demand elasticity is 0.5. (a) Construct the demand curve. (b) What is the consumer surplus resulting in this market? (c) Suppose a policy leads to a product price of 8 (assume constant marginal costs), what are the benefits of the project?
6. Suppose a government project increases the supply of a market good. A benefit cost analyst assumes that the project will not result in a change in prices when computing the benefits of the project. (a) Graph and describe the theoretically correct measure of project benefits under this assumption. Suppose, in fact, the supply change does change prices. What is (b) the sign of bias and (c) its expected magnitude when prices are assumed constant. Use a graph to explain your answer.
7. Suppose a government project increases the demand of a market good. A benefit cost analyst assumes that the project will not result in a change in prices when computing the costs of the project. Yet, in practice the change will occur. What is (a) the sign of bias and (b) its expected magnitude when prices are assumed constant. Use a graph to explain your answer.
8. Secondary market effects can usually be ignored. (a) When there are price effects, errors in primary market benefits and costs are systematically offset by benefits and costs in secondary markets. (b) When there are no price effects, secondary market effects are either the "dual" choice problem or insignificant. Explain each of these statements (a and b) using an example of a consumer of jelly sandwiches and a sugar subsidy policy.
9. Review problem sets and Chapter 2, #4, Chapter 4, #1