Current equilibrium price

Current equilibrium price
Massachusetts Governor Deval Patrick recently proposed allowing the construction of casinos in
Massachusetts as a way to stimulate the economy.
The Governor calls a meeting in his office with his staff and representatives from two interest
groups: Gambling NO!, an anti-gambling group, and Gambling YES!, a group representing casino
owners. The Governor tells the assembled group that he thinks it is a good idea to allow casinos in
Massachusetts based on his analysis of the market, which is presented in the following table:
Table 1.1: Costs and Benefits of Casinos in Massachusetts
Total Benefit to Total Cost to
Number of Casino Patrons Casino Owners
Casinos ($millions) ($ millions)
ma
n‘:
a) In Table 1.1 add the marginal private benefit and marginal private cost of casinos. And graph
the marginal private benefit and marginal private costs in Figure Al .1 below.
Economics 101 F ma] Exam Question List Page I of 15
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QUESTION 1
Massachusetts Governor Deval Patrick recently proposed allowing the construction of casinos in
Massachusetts as a way to stimulate the economy.
The Governor calls a meeting in his office with his staff and representatives from two interest
groups: Gambling NO!, an anti-gambling group, and Gambling YES!, a group representing casino
owners. The Governor tells the assembled group that he thinks it is a good idea to allow casinos in
Massachusetts based on his analysis of the market, which is presented in the following table:
Table 1.1: Costs and Benefits of Casinos in Massachusetts
Total Benefit to Total Cost to
Number of Casino Patrons Casino Owners
Casinos ($millions) ($ millions)
0 0 0
1 85 10
2 155 30
3 210 60
4 250 100
5 275 150
6 285 210
a) In Table 1.1 add the marginal private benefit and marginal private cost of casinos. And graph
the marginal private benefit and marginal private costs in Figure A1.1 below.

Economics 101 Final Exam Question List Page 1 of 15
Figure A1.1: The Massachusetts Gambling Market
110
100
90
Marginal Benefits, Costs ($ millions)

80
70
60
50
40
30
20
10
0
0 1 2 3 4 5 6 7
Quantity of Casinos

b) Given your answers to part (a), What is the market equilibrium QUANTITY of casinos?
The Governor declares that he wants to allow the market to decide how many casinos are actually
built. The representative for Gambling YES! objects. She says, “Governor, allowing the free market
to determine the quantity of casinos is the wrong thing to do. You are not taking into account all of
the wonderful external benefits casinos bring with them—such as increased tourism revenues for
neighboring towns, and increased analytical skills among the citizens of Massachusetts (due to all
the risk-calculations gambling requires!). We estimate that there is an external benefit of $25 million
per casino!”
c) Assuming that the representative of Gambling YES! is right, what kind of externality (if any)
is involved with casino construction? Positive, negative, or no externality?
d) Express the information from the Gambling YES! representative on your graph in Figure
A1.1.
e) Assuming that the representative of Gambling YES! is right, what is the socially optimal
number of casinos?
The representative of Gambling NO! then says, “Governor, my friend from Gambling YES! is
completely wrong. Not only are there NO external benefits from gambling, there are actually
significant external costs—such as increased levels of crime around the casinos, and increased health
care costs from treating the increased levels of gambling addiction. We estimate that these external
Economics 101 Final Exam Question List Page 2 of 15
costs amount to $50 million per casino!”
f) Assuming that the representative of Gambling NO! is right, what kind of externality (if any)
is involved with casino construction? Positive, negative, or no externality?
g) Express the information from the Gambling NO! representative on your graph in Figure A1.2
below. (Note: you will first have to redraw the marginal private benefit and marginal private
cost curves you drew in part (a).)
Figure A1.2: The Massachusetts Gambling Market
110
100
90
Marginal Benefits, Costs ($ millions)

80
70
60
50
40
30
20
10
0
0 1 2 3 4 5 6 7
Quantity of Casinos

h) Assuming that the representative of Gambling NO! is right, what is the socially optimal
number of casinos?
Governor Patrick consults with his staff and decides that the information from Gambling NO! is
correct (and the information from Gambling YES! is incorrect). He still wants to build casinos in
Massachusetts, but he decides that the government should try to do something to correct for the
inefficient number of casinos that would be built if the decision were left up to the market.
i) Suggest to the Governor a way that he could help to correct for the externality. Explain why
you think your suggestion will work using the graph in figure A1.2 (with any additions you
need to make your point).

Economics 101 Final Exam Question List Page 3 of 15
QUESTION 2:
The engineers at Nokia, the Finnish cellular phone company, have come up with a spectacular new
phone technology. Their new NokiWave System is not only a phone, MP3 player and micro
computer, it is also a teleportation device that can transport the user to any of 1,000 pre-programmed
spots in the world. Importantly for Nokia, no one else in the world has this technology. They are the
sole producers of Teleporting Cell Phones.
Figure 2.1: NokiWave and the Market for Teleporting Cell Phones
Cost/Price ($)
7,000
6,000
5,000
4,000
Marginal
3,000 Cost
2,000 Demand
1,000 Marginal
Revenue
10 20 30 40 50 60 70 80 90 100 Quantity (thousands)

Figure 2.1 above shows Nokia’s cost curves for production of NokiWave Systems as well as the
market demand for teleporting cell phones. Nokia has constant marginal costs of production, and no
fixed costs. (Note: It is unrealistic to think that Nokia could have developed this product without any
fixed costs (like research & development), but that’s the story we’re going with for this question.)
a. How many NokiWave systems will Nokia produce? What price will it charge for them?
Show this on Figure B2.1.
b. On Figure B2.1, indicate the area that represents Nokia’s profit (if any), the area that
represents consumer surplus (if any) and the area that represents deadweight loss (if any).
A student advocacy group called Students For Teleportation complains to Nokia that the price of the
NokiWave is too high. They inform Nokia that there are about 20,000 students in the market who
would be willing to pay $4,000 for a NokiWave.

Economics 101 Final Exam Question List Page 4 of 15
c. You are an advisor to Nokia. What action would you suggest to them, given this new
information about the students? What impact (if any) would your suggestion have on Nokia’s
profits? Consumers’ surplus? Deadweight loss? (Note: You can use Figure B2.1a below to
illustrate your answer. Note that Figure B2.1a is an exact copy of Figure B2.1 except that the
marginal revenue curve has been removed to make the diagram less cluttered.)
Figure B2.1a: NokiWave and the Market for Teleporting Cell Phones
Cost/Price ($)
7,000
6,000
5,000
4,000
Marginal
3,000 Cost
2,000 Demand
1,000
10 20 30 40 50 60 70 80 90 100 Quantity (thousands)

Economics 101 Final Exam Question List Page 5 of 15
Eventually, Motorola discovers the technology for cell phone teleportation systems and produces its
own product MotoPort that is exactly identical to NokiWave. Fearing that a price war will occur
(and thus drive out all the profits—which have gotten much larger than they were in the early days
of the industry, depicted in Figure B2.1), Gregory Brown, the CEO of Motorola, arranges a secret
meeting with Nokia CEO Olli-Pekka Kallasvuo, at which he says the following:
“OK, Olli, here’s the situation. If we both agree to produce 200,000 systems, we’ll make the
most profit possible—$150 million—which we’ll split evenly between us. This is much better
than our other alternative, which is to produce 400,000 each, which will produce only $80
million in total profits for us to split evenly. So what do you say? Let’s agree to produce only
200,000 units each.”
But…Olli knows that Gregory Brown is leaving out one crucial piece of information: that if they
both agree to produce only 200,000 units, but one person cheats and produces 400,000, the cheater
will earn $90 million while the other company will get only $35 million.
The payoff matrix below describes the situation:
Motorola
Make 200,000 Make 400,000
Units Units

Make $75 million $90 million
200,000 profit profit
Units
$75 million $35 million
profit profit
Nokia
$35 million $40 million
Make profit profit
400,000
Units
$90 million $40 million
profit profit

d. Is the Motorola CEO’s suggestion of producing 200,000 units each a Nash equilibrium? If
not, are there any Nash equilibria in this game? If so, what is it/what are they?
Economics 101 Final Exam Question List Page 6 of 15
The Nokia CEO recognizes that the above analysis is not quite complete. Since Nokia and Motorola
will be competitors for a long time, there may be an opportunity for them to sustain co-operation and
earn higher profits by using strategies that reward good behavior and punish bad behavior.
Specifically, imagine that each player can choose either to always produce 400,000 units, or play a
“tit-for-tat” strategy, which involves producing 200,000 units in period 1, and in period 2 producing
however many units the other player produced in period 1.
e. Fill in the payoffs to each player IN THE TOP LEFT and TOP RIGHT BOXES (the ones
marked “a” and “b”) of the payoff matrix below. (You are asked to fill in the rest in the next
part).
Motorola
Always Make
Tit-for-Tat 400,000 Units
Units
a b
Tit-for-Tat

Nokia
c d
Always
Make
400,000
Units

f. Fill in the remaining two boxes (marked “c” and “d”) and determine if there are any Nash
Equilibria in this two-period game. Does this example demonstrate how co-operation can be
sustained even when the players cannot write enforceable contracts or trust each other not to
cheat? Explain.

Economics 101 Final Exam Question List Page 7 of 15
QUESTION 3:
The government of Massachusetts has just launched a new program to give free pre-school education
to 4 year-old children from poor families. To raise money for the program, they decide to implement
a new tax.
Massachusetts Governor Deval Patrick must decide what kind of tax to introduce. He is currently
considering two proposals: a tax on salt, and a tax on gourmet chocolate. In Massachusetts, both salt
and gourmet chocolate are provided through perfectly competitive markets. Figures 2.1 and 2.2
below show supply and demand in the markets for salt and gourmet chocolate in Massachusetts.
FIGURE 2.1: The Massachusetts Salt Market
Figure 1-1(a): The Massachusetts Salt Market
$5.00
$4.50
$4.00
A
$3.50
Price ($ per pound)

$3.00
$2.50
$2.00
$1.50
$1.00
$0.50
$0.00
0 5 10 15 20 25 30 35 40 45 50
Thousands of Pounds

FIGURE 2.2: The
Figure 1-1(b): Massachusetts
The Massachusetts Gourmet
Gourmet Chocolate
Chocolate Market Market
$5.00
$4.50
$4.00
$3.50
B
Price ($ per piece)

$3.00
$2.50
$2.00
$1.50
$1.00
$0.50
$0.00
0 5 10 15 20 25 30 35 40 45 50
Thousands of Pieces

Answer the following questions:
Economics 101 Final Exam Question List Page 8 of 15
a. Assuming no taxes have been levied yet, and the markets are operating freely, label the
equilibrium points on figures 2.1 and 2.2 and indicate the equilibrium price and quantity.
b. For what values of price elasticity of demand is a demand curve considered ELASTIC?
INELASTIC? UNIT ELASTIC?
c. Calculate the price elasticity of demand for salt and gourmet chocolate around the
equilibrium point. (Note: you need to use 2 points to do this. Use the equilibrium point and
point A for the salt market, and the equilibrium point and point B for the gourmet chocolate
market.) Which market has more elastic demand?
d. What are the characteristics of Salt and Gourmet Chocolate that makes demand for them
elastic or inelastic? That is, why does it make sense that demand for them is elastic or
inelastic as you indicated in your answer to part (c)?
Governor Patrick hires you as a consultant on the project, and gives you the following instructions:
“I’m thinking about putting a $2 per pound tax on salt producers or a $2 per piece tax on gourmet
chocolate consumers. I need your help in figuring out which tax is the better one. Specifically, I need
to know which tax will raise more money for the state, which tax will generate the least deadweight
loss, and which tax will put a larger burden on consumers.”
e. To address Governor Patrick’s questions, fill in the blanks in the columns below. (You can
show your work in your bluebook): (7 pts)
Salt Market Chocolate Market
Before the tax:
Equilibrium Price
Equilibrium Quantity
After the tax:
Price paid by consumers
Price received by producers
Quantity bought/sold
Tax revenue
Deadweight Loss
f. In figures 2.1 and 2.2 above, indicate the areas of consumer surplus, producer surplus, tax
revenue and deadweight loss that would result if the taxes were put into place in each market.
g. Governor Patrick tells you that he’s considering going with the tax on Salt. What are the
advantages and disadvantages of using this tax instead of the tax on gourmet chocolate?
Imagine that, just before Governor Patrick announces his tax on Salt an amazing salt substitute
called NearSalt is discovered. It looks and tastes exactly like salt, but is not, in fact, salt.
h. Does the discovery of NearSalt change the relative attractiveness of the Salt tax (relative to
the gourmet chocolate tax)? Explain your answer, and be sure to discuss the role of elasticity.
(5 pts)

Economics 101 Final Exam Question List Page 9 of 15
QUESTION 4
We are asked to help a consumer (Joe) determine his optimal consumption bundle. His weekly
income is $48. The only goods that exist in his world are cups of coffee and sandwiches. Both are
“normal” goods. A cup of coffee costs $3 and a sandwich costs $6.
a. In your bluebook, draw a set of axes with “Sandwiches” on the X axis and “Cups of Coffee” on
the Y axis. Now draw Joe’s “budget line” (that is, a line representing the combinations of the
two goods Joe could consume if he spends all of his money).
Tables 4-1 and 4-2 below report the total utility Joe receives from consuming different amounts of
coffee and sandwiches. Use the information in these tables to answer parts (b) and (c). (Note: the
two columns on the right have been left empty to give you room to work, if you want it.)
Table 4-1. Joe’s Utility from CUPS OF COFFEE
Total
Cups of Coffee Utility
0 0
1 90
2 174
3 252
4 324
5 390
6 450
7 504
8 552
9 594
10 630
Table 4-2. Joe’s Utility from SANDWICHES
Quantity of Total
Sandwiches Utility
0 0
1 234
2 450
3 648
4 828
5 990
6 1,134
7 1,260
8 1,368
9 1,458
10 1,530
b. Determine Joe’s optimal consumption of coffee and sandwiches using the concept of marginal
utility per dollar. For full credit you should explain (and show) exactly how you determined
Joe’s optimal consumption point (be sure to explain the role played by marginal utility per
dollar).
Economics 101 Final Exam Question List Page 10 of 15
c. The price of a sandwich decreases to $4 (and nothing else changes). Draw Joe’s new budget
line in your bluebook (on a new set of axes).
d. Without calculating the new optimal consumption point, explain how you expect Joe’s
consumption to change. For full credit, use the concept of marginal utility per dollar in your
answer.
e. Determine the new optimal consumption point under the new sandwich price of $4. Again,
explain and show how you determined this was the optimal point and what role marginal utility
per dollar played in your calculations. I’ve reprinted tables 2-1 and 2-2 below in case you need
to use them in your answer. (HINT: if you cannot precisely satisfy the optimal spending rule,
you need to just get as close as possible to it.)
Table 4-1. Joe’s Utility from CUPS OF COFFEE
Total
Cups of Coffee Utility
0 0
1 90
2 174
3 252
4 324
5 390
6 450
7 504
8 552
9 594
10 630
Table 4-2. Joe’s Utility from SANDWICHES
Quantity of Total
Sandwiches Utility
0 0
1 234
2 450
3 648
4 828
5 990
6 1,134
7 1,260
8 1,368
9 1,458
10 1,530
f. Explain how the income and substitution effects affect Joe’s consumption decision when the
price of sandwiches changes from $6 to $4.

Economics 101 Final Exam Question List Page 11 of 15
QUESTION 5
Table 5-1 below contains total cost data for Arjun’s Asparagus farm for the year 2012.
Table 5-1. Annual Costs for Arjun’s Asparagus Farm
Average Average Average
Total Fixed Variable Marginal Total Fixed Variable
Cost Cost Cost Cost Cost Cost Cost
Output (TC) (FC) (VC) (MC) (ATC) (AFC) (AVC)
0 $150
1 190
2 240
3 300
4 370
5 450
6 540
7 640
8 750
9 870
10 1,000
11 1,140
Each year, Arjun’s costs consist of rent payments on his land, and wage payments to his workers.
Arjun must pay a full 12-months’ rent at the beginning of each year. Workers can be hired and fired
at any time.
a. How are fixed and variable costs different? Which of Arjun’s costs are fixed costs? Which
are variable costs?
b. Arjun tells you his rent is $150 per year. Fill in the fixed and variable cost columns in Table
5-1.
c. Fill in the Marginal Cost, Average Total Cost, Average Fixed Cost and Average Variable
Cost columns in Table 5-1.
d. Graph MC, ATC and AVC on the axes provided in Figure 1-1 below. (Note: you must label
the axes and each of the curves you draw.)

Economics 101 Final Exam Question List Page 12 of 15
Figure 5-1. Cost Curves for Arjun’s Asparagus Farm
200
180
160
140
120
100
80
60
40
20
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

The asparagus market is perfectly competitive: Arjun is one of many identical producers of
asparagus, and he sells into a market with many consumers. Figure 5-2 below shows supply and
demand in the asparagus market.
Figure 5-2. The Asparagus Market
Price ($)
Supply
200
160
120
80
40
Demand
10 20 30 40 50 60 70 80 90 100 Quantity (Tons)
Economics 101 Final Exam Question List Page 13 of 15
e. What is the equilibrium price in the asparagus market?
f. Using figures 5-3(a) and 5-3(b) below, show how much asparagus Arjun produces and at
what price he sells his asparagus. Calculate Arjun’s profit (if any) and label the area
representing profit in Figure 5-3(a) (if there is any). (Note: you will have to reproduce
Arjun’s cost curves in Figure 5-3(a)).

Figure 5-3(a). Arjun’s Production Decision Figure 5-3(b). The Asparagus Market
$200##
P ($)
200 S
$160##
160
$120##
120
$80##
80
$40##
40 D
$0##
0# 1# 2# 3# 4# 5# 6# 7# 8# 9# 10# 11#
Asparagus(Output((Tons)(
10 20 30 40 50 60 70 80 90 100 Q (Tons)

Economics 101 Final Exam Question List Page 14 of 15
g. Could the current equilibrium price (your answer to part (e)) be a long-run equilibrium price? If
so, how do you know? If not, show in Figures 5-3(a) and 5-3(b) how the market will adjust to its
long-run equilibrium. Indicate the long-run equilibrium price, Arjun’s level of production
Figure 5-3(a). Arjun’s Production Decision Figure 5-3(b). The Asparagus Market
P ($)
$200##
200 S
$160##
160
$120##
120
$80##
80
$40##
40 D
$0##
0# 1# 2# 3# 4# 5# 6# 7# 8# 9# 10# 11#
Asparagus(Output((Tons)(
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