SPEA V 202 Indiana University Bloomington Economics Problems


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SPEA V-202 PROBLEM SET 2 DUE: March 10th, 11:59PM
1. These problem sets are intended to prepare you for how questions are written on
the exams. Although group work is encouraged on the Problem Sets, you are
responsible for knowing the information for the exams since you will take exams
2. Upload your solutions to Canvas before the due date (March 10th, 11:59pm).
3. Upload your solutions as a SINGLE Word or PDF document to Canvas before the due
4. Make sure your answers are clear. You may have points taken off if your answers are
not legible. Refer to the syllabus for more information on how this assignment will
be graded. You can draw graphs using pens in a sheet of paper, take a picture of it,
and add it to the PDF file. (Graphs with color would be preferred). IF YOU CHOOSE
AND READABLE (use ruler and whatever needed).
5. For each answer, make sure to report the number of the question and the
corresponding letter of the sub-question (if any).
6. Grading is explained in the Canvas assignment and Syllabus.
Problem Set 2
1) Many feel the that federal government should raise the minimum wage.
a) Draw a supply and demand diagram for a typical perfectly competitive labor market. Label
equilibrium price and quantity.
b) Some feel that raising the minimum wage introduces inefficiencies. Why might this be? Can you
show us on the graph?
c) Let us now turn to the labor market for grocery store workers in Little town. Recently one of the
last two grocery stores in Little town closed leaving only one employer for grocery store workers
in this area. This labor market is not very competitive. What type of market structure is this?
d) Draw a typical supply curve (i.e. average expenditure), marginal expenditure, and demand for
the grocery store in Little Town. Label the equilibrium wage and number of grocery store
e) Suppose that some time has passed and the population has grown in Little Town and there are
now many grocery stores. Now suppose that the grocery store workers unionize. Draw a graph
to depict the equilibrium wage and number of workers in this new market.
f) Where would the union want the wages to be? Is there more than one wage to consider?
2) Provide two reasons as to why wages can differ across otherwise similar individuals.
SPEA V-202 PROBLEM SET 2 DUE: March 10th, 11:59PM
3) The United States currently imports all of its coffee. The annual demand for coffee by U.S.
consumers is given by the demand curve ???????? = 150 ? 10????, where ???????? is quantity (in millions of
pounds) and ???? is the market price per pound of coffee. Suppose the domestic supply is ???????? =
10???? ? 50. The U.S. coffee market is competitive. Suppose that the world price of coffee is $6.
Congress is considering a tariff on coffee imports of $2 per pound.
a) Find the producer and consumer surplus if there was no trade.
b) Calculate the consumer and producer surplus after we engage in free trade.
c) If the tariff is imposed calculate the changes to consumer and producer surplus.
d) Other than lower prices, provide two benefits that can occur as a result of free trade.
4) Why do some politicians on both sides of the aisle (e.g. Trump and Sanders) support “bringing back
the jobs”? Does this mean that the consensus among economists that trade is good, is wrong?
5) Assume the US is an importer of motorcycles and there are no trade restrictions. US consumers buy
1 million motorcycles per year, of which 400,000 are produced domestically and 600,000 are
a) Suppose that a technological advance among Japanese motorcycle manufacturers causes the
world price of motorcycles to fall by $100. Draw a graph to show how this change affects the
welfare of US consumers and US producers and how it affects total surplus in the US.
b) After the fall in price, consumers buy 1.2 million motorcycles, of which 200,000 are produced
domestically and 1 million are imported. Calculate the change in consumer surplus, producer
surplus, and total surplus from the price reduction.
c) If the government responded by putting a $100 tariff on imported motorcycles, what would this
do? Calculate the revenue that would be raised and the deadweight loss. Would it be a good
policy from the standpoint of US welfare? Who might support this policy?
d) Suppose that the fall in price is attributable not to technological advance, but to a $100 per
motorcycle subsidy from the Japanese government to Japanese industry. How would this affect
your analysis?
6) Explain why governments sometimes attempt to pass legislation to prevent “price gouging.” Draw a
diagram that shows this scenario and explain what may occur if such legislation is passed.
7) Is environmental protection a normal good? How do we know? Briefly explain.
SPEA V-202 PROBLEM SET 2 DUE: March 10th, 11:59PM
8) Peterson, Hoffer, and Millner (1995) showed that air bag use has led to increases in car crashes.
Despite this finding, the government mandates that new cars have airbags, rather than taxing their
use. Is this policy a contradiction? Can there be a positive externality resulting from airbags?
9) Recall our discussion of price gouging of necessities during natural disasters.
a) Briefly describe what a price ceiling is and when it can be considered binding and not binding.
b) What problems can arise from imposing a price ceiling?
c) What is a price ceiling alternative that does not involve distorting the equilibrium price and
quantity of necessities?
10) Why do governments feel the need to intervene when goods/services are non-excludable?
11) In the early 90s congress passed a tax on luxury goods (e.g. yachts) expecting to collect revenue they
could then use on public goods. What was the eventual outcome of this policy for the demanders,
suppliers, and members of congress?
12) Using economic theory explain why an economist would be concerned about climate change.
13) Before I started my PhD program, I worked at a consulting firm and made relatively more money
than right now. Because my income was high enough, I could afford Nike shoes for my workouts.
After I decided to go back to school, I started buying unbranded shoes. Hence, as my income
dropped, my demand for unbranded shoes went up.
a) What kind of good are unbranded shoes?
b) Write the formula for income elasticity.
c) Explain what income elasticity is.

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Explanation & Answer:
19 Problems


wages and family income

Low Skill Employees

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