Midterm: Fall 1997

Greetings. Please write your name on the line above and write your exam number but NOT your name on the cover of your blue book AND on you Supplementary Worksheet. You must turn in your test copy AND your blue book AND your Supplementary Worksheet to receive a passing grade for the exam.

Please answer each of the exam questions as well as you can. Available exam points are distributed in proportion to the recommended time limits listed in the exam. The recommended times sum to 50 minutes, but you will be given 55 minutes to complete the exam. Do the best you can on each question, and keep in mind that plenty of partial credit is available.

Don't forget the Oxy spirit of honor. Please do NOT discuss this exam AT ALL until 2:30 this afternoon. Good luck!

1. (6 minutes) Answer any one of the Cooperative Learning Lab (CLL) questions on the page attached to the end of this quiz. (Available only at CLL.)

    2. (6 minutes)
    a. Consider the market for ice cream. Suppose that the price of chocolate topping for ice cream sundaes falls and the price of cream used to make ice cream rises. Indicate whether each of the following will rise, fall, remain the same, or change in an uncertain direction: (1) the equilibrium price of ice cream and (2) the equilibrium quantity of ice cream. Briefly support your answers.
    b. Decide whether the following is true or false, and briefly explain your answer: If quantity demanded for a product falls when the price rises, then demand must be elastic.

    3. (6 minutes)
    a. We covered two major types of problems which can arise in product markets. List and/or briefly describe them.
    b. In well-functioning product markets, taxes reduce efficiency. Under what circumstances, if any, can taxes in a product market increase efficiency instead? Explain briefly.
    c. In well-functioning product markets, price ceilings reduce efficiency. Under what circumstances, if any, can a price ceiling in a product market increase efficiency instead? Explain briefly.

4. (8 minutes) Complete the information accompanying the top set of diagrams on the Supplementary Worksheet. Put your answers directly on the work sheet.

5. (12 minutes) Consider the following excerpt from "Lojack Benefits All Car Owners in its Area," published in the July 1997 issue of The NBER Digest (NBER= the National Bureau of Economic Research):

With Lojack, a small radio transmitter is hidden in one of many possible locations within a car. When the car is reported stolen, the police remotely activate the transmitter, allowing specially equipped cars and helicopters to track the precise location and movement of the stolen vehicle. Of stolen vehicles equipped with Lojack, 95 percent are recovered, compared to roughly 60 percent of stolen vehicles overall....
[T]he presence of Lojack [in an area] is associated with a sharp fall in overall auto theft....[T]he direct benefit to the Lojack owner represents less than 10 percent of the overall social benefits of installing Lojack, since almost all of the benefits are the result of reduced auto theft in the area.

    a. Illustrate a private-market equilibrium for Lojack in a supply and demand diagram.
    b. Consider the highlighted passage above. Is the private-market equilibrium efficient? If so, explain why. If not, explain why not, and illustrate the situation in your diagram, indicating the welfare loss, if any, at the private-market equilibrium.
    c. What policy, if any, do you think was recommended in the NBER article? Explain briefly.

    6. (12 minutes) Price floors for milk (based on the article, "Milk Prices to Rise; Southland to Be Hit Hardest." Los Angeles Times, September 25, 1997). The diagrams appear on the Supplementary Worksheet.
    a. (1) In the lefthand diagram for question 6, illustrate the consequence of the events cited in Passage B of the article. Label the new free-market price as PB.
    (2) Suppose you were a state government regulator of raw milk prices with a goal of promoting efficiency in the market. Indicate in your diagram the price you would recommend for raw milk after the events of Passage B.
    (3) How does the price you recommended compare to the free-market price you indicated in part (1)? Is government regulation necessary to establish that price? Why or why not?
    (4) Now add a price floor to your diagram which illustrates the likely implications of Passage A of the article. Label the price floor PF. Indicate in your diagram the minimum welfare gain or loss of the price floor, if any.
    b. (Consider this separately from part a.) The righthand diagram for question 6 illustrates the California raw milk market with potential supply from both California and Arizona producers. Use the information from the diagram to help you fill in the blanks at the bottom of the Supplementary Worksheet.