S. Klepper, Economics 73-100, Fall 2009

Solutions to Exam III

1. The payment of $.33 for each unit of output purchased by buyers shifts the market demand schedule. Previously, the highest price any demander could pay for a unit of output was $.86, which is the redemption value for the first unit of output purchased. With the payment of $.33, buyers could pay as much as $1.19 for the first unit of output as their share of the payment would only be $.86, which equals the redemption value of the first unit. Hence if there were 24 buyers, 24 units of output would now be demanded at a price of $1.19. Similarly, previously the total quantity demanded at a price of $.84 was 48 units, whereas the same 48 units would now be demanded at a price of $1.17. The new market demand schedule is thus:

Price	Quantity
$1.19	24
1.17	48
1.12	72
1.02	96
0.84	120
0.69	144
0.61	168

The costs of sellers have not changed, so their supply behavior will not change. They will still be willing to supply four units of output at a price of $.69 and no units of output at any lower price. If there are 40 sellers, then collectively they would be willing to supply 160 units of output at a price of $.69. This still exceeds the quantity demanded at this price, so the equilibrium price will be $.69, as in the version of the experiment conducted in class. The total quantity demanded at this price is now 144 units rather than 96, which was the quantity demanded at a price of $.69 in the version of the experiment conducted in class. This is sufficient to support 144/4 or 36 producers. So the new quantity transacted will be 144 units by 36 sellers versus 96 units transacted by 24 sellers in the version of the experiment conducted in class. Therefore, the quantity transacted will be 50% greater than the version of the experiment conducted in class.

Each buyer will purchase six units of output, which is 50% greater than the version of the experiment conducted in class. Each seller that sells a positive level of output will still sell four units of output and 36 producers will sell output in round 2 versus 24 in round 2 of the version of the experiment conducted in class. Therefore, 4 or 10% of the sellers will exit the market between rounds 1 and 2 whereas 40% of the sellers exited the market in the version of the experiment conducted in class.

Ignoring the commission, all sellers will still earn $.99 in profit. Buyers will earn $1.32 more in profit from the sale of the first four units of output, reflecting the fact that the price has not changed but they receive a payment of $.33 per unit purchased. They will also sell a fifth unit on which they earn profit of $.18 ($.69 - $.51) and a sixth unit on which they earn the commission of $.05. Therefore, the profits of buyers in round 2 will be more than $1.32 greater than in round 2 of the version of the experiment conducted in class.

Based on this discussion, the answers to the individual questions, with the points allotted to them in brackets, are:

[4] 1. False

[5] 2. True

[5] 3. True

[5] 4. True

[5] 5. True

[5] 6. True

[5] 7. True

[6] 8. False

[7] 9. True

2. This problem is analyzed graphically in the figure below. If the government supplies 1 million new homes per year at the market price, in the short run the market supply curve of new homes will shift to the right by 1 million homes at every price. This is represented below by the shift in the market supply curve from S₀ to S₁. The market demand curve for new homes will not change. Consequently, as pictured in the graph the price of new homes will fall in the short run. The quantity of new homes sold will rise but by less than 1 million new homes, as private home producers will decrease the quantity they produce in response to the decrease in price. In the short run, private home producers will also sustain a decrease in their profits due to the fall in price, hence they will earn negative economic profits.

In the long run, private home producers will exit due to earning negative economic profits. Since the average total cost of production of private home producers has not changed, exit will continue until the price rises back to its level prior to the government plan. Since the demand curve for new homes has not changed, the quantity demanded and hence the total number of new homes produced and sold will be the same as before the government plan.

Based on this discussion, the answers to the individual questions, with points allotted to the questions, are:

[4] 10. False

[4] 11. True

[6] 12. True

[6] 13. True

[5] 14. False

[5] 15. True

[4] 16. True

3. If the earnings of young workers are depressed, then they will have more difficulty satisfying their economic aspirations. This will increase the suicide rate of young men in the next ten years, but it will have no effect on the suicide rate of older men. It will also cause the fertility rate for the next ten years to be lower than it would have been without the recession. This means that 20 years later beginning in 2028 and continuing for ten years through 2037, the number of young workers will be less than it would have been if the recession had not occurred. This will make it easier for young workers to satisfy their economic aspirations, causing the fertility rate in 2028-2037 to be higher than it would have been without the recession. In the next ten years, the participation rate of women aged 18-25 will be greater than it would have been without the recession as young women try to make up for the lower earnings of their spouses. Men over 55 in the period 2028-2037 will all have been over age 20 during the period 2008-2019 and so would not have been affected by the recession. Consequently, the suicide rate of men over 55 in the period 2028-2037 will not be affected by the recession.

Based on this discussion, the answers to the individual questions, with points allotted to the questions, are:

[4] 17. False

[6] 18. True

[4] 19. True

[5] 20. False