1 Welfare economics (a) Explain the intuition for why all competitive equilibria are Pareto efficient when the
First Welfare Theorem (FWT) holds. [7 marks]
(b) Your Director at the Ministry of Finance is advocating that the federal government
increase tariffs on a foreign country to protect local blue-collar jobs. Does the Second
Welfare Theorem (SWT) justify this policy? Explain your reasoning. [9 marks]
(c) The FWT and SWT rely on several assumptions. Choose one assumption and explain
why the FWT and SWT do not hold if this assumption fails.
2 Consumer Theory [25 marks]
Consider an economy with two goods, x1 and x2, and a representative consumer. The
consumer is endowed with income Y . The price of good 1 is equal to p1 and the price
1
of good 2 is equal to p2. The consumer faces a unit tax on good 1 of t. The consumer’s preferences over x1 and x2 can be represented by the utility function U(x1, x2) =
0.25ln(x1) + 0.75ln(x2).
(a) What is this consumer’s budget constraint?
(b) Solve for the consumer’s utility maximizing demands for x∗
1(p1, p2, Y ) and consumption x∗
2(
3 Cost-Benefit Analysis [25 marks] (a) Assume that the discount rate is r = 0.02 and that the earnings impact at age 28,
$3,282, remains the same from age 29 until retirement at age 64. Assuming that time
2
begins at age 19, calculate the present value of the impact of the Pathways program on
lifetime (age 19-64) earnings. [8 marks]
(b) Now, assume that the discount rate is r = 0.05 and that the earnings impact at age
28, $3,282, remains the same from age 29 until retirement at age 64. Assuming that time
begins at age 19, calculate the present value of the impact of the Pathways program on
lifetime (age 19-64) earnings. [8 marks]
(c) The present value of the costs of the Pathways program is $14,935 per student. If
r = 0.02, does the present value of the benefits of the Pathways program exceed its
costs? What about when r = 0.05? If the program’s benefits exceed its costs for only
one of the two discount rates, explain why. [9 marks]
4 Tax Incidence [15 marks]
The market for electric cars is characterized by the following supply and demand curves.
QD = D(P) = 8 − 2P
QS = S(P) = 3 + 6P
(a) Calculate the equilibrium price and quantity for this market. [2 marks]
(b) Calculate the price elasticity of demand, ed, and the price elasticity of supply, es.
Evaluate these elasticities at the equilibrium price and quantity. [3 marks]
(c) The government is considering whether or not to introduce a unit subsidy of t for
each unit of electric cars purchase. Suppose that the statutory incidence of this subsidy
is on consumers. Use the equilibrium condition, D(P∗ − t) = S(P∗) = Q∗ (i.e. that
demand equals supply in equilibrium), to derive an equation in terms of es and ed that
describes what fraction of the subsidy is borne by buyers/consumers
0 comments