Economics 031-001

Instr. José-Víctor Ríos-Rull

First Quiz

Instructions:

• Answer all sections of this test. This is a 45 minute/45 point exam.
• Graphs are helpful. Carefully label the graphs if you use them.
• Write all answers in the blue books provided. Show all work.
• Write your name and your instructors name in every blue book that you use.
• This exam is given under the rules of Penn's Honor System.
• All blue books, blank or filled, must be handed in at the end of this exam. No blue books may be taken from this room.

Good luck!

1. (5 points) What has been the main change in the structure of federal expenditures in the last forty years? Has it gone up or down? Which component has changed the most?

   Federal expenditures have grown up substantially, especially those associated to transfers, such as social security.

2. (10 points). List the basic four assumptions underlying indifference curve analysis. Also state an additional assumption that ensures that the income effect associated to the decrease of one price induces the consumers to consume more of all other goods.

   1) Preferences are complete, (either A is preferred to B, or B to A or they are indifferent. 2) They are consistent, this is transitive: A preferred to B and B to C implies A is preferred to C. 3) Monotnoic: more is preferred to less. 4) Declining marginal rate of substitution: the amount of money that an individual will give up to obtain additional unites of a good will decrease as more units of the good are acquired.

   Goods are normal: the income effect of a price increase acts to decrease consumption.

3. (10 points) How do we measure the benefits that consumers obtain from a good. Explain.

   We measure those benefits by the area under the demand curve up to the amount consumed, since it tells us how much consumers are willing to pay to get additional units. Obviously since consumers pay for the good, the actual benefit is the area under the demand curve minus the amount payed. This is called CONSUMER SURPLUS.

4. (10 points) Under certain conditions markets achieve efficient allocations. Describe a specific condition that violates is broken and that may have been argued by the owners of the Philadelphia Phillies when they tried to convinced the city to pay for part of a new stadium.

   Sorry for the mistake. This question should have said

   Under certain conditions markets achieve efficient allocations. Describe a specific condition that may have been argued by the owners of the Philadelphia Phillies as being violated when they tried to convinced the city to pay for part of a new stadium.

   That the private benefit of the consumers that pay for the tickets of the Phillies are equal to the social benefit provided by the team. Many fans could benefit from the team being in the city. The owners could argue that the team provides a positive externality.

5. (10 points) Define efficiency, or Pareto optimality. Can we say, as economists, that any non-efficient allocation is worse than an efficient one? Can you think of a way that could be used to compare all allocations.
   Efficiency is an allocation such that there is no other that will make somebody strictly happier and nobody unhappier. No we cannot say such a thing as economists because there may be inefficient allocations where some people are better than in an efficient allocation. See graph. Point A is not efficient yet household 2 prefers it to point B which is efficient. Some economists have proposed to use the compensation criteria which attempts to measure the value of the gains to gainers in dollar terms and compare them to the value of the losses to losers.