3 Overview of Trouble Spots 10. Monopolistic Competition and Economies of Scale9. A Tax Reduces Allocative Efficiency8. Capital Flight Decreases SLF and Increases r.7. A Lump-Sum Tax Doesn’t Effect Q* because it Doesn’t Effect MC6. Elasticity Calculation and Interpretation5. Money/Deposit Multiplier4. An Increase in the Money Supply Results (via #3) in a Decrease in Real Wages3. Real Wages Fall due to an Increase in the Price Level2. Link between Growth and Capital Formation1. SRPC Shifts due to Changes in Inflationary Expectations
4 10. Overseas Micro 1 (e)Question: In the long run, will the [monopolistically competitive] company be operating in a region where economies of scale exist? Explain.Answer: Yes (52 percent answered correctly), because the firm produces a quantity of output on the downward sloping portion of its long-run ATC.(27 percent answered correctly)A majority got the DWL direction correct, although a coin flip between DWL up or down would give 50% of the students this answer.The explanation is not easy. The graph is elaborate, although the intuition should be clear to good students. A tax on producers increases the marginal cost and thereby decreases the market supply, which is a sum of the firm supply curves. The DWL results from too few being produced, and the tax results in even fewer being produced because tax up => MC up => Q down. Thus, even more DWL.A lump-sum tax would cause exit as well. If a student argued that it could have been a small or one-time lump-sum tax with no effect, that would be considered.
5 Monopolistic Competition Marginal Cost$/unitLong-Run Average CostPDemandQQuantityMarginal Revenue
6 Monopolistic Competition Marginal Cost$/unitEconomies of ScaleLong-Run Average CostPDemandQQuantityMarginal Revenue
7 9. Micro 2 (d)Price ($)SD90S + Tax60$2$4$8$6$5Question:Assuming no externalities, how does the tax affect allocative efficiency? Explain.
8 The tax creates deadweight loss. OR The total surplus decreases. Answer: Due to the tax, the outcome is no longer allocatively efficient.The tax creates deadweight loss.ORThe total surplus decreases.(22% answered correctly)Price ($)SD90S + Tax60$2$4$8$6$5Deadweight Loss
9 8. Macro 2 (b)Question: Using a correctly labeled graph of the loanable funds market in Tara, show the impact of this decision by investors [to move their funds out of the country of Tara] on the real interest rate in Tara.
10 The GraphReal interest rateSLFrDLFQLoanable funds40% Correct
11 The Shift and Change 22% Correct Real interest rate SLF’ SLF r' r DLF Q’QLoanable funds22% Correct
12 7. Micro 1 (b)Question: Assume that the government grants CableNow a lump-sum subsidy of $1 million. Will this policy change CableNow’s profit maximizing quantity of cable services? Explain.Answer: No (46% answered correctly—note that guessing would yield 50% correct), because the lump-sum tax will not affect marginal cost (or marginal revenue, the two determinants of Q*).18% answered correctly
13 6. Micro 2 (c)Question: Is the demand price elastic, inelastic, or unit elastic between the prices of $5 and $6? Explain.Explain point for wrong current account change was accepted because the order of these two parts of the question was not important.
14 The Graph ProvidedPrice ($)S + Tax$8S$6$5$4$2D6090Quantity
15 Answer: The demand is price elastic because elasticity is [(60-90)/75]/[(6-5)/5.5] = -2.2 which is less than -1ORbecause total revenue decreased from $5 x 90 = 450 to $6 x 60 = $360 when price increased from $5 to $6.(15% answered correctly)
16 5. Macro 3 (a) iiQuestion: Assume that the reserve requirement is 20 percent and banks hold no excess reserves. Assume that Kim deposits $100 of cash from her pocket into her checking account. Calculate the maximum change in demand deposits in the banking system.Answer: (The money multiplier of) 5 x $100 = $500.(14% answered correctly.)
17 3. and 4. Macro 3 (c)Question: Given the increase in the money supply in part (b), what happens to real wages in the short run?Answer: Real wages fall (20% answered correctly) because the increase in the money supply raises the price level (or inflation).(15% answered correctly)
18 2. Macro 2 (c)Question: Given your answer in part (b) [that interest rates increase], what will happen to Tara’s rate of economic growth? Explain.Answer: The growth rate will fall (61% correct) because investment spending decreases, and as a result, capital formation will decrease.9% answered correctly
19 1. Macro 1 (f) iQuestion: Assume the Federal Reserve action [to reduce inflation] is successful. What will happen to each of the following as the economy approaches a new long-run equilibrium?(i) The short-run Phillips curve. Explain.(ii) The natural rate of unemployment.
21 Answer: The SRPC will shift to the left (28% answered correctly) because the Fed policy will lower inflationary expectations.(2% answered correctly)The natural rate of unemployment will not change. (24% answered correctly)
22 Screen shot of poorly labeled graph from AP Central?