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Principles of Macroeconomics
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Directions: Answer the following questions.
1. In a letter to a magazine, Mr. Smith wrote: “If people will buy less gasoline, the supply would
increase and the price would fall. Simple- but fundamental economics.”Do you agree with Mr.
Smith? Why or why not? (5 pts).
2. Consider each market in the questions below. Assume that the market is competitive. The
market is initially in equilibrium. Assuming all else is constant, what effect does each of the
factor mentioned have on the equilibrium price and quantity in each of the market? Use graph to
illustrate your anwer. Use subscript “1” to show the initial demand and supply curves, and the
initial equilibrium price and quantity. Use subscript “2” to show the new demand or supply
curve, and the new equilibrium price and quantity. At the bottom of your graph indicate the
following: P↑ for increase, P↓ for decrease, Q↑ for increase, and Q↓ for decrease.(Hint: you
must first draw a graph indicating the initial equilibrium price and quantity. You must
label your graphs as instructed above (30 pts).
a. It used to take us an hour to build a smoke detector. Now it takes from 6 to 10 minutes.
What happens in the market for smoke detectors?
b. Suppose the market for Mickey Mouse T-shirts is in the equilibrium. A new
technology appears that reduces the costs of making the shirts. At the same time, a
successful advertising campaign for the shirts is launched on children’s TV shows
c. Sugar prices leap. What happens in the market for sugar alternatives?
d. Prices of baseball tickets have risen over the last 20 years, yet attendance continues to
rise. What has happened in the market for baseball games?
e. For dietary reasons, the U.S. public reduces substantially its consumption of candy and
pastry. What happens in the sugar market? Assume the sugar market is competitive.
3. a. What is asymmetric information? (5)
b. What is adverse selection, and when does it occur? (5)
c. What is moral hazard, and when does it occur? (5)
d. What are public goods, what problem is caused by public goods, and how can it be
overcome? (15 pts).
Why does the government use price ceiling and price floor? (10).
On March 9, 2017 the U.S. Republican Party unveiled a health care plan for Americans,
which they call: American Health Care Act (AHCA). It is designed to replace the 2010
Democratic Party health care plan called the Affordable Health Act (ACA) popularly
known as the Obamacare.
On March 13, 2017 the non-partisan Congressional Budget Office (CBO) “scored” the
Republican Party AHCA plan. The architects of the AHCA plan and the White House
immediately and aggressively dismissed the some of the estimates of the CBO score
because it did not conform to their positive expectations of their plans while praising its
estimate of the budget deficit and insurance premium from 2017 to 2026, and about 10
per cent reduction in health insurance premium in the same period. (Please do your own
research on the issue). Based on this information please answer the following questions
to the best of your understanding our discussions on Market Failure. (25)
Explain the philosophical underpinning of the architects of the AHCA.
Which estimates of the CBO are rejected by the architects of the AHCA and the White
House? And which estimates do they praise?
What criteria of market efficiency does the AHCA violate?
Based on the COB’s score of the AHCA, explain why the health plan does not achieve a
socially optimal number of Americans with affordable health insurance from 2017 to
2026? (Hint: think in terms of external benefits and external costs, or positive and
negative externalities, and asymmetric information we discussed in our last lecture before
the spring break)
Since the only aspect of the architects of the AHCA plan accepts is its budgetary and
premium impacts, what is the opportunity cost of these two impacts?