Fall, 1996 1. CMU issues a number of parking tickets each year to drivers who illegally use campus parking. Unfortunately, some drivers ignore the tickets and accumulate massive amounts of fines (you know who you are). Of course, tracking down such scofflaws is very expensive, and thus CMU can only afford to prosecute (typically by immobilizing the owner's automobile through the use of the ``Denver Boot'') a small percentage of these violators. Currently, CMU randomly prosecutes such violators. As an alternative, suppose CMU announces a policy in which they will prosecute the violators in alphabetical order of the license numbers of the cars. [5] Is the ``ordered'' prosecution policy likely to result in better overall compliance, worse compliance, or about the same? [15] Why? 2. In Santa Fe, New Mexico, housing prices have risen about 20\% per year over the past decade. A group concerned with affordable housing wants to make sure that even modest income families will be able to afford a home of their own, and has decided to create a new housing development. The group is willing to sell houses to anyone, but will limit the price at which owners are allowed to sell their houses to a ``fair'' return of 5\% per year. Thus, if an owner pays \$100,000 for a house and wishes to sell in five years, she would only be allowed to charge \$128,000, while if she were to sell it on the open market she could get \$248,000. The group feels that such a policy will allow affordable housing on into the future. [5] Suppose an owner wants to leave Santa Fe after a few years. Rather than selling the house at the controlled price, what kind of behavior (without selling the house) could the owner engage in to circumvent the selling restriction? [5] Does this behavior defeat the original goal of allowing these houses to be owned by modest income families in the future? [10] Suppose an owner decides to sell her house after a few years. Given the restricted price, what do you expect would happen when the house is offered for sale? How will the final buyer be determined? [5] How effective is this price restriction policy at meeting the group's original goals of long-term affordable housing? 3. A market consists of four buyers with values of \$10, \$25, \$5, and \$20, and five sellers with costs of \$22, \$12, \$7, \$12, and \$17. Suppose that the market is run and the \$25 buyer trades with a \$12 seller at a price of \$18, and the \$10 buyer trades with the \$7 seller at a price of \$9. [10] In the diagram below plot the supply and demand curves underlying the market described above. (Make sure you label all axes and curves.) Make a prediction of the equilibrium price and quantity, and calculate the maximum possible surplus available in the market. [3] Eq. Price = \hrulefill, [3] Eq. Quantity = \hrulefill [4] Maximum Possible Surplus = \hrulefill [5] What is the efficiency of the market, given the two trades that occurred? Now, assume that the government decides to subsidize all sellers, by giving them an additional \$5 for every trade that they make. [5] In the diagram above, plot any changes in the supply and demand curves when the subsidy is in effect using dotted lines. (Make sure you label the new curve(s).) Assuming the subsidy, make a prediction of the equilibrium price and quantity, and calculate the maximum possible surplus available in the market. (Hint: Be careful when you calculate the maximum surplus to take in to account that the subsidy payments must be made by taxing the market participants.) [3] Eq. Price = \hrulefill, [3] Eq. Quantity = \hrulefill [4] Maximum Possible Surplus (with the subsidy) = \hrulefill [5] Dead weight loss from the subsidy is = \hrulefill [5] Why do subsidies lead to a dead weight loss? 4. Currently, CMU will put students who want to get into a full class on a waiting list on a first-come basis, and then allow them to enter the course in order as spaces become available. [5] Is the outcome of this policy Pareto Efficient? [5] Why or why not? [5] Suggest an alternative policy inspired by markets. [5] Is the outcome of your alternative policy Pareto Efficient? 5. Suppose that the new student center has 15 empty offices that it wishes to fill. Furthermore, assume that there are 5 business that are at most willing-to-pay \$100 each per month for these offices, and hundreds of student organizations that are willing-to-pay at most \$25 each per month. Suppose the student center offers to rent these offices on a market, and is willing to accept any price for the 15 offices. [5] Draw and clearly label the {\it separate} demand curves for this situation for the businesses (on the left) and the student organizations (on the right). [10] On the diagram {\it below} draw the {\it aggregate demand curve} for the Student Center office market and the supply curve. {\it Use this diagram to answer the remaining questions.} [2] Eq. Price = \hrulefill, [2] Eq. Quantity = \hrulefill, [3] How many businesses obtain offices at that price? \hrulefill [3] How many student organizations obtain offices at that price? \hrulefill Student organizations are frustrated with the above outcome and decide that a new policy should be invoked. For every office a business buys, it must purchase an office for a student organization as well. [10] Draw and clearly label the new demand curve for the market under this policy. (Hint: Now, to get a single office, the business must purchase two offices (and give one away).) [3] Eq. Price = \hrulefill, [3] Eq. Quantity = \hrulefill, [2] How many businesses obtain offices at that price? \hrulefill [2] How many student organizations obtain offices at that price (including those that get free offices)?\hrulefill 6. For each of the following situations, make a prediction about what will happen to the equilibrium price and quantity in the market after the policy is invoked. Assume ``normal looking'' supply and demand curves, and straight-forward effects. (It will be very helpful if you sketch a supply and demand diagram for each situation.) {\it No partial credit will be given in this section.} [5] In the market for apples, a report is issued that ``an apple a day really does keep the doctor away,'' and growing conditions for apples are unusually favorable. Price will: increase, decrease, stay the same, can't tell? Quantity will: increase, decrease, stay the same, can't tell? [5] In the cigarette market, the government requires buyers to destroy one pack of cigarettes for every pack purchased. Price will: increase, decrease, stay the same, can't tell? Quantity will: increase, decrease, stay the same, can't tell? [5] In the market for web page specialists, schools begin to offer more training in this area and software makers begin to make it easier to create web pages from within existing word processing software. Price will: increase, decrease, stay the same, can't tell? Quantity will: increase, decrease, stay the same, can't tell? [5] In the market for hard copies of the New York Times, an electronic version of the paper is offered free on the web, and {\it Time} magazine lowers its cover price. Price will: increase, decrease, stay the same, can't tell? Quantity will: increase, decrease, stay the same, can't tell? [5] In the market for laptop computers, both the quality and costs of portable display screens increase. Price will: increase, decrease, stay the same, can't tell? Quantity will: increase, decrease, stay the same, can't tell? [5] In the market for CMU undergraduate degrees, a new report is issued indicating that the quality of CMU's undergraduate education programs is declining, and wages for non-college educated individuals increase. Price will: increase, decrease, stay the same, can't tell? Quantity will: increase, decrease, stay the same, can't tell?