ECON4540 Practice Exam

ECON4540 Practice Exam 1 Fall 2003

Use separate sheets of paper as needed to answer. Please be sure to put your name on your answer sheets and the part of the exam you are answering and the number of the question you are answering. When done staple all your answer sheets and your exam together and hand them in.

Part I (80 points): Please briefly explain your responses.

1. A proposal is brought to you that argues people need to be able to buy gas to get to work and to be able to enjoy the pursuit of life, liberty, and happiness, therefore we should put a cap on the price of gasoline at $0.99. Do you see any problems? (Please include a demand and supply sketch.)

2. If you were thinking of imposing a sales tax on a good, a) why would you care about the price elasticity of demand for the good? b) What are some of the factors that influence price elasticity? (Hint: A classic policy error, made in 1991, was raising the taxes on yachts because the demand for yachts was found to be more elastic than originally expected.)

3. What is meant by an "off-budget" cost? Please give at least one example.

4. For about 200 years the National Weather Service has provided weather forecasts and now you can get their weather forecasts from the Internet ( In what ways might a weather forecast be a public good (or near public good)? How does technology influence whether a good fits this category?

5. What's the difference between a public good and a publicly provided good?

6. In Modesto citizens who sit on juries are paid $5 per day and receive free bus passes. Suppose that you are evaluating whether to have 12-person or 6-person juries. In conducting your study how would you evaluate the costs of the juries?

7. What are some of the major differences between a social insurance program and an income redistribution program? Please include examples.

8. Discuss some of the alternative approaches to dealing with negative externalities.

Part II 20 points: Please show your work.

1. Suppose the city you work for is considering building a library. The initial cost of the building and land is estimated at $3 million. Staffing, maintenance of collections, and building maintenance are estimated at $150,000 a year. The city has about 50,000 people. About 10,000 people would use the library about once per week and would value these visits at about $1 each. Another 10,000 people would use the library about twice per year and value each visit at about $5 each. The other 30,000 people have about a 50% probability of going to the library about once a year and value each visit at $10. The interest rate is 10 percent.

a) What is the approximate present value of the project's costs? What is the approximate net present value of the project based on the data you have? Is the project admissible?

b) Suppose the maintenance cost estimates and benefit estimates were in current dollars and the interest rate of 10% was in nominal terms. Someone points out they expect 5% inflation. How would your estimates of the approximate present value of the project's costs, benefits, and net present value change?

c) Suppose instead we could use less expensive modular construction that costs $500,000 to install, but it is in a tough neighborhood and less sturdy materials so even with the maintenance after 4 years the building would have to be scrapped. What would be the approximate present value of the project's costs?

d) There's another project that would benefit a different group of 10,000 people $100 each immediately at a total cost of $600,000. Unfortunately, due to insufficient budget you can only do one of the projects. What "distributional weight" would make you indifferent between the original project in part "a)" and this new project?