1.    Bears have become a problem at Lake Tahoe, even wandering onto the beaches where children play.  When families put their household garbage outside in not-bear-proof containers, bears eat the garbage and then return regularly.  So local communities around Lake Tahoe now require that families purchase & use bear-proof garbage containers which cost $250 each. 

    Last year, if you put your garbage out in a not-bear-proof container, you had to pay a fine of $100 for the first offense and $500 for the second & each subsequent offense.  But you could get back all the money you paid in fines once you bought a bear-proof container.  There were still lots of problems with bears last year. 

    This year, the fine is $300 for the first offense, and $1,000 for the second & subsequent offenses and you can’t get the money back after you buy a bear-proof container.

a.    What is the definition of “negative externality”?  Why is “putting household garbage in a not-bear-proof container” an activity that generates negative externalities at Lake Tahoe?

b.    Compare last year’s fine and this year’s fine: do you think this year’s fine will do a better job, a worse job, or the same job of eliminating the use of not-bear-proof garbage containers?  Explain.

2.  Suppose the economy can be described by the following equations (all values are billions of dollars per year):

        C = 800 + 0.6Yd        EX = 1500        TR = 1000
        I = 1000            IM = 2000        TA = 1500
        G = 3000
           
a.    What is the equilibrium level of output and income?  Show all your work or you will receive zero (0) points on this question.  If you cannot solve this problem without a calculator, set it up and go as far as you can to receive as much partial credit as possible.  No calculators allowed during the exam.

b.    At the right, draw a graph that shows the determination of macro equilibrium for this economy.  Be sure to show the values of the intercept, slope, and equilibrium income.


3. 
a.    Spending for construction of new houses has fallen by $200 billion per year.   As a result, will GDP fall by $200 billion per year, more than $200 billion per year, or less than $200 billion per year?  Clearly and completely, explain why.  (Assume there is no policy reaction.  And remember: just giving the name of an economic concept is not the same as explaining.)

b.    Some mis-informed people said that the drop in construction (noted in part a) posed no problem for the U.S. economy because “those workers were all undocumented workers from Mexico who will go back to Mexico.”  The premise of that statement is incorrect.  But let’s assume – incorrectly, but for the sake of argument – that indeed all the laid off workers in construction were undocumented workers from Mexico who returned to Mexico after being laid off.  (That’s not true, but let’s make the assumption for a few minutes.)  Compare two situations: [1] all the laid off construction workers returned to Mexico, and [2] all the laid off construction workers stayed in the U.S.  Would the effect on U.S. GDP of the drop in construction spending when all laid-off workers return to Mexico be smaller than, larger than, or the same as the effect when all laid-off workers stay in the U.S.?  Explain.


4.  The Federal Reserve (the Fed) conducts monetary policy.  Suppose the economy begins at the Fed’s target inflation rate and target unemployment rate, which are shown as infl0 and un0 in the graph in part c below.

a.    When construction spending decreases (as in Question 3a) and the unemployment rate rises, what effect does this have on the inflation rate?  Why?

b.    The Fed reacts.  What does the Fed do to fight the effects of the decrease in construction spending?  Why will the Fed’s action affect unemployment and inflation?

c.    At the same time that construction spending decreases, the economy experiences a cost shock that increases oil prices.  Draw the Phillips Curve at the right.  Label the initial position – before anything happens – as point A.  Show the effect of the decrease in construction spending as point B.  Show the effect of the cost shock as point C.  Show the combined effect of the Fed fighting the decrease in construction spending and the oil cost shock as point D.

d.    Can the Fed simultaneously fight both the construction spending decrease and the oil cost shock?  Explain.

5.
a.    What does it mean for a household to earn the “median income” in the U.S.?  In 2005, what was the median household income in the U.S.?  (Round to the nearest $10,000).

b.    Since 2000, has the U.S. income distribution become more or less unequal?  Drawing on article #16, (“Special Report: The Rich, the Poor and the Gap Between Them - Inequality in America.”  The Economist, June 17, 2006), offer one piece of evidence that illustrates the change in income inequality and one possible reason for the change in income inequality since 2000.  (There is more space here than we think you need.)

 The exam was written as a 50 minute exam.

1.    Laptops can be beneficial to students for note-taking.  But web surfing, solitaire, email, you-tube, and more is distracting to students seated behind the laptop.
a.    Consider Sorena.  His private marginal cost of using the laptop in class is the wear and tear on the laptop and the risk the laptop will be lost or stolen.  His downward-sloping marginal benefit is better note-taking.  But Sorena also checks email, surfs the web, and watches an occasional you-tube video during class.
    Draw a graph at the right that shows (1) how many hours per semester Sorena would want to use his laptop, and (2) the socially optimal number of hours per semester that Sorena should use his laptop in class.  Explain.
b.    An econ student tells the prof she should impose a penalty (essentially, a tax) on laptop users who are doing more than just note-taking.  What determines the size of the penalty?  Will the penalty eliminate the distracting behavior?  Why or why not?

2.    Article #14, “The Lemongrass War,” describes competition between two Indonesian restaurants in Queens, New York: Padang Raya (owned by Mr. Rahman Imansjah) and Manangasli (owned by Ms. Nani Tanzil).
a.    Why does “monopolistic competition” characterize Padang Raya and Manangasli?
b.    Padang Raya opened first, in June 2004.  Draw a graph that shows the profit-maximizing price and quantity of meals sold and the profit earned at Padang Raya when Ms. Tanzil worked there as a chef.
c.    Then Ms. Tanzil was fired.  In August 2005, she opened her own restaurant, Manangasli.  In your graph, how would you show the effect of this new restaurant on Padang Raya?  (Tell us. Don’t draw it.)  Why?

3.    Suppose the economy can be described by the following equations (all values are billions of dollars per quarter):
a.    What is the equilibrium level of output and income?  Show all your work or you will receive zero (0) points on this question.  If you cannot solve this problem without a calculator, set it up and go as far as you can (cost of not fully solving = loss of 3 points).  No calculators allowed during the exam.
b.    Government spending for military equipment and personnel rises by $100 billion per quarter.  Will the equilibrium level of output and income rise by more than, less than, or exactly $100 billion per quarter?  Explain why.

4.    The Federal Open Market Committee (FOMC) of the Federal Reserve (the Fed) conducts monetary policy.
a.    When the Federal Reserve lowers interest rates, does investment spending fall, rise, or stay the same? Why?
b.    When the unemployment rate falls, does the inflation rate fall, rise, or stay the same?  Why?
c.    What is an inflation dove?  An inflation hawk? 
d.    The inflation rate and the unemployment rate are initially both at the Fed’s target or goal rates.  Then the price of oil rises due to supply restrictions.  What does the Fed do when oil prices rise if the FOMC members are inflation hawks?  What does it do if the FOMC members are inflation doves? 
    Draw a Phillips Curve graph at the right which shows the effects of the rise in oil prices and the Fed’s reaction.  Label the initial position “A”, the hawk position “H”, and the dove position “D”.

5.     Answer only two (2) of the three (3) parts in this question.
a.    Define “gross domestic product.”  What was the 2006 value of nominal GDP for the United States?
b.    Is everyone who is out of work “unemployed”?  Explain.  What was the February 2007 unemployment rate for the United States?
c.    What is the “consumer price index”?  What was the inflation rate in the U.S. between December 2005 and December 2006?