1- [Free Market & Market Failures – 30p]
a- Explain how market forces (the invisible hand) guide consumers and producers toward the equilibrium. This requires a complete explanation of why the intersection of supply and demand is the equilibrium. Use supply and demand diagrams for a graphical presentation of your arguments. The graphs and your explanation should complement each other (10p).
b- Explain how the same process you described in part (a) could result in the socially optimal outcome. Furthermore, graphically show that any deviation from the equilibrium of a free and competitive market reduces social welfare (10p).
c- In what situations is the free market outcome not socially optimal? Explain the four distinct cases that we covered in the class and for each case, provide at least one example (10p)
2- [Bilateral Trade & Trade Policies – 20p]
Consider an economic environment in which China and the United States engage in bilateral trade. For simplicity, assume that only two goods are being traded between the two countries: consumer electronics and agricultural products.
China has a comparative advantage in consumer electronics, and the US has a comparative advantage in agricultural and farm products. China is the foremost global producer of consumer electronics, while the US is one of many producers of those agricultural and farm products that China demands.
Both China and the US have been subsidizing their producers to remain competitive in the global market. Assume that the subsidy sizes in both countries are similar. Who benefits more from these government subsidies? Use supply and demand diagrams and explain.
3- [Public Policy toward Polluting Industries – 25p]
Consider the market for fossil fuels, which includes all polluting industries that are significant sources of greenhouse gases that contribute to global warming. 3
a- Using supply and demand diagrams show that a free market for fossil fuels is inefficient. Using words only,explain the source of free market’s inefficiencies. (5p)
b- Assume that the economy is characterized by a recession (an overall decrease in the level of economic activities). Use supply and demand diagrams and discuss the effectiveness of a cap & trade vs. a carbon tax policy in controlling the emission of greenhouse gases (10p).
c- Proponents of supply-side economics argue that lowering taxes and loosening regulations benefits the society because they result in a greater supply of goods and services at lower prices and less unemployment.
Is the logic of supply-side economics applicable to the polluting industries? Do you expect to see the usual positive relationship between the tax size and DWL of tax in this situation? Why or why not? Explain and use the supply and demand model for a graphical presentation of your logic. (10p)
4- [Labor Market – 25 p]
Assume that the labor market for less-skilled workers is characterized by a few big employers (e.g., Walmart or Amazon) who gain rent (have market power).
a- Use the supply and demand model to show that this market structure causes inefficiency compared with a competitive market. (5p)
b- Use the supply and demand model to show that all else the same, this market structure causes more inefficiency when the supply curve is more elastic. Using words only, explain your graphical results. (10p)
c- Use the supply and demand model to show that the government can reduce inefficiencies and improve workers’ surplus and earnings by implementing a minimum wage. (10p)
