Problem Set 1

  1. For each of the following scenarios, use a supply and demand diagram to illustrate the effect of the given shock on the equilibrium price and quantity in the specified competitive market. Explain whether there is a shift in the demand curve, the supply curve, or neither.
    • An unexpected temporary heat wave hits the East Coast. Show the effect in the ice cream market in New England.
    • The government introduces a tax on ice cream which is paid by producers. What is the effect in the ice cream market?
    • Suppose the government imposes a price cap on bottled water. Show the effect in the bottled water market
  2. Explain why governments sometimes attempt to pass legislation to prevent “price gauging.” Draw a diagram that shows this scenario, and explain what may occur if such legislation is passed.
  3. Suppose the government wants to punish a steel plants for polluting the air. Should the government levy a tax on the consumers or producers? Explain.
  4. A survey of Washington residents comes out that says that those with more years of education tend to be healthier. Can we conclude that going to school leads to better health? Why or Why not?
  5. Is value of the price elasticity of demand is equal to the slope of the demand curve? Why or Why not?
  6. Is environmental protection a normal good? How do we know? Briefly explain.
  7. Peterson, Hoffer, and Millner (1995) showed that air bag use has led to increases in car crashes. Despite this finding, the government mandates that new cars have airbags, rather than taxing their use. Is this policy a contradiction? Can there be a positive externality resulting from airbags?


  1. When the state of Virginia imposed stricter regulations on air pollution in 2003, it also authorized an auction of pollution permits, allowing some plants to emit larger amounts of ozone-depleting chemicals than would otherwise be allowed, and some to emit less. Theory predicts that this auction led to a socially efficient allocation of pollution. Describe how this outcome would occur.
  2. Recall our discussion of price gauging of necessities during natural disasters.
    • Briefly describe what a price ceiling is and when it can be considered binding and not binding.
    • What problems can arise from imposing a price ceiling?
    • What is a price ceiling alternative that does not involve distorting the equilibrium price and quantity of necessities?
  3. Why do governments feel the need to intervene when goods/services are non-excludable?
  4. In the early 90s congress passed a tax on luxury goods (e.g. yachts) expecting to collect revenue they could then use on public goods. What was the eventual outcome of this policy for the demanders, suppliers, and members of congress?
  5. Suppose the government wanted to address the fact that a firm was dumping lead into the drinking water of a small town. Which type of policy should the government implement (i.e. regulation or taxation)? Why?
  6. Using economic theory explain why economist would be concerned about climate change.
  7. The United States currently imports all of its coffee. The annual demand for coffee by U.S. consumers is given by the demand curve Qd =150−10P, where Qd is quantity (in millions of pounds) and P is the market price per pound of coffee. Suppose the domestic supply is Qs =10P−50. The U.S. coffee market is competitive. Suppose that the world price of coffee is $6. Congress is considering a tariff on coffee imports of $2 per pound.
    • Find the producer and consumer surplus if there was no trade.
    • Calculate the consumer and producer surplus after we engage in free trade.
    • If the tariff is imposed calculate the changes to consumer and producer surplus.
    • Other than lower prices, provide two benefits that can occur as a result of free trade.
  8. Why do some politicians on both sides of the aisle (e.g. Trump and Sanders) support “bringing back the jobs”?[1] Does this mean that the consensus among economist, that trade is good, is wrong?
  9. Why do larger employers provide private insurance?
  10. Describe what adverse selection is and why this is a concern in insurance markets.
  11. How are Medicaid and Medicare funded? Generally what level of government administers each program respectively?

SPEA V-202                                                                   Problem Set 1                                                                    Page 3 of 3

  1. Prior to any health insurance, suppose that the societal cost of providing a doctor’s visit is a constant $100 co-pay. With insurance the visit is now $20. Suppose that the demand for visits can be expressed as.
    • Draw and label a graph representing the demand, supply, and social marginal cost (and benefit) curves.
    • Are there any inefficiencies present? Depict this on the graph and express the amount of the inefficiency.
    • If there is any inefficiency, why does this occur? If not, why should we not be concerned about inefficiencies?
  2. Describe how the Paris Climate Agreement is an improvement on the Kyoto Protocol.
  3. Consider two polluting firms for which the government is considering to regulating to address a negative externality. Suppose that firm A’s additional cost of pollution reduction is less than that of firm B. In other words, it cost Firm A more to reduce pollution by an additional unit. Suppose the government decides it wants to cut pollution back by 200 units. One consideration is to split the reduction evenly among both Firm A and Firm B. Is this the most efficient way to allocate the reduction? Explain.
  4. Pick one of the videos or readings that was assigned outside of class and connect it to the theory discussed in class. Write about 3-4 sentences and draw any appropriate graphs.
  5. Currie and Walker (2011) estimate the effects of an electronic toll booth on infant health.
    • Describe the mechanism by which this relationship can occur (b) How did the authors go about estimating these effects?

(c) What potential concerns did they/could they have about biased results?

[1] They are referring to Blue collar jobs that have since left due to trade liberalization.

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