Question 1 (10 marks)
Evaluate the following statements (your answer for all three parts should be no more than :
a) ”Since I own my own home, housing costs me nothing”.(3 marks)
b) “These lectures are boring and useless, but since I have paid for them, I am going to attend all of them”. (4 marks)
c) “Petrol is essential for people who own motor vehicles, therefore the demand curve for petrol is perfectly inelastic”. (3 marks)
Question 2 (20 marks)
The table below shows the production possibilities for two countries, Australia and Canada.
These countries each produce only two goods, ‘cheese’ and ‘wine’:
Australia’s production
per day
Canada’s production
per day
a) On separate diagrams draw the production possibility frontier (PPF) for each country, putting cheese on the x axis and wine on the y axis. Assume constant opportunity cost.
b) Use the information in the table to explain the meaning of absolute advantage.
c) Which country has the comparative advantage in wine production?
Which country has a comparative advantage in cheese production?
Make sure you fully explain your answers.
d) Assume a terms of trade of 1 unit of cheese = 2.5 units of wine. Explain why each country would find these terms of trade acceptable. Draw the consumption possibility frontier (CPF) in the PPF diagram from a) for each country. Explain how you constructed the CPF.
e) Use the diagram from d) to demonstrate the ‘gains from trade’. Explain your answer.

Question 3 (25 marks)
Assume that the retail price of petrol in Australia is $1.50 per litre. This price includes a per unit tax of 38 cents per litre. Assume that the supply of petrol is perfectly elastic. At the price of $1.50 the quantity traded per year is 18 billion litres. It has been proposed to cut the
tax by 5 cents to 33 cents per litre. Answer the following questions.
a) What is the effect of the reduction of the tax on the retail price?
b) Assume the demand curve is linear and that the reduction in price causes the quantity of petrol traded to increase by 61.02 million litres. Calculate the elasticity of demand at the mid-point between the original and new price.
c) What is the tax revenue collected before and after the tax is cut by 5 cents per litre?
d) What is the change in the deadweight loss from the petrol tax when it is cut by 5 cents per litre?
e) Calculate the ratio of the change in deadweight loss from part (d) to the change in tax revenue in part (c). What does this ratio tell you?
Question 4 (25 marks)
The first two columns of the table below show the market demand schedule for an industrial chemical. The production of this chemical generates a negative externality in the form of atmospheric pollution. The third column shows the marginal private cost (MC) of producing
this chemical in this market.
Price (dollars per tonne) Quantity (tonnes per day)
Marginal Cost (dollars
per tonne)
0 6000 120
40 5000 100
80 4000 80
120 3000 60
160 2000 40
200 1000 20
The marginal external cost (MEC) of the pollution created is equal to the MC at every level of output produced: that is, MC=MEC and therefore marginal social cost (MSC) = 2 x MC.
a) With no pollution control, what is the quantity of chemical produced, the price of the chemical per tonne, and the marginal external cost of the pollution generated?
b) With no pollution control, what is the marginal social cost of the chemicals produced and the deadweight loss?

c) Suppose that the government levies a tax on the producers, such that the market produces the efficient quantity. What is the price of the chemical per tonne, the tax per tonne, and the tax revenue per day?
d) Draw a diagram to illustrate all of the above.
e) Assuming there are a small number of parties involved in this chemical market, and that transactions costs are low, outline another way (apart from the tax) that the externality issue could be dealt with.
Question 5 (20 marks)
In many major cities around the world the taxi ride market is regulated by the government. A common form of regulation is the requirement that taxi operators must hold a government issued taxi licence. Assume the following holds in one such city. Only 500 licences are
issued and each taxi can only offer six taxi rides per day. Assume there are no government controls on the price that can be charged per ride. Assume that the demand curve for taxi rides is linear and obeys the law of demand. Assume that in an unregulated market (that is
in a market with no licence requirements) the supply curve for taxi rides would be an upward sloping straight line starting at the origin. Answer the following questions.
a) Draw a diagram representing the unregulated taxi ride market. Put price per ride on the vertical axis and taxi rides per day on the horizontal axis. Assume that the unregulated equilibrium quantity transacted is 5000 rides per day.
b) Indicate the areas of consumer surplus and producer surplus in the unregulated market. Explain briefly what is meant by consumer surplus and producer surplus.
c) Now draw the supply curve representing the regulated taxi ride market. Explain the shape of this curve.
d) Will the regulated equilibrium price and quantity be higher or lower than the unregulated equilibrium price and quantity? Show the regulated equilibrium price and quantity on the diagram.
e) Indicate the areas of consumer surplus, producer surplus under the regulated market. Is there a deadweight loss in the regulated market? If so indicate the area of dead weight loss on the diagram.

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