This part of the written comprehensive exam in Economics is divided into two parts, macro and micro, which are given equal weight in your final Economics comprehensive grade.
Answer each part in a separate bluebook. Be sure to put your identification number on each bluebook. In addition, put "Micro" on the cover of the bluebook containing the micro part and "Macro" on the other bluebook.
Your answers will be graded on the basis of the CONTENT and PRESENTATION of the economic analysis. The Macro part is an ESSAY, so you should be sure to take time to organize your ideas and present them in coherent form. Your answer should include appropriate verbal, graphical, and mathematical reasoning. The Micro part is composed of a series of specific questions. Please number each answer in your bluebook and write coherently and legibly.
Remember, the Macro and Micro sections are equally weighted, so you should allocate your time efficiently.
Use the 30 minute reading period to read the entire exam carefully, underlining important information. You may write notes on the exam but we will only evaluate answers in the blue book.
You have until 12:00 PM to complete the exam. Good luck.
1997 Macroeconomics Comprehensive Exam Essay
Many members of the new Congress regard reduction of the federal budget deficit as their top priority. This question asks you to evaluate the shortrun consequences of deficit reduction. Specifically, what are the comparative static consequences of the government reducing, in 1997, its budget deficit by reducing government expenditures on goods and services if the Fed adheres to a nominal money supply target? Assume in your answer that the public expects output prices to be the same in 1997 as existed in 1996. Provide a literate explanation using appropriate graphs (refer to specific points and numbers in your graphs in your essay for concreteness). Examine the shortrun effects on prices, real GDP, employment, interest rates, exchanges rates, the composition of GDP, and private savings. Employ IS, LM, balance of payments equilibrium conditions, aggregate demand [D(P)], aggregate supply [S(P)], foreign exchange demand, and supply graphs and analysis in developing your answer. Explain in words how and why agents respond to produce the graphical illustration.
Your answer will be evaluated on the clarity, coherence, and completeness of your
answer as well as on the conclusions and graphs.
WASHINGTON (Reuter) - U.S. tobacco companies will manufacture a record number of cigarettes this year, largely to meet burgeoning overseas demand, the government said Monday.
The Agriculture Department estimated U.S. cigarette production would climb to 760 billion cigarettes in 1996, the highest on record, and up from roughly 747 billion cigarettes made the prior year.
Americans smoked about 487 billion cigarettes in 1996, the department said. Consumption has remained about the same for the past four years.
However, U.S. cigarette exports grew by 12.5 percent to 260 billion in 1996. Exports have been trending upwards strongly since the mid-1980s. By comparison, in 1985 U.S. cigarette exports rang in at 58.9 billion.
QUESTION 1: Economics is the study of the allocation of scarce resources to
competing ends. Exactly what is the allocation problem faced by society with respect to
cigarettes?
QUESTION 2: Markets as an allocation mechanism require sellers and buyers for each
product. For buyers, the demand curve for each product shows optimal quantity
demanded as a function of price. In deciding how many cigarettes to buy at a given price,
the smoker acts as if he or she solves the following constrained optimization problem:
max Utility=f(C, OG)
C, OG
s.t. PCC + POGOG = M
where C = number of Cigarettes
OG = index of Other Goods
PC, POG = Price of Cigarettes, Price of Other Goods
M = Income
Illustrate the consumer choice problem graphically. Label everything carefully.
QUESTION 3: Cigarette manufacturers are especially interested in the price elasticity of demand and advertising elasticity of demand for cigarettes. Define these two elasticities, then provide a numerical guess of the value of these two elasticities for the US cigarette market. Finally, briefly explain your reasoning for the sign (positive or negative) and magnitude (actual numerical value) of each guess.
[Use the information provided below to answer questions 4, 5 and 6.]
In an attempt to more than wildly guess the price elasticity of demand for cigarettes,
someone has collected data on quantity demanded of cigarettes (in packs) and price
(cents/pack) in California from 1960 to 1989 in order to estimate the following model:
Q Cig Demanded per capitai = 0 + 1RealPrice of Cigi + 2RealIncome per capitai + i
(Real price and real income are expressed in terms of 1980 dollars.)
After correcting for first-order autocorrelation, the estimated equation (with SEs in parentheses) is:
Predicted Q = 228 - 0.33RealPrice - 0.0061RealIncome per capita
(12.78) (0.11) (0.0008)
QUESTION 4: Why are real price of cigarettes and real income used in estimating the equation instead of their nominal counterparts?
QUESTION 5: Calculate the price elasticity of demand at the average Q, 122 packs,
and average RealPrice, 90 cents/pack.
QUESTION 6: Many people believe that cigarette smoking is an all-or-nothing
proposition that is not influenced at all by price. They argue that the addictive nature of
nicotine means that smokers will continue to smoke the same amount regardless of how
much price increases. Does the estimated equation above support the hypothesis that
the market (inverse) cigarette demand curve is perfectly inelastic?
(HINT: A perfectly inelastic demand curve drawn as Q*=f(P) has zero slope, dQ*/dP = 0.)
QUESTION 7: Most people are aware that cigarettes (like alcohol and gasoline) carry
per unit taxes‹Indiana taxes cigarettes at 15.5¢/pack while several northeastern
states apply taxes of over 50 cents on each pack of cigarettes. If the objective of the
taxing authority is to minimize deadweight loss, explain (using supply and demand
analysis) why products with low price elasticities are singled out to be taxed.
QUESTION 8: Opponents of cigarette smoking claim that "second hand smoke" hurts
non-smokers and, therefore, the market inefficiently allocates resources in the case of
cigarette output. Use the supply and demand graph below to explain the "market
failure" argument in the case of cigarettes by showing the deadweight loss and explaining
what this means:
Within every tobacco-producing county, the government sets an overall production limit by issuing a certain number of permits to produce tobacco, with each permit allowing a farmer to produce one pound of tobacco in the current crop year. These permits are distributed to the farmers in the county. The farmers are allowed to buy and sell permits, but only within the county. For example a farmer with 5000 permits could sell 4000 permits, retaining only 1000 for him or herself. This farmer could then harvest only 1000 pounds of tobacco that year. These permits are called "quota", which is confusing because quota is both the name for the overall limit on production and for the individual permits to produce within that limit. The price of the quota is called the "lease rate," because they confer the right to harvest tobacco during a given period. The lease rate is measured in $ per pound of tobacco.
The following material is adapted from a 1995 article in the Journal of Political Economy by Rucker, Thurman, and Sumner.
QUESTION 9: Given demand for tobacco, draw a supply and demand graph (with clearly labelled x and y axes) that shows how the government policy determines the support price for tobacco.
QUESTION 10: Quota is actively traded. Why does the market for quota exist?