Questions that caused trouble on the first midterm.

Q: If the amount of gasoline consumed per family is approximately the same at all income levels, then an excise tax on gasoline would be

1. a progressive tax. No, a progressive tax is one where (tax/income) increases as income increases.
2. a proportional tax. Most of you gave this answer, but it is not correct. An excise tax is so much per unit, like say 50 cents a gallon. If each family buys about the same amount of gasoline, they each pay about the same in excise tax on gasoline; but their incomes differ, so (tax/income) cannot be constant as income varies, which is the definition of a proportional tax.
3. a regressive tax. This is the right answer; see the discussion under b. If each family pays the same amount in gas tax, (tax/income) must go down as income goes up, the definition of a regressive tax (this is jargon). Only about 20% of you got this right -- the lowest percentage of any question on the test.
4. Was obviously wrong and only fooled two people.

Q: (I) The height of the supply curve indicates the minimum price necessary to induce suppliers to supply the quantity specified.

(II) The height of the demand curve indicates the value consumers place on an additional unit of the commodity.

The responses were then mixes of true and false. I am not sure why this caused so much trouble; we had mentioned this way of interpreting supply and demand curves more than once, but only about a third of you got this right -- both statements are true. Partly [from comments on the evaluation questionnaires] it may be wording and unfamiliarity with this way of "seeing" a graph -- 'height' is vertical ordinate, how high above the X-axis (Quantity axis) the curve is. If you are still unsure about this, re-read the sections of the textbook about supply and demand [p. 59, bottom p. 61, in the eighth edition].

Q: Which of the following is true?

1. When there are no external benefits or external costs, competitive markets generally result in socially efficient output levels. This was the correct answer, although less than half of you got it and more of you preferred b. In effect, this is the economics jargon definition of efficient: in a competitive market, if only the buyer and seller are affected by the transaction [i.e. no external benefits or costs, no impact on third parties not the buyer or seller], the outcome is efficient -- because at the margin, the value to the buyer is exactly equal to the opportunity cost of producing the last unit, and for the units exchanged prior to the last one the value to the buyer was greater than the opportunity cost of production. In other words, we are maximizing the possible gains from exchange, and producing the most highly valued output possible -- that is what economics terms efficient.
2. If both the buyer and seller agree to an exchange, it will always be consistent with ideal economic efficiency. This was the most popular response, but if it was true then economic jargon would be really crazy. Most drug purchasers agree to their purchases; are drug sales consistent with efficiency? When gasoline contained lead additives, motorists freely agreed to buy it -- and spewed out exhaust which poisoned fish, vegetation, and stunted the development of children (negative externalities); was that consistent with efficiency? There has to be an absence of externalities for market outcomes to be efficient.
3. The market system tends to allocate too many resources into activities that generate external benefits. This fooled about one in five of you, but it is back to front: the market system tends to allocate too few resources into activities that generate external benefits, because it does not take into account those benefits to persons not involved in the actual purchases.
4. The market system tends to allocate too many resources into producing public goods. This only fooled the inevitable 2%; it is wrong, a market system will tend to allocate NO resources at all into producing pure public goods.

Q: Suppose that gasoline prices increase sharply during the next six months. If the situation persists, the reduction in quantity demanded in response to the higher prices will

1. drive gasoline prices sharply higher. No, this is nonsense. A "reduction in quantity demanded in response to the higher prices" is a move up the demand curve, it cannot be driving gas prices higher. Only fooled the standard 2%.
2. drive gasoline prices sharply lower. This is a little trickier. A "reduction in demand" [demand curve shifting in to the left] would do that, but that is not what we have here -- we have a movement up the demand curve. So this is wrong, but it fooled 27% of you.
3. be larger in the short run than in the long run. Now we are getting to the point, but you have got to remember what common sense says about price elasticity of demand [responsiveness of the amount people want to buy to changes in price] in the short run and the long run. In the gasoline case, in the short run -- immediately -- people cannot do much to adjust to the new price; they can forgo some trips, share others, but they are not all going to run out and buy smaller, more fuel-efficient cars, or move closer to their jobs, schools, or shopping, right away. Over time, some people will do those things, make carpool arrangements, etc, in order to spend less on gas. So the reduction in the quantity of gas they want to buy -- the quantity demanded -- will be larger with more time [in the long run], not less [in the short run]. So this response was wrong, but 37% of you liked it.
4. be larger in the long run than in the short run. See discussion under c. above; this was the right answer, but only 35% of you got it (or read this far).

Q: Which of the following events would be sufficient to change the supply of handguns?

X = a decrease in the price of resources used in producing handguns

Y = an improvement in technology, reducing the production cost of handguns

Z = an increase in the price of rifles, a substitute product for handguns.

Q: Land used to grow corn is also often used to grow soybeans. Thus, an increase in the demand for (and price of) corn will

1. decrease the opportunity cost of producing soybeans. Opportunity cost is the most highly-valued alternative foregone, i.e. not chosen. The alternative to growing soybeans is growing corn, the price of corn has gone up; so the value of the alternative to producing soybeans has gone up, i.e. the opportunity cost of producing soybeans has increased -- not decreased. This response was wrong, but 40% of you chose it.
2. increase the opportunity cost of producing soybeans. See discussion under a. above. This was the right answer, and 48% of you got it right.
3. decrease the demand for soybeans. 3% of you chose this, and I am still trying to figure out why. Price of corn went up; this answer says that makes you want to buy fewer soybeans at the same price for soybeans (which is what decrease the demand for soybeans means). That would happen only if soybeans and corn were complements, i.e. consumed together. But usually if anything they are thought of as substitutes (in animal feeds, and as raw materials for edible oils). I had not heard of the corn-and-soybean diet; if you can prove it exists, I'll give you credit for this answer.
4. increase the supply of soybeans. This is another way of saying -- make farmers willing to sell more soybeans at an unchanged price of soybeans -- which would happen if the opportunity cost of producing soybeans had gone down, so this response is really the same as response a., which was wrong -- and if there are two equivalent answers, they can't both be right on this kind of test. Only 8% of you chose this.