Chicago. Final exam for Price Theory (B). Friedman. Winter quarter 1964

The spirit of Chicago’s boot-camp training in price theory with Milton Friedman as canonical drill  instructor is captured in the examination transcribed below. 

Trivial observation: Questions 9 through 11 are based on a fictional monopoly Gimcrack Company that appears to be a homage to the old song “Jim Crack Corn” (a.k.a. “Blue tail Fly”). One can imagine the American graduate students hearing the voice of the folk singer Burl Ives rendering the tune as they attempted to answer the questions.

*  *  *  *  *  *  *  *  *  *

Some other exams for the second quarter of graduate price theory at Chicago from this period have been previously posted:

December 16, 1959 (Friedman); December 1960 (Friedman?); February 10/March 15, 1965 (Griliches); December 1965 (Telser)

___________________________

ECONOMICS 301
FINAL EXAM — Winter, 1964

M. Friedman
March 19, 1964

I. [25 Points] Indicate whether each of the following statements is true (T), false (F), or uncertain (U) and state briefly (on this paper) the reason for your answer.

1. The elasticity of a straight line demand curve varies from point to point.
2. In the long run, demand has no influence on the price of the product of a competitive industry that uses no specialized resources.
3. Marginal revenue is always greater than average revenue when average revenue is rising as quantity increases.

[4. and 5.] Assume that the government is going to purchase a predetermined quantity of rice for foreign relief and that it is considering making its purchases (a) directly from the growers of rice, or (b) through the regular dealer on the grain exchange. Assume also that there are no other governmental actions affecting rise growing or marketing.

4. The price to the domestic consumer of rice that remains will be higher in case (a) than in case (b).
5. The price received by the farmer for the rice that remains will be higher in case (a) than in case (b).

6. An “inferior” good is one such that a larger quantity is demanded at a high than at a low price.
7. If the quantity of Y increases and the quantity of X decreases in such a way as to keep total utility constant, then the rate of substitution of Y for X is independent of the quantity of X.
8. The income of the farmers raising corn increases when the price of corn rises. The rise in income is the “income effect of the rise in price.”

[9., 10., 11.] The Gimcrack Company is a monopoly, selling in two distinct markets. Transportation costs between the two markets can be neglected.

9. The company will always charge the same price for gimcracks in the two markets.
10. The company will sell such quantities in the two markets as will make the elasticities of demand the same in the two markets.
11. The company will sell such quantities in the two markets as will make marginal revenue the same in the two markets.

II. [25 Points] Fill in the blanks in the following questions.

1. Consider three demand curves for commodity X: A for given money income and other prices; B, for given apparent real income in Slutsky’s sense; C, for given real income in Hick’s sense. Let all three curves go through the point (p_o , x_o)
   If X is a superior good, then for a price lower than p₀, the quantity demanded will be larger for_____ than for _____. (Insert A, B, C, in correct spaces.)
   If X is an inferior good, then for a price lower than p₀, the quantity demanded will be larger for _____ than for _____.
   Suppose p₀ = $5, X₀ = $20, the corresponding money income $1, 000, and the income elasticity of demand for X is 2. Suppose that at a price $4, the quantity demanded on curve A is 25. Then the income compensation required to pass from A to B is $_____ (be sure to indicate sign of change) and the quantity demanded on curve B is _____.
2. Blank is indifferent whether he wagers $1 at even-money that a coin he regards as fair will come up heads. He is eager to wager $1 against $3 (i.e., he pays $1 if he loses, receives $3 if he wins) that heads will come up twice in two successive throws of this coin. (He regards the throws as independent and so the chances of two successive heads as one in four.) Let the utility of his income if he loses $1 be 100; if he wins $1, 101. Then the utility to him of his present income can be taken to be _____ (insert a number); the utility to his present income plus $3 _____ (insert the most accurate statement the evidence permits).

III. [25 Points.] Find the mistakes (there are at least six) in the accompanying diagram showing long run and short run marginal and average cost curves for an individual firm, and explain the general principle corresponding to each particular mistake.

[NOTE: The answer to question III has been transcribed and posted with the Friedman’s December 16, 1959 exam for Economics 301.]

IV. [25 Points] Consider two alternative taxes imposed on a commodity: (a) a specific tax of T dollars per unit sold: (b) an ad valorem tax of t per cent of the price of the product.
Assume that the commodity is produced and sold under strictly competitive conditions and that the price inclusive of tax when the tax of T is imposed is P₀. (i) Prove graphically that an ad valorem tax of t – T/P₀will result in the same equilibrium price. (ii) Suppose a tax rate slightly greater than t – T/P₀ is imposed. Under what conditions, if any, is it certain that the revenue will increase? (iii) Decrease?
Assume alternatively that the commodity is produced and sold by a monopoly. Suppose that, when a specific tax of T is imposed, the monopolist chose to sell at a price (inclusive of tax) of P₁. Suppose now, an ad valorem tax of t – T/P₁ is imposed. (iv) Will the monopolist’s optimum price be P₁? If not, will it be higher? or lower? Prove your answer.

V. [20 Points] When someone offers a cigarette to pipe-puffing Surgeon General Luther Terry, he always grabs it. “Every one I accept I tear up,” he says. “That way there’s one less cigarette.” (Time, February 7, 1964).
Analyze the economics of the Surgeon General’s policy. In doing so, assume of course, that a substantial class of people with similar beliefs behave the same way, so the effect is at least potentially appreciable. Would it contribute to his objective of reducing smoking? If so, through what channels?

___________________________

PROBLEM
for
ECONOMICS 301
Winter Quarter, 1964

Analyze the business practice discussed in the accompanying excerpt from a Wall Street Journal story of December 4 1963.

Under what circumstances, if any would you expect such a practice to be in the self-interest of the participating companies? How would you suggest testing your explanation?

Source: Hoover Institution Archives. Milton Friedman Papers. Box 77. Folder: University of Chicago, Econ. 301.

Image Source: Detail from picture of Milton Friedman (November 1957) at the Center for Advanced Study in the Behavioral Sciences, Stanford. University of Chicago Photographic Archive, pf1-06234, Hanna Holborn Gray Special Collections Research Center, University of Chicago Library.