Eco 201 Name_______________________________ Test 2m 8 July 2004 100 points. Please allocate your time efficiently. Please write answers in ink. For the present value problems, show your work. 1. Bill Gates, the CEO of Microsoft, explained his company’s pricing of software: “At first the price of a new software package is high because of our high research and development costs, but once we have covered those costs, we are able to lower the price to our customers.” Is this the reason that new software is initially priced at a high level, and then later is offered at lower prices? 2. Suppose Congress passes legislation to raise the federal excise tax on cigarettes. Assume that cigarette sellers collect the tax. Illustrate the effect that a hike in the tax on cigarettes has on the price of cigarettes and on the quantity of cigarettes exchanged. Also, indicate the incidence of the tax on both buyers and sellers. Who is likely to bear most of the tax in the first year—buyers or sellers? Explain why. How does the incidence of the tax change after a period of five years? Explain. 3. Steven Happle and Marianne Jennings (HJ) reported in the Wall Street Journal ("Herd Them Together and Scalp Them" 23 February 1995) that Phoenix became the first city in the U.S. to openly encourage ticket scalping at the event site and to centralize the market. The Phoenix ordinance got its first test on 12 February 1995 when about 400 ticket scalpers gathered together in a designated area across the street from the basketball arena to legally resell tickets to the NBA All-Star Game that was to be played later in the day. Happle and Jennings reported the following: Prices for $100 face-value upper-deck seats that sold earlier in the week for $450 were fetching $300 two hours before the game and $150 at tip-off. Seventh-row seats that sold on Saturday for $1000 went for $500 two hours before tip-off. One professional scalper complained in the newspapers, "We can't make nothing." In other words, the new open market produced remarkable yet predictable results. Explain why HJ contend that these results were predictable. Is this example comparable to the question in the textbook about the variation in prices you will observe at yard sales compared to the variation in prices at department stores? Explain. 4. A Russian diplomat spoke at Wofford College on Tuesday, 12 April 1994. In his comments about markets in Russia, he observed that many Russian merchants simply buy products in the West in order to sell them to other Russians in Moscow. He stated that eventually many of these merchants would expand their enterprises to engage in productive activities. What do you think he meant by "productive activities"? Would you agree with him that these merchants are not currently engaged in productive activities? Explain. 5. a. On Tuesday, 21 April 1998, the Spartanburg Herald-Journal reported (p. B1) that the Spartanburg City Council is considering the purchase of the third floor in the BellSouth buildingat the corner of E. Main and Pine Street for the emergemcy communications center. The price will be $250,000 and an additional $350,000 will be spent on renovation. If the space were leased, it would cost $50,000 a year. Assume the rent would be paid at the end of each year, and that no renovations would be need if the space were rented. Also assume that if the county decides to purchase it, the useful life of the facility will be 20 years, and that at the end of 20 years, the county will be able to sell the space for $500,000. The county would finance the purchase by issuing bonds which pay 6% interest. Evaluate each of the options. Which is cheaper, renting, or buying? For the purchase option, assume that the costs will occur immediately. b. You borrow $10,000 to be repaid in ten equal annual installments at 9%. 1. How much will each of the installment payments be? 2. How much will you still owe after making the second annual