1. A survey shows an increase in drug use by young people.

In the ensuing debate, two

hypotheses are proposed:

(1) Reduced police efforts have increased the availability of drugs on the street.
(2) Cutbacks in education efforts have decreased awareness of the dangers of drug
addiction.

(a) Use supply-and-demand diagrams to show how each of these could lead to an increase in
the quantity of drugs consumed.
(b) How could information (e.g. on what has been happening to the price of drugs) help us to
distinguish between these explanations?

2. (a) Suppose the annual demand function for the Honda Accord is

QD = 5000 10PA + 10PC 50PF

where PA and PC are the prices of the Accord and the Toyota Camry respectively (in lakhs of
rupees) and PF is the price of fuel (in rupees per litre). What is the elasticity of demand for the
Accord with respect to the price of the Camry when both cars sell for Rs 15 lakhs and fuel
costs Rs. 60 per litre? What is the elasticity with respect to the price of fuel?

(b) Suppose the demand function for wheat is Qdwheat = 15 Pwheat and the supply function is
Qswheat = 5 Pwheat 6. What is the equilibrium price of wheat and what are the equilibrium
quantities bought and sold? What is the elasticity of demand at the equilibrium price? If wheat
prices were to rise, starting from the equilibrium price, would the total expenditure on wheat
go up or down?

3. A large paper factory dumps polluting chemicals into a river. Tens of thousands of people
living along the river are affected. A group of those affected coordinate and file a suit claiming
relief. You are summoned as an expert and impartial economist, and asked to comment on
each of the following proposed alternative courses of action. What would your testimony be?
Explain in each case.

(a) Do nothing. The Coase theorem tells us that the parties involved can achieve the
optimal solution without governmental interference.
(b) Order an immediate total ban on the dumping.
(c) Impose a tax on the factory equal to the marginal damage costs.

4. (a) Government involvement in general scientific research has been justified on the grounds
that advances in knowledge are public goods. Explain the argument.

(b) It has been argued that the following are examples of mixed goods essentially private
but partly public. For each discuss what the public and private components are, and whether
the government should or should not be involved in their provision.
(i) Medical care
(ii) Air traffic control.