Practice Midterm 1 - Module 3 Cases

How to Use This Practice Exam

This exam covers the four cases discussed in Module 3. It is built the way the syllabus says the real exam works: it rewards structured reasoning, problem framing, evidence evaluation, and argument construction, not memorized facts.

Designed for about 75 minutes. Total: 120 points.
Each question has a hidden model answer in a callout. In Obsidian's reading or live-preview mode, click the answer bar to reveal it. Try to write a full answer first.
A good answer names the concept, applies it to the case, and states the trade-off. Bullet points are fine if the logic is visible.
The italic line under each question tells you which exam skill it is training.

Part	Case	Points
1	Pricing the EpiPen	30
2	The Elevator Saga	25
3	Liconsa and Social Assistance for Milk	35
4	The Effects of Rice Subsidies in Thailand	30

Part 1 - Pricing the EpiPen

Q1 (12 pts). After acquiring the EpiPen in 2007, Mylan raised its price by more than 400% yet kept roughly 90% market share and a growing patient base. Why was this possible? In your answer, explain the combined role of barriers to entry and the price elasticity of demand.

Tests: problem framing and applying the monopoly model to evidence.

[!success]- Model answer The EpiPen is a near-monopoly, and a monopoly can hold price far above marginal cost only if two things both hold: rivals cannot enter, and buyers cannot or will not walk away.

Barriers to entry: the drug (epinephrine) is generic, but the auto-injector device is patented; a rival needs slow, costly FDA approval for a combination drug-device product; the brand became a genericized trademark ("the Kleenex of auto-injectors"); and switching costs are high because patients, parents, schools, and first responders are trained on the specific device, while pharmacists cannot freely substitute.

Inelastic demand: the EpiPen is life-saving with no substitute in an emergency, there is no time to shop, and insured patients are shielded from the price. Inelastic demand means raising price loses few sales.

Together: no entry means the markup is not competed away; inelastic demand means the firm both can and wants to raise price. Adrenaclick was cheaper (USD 142) yet held only 7% share - proof that a cheaper rival does not discipline price when buyers will not switch.

Q2 (10 pts). The "My EpiPen Savings Card" gave many insured patients a USD 0 co-pay. A classmate says this shows Mylan was trying to help patients. Why is an economist likely to read the card differently, and why does it also reduce political pressure on Mylan?

Tests: critiquing an argument and identifying a hidden mechanism.

[!success]- Model answer The card is best understood as couponing - a price-discrimination device, not generosity.

The card only lowers the patient's out-of-pocket cost. The insurer still pays the high list price, so Mylan's revenue per pen is not cut for insured buyers.

It segments the market: insured patients (shielded, pay near zero) versus uninsured patients (pay the full USD 600). Mylan extracts the most from each group.

Politically, the insured are the largest and most vocal group. By making them feel no price, the card keeps their demand inelastic and removes their incentive to complain. The uninsured are fewer and less organized. So the card defuses the backlash while the high list price - ultimately paid by insurers and, via Medicaid and CHIP, by taxpayers - stays in place.

Q3 (8 pts). An emergency auto-injector sells for USD 300 per pen against a marginal cost of about USD 3. Compute the Lerner Index and the implied price elasticity of demand. Why does the result tell you the market is not competitive?

Tests: applying a formula and interpreting the number.

[!success]- Model answer Lerner Index: L = (P - MC) / P = (300 - 3) / 300 = 0.99.

Implied elasticity: |elasticity| = 1 / L = 1 / 0.99 ≈ 1.01.

Interpretation: a competitive firm prices at marginal cost, so L is near 0. Here L is near 1 - almost the entire price is markup - which signals substantial market power. The operating point is only barely elastic: a monopolist always ends on the elastic part of demand, but with marginal cost near zero, a near-unit-elastic point produces an enormous price. The number is a direct measure that this is a price-maker, not a price-taker.

Part 2 - The Elevator Saga

Q4 (13 pts). Anna Horvath argues that deciding the elevator by majority vote is a poor method. Why is she right? Why does the pivot mechanism handle the underlying problem better?

Tests: comparing institutions against an efficiency benchmark.

[!success]- Model answer The elevator is a public good, and the efficient rule (the Samuelson condition) is to build it if and only if the sum of individual values is at least the cost.

Majority voting counts heads, not intensity. A majority of mildly-opposed residents can block an elevator that a minority values intensely, even when total value exceeds cost. Voting throws away information about how much each person cares, so it can give the wrong answer.

The pivot mechanism collects pledges that approximate values, so it effectively sums intensity: build if total pledges reach the cost - which mirrors the Samuelson rule.

It also fixes the honesty problem: each homeowner pays a fixed fair share, not their pledge, so lowballing does not cut their bill; and a pivotal homeowner pays a penalty equal to the cost imposed on others. This makes truthful pledging a dominant strategy, so the summed pledges actually reflect true values.

Q5 (12 pts). The elevator costs EUR 72,000. A sixth-floor homeowner has a fair share of f = EUR 5,175 and values the elevator at v = EUR 9,000. Everyone else pledges a total of B_other = EUR 64,000. If she pledges honestly, is the elevator built, is she pivotal, what does she pay, and what is her payoff? Show your steps.

Tests: executing the pivot-mechanism procedure.

[!success]- Model answer Honest pledge: b = v = EUR 9,000.

Total pledges B = B_other + b = 64,000 + 9,000 = EUR 73,000. Since 73,000 is at least 72,000, the elevator is built.

Pivotal test: compare B with B - b + f = 64,000 + 5,175 = EUR 69,175. This is below 72,000, while B is above it - the two are on opposite sides, so she is pivotal (her pledge is what got the elevator approved).

Penalty: F_other = 72,000 - f = 72,000 - 5,175 = 66,825. Penalty = F_other - B_other = 66,825 - 64,000 = EUR 2,825.

Payment = fair share + penalty = 5,175 + 2,825 = EUR 8,000.

Payoff = v - payment = 9,000 - 8,000 = +EUR 1,000.

She still gains, because she genuinely values the elevator above what she pays.

Q6 (13 pts). Why would an economist argue that giving poor families cash would leave them better off than the milk subsidy of equal cost? Why might the Mexican government still rationally prefer the milk subsidy?

Tests: applying consumer theory and weighing competing objectives.

[!success]- Model answer Cash dominance: with an equal-cost cash transfer, a family can buy any bundle it could afford under the milk subsidy, including the subsidized bundle itself, plus many others. More choice cannot lower utility, so cash leaves the family at least as well off - usually strictly better, because a price subsidy also adds a substitution distortion. This is the consumer-sovereignty argument: the family knows its own needs.

Yet the government may rationally still choose milk:

Paternalism / merit good: it values child nutrition more than the family does, or distrusts how cash is spent.

Externalities: well-nourished children generate social benefits the family does not fully count.

Self-targeting: the ordeal of queuing at a Diconsa shop screens out the non-poor, reducing leakage.

Political economy and administration: "milk for children" is easy to fund, builds constituencies (including dairy producers), and the barcoded system had less fraud than the tortilla program.

Q7 (12 pts). Defenders of Liconsa point to Exhibit 1: families spent almost all of their "savings" on more milk. Why do they argue this proves the program is nutritional and complementary to Oportunidades? Why is that interpretation contestable?

Tests: evidence evaluation - reading data without over-claiming.

[!success]- Model answer Defenders' reading: if the milk subsidy were just disguised income support, families would spread the savings across many goods. Instead the windfall went almost entirely back into more milk (savings available for other goods were tiny, even negative for the poorest rural families). So the program genuinely raises nutrition and is a different instrument from the income-support Oportunidades - the two are complements, not substitutes, and should both be available.

Why it is contestable: pouring the windfall into milk is exactly the substitution effect that a price subsidy is expected to produce. The data are equally consistent with "the subsidy distorted consumption toward milk." Whether the extra milk is a benefit or a deadweight loss depends on a value judgment - whether you accept the merit-good / externality rationale for nutrition. The evidence does not settle that; it is consistent with both stories.

Q8 (10 pts). Liconsa's milk program is described as "self-financing." Why is that label misleading, and who actually bears the cost?

Tests: spotting hidden and opportunity costs.

[!success]- Model answer "Self-financing" only means the program needs no line in the government budget - it does not mean costless.

Mexico protects its dairy industry by limiting powdered-milk imports: the world price of bulk powder is only about 45% of the Mexican price, and private importers must pay a 125% tariff. Liconsa is allowed to import bulk powder without that tariff, so it captures the gap - a quota rent.

The cost is real but hidden in trade policy. It is borne by Mexican milk consumers, who face protected high prices, and by the public through forgone tariff revenue. The lesson: "self-financing" usually conceals an opportunity cost - here, a transfer routed through an import barrier rather than the budget.

Part 4 - The Effects of Rice Subsidies in Thailand

Q9 (10 pts). Why did Thailand's plan to drive up the world price of rice by buying and stockpiling fail?

Tests: identifying a flawed assumption behind a policy.

[!success]- Model answer The plan assumed Thailand had market power in the world rice market - that by withholding supply it faced a downward-sloping, inelastic residual demand curve, like a monopolist or a dominant cartel member.

In reality Thailand is one of several large exporters. India and Vietnam sell a very close substitute, and when Thailand held rice back they simply expanded their own exports to fill the gap (India even had a stockpile from restricting exports after 2007). So Thailand actually faced a highly elastic residual demand curve: it could not move the world price - it only lost market share and its number-one-exporter title.

General lesson: a lone supplier (or a would-be cartel) cannot raise the price by cutting its own output when close substitutes and non-cooperating rival suppliers exist. The one who cuts just hands customers to rivals.

Q10 (10 pts). The scheme was meant to help poor tenant rice farmers, but farmland rent quadrupled (from 500 to 2,000 baht per rai). Why did much of the benefit end up with landlords rather than farmers?

Tests: applying the concept of incidence.

[!success]- Model answer This is subsidy incidence through capitalization.

When the support price raises the return to farming, farmers compete to obtain the fixed factor needed to farm - land. That competition bids up land rents and prices. The benefit of the subsidy is therefore capitalized into the rent of land.

Since 76% of farmland was owned by landlords, the higher rent flows to landowners, not to the tenant farmers who actually grow the rice. Large corporate producers (five firms produced 44.66% of exported rice) also captured a big share.

The principle: the party that legally receives a subsidy is not necessarily the one who economically benefits. The benefit settles on the owner of the most inelastically supplied input - here, land.

Q11 (10 pts). Total program spending was 934,510 million THB and sales revenue was 180,110 million THB. Compute the net cash loss in THB and in USD (34 THB = 1 USD). Why does this figure still understate the true cost of the program?

Tests: computation plus recognizing what a number leaves out.

[!success]- Model answer Net cash loss = total spending - sales revenue = 934,510 - 180,110 = 754,400 million THB.

In USD: 754,400 / 34 ≈ USD 22.2 billion. The government recovered under 20% of what it spent.

It understates the true cost because it omits:

About 18.7 million tons of rice still unsold in government storage, degrading in value.

The 100,000 tons that disappeared from granaries (fraud / loss).

Negative externalities of the induced over-production - water depletion, fertilizer pollution, deforestation.

The political cost - the scheme's collapse helped trigger the coup.

Part 5 - Synthesis

This part is not separately weighted; it is a full-length practice question of the kind the syllabus emphasizes.

Q12 (open, ~15 min). Choose either the EpiPen or the Thai rice case. Imagine you are advising a policymaker. In two or three sentences, frame the central problem. Then recommend one policy and justify it, naming the main trade-off your recommendation accepts.

Tests: framing, argument construction, and honest treatment of trade-offs.