Practice Midterm 4 - New Cases

How to Use This Practice Exam

A second set of unseen cases, each a close cousin of one Module 3 case. The goal is the syllabus skill of transferring a framework to a new situation: identify which market-failure or intervention template the case fits, then run that template.

Designed for about 75 minutes. Total: 120 points across twelve weighted questions, plus an unweighted synthesis question.
Read each vignette, then answer. Hidden model answers are in callouts - in Obsidian, click the bar to reveal. Write your own answer first.
The mapping to Module 3: Case 1 mirrors EpiPen; Case 2 mirrors the Elevator Saga; Case 3 mirrors Liconsa; Case 4 mirrors Thai rice subsidies.

Case 1 - Pricing ReviveJect

ReviveJect is an auto-injector that delivers naloxone, a drug that reverses an opioid overdose within minutes. Naloxone itself is old, off-patent, and cheap; it is also sold as a low-cost nasal spray and in injectable vials. ReviveJect's maker holds patents on the auto-injector device, which talks a bystander through the steps by voice. Over three years the maker raised ReviveJect's price from a few hundred dollars to several thousand dollars per twin-pack. The main buyers are public health departments and first-responder agencies, often spending grant money, amid an opioid-overdose epidemic. The company donates free devices to some community groups.

Q1 (10 pts). Cheaper forms of naloxone exist, yet ReviveJect's maker can charge thousands of dollars for the same drug in a device. Why?

Tests: applying the monopoly / barriers-to-entry framework to a new product.

[!success]- Model answer The drug is cheap, but the device is a differentiated, patent-protected product, and that is where the market power sits.

Patents on the auto-injector mechanism block direct copies.

Product differentiation: the voice-guided auto-injector is easy for an untrained, panicking bystander to use. The nasal spray and vials are cheaper but are not perfect substitutes for that user - just as Adrenaclick was a poor substitute for the EpiPen.

Switching costs and familiarity: agencies train staff and the public on a specific device.

Inelastic demand: it is used in a life-or-death emergency, with no time to compare options.

With entry blocked and demand inelastic, the maker can price the device far above the cost of the drug inside it.

Q2 (12 pts). ReviveJect's main buyers are public agencies spending grant money. Why does that make demand even less price-sensitive, and what does it do to the price?

Tests: extending the third-party-payer idea to public procurement.

[!success]- Model answer This is a third-party-payer distortion in a public-procurement form.

The agency that buys and deploys ReviveJect is not spending its own money in a price-disciplining way - it is spending an earmarked grant. If it does not spend the grant on naloxone devices, it may simply lose the funds.

Faced with a politically urgent epidemic, agencies are under pressure to buy now, and the human stakes make them willing to pay a high price.

So the buyer's demand is highly inelastic - it barely falls when the price rises.

Effect on price: knowing buyers will pay almost regardless, the maker can raise the price aggressively. As in the EpiPen case, when the entity choosing the product does not feel a normal budget constraint, the seller captures the difference - and the cost lands on taxpayers, who fund the grants.

Q3 (10 pts). The maker donates free devices to some community groups while charging public payers a high price. Why should this be analyzed as price discrimination rather than generosity, and who ultimately pays?

Tests: critiquing a goodwill claim - transfers the EpiPen savings-card analysis.

[!success]- Model answer The donations are best read as price discrimination plus public relations, not generosity.

The firm segments its buyers: it gives devices free to visible, vocal community groups (whose demand would be very elastic - they could not pay the high price anyway, so a sale there was never likely) while charging public agencies the full high price (inelastic, grant-funded demand).

The donations generate goodwill and defuse criticism, making the high price politically easier to sustain.

Charging each segment what it will bear is textbook third-degree price discrimination.

Who pays: the high price to public agencies stays in place, so taxpayers fund the bulk of the cost. The donations are a small, targeted cost that protects the profitable high price - the same logic as the EpiPen savings card.

Case 2 - The Village Well

Greenfield is a farming village of 60 households. A shared deep tube-well and pump costing USD 600,000 would give every household reliable irrigation water. Once built, any household can draw water from it, and the village cannot easily exclude non-payers. Households with larger plots would benefit more. The village proposes funding the well through voluntary contributions.

Q4 (12 pts). Is the village well a public good? Analyze non-rivalry and non-excludability carefully - and identify a second, distinct problem the village will face after the well is built.

Tests: precise application of public-good criteria, including a subtle distinction.

[!success]- Model answer You must separate the infrastructure from the water it delivers.

The well and pump (the capital good) behave like a public good for the village: it is non-rival (one household's access to the structure does not use it up) and effectively non-excludable (once built, it is hard to keep any household from drawing on it). This creates the free-rider problem in funding it - each household understates its willingness to contribute, so voluntary contributions under-provide the well.

The water itself, however, is rival: water one household pumps is no longer available to others, especially as the water table falls. Water is a common-pool resource - non-excludable but rival.

So there are two distinct problems: (1) a public-good provision problem - getting the well funded and built; and (2) after it exists, a common-pool / over-extraction problem - households over-pumping a shared, depletable resource (a tragedy-of-the-commons risk).

Q5 (12 pts). Voluntary contributions are likely to under-fund the well. Design a mechanism that would fund it efficiently and induce households to reveal honestly how much the well is worth to them.

Tests: constructing a preference-revealing mechanism.

[!success]- Model answer Use a pivot mechanism:

Each of the 60 households submits a pledge equal to the well's value to it.

Assign fair shares in advance - fixed and independent of pledges - for example scaled by plot size, summing to USD 600,000.

Decision rule: build the well if and only if the sum of pledges is at least USD 600,000 (this implements the Samuelson condition - build if total value covers cost).

Payment: each household pays its fixed fair share if the well is built, not its pledge.

Pivotal household: if a household's pledge changed the decision, it pays a penalty equal to the cost it imposed on the others.

Why it induces honesty: because the bill is a fixed fair share, a household cannot lower its payment by lowballing - the free-rider incentive is gone. The pledge only decides whether the well is built, and the pivotal penalty internalizes the effect of changing the outcome. As in a second-price auction, truthful pledging becomes a dominant strategy. Any penalty surplus must go to a party outside the village.

Q6 (10 pts). A year after the well is built, households over-pump it and the water table drops sharply. What kind of problem is this, and what instruments could address it?

Tests: recognizing a common-pool externality and matching instruments to it.

[!success]- Model answer This is the common-pool / tragedy-of-the-commons problem - a negative externality. Each household, deciding how much to pump, considers only its private benefit and ignores the cost it imposes on everyone else through a lower water table. Privately rational pumping adds up to collectively ruinous over-extraction.

Instruments to address it:

Price the water by volume, with a rising block tariff - a higher price per unit at higher usage - so heavy users face the marginal social cost of depletion (a Pigouvian-style correction; the same tool Thailand used for irrigation water).

Quotas - a cap on each household's withdrawals.

Community governance rules - locally agreed and monitored limits, rotation schedules, and sanctions for over-use.

The key idea: make each household internalize the depletion cost it imposes on the shared resource.

Case 3 - Housing Help in Rivertown

Rivertown wants to help low-income families afford housing and is weighing three options of equal budgetary cost: (A) build and operate public housing units rented out cheaply; (B) give families housing vouchers that can be spent only on rent; or (C) give families an unconditional cash transfer. Officials note that decent housing is widely seen as a basic need, and that reducing homelessness is thought to benefit the whole city.

Q7 (10 pts). Why would an economist argue that the unconditional cash transfer (Option C) leaves a family at least as well off as the equal-cost housing voucher (Option B)? Why might Rivertown still rationally choose the voucher?

Tests: the cash-versus-in-kind argument in a new setting.

[!success]- Model answer Cash dominance: with the unconditional cash transfer, a family can buy any bundle it could afford with the voucher, including spending it all on rent, plus every other option. More choice cannot lower utility, so cash leaves the family at least as well off - strictly better if the family would have preferred a cheaper home and more of other goods. The family is the best judge of its own needs (consumer sovereignty).

Yet Rivertown may still rationally choose the voucher:

Merit good / paternalism: the city values decent housing itself and may distrust how cash would be used.

Externalities: stable housing and less homelessness generate benefits for the whole city - public health, safety, neighborhood stability - that the family does not fully count.

Standards enforcement: a voucher tied to inspected units lets the city enforce minimum housing quality.

Political support: "housing for families" is easier to fund than untied cash.

Q8 (12 pts). When is a housing voucher exactly equivalent to a cash transfer for the family, and when does it bind and create a distortion? Use the idea of inframarginal versus marginal recipients.

Tests: the inframarginal/marginal distinction applied precisely.

[!success]- Model answer It depends on whether the voucher constraint binds.

Inframarginal family: a family that would have spent more on rent than the voucher's value anyway, even without help. For this family the voucher simply pays for rent it was going to buy regardless, freeing up its own cash for other goods. The voucher then acts exactly like a cash transfer - a pure income effect, no distortion.

Marginal family: a family that, given the extra resources, would prefer to spend less on housing than the voucher requires - it would rather have a cheaper home plus more food, transport, or savings. For this family the voucher binds: it is forced to over-consume housing relative to what it would freely choose. It is worse off than it would be with equal-cost cash - that gap is the distortion / deadweight loss of the in-kind form.

So a voucher is harmless (cash-equivalent) for families who already spend a lot on rent, and distorting for families whose preferred housing spending is below the voucher amount.

Q9 (10 pts). Rivertown argues that vouchers reduce homelessness, which benefits everyone. How does that externality argument change the cash-versus-in-kind comparison?

Tests: integrating externalities into the transfer-design decision.

[!success]- Model answer The cash-dominance result is about the family's own private utility. An externality changes the social calculation.

If housing generates positive externalities - less homelessness, better public health, safer and more stable neighborhoods, lower public costs of emergency services - then the family's private valuation of housing understates its social value. Society would like the family to consume more housing than the family, acting on private preferences alone, would choose.

In that case, steering consumption toward housing with a voucher can be efficient: the in-kind constraint pushes the family toward the level of housing that is socially optimal, correcting the externality. The "distortion" the voucher imposes on the marginal family is now (partly or fully) offsetting a market failure, not creating a loss.

Bottom line: cash beats in-kind for the recipient's private welfare; once positive externalities are present, the social comparison can favor the in-kind voucher.

Case 4 - Montavia's Coffee Scheme

Montavia is a significant - but not dominant - coffee-exporting country. To raise farm incomes, its government guarantees coffee farmers a price 40% above the world price and buys and stockpiles the beans farmers cannot sell privately, expecting to push the world price up and sell the stockpile at a profit later. Brazil and Vietnam are also large coffee exporters. After two years, Montavia's warehouses are full, the world price has not risen, and stored beans are losing quality.

Q10 (10 pts). Why is Montavia's plan to raise the world price of coffee by stockpiling likely to fail?

Tests: the market-power / residual-demand analysis transferred to a new commodity.

[!success]- Model answer The plan assumes Montavia has market power in the world coffee market - that by withholding supply it faces a downward-sloping, inelastic residual demand curve. It does not.

Montavia is one of several significant exporters. Brazil and Vietnam sell a close substitute, and when Montavia withholds beans they can simply expand their own exports to fill the gap. Montavia therefore faces a highly elastic residual demand curve: cutting its sales does not move the world price - it only loses market share to rivals.

This is the same failure as Thailand's rice scheme: a single supplier (or a would-be cartel) cannot prop up the world price by withholding its own output when close substitutes and non-cooperating rival exporters exist. The result is full warehouses, a degrading stockpile, and an unchanged world price.

Q11 (10 pts). The guaranteed price keeps Montavia's farmers producing more coffee than the world wants to buy. Identify the deadweight loss and the other costs of the scheme.

Tests: welfare analysis of a price support.

[!success]- Model answer The guaranteed price is a binding price floor, so quantity supplied exceeds quantity demanded and the government must buy the surplus.

Deadweight loss from over-production: the support price pulls farmers to expand output until their marginal cost equals the support price, but the extra beans are worth only the world price to buyers. Resources (land, labor, inputs) are spent producing coffee worth less than it cost - a loss of roughly 1/2 x (support price - world price) x (extra quantity).

Storage and spoilage: warehouses fill, storage is expensive, and stored beans lose quality over time.

Resale loss: beans bought at the high guaranteed price will be sold, if at all, at the lower world price - a direct fiscal loss.

Taxpayer cost: the whole scheme is financed by the public budget.

Possible environmental costs if farmers clear land to expand coffee onto marginal plots.

Q12 (10 pts). Who is likely to capture most of the benefit of Montavia's scheme, and what less-distorting policy would you recommend instead?

Tests: incidence reasoning plus a policy recommendation.

[!success]- Model answer Incidence: the benefit will not stay mainly with smallholder farmers. A higher return to growing coffee raises competition for the fixed factor - land suitable for coffee - so the benefit is capitalized into the rent and price of coffee land. Owners of good coffee land, and larger estates that produce the most, capture a disproportionate share. Tenant or smallholder farmers gain far less than the headline price increase suggests - the same pattern as land rent in the Thai rice case.

Recommendation: replace the price support with decoupled direct income support - a payment to coffee-farming households not tied to how much they produce. This supports incomes without the incentive to over-produce, so it removes the surplus, the storage and spoilage losses, and the deadweight loss. Alternatives or complements: price or crop insurance against bad years, and investment in productivity and quality so Montavia competes on its real strengths rather than propping up a price it cannot control.

Synthesis

Q13 (open, ~12 min). The professor hands you a brand-new case you have never seen. Describe the step-by-step procedure you would follow to analyze it, and explain why starting that way scores better than immediately writing everything you know.

Tests: meta-level command of the course method.

[!success]- Model answer A disciplined procedure:

Classify the situation. Which template does it fit - a public good, an externality / common-pool resource, imperfect competition / monopoly, asymmetric information, or a government intervention (transfer, subsidy, price support)? Naming the template first organizes everything after it.

State the efficiency benchmark the case is measured against - the Samuelson condition for a public good, price equal to marginal cost for competition, marginal social cost equals marginal social benefit for an externality.

Identify the actors and their incentives - who decides, who pays, who benefits, and what each one is trying to do.

Work through winners, losers, and the deadweight loss, with any formula or numbers the case provides.

Check incidence - who legally receives a benefit is not always who economically gains (capitalization).

Recommend a policy and name its trade-off honestly.

Why open this way: it shows the grader you have framed the problem before diving into detail. An answer that immediately dumps facts looks unstructured and often misses the central mechanism. As the syllabus stresses, the exam rewards structured reasoning and clear argument - so a visible framework, applied to the specific case, beats a pile of recalled information.