Pop Quiz

by Don Boudreaux on May 13, 2011

in Economics

Here are a three multiple-choice questions that I wrote for my Principles of Economics (ECON 103) final exam that my students took earlier this week:

Which group of persons would most likely benefit from rent control imposed in the city of Washington, DC?
a. landlords in Washington, DC
b. persons seeking to rent apartments in Washington, DC
c. landlords in the DC suburbs without rent control
d. renters in the DC suburbs without rent control

Suppose that engineers at BMW invent a new machine that dramatically increases BMW’s efficiency at producing automobiles and, thus, causes BMW’s production costs to significantly fall.  As a result, BMW expands its output and lowers its prices.  But also, BMW patents this new machine; only BMW can use it.  What is the most likely consequence of this particular invention on the prices that General Motors, Ford, Toyota, and other auto makers charge for the automobiles they produce?
a. no change in the prices of non-BMW automobiles
b. the prices of non-BMW automobiles will fall
c. the prices of non-BMW automobiles will rise
d. there’s insufficient information to answer this question

In the 1970s, the federal government imposed price ceilings on oil.  The goal was to make fuels such as gasoline and heating oil more affordable.  One consequence was
a. consumers ended up getting less oil (and oil products, such as gasoline and fuel oil) than they would have gotten without the price ceiling
b. gasoline shortages
c. higher costs to consumers of acquiring oil and oil products
d. all of the above

Anyone want to list the answers in the comments section?

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{ 231 comments }

Eugene May 16, 2011 at 12:27 pm

1 – C. we know the answer by now.
2 – B. the price of non-BMW automobiles will fall. Ford will have to lower their price or they simply will not sell any vehicles.
3 – D. If the gasoline producers can’t charge market prices for their product they will simply produce a lot less of it which results in all of the mentioned problems.

Tim May 16, 2011 at 12:30 pm

For answer 2, the answer is E — Other. BMW is not a full-line manufacturer, and their product line-up consists of higher-end luxury coupes, sedans, and small CUVs. They also depend on a certain exclusivity as part of their brand reputation; so as they increase production and volume, their old customers move to Mercedes and Audi — and would be willing to pay a premium for exclusivity.

Since people don’t really cross-shop BMW and the broader products of GM, Toyota, and Ford; and the price points are much lower than BWM’s starting price, there would be little impact. The bigger impact would be the luxury marques of full-line manufacturers (Lexus, Lincoln, Cadillac, Infinity).

The prices in segments where BMW doesn’t have vehicles (SUVs, trucks, commercial vehicles) would be unaffected.

Dan May 17, 2011 at 12:28 am

The luxury lines….. You mean where GM makes it’s profits….. They don’t make much, if anything on those shitty geo cars or other cafe law builds. And when BMW lowers their prices to undercut those profitable lines, bailout 2&3&4&5&6&7&8&9 will occur.

Tim May 17, 2011 at 1:54 pm

Actually, GM’s most profitable segments are their full size trucks. They typically have lower content, so the variable cost is lower; and can sell at a higher marginal rate, because so many are bought for business.

Stephen June 2, 2011 at 7:42 am

I agree with Tim. Why would BMW lower the value of its product? They have spent a lot of money associating BMW with luxury. They would also want to make the most money and test the maximum limits of profit. I think their shareholders would benefit the most with increased profits.

Don Boudreaux June 2, 2011 at 8:30 am

You clearly haven’t studied economics. In a later post, I’ll explain why it is in BMW’s interest to cut its prices as its costs of production fall.

Jonas Edholm May 16, 2011 at 3:39 pm

Question #2,

I’d say answer “d”. Since mentioned above BMW is a premium brand and its competitors is other premium brands like Mercedes, Audi and Lexus. If BMW lowers the price of their cars the brand will lose status. Those people who care about extending the length of their penises will chose other brands. Hence, the price of the non-BMW premium brands will rise, all else equal.

Now we’re left with the “value” brands, such as Toyota, GM and Ford. BMW makes astonishing high quality cars and if the price of BMW cars would get below those of the value brand competitors then they’d have to lower their prices.

Since this information is not included in the question I find the answer to be “d”.

And for question #3, “d”.

Kevin H May 16, 2011 at 6:25 pm

In regards to Question #2:

Non-BMW sellers will lower their profit margin on vehicles that compete with BMW and most likely license the productivity increasing technology on products that don’t compete with BMW.

Also BMW, now sitting on a larger cash reserves will consider buying a brand they don’t directly compete with to enter into new markets. Using their new technology they will have a hand up in the new market driving down costs in that area too.

Not far down the road the technology will be duplicated or surpassed and the consumers will benefit again by having better and cheaper cars.

Bud May 17, 2011 at 12:27 pm

I put this on the Answer to question #1 line –
Agreed questions #1 and #3 there does seem to be a lot of agreement. A few points per question #2 worth considering – since I haven’t seen as much discussion on it.
Answer A – On one hand you could say that other cars will lower price to remain competitive (Answer B – the blog consensus), but on the other hand, BMW is such a small luxury segment of the market, that it may not have an impact on the market as a whole. Also, it depends on how much it lowers the price. BMWs are expensive, unless prices are lowered a lot, they’re probably still out of reach of average consumers in the U.S. and thus not really competing with Ford et al.

Therefore Answer D – If BMW lowers its price, it may no longer be viewed as a luxury good and could therefore end up competing with firms like Ford. Or that firms like Ford believe they have to maintain a distance in price from BMW in order not to lose business to folks on the fence between regular and luxury cars. But for any of that to be analyzed, we have to know what cost structures the competitors face.

Kevin H May 17, 2011 at 5:52 pm

@Bud BMW could offer the car at the same price but load in many more perks than offered before and still increase the profit margin. So the the car wouldn’t be cheaper but be a much better value and it would make BMW richer.

grace May 17, 2011 at 9:35 pm

me

grace May 17, 2011 at 9:36 pm

what is a penguin

fred flintstone May 18, 2011 at 10:00 am

it can’t be D for question 3 because that would make it 3 consequences. “One consequence was all of the above.” eh?

Victor May 18, 2011 at 10:20 am

1 is c. I live in Holland, and we have rent control and an enormous surplus of demand, and of course no willingness to create supply. If there were houses without rent control, they would be in high demand (due to lack of supply) and thus more expensive.
2 is b. No matter that the machine is patented, competition will have to compete with BMW, they will make it work somehow or die.
3 is d. Higher prices are THE incentive to invest and produce more, by placing a ceiling that incentive apparently will not be great enough for supply to meet demand. Result: less will be produced than needed and less will be invested in production techniques that in the long run will cheapen oil production.

Victor May 18, 2011 at 10:34 am

Btw I am reading the other answers now (I didnt want to read any spoilers on the quiz) but the luxury brand argument really doesn’t hold up. I think a luxury brand (in this context) is something where the buyers value of the product has little correlation with the production cost, e.g. Gucci handbags, which are fine quality of course, but the production value is way lower than the shop value. Going back to the BMW, which is a car with excellent value, real “bang for your buck”. Now when Gucci sells their products for Wallmart prices, the hype will be over instantaneously, not so for BMW, which are bought (in Europe at least) because you just get the most for your money, when it will be cheaper, even better. And I think in general for such pricey items as cars the correlation between quality and price is high and consumers are critical and not easily gimmicked by a posh brand.

David Boudreau May 18, 2011 at 1:36 pm

It matters not the BMW produces mainly luxury vehicles — by lowering their price, some buyers who would not have bought BMWs due to price “upgrade” to a luxury vehicle and this will ripple down throughout the range of vehicles affecting pricing of all non-BMW vehicles.

andy May 18, 2011 at 8:57 pm

Don I really think you need to post the answer to question 2 – there seems to be little consensus….for what its worth i think the answer is D….while I think that answer B is quite possible I think for non-BMW prices to fall you need to make assumptions that aren’t explicitly stated in the question (i.e. you need more information than the question provides so D must be the correct answer).

The problem seems to me that we don’t know what BMW’s attitude to their new technology will be. Maybe they won’t want to increase their market share and will be happy just selling as many cars as they previously did (albeit at a higher profit margin). In this case the price of other non-BMW cars wouldn’t be affected. However BMW might want to increase their market share by lowering their prices (which they could do without sacrificing margin due to the new technology) in which case others would have to follow in order to stay competitive.

So i’ll go with option D because without making assumptions about BMW’s corporate strategies/constraints/decision making processes I can’t say for sure whether they will force the competitors prices down or not. They might just enjoy making the rent while the patent is in place.

best regards – andy

Bud May 19, 2011 at 10:12 am

Of course he needs to post the answer – why suggest he doesn’t?

Jake S. May 26, 2011 at 10:50 pm

Something I have… ADD. :-)

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