ECON 312 Test Bank
ECON 312 Test Bank
Explain the law of supply. Why does the supply curve slope upward? How is the market…
ECON 312 Test Bank
ECON 312 Test Bank
McConnell Brue Flynn 19th Edition 24 Chapters
Chapter 01 Limits, Alternatives, and Choices (+ Appendix)
- Briefly explain the use of graphs as a way to represent economic relationships. What is an inverse relationship? How does it graph? What is a direct relationship? How does it graph?
- Describe the graphical relationship between ticket prices and the number of people choosing to visit amusement parks. Is that relationship consistent with the fact that, historically, park attendance and ticket prices have both risen? Explain.
- Look back at Figure 2, which shows the inverse relationship between ticket prices and game attendance at Gigantic State University. (a) Interpret the meaning of both the slope and the intercept. (b) If the slope of the line were steeper, what would that say about the amount by which ticket sales respond to increases in ticket prices? (c) If the slope of the line stayed the same but the intercept increased, what can you say about the amount by which ticket sales respond to increases in ticket prices?
- Graph and label as either direct or indirect the relationships you would expect to find between (a) the number of inches of rainfall per month and the sale of umbrellas, (b) the amount of tuition and the level of enrollment at a university, and (c) the popularity of an entertainer and the price of her concert tickets.
- Indicate how each of the following might affect the data shown in the table and graph in Figure 2 of this appendix:
- GSU’s athletic director schedules higher-quality opponents.
- An NBA team locates in the city where GSU plays.
- GSU contracts to have all its home games televised.
- The following table contains data on the relationship between saving and income. Rearrange these data into a meaningful order and graph them on the accompanying grid. What is the slope of the line? The vertical intercept? Write the equation that represents this line. What would you predict saving to be at the $12,500 level of income?
- Construct a table from the data shown on the graph below. Which is the dependent variable and which the independent variable? Summarize the data in equation form.
- Suppose that when the interest rate on loans is 16 percent, businesses find it unprofitable to invest in machinery and equipment. However, when the interest rate is 14 percent, $5 billion worth of investment is profitable. At 12 percent interest, a total of $10 billion of investment is profitable. Similarly, total investment increases by $5 billion for each successive 2-percentage-point decline in the interest rate. Describe the relevant relationship between the interest rate and investment in a table, on a graph, and as an equation. Put the interest rate on the vertical axis and investment on the horizontal axis. In your equation use the form i = a + bI , where i is the interest rate, a is the vertical intercept, b is the slope of the line (which is negative), and I is the level of investment.
- Suppose that C = a + bY , where C = consumption, a = consumption at zero income, b = slope, and Y = income.
- Are C and Y positively related or are they negatively related?
- If graphed, would the curve for this equation slope upward or slope downward?
- Are the variables C and Y inversely related or directly related?
- What is the value of C if a = 10, b = .50, and Y = 200?
- What is the value of Y if C = 100, a = 10, and b = .25?
- The accompanying graph shows curve XX’ and tangents at points A , B , and C . Calculate the slope of the curve at these three points.
- In the accompanying graph, is the slope of curve AA’ positive or negative? Does the slope increase or decrease as we move along the curve from A to A’? Answer the same two questions for curve BB’.
Chapter 02 The Market System and the Circular Flow
- Contrast how a market system and a command economy try to cope with economic scarcity.
- How does self-interest help achieve society’s economic goals? Why is there such a wide variety of desired goods and services in a market system? In what way are entrepreneurs and businesses at the helm of the economy but commanded by consumers?
- Why is private property, and the protection of property rights, so critical to the success of the market system? How do property rights encourage cooperation?
- What are the advantages of using capital in the production process? What is meant by the term “division of labor”? What are the advantages of specialization in the use of human and material resources? Explain why exchange is the necessary consequence of specialization.
- What problem does barter entail? Indicate the economic significance of money as a medium of exchange. What is meant by the statement “We want money only to part with it”?
- Assume that a business firm finds that its profit is greatest when it produces $40 worth of product A. Suppose also that each of the three techniques shown in the table below will produce the desired output:
- Some large hardware stores such as Home Depot boast of carrying as many as 20,000 different products in each store. What motivated the producers of those individual products to make them and offer them for sale? How did the producers decide on the best combinations of resources to use? Who made those resources available, and why? Who decides whether these particular hardware products should continue to be produced and offered for sale?
- What is meant by the term “creative destruction”? How does the emergence of MP3 (or iPod) technology relate to this idea?
- In a sentence, describe the meaning of the phrase “invisible hand.”
- In market economies, firms rarely worry about the availability of inputs to produce their products, whereas in command economies input availability is a constant concern. Why the difference?
- Distinguish between the resource market and the product market in the circular flow model. In what way are businesses and households both sellers and buyers in this model? What are the flows in the circular flow model?
- LAST WORD What explains why millions of economic resources tend to get arranged logically and productively rather than haphazardly and unproductively?
- Table 2.1 contained information on three techniques for producing $15 worth of bar soap. Assume that we said “$15 worth of bar soap” because soap cost $3 per bar and all three techniques produce 5 bars of soap ($15 = $3 per bar x 5 bars). So you know each technique produces 5 bars of soap.
- What technique will you want to use if the price of a bar of soap falls to $2.75? What if the price of a bar of soap rises to $4? To $5?
- How many bars of soap will you want to produce if the price of a bar of soap falls to $2.00?
- Suppose that the price of soap is again $3 per bar but that the prices of all four resources are now $1 per unit. Which is now the least-profitable technique?
- If the resource prices return to their original levels (the ones shown in the table) but a new technique is invented that can produce 3 bars of soap (yes, 3 bars, not 5 bars!) using 1 unit of each of the four resources, will firms prefer the new technique?
- Suppose Natasha currently makes $50,000 per year working as a manager at a cable TV company. She then develops two possible entrepreneurial business opportunities. In one, she will quit her job to start an organic soap company. In the other, she will try to develop an Internet-based competitor to the local cable company. For the soap-making opportunity, she anticipates annual revenue of $465,000 and costs for the necessary land, labor, and capital of $395,000 per year. For the Internet opportunity, she anticipates costs for land, labor, and capital of $3,250,000 per year as compared to revenues of $3,275,000 per year. (a) Should she quit her current job to become an entrepreneur? (b) If she does quit her current job, which opportunity would she pursue?
- With current technology, suppose a firm is producing 400 loaves of banana bread daily. Also assume that the least-cost combination of resources in producing those loaves is 5 units of labor, 7 units of land, 2 units of capital, and 1 unit of entrepreneurial ability, selling at prices of $40, $60, $60, and $20, respectively. If the firm can sell these 400 loaves at $2 per unit, what is its total revenue? Its total cost? Its profit or loss? Will it continue to produce banana bread? If this firm’s situation is typical for the other makers of banana bread, will resources flow toward or away from this bakery good?
- Let’s put dollar amounts on the flows in the circular flow diagram of Figure 2.2. LO5
- Suppose that businesses buy a total of $100 billion of the four resources (labor, land, capital, and entrepreneurial ability) from households. If households receive $60 billion in wages, $10 billion in rent, and $20 billion in interest, how much are households paid for providing entrepreneurial ability?
- If households spend $55 billion on goods and $45 billion on services, how much in revenues do businesses receive in the product market?
Chapter 03 Demand, Supply, and Market Equilibrium
- Explain the law of demand. Why does a demand curve slope downward? How is a market demand curve derived from individual demand curves?
- What are the determinants of demand? What happens to the demand curve when any of these determinants change? Distinguish between a change in demand and a movement along a fixed demand curve, noting the cause(s) of each.
- What effect will each of the following have on the demand for small automobiles such as the Mini-Cooper and Smart car?
- Small automobiles become more fashionable.
- The price of large automobiles rises (with the price of small autos remaining the same).
- Income declines and small autos are an inferior good.
- Consumers anticipate that the price of small autos will greatly come down in the near future.
- The price of gasoline substantially drops.
- Explain the law of supply. Why does the supply curve slope upward? How is the market supply curve derived from the supply curves of individual producers?
- What are the determinants of supply? What happens to the supply curve when any of these determinants changes? Distinguish between a change in supply and a change in the quantity supplied, noting the cause(s) of each.
- What effect will each of the following have on the supply of auto tires?
- A technological advance in the methods of producing tires.
- A decline in the number of firms in the tire industry.
- An increase in the prices of rubber used in the production of tires.
- The expectation that the equilibrium price of auto tires will be lower in the future than currently.
- A decline in the price of the large tires used for semi trucks and earth-hauling rigs (with no change in the price of auto tires).
- The levying of a per-unit tax on each auto tire sold.
- The granting of a 50-cent-per-unit subsidy for each auto tire produced.
- “In the corn market, demand often exceeds supply and supply sometimes exceeds demand.” “The price of corn rises and falls in response to changes in supply and demand.” In which of these two statements are the terms “supply” and “demand” used correctly? Explain
- In 2001 an outbreak of foot-and-mouth disease in Europe led to the burning of millions of cattle carcasses. What impact do you think this had on the supply of cattle hides, hide prices, the supply of leather goods, and the price of leather goods?
- Critically evaluate: “In comparing the two equilibrium positions in Figure 3.7b, I note that a smaller amount is actually demanded at a lower price. This refutes the law of demand.”
- For each stock in the stock market, the number of shares sold daily equals the number of shares purchased. That is, the quantity of each firm’s shares demanded equals the quantity supplied. So, if this equality always occurs, why do the prices of stock shares ever change?
- Suppose the total demand for wheat and the total supply of wheat per month in the Kansas City grain market are as shown in the nearby table. Suppose that the government establishes a price ceiling of $3.70 for wheat. What might prompt the government to establish this price ceiling? Explain carefully the main effects. Demonstrate your answer graphically. Next, suppose that the government establishes a price floor of $4.60 for wheat. What will be the main effects of this price floor? Demonstrate your answer graphically.
- What do economists mean when they say “price floors and ceilings stifle the rationing function of prices and distort resource allocation”?
- LAST WORD In some countries, such as France, every corpse is available for doctors to “harvest” for organs unless the deceased, while still alive, signed a form forbidding the organs to be harvested. In the USA, it is the opposite: No harvesting is allowed unless the deceased had signed, while still alive, an organ donor form authorizing doctors to harvest any needed organs. Use supply and demand figures to show in which country organ shortages are likely to be less severe.
- Suppose there are three buyers of candy in a market: Tex, Dex, and Rex. The market demand and the individual demands of Tex, Dex, and Rex for candy are given in the table below.
- Fill in the table for the missing values.
- Which buyer demands the least at a price of $5? The most at a price of $7?
- Which buyer’s quantity demanded increases the most when the price is lowered from $7 to $6?
- Which direction would the market demand curve shift if Tex withdrew from the market? What if Dex doubled his purchases at each possible price?
- Suppose that at a price of $6, the total quantity demanded increases from 19 to 38. Is this a “change in the quantity demanded” or a “change in demand”?
The figure below shows the supply curve for tennis balls, S1, for Drop Volley tennis, a producer of tennis equipment. Use the figure and the table below to give your answers to the following questions.
- Refer to the expanded table below from question 11.
- What is the equilibrium price? At what price is there neither a shortage nor a surplus? Fill in the surplus-shortage column and use it to confirm your answers.
- Graph the demand for wheat and the supply of wheat. Be sure to label the axes of your graph correctly. Label equilibrium price P and equilibrium quantity Q.
- How big is the surplus or shortage at $3.40? At $4.90? How big a surplus or shortage results if the price is 60 cents higher than the equilibrium price? 30 cents lower than the equilibrium price?
- How will each of the following changes in demand and/or supply affect equilibrium price and equilibrium quantity in a competitive market; that is, do price and quantity rise, fall, or remain unchanged, or are the answers indeterminate because they depend on the magnitudes of the shifts? Use supply and demand to verify your answers.
- Supply decreases and demand is constant.
- Demand decreases and supply is constant.
- Supply increases and demand is constant.
- Demand increases and supply increases.
- Demand increases and supply is constant.
- Supply increases and demand decreases.
- Demand increases and supply decreases.
- Demand decreases and supply decreases.
- Use two market diagrams to explain how an increase in state subsidies to public colleges might affect tuition and enrollments in both public and private colleges.
- ADVANCED ANALYSIS Assume that demand for a commodity is represented by the equation P = 10 – .2Qd and supply by the equation P = 2 + .2Qs, where Qd and Qs are quantity demanded and quantity supplied, respectively, and P is price. Using the equilibrium condition Qs = Qd, solve the equations to determine equilibrium price. Now determine equilibrium quantity
- Suppose that the demand and supply schedules for rental apartments in the city of Gotham are as given in the table below. LO5
- What is the market equilibrium rental price per month and the market equilibrium number of apartments demanded and supplied?
- If the local government can enforce a rent-control law that sets the maximum monthly rent at $1500, will there be a surplus or a shortage? Of how many units? And how many units will actually be rented each month?
- Suppose that a new government is elected that wants to keep out the poor. It declares that the minimum rent that can be charged is $2500 per month. If the government can enforce that price floor, will there be a surplus or a shortage? Of how many units? And how many units will actually be rented each month?
- Suppose that the government wishes to decrease the market equilibrium monthly rent by increasing the supply of housing. Assuming that demand remains unchanged, by how many units of housing would the government have to increase the supply of housing in order to get the market equilibrium rental price to fall to $1500 per month? To $1000 per month? To $500 per month?
Chapter 04 Elasticity
- Explain why the choice between 1, 2, 3, 4, 5, 6, 7, and 8 “units,” or 1000, 2000, 3000, 4000, 5000, 6000, 7000, and 8000 movie tickets, makes no difference in determining elasticity in Table 4.1.
- Graph the accompanying demand data, and then use the midpoint formula for Ed to determine price elasticity of demand for each of the four possible $1 price changes. What can you conclude about the relationship between the slope of a curve and its elasticity?
Explain in a nontechnical way why demand is elastic in the northwest segment of the demand curve and inelastic in the southeast segment.
- What are the major determinants of price elasticity of demand? Use those determinants and your own reasoning in judging whether demand for each of the following products is probably elastic or inelastic: (a) bottled water; (b) toothpaste; (c) Crest toothpaste; (d) ketchup; (e) diamond bracelets; (f) Microsoft’s Windows operating system.
- What effect would a rule stating that university students must live in university dormitories have on the price elasticity of demand for dormitory space? What impact might this in turn have on room rates?
- Calculate total-revenue data from the demand schedule in question 2. Graph total revenue below your demand curve. Generalize about the relationship between price elasticity and total revenue.
- How would the following changes in price affect total revenue? That is, would total revenue increase, decrease, or remain unchanged?
- Price falls and demand is inelastic.
- Price rises and demand is elastic.
- Price rises and supply is elastic.
- Price rises and supply is inelastic.
- Price rises and demand is inelastic.
- Price falls and demand is elastic.
- Price falls and demand is of unit elasticity.
- In 2006, Willem De Kooning’s abstract painting Woman III sold for $137.5 million. Portray this sale in a demand and supply diagram and comment on the elasticity of supply. Comedian George Carlin once mused, “If a painting can be forged well enough to fool some experts, why is the original so valuable?” Provide an answer. In 2006, Willem De Kooning’s abstract painting Woman III sold for $137.5 million. Portray this sale in a demand and supply diagram and comment on the elasticity of supply. Comedian George Carlin once mused, “If a painting can be forged well enough to fool some experts, why is the original so valuable?” Provide an answer.
- Suppose the cross elasticity of demand for products A and B is +3.6 and for products C and D is -5.4. What can you conclude about how products A and B are related? Products C and D?
- The income elasticities of demand for movies, dental services, and clothing have been estimated to be +3.4, +1, and +.5, respectively. Interpret these coefficients. What does it mean if an income elasticity coefficient is negative?
- Research has found that an increase in the price of beer would reduce the amount of marijuana consumed. Is cross elasticity of demand between the two products positive or negative? Are these products substitutes or complements? What might be the logic behind this relationship?
- LAST WORD What is the purpose of charging different groups of customers different prices? Supplement the three broad examples in the Last Word with two additional examples of your own. Hint: Think of price discounts based on group characteristics or time of purchase.
- Look at the demand curve in Figure 4.2a. Use the midpoint formula and points a and b to calculate the elasticity of demand for that range of the demand curve. Do the same for the demand curves in Figures 4.2b and 4.2c using, respectively, points c and d for Figure 4.2b and points e and f for Figure 4.2c.
- Investigate how demand elasticities are affected by increases in demand. Shift each of the demand curves in Figures 4.2a, 4.2b, and 4.2c to the right by 10 units. For example, point a in Figure 4.2a would shift rightward from location (10 units, $2) to (20 units, $2) while point b would shift rightward from location (40 units, $1) to (50 units, $1). After making these shifts, apply the midpoint formula to calculate the demand elasticities for the shifted points. Are they larger or smaller than the elasticities you calculated in Problem 1 for the original points? In terms of the midpoint formula, what explains the change in elasticities?
- Suppose that the total revenue received by a company selling basketballs is $600 when the price is set at $30 per basketball and $600 when the price is set at $20 per basketball. Without using the midpoint formula, can you tell whether demand is elastic, inelastic, or unit-elastic over this price range?
- Danny “Dimes” Donahue is a neighborhood’s 9-year old entrepreneur. His most recent venture is selling homemade brownies that he bakes himself. At a price of $1.50 each, he sells 100. At a price of $1.00 each, he sells 300. Is demand elastic or inelastic over this price range? If demand had the same elasticity for a price decline from $1.00 to $0.50 as it does for the decline from $1.50 to $1.00, would cutting the price from $1.00 to $0.50 increase or decrease Danny’s total revenue?
- What is the formula for measuring the price elasticity of supply? Suppose the price of apples goes up from $20 to $22 a box. In direct response, Goldsboro Farms supplies 1200 boxes of apples instead of 1000 boxes. Compute the coefficient of price elasticity (midpoints approach) for Goldsboro’s supply. Is its supply elastic, or is it inelastic?
- ADVANCED ANALYSIS Currently, at a price of $1 each, 100 popsicles are sold per day in the perpetually hot town of Rostin. Consider the elasticity of supply. In the short run, a price increase from $1 to $2 is unit elastic (Es = 1.0). So how many popsicles will be sold each day in the short run if the price rises to $2 each? In the long run, a price increase from $1 to $2 has an elasticity of supply of 1.50. So how many popsicles will be sold per day in the long run if the price rises to $2 each? (Hint: Apply the midpoints approach to the elasticity of supply.)
- Lorena likes to play golf. The number of times per year that she plays depends on both the price of playing a round of golf as well as Lorena’s income and the cost of other types of entertainment—in particular, how much it costs to go see a movie instead of playing golf. The three demand schedules in the table below show how many rounds of golf per year Lorena will demand at each price under three different scenarios. In scenario D1, Lorena’s income is $50,000 per year and movies cost $9 each. In scenario D2, Lorena’s income is also $50,000 per year, but the price of seeing a movie rises to $11. And in scenario D3, Lorena’s income goes up to $70,000 per year while movies cost $11.
Chapter 05 Market Failures: Public Goods and Externalities
- Explain the two causes of market failures. Given their definitions, could a market be affected by both types of market failures simultaneously?
- Draw a supply and demand graph and identify the areas of consumer surplus and producer surplus. Given the demand curve, what impact will an increase in supply have on the amount of consumer surplus shown in your diagram? Explain why.
- Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these two sets of ideas?
- What are the two characteristics of public goods? Explain the significance of each for public provision as opposed to private provision. What is the free-rider problem as it relates to public goods? Is S. border patrol a public good or a private good? Why? How about satellite TV? Explain.
- Draw a production possibilities curve with public goods on the vertical axis and private goods on the horizontal axis. Assuming the economy is initially operating on the curve, indicate how the production of public goods might be increased. How might the output of public goods be increased if the economy is initially operating at a point inside the curve?
- Use the distinction between the characteristics of private and public goods to determine whether the following should be produced through the market system or provided by government: (a) French fries, (b) airport screening, (c) court systems, (d) mail delivery, and (e) medical care. State why you answered as you did in each case.
- What divergences arise between equilibrium output and efficient output when (a) negative externalities and (b) positive externalities are present? How might government correct these divergences? Cite an example (other than the text examples) of an external cost and an external benefit.
- Why are spillover costs and spillover benefits also called negative and positive externalities? Show graphically how a tax can correct for a negative externality and how a subsidy to producers can correct for a positive externality. How does a subsidy to consumers differ from a subsidy to producers in correcting for a positive externality?
- An apple grower’s orchard provides nectar to a neighbor’s bees, while the beekeeper’s bees help the apple grower by pollinating his apple blossoms. Use Figure 5.6b to explain why this situation of dual positive externalities might lead to an underallocation of resources to both apple growing and beekeeping. How might this underallocation get resolved via the means suggested by the Coase theorem?
- The Lojack car recovery system allows the police to track stolen cars. As a result, they not only recover 90% of Lojack-equipped cars that are stolen but also arrest many auto thieves and shut down many “chop shops” that take apart stolen vehicles to get at their used parts. Thus, Lojack provides both private benefits and positive externalities. Should the government consider subsidizing Lojack purchases?
- Explain the following statement, using the MB curve in Figure 5.9 to illustrate: “The optimal amount of pollution abatement for some substances, say, dirty water from storm drains, is very low; the optimal amount of abatement for other substances, say, cyanide poison, is close to 100 percent.”
- Explain why zoning laws, which allow certain land uses only in specific locations, might be justified in dealing with a problem of negative externalities. Explain why in areas where buildings sit close together tax breaks to property owners for installing extra fire prevention equipment might be justified in view of positive externalities. Explain why excise taxes on beer might be justified in dealing with a problem of external costs.
- LAST WORD Distinguish between a carbon-tax and a cap-and-trade strategy for reducing carbon dioxide and other so-called greenhouse gases (that are believed by many scientists to be causing global warming). Which of the two strategies do you think would have the most political support in an election in your home state? Explain your thinking.
- Refer to Table 5.1. If the six people listed in the table are the only consumers in the market and the equilibrium price is $11 (not the $8 shown), how much consumer surplus will the market generate?
- Refer to Table 5.2. If the six people listed in the table are the only producers in the market and the equilibrium price is $6 (not the $8 shown), how much producer surplus will the market generate?
- Look at Tables 5.1 and 5.2 together. What is the total surplus if Bob buys a unit from Carlos? If Barb buys a unit from Courtney? If Bob buys a unit from Chad? If you match up pairs of buyers and sellers so as to maximize the total surplus of all transactions, what is the largest total surplus that can be achieved?
- ADVANCED ANALYSIS Assume the following values for Figures 5.4a and 5.4b. Q1 = 20 bags. Q2 = 15 bags. Q3 = 27 bags. The market equilibrium price is $45 per bag. The price at a is $85 per bag. The price at c is $5 per bag. The price at f is $59 per bag. The price at g is $31 per bag. Apply the formula for the area of a triangle (Area = ½ x Base x Height) to answer the following questions. LO2
- What is the dollar value of the total surplus (producer surplus plus consumer surplus) when the allocatively efficient output level is being produced? How large is the dollar value of the consumer surplus at that output level?
- What is the dollar value of the deadweight loss when output level Q2 is being produced? What is the total surplus when output level Q2 is being produced?
- What is the dollar value of the deadweight loss when output level Q3 is produced? What is the dollar value of the total surplus when output level Q3 is produced?
- On the basis of the three individual demand schedules below, and assuming these three people are the only ones in the society, determine (a) the market demand schedule on the assumption that the good is a private good and (b) the collective demand schedule on the assumption that the good is a public good.
- Use your demand schedule for a public good, determined in problem 5, and the following supply schedule to ascertain the optimal quantity of this public good.
- 7. Look at Tables 5.1 and 5.2, which show, respectively, the willingness to pay and willingness to accept of buyers and seller of bags of oranges. For the following questions, assume that the equilibrium price and quantity will depend on the indicated changes in supply and demand. Assume that the only market participants are those listed by name in the two tables. LO4
- What is the equilibrium price and quantity for the data displayed in the two tables?
- What if instead of bags of oranges, the data in the two tables dealt with a public good like fireworks displays. If all the buyers free ride, what will be the quantity supplied by private sellers?
- Assume that we are back to talking about bags of oranges (a private good), but that the government has decided that tossed orange peels impose a negative externality on the public that must be rectified by imposing a $2-per-bag tax on sellers. What is the new equilibrium price and quantity? If the new equilibrium quantity is the optimal quantity, by how many bags were oranges being overproduced before?
Chapter 06 Consumer Behavior (+ Appendix)
- What information is embodied in a budget line? What shifts occur in the budget line when money income (a) increases and (b) decreases? What shifts occur in the budget line when the price of the product shown on the vertical axis (c) increases and (d) decreases?
- What information is contained in an indifference curve? Why are such curves (a) downsloping and (b) convex to the origin? Why does total utility increase as the consumer moves to indifference curves farther from the origin? Why can’t indifference curves intersect?
- Using Figure 4, explain why the point of tangency of the budget line with an indifference curve is the consumer’s equilibrium position. Explain why any point where the budget line intersects an indifference curve is not equilibrium. Explain: “The consumer is in equilibrium where MRS= PB/PA.”
- Complete the following table and answer the questions below: LO1
- At which rate is total utility increasing: a constant rate, a decreasing rate, or an increasing rate? How do you know?
- “A rational consumer will purchase only 1 unit of the product represented by these data since that amount maximizes marginal utility.” Do you agree? Explain why or why not.
- “It is possible that a rational consumer will not purchase any units of the product represented by these data.” Do you agree? Explain why or why not.
- Simpson buys loaves of bread and quarts of milk each week at prices of $1 and 80 cents, respectively. At present she is buying these products in amounts such that the marginal utilities from the last units purchased of the two products are 80 and 70 utils, respectively. Is she buying the utility-maximizing combination of bread and milk? If not, how should she reallocate her expenditures between the two goods?
- How can time be incorporated into the theory of consumer behavior? Explain the following comment: “Want to make millions of dollars? Devise a product that saves Americans lots of time.”
- Before economic growth, there were too few goods; after growth, there is too little time.
- It is irrational for an individual to take the time to be completely rational in economic decision making.
- Telling your spouse where you would like to go out to eat for your birthday makes sense in terms of utility maximization.
- In the last decade or so there has been a dramatic expansion of small retail convenience stores (such as 7 Eleven, Kwik Shop, and Circle K), although their prices are generally much higher than prices in large supermarkets. What explains the success of the convenience stores?
- Many apartment-complex owners are installing water meters for each apartment and billing the occupants according to the amount of water they use. This is in contrast to the former procedure of having a central meter for the entire complex and dividing up the collective water expense as part of the rent. Where individual meters have been installed, water usage has declined 10 to 40 percent. Explain that drop, referring to price and marginal utility.
- Using the utility-maximization rule as your point of reference, explain the income and substitution effects of an increase in the price of product B, with no change in the price of product A.
- Assume that the data in the accompanying table give an indifference curve for Mr. Chen. Graph this curve, putting A on the vertical axis and B on the horizontal axis. Assuming that the prices of A and B are $1.50 and $1, respectively, and that Mr. Chen has $24 to spend, add his budget line to your graph. What combination of A and B will Mr. Chen purchase? Does your answer meet the MRS =PB/PA rule for equilibrium?
- Explain graphically how indifference analysis can be used to derive a demand curve.
- ADVANCED ANALYSIS First, graphically illustrate a doubling of income without price changes in the indifference curve model. Next, on the same graph, show a situation in which the person whose indifference curves you are drawing buys considerably more of good B than good A after the income increase. What can you conclude about the relative coefficients of the income elasticity of demand for goods A and B (Chapter 4)?
- ADVANCED ANAYLSIS A “mathematically fair bet” is one in which the amount won will on average equal the amount bet, for example when a gambler bets, say, $100 for a 10 percent chance to win $1000 ($100 = .10 x $1000). Assuming diminishing marginal utility of dollars, explain why this is not a fair bet in terms of utility. Why is it even a less fair bet when the “house” takes a cut of each dollar bet? So is gambling irrational?
- Suppose that Ike is loss averse. In the morning, Ike’s stockbroker calls to tell him that he has gained $1000 on his stock portfolio. In the evening, his accountant calls to tell him that he owes an extra $1000 in taxes. At the end of the day, does Ike feel emotionally neutral since the dollar value of the gain in his stock portfolio exactly offsets the amount of extra taxes he has to pay? Explain.
- You just accepted a campus job helping to raise money for your school’s athletic program. You are told to draft a fundraising letter. The bottom of the letter asks recipients to write down a donation amount. If you want to raise as much money as possible, would it be better if the text of that section mentioned that your school is #3 in the nation in sports or that you are better than 99% of other schools at sports? Explain.
- LAST WORD What do you think of the ethics of using unconscious nudges to alter people’s behavior? Before you answer, consider the following argument made by economists Richard Thaler and Cass Sunstein, who favor the use of nudges. They argue that in most situations we couldn’t avoid nudging even if we wanted to because whatever policy we choose will contain some set of unconscious nudges and incentives that will influence people. Thus, they say, we might as well choose the wisest set of nudges.
- Mylie’s total utility from singing the same song over and over is 50 utils after one repetition, 90 utils after two repetitions, 70 utils after three repetitions, 20 utils after four repetitions, -50 utils after five repetitions, and -200 utils after six repetitions. Write down her marginal utility for each repetition. Once Mylie’s total utility begins to decrease, does each additional singing of the song hurt more than the previous one or less than the previous one?
- John likes Coca-Cola. After consuming one Coke, John has a total utility of 10 utils. After two Cokes, he has a total utility of 25 utils. After three Cokes, he has a total utility of 50 utils. Does John show diminishing marginal utility for Coke or does he show increasing marginal utility for Coke? Suppose that John has $3 in his pocket. If Cokes cost $1 each and John is willing to spend one of his dollars on purchasing a first can of Coke, would he spend his second dollar on a Coke, too? What about the third dollar? If John’s marginal utility for Coke keeps on increasing no matter how many Cokes he drinks, would it be fair to say that he is addicted to Coke?
- Suppose that Omar’s marginal utility for cups of coffee is constant at 1.5 utils per cup, no matter how many cups he drinks. On the other hand, his marginal utility per doughnut is 10 for the first doughnut he eats, 9 for the second he eats, 8 for the third he eats, and so on (that is, declining by 1 util per additional doughnut). In addition, suppose that coffee costs $1 per cup, doughnuts cost $1 each, and Omar has a budget that he can spend only on doughnuts, coffee, or both. How big would that budget have to be before he would spend a dollar buying a first cup of coffee?
- Columns 1 through 4 in the table below show the marginal utility, measured in utils, that Ricardo would get by purchasing various amounts of products A, B, C, and D. Column 5 shows the marginal utility Ricardo gets from saving. Assume that the prices of A, B, C, and D are, respectively, $18, $6, $4, and $24 and that Ricardo has an income of $106. LO2
- What quantities of A, B, C, and D will Ricardo purchase in maximizing his utility?
- How many dollars will Ricardo choose to save?
- Check your answers by substituting them into the algebraic statement of the utility-maximizing rule (verify that all of the income has been exhausted between the various goods and savings).
- You are choosing between two goods, X and Y, and your marginal utility from each is as shown in the table below. If your income is $9 and the prices of X and Y are $2 and $1, respectively, what quantities of each will you purchase to maximize utility? What total utility will you realize? Assume that, other things remaining unchanged, the price of X falls to $1. What quantities of X and Y will you now purchase? Using the two prices and quantities for X, derive a demand schedule (prices and quantities demanded table) for X.
- ADVANCED ANAYLSIS Let MUA = z = 10 – x and MUB = z = 21 – 2y, where z is marginal utility per dollar measured in utils, x is the amount spent on product A, and y is the amount spent on product B. Assume that the consumer has $10 to spend on A and B—that is, x + y = 10. How is the $10 best allocated between A and B? How much utility will the marginal dollar yield?
- Suppose that with a budget of $100, Deborah spends $60 on sushi and $40 on bagels when sushi costs $2 per piece and bagels cost $2 per bagel. But then, after the price of bagels falls to $1 per bagel, she spends $50 on sushi and $50 on bagels. How many pieces of sushi and how many bagels did Deborah consume before the price change? At the new prices, how much money would it have cost Deborah to buy those same quantities (the ones that she consumed before the price change)? Given that it used to take Deborah’s entire $100 to buy those quantities, how big is the income effect caused by the reduction in the price of bagels?
Chapter 07 Businesses and the Costs of Production
- Distinguish between explicit and implicit costs, giving examples of each. What are some explicit and implicit costs of attending college?
- Distinguish between accounting profit, economic profit, and normal profit. Does accounting profit or economic profit determine how entrepreneurs allocate resources between different business ventures?
- Which of the following are short-run and which are long-run adjustments? LO1
- Wendy’s builds a new restaurant.
- Harley-Davidson Corporation hires 200 more production workers.
- A farmer increases the amount of fertilizer used on his corn crop.
- An Alcoa aluminum plant adds a third shift of workers.
- Complete the table directly below by calculating marginal product and average product.
Plot the total, marginal, and average products and explain in detail the relationship between each pair of curves. Explain why marginal product first rises, then declines, and ultimately becomes negative. What bearing does the law of diminishing returns have on short-run costs? Be specific. “When marginal product is rising, marginal cost is falling. And when marginal product is diminishing, marginal cost is rising.” Illustrate and explain graphically.
- Why can the distinction between fixed costs and variable costs be made in the short run? Classify the following as fixed or variable costs: advertising expenditures, fuel, interest on company-issued bonds, shipping charges, payments for raw materials, real estate taxes, executive salaries, insurance premiums, wage payments, depreciation and obsolescence charges, sales taxes, and rental payments on leased office machinery. “There are no fixed costs in the long run; all costs are variable.” Explain.
- List several fixed and variable costs associated with owning and operating an automobile. Suppose you are considering whether to drive your car or fly 1000 miles to Florida for spring break. Which costs—fixed, variable, or both—would you take into account in making your decision? Would any implicit costs be relevant? Explain.
- A firm has fixed costs of $60 and variable costs as indicated in the table at the bottom of this page. Complete the table and check your calculations by referring to question 4 at the end of Chapter 8.
- Indicate how each of the following would shift the (1) marginal-cost curve, (2) average-variable-cost curve, (3) average-fixed-cost curve, and (4) average-total-cost curve of a manufacturing firm. In each case specify the direction of the shift. LO3
- A reduction in business property taxes.
- An increase in the nominal wages of production workers.
- A decrease in the price of electricity.
- An increase in insurance rates on plant and equipment.
- An increase in transportation costs.
- Suppose a firm has only three possible plant-size options, represented by the ATC curves shown in the accompanying figure. What plant size will the firm choose in producing (a) 50, (b) 130, (c) 160, and (d) 250 units of output? Draw the firm’s long-run average-cost curve on the diagram and describe this curve.
- Use the concepts of economies and dis-economies of scale to explain the shape of a firm’s long-run ATC curve. What is the concept of minimum efficient scale? What bearing can the shape of the long-run ATC curve have on the structure of an industry?
- LAST WORD What is a sunk cost? Provide an example of a sunk cost other than one from this book. Why are such costs irrelevant in making decisions about future actions?
- Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4000 per year if alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3000 per year. Total annual revenue from pottery sales is $72,000. Calculate the accounting profit and the economic profit for Gomez’s pottery firm.
- Imagine you have some workers and some hand-held computers that you can use to take inventory at a warehouse. There are diminishing returns to taking inventory. If one worker uses one computer, he can inventory 100 items per hour. Two workers can together inventory 150 items per hour. Three workers can together inventory 160 items per hour. And four or more workers can together inventory fewer than 160 items per hour. Computers cost $100 each and you must pay each worker $25 per hour. If you assign one worker per computer, what is the cost of inventorying a single item with one worker? What if you assign two workers per computer? Three? How many workers per computer should you assign if you wish to minimize the cost of inventorying a single item?
- You are a newspaper publisher. You are in the middle of a one-year rental contract for your factory that requires you to pay $500,000 per month, and you have contractual labor obligations of $1 million per month that you can’t get out of. You also have a marginal printing cost of $.25 per paper as well as a marginal delivery cost of $.10 per paper. If sales fall by 20 percent from 1 million papers per month to 800,000 papers per month, what happens to the AFC per paper, the MC per paper, and to the minimum amount that you must charge to break even on these costs?
- There are economies of scale in ranching, especially with regard to fencing land. Suppose that barbed-wire fencing costs $10,000 per mile to set up. How much would it cost to fence a single property whose area is one square mile if that property also happens to be perfectly square, with sides that are each one-mile long? How much would it cost to fence exactly four such properties, which together would contain four square miles of area? Now, consider how much it would cost to fence in four square miles of ranch land if, instead, it comes as a single large square that is two-miles long on each side. Which is more costly—fencing in the four, one-square-mile properties or the single four-square-mile property?
Chapter 08 Pure Competition in the Short Run
- Briefly state the basic characteristics of pure competition, pure monopoly, monopolistic competition, and oligopoly. Under which of these market classifications does each of the following most accurately fit? (a) a supermarket in your hometown; (b) the steel industry; (c) a Kansas wheat farm; (d) the commercial bank in which you or your family has an account; (e) the automobile industry. In each case justify your classification.
- Strictly speaking, pure competition is relatively rare. Then why study it?
- Use the following demand schedule to determine total revenue and marginal revenue for each possible level of sales:
- What can you conclude about the structure of the industry in which this firm is operating? Explain.
- Graph the demand, total-revenue, and marginal-revenue curves for this firm.
- Why do the demand and marginal-revenue curves coincide?
- “Marginal revenue is the change in total revenue associated with additional units of output.” Explain verbally and graphically, using the data in the table.
- “Even if a firm is losing money, it may be better to stay in business in the short run.” Is this statement ever true? Under what condition(s)?
- Consider a firm that has no fixed costs and which is currently losing money. Are there any situations in which it would want to stay open for business in the short run? If a firm has no fixed costs, is it sensible to speak of the firm distinguishing between the short run and the long run?
- Why is the equality of marginal revenue and marginal cost essential for profit maximization in all market structures? Explain why price can be substituted for marginal revenue in the MR = MC rule when an industry is purely competitive.
- “That segment of a competitive firm’s marginal-cost curve that lies above its average-variable-cost curve constitutes the short-run supply curve for the firm.” Explain using a graph and words.
- LAST WORD If a firm’s current revenues are less than its current variable costs, when should it shut down? If it decides to shut down, should we expect that decision to be final? Explain using an example that is not in the book.
- A purely competitive firm finds that the market price for its product is $20. It has a fixed cost of $100 and a variable cost of $10 per unit for the first 50 units and then $25 per unit for all successive units. Does price exceed average variable cost for the first 50 units? What about for the first 100 units? What is the marginal cost per unit for the first 50 units? What about for units 51 and higher? For each of the first 50 units, does MR exceed MC? What about for units 51 and higher? What output level will yield the largest possible profit for this purely competitive firm? (Hint: Draw a graph similar to Figure 8.2 using data for this firm.)
- A purely competitive wheat farmer can sell any wheat he grows for $10 per bushel. His five acres of land show diminishing returns because some are better suited for wheat production than others. The first acre can produce 1000 bushels of wheat, the second acre 900, the third 800, and so on. Draw a table with multiple columns to help you answer the following questions. How many bushels will each of the farmer’s five acres produce? How much revenue will each acre generate? What are the TR and MR for each acre? If the marginal cost of planting and harvesting an acre is $7000 per acre for each of the five acres, how many acres should the farmer plant and harvest?
- Karen runs a print shop that makes posters for large companies. It is a very competitive business. The market price is currently $1 per poster. She has fixed costs of $250. Her variable costs are $1000 for the first thousand posters, $800 for the second thousand, and then $750 for each additional thousand posters. What is her AFC per poster (not per thousand!) if she prints 1000 posters? 2000? 10,000? What is her ATC per poster if she prints 1000? 2000? 10,000? If the market price fell to 70 cents per poster, would there be any output level at which Karen would not shut down production immediately?
- Assume the following cost data are for a purely competitive producer: LO3
- At a product price of $56, will this firm produce in the short run? If it is preferable to produce, what will be the profit-maximizing or loss-minimizing output? What economic profit or loss will the firm realize per unit of output?
- Answer the questions of 4a assuming product price is $41.
- Answer the questions of 4a assuming product price is $32.
- In the table below, complete the short-run supply schedule for the firm (columns 1 and 2) and indicate the profit or loss incurred at each output (column 3).
- Now assume that there are 1500 identical firms in this competitive industry; that is, there are 1500 firms, each of which has the cost data shown in the table. Complete the industry supply schedule (column 4).
- Suppose the market demand data for the product are as follows:
What will be the equilibrium price? What will be the equilibrium output for the industry? For each firm? What will profit or loss be per unit? Per firm? Will this industry expand or contract in the long run?
Chapter 09 Pure Competition in the Long Run
- Explain how the long run differs from the short run in pure competition.
- Relate opportunity costs to why profits encourage entry into purely competitive industries and how losses encourage exit from purely competitive industries.
- How do the entry and exit of firms in a purely competitive industry affect resource flows and long‐run profits and losses?
- Using diagrams for both the industry and a representative firm, illustrate competitive long‐run equilibrium. Assuming constant costs, employ these diagrams to show how (a) an increase and (b) a decrease in market demand will upset that long‐run equilibrium. Trace graphically and describe verbally the adjustment processes by which long‐run equilibrium is restored. Now rework your analysis for increasing‐ and decreasing‐cost industries and compare the three long‐run supply curves.
- In long‐run equilibrium, P = minimum ATC = MC. Of what significance for economic efficiency is the equality of P and minimum ATC? The equality of P and MC? Distinguish between productive efficiency and allocative efficiency in your answer.
- Suppose that purely competitive firms producing cashews discover that P exceeds MC. Will their combined output of cashews be too little, too much, or just right to achieve allocative efficiency? In the long run, what will happen to the supply of cashews and the price of cashews? Use a supply and demand diagram to show how that response will change the combined amount of consumer surplus and producer surplus in the market for cashews.
- The basic model of pure competition reviewed in this chapter finds that in the long run all firms in a purely competitive industry will earn normal profits. If all firms will only earn a normal profit in the long run, why would any firms bother to develop new products or lower‐cost production methods? Explain.
- “Ninety percent of new products fail within two years—so you shouldn’t be so eager to innovate.” Do you agree? Explain why or why not.
- LAST WORD How does a generic drug differ from its brand‐name, previously patented equivalent? Explain why the price of a brand‐name drug typically declines when an equivalent generic drug becomes available? Explain how that drop in price affects allocative efficiency.
- A firm in a purely competitive industry has a typical cost structure. The normal rate of profit in the economy is 5 percent. This firm is earning $5.50 on every $50 invested by its founders. What is its percentage rate of return? Is the firm earning an economic profit? If so, how large? Will this industry see entry or exit? What will be the rate of return earned by firms in this industry once the industry reaches long-run equilibrium?
- A firm in a purely competitive industry is currently producing 1000 units per day at a total cost of $450. If the firm produced 800 units per day, its total cost would be $300, and if it produced 500 units per day, its total cost would be $275. What are the firm’s ATC per unit at these three levels of production? If every firm in this industry has the same cost structure, is the industry in long‐run competitive equilibrium? From what you know about these firms’ cost structures, what is the highest possible price per unit that could exist as the market price in long‐run equilibrium? If that price ends up being the market price and if the normal rate of profit is 10 percent, then how big will each firm’s accounting profit per unit be?
- There are 300 purely competitive farms in the local dairy market. Of the 300 dairy farms, 298 have a cost structure that generates profits of $24 for every $300 invested. What is their percentage rate of return? The other two dairies have a cost structure that generates profits of $22 for every $200 invested. What is their percentage rate of return? Assuming that the normal rate of profit in the economy is 10 percent, will there be entry or exit? Will the change in the number of firms affect the two that earn $22 for every $200 invested? What will be the rate of return earned by most firms in the industry in long‐run equilibrium? If firms can copy each other’s technology, what will be the rate of return eventually earned by all firms?
Chapter 10 Pure Monopoly
- “No firm is completely sheltered from rivals; all firms compete for consumer dollars. If that is so, then pure monopoly does not exist.” Do you agree? Explain. How might you use Chapter 4’s concept of cross elasticity of demand to judge whether monopoly exists?
- Discuss the major barriers to entry into an industry. Explain how each barrier can foster either monopoly or oligopoly. Which barriers, if any, do you feel give rise to monopoly that is socially justifiable?
- How does the demand curve faced by a purely monopolistic seller differ from that confronting a purely competitive firm? Why does it differ? Of what significance is the difference? Why is the pure monopolist’s demand curve not perfectly inelastic?
- Use the demand schedule below to calculate total revenue and marginal revenue at each quantity. Plot the demand, total‐revenue, and marginal-revenue curves, and explain the relationships between them. Explain why the marginal revenue of the fourth unit of output is $3.50, even though its price is $5. Use Chapter 4’s total‐revenue test for price elasticity to designate the elastic and inelastic segments of your graphed demand curve. What generalization can you make as to the relationship between marginal revenue and elasticity of demand? Suppose the marginal cost of successive units of output was zero. What output would the profit‐seeking firm produce? Finally, use your analysis to explain why a monopolist would never produce in the inelastic region of demand.
- Assume that a pure monopolist and a purely competitive firm have the same unit costs. Contrast the two with respect to (a) price, (b) output, (c) profits, (d) allocation of resources, and (e) impact on income transfers. Since both monopolists and competitive firms follow the MC = MR rule in maximizing profits, how do you account for the different results? Why might the costs of a purely competitive firm and those of a monopolist be different? What are the implications of such a cost difference?
- Critically evaluate and explain each statement: LO3
- Because they can control product price, monopolists are always assured of profitable production by simply charging the highest price consumers will pay.
- The pure monopolist seeks the output that will yield the greatest per‐unit profit.
- An excess of price over marginal cost is the market’s way of signaling the need for more production of a good.
- The more profitable a firm, the greater its monopoly power.
- The monopolist has a pricing policy; the competitive producer does not.
- With respect to resource allocation, the interests of the seller and of society coincide in a purely competitive market but conflict in a monopolized market.
- Assume a monopolistic publisher has agreed to pay an author 10 percent of the total revenue from the sales of a text. Will the author and the publisher want to charge the same price for the text? Explain.
- S. pharmaceutical companies charge different prices for prescription drugs to buyers in different nations, depending on elasticity of demand and government-imposed price ceilings. Explain why these companies, for profit reasons, oppose laws allowing reimportation of drugs to the United States.
- Explain verbally and graphically how price (rate) regulation may improve the performance of monopolies. In your answer distinguish between (a) socially optimal (marginal‐cost) pricing and (b) fair‐return (average‐total‐cost) pricing. What is the “dilemma of regulation”?
- It has been proposed that natural monopolists should be allowed to determine their profit‐maximizing outputs and prices and then government should tax their profits away and distribute them to consumers in proportion to their purchases from the monopoly. Is this proposal as socially desirable as requiring monopolists to equate price with marginal cost or average total cost?
- LAST WORD How was De Beers able to control the world price of diamonds even though it produced only 45 percent of the diamonds? What factors ended its monopoly? What is its new strategy for earning economic profit, rather than just normal profit?
- Suppose a pure monopolist is faced with the demand schedule shown below and the same cost data as the competitive producer discussed in problem 4 at the end of Chapter 8. Calculate the missing total‐revenue and marginal‐revenue amounts, and determine the profit‐maximizing price and profit‐maximizing output for this monopolist. What is the monopolist’s profit? Verify your answer graphically and by comparing total revenue and total cost.
- Suppose that a price‐discriminating monopolist has segregated its market into two groups of buyers. The first group described by the demand and revenue data that you developed for problem 1. The demand and revenue data for the second group of buyers is shown in the accompanying table. Assume that MC is $13 in both markets and MC = ATC at all output levels. What price will the firm charge in each market? Based solely on these two prices, which market has the higher price elasticity of demand? What will be this monopolist’s total economic profit?
- Assume that the most efficient production technology available for making vitamin pills has the cost structure given in the following table. Note that output is measured as the number of bottles of vitamins produced per day and that costs include a normal profit.
- A new production technology for making vitamins is invented by a college professor who decides not to patent it. Thus, it is available for anybody to copy and put into use. The TC per bottle for production up to 100,000 bottles per day is given in the following table.
A new production technology for making vitamins is invented by a college professor who decides not to patent it. Thus, it is available for anybody to copy and put into use. The TC per bottle for production up to 100,000 bottles per day is given in the following table.
- What is ATC for each level of output listed in the table?
- Suppose that for each 25,000‐bottle per day increase in production above
100,000 bottles per day, TC increases by $5000 (so that, for instance, 125,000 bottles per day would generate total costs of $85,000 and 150,000 bottles per day would generate total costs of $90,000). Is this a decreasing‐cost industry?
- Suppose that the price of a bottle of vitamins is $1.33 and that at that price the total quantity demanded by consumers is 75,000,000 bottles. How many firms will there be in this industry?
- Suppose that instead the market quantity demanded at a price of $1.33 is only 75,000. How many firms do you expect there to be in this industry?
- Review your answers to parts b, c, and d. Does the level of demand determine this industry’s market structure?
- Compare your answer to part d of this question with your answer to part d of problem 3. Do both production technologies show constant returns to scale?
- Suppose you have been tasked with regulating a single monopoly firm that sells 50‐pound bags of concrete. The firm has fixed costs of $10 million per year and a variable cost of $1 per bag no matter how many bags are produced.
- If this firm kept on increasing its output level, would ATC per bag ever increase? Is this a decreasing‐cost industry?
- If you wished to regulate this monopoly by charging the socially optimal price, what price would you charge? At that price, what would be the size of the firm’s profit or loss? Would the firm want to exit the industry?
- You find out that if you set the price at $2 per bag, consumers will demand 10 million bags. How big will the firm’s profit or loss be at that price?
- If consumers instead demanded 20 million bags at a price of $2 per bag, how big would the firm’s profit or loss be?
- Suppose that demand is perfectly inelastic at 20 million bags, so that consumers demand 20 million bags no matter what the price is. What price should you charge if you want the firm to earn only fair rate of return? Assume as always that TC includes a normal profit.
Chapter 11W Technology, R&D, and Efficiency
- What is meant by technological advance, as broadly defined? How does technological advance enter into the definition of the very long run? Which of the following are examples of technological advance, and which are not: an improved production process; entry of a firm into a profitable purely competitive industry; the imitation of a new production process by another firm; an increase in a firm’s advertising expenditures?
- Listed below are several possible actions by firms. Write “INV” beside those that reflect invention, “INN” beside those that reflect innovation, and “DIF” beside those that reflect diffusion.
- Contrast the older and the modern views of technological advance as they relate to the economy. What is the role of entrepreneurs and other innovators in technological advance? How does research by universities and government affect innovators and technological advance? Why do you think some university researchers are becoming more like entrepreneurs and less like “pure scientists”?
- Consider the effect that corporate profit taxes have on investing. Look back at Figure 11W.4. Suppose that the r line is the rate of return a firm earns before taxes. If corporate profit taxes are imposed, the firm’s after‐tax returns will be lower (and the higher the tax rate, the lower the after‐tax returns). If the firm’s decisions about R&D spending are based on comparing after‐tax returns with the interest‐rate costs of funds, how will increased corporate profit taxes affect R&D spending? Does this effect modify your views on corporate profit taxes? Discuss.
- Answer the following lettered questions on the basis of the information in this table:
- If the interest‐rate cost of funds is 8 percent, what will be the optimal amount of R&D spending for this firm?
- Explain why $20 million of R&D spending will not be optimal.
- Why won’t $60 million be optimal either?
- Explain: “The success of a new product depends not only on its marginal utility but also on its price.”
- Learning how to use software takes time. So once customers have learned to use a particular software package, it is easier to sell them software upgrades than to convince them to switch to new software. What implications does this have for expected rates of return on R&D spending for software firms developing upgrades versus firms developing imitative products?
- Why might a firm making a large economic profit from its existing product employ a fast‐second strategy in relationship to new or improved products? What risks does it run in pursuing this strategy? What incentive does a firm have to engage in R&D when rivals can imitate its new product?
- Do you think the overall level of R&D would increase or decrease over the next 20 to 30 years if the lengths of new patents were extended from 20 years to, say, “forever”? What if the duration were reduced from 20 years to, say, 3 years?
- Make a case that neither pure competition nor pure monopoly is conducive to a great deal of R&D spending and innovation. Why might oligopoly be more favorable to R&D spending and innovation than either pure competition or pure monopoly? What is the inverted‐U theory of R&D, and how does it relate to your answers to these questions?
- Evaluate: “Society does not need laws outlawing monopolization and monopoly. Inevitably, monopoly causes its own self‐destruction since its high profit is the lure for other firms or entrepreneurs to develop substitute products.”
- LAST WORD Identify a specific example of each of the following in this chapter’s Last Word: (a) entrepreneurship, (b) invention, (c) innovation, and (d) diffusion.
- Suppose a firm expects that a $20 million expenditure on R&D this year will result in a new product that will increase its profit next year by $1 million.
- What is the expected rate of return on this R&D expenditure?
- Suppose the firm can get a bank loan at 6 percent interest to finance its $20 million R&D project. Will the firm undertake the project?
- Now suppose the interest‐rate cost of borrowing, in effect, falls to 4 percent because the firm decides to use its own retained earnings to finance the R&D. Will this lower interest rate change the firm’s R&D decision?
- Now suppose that the firm has savings of $20 million—enough money to fund the R&D expenditure without borrowing. If the firm has the chance to invest this money either in the R&D project or in government bonds that pay 3.5 percent per year, which should it do?
- What if the government bonds were paying 6.5 percent per year?
- 2. A firm faces the following costs. Its total cost of capital = $1000; its price paid for labor = $12 per labor unit; and its price paid for raw materials = $4 per raw‐material unit.
- a. Suppose the firm can produce 5000 units of output this year by combining its fixed capital with 100 units of labor and 450 units of raw materials. What are the total cost and average total cost of producing the 5000 units of output?
- b. Now assume the firm improves its production process so that it can produce 6000 units of output this year by combining its fixed capital with 100 units of labor and 450 units of raw materials. What are the total cost and average total cost of producing the 6000 units of output?
- If units of output can always be sold for $1 each, then by how much does the firm’s profit increase after it improves its production process?
- Suppose that implementing the improved production process would require a one-time-only cost of $1100. If the firm only considers this year’s profit, would the firm implement the improved production process? What if the firm considers its profit not just this year but in future years as well?
Chapter 11 Monopolistic Competition and Oligopoly
- How does monopolistic competition differ from pure competition in its basic characteristics? From pure monopoly? Explain fully what product differentiation may involve. Explain how the entry of firms into its industry affects the demand curve facing a monopolistic competitor and how that, in turn, affects its economic profit.
- Compare the elasticity of a monopolistic competitor’s demand with that of a pure competitor and a pure monopolist. Assuming identical long-run costs, compare graphically the prices and outputs that would result in the long run under pure competition and under monopolistic competition. Contrast the two market structures in terms of productive and allocative efficiency. Explain: “Monopolistically competitive industries are populated by too many firms, each of which produces too little.”
- “Monopolistic competition is monopolistic up to the point at which consumers become willing to buy close-substitute products and competitive beyond that point.” Explain.
- “Competition in quality and service may be just as effective as price competition in giving buyers more for their money.” Do you agree? Why? Explain why monopolistically competitive firms frequently prefer nonprice competition to price competition.
- Critically evaluate and explain:
(a) In monopolistically competitive industries, economic profits are competed away in the long run; hence, there is no valid reason to criticize the performance and efficiency of such industries.
(b) In the long run, monopolistic competition leads to a monopolistic price but not to monopolistic profits.
- Why do oligopolies exist? List five or six oligopolists whose products you own or regularly purchase. What distinguishes oligopoly from monopolistic competition?
- Answer the following questions, which relate to measures of concentration:
(a) What is the meaning of a four-firm concentration ratio of 60 percent? 90 percent? What are the shortcomings of concentration ratios as measures of monopoly power?
(b) Suppose that the five firms in industry A have annual sales of 30, 30, 20, 10, and 10 percent of total industry sales. For the five firms in industry B, the figures are 60, 25, 5, 5, and 5 percent. Calculate the Herfindahl index for each industry and compare their likely competitiveness.
- Explain the general meaning of the following profit payoff matrix for oligopolists C and D. All profit figures are in thousands.
(a) Use the payoff matrix to explain the mutual interdependence that characterizes oligopolistic industries.
(b) Assuming no collusion between X and Y, what is the likely pricing outcome?
(c) In view of your answer to 8b, explain why price collusion is mutually profitable. Why might there be a temptation to cheat on the collusive agreement?
- What assumptions about a rival’s response to price changes underlie the kinked-demand curve for oligopolists? Why is there a gap in the oligopolist’s marginal-revenue curve? How does the kinked-demand curve explain price rigidity in oligopoly? What are the shortcomings of the kinked-demand model?
- Why might price collusion occur in oligopolistic industries? Assess the economic desirability of collusive pricing. What are the main obstacles to collusion? Speculate as to why price leadership is legal in the United States, whereas price-fixing is not.
- Why is there so much advertising in monopolistic competition and oligopoly? How does such advertising help consumers and promote efficiency? Why might it be excessive at times?
- ADVANCED ANALYSIS Construct a game-theory matrix involving two firms and their decisions on high versus low advertising budgets and the effects of each on profits. Show a circumstance in which both firms select high advertising budgets even though both would be more profitable with low advertising budgets. Why won’t they unilaterally cut their advertising budgets?
- LAST WORD What firm dominates the S. beer industry? What demand and supply factors have contributed to “fewness” in this industry?
- Suppose that a small town has seven burger shops whose respective shares of the local hamburger market are (as percentages of all hamburgers sold): 23%, 22%, 18%, 12%, 11%, 8%, and 6%. What is the four‐firm concentration ratio of the hamburger industry in this town? What is the Herfindahl index for the hamburger industry in this town? If the top three sellers combined to form a single firm, what would happen to the four‐firm concentration ratio and to the Herfindahl index?
- Suppose that the most popular car dealer in your area sells 10 percent of all vehicles. If all other car dealers sell either the same number of vehicles or fewer, what is the largest value that the Herfindahl index could possibly take for car dealers in your area? In that same situation, what would the four‐firm concentration ratio be?
- Suppose that an oligopolistically competitive restaurant is currently serving 230 meals per day (the output where MR = MC). At that output level, ATC per meal is $10 and consumers are willing to pay $12 per meal. What is the size of this firm’s profit or loss? Will there be entry or exit? Will this restaurant’s demand curve shift left or right? In long‐run equilibrium, suppose that this restaurant charges $11 per meal for 180 meals and that the marginal cost of the 180th meal is $8. What is the size of the firm’s profit? Suppose that the allocatively efficient output level in long-run equilibrium is 200 meals. Is the deadweight loss for this firm greater than or less than $60?
Chapter 11 Monopolistic Competition and Oligopoly (Appendix)
- Is the game shown by Figure 11.3 in the chapter (not this appendix) a zero-sum game or is it a positive-sum game? How can you tell? Are there dominant strategies in this game? If so, what are they? What cell represents a Nash equilibrium and why? Explain why it is so difficult for Uptown and RareAir to achieve and maintain a more favorable cell than the Nash equilibrium in this single-period pricing game.
- Refer to the payoff matrix in question 8 at the end of this chapter. First, assume this is a one-time game. Explain how the $60/$57 outcome might be achieved through a credible threat. Next, assume this is a repeated game (rather than a one-time game) and that the interaction between the two firms occurs indefinitely. Why might collusion with a credible threat not be necessary to achieve the $60/$57 outcome?
- Refer to the payoff matrix below. LO8
Assuming this is a sequential game with no collusion, what is the outcome if Firm A moves first to build a new type of commercial aircraft? Explain why first-mover strategies in the real-world are only as good as the profit projections on which they are based. How could a supposed “win” from moving first turn out to be a big loss, whereas the “loss” of being preempted turn out to be a blessing in disguise?
- ADVANCED ANALYSIS Suppose you are playing a game in which you and one other person each picks a number between 1 and 100, with the person closest to some randomly selected number between 1 and 100 winning the jackpot. (Ask your instructor to fund the jackpot.) Your opponent picks first. What number do you expect her to choose? Why? What number would you then pick? Why are the two numbers so close? How might this example relate to why Home Depot and Lowes, Walgreens and Rite-Aid, McDonald’s and Burger King, Borders and Barnes & Noble, and other major pairs of rivals locate so close to each other in many well-defined geographical markets that are large enough for both firms to be profitable?
- Consider a “punishment” variation of the two‐firm oligopoly situation shown in the figure below. Suppose that if one firm sets a low price while the other sets a high price, then the firm setting the high price can fine the firm setting the low price. Suppose that whenever a fine is imposed, X dollars is taken from the low‐price firm and given to the high‐price firm. What is the smallest amount that the fine X can be such that both firms will want to always set the high price?
- Consider whether the promises and threats made toward each other by duopolists and oligopolists are always credible (believable). Look at the figure below. Imagine that the two firms will play this game twice in sequence and that each firm claims the following policy. Each says that if both it and the other firm choose the high price in the first game, then it will also choose the high price in the second game (as a reward to the other firm for cooperating in the first game).
- a) As a first step toward thinking about whether this policy is credible, consider the situation facing both firms in the second game. If each firm bases its decision on what to do in the second game entirely on the payouts facing the firms in the second game, which strategy will each firm choose in the second game?
- b) Now move backward in time one step. Imagine that it is the start of the first game and each firm must decide what to do during the first game. Given your answer to part a, is the publicly stated policy credible? (Hint: No matter what happens in the first game, what will both firms do in the second game?)
- c) Given your answers to a and b, what strategy will each firm choose in the first game?
Chapter 12 The Demand for Resources
- What is the significance of resource pricing? Explain how the factors determining resource demand differ from those determining product demand. Explain the meaning and significance of the fact that the demand for a resource is a derived demand. Why do resource demand curves slope downward?
- At the bottom of the page, complete the labor demand table for a firm that is hiring labor competitively and selling its product in a competitive market.
- How many workers will the firm hire if the market wage rate is $27.95? $19.95? Explain why the firm will not hire a larger or smaller number of units of labor at each of these wage rates.
- Show in schedule form and graphically the labor demand curve of this firm.
- Now again determine the firm’s demand curve for labor, assuming that it is selling in an imperfectly competitive market and that, although it can sell 17 units at $2.20 per unit, it must lower product price by 5 cents in order to sell the marginal product of each successive labor unit. Compare this demand curve with that derived in question 2b. Which curve is more elastic? Explain.
- In 2009 General Motors (GM) announced that it would reduce employment by 21,000 workers. What does this decision reveal about how GM viewed its marginal revenue product (MRP) and marginal resource cost (MRC)? Why didn’t GM reduce employment by more than 21,000 workers? By fewer than 21,000 workers?
- What factors determine the elasticity of resource demand? What effect will each of the following have on the elasticity or the location of the demand for resource C, which is being used to produce commodity X? Where there is any uncertainty as to the outcome, specify the causes of that uncertainty. LO4
- An increase in the demand for product X.
- An increase in the price of substitute resource D.
- An increase in the number of resources substitutable for C in producing X.
- A technological improvement in the capital equipment with which resource C is combined.
- A fall in the price of complementary resource E.
- A decline in the elasticity of demand for product X due to a decline in the competitiveness of product market X.
- Suppose the productivity of capital and labor are as shown in the accompanying table. The output of these resources sells in a purely competitive market for $1 per unit. Both capital and labor are hired under purely competitive conditions at $3 and $1, respectively.
- In each of the following four cases, MRPL and MRPC refer to the marginal revenue products of labor and capital, respectively, and PL and PC refer to their prices. Indicate in each case whether the conditions are consistent with maximum profits for the firm. If not, state which resource(s) should be used in larger amounts and which resource(s) should be used in smaller amounts. LO5
- MRPL = $8; PL = $4; MRPC = $8; PC = $4
- MRPL = $10; PL = $12; MRPC = $14; PC = $9
- MRPL = $6; PL = $6; MRPC = $12; PC = $12
- MRPL = $22; PL = $26; MRPC = $16; PC = $19
- Florida citrus growers say that the recent crackdown on illegal immigration is increasing the market wage rates necessary to get their oranges picked. Some are turning to $100,000 to $300,000 mechanical harvesters known as “trunk, shake, and catch” pickers, which vigorously shake oranges from the trees. If widely adopted, what will be the effect on the demand for human orange pickers? What does that imply about the relative strengths of the substitution and output effects?
- LAST WORD Explain the economics of the substitution of ATMs for human tellers. Some banks are beginning to assess transaction fees when customers use human tellers rather than ATMs. What are these banks trying to accomplish?
- A delivery company is considering adding another vehicle to its delivery fleet, all the vehicles of which are rented for $100 per day. Assume that the additional vehicle would be capable of delivering 1500 packages per day and that each package that is delivered brings in ten cents ($.10) in revenue. Also assume that adding the delivery vehicle would not affect any other costs.
- What is the MRP? What is the MRC? Should the firm add this delivery vehicle?
- Now suppose that the cost of renting a vehicle doubles to $200 per day. What are the MRP and MRC? Should the firm add a delivery vehicle under these circumstances?
- Next suppose that the cost of renting a vehicle falls back down to $100 per day but, due to extremely congested freeways, an additional vehicle would only be able to deliver 750 packages per day. What are the MRP and MRC in this situation? Would adding a vehicle under these circumstances increase the firm’s profits?
- Suppose that marginal product tripled while product price fell by one‐half in Table 12.1. What would be the new MRP values in Table 12.1? What would be the net impact on the location of the resource demand curve in Figure 12.1?
- Suppose that a monopoly firm finds that its MR is $50 for the first unit sold each day, $49 for the second unit sold each day, $48 for the third unit sold each day, and so on. Further suppose that the first worker hired produces 5 units per day, the second 4 units per day, the third 3 units per day, and so on. LO3
- What is the firm’s MRP for each of the first five workers?
- Suppose that the monopolist is subjected to rate regulation and the regulator stipulates that it must charge exactly $40 per unit for all units sold. At that price, what is the firm’s MRP for each of the first five workers?
- If the daily wage paid to workers is $170 per day, how many workers will the unregulated monopoly demand? How many will the regulated monopoly demand? Looking at those figures, will the regulated or the unregulated monopoly demand more workers at that wage?
- If the daily wage paid to workers falls to $77 per day, how many workers will the unregulated monopoly demand? How many will the regulated monopoly demand? Looking at those figures, will the regulated or the unregulated monopoly demand more workers at that wage?
- Comparing your answers to parts c and d, does regulating a monopoly’s output price always increase its demand for resources?
- Consider a small landscaping company run by Mr. Viemeister. He is considering increasing his firm’s capacity. If he adds one more worker, the firm’s total monthly revenue will increase from $50,000 to $58,000. If he adds one more tractor, monthly revenue will increase from $50,000 to $62,000. Additional workers each cost $4000 per month while an additional tractor would also cost $4000 per month. LO5
- What is the marginal product of labor? The marginal product of capital?
- What is the ratio of the marginal product of labor to the price of labor (MPL/PL)?
What is the ratio of the marginal product of capital to the price of capital (MPK/PK)?
- Is the firm using the least‐costly combination of inputs?
- Does adding an additional worker or adding an additional tractor yield a larger increase in total revenue for each dollar spent?
Chapter 13 Wage Determination (+ Appendix)
- Which industries and occupations have the highest rates of unionization? Which the lowest? Speculate on the reasons for such large differences.
- What percentage of wage and salary workers are union members? Is this percentage higher, or is it lower, than in previous decades? Which of the factors explaining the trend do you think is most dominant?
- Suppose that you are president of a newly established local union about to bargain with an employer for the first time. List the basic areas you want covered in the work agreement. Why might you begin with a larger wage demand than you actually are willing to accept? What is the logic of a union threatening an employer with a strike during the collective bargaining process? Of an employer threatening the union with a lockout? What is the role of the deadline in encouraging agreement in collective bargaining?
- Explain how featherbedding and other restrictive work practices can reduce labor productivity. Why might strikes reduce the economy’s output less than the loss of production by the struck firms?
- What is the estimated size of the union wage advantage? How might this advantage diminish the efficiency with which labor resources are allocated in the economy? Normally, labor resources of equal potential productivity flow from low-wage employment to high-wage employment. Why does that not happen to close the union wage advantage?
- Contrast the voice mechanism and the exit mechanism for communicating dissatisfaction. In what two ways do labor unions reduce labor turnover? How might such reductions increase productivity?
- Suppose that a delivery company currently uses one employee per vehicle to deliver packages. Each driver delivers 50 packages per day, and the firm charges $20 per package for delivery.
- What is the MRP per driver per day?
- Now suppose that a union forces the company to place a supervisor in each vehicle at a cost of $300 per supervisor per day. The presence of the supervisor causes the number of packages delivered per vehicle per day to rise to 60 packages per day. What is the MRP per supervisor per day? By how much per vehicle per day do firm profits fall after supervisors are introduced?
- How many packages per day would each vehicle have to deliver in order to maintain the firm’s profit per vehicle after supervisors are introduced?
- Suppose that the number of packages delivered per day cannot be increased (only 50 are delivered) but that the price per delivery might potentially be raised. What price would the firm have to charge for each delivery in order to maintain the firm’s profit per vehicle after supervisors are introduced?
- Suppose that a car factory initially hires 1500 workers at $30 per hour and that each worker works 40 hours per week. Then the factory unionizes, and the new union demands that wages be raised by 10 percent. The firm accedes to that request in collective bargaining negotiations but then decides to cut the factory’s labor force by 20 percent due to the higher labor costs. LO7
- a. What is the new union wage? How many workers does the factory employ after the agreement goes into affect?
- How much in total did the factory’s workers receive in wage payments each week before the agreement? How much do the factory’s remaining workers receive in wage payments each week after the agreement?
- Suppose that the workers who lose their jobs as a result of the agreement end up unemployed. By how much do the total wages received each week by the initial 1500 workers (both those who continue to be employed at the factory and those who lose their jobs) change from before the agreement to after the agreement?
- If the workers who lose their jobs as a result of the agreement end up making $15 per hour at jobs where they work 40 hours per week, by how much do the total wages received each week by the initial 1500 workers change from before the agreement to after the agreement?
Chapter 13 Wage Determination
- Explain why the general level of wages is high in the United States and other industrially advanced countries. What is the single most important factor underlying the long‐run increase in average real‐wage rates in the United States?
- Why is a firm in a purely competitive labor market a wage taker? What would happen if it decided to pay less than the going market wage rate?
- Describe wage determination in a labor market in which workers are unorganized and many firms actively compete for the services of labor. Show this situation graphically, using W1 to indicate the equilibrium wage rate and Q1 to show the number of workers hired by the firms as a group. Show the labor supply curve of the individual firm, and compare it with that of the total market. Why the differences? In the diagram representing the firm, identify total revenue, total wage cost, and revenue available for the payment of non-labor resources.
- Suppose the formerly competing firms in question 3 form an employers’ association that hires labor as a monopsonist would. Describe verbally the effect on wage rates and employment. Adjust the graph you drew for question 3, showing the monopsonistic wage rate and employment level as W2 and Q2, respectively. Using this monopsony model, explain why hospital administrators sometimes complain about a “shortage” of nurses. How might such a shortage be corrected?
- Assume a monopsonistic employer is paying a wage rate of Wm and hiring Qm workers, as indicated in Figure 13.8. Now suppose an industrial union is formed that forces the employer to accept a wage rate of Wc. Explain verbally and graphically why in this instance the higher wage rate will be accompanied by an increase in the number of workers hired.
- Have you ever worked for the minimum wage? If so, for how long? Would you favor increasing the minimum wage by a dollar? By two dollars? By five dollars? Explain your reasoning.
- “Many of the lowest‐paid people in society—for example, short‐order cooks— also have relatively poor working conditions. Hence, the notion of compensating wage differentials is disproved.” Do you agree? Explain.
- What is meant by investment in human capital? Use this concept to explain (a) wage differentials and (b) the long‐run rise of real wage rates in the United States.
- What is the principal‐agent problem? Have you ever worked in a setting where this problem has arisen? If so, do you think increased monitoring would have eliminated the problem? Why don’t firms simply hire more supervisors to eliminate shirking?
- LAST WORD Do you think exceptionally high pay to CEOs is economically justified? Why or why not?
- Workers are compensated by firms with “benefits” in addition to wages and salaries. The most prominent benefit offered by many firms is health insurance. Suppose that in 2000 workers at one steel plant were paid $20 per hour and in addition received health benefits at the rate of $4 per hour. Also suppose that by 2010 workers at that plant were paid $21 per hour but received $9 in health insurance benefits. LO1
- By what percentage did total compensation (wages plus benefits) change at this plant from 2000 to 2010? What was the approximate average annual percentage change in total compensation?
- By what percentage did wages change at this plant from 2000 to 2010? What was the approximate average annual percentage change in wages?
- If workers value a dollar of health benefits as much as they value a dollar of wages, by what total percentage will they feel that their incomes have risen over this time period? What if they only consider wages when calculating their incomes?
- Is it possible for workers to feel as though their wages are stagnating even if total compensation is rising?
- 2. Complete the following labor supply table for a firm hiring labor competitively:
- Show graphically the labor supply and marginal resource (labor) cost curves for this firm. Are the curves the same or different? If they are different, which one is higher?
- Plot the labor demand data of question 2 in Chapter 12 on the graph used in part a above. What are the equilibrium wage rate and level of employment?
- 3. Assume a firm is a monopsonist that can hire its first worker for $6 but must increase the wage rate by $3 to attract each successive worker (so that the second worker must be paid $9, the third $12, and so on).
- Draw the firm’s labor supply and marginal resource cost curves. Are the curves the same or different? If they are different, which one is higher?
- On the same graph, plot the labor demand data of question 2 in Chapter 12. What are the equilibrium wage rate and level of employment?
- Compare these answers with those you found in problem 2. By how much does the monoposonist reduce wages below the competitive wage? By how much does the monopsonist reduce employment below the competitive level?
- Suppose that low‐skilled workers employed in clearing woodland can each clear one acre per month if they are each equipped with a shovel, a machete, and a chainsaw. Clearing one acre brings in $1000 in revenue. Each worker’s equipment costs the worker’s employer $150 per month to rent and each worker toils 40 hours per week for four weeks each month.
- What is the marginal revenue product of hiring one low‐skilled worker to clear woodland for one month?
- How much revenue per hour does each worker bring in?
- If the minimum wage were $6.20, would the revenue per hour in part b exceed the minimum wage? If so, by how much per hour?
- Now consider the employer’s total costs. These include the equipment costs as well as a normal profit of $50 per acre. If the firm pays workers the minimum wage of $6.20 per hour, what will the firm’s economic profit or loss be per acre?
- At what value would the minimum wage have to be set so that the firm would make zero economic profit from employing an additional low‐skilled worker to clear woodland?
- Suppose that a car dealership wishes to see if efficiency wages will help improve its salespeople’s productivity. Currently, each salesperson sells an average of one car per day while being paid $20 per hour for an eight‐hour day.
- What is the current labor cost per car sold?
- Suppose that when the dealer raises the price of labor to $30 per hour the average number of cars sold by a salesperson increases to two per day. What is now the labor cost per car sold? By how much is it higher or lower than it was before? Has the efficiency of labor expenditures by the firm (cars sold per dollar of wages paid to salespeople) increased or decreased?
- Suppose that if the wage is raised a second time to $40 per hour the number of cars sold rises to an average of 2.5 per day. What is now the labor cost per car sold?
- If the firm’s goal is to maximize the efficiency of its labor expenditures, which of the three hourly salary rates should it use: $20 per hour, $30 per hour, or $40 per hour?
- By contrast, which salary maximizes the productivity of the car dealer’s workers (cars sold per worker per day)?
Chapter 14 Rent, Interest, and Profit
- How does the economist’s use of the term “rent” differ from everyday usage? Explain: “Though rent need not be paid by society to make land available, rental payments are very useful in guiding land into the most productive uses.”
- Explain why economic rent is a surplus payment when viewed by the economy as a whole but a cost of production from the standpoint of individual firms and industries. Explain: “Land rent performs no ‘incentive function’ for the overall economy.”
- In the 1980s land prices in Japan surged upward in a “speculative bubble.” Land prices then fell for 11 straight years between 1990 and 2001. What can we safely assume happened to land rent in Japan over those 11 years? Use graphical analysis to illustrate your answer.
- How does Henry George’s proposal for a single tax on land relate to the elasticity of the supply of land? Why are there so few remaining advocates of George’s proposal?
- If money is not an economic resource, why is interest paid and received for its use? What considerations account for the fact that interest rates differ greatly on various types of loans? Use those considerations to explain the relative sizes of the interest rates on the following:
- A 10‐year $1000 government bond.
- A $20 pawnshop loan.
- A 30‐year mortgage loan on a $175,000 house.
- A 24‐month $12,000 commercial bank loan to finance the purchase of an automobile.
- A 60‐day $100 loan from a personal finance company.
- Why is the supply of loanable funds upsloping? Why is the demand for loanable funds downsloping? Explain the equilibrium interest rate. List some factors that might cause it to change.
- Here is the deal: You can pay your college tuition at the beginning of the academic year or the same amount at the end of the academic year. You either already have the money in an interest‐bearing account or will have to borrow it. Deal, or no deal? Explain your financial reasoning. Relate your answer to the time-value of money, present value, and future value.
- What are the major economic functions of the interest rate? How might the fact that many businesses finance their investment activities internally affect the efficiency with which the interest rate performs its functions?
- Distinguish between nominal and real interest rates. Which is more relevant in making investment and R&D decisions? If the nominal interest rate is 12 percent and the inflation rate is 8 percent, what is the real rate of interest?
- Historically, usury laws that put below‐equilibrium ceilings on interest rates have been used by some states to make credit available to poor people who could not otherwise afford to borrow. Critics contend that poor people are those most likely to be hurt by such laws. Which view is correct?
- How do the concepts of accounting profit and economic profit differ? Why is economic profit smaller than accounting profit? What are the three basic sources of economic profit? Classify each of the following according to those sources:
- A firm’s profit from developing and patenting a new medication that greatly reduces cholesterol and thus diminishes the likelihood of heart disease and stroke.
- A restaurant’s profit that results from the completion of a new highway past its door.
- The profit received by a firm due to an unanticipated change in consumer tastes.
- Why is the distinction between insurable and uninsurable risks significant for the theory of profit? Carefully evaluate: “All economic profit can be traced to either uncertainty or the desire to avoid it.” What are the major functions of economic profit?
- What is the combined rent, interest, and profit share of the income earned by Americans in a typical year if proprietors’ income is included within the labor (wage) share?
- LAST WORD Assume that you borrow $5000, and you pay back the $5000 plus $250 in interest at the end of the year. Assuming no inflation, what is the real interest rate? What would the interest rate be if the $250 of interest had been discounted at the time the loan was made? What would the interest rate be if you were required to repay the loan in 12 equal monthly installments?
- Suppose that you own a 10‐acre plot of land that you would like to rent out to wheat farmers. For them, bringing in a harvest involves $30 per acre for seed, $80 per acre for fertilizer, and $70 per acre for equipment rentals and labor. With these inputs, the land will yield 40 bushels of wheat per acre. If the price at which wheat can be sold is $5 per bushel and if farmers want to earn a normal profit of $10 per acre, what is the most that any farmer would pay to rent your 10 acres? What if the price of wheat rose to $6 per bushel?
- Suppose that the demand for loanable funds for car loans in the Milwaukee area is $10 million per month at an interest rate of 10 percent per year, $11 million at an interest rate of 9 percent per year, $12 million at an interest rate of 8 percent per year, and so on. If the supply of loanable funds is fixed at $15 million, what will be the equilibrium interest rate? If the government imposes a usury law and says that car loans cannot exceed 3 percent per year, how big will the monthly shortage (or excess demand) for car loans be? What if the usury limit is raised to 7 percent per year?
- To fund its wars against Napoleon, the British government sold consol bonds. They were referred to as “perpetuities” because they would pay £3 every year in perpetuity (forever). If a citizen could purchase a consol for £25, what would its annual interest rate be? What if the price were £50? £100? Bonds are known as “fixed income” securities because the future payments that they will make to investors are fixed by the bond agreement in advance. Do the interest rates of bonds and other investments that offer fixed future payments vary positively or inversely with their current prices?
- Suppose that the interest rate is 4 percent. What is the future value of $100 four years from now? How much of the future value is total interest? By how much would total interest be greater at a 6 percent interest rate than at a 4 percent interest rate?
- You are currently a worker earning $60,000 per year but are considering becoming an entrepreneur. You will not switch unless you earn an accounting profit that is on average at least as great as your current salary. You look into opening a small grocery store. Suppose that the store has annual costs of $150,000 for labor, $40,000 for rent, and $30,000 for equipment. There is a one‐half probability that revenues will be $200,000 and a one‐half probability that revenues will be $400,000.
Chapter 15 Natural Resource and Energy Economics
- Describe Thomas Malthus’ theory of human reproduction. Does it make sense for some species—say bacteria or rabbits? What do you think makes humans different?
- Demographers have been very surprised that total fertility rates have fallen below 2.0, especially because most people in most countries tell pollsters that they would like to have at least two children. Can you think of any possible economic factors that may be causing women in so many countries to average fewer than two children per lifetime? What about other social or political changes?
- Resource consumption per person in the United States is either flat or falling, depending on the resource. Yet living standards are rising due to improvements in technology that allow more output to be produced for every unit of input used in production. What does this say about the likelihood of our running out of resources? Could we possibly maintain or improve our living standards even if the population were expected to rise in the future rather than fall?
- Suppose that you hear two people arguing about energy. One says that we are running out of energy. The other counters that we are running out of cheap energy. Explain which person is correct and why.
- A community has a nighttime energy demand of 50 megawatts but a peak daytime demand of 75 megawatts. It has the chance to build a 90‐megawatt coal‐fired plant that could easily supply all of its energy uses even at peak daytime demand. Should it necessarily proceed? Could there be lower‐cost options? Explain.
- Recall the model of nonrenewable resource extraction presented in Figure 15.7. Suppose that a technological breakthrough means that extraction costs will fall in the future (but not in the present). What will this do to future profits and, therefore, to current user cost? Will current extraction increase or decrease? Compare this to a situation where future extraction costs remain unchanged but current extraction costs fall. In this situation, does current extraction increase or decrease? Does the firm’s behavior make sense in both situations? That is, does its response to the changes in production costs in each case maximize the firm’s stream of profits over time?
- If the current market price rises, does current extraction increase or decrease? What if the future market price rises? Do these changes in current extraction help to ensure that the resource is extracted and used when it is most valuable?
- ADVANCED ANALYSIS Suppose that a government wants to reduce its economy’s dependence on coal and decides as a result to tax coal mining companies $1 per ton for every ton of coal that they mine. Assuming that coal mining companies treat this tax as an increase in extraction costs this year, what effect will the tax have on current extraction in the model used in Figure 15.7? Now, think one step ahead. Suppose that the tax will be in place forever, so that it will also affect extraction costs in the future. Will the tax increase or decrease user cost? Does this effect increase or decrease the change in current extraction caused by the shift of the EC curve? Given your finding, should environmental taxes be temporary?
- ADVANCED ANALYSIS User cost is equal to the present ‐value of future profits in the model presented in Figure 15.7. Will the optimal quantity to mine in the present year increase or decrease if the market rate of interest rises? Does your result make any intuitive sense? (Hint: If interest rates are up, would you want to have more or less money right now to invest at the market rate of interest?)
- Various cultures have come up with their own methods to limit catch size and prevent fishery collapse. In old Hawaii, certain fishing grounds near shore could be used only by certain individuals. And among lobstermen in Maine, strict territorial rights are handed out so that only certain people can harvest lobsters in certain waters. Discuss specifically how these systems provide incentives for conservation. Then think about the enforcement of these property rights. Do you think similar systems could be successfully enforced for deep‐sea fishing, far off shore?
- Aquaculture is the growing of fish, shrimp, and other seafood in enclosed cages or ponds. The cages and ponds not only keep the seafood from swimming away but also provide aquaculturalists with strong property rights over their animals. Does this provide a good incentive for low‐cost production as compared with fishing in the open seas where there are few if any property rights?
- LAST WORD The figure in the Last Word section shows that a 10‐fold increase in a country’s GDP per person is associated with about a 20‐point increase in EPI. On the other hand, GDP per person was $38,165 in the United States in 2007 but only $32,775 in Switzerland despite the fact that Switzerland had an EPI score of 95.5 while the United States had an EPI score of only 81.0. So does getting rich guarantee doing well environmentally? Discuss
- Suppose that the current (first) generation consists of 1 million people, half of whom are women. If the total fertility rate is 1.3 and the only way people die is of old age, how big will the fourth generation (the great‐grandchildren) be? How much smaller (in percentage terms) is each generation than the previous generation? How much smaller (in percentage terms) is the fourth generation than the first generation? Are you surprised by how quickly the population declines?
- A coal‐fired power plant can produce electricity at a variable cost of 4 cents per kilowatt hour when running at its full capacity of 30 megawatts per hour, 16 cents per kilowatt hour when running at 20 megawatts per hour, and 24 cents per kilowatt hour when running at 10 megawatts per hour. A gas‐fired power plant can produce electricity at a variable cost of 12 cents per kilowatt‐hour at any capacity from 1 megawatt per hour to its full capacity of 5 megawatts per hour. The cost of constructing a coal‐fired plant is $50 million but it only costs $10 million to build a gas‐fired plant.
- Consider a city that has a peak afternoon demand of 80 megawatts of electricity. If it wants all plants to operate at full capacity, what combination of coal‐fired plants and gas‐fired plants would minimize construction costs?
- How much will the city spend on building that combination of plants?
- What will the average cost per kilowatt‐hour be if you average over all 80 megawatts that are produced by that combination of plants? (Hint: A kilowatt is one thousand watts while a megawatt is one million watts).
- What would the average cost per kilowatt‐hour be if the city had instead built three coal‐fired plants?
- Suppose that Sea Shell oil company (SS) is pumping oil at a field off the coast of Nigeria. At this site, it has an extraction cost of $30 per barrel for the first 10 million barrels it pumps each year and then $60 per barrel for all subsequent barrels that it pumps each year, up to the site’s maximum capacity of 90 million barrels per year.
- Suppose the user cost is $50 per barrel for all barrels and that the current market price for oil is $90 per barrel. How many barrels will SS pump this year? What is the total accounting profit on the total amount of oil it pumps? What is the total economic profit on those barrels of oil?
- What if the current market price for oil rises to $120 per barrel while the user cost remains at $50 per barrel? How many barrels will SS pump and what will be its accounting profit and its economic profit?
- If the current market price remains at $120 per barrel but the user cost rises to $95 per barrel, how many barrels will SS pump this year and what will be its accounting profit and its economic profit?
- Eric and Kyle are fishermen with different equipment and, as a result, different costs for catching fish. Eric’s costs for catching fish are $1000 per ton for the first five tons and then $2500 per ton for any additional tons. Kyle can harvest fish at a cost of $3000 for the first 15 tons and then $1400 for any additional tons.
- If society wants 30 tons of fish and for some reason will only allow one of the two guys to do all the fishing, which guy should society choose if it wants to minimize the cost of catching those 30 tons of fish? How much will the total cost of catching the fish be? What will the average cost‐per‐ton be for the 30 tons?
- If society wants 30 tons of fish and wants them for the least cost regardless of which guy is catching them, how much should Eric and Kyle each catch? How much will the total cost of catching 30 tons be? What will the average cost‐per‐ton be for the 30 tons?
- Suppose that Eric and Kyle can both sell whatever amount of fish they catch for $3000 per ton. Also suppose that Eric is initially given ITQs for 30 tons of fish while Kyle is given ITQs for zero tons of fish. Suppose that Kyle is willing to pay Eric $550 per ton for as many tons of ITQs as Eric is willing to sell to Kyle. How much profit would Eric make if he used all the ITQs himself? What if Eric sold 25 tons’ worth of his ITQs to Kyle while using the other 5 tons of ITQs to fish for himself?
- What price per ton can Kyle offer to pay Eric for 25 tons of ITQs such that Eric would make exactly as much money from that deal (in which he sells 25 tons’ worth of his ITQs to Kyle while using the rest to fish for himself) as he would by using 30 tons of ITQs for himself?
Chapter 16 Public Finance: Expenditures and Taxes
- Use a circular flow diagram to show how the allocation of resources and the distribution of income are affected by each of the following government actions.
- The construction of a new high school.
- A 2‐percentage‐point reduction of the corporate income tax.
- An expansion of preschool programs for disadvantaged children.
- The levying of an excise tax on polluters.
- What do economists mean when they say government purchases are “exhaustive” expenditures whereas government transfer payments are “non-exhaustive” expenditures? Cite an example of a government purchase and a government transfer payment.
- What is the most important source of revenue and the major type of expenditure at the Federal level? At the state level? At the local level?
- Distinguish between the benefits‐received and the ability‐to‐pay principles of taxation. Which philosophy is more evident in our present tax structure? Justify your answer. To which principle of taxation do you subscribe? Why?
- What is meant by a progressive tax? A regressive tax? A proportional tax? Comment on the progressivity or regressivity of each of the following taxes, indicating in each case where you think the tax incidence lies: (a) the Federal personal income tax; (b) a 4 percent state general sales tax; (c) a Federal excise tax on automobile tires; (d) a municipal property tax on real estate; (e) the Federal corporate income tax; (f) the portion of the payroll tax levied on employers.
- What is the tax incidence of an excise tax when demand is highly inelastic? Highly elastic? What effect does the elasticity of supply have on the incidence of an excise tax? What is the efficiency loss of a tax, and how does it relate to elasticity of demand and supply?
- Given the inelasticity of cigarette demand, discuss an excise tax on cigarettes in terms of efficiency loss and tax incidence.
- ADVANCED ANALYSIS Suppose the equation for the demand curve for some product X is P = 8 ‐ .6Q and the supply curve is P = 2 + .4Q. What are the equilibrium price and quantity? Now suppose an excise tax is imposed on X such that the new supply equation is P = 4 + .4Q. How much tax revenue will this excise tax yield the government? Graph the curves, and label the area of the graph that represents the tax collection “TC” and the area that represents the efficiency loss of the tax “EL.” Briefly explain why area EL is the efficiency loss of the tax but TC is not.
- Is it possible for a country with a regressive tax system to have a tax‐spending system that transfers resources from the rich to the poor?
- LAST WORD Does a progressive tax system by itself guarantee that resources will be redistributed from the rich to the poor? Explain. Is the tax system in the United States progressive, regressive, or proportional? Does the tax-spending system in the United States redistribute resources from higher income earners to lower income earners?
- Suppose a tax is such that an individual with an income of $10,000 pays $2000 of tax, a person with an income of $20,000 pays $3000 of tax, a person with an income of $30,000 pays $4000 of tax. What is each person’s average tax rate? Is this tax regressive, proportional, or progressive?
- Suppose in Fiscalville there is no tax on the first $10,000 of income, but a 20 percent tax on earnings between $10,000 and $20,000 and a 30 percent tax on income between $20,000 and $30,000. Any income above $30,000 is taxed at 40 percent. If your income is $50,000, how much will you pay in taxes? Determine your marginal and average tax rates. Is this a progressive tax?
- For tax purposes, “gross income” is all the money a person receives in a given year from any source. But income taxes are levied on “taxable income” rather than gross income. The difference between the two is the result of many exemptions and deductions. To see how they work, suppose you made $50,000 last year in wages, $10,000 from investments, and were given $5000 as a gift by your grandmother. Also assume that you are a single parent with one small child living with you.
- What is your gross income?
- Gifts up to $13,000 per year are not counted as taxable income. Also, the “personal exemption” allows you to reduce your taxable income by $3650 for each member of your household. Given these exemptions, what is your taxable income?
- Next, assume you paid $700 in interest on your student loans last year, put $2000 into a health savings account (HSA), and deposited $4000 into an individual retirement account (IRA). These expenditures are all tax exempt, meaning that any money spent on them reduces taxable income dollar-for-dollar. Knowing that fact, what is now your taxable income?
- Next, you can either take the so‐called standard deduction or apply for itemized deductions (which involve a lot of tedious paperwork). You opt for the standard deduction that allows you as head of your household to exempt another $8500 from your taxable income. Taking that into account, what is your taxable income?
- Apply the tax rates shown in Table 16.1 to your taxable income. How much Federal tax will you owe? What is the marginal tax rate that applies to your last dollar of taxable income?
- As the parent of a dependent child, you qualify for the government’s $1000 per-child “tax credit.” Like all tax credits, this $1000 credit “pays” for $1000 of whatever amount of tax you owe. Given this credit, how much money will you actually have to pay in taxes? Using that actual amount, what is your average tax rate relative to your taxable income? What about your average tax rate relative to your gross income?
Chapter 17 Asymmetric Information, Voting, and Public Choice
- Because medical records are private, an individual applying for health insurance will know more about his own health conditions than will the insurance companies to which he is applying for coverage. Is this likely to increase or decrease the insurance premium that he will be offered? Why?
- Why is it in the interest of new homebuyers and builders of new homes to have government building codes and building inspectors?
- Place an “M” beside the items in the following list that describe a moral hazard problem and an “A” beside those that describe an adverse selection problem.
- A person with a terminal illness buys several life insurance policies through the mail.
- A person drives carelessly because he or she has automobile insurance.
- A person who intends to “torch” his warehouse takes out a large fire insurance policy.
- A professional athlete who has a guaranteed contract fails to stay in shape during the off‐season.
- A woman who anticipates having a large family takes a job with a firm that offers exceptional childcare benefits.
- Explain how affirmative and negative majority votes can sometimes lead to inefficient allocations of resources to public goods. Is this problem likely to be greater under a benefits‐received or an ability‐to‐pay tax system? Use the information in Figures 17.1a and 17.1b to show how society might be better off if Adams were allowed to buy votes.
- Explain the paradox of voting through reference to the accompanying table, which shows the ranking of three public goods by voters Jay, Dave, and Conan:
- Suppose there are only five people in a society and each favors one of the five highway construction options listed in Table 5.4 (“No new construction” is one of the five options). Explain which of these highway options will be selected using a majority paired‐choice vote. Will this option be the optimal size of the project from an economic perspective?
- Jean Baptiste Colbert was the Minister of Finance under King Louis XIV of France. He famously observed that, “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” How does his comment relate to special interests and the collective action problem?
- What is rent seeking and how does it differ from the kinds of profit maximization and profit seeking that we discussed in previous chapters? Provide an actual or a hypothetical example of rent seeking by firms in an industry. By a union. By a professional association (for example, physicians, school teachers, or lawyers). Why do elected officials often accommodate rent‐seeking behavior, particularly by firms, unions, and professional groups located in their home states?
- How does the problem of limited and bundled choice in the public sector relate to economic efficiency? Why are public bureaucracies possibly less efficient than business firms?
- Explain: “Politicians would make more rational economic decisions if they weren’t running for reelection every few years.”
- LAST WORD How do the concepts of pork‐barrel politics and logrolling relate to the items listed in the Last Word?
- Consider a used car market with asymmetric information. Owners of used cars know what their vehicles are worth but have no way of credibly demonstrating those values to potential buyers. Thus, potential buyers must always worry that the used car they are being offered may be a low‐quality “lemon.”
- Suppose that there are equal numbers of good and bad used cars in the market and that good used cars are worth $13,000 while bad used cars are worth $5,000. What is the average value of a used car?
- By how much does the average value exceed the value of a bad used car? By how much does the value of a good used car exceed the average value?
- Would a potential seller of a good used car be willing to accept the average value as payment for her vehicle?
- If a buyer negotiates with a seller to purchase the seller’s used car for a price equal to the average value, is the car more likely to be good or bad?
- Will the used car market come to feature mostly—if not exclusively—lemons? How much will used cars end up costing if that all the good cars are withdrawn?
2.Domestic sugar producers in the United States have convinced the Federal government to impose price supports and import quotas that keep the domestic price of sugar at more than double the world price of sugar. This costs domestic sugar consumers about $2 billion each year in higher sugar costs. Taxpayers also provide $150 million of subsidies each year directly to sugar growers.
- There are about 300 million people living in the United States. How much on average does the $2 billion in higher sugar prices cost Americans each year? What about the $150 million paid directly to sugar growers? What is the combined average cost per person for these two items?
- About half the $150 million per year in subsidies goes to growers of sugar cane, the other half to growers of sugar beets. But there are about 13,000 beet growers compared to only 1500 cane growers. How much on average does a beet grower receive? How much on average does a cane grower receive?
- For both cane and beets, a relatively few big producers garner most of the subsidies. About 2000 beet farms receive about half the subsidies flowing to beet farmers. But cane is even more concentrated, with only 20 cane farms receiving about half of all cane sugar subsidies. About how much on average do the 2000 beet farms receive in subsidies? What about the 20 cane farms?
- Look back at your answers to parts a and c. Compare the combined average cost per person of the sugar subsidies with the average amount of subsidy received by the 20 largest cane sugar producers. How many people would you have to mobilize to oppose sugar subsidies so that their combined personal losses exceed the money going to just one of the 20 largest cane farms?
Chapter 18 Antitrust Policy and Regulation
- Both antitrust policy and industrial regulation deal with monopoly. What distinguishes the two approaches? How does government decide to use one form of remedy rather than the other?
- Describe the major provisions of the Sherman and Clayton acts. What government entities are responsible for enforcing those laws? Are firms permitted to initiate antitrust suits on their own against other firms?
- Contrast the outcomes of the Standard Oil and U.S. Steel cases. What was the main antitrust issue in the DuPont cellophane case? In what major way do the Microsoft and Standard Oil cases differ?
- Why might one administration interpret and enforce the antitrust laws more strictly than another? How might a change of administrations affect a major monopoly case in progress?
- How would you expect antitrust authorities to react to:
- A proposed merger of Ford and General Motors.
- Evidence of secret meetings by contractors to rig bids for highway construction projects.
- A proposed merger of a large shoe manufacturer and a chain of retail shoe stores.
- A proposed merger of a small life‐insurance company and a regional candy manufacturer.
- An automobile rental firm that charges higher rates for last‐minute rentals than for rentals reserved weeks in advance.
- Suppose a proposed merger of firms would simultaneously lessen competition and reduce unit costs through economies of scale. Do you think such a merger should be allowed?
- In the 1980s, PepsiCo Inc., which then had 28 percent of the soft‐drink market, proposed to acquire the Seven‐Up Company. Shortly thereafter the Coca‐Cola Company, with 39 percent of the market, indicated it wanted to acquire the Dr Pepper Company. Seven‐Up and Dr Pepper each controlled about 7 percent of the market. In your judgment, was the government’s decision to block these mergers appropriate?
- Why might a firm charged with violating the Clayton Act, Section 7, try arguing that the products sold by the merged firms are in separate markets? Why might a firm charged with violating Section 2 of the Sherman Act try convincing the court that none of its behavior in achieving and maintaining its monopoly was illegal?
- “The social desirability of any particular firm should be judged not on the basis of its market share but on the basis of its conduct and performance.” Make a counterargument, referring to the monopoly model in your statement.
- What types of industries, if any, should be subjected to industrial regulation? What specific problems does industrial regulation entail?
- In view of the problems involved in regulating natural monopolies, compare socially optimal (marginal‐cost) pricing and fair‐return pricing by referring again to Figure 10.9. Assuming that a government subsidy might be used to cover any loss resulting from marginal‐cost pricing, which pricing policy would you favor? Why? What problems might such a subsidy entail?
- How does social regulation differ from industrial regulation? What types of benefits and costs are associated with social regulation?
- Use economic analysis to explain why the optimal amount of product safety may be less than the amount that would totally eliminate risks of accidents and deaths. Use automobiles as an example.
- LAST WORD Under what law and on what basis did the Federal district court find Microsoft guilty of violating the antitrust laws? What was the initial district court’s remedy? How did Microsoft fare with its appeal to the court of appeals? Was the final remedy in the case a structural remedy or a behavioral remedy?
- Suppose that there are only three types of fruit sold in the United States. Annual sales are 1 million tons of blueberries, 5 million tons of strawberries, and 10 million tons of bananas. Suppose that of those total amounts, the Sunny Valley Fruit Company sells 900,000 tons of blueberries, 900,000 tons of strawberries, and 7.9 million tons of bananas.
- What is Sunny Valley’s market share if the relevant market is blueberries? If a court applies the “90‐60‐30 rule” when considering just the blueberry market, would it rule that Sunny Valley is a monopoly?
- What is Sunny Valley’s market share if the relevant market is all types of berries? Would the court rule Sunny Valley to be monopolist in that market?
- What if the relevant market is all types of fruit? What is Sunny Valley’s market share, and would the court consider Sunny Valley to be a monopolist?
- Carrot Computers and its competitors purchase touch screens for their handheld computers from several suppliers. The six makers of touch screens have market shares of, respectively, 19 percent, 18 percent, 14 percent, 16 percent, 20 percent, and 13 percent.
- What is the Herfindahl index for the touch screen manufacturing industry?
- By how much would a proposed merger between the two smallest touch screen makers increase the Herfindahl index? Would the government be likely to challenge that proposed merger?
- If Carrot Computers horizontally merges with its competitor Blueberry
Handhelds, by how much would the Herfindahl index change for the touch screen industry?
Chapter 19 Agriculture: Economics and Policy
- Carefully evaluate: “The supply and demand for agricultural products are such that small changes in agricultural supply result in drastic changes in prices. However, large changes in agricultural prices have modest effects on agricultural output.” (Hint: A brief review of the distinction between supply and quantity supplied may be helpful.) Do exports increase or reduce the instability of demand for farm products? Explain.
- What relationship, if any, can you detect between the facts that farmers’ fixed costs of production are large and the supply of most agricultural products is generally inelastic? Be specific in your answer.
- Explain how each of the following contributes to the farm problem:
- The inelasticity of demand for farm products.
- The rapid technological progress in farming.
- The modest long‐run growth in demand for farm commodities.
- The volatility of export demand.
- The key to efficient resource allocation is shifting resources from low-productivity to high‐productivity uses. In view of the high and expanding physical productivity of agricultural resources, explain why many economists want to divert additional resources away from farming in order to achieve allocative efficiency.
- Explain and evaluate: “Industry complains of the higher taxes it must pay to finance subsidies to agriculture. Yet the trend of agricultural prices has been downward while industrial prices have been moving upward, suggesting that on balance agriculture is actually subsidizing industry.”
- “Because consumers as a group must ultimately pay the total income received by farmers, it makes no real difference whether the income is paid through free farm markets or through price supports supplemented by subsidies financed out of tax revenue.” Do you agree?
- If in a given year the indexes of prices received and paid by farmers were 120 and 165, respectively, what would the parity ratio be? Explain the meaning of that ratio.
- Explain the economic effects of price supports. Explicitly include environmental and global impacts in your answer. On what grounds do economists contend that price supports cause a misallocation of resources?
- Use supply and demand curves to depict equilibrium price and output in a competitive market for some farm product. Then show how an above‐equilibrium price floor (price support) would cause a surplus in this market. Demonstrate in your graph how government could reduce the surplus through a policy that (a) changes supply or (b) changes demand. Identify each of the following actual government policies as primarily affecting the supply of or the demand for a particular farm product: acreage allotments; the food‐stamp program; the Food for Peace program; a government buyout of dairy herds; export promotion.
- Do you agree with each of the following statements? Explain why or why not.
- The problem with U.S. agriculture is that there are too many farmers. That is not the fault of farmers but the fault of government programs.
- The Federal government ought to buy up all U.S. farm surpluses and give them away to developing nations.
- All industries would like government price supports if they could get them; agriculture has obtained price supports only because of its strong political clout.
- What are the effects of farm subsidies such as those of the United States and the
European Union on (a) domestic ‐agricultural prices, (b) world agricultural prices, and (c) the international allocation of agricultural resources?
- Use public choice theory to explain the persistence of farm subsidies in the face of major criticisms of those subsidies. If the special‐interest effect is so strong, what factors made it possible in 1996 for the government to end price supports and acreage allotments for several crops?
- What was the major intent of the Freedom to Farm Act of 1996? Do you agree with the intent? Why or why not? Did the law succeed in reducing overall farm subsidies? Why or why not?
- Distinguish the major features of direct subsidies, countercyclical payments, and marketing loan subsidies under the Food, Conservation, and Energy Act of 2008. In what way do countercyclical payments and marketing loans help reduce the volatility of farm income? In what way do direct subsidies perpetuate the long‐run farm problem of too many resources in agriculture?
- LAST WORD What groups benefit and what groups lose from the S. sugar subsidy program?
- Suppose that corn currently costs $4 per bushel and that wheat currently costs $3 per bushel. Also assume that the price elasticity of corn is .10 while the price elasticity of wheat is .15. For the following questions about elasticities, simply use the percentage changes that are provided rather than attempting to calculate those percentage changes yourself using the midpoint formula given in Chapter 4.
- If the price of corn fell by 25 percent to $3 per bushel, by what percentage would the quantity demanded of corn increase? What if the price of corn fell by 50 percent to $2 per bushel?
- To what value would the price of wheat have to fall in order to induce consumers to increase their purchases of wheat by 5 percent?
- If the government imposes a $.40 per bushel tax on corn so that the price of corn rises by ten percent to $4.40 per bushel, by what percentage would the quantity demanded of corn decrease? If the initial quantity demanded is 10 billion bushels per year, by how many bushels would the quantity demanded decrease in response to this tax?
- Suppose that both wheat and corn have an income elasticity of .1.
- If the average income in the economy increases by 2 percent each year, by how many percentage points does the quantity demanded of wheat increase each year, holding all other factors constant? Holding all other factors constant, if 10 billion bushels are demanded this year, by how many bushels will the quantity demanded increase next year if incomes rise by 2 percent?
- Given that average personal income doubles in the United States about every 30 years, by about how many percentage points does the quantity demanded of corn increase every 30 years, holding all other factors constant?
- Suppose that 10 workers were required in 2010 to produce 40,000 bushels of wheat on a 1000‐acre farm.
- What is the average output per acre? Per worker?
- If in 2020 only 8 workers produce 44,000 bushels of wheat on that same 1000‐ acre farm, what will be the average output per acre? Per worker?
- By how many percentage points does productivity (output per worker) increase over those ten years? Over those ten years, what is the average annual percentage increase in productivity?
- In 2009, it was estimated that the total value of all corn‐production subsidies in the United States totaled about $4 billion. The population of the United States was approximately 300 million people that year.
- On average, how much did corn subsides cost per person in the United States in
2009? (Hint: A billion is a 1 followed by nine zeros. A million is a 1 followed by six zeros.)
- If each person in the United States is only willing to spend $.50 to support efforts to overturn the corn subsidy, and if anti‐subsidy advocates can only raise funds from 10 percent of the population, how much money will they be able to raise for their lobbying efforts?
- If the recipients of corn subsidies donate just one percent of the total amount that they receive in subsidies, how much could they raise to support lobbying efforts to continue the corn subsidy?
- By how many dollars does the amount raised by the recipients of the corn subsidy exceed the amount raised by the opponents of the corn subsidy?
Chapter 20 Income Inequality and Poverty
- Use quintiles to briefly summarize the degree of income inequality in the United States. How and to what extent does government reduce income inequality?
- Assume that Al, Beth, Carol, David, and Ed receive incomes of $500, $250, $125, $75, and $50, respectively. Construct and interpret a Lorenz curve for this five-person economy. What percentage of total income is received by the richest quintile and by the poorest quintile?
- How does the Gini ratio relate to the Lorenz curve? Why can’t the Gini ratio exceed 1? What is implied about the direction of income inequality if the Gini ratio declines from 0.42 to 0.35? How would one show that change of inequality in the Lorenz diagram?
- Why is the lifetime distribution of income more equal than the distribution in any specific year?
- Briefly discuss the major causes of income inequality. With respect to income inequality, is there any difference between inheriting property and inheriting a high IQ? Explain.
- What factors have contributed to increased income inequality since 1970?
- Should a nation’s income be distributed to its members according to their contributions to the production of that total income or according to the members’ needs? Should society attempt to equalize income or economic opportunities? Are the issues of equity and equality in the distribution of income synonymous? To what degree, if any, is income inequality equitable?
- Do you agree or disagree? Explain your reasoning. “There need be no trade‐off between equality and efficiency. An ‘efficient’ economy that yields an income distribution that many regard as unfair may cause those with meager incomes to become discouraged and stop trying. So efficiency may be undermined. A fairer distribution of rewards may generate a higher average productive effort on the part of the population, thereby enhancing efficiency. If people think they are playing a fair economic game and this belief causes them to try harder, an economy with an equitable income distribution may be efficient as well.
- Comment on or explain:
- Endowing everyone with equal income will make for very unequal enjoyment and satisfaction.
- Equality is a “superior good”; the richer we become, the more of it we can afford.
- The mob goes in search of bread, and the means it employs is generally to wreck the bakeries.
- Some freedoms may be more important in the long run than freedom from want on the part of every individual.
- Capitalism and democracy are really a most improbable mixture. Maybe that is why they need each other—to put some rationality into equality and some humanity into efficiency.
- The incentives created by the attempt to bring about a more equal distribution of income are in conflict with the incentives needed to generate increased income.
- How do government statisticians determine the poverty rate? How could the poverty rate fall while the number of people in poverty rises? Which group in each of the following pairs has the higher poverty rate: (a) children or people age 65 or over? (b) African Americans or foreign‐born noncitizens? (c) Asians or Hispanics?
- What are the essential differences between social insurance and public assistance programs? Why is Medicare a social insurance program whereas Medicaid is a public assistance program? Why is the earned‐income tax credit considered to be a public assistance program?
- The labor demand and supply data in the following table relate to a single occupation. Use them to answer the questions that follow. Base your answers on the taste‐for‐discrimination model.
- Plot the labor demand and supply curves for Hispanic workers in this occupation.
- What are the equilibrium Hispanic wage rate and quantity of Hispanic employment?
- Suppose the white wage rate in this occupation is $16. What is the Hispanic‐to-white wage ratio?
- Suppose a particular employer has a discrimination coefficient d of $5 per hour. Will that employer hire Hispanic or white workers at the Hispanic‐white wage ratio indicated in part c? Explain.
- Suppose employers as a group become less prejudiced against Hispanics and demand 14 more units of Hispanic labor at each Hispanic wage rate in the table. What are the new equilibrium Hispanic wage rate and level of Hispanic employment? Does the Hispanic‐white wage ratio rise or fall? Explain.
- Suppose Hispanics as a group increase their labor services in that occupation, collectively offering 14 more units of labor at each Hispanic wage rate. Disregarding the changes indicated in part e, what are the new equilibrium Hispanic wage rate and level of Hispanic employment? Does the Hispanic‐white wage ratio rise, or does it fall?
- Males under the age of 25 must pay far higher auto insurance premiums than females in this age group. How does this fact relate to statistical discrimination? Statistical discrimination implies that discrimination can persist indefinitely, while the taste‐for‐discrimination model suggests that competition might reduce discrimination in the long run. Explain the difference.
- Use a demand and supply model to explain the impact of occupational segregation or “crowding” on the relative wage rates and earnings of men and women. Who gains and who loses from the elimination of occupational segregation? Is there a net gain or a net loss to society? Explain.
- LAST WORD Go to Table 1 in the Last Word and compute the ratio of average wealth to median wealth for each of the 5 years. What trend do you find? What is your explanation for the trend? The Federal estate tax redistributes wealth in two ways: by encouraging charitable giving, which reduces the taxable estate, and by heavily taxing extraordinarily large estates and using the proceeds to fund government programs. Do you favor repealing the estate tax? Explain.
- In 2010, Forbes magazine listed Bill Gates, the founder of Microsoft, as the richest person in the United States. His personal wealth was estimated to be $53 billion. Given that there were about 309 million people living in the United States that year, how much could each person have received if Gates’ wealth had been divided equally among the population of the United States? (Hint: A billion is a 1 followed by 9 zeros while a million is a 1 followed by six zeros.)
- Imagine an economy with only two people. Larry earns $20,000 per year while Roger earns $80,000 per year. As shown in the following figure, the Lorenz curve for this two‐person economy consists of two line segments. The first runs from the origin to point a while the second runs from point a to point b.
- Calculate the Gini ratio for this two‐person economy using the geometric formulas for the area of a triangle (= ½ x base x height) and the area of a rectangle (= base x height). Hint: The area under the line segment from point a to point b can be thought of as the sum of the area of a particular triangle and the area of a particular rectangle.
- What would the Gini ratio be if the government taxed $20,000 away from Roger and gave it to Larry? (Hint: The figure will change.)
- Start again with Larry earning $20,000 per year and Roger earning $80,000 per year. What would the Gini ratio be if both their incomes doubled? How much has the Gini ratio changed from before the doubling in incomes to after the doubling in incomes?
- In 2010, many unskilled workers in the United States earned the Federal minimum wage of $7.25 per hour. By contrast, average earnings in 2010 were about $22 per hour and certain highly skilled professionals such as doctors and lawyers earned $100 or more per hour. LO6
- If we assume that wage differences are caused solely by differences in productivity, how many times more productive was the average worker than a worker being paid the Federal minimum wage? How many times more productive was a $100‐per‐hour lawyer compared to a worker earning minimum wage?
- Assume that there are 20 minimum‐wage workers in the economy for each $100‐ per‐hour lawyer. Also assume that both lawyers and minimum‐wage workers work the same number of hours per week. If everyone works 40 hours per week, how much does a $100‐per hour lawyer earn a week? How much does a minimum‐wage worker earn a week?
- Suppose that the government pairs each $100‐per‐hour lawyer with 20 nearby minimum‐wage workers. If the government taxes 25 percent of each lawyer’s income each week and distributes it equally among the 20 minimum‐wage workers with whom each lawyer is paired, how much will each of those minimum‐wage workers receive each week? If we divide by the number of hours worked each week, how much does each minimum‐wage worker’s weekly transfer amount to on an hourly basis?
- What if instead the government taxed each lawyer 100 percent before dividing the money equally among the 20 minimum‐wage workers with whom each lawyer is paired—how much per week will each minimum wage worker receive (assuming the lawyer continues to work)? And how much is that on an hourly basis?
- The desire to maximize profits can work against racial and other types of discrimination. To see this, consider two equally productive accountants named Ted and Jared. Ted is black, and Jared is white. Both can complete 10 audits per month. LO7
- Suppose that for any accounting firm that hires either Ted or Jared, all the other costs of performing an audit (besides paying either Ted or Jared) come to $1000 per audit. If the going rate that must be paid to hire an accountant is $7000 per month, how much will it cost an accounting firm to produce one audit if it hires either Ted or Jared to do the work?
- If the market price that accounting firms charge their clients for an audit is $1800, what would the accounting profit per audit be for a firm that hired either Ted or Jared? What is the profit rate as a percentage?
- Suppose that firm A dislikes hiring black accountants while firm B is happy to hire them. So Ted ends up working at firm B rather than firm A. If Ted works 11 months per year, how many audits will he complete for firm B each year? How much in accounting profits will firm B earn each year from those audits?
- Since firm A passed on hiring Ted because he was black, firm A is forgoing the profits it could have earned if it had hired Ted. If the firm is willing to forgo up to $5,000 per year in profit to avoid hiring blacks, by how many dollars will firm A regret its decision not to hire Ted?
Chapter 21 Health Care
- Why would increased spending as a percentage of GDP on, say, household appliances or education in a particular economy be regarded as economically desirable? Why, then, is there so much concern about rising expenditures as a percentage of GDP on health care?
- What are the “twin problems” of the health care industry as viewed by society? How are they related?
- Briefly describe the main features of Medicare and Medicaid, indicating how each is financed.
- What are the implications of rapidly rising health care prices and spending for (a) the growth of real wage rates, (b) government budgets, and (c) offshoring of S. jobs? Explain.
- What are the main groups without health insurance?
- List the special characteristics of the S. health care market and specify how each affects health care problems.
- What are the estimated income and price elasticities of demand for health care? How does each relate to rising health care costs?
- Briefly discuss the demand and supply factors that contribute to rising health costs. Specify how (a) asymmetric information, (b) fee-for-service payments, (c) defensive medicine, and (d) medical ethics might cause health care costs to rise.
- How do advances in medical technology and health insurance interact to drive up the cost of medical care?
- Using the concepts in Chapter 6’s discussion of consumer behavior, explain how health care insurance results in an over allocation of resources to the health care industry. Use a demand and supply diagram to specify the resulting efficiency loss.
- How is the moral hazard problem relevant to the health care market?
- What is the rationale for exempting a firm’s contribution to its workers’ health insurance from taxation as worker income? What is the impact of this exemption on allocative efficiency in the health care industry?
- What are (a) preferred provider organizations and (b) health maintenance organizations? In your answer, explain how each is designed to alleviate the overconsumption of health care.
- What are health savings accounts (HSAs)? How might they reduce the over-consumption of health care resulting from traditional insurance? How might they introduce an element of price competition into the health care system?
- How does the PPACA attempt to ensure affordable insurance for the poor?
- What were the objections made by opponents of the PPACA?
- LAST WORD What are the three major cost‐reducing features of the Singapore health care system? Which one do you think has the largest effect on holding down the price of medical care in Singapore? What element of the Singapore system is shared by the Whole Foods and State of Indiana systems? What elements are missing? How difficult do you think it would be to implement those missing elements in the United States? Explain.
- Suppose that the price elasticity for hip replacement surgeries is 0.2. Further suppose that hip replacement surgeries are originally not covered by health insurance and that at a price of $50,000 each, 10,000 such surgeries are demanded each year.
- Suppose that health insurance begins to cover hip replacement surgeries and that everyone interested in getting a hip replacement has health insurance. If insurance covers 50 percent of the cost of the surgery, by what percent would you expect the quantity demanded of hip replacements to increase? What if insurance covered 90 percent of the price? (Hint: Do not bother to calculate the percentage changes using the midpoint formula given in Chapter 4. If insurance covers 50 percent of the bill, just assume that the price paid by consumers falls 50 percent.)
- Suppose that with insurance companies covering 90 percent of the price, the increase in demand leads to a jump in the price per hip surgery from $50,000 to $100,000. How much will each insured patient now pay for a hip replacement surgery? Compared to the original situation where hip replacements cost $50,000 each but people had no insurance to help subsidize the cost, will the quantity demanded increase or decrease? By how much?
- The Federal tax code allows businesses but not individuals to deduct the cost of health insurance premiums from their taxable income. Consider a company named HeadBook that could either spend $5000 on an insurance policy for an employee named Vanessa or could increase her annual salary by $5000 instead.
- As far as the tax code is concerned, HeadBook will increase its expenses by $5000 in either case. If it pays for the policy, it incurs a $5000 health care expense. If it raises Vanessa’s salary by $5000, it incurs a $5000 of salary expense. If HeadBook is profitable and pays corporate profit taxes at a marginal 35 percent rate, by how much will HeadBook’s tax liability be reduced in either case?
- Suppose that Vanessa pays personal income tax at a marginal 20 percent rate. If HeadBook increases her salary by $5000, how much of that increase will she have after paying taxes on that raise? If Vanessa can only devote what remains after paying taxes on the $5000 to purchasing health insurance, how much will she be able to spend on health insurance for herself?
- If HeadBook spends the $5000 on a health insurance policy for Vanessa instead of giving it to her as a raise, how many more dollars will HeadBook be able to spend on Vanessa’s health insurance than if she had to purchase it herself after being given a $5000 raise and paying taxes on that raise?
- Would Vanessa prefer to have the raise or to have HeadBook purchase insurance for her? Would HeadBook have any profit motive for denying Vanessa her preference?
- Suppose the government changes the tax law so that individuals can now deduct the cost of health insurance from their personal incomes. If Vanessa gets the $5000 raise and then spends all of it on health insurance, how much will her tax liability change? How much will she be able to spend on health insurance? Will she now have a preference for HeadBook to buy insurance on her behalf?
- Preventive care is not always cost effective. Suppose that it costs $100 per person to administer a screening exam for a particular disease. Also suppose that if the screening exam finds the disease, the early detection given by the exam will avert $1000 of costly future treatment.
- Imagine giving the screening test to 100 people. How much will it cost to give those 100 tests? Imagine a case in which 15 percent of those receiving the screening exam test positive. How much in future costly treatments will be averted? How much is saved by setting up a screening system?
- Imagine that everything is the same as in part a except that now only 5 percent of those receiving the screening exam test positive. In this case, how much in future costly treatments will be averted? How much is lost by setting up a screening system?
Chapter 22 Immigration
- Which of the following statements are true? Which are false? Explain why the false statements are untrue.
- More immigrants arrive to the United States each year illegally than legally.
- The majority of legal immigrants are men.
- Over half the new legal immigrants to the United States each year are from Mexico.
- Most legal immigrants to the United States gain their legal status through employment-based preferences.
- In what respect is the economic decision to move across international borders an investment decision? Why do economic migrants move to some countries, but not to others? Cite an example of an explicit cost of moving; an implicit cost of moving. How do distance and age affect the migration decision? How does the presence of a large number of previous movers to a country affect the projected costs and benefits of subsequent movers?
- Suppose that the projected lifetime earnings gains from migration exceed the costs of moving. Explain how the decision to move might be reversed when a person considers present value.
- Use the accompanying tables for Neon and Zeon to answer the questions that follow. Assume that the wage rate shown equals hourly output and income, and that the accumulated output and income are the sum of the marginal revenue products (MRPs) of each worker.
- Which country has the greater stock of capital and technological prowess? How can you tell?
- Suppose the equilibrium wage rate is $19 in Neon and $7 in Zeon. What is the domestic output (= domestic income) in the two countries?
- Assuming zero migration costs and initial wage rates of $19 in Neon and $7 in Zeon, how many workers will move to Neon? Why will not more than that number of workers move to Neon?
- After the move of workers, what will the equilibrium wage rate be in each country? What will the domestic output be after the migration? What is the amount of the combined gain in domestic output produced by the migration? Which country will gain output; which will lose output? How will the income of native-born workers be affected in each country?
- How might the output and income gains from immigration shown by the simple immigration model be affected by (a) unemployment in the originating nation, (b) remittances by immigrants to the home country, and (c) backflows of migrants to the home country?
- Suppose initially that immigrant labor and native-born labor are complementary resources. Explain how a substantial immigration might change the demand for native-born workers, altering their wages. (Review the relevant portion of Chapter 12 if necessary to help answer this question.) Next, suppose that new immigrant labor and previous immigrant labor (not native-born) are substitute resources. Explain how a substantial immigration of new workers might affect the demand for previous immigrants, altering their wages.
- What is a “brain drain” as it relates to international migration? If emigrants are highly educated and received greatly subsidized education in the home country, is there any justification for that country to levy a “brain drain” tax on them? Do you see any problems with this idea?
- In July 2007 The Wall Street Journal (WSJ) reported that a growing shortage of skilled labor in Eastern European countries such as Slovakia was driving up wages in key industries and reducing business income. The reason for the shortages was a large migration of skilled Eastern European workers to Western European countries. Use the simple immigration model to demonstrate the key elements of the WSJ story as just described.
- Why is each of these statements somewhat misleading? (a) “Illegal immigrants take only jobs that no American wants.” (b) “Deporting 100,000 illegal immigrants would create 100,000 job openings for Americans.”
- Why are so many state and local governments greatly concerned about the Federal government’s allegedly lax enforcement of the immigration laws and Congressional proposals to grant legal status (amnesty) to the 11 million illegal immigrants in the United States? How might an amnesty program affect the flow of future border crossings?
- If someone favors the free movement of labor within the United States, is it inconsistent for that person to also favor restrictions on the international movement of labor? Why or why not?
- LAST WORD What were the five main features of the proposed immigration reform of 2007? Which of these features, as general principles, do you support? Which do you oppose? Explain your reasoning.
- Mexico has daily (rather than hourly) minimum wage laws. In 2010, the daily minimum wage in Mexico was about 60 pesos per day, and the exchange rate between Mexican pesos and U.S. dollars was about 12 pesos per dollar.
- In 2010, what was the Mexican minimum daily wage in terms of dollars?
- Given that Mexican employees typically work 8-hour days, about how much per hour is the Mexican minimum wage in terms of dollars?
- In 2010, the Federal minimum wage in the United States was $7.25 per hour. How many times larger was the hourly U.S. Federal minimum wage than the hourly Mexican minimum wage?
- If unskilled workers have a tendency to migrate to where they can obtain the highest compensation for their labor, which country is more likely to be receiving low-skilled immigrants?
- Differences in productivity are usually the major force behind differences in wages and unit labor costs. Suppose that a single unskilled worker at a pottery factory in Mexico can produce 1 mug per hour. By comparison, suppose that a single unskilled worker at a pottery factory in the United States can produce 14 mugs per hour because more and better machinery generates higher labor productivity. The Mexican mugs and the American mugs are identical in quality and durability and sell for the same price.
- If unskilled pottery workers are paid the local minimum wage in both countries, how much is the labor cost per mug for mugs produced in Mexico? For mugs produced in the United States? (Use the minimum wages from Problem 1 and make all calculations in dollars.)
- With regard to mug production, how much higher are labor costs per hour in the United States?
- With regard to mug production, how much higher are labor costs per unit in Mexico?
- Do higher labor costs per hour always imply higher labor costs per unit?
- If firms with lower labor costs per unit expand while those with higher labor costs per unit contract, in which country will mug-making firms be increasing in size and hiring more employees? If unskilled pottery workers relocate to where they can find jobs, to which country will they be moving?
- There is evidence that, other things equal, a 10 percent increase in the number of workers having a particular skill level leads to about a 4 percent decline in wages for workers with that skill level. In addition, this 10-to-4 ratio appears to hold true whether the increase in labor supply is caused by domestic changes in labor supply or by an influx of foreign immigrants.
- Suppose 42,000 computer programmers work in Silicon Valley. If the number of computer programmers in Silicon Valley increases by 1260 because of a change in U.S. immigration laws, by how many percentage points would you expect the wage of computer programmers to fall in Silicon Valley?
- Suppose that 8,000 full-time cooks work in restaurants in the Denver area. If Denver becomes popular both with U.S. citizens and with foreigners such that 400 full-time cooks move to Denver from other parts of the United States while 480 full-time cooks move to Denver from other countries, by how much would you expect the wages of full-time cooks to fall in Denver?
- In 2008, an estimated 7.8 million Mexican-born immigrants were employed in the United States.
- If 60 percent of the Mexican-born immigrants remitted money to family members in Mexico in 2008, and if they each sent $100 per month, how much money did they remit in total for the year?
- If, instead, 100 percent of the Mexican-born immigrants remitted money to family members in Mexico in 2008, and if they each sent $250 per month, how much money did they remit in total for the year?
- The actual amount remitted to Mexico in 2008 by Mexican-born immigrants living in the United States was about $22 billion. If we assume that 75 percent of the Mexican-born immigrants remitted money to Mexico that year and if we further assume that each of those immigrants remitted an equal amount each month, how much per month did each of those immigrants have to remit to total $22 billion for the year?
Chapter 23 International Trade
- Quantitatively, how important is international trade to the United States relative to the importance of trade to other nations? What country is the United States’ most important trading partner, quantitatively? With what country does the United States have the largest trade deficit?
- Distinguish among land-, labor-, and capital-intensive goods, citing an example of each without resorting to book examples. How do these distinctions relate to international trade? How do distinctive products, unrelated to resource intensity, relate to international trade?
- Explain: “The United States can make certain toys with greater productive efficiency than can China. Yet we import those toys from China.” Relate your answer to the ideas of Adam Smith and David Ricardo.
- Suppose Big Country can produce 80 units of X by using all its resources to produce X or 60 units of Y by devoting all its resources to Y. Comparable figures for Small Nation are 60 units of X and 60 units of Y. Assuming constant costs, in which product should each nation specialize? Explain why. What are the limits of the terms of trade between these two countries? How would rising costs (rather than constant costs) impact the extent of specialization and trade between these two countries?
- What is an export supply curve? What is an import demand curve? How do such curves relate to the determination of the equilibrium world price of a tradable good?
- Why is a quota more detrimental to an economy than a tariff that results in the same level of imports as the quota? What is the net outcome of either tariffs or quota for the world economy?
- Draw a domestic supply and demand diagram for a product in which the United States does not have a comparative advantage. What impact do foreign imports have on domestic price and quantity? On your diagram show a protective tariff that eliminates approximately one-half of the assumed imports. What are the price-quantity effects of this tariff on (a) domestic consumers, (b) domestic producers, and (c) foreign exporters? How would the effects of a quota that creates the same amount of imports differ?
- “The potentially valid arguments for tariff protection—military self-sufficiency, infant industry protection, and diversification for stability—are also the most easily abused.” Why are these arguments susceptible to abuse?
- Evaluate the effectiveness of artificial trade barriers, such as tariffs and import quotas, as a way to achieve and maintain full employment throughout the S. economy. How might such policies reduce unemployment in one U.S. industry but increase it in another U.S. industry?
- In 2007, manufacturing workers in the United States earned average compensation of $30.56 per hour. That same year, manufacturing workers in Mexico earned average compensation of $3.91 per hour. How can S. manufacturers possibly compete? Why isn’t all manufacturing done in Mexico and other low-wage countries?
- How might protective tariffs reduce both the imports and the exports of the nation that levies tariffs? In what way do foreign firms that “dump” their products onto the S. market in effect provide bargains to American consumers? How might the import competition lead to quality improvements and cost reductions by American firms?
- Identify and state the significance of each of the following trade-related entities: (a) the WTO; (b) the EU; (c) the Euro Zone; and (d) NAFTA.
- What form does trade adjustment assistance take in the United States? How does such assistance promote political support for free trade agreements? Do you think workers who lose their jobs because of changes in trade laws deserve special treatment relative to workers who lose their jobs because of other changes in the economy, say, changes in patterns of government spending?
- What is offshoring of white-collar service jobs and how does that practice relate to international trade? Why has offshoring increased over the past few decades? Give an example (other than that in the textbook) of how offshoring can eliminate some American jobs while creating other American jobs.
- LAST WORD What was the central point that Bastiat was trying to make in his imaginary petition of the candlemakers?
- Assume that the comparative-cost ratios of two products—baby formula and tuna fish—are as follows in the nations of Canswicki and Tunata:
Canswicki: 1 can baby formula ≡ 2 cans tuna fish
Tunata: 1 can baby formula ≡ 4 cans tuna fish
In what product should each nation specialize? Which of the following terms of trade would be acceptable to both nations: (a) 1 can baby formula ≡ 2 1/2 cans tuna fish; (b) 1 can baby formula ≡ 1 can tuna fish; (c) 1 can baby formula ≡ 5 cans tuna fish?
- The accompanying hypothetical production possibilities tables are for New Zealand and Spain. Each country can produce apples and plums. Plot the production possibilities data for each of the two countries separately. Referring to your graphs, answer the following:
- What is each country’s cost ratio of producing plums and apples?
- Which nation should specialize in which product?
- Show the trading possibilities lines for each nation if the actual terms of trade are 1 plum for 2 apples. (Plot these lines on your graph.)
- Suppose the optimum product mixes before specialization and trade were alternative B in New Zealand and alternative S in Spain. What would be the gains from specialization and trade?
- The following hypothetical production possibilities tables are for China and the United States. Assume that before specialization and trade the optimal product mix for China is alternative B and for the United States is alternative U.
- Are comparative-cost conditions such that the two areas should specialize? If so, what product should each produce?
- What is the total gain in apparel and chemical output that would result from such specialization?
- What are the limits of the terms of trade? Suppose that the actual terms of trade are 1 unit of apparel for 1½ units of chemicals and that 4 units of apparel are exchanged for 6 units of chemicals. What are the gains from specialization and trade for each nation?
- Refer to Figure 3.6, page 57. Assume that the graph depicts the U.S. domestic market for corn. How many bushels of corn, if any, will the United States export or import at a world price of $1, $2, $3, $4, and $5? Use this information to construct the U.S. export supply curve and import demand curve for corn. Suppose that the only other corn-producing nation is France, where the domestic price is $4. Which country will export corn; which county will import it?
Chapter 24 The Balance of Payments, Exchange Rates, and Trade Deficits
- Do all international financial transactions necessarily involve exchanging one nation’s distinct currency for another? Explain. Could a nation that neither imports goods and services nor exports goods and services still engage in international financial transactions?
- Explain: “U.S. exports earn supplies of foreign currencies that Americans can use to finance imports.” Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets:
- A U.S. airline firm purchases several Airbus planes assembled in France.
- A German automobile firm decides to build an assembly plant in South Carolina.
- A U.S. college student decides to spend a year studying at the Sorbonne in Paris.
- An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter.
- The U.S. economy grows faster than the French economy.
- A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person.
- It is widely expected that the euro will depreciate in the near future.
- What do the plus signs and negative signs signify in the S. balance of payments statement? Which of the following items appear in the current account and which appear in the capital and financial account? U.S. purchases of assets abroad; U.S. services imports; foreign purchases of assets in the United States; U.S. good exports, U.S. net investment income. Why must the current account and the capital and financial account sum to zero?
- What are official reserves? How do net sales of official reserves to foreigners and net purchases of official reserves from foreigners relate to S. balance-of-payment deficits and surpluses? Explain why these deficits and surpluses are not actual deficits and surpluses in the overall balance of payments statement.
- Generally speaking, how is the dollar price of euros determined? Cite a factor that might increase the dollar price of euros. Cite a different factor that might decrease the dollar price of euros. Explain: “A rise in the dollar price of euros necessarily means a fall in the euro price of dollars.” Illustrate and elaborate: “The dollar-euro exchange rate provides a direct link between the prices of goods and services produced in the Euro Zone and in the United States.” Explain the purchasing-power-parity theory of exchange rates, using the euro-dollar exchange rate as an illustration.
- Suppose that a Swiss watchmaker imports watch components from Sweden and exports watches to the United States. Also suppose the dollar depreciates, and the Swedish krona appreciates, relative to the Swiss franc. Speculate as to how each would hurt the Swiss watchmaker.
- Explain why the U.S. demand for Mexican pesos is downsloping and the supply of pesos to Americans is upsloping. Assuming a system of flexible exchange rates between Mexico and the United States, indicate whether each of the following would cause the Mexican peso to appreciate or depreciate, other things equal:
- The United States unilaterally reduces tariffs on Mexican products.
- Mexico encounters severe inflation.
- Deteriorating political relations reduce American tourism in Mexico.
- The U.S. economy moves into a severe recession.
- The United States engages in a high-interest-rate monetary policy.
- Mexican products become more fashionable to U.S. consumers.
- The Mexican government encourages U.S. firms to invest in Mexican oil fields.
- The rate of productivity growth in the United States diminishes sharply.
- Explain why you agree or disagree with the following statements:
- A country that grows faster than its major trading partners can expect the international value of its currency to depreciate.
- A nation whose interest rate is rising more rapidly than interest rates in other nations can expect the international value of its currency to appreciate.
- A country’s currency will appreciate if its inflation rate is less than that of the rest of the world
- “Exports pay for imports. Yet in 2009 the nations of the world exported about $379 billion more of goods and services to the United States than they imported from the United States.” Resolve the apparent inconsistency of these two statements.
- Diagram a market in which the equilibrium dollar price of 1 unit of fictitious currency zee (Z) is $5 (the exchange rate is $5 =Z1). Then show on your diagram a decline in the demand for zee.
- Suppose that a country follows a managed-float policy but that its exchange rate is currently floating freely. In addition, suppose that it has a massive current account deficit. Does it also necessarily have a balance-of -payments deficit? If it decides to engage in a currency intervention to reduce the size of its current account deficit, will it buy or sell its own currency? As it does so, will its official reserves of foreign currencies get larger or smaller? Would that outcome indicate a balance-of-payments deficit or a balance-of- payments surplus?
- What have been the major causes of the large U.S. trade deficits in recent years? What are the major benefits and costs associated with trade deficits? Explain: “A trade deficit means that a nation is receiving more goods and services from abroad than it is sending abroad.” How can that considered to be “unfavorable”?
- LAST WORD Suppose Super D’Hiver—a hypothetical French snowboard retailer—wants to order 5000 snowboards made in the United States. The price per board is $200, the present exchange rate is 1 euro = $1, and payment is due in dollars when the boards are delivered in 3 months. Use a numerical example to explain why exchange-rate risk might make the French retailer hesitant to place the order. How might speculators absorb some of Super D’Hiver’s risk?
- Alpha’s balance-of-payments data for 2010 are shown below. All figures are in billions of dollars. What are the (a) balance on goods, (b) balance on goods and services, (c) balance on current account, and (d) balance on capital and financial account? Suppose Alpha sold $10 billion of official reserves abroad to balance the capital and financial account with the current account. Does Alpha have a balance-of-payments deficit or does it have a surplus?
- China had a $372 billion overall current account surplus in 2007. Assuming that China’s net debt forgiveness was zero in 2007 (its capital account balance was zero), by how much did Chinese purchases of financial and real assets abroad exceed foreign purchases of Chinese financial and real assets?
- Refer to following table, in which Qd is the quantity of yen demanded, P is the dollar price of yen, Qs is the quantity of yen supplied in year 1, and Qs‘ is the quantity of yen supplied in year 2. All quantities are in billions and the dollar-yen exchange rate is fully flexible.
- What is the equilibrium dollar price of yen in year 1?
- What is the equilibrium dollar price of yen in year 2?
- Did the yen appreciate or did it depreciate relative to the dollar between years 1 and 2?
- Did the dollar appreciate or did it depreciate relative to the yen between years 1 and 2?
- Which one of the following could have caused the change in relative values of the dollar and yen between years 1 and 2: (1) More rapid inflation in the United States than in Japan; (2) an increase in the real interest rate in the United States but not in Japan; or (3) faster growth of income in the United States than in Japan.
- Suppose that the current Canadian dollar (CAD) to U.S. dollar exchange rate is $.85 CAD = $1 US and that the U.S. dollar price of an Apple iPhone is $300. What is the Canadian dollar price of an iPhone? Next, suppose that the CAD to US dollar exchange rate moves to $.96 CAD = $1 US. What is the new Canadian dollar price of an iPhone? Other things equal, would you expect Canada to import more or fewer iPhones at the new exchange rate?
- Return to Problem 3 and assume the exchange rate is fixed against the dollar at the equilibrium exchange rate that occurs in year 1. Also suppose that Japan and the United States are the only two countries in the world. In year 2, what quantity of yen would the Japanese government have to buy or sell to balance its capital and financial account with its current account? In what specific account would this purchase or sale show up in Japan’s balance of payments statement: Foreign purchases of assets in Japan or Japanese purchase of assets abroad? Would this transaction increase Japan’s stock of official reserves or decrease its stock?