Problem Set
Answers
Q4R 2. The opportunity cost of seeing a
movie includes the monetary cost of admission plus the time cost of going to t
he theater and attending the show. The time cost depends on what else you
might do with that time; if it's staying home and watching TV, the time
cost may be small, but if it's working an extra three hours at your job, the
time cost is the money you could have earned.
Q4R 3. The marginal benefit of a glass of
water depends on your circumstances. If you've just run a marathon, or
you've been walking in the desert sun for three hours, the marginal benefit is
very high. But if you've been drinking a lot of liquids recently, the
marginal benefit is quite low. The point is, that even the necessities of
life, like water, don't always have large marginal benefits.
P&A 6. Harry suggests looking at whether
productivity would rise or fall. Productivity is certainly important,
since the more productive workers are, the lower the cost per gallon of
potion. Ron wants to look at average cost. But both Harry and Ron
are missing the other side of the equation--revenue. A firm wants to
maximize its profits, so it needs to examine both costs and
revenues. Thus, Hermione is right--it is best to examine whether the extra
revenue would exceed the extra costs. In addition, Hermione is
the only one who's thinking at the margin.
And anyone who's read Harry
Potter knows that Hermione is always right.
P&A 14. If Americans save more and its
leads to more spending on factories, there will be an increase in production
and productivity, since the same number of workers will have more equipment to
work with. The benefits from higher productivity will go to both the
workers, who will get paid more since they're producing more, and the factory
owners, who will get a return on their investments.
There's no such thing as a free
lunch, though, because when people save more, they're giving up spending.
They get higher incomes at the cost of buying goods.
Q4R #4 If a disease kills half of
the economy's cow population, less milk production is possible, so the PPF
shifts inward (PPF2). Note that if the economy produces all cookies, so
it doesn't need any cows, then the production is unaffected. But if the
economy produces any milk at all, then there will be less production
possible after the disease hits.
P&A #7 Positive statements are descriptive and make
a claim about how the world IS, while normative statements are prescriptive and
make a claim about how the world OUGHT TO BE. Here's an example.
Positive: A rapid growth rate of money is the cause of inflation.
Normative: The government should keep the growth rate of money low.
2. a. Construct
graphically the production possibilities frontier for the city of
|
|
Automobiles (Thousands) |
|
75 |
0 |
|
60 |
6 |
|
45 |
11 |
|
30 |
15 |
|
15 |
18 |
|
0 |
20 |
a.
b.
c. Efficient points are
when society is producing the most that it can, given its resources, and is ON
the PPF. Inefficient points are inside the PPF, when society is letting
some resources go unused, so they are not producing as much as is
possible. Unattainable points are outside of the PPF--the region where
society would *like* to be, but is unable because of limited resources
.
d. If
3.(from the Study Guide). The following
table represents Joe's demand for cups of gourmet coffee. Use this
information to answer the questions found below.
|
Price per cup of coffee |
Quantity demanded of coffee |
|
$5 |
2 cups |
|
4 |
4 |
|
3 |
6 |
|
2 |
8 |
|
1 |
10 |
a. Plot and
connect the points from the table on a set of axes with "Price of
coffee" on the y-axis and "Quantity demanded of coffee" on the
x-axis.
b. The slope of Joe's demand curve for coffee in the price range of $5
and $4 is:
(5-4)/(2-4) = -1/2
c. In the price range of $2
and $1 it is: (2-1)/(8-10) = -1/2
d. The price of coffee and Joe's quantity demanded of coffee are
negatively correlated. We can tell this because we have a downward
sloping line (or the slope is negative, or as price rises, quantity falls).
e. If the price of coffee moves from $2 per cup to $4 per cup, the
quantity demanded will fall from 8 cups to 4 cups. This is a movement
along the demand curve.
f. If Joe's income doubles from $20,000 to $40,000 per year, his
demand curve shifts out, as shown by the dark line in the graph above.
g. The doubling of Joe's income causes a shift in his demand curve,
because income changed--and income is not a variable which is measured on
either axis.
P&A 4
|
|
Pizza |
Root Beer |
|
Pat |
2 hours |
4 hours |
|
Chris |
4 hours |
6 hours |
a. OC of
making a pizza-- Pat's OC is 1/2 root beer, Chris's OC is 2/3 root beer.
Pat has the absolute advantage in making Pizza since she can
produce it in absolutely less time.
Pat also has the comparative advantage in pizza, since she has to
give up less root beer to make one more pizza.
b. Pat will trade away
pizza in exchange for the root beer that Chris will make.
c. The most a pizza will go
for is 2/3 of a root beer, and the least that a pizza will go for is 1/2 root
beer. These are simply the opportunity costs for Chris and Pat. If
the price of a pizza is too high (more than 2/3 root beer) nobody will want a
pizza and then no trade will occur. If the price of pizza is too low
(less than 1/2 root beer) nobody will want to produce root beer, and only pizza
will be made.
P&A5
a. The opportunity cost of producing one car in anada is 15 bushels of
wheat. The opportunity cost of producing one more bushel of wheat is 1/15th
of a car. The opportunity costs are reciprocals of each other.
b.
If
c. If Canada accepts this
trade, and they produce only cars (20 million cars), they have a total
consumption of 10 million cars and 200 bushels of wheat. This was an
unattainable point without trade, and thus they SHOULD accept the
P&A 6
It IS sensible. Although the professor has an ABSOLUTE advantage in both
writing chapters and gathering data, trade should be based on COMPARATIVE
advantage. The professor is going to be a MUCH better writer, and a
student can adequately find data (although it will take him or her more time
than it would the professor).
The key is that the student is a
*relatively* better data gatherer, and the professor is a *relatively* better
writer.
1. Show how the following demand
curves are likely to shift in response to the indicated changes:
In words:
a. drought: will lessen consumers need for umbrellas (tastes
change). This will lower demand, shifting the demand curve to the left.
b. high popcorn
prices: If we assume that popcorn and movie tickets are complements, then
an increase in popcorn prices means lower popcorn AND movie ticket
consumption. This is a decrease in the demand for movie tickets, and is
shown by a leftward shift of the demand curve.
c. increased price of tea:
if Coffee and tea are substitutes, then an increase in the price of tea means
less tea consumption and more coffee consumption. This increase in
Demand will cause the demand curve to shift out or to the right.
d. higher
income/computers: If computers are a normal good, the increase in
consumer income will increase the demand for computers, shifting the demand
curve to the right.
e. higher
income/Ramen: If Ramen is an inferior good, then the increase in consumer
income will decrease the demand for Ramen noodles, shifting the demand curve to
the left.
P&A # 1
a. cold snap will cause a shortage of oranges, so as supply of oranges
falls, the price of oranges rises. As oranges are the leading input into
orange juice, the supply of orange juice will decrease because of the higher
price of oranges. This will shift supply left, increasing the price and
decreasing the quantity.
b.
c. War in the
Furthermore, the increased price of gas influences the market for used
Cadillacs in the following way. Gas is a complement good to
Caddilacs. When the price of the compliment rises (gas prices rose) the
demand for used Cadillacs will fall. This shifts the demand curve left,
lowering price. IN ADDITION. . .more people will want to switch from
driving a Cadillac to a more fuel-efficient car. They sell their
Cadillacs, increasing the supply of used Cadillacs as well. Supply shifts
right, further lowering the price.
Note: since we had a shift
of both supply and demand curve for Cadillacs, we cannot be certain how the
quantity of used Cadillacs will change. We CAN be certain of the decrease
in price.
P&A3 Minivans
a. More kids means tastes for minivans improve. Demand
increases, shifting right. Price and quantity increase.
b. increase steel prices--input prices rise, lowering
supply. Supply shifts left, increasing price and decreasing quantity.
c. New technology will increase supply. Supply shifts
right, decreasing price and increasing quantity.
d. Prices of stations wagons rise--this is a substitute to
the minivan. Fewer people will buy station wagons, so more will buy
minivans. This increases the demand for minivans, shifting demand right
and increasing price and quantity
e. lower wealth will decrease the demand for minivans.
This shifts the demand curve left, lowering both price and quantity.
P&A 6 In 2010, there will be a big need
for baby sitters, so demand for babysitters rises. This shifts the demand
curve right, increasing the price of baby sitting services.
By 2020, the number of teenagers old enough to baby sit skyrockets, so that the
supply of baby sitters rises. This shift of supply to the right will
lower the price of baby sitting services.
P&A12 (This was a tricky one.) First, the
"successful marketing campaign" aimed to change people's tastes
for champagne. As it was successful, it increased demand, shifting
the demand curve to the right. This caused the "stratospheric
champagne prices" (higher prices) that the execs were "giddy"
about.
Their fears about the high prices
causing demand to plummet are incorrect, because they did not look at WHY
prices rose. They changed consumer tastes for the product (through the ad
campaign) and thus increased customer demand for the product. . .meaning that
consumers are now WILLING to pay more for their champagne. The execs
should not worry, but celebrate with some of that overpriced champagne.
P&A9: Equilibrium price is $6 and the
quantity is 81. Even if you didn't draw this, you could have seen this on
the supply schedule, since at a price of $6, both quantity demanded and
quantity supplied are 81.
If the market price were too high, then there would be excess supply. The
suppliers would lower prices to get rid of inventories, and lower their
production accordingly. If the market price were too low, then there
would be excess demand (shortage). The consumers would be willing to pay
a higher price to get the pizza, and would bid up the price accordingly.
3. a. the price of cheeseburgers
falls--substitute goods gets cheaper, so demand for pizza falls. This
shifts demand left, lowering both price and quantity.
b. the price of mozzarella increases--input good price
rises, so supply falls. Supply shifts left, raising price and lowering
quantity.
c. consumers' incomes rise--demand rises as incomes
rise, WHEN pizza is a normal good. Demand shifts right, increasing price
and quantity.
d. new automated pizza-making technology is
introduced--the new technology will increase supply. Supply shifts right,
decreasing price and increasing quantity.
1. Twenty gallons of water will give you
greater total utility, because the quantity is larger. Our total
utility rises as we consume more of a good.
2. Twelve gallons of water will give
you greater marginal utility, because our marginal utility decreases as
we consumer more of the good. By the 12th gallon, we've already had quite
a bit of water. By the 20th gallon we may actually be sick of water and
will gain only very little from its consumption.
P&A # 1 The bad weather will decrease the supply
of lemons available, which will cause the price to rise and the quantity to
fall. This LOWERS the amount of consumer surplus in the market for
lemons. The higher price of lemons will also decrease the supply of
lemonade (as lemons are the main input into lemonade). The lower supply
of lemonade will increase the price and decrease the quantity of
lemonade. This also will LOWER the consumer surplus in the market for
lemonade. (In both the market for lemons or the market for lemonade,
consumer surplus shrinks from the combined purple and blue sections, to ONLY
the blue section, when the prices rise.)
P&A # 7. Demand is in blue: the
horizontal stretches are at $8 (Ricki), $7 (Jerry), $5 (Montel) and $2
(Oprah). The supply curve is in red: the horizontal stretches are
at $2 (Firm D), $3 (Firm A), $4 (Firm C) and $6 (Firm B).
Efficiency: Supply equals demand at a quantity of three haircuts.
Who cuts hair? The lowest cost (most efficient) suppliers--Firms D, A and
C, in this example.
Who gets a haircut? Those who want it the most--Ricki, Jerry and Montel,
in this example.
Maximum Total Surplus is 11. This is the area between supply and demand,
summed up for each of the three haircuts.
NOTICE: The question did
not ask for price. Why? Because we cannot be certain. We can
say that price will be somewhere between $4 and $5, because that is the section
where supply and demand are equal. Without a set price, the individual
consumer and producer surplus cannot be determined.
If I were to tell you that price
ends up at $5, CS = 5 and PS = 6. If Price were $4, then CS = 8 and PS =
3. In either case TS = 11. However, consumers do better with the
lower price and producers do better with the higher price.
1. a.
The price elasticity of demand describes how responsive the quantity demanded is
to a change in the price of that good. Large elasticities mean that there
is a greater demand response (or it is more elastic).
b. Goods
which have elastic demand curves: there are many answers, but in general,
they would be goods categorized as luxuries, goods over long time horizons,
good with close substitutes and goods in narrowly defined markets.
c. Goods
which have inelastic demand curves: again, there are many answers, but in
general, they would be goods categorized as necessities, goods over very short
time horizons, goods without close substitutes, and goods in broadly defined
markets.
d.
Elastic demand curves are flat and inelastic demand curves are steep:
Elastic demand curves imply that the quantity demanded is very responsive (or
very large) for a change in price. If the slope is "rise over
run", and the "rise" here is price and the "run" is
quantity demanded, then elastic demand curves have a very large "run"
for a given "rise." If the denominator is larger, the slope will
be smaller. . .or flatter as the question put it. Alternatively, an
inelastic demand curve is NOT very responsive. So we'd see small changes
in quantity demanded, or small "runs" for a given price change.
The smaller denominator makes the slope larger. . .implying a steeper demand
curve.
2. If the price elasticity
of demand for a good is elastic, its price should be decreased in order to
increase total revenue. The elastic good would see a larger increase in
quantity demanded compared to the decrease in price. Although the firm
would be making less money on each good that they sell, they would be more than
compensated by selling many, many more goods.
3. Mankiw P&A #1
a. Mystery novels, because they are a luxury, not a necessity.
b. Beethoven, because it is a narrowly defined market and there are more
close substitutes like Bach or Brahms.
c. Heating oil over the next five years, because of the longer time
frame. People will evenually switch out of oil heat to gas heat.
d. Root beer, as it is a "luxury" item compared to water.
4. Mankiw P&A #3 a
i.the price elasticity of demand for consumers with incomes of $10,000 is unit
elastic.
ii.the price elasticity of demand for consumers with incomes of 12,000 is
inelastic.
Mankiw #3 b
i. When price is $12, the income elasticity is:
ii. When price is $16, the
income elasticity is:
5. Mankiw P&A # 8
a. If we recall that the elasticity is equal to the percentage change in
quantity demanded by the percentage change in price, we can solve for the
percentage change in price. We were given information that the elasticity
was 0.4 and that the desired change in quantity demanded was 20%.
This implies that they should increase price by 50%, or increase it from $2 to
$3.
b. Five years from
now. The higher prices now will cause some people to eventually quit
smoking (or not start) so that demand will fall much more in the long run than
it will in the short run.
c. Teens should have a
larger price elasticity of demand for cigarettes because this is when most
people begin smoking. If prices are higher, fewer teens will become
addicted in the upcoming years, and quantity demanded will be more
affected later than it can be now.
6. The elasticity of supply
of lawnmowers would be larger over the span of one year. Supply is more
flexible over longer time horizons since it takes time to increase production (hire
more workers, order more equipment, etc.). Over the short run, you can
only change the quantity supplied by what you have already built (and these
days, inventories are kept relatively small).
7. Mankiw P&A # 11
a. As seen in the figure below, both the equilibrium price and the
equilibrium quantity will increase when demand increases.
b. The Beachfront properties will experience a larger change in price
(and a smaller change in quantity) because of the inelastic supply.
c. The Auto market will experience a larger change in quantity (and a
smaller change in price) because of the elastic supply.
d. Consumer spending (Price x Quantity) increases in both cases, since
both price and quantity increase. (However, we cannot say precisely which
will increase more.)
First, the competitive
equilibrium is drawn on the left. There is no deadweight loss when we are
at the competitive equilibrium because we are selling the efficient quantity at
the efficient price.
a. The new equilibrium is on the
right. The price will increase and the quantity will decrease, compared
to the competative equilibrium. There is a surplus of cheese (excess
supply). There is a deadweight loss as a result of the price floor,
because the quantity is restricted. Therefore, we cannot get any surplus
on the items that are never sold.
b. It is definitely
possible that the farmers can lose revenue (Price x Quantity) when the price
floor is increased. Although the price does rise, if the quantity falls
by a greater percentage than the increased price, the farmers Total Revenue
will fall. The more elastic is the demand for Cheese, the higher is the
probability that they will lose TR as a result of the price floor. (Recall that
when demand is Elastic, price increases will DECREASE total revenue.
2. Mankiw P&A #4
a. without the tax: Price paid for beer by consumer is P*,
Price recieved by sellers is also P*, Quantity of beer sold is Q*. There
is NO difference between the price paid by consumers and the price received by
sellers.
b. with the $2 tax:
Price paid by consumers is Pb, Price received by sellers is Ps, quantity sold
is Qt. The difference between the consumer and seller prices is (Pb-Ps)
which is equal to $2 in this case (the size of the tax). The quantity of
beer sold has decreased with the tax in place. Ttotal welfare has
decreased when the tax is imposed. Both producer and consumer surplus
shrink, and the government revenue does not equal this loss in CS and PS.
There is a deadweight loss.
3. Mankiw P&A
#6.
The $500 tax on luxury cars will be split between consumers and sellers, such that
the price that consumers pay will rise, but not by the full $500.
1. Mankiw P&A # 2.
a. Fire extinguishers exhibit a positive externality because fires can
spread from one person's apartment or house to another persons. So if Mr.
A has a fire extinguisher and uses it on a fire in his apartment, he saves Ms.
B from having his fire spread to her apartment and messing up her things.
b. See the graph
below. The private supply and social costs supply curves are one in the
same. This is a Consumption externality, which means that the demand
curve will be different. There is a larger "social demand"
function.
c. The Efficient price and
quantity are Pe and Qe in the graph above. the Market price and quantity
are P* and Q*. Since Mr. A doesn't take into account the problems a fire
in his place would cause for Ms. B, his willingness to pay (demand) does not
take HER benefits into account. Therefore, fewer fire extinguishers are
purchased, in a market equilibrium, than is socially optimal.
d. The government could
subsidize the price of a fire extinguisher. . .give everyone who purchases one
a $10 rebate on their taxes or something. The lower price would induce
more individuals to buy the fire extinguisher, so we'd get to the efficient
quantity, Qe.
2. Mankiw P&A #4.
a. Noise pollution is the externality. The fact that Ringo's music
is so loud that it disturbs Luciano.
b. The landlord could do a
couple of things. . .he could put a "noise limit" in effect like many
communitites do. (
This policy could still be
inefficient. . .if Luciano isn't home (out performing in
c. Ringo and Luciano could
figure out a payment scheme to allow for an efficient outcome, or a time
schedule whereby Ringo could play the music loud at the times of the day
that Luciano is away from the apartment.
If Luciano only speaks Italian
and Ringo only speaks english, then they might have a hard time reaching an
agreement.
1.This is a question with lots of possible answers. . .
2. Mankiw P&A #2
a. Police protection--Natural monopoly (so long as there is not TOO much
crime)--Excludable because the police can choose to not protect certain
neighborhoods or sections of society, and Non-rival, in most cases. If
there was a lot of crime--so that policemen could not get to the crime
quickly--then it would be rival, and therefore it would be a private good (both
excludable and rival).
snow plowing--common resource--plowed roads are
non-excludable (as are most roads), but it can be rival. . .If there is a lot
of snow, the plowing of your street may hinder the truck from getting to
my street.
education--private good (with a positive
consumption externality)--it IS excludable, in the sense that you have to pay
to attend even public universities. (Or have a taxpaying parent in the
neighborhood to go to a particular grade school). It is also rival, in
the sense that one more student means that less of the teacher's time is going
to be spent on the students who were already there.
rural roads--public good--they are not excludable and
are not rival (unless they are congested, but most rural roads are not)
city streets--common resources when congested, public
goods when not congested. They are always non-excludable, but can be
rival or non-rival depending on the time of day.
b. The government may
provide certain goods that are not public goods (such as education) because of
the externalities associated with them.
8. Mankiw P&A #3
a. Charlie is a Free Rider
b. The government could
help solve the problem by sponsoring the show, or by supporting public
television in general (which they do. . .anybody out there listen to NPR?)
c. The private market could
also solve the problem by making people watch commercials that are incorporated
into the program. Parents don't like this for children's shows, so it
becomes more difficult. "Product placement" inside the TV
program would also work (Seinfeld did a LOT of this. . .making sure that the
Wheaties box was in plain view when they were in the kitchen, or the Pepsi can
on the coffee table, yadda, yadda, yadda. . .)
Cable TV changes all of this. .
.They make television excludable, making it a . . .natural monopoly.
1. Mankiw Q4R #2. Several answers are possible, including the wages
or salary that the entrepreneur could have earned had he or she gone to another
job; any lost interest on savings that they put into the
business; day care costs if they have children and were previously
staying at home with them. . .
2. Mankiw P&A #2
a. opportunity costs, in the production sense, are all of those things
that must be foregone in order to produce the product. These include both
explicit costs (which require money to physically leave the firm) and implicit
costs (things like wages and interest that are lost when a person starts a new
business).
b. The opportunity cost of
your aunt's opening the store, would (at a minimum) be the $500,000 to run the
place (explicit costs) and the $50,000 it costs her in lost salary (implicit
cost). If she could only sell $510,000 worth of merchandise, she should
not open the store, since it will not cover BOTH the explicit and the implicit
costs ($550,000).
3. Mankiw P&A #5
a. Marginal product first
increases--showing increasing returns to scale--and then decrecreases--showing diminishing
returns to scale, for outputs beyond 90 or so units.
b. Total cost = $200 + $100
* (# of Workers), or fixed cost plus variable costs.
c. ATC = TC/Q. ATC
first falls, and then rises.
d. MC = change in TC/change
in Q, or since the change in TC is always $100, and you calculated MP (which IS
the change in Q), you can simply divide $100/MP to get MC.
e. MP & MC: When MP is rising, MC is falling. Also the
reverse--when MP falls, MC rises.
f. When the Marginal cost
is less than the total cost, ATC is falling. When MC is greater than ATC,
ATC is rising. We can also see this in the graph.
Notice that the MC curve does in
fact cross the ATC curve at the minimum of the ATC curve (when we draw the MC
point 'between' the two outputs).
4. Mankiw
P&A #9
As shown by the minimum of the ATC, the efficient scale for Vinnie's painting
business is 4 houses.
1. The characteristics of Perfect Competition:
- many buyers and sellers
- goods are largely the same
- free entry & exit
cola &
beer are certainly
not Perfectly Competitive,
- they both violate the "same goods" assumption.
- People are Pepsi drinkers or Coke drinkers and have a
definite preference.
- These same "branding" occurs with beer as
well.
tap water is probably not Perfectly
Competitive.
- there are not many sellers of tap water
- usually this is a "natural monopoly" set up by
the municipality
- there is also a big barrier to entry, since you'd have
to put pipes into everyone's house to deliver them tap water.
bottled water is probably the best example of a
Perfectly Competitive firm
- There are many buyers & sellers
- Water tastes basically the same. Some people will
say that one brand tastes better than the other, but the differences in
water are clearly NOT as large as the differences in colas or beers.
- There are no major barriers to entry. . .you need only a
bottle supplier and a source of water.
2. Mankiw
P&A #6
a. Profit = TR - TC. This firm maximizes profit when they produce
either 5 or 6 units of the good.
b. MR = change in TR
(since the change in quantity is always 1), MC = change in TC (since the
change in quantity is always 1) These curves cross between 5 and 6, which
is the profit maximizing answer that we found in part a.
c. This firm is in a perfectly competitive industry because the Marginal
Revenue = Average Revenue = P.
This firm is NOT in a long run equilibrium, because a Perfectly Competitive
firm earns zero profits in the long run.
3. a. The short-run
equilibrium of a perfectly competitive firm that is making a positive
profit. The shaded yellow area is the profit.
b. The short-run equilibrium of a perfectly competitive firm that is
making a negative profit. The shaded red area is a loss.
c. The short-run equilibrium of a perfectly competitive firm that should shut
down. The shaded red area is a loss.
d. When price is above the
minimum of ATC, the firm always make a positive profit, because the additional
revenue per unit is greater than the cost per unit. When price is below the
minimum of AVC the firm should shut down, because it cannot even cover its
variable costs.
4. Which characteristic of
perfect competition is responsible for zero profits in the long run? FREE
ENTRY & EXIT
If there are firms making profits
- other entrepreneurs will want to ENTER the market.
- This INCREASES SUPPLY in the market
- which DRIVES DOWN PRICE
- This LOWERS MR and lowers profits
- Entry will occur until the price falls enough that firms
are no longer making positive profits (Price equals the minimum of ATC).
If there are firms making a loss. . .
- some entrepreneurs will want to EXIT the market.
- This DECREASES SUPPLY in the market
- which DRIVES PRICE UP
- This INCREASES MR and decreases the loss that any firm
will make.
- Exit occurs until the price rises enough that firms are
no longer making a loss (Price equals the minimum of ATC).
5. Mankiw P&A #3.
a. The marginal cost of a string is $0.30.
- remember that for competitive industries, the
equilibrium is where MC = MR, and MR = P.
- Here, we are TOLD that the industry is competitive and
that the price is $0.30.
- So MC MUST be $0.30 as well.
b. The
industry is NOT in a long run equilibrium,
- because each firm will make a positive profit
(competitive firms make zero profits in the long run.)
- price of $0.30 is greater than the average total cost of
$0.20, so profits will be $0.10 times how ever many strings an individual
firm sells
1 & 2. Mankiw Q4R #4 & 5.
- The monopoly price and quantity are Pm and Qm, where Marginal
Revenue = Marginal Cost.
- The competitive price is Q*, where Demand = Marginal
Cost.
- The deadweight loss from monopoly is the purple
triangle. This is the area between the demand and marginal cost
curves over the quantity that is produced by the PC firm that is NOT
produced by the monopoly.
3. Mankiw P&A #1.
a. See table below for
numbers. . .
TR = Price times Quantity
TC = FC + VC = $2 million + ($10 * Quantity)
Profit = TR - TC
A profit maximizing publisher
would choose to produce 500,000 books at a price of $50. (Notice that the
monopolist is indifferent (makes the same profit) at a price of $60 and
quantity of 400,000. The economists prefer the higher quantity. . .
it allows for greater consumer surplus.)
b. See table above for Marginal
Revenue. In this case, Marginal revenue is always less than price.
This is normal for a monopolist.
c. See the graphs
below. Marginal Cost was a constant $10 per book, so it just a horizontal
line at $10. Units on the x-axis are in 100,000's.
As seen below, the MC and MR
curves cross between 400,000 and 500,000 books. This is the profit
maximizing quantity for this monopolist.
d. The deadweight loss is
the purple triangle above. This is the area between the Demand and
Marginal Cost from the quantity that the Monopolist produces to the Competitive
quantity (900,000).
The deadweight loss is the loss
of total surplus to society, which results from the monopolist restricting output
below the efficient quantity.
e. If the Fixed cost rose
from $2 million to $3 million, only the Total Cost and Profit figures would
change. Each of the TC numbers would rise by $1 million and each of the
Profit numbers would fall by $1 million. This leaves Marginal Cost AND
Marginal Revenue unchanged, meaning that the Monopoly price and quantity will NOT
change.
f. If the publisher wanted
to "maximize economic efficiency" they would be acting as a perfectly
competitive market. They would produce where P = MC. Since MC = 10,
they would produce at a price of $10, and publish 900,000 books. In doing
so, they would be earning a loss of $2 million.
4. Mankiw P&A #9.
Since Placebo Drugs holds a
patent, they are by definition, a monopolist in this market.
a. This is the basic
monopolist graph. Quantity is determined by the intersection of MC and
MR. Then Price is off the demand curve at the monopoly quantity.
Profits are the difference between price and ATC at the monopoly quantity, over
all units that the monopolist sells.
b. A PER BOTTLE tax will
increase the marginal cost (as it did in our restaurant experiment). A
higher MC, means that the new intersection between MC and MR is at a lower
quantity. A lower quantity will mean a higher price. (The old price
& quantity are where the grey dashed lines are. The new price &
quantity are the solid lines.)
c. This was tricky.
The tax definitely reduces profits. Think of it this way. . .the could
have produced the old quantity when the tax was Not imposed. However,
that was NOT a profit maximizing quantity. So (irrespective of the tax)
the profits at the quantity from part a were MORE than the profits from part
b. Then. . .they have to take into account the additional costs from the
tax. So profits are lower to begin with at the lower quantity, plus they
have to give up more profits to pay the tax.
d. The "lump sum"
tax, or fixed amount, does not influence price or quantity to change, but only
changes the Average Total Cost and Profits. Basically, the fixed tax
amount is a Fixed Cost, and will not change our Marginal cost OR the Marginal
Revenue. Since the old MC is the same as the old MR, the maximizing
quantity is the same as in part a. Price will also be the same because
the quantity does not change.
However, profits WILL be lower
with the lump sum tax. They still earn the same Total Revenue (b/c same P
& Q) , but Total Cost rises (b/c FC rises), lowering profits.
Mankiw P&A #12
a. First, the patent gives this drug manufacturer a monopoly, so it
prices the good as a monopolist does. Total surplus is the sum of
consumer surplus and Producer surplus, which is the difference between the
Demand curve and the "Supply" curve (Marginal Cost, for the
monopolist), over the goods that the monopolist sells.
b. If the firm can
perfectly price discriminate, the consumer surplus and deadweight loss
disappear. These both become additional producer surplus. . .such that it
is easy to see that both producer surplus and total surplus rise.
2. P&A #16
a. See the graph. Pm
is the monopoly price without price discrimination.
b. Areas X (monopoly
profit, light blue), Y (Consumer Surplus, yellow), and Z (Deadweight loss,
Purple) are shaded above.
c. If the monopolist can
perfectly price discriminate, the monopolist profits are X + Y + Z
d. The change in monopoly
profits due to price discrimination is (Y + Z). The change in total
surplus is Z (the deadweight loss is gained).
The
change in monopoly profits is larger, so long as Y > 0. (Because Y + Z
has to be larger than Z when Y is positive.)
e. Monopolist pays a fixed price C to price discriminate.
They
will earn X if they choose not to price discriminate.
They will earn (X + Y + Z) - C if they choose to price discriminate.
This
implies that the business WILL bear the fixed cost to price discriminate
IF: (X +Y + Z) - C > X (the earnings from PD
> earnings from not discriminating)
Simplifying.
. .the X drops out of both sides, so if (Y + Z) > C then the monopolist WILL choose to price discriminate.
f. Now we look at Total Surplus (instead of monopoly profits)
If
the monopolist does NOT price discriminate, then Total Surplus is X + Y
If the monopolist DOES price discriminate, then Total Surplus is (X + Y + Z) -
C
So
the social planner will have the monopolist price discriminate only IF:
(X + Y + Z) - C > X + Y.
Simplifying
here is different. . .both the X and the Y drop out. So the Social
Planner will have the monopolist price discriminate when Z > C.
g. There is a difference in outcomes when (Y + Z) > C > Z.
Or
in Layman's terms, when the Cost to price discriminate is bigger than the DWL,
but not bigger than the sum of the DWL plus the Consumer Surplus under the
single price monopoly. In this case, the Social planner WOULD NOT have
the monopolist price discriminate, but the Monopolist making his own decision
WOULD choose to do so.
So
the Social planner has a smaller incentive for price discrimination than the
monopolist acting alone does. The monopolist might price
discriminate, even if it is NOT socially optimal.
Mankiw P&A #2.
a. "many
suppliers" implies perfect competition. For PC firms, MR = P.
Since the Marginal Cost is $1,000 per diamond, MR = P = MC at a price of $1,000
and a quantity of 12,000,000 diamonds.
b. "only one
supplier" implies monopoly behavior. For a monopoly, we need to
calculate TR and MR for each price. See the table for these figures.
For
the monopolist, MR = MC at a price of $7,000 and quantity of 6,000.
c. the cartel would split
the monopoly quantity and sell at the monopoly price. So price is $7,000
and
In
this case,
If
d. Since
1. Mankiw P&A #1.
Basically asked yourself the following.
. .
1. Are there many
sellers or only one seller?
If you respond that there is only
one seller. . .Then it is a Monopoly.
2. Are the goods the
same? Or are they different?
If there is no difference, it is
Perfectly Competitive. If there are differences in taste, quality, brand
names, etc, then it is Monopolistically Competitive.
a. Pencils--Perfectly
Competitive--there are a large number of manufacturers of pencils. . .and they
are all pretty much the same.
b. Bottled Water--Monopolistically
Competitive--Water is mostly the same. However, some people will
argue that some bottled water tastes better than others, so it could be
considered a Monopolistically Competitive industry. If you make the
assumption that all bottled water is exactly the same, then it would be a
Perfectly Competitive industry.
c. Copper--PC--All copper
is identical (it has a scientific formula, no?) and there are a large number of
producers.
d. local telephone
service--Monopolistic (in the vast majority of markets)--when you don't have
mega-populations, like in NYC, telephone service is a natural monopoly:
it is cheaper for one firm to supply all of the output.
e. Peanut
Butter--Monopolistically Competitive--because different brand names exists
(Peter Pan, Skippy, etc.) that have different quality characteristics.
f.
Lipstick--Monopolistically Competitive--lipstick from different firms differs slightly
(stays on longer, better choices of colors, etc), but there are a large number
of firms that can enter or exit without restrictions.
2. Mankiw P&A #4
a. See the graph
below. Qmc and Pmc are the profit maximizing output and price for Sparkle.
b. Sparkle's profit is zero, because price equals the average total cost.
c. Consumer surplus (CS) and Deadweight Loss (DWL) are shaded below.
d. If Sparkle was forced to
produce at the efficient level of output, the firm would end up exiting the
market in the long run. The efficient level would be where Demand equals
Marginal Cost. At that Quantity, Price is lower than Average Total Cost,
and Sparkle would lose money. Therefore, they would exit, rather than
make negative profits year after year. Sparkle's customers would lose
their consumer surplus, because they would be unable to buy anymore of
Sparkle's toothpaste.
3. Mankiw P&A #5.
a. The dominant strategy
for the
b. Nash Equilibrium is a
situation where economic actors interacting with each other choose their best
strategy given the strategies that all the other actors have chosen. The
NE for Trade Policy is one in which both countries place high tariffs,
resulting in a lower outcome for each country.
to think about it more slowly. .
.
1. If the US was Definitely going to charge LOW tariffs. . .Mexico would
rather charge high tariffs and get $30 billion (instead of $25 billion.)
2. If the US was Definitely
going to charge HIGH tariffs. . .Mexico would rather charge high tariffs
and get $20 billion (instead of $10 billion.)
3. If Mexico was Definitely
going to charge LOW tariffs. . .the US would rather charge high tariffs
and get $30 billion (instead of $25 billion.)
4. If Mexico was Definitely
going to charge HIGH tariffs. . .the US would rather charge High tariffs
and get $20 billino (instead of $10 billion.)
So the dominant strategy of both
countries is to charge High Tariffs.
c. Yes, NAFTA is
justifiable, given the game presented above. Only when barriers are
reduced simeltaneously, will both countries agree to the change. Neither
one would reduce tariffs unilaterally, because they would lose $10
billion. However, by reducing the tariffs at the same time they
will both gain $5 billion.
4. Mankiw P&A #8.
a. Decision box below.
b. The Nash Equilibrium is
the situation where both airlines offer a low price, which results in low
profits for both firms.
to think about it more slowly. .
.
1. If Braniff was Definitely going to charge a LOW price. . .American
would rather charge a low price and get low profits (instead of very low
profits).
2. If Braniff was
Definitely going to charge a HIGH price. . .American would rather charge a low
price and get high profits (instead of very medium profits).
3. If American was
Definitely going to charge a LOW price. . .Braniff would rather charge a low
price and get low profits (instead of very low profits).
4. If American was
Definitely going to charge a HIGH price. . .Braniff would rather charge a low
price and get high profits (instead of very medium profits).
So the Dominant strategy for both
firms is to charge a low price.
P&A 3.
No, time and actions are generally better indicators for love. Words are CHEAP and thus some people
overuse them. To be effective, the
signal must be costly.
P&A 4.
If HIV+ status can not be asked on an insurance application, it helps
those who are HIV+ and hurts those who do not have the virus. Those who are HIV+ should be paying
higher rates for insurance because of larger health care and medication costs
incurred by those who are ill.
However, as it stand, the non-HIV+ people end up paying higher rates to
cover those that are HIV+. As this
increases price, it will decrease the number of people with health
insurance. Specifically, the
healthiest will drop out, leaving insurers a less-healthy group of claimants.
P&A 6.
This violates the Independence of Irrelevant Alternatives. The availability of Strawberry as
an option should not change the person’s preference for Vanilla over Chocolate.
P&A 9.
This is a deviation from rationality, as it is time inconsistent. They might have meant to get insurance
earlier, but never got around to doing so. When the event struck close to home (even if they were
unaffected), it was enough to remind them (or scare them) into getting
insurance.