Economics:Model Answers

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This contains all the model answers for the Economics course. For specific model answers for each lecture, see Economics_Lectures.

Model Answers in bold:

Contents

Lecture One Assignment

Introductory: 1. In three sentences or less, what do you hope to learn in this course?

To learn how businesses try to make money and how consumers try to keep money.

2. Give two short examples each of “normative statements” and “positive statements.”

Positive: fish live in trees. (NOTE that a positive statement is a factual claim that need not be true.)

Normative: people should eat less fast food.

3. Describe a few transaction costs associated with buying something.

Spending time looking for a store that sells it, and then spending more time look for the store that sells it at the lowest price, and then spending money and traveling to the store to buy it.

Intermediate: 4. Give some examples of scarcity created entirely by man (rather than nature), such as a ticket on the maiden voyage of the Titanic. Why do people create and emphasize scarce things? Does the illusion of scarcity increase the price? Does television prefer talking about scarce items? Why?

The office of President of the United States.

Tickets at the Super Bowl.

Being the first man to step foot on the moon.

5. What do you think are the main reasons that the “invisible hand” is preferable to government dictating how a pencil should be made? Rank your reasons in order of importance.

1. The invisible hand motivates people to work harder.

2. The invisible hand motivates people to reduce waste.

3. The invisible hand motivated people to invent and create.

4. No single entity, such as government, is smart enough at planning.

5. The invisible hand can adjust to change more quickly than government.

6. Why can volunteer work sometimes be more efficient and productive than hired labor? Where is the invisible hand for volunteer work?

Charity provides religious and spiritual rewards, which can be an even greater motivator than money. Also, there are fewer transaction costs in charity, as fewer people are trying to make money as middlemen.

Honors: Write an essay of about 300 words on one or more of the following topics:
7. Read the account of the multiplication of the loaves by Jesus. Matthew 14:13-21. After reading that, do you think scarcity really does exist?

Maybe not. It didn't on that day with Jesus. Perhaps scarcity is a human illusion, and the result of turning away from God.


8. What is money, really?

Perhaps it is only a form of speech. Often it is given more meaning than it really has. People who win the lottery end up worse off than those who lose.


9. Should spending money be protected by the free speech clause?

Yes, because otherwise politicians are censoring valid criticism of their work.


10. Does the U.S. Constitution protect private property?

Yes, such as the Fifth Amendment.

Lecture Two Assignment

Introductory: 1. In a free market, the price and quantity at which goods are sold are where __________ equals ___________.

supply equals demand

2. Suppose the price demand curve is P = $20 - Q, where P is price and Q is quantity. Also suppose the price supply curve is P = $4 + Q. At what price and quantity will the good be sold?

The good is sold where supply equals demand. That means the supply P must equal the demand P, and the supply Q must equal the demand Q. This can be found by graphing the above two equations and seeing where they intersect, or by solving them by setting P to the same value in both:

P = $20 − Q
P = $4 + Q

Therefore

20 − Q = 4 + Q
20 = 4 + 2Q
4 + 2Q = 20
2Q = 16
Q = 8

Plugging this back into the first equation gives P:

P = $20 − Q = $20 − 8 = $12

Checking our work, we plug this P and Q into the second equation:

12 = 4 + 8 = 12

Answer: Q = 8, P = $12

Intermediate: 3. Draw the supply and demand for air. In addition, draw the supply and demand for a good that costs $10000000000000000000000000 trillion dollars.

The demand curve for air must be at a zero price, which is the x-axis (P=0 everywhere, although note that if the quantity of air ever approached zero then the demand price would sharply increase as people would pay to survive). The supply curve for air must be at fixed quantity, and hence a vertical line. They must intersect at P=0, Q=amount of air in the atmosphere:

Air supply and demand.jpg

Note, however, that air is not a scarce good, and that is why its supply and demand curves are so unusual and nonsensical.

The point where supply equals demand for an extremely expensive good must be at low quantity Q. From there the supply curve would slope upwards, and the demand curve would slope downwards:

Expensive good supply and demand.jpg

(thanks to Kevin for both graphs above)

4. Suppose 1000 persons in a town each have the following weekly demands for gas, and the gas stations have the following weekly supplies:


Gallons Demand Price/gallon Supply Price/gallon
10 $2.50 $.50
20 $2 $.75
30 $1 $1
40 $.75 $1.50

(A) What is the price and overall quantity of gas sold each week?

The price and quantity at which the good (gas) is sold is where supply equals demand. That means that the P for supply equals the P for demand, and the Q for supply equals the Q for demand. Looking at the above table, where do both the P and Q for supply equal the corresponding P and Q for demand? That occurs on the third line above: Q equals 30 for both supply and demand, and P equals $1 for both supply and demand. The answer is there: P=$1, Q=30.

(B) Suppose Congress declares war and imposes a price control of $.75 per gallon. At what price and overall quantity will gas sell each week?

When price P is fixed by the government at $.75, then what is the corresponding Q supply and demand? Looking at the table, the corresponding Q in the supply column is 20 gallons, and the corresponding Q in the demand column is 40 gallons. The lower number is what matters, because nothing can be bought unless it is both supplied and demanded. So the supply is 20 gallons and that is what is sold at $.75 per gallon. That is 20 times 0.75 = $15 per person, or $15,000 for the whole town. Some may try to buy and sell gas illegally at a higher price, as illegal markets often develop when there are price controls.

5. Suppose the government limits the supply of Toyota cars that can be imported in 2008 to a certain quota. What effect does this have on the supply curve, and on the equilibrium price? Who is helped by this import quota, and who is hurt? Be as specific as possible.

Import quotas cause the supply curve to shift upward, and for the equilibrium where supply meets demand to shift to less quantity at a greater price. the consumers are hurt by import quotas, and everyone pays more for the cars and some people who wanted the car at its lower, free market price, cannot buy it at the higher price. Sellers of Toyota cars are helped because they make bigger profits per car sold, although they cannot sell as many as before.

6. Suppose you went to see the opening of your favorite new movie, but it is sold out. However, there are four independent scalpers are (illegally) reselling their tickets outside. Four strangers are each willing to pay the scalpers at most $15, $10, $9 and $8 for a ticket. The scalpers are initially willing to sell each of their tickets for at least $7, $8, $9, and $12. The eight of you get together and bargain, and then tickets are sold at a common price. What is the price and how many tickets sell at that price? Should scalping be illegal in New Jersey?

One customer (C1) is willing to pay $15. Another customer (C2) is willing to pay $10. Likewise, customers C3 will pay $9 and C4 will pay $8. One scalper (S1) scalper willing to sell for $7, scalper S2 will sell at $8, S3 will sell at $9, and S4 at $12. C1, C2, and C3 will all be willing to buy tickets from S1, S2, and S3 at $9. S4 is not willing to sell at the price, and C4 is not willing to buy at the that price, so both choose not to deal. Three tickets are thus sold at the "common price" or market price of $9 each.

Scalping is a form of free market activity. If there are willing buyers and sellers for the tickets, then why interfere with these sales? Scalping is illegal in New Jersey, but still happens illegally.

Honors: Write an essay of about 300 words total on one or more of the following topics:
7. Should government regulations require and monitor honest and full disclosure of information by sellers to buyers?

For the buyer to make informed decisions, he must have information. Even "buyer beware" (caveat emptor) assumes a buyer who can find information. The seller has the information, and regulations requiring it to tell the buyer seem helpful to free enterprise.


8. Should price discrimination be illegal?

For banning price discrimination: a common price encourages more economic activity.

For allowing price discrimination: if buyers and sellers are willing to exchange at different prices, doesn't this maximize overall benefit?


9. What is an economic incentive for excluding homeschooled athletes from high school sports? Should that be legal?

By banning homeschoolers from sports, public and private schools are encouraging students to enroll in their schools. That brings them more money.


10. Describe your view of if or how government should regulate medical prices.

It shouldn't. Price controls, as illustrated by the gasoline problem above, results in shortages.


11. “Economic theory of law and the public domain - When is Piracy Economically Desirable?” See http://lexnet.bravepages.com/media1.html

Piracy of information can increase market activity. Napster caused much additional traffic on the internet in the late 1990s, and this helped the dot-com boom. But copyright violations are illegal in order to encourage the creation of new works. It is a delicate policy balance between promoting market activity now and promoting creative works for future benefit.

Lecture Three Assignment

Introductory: 1. In a free market, the responsiveness of demand to a change in price is known as its ____________.

Price elasticity of demand.

2. A good that is addictive often has (elastic or inelastic) demand for it. Choose the correct answer.

Inelastic.

3. Give examples of a complement and a substitute for breakfast eggs.

Complement for eggs: ham, bacon, toast, sausage, cheese, salt, pepper.

Substitute for eggs: oatmeal, french toast, pancakes, cereal.

Intermediary: 4. Describe a perfectly elastic demand curve, and a perfectly inelastic one.

Perfectly elastic: a horizontal line. Perfectly inelastic: a vertical line.

5. If the demand curve is a straight line having negative slope (i.e., increasing quantity as price decreases), then draw or describe the shape of its curve for price elasticity of demand:

The point here is that the price elasticity of demand changes depending on where you are on the straight-line curve, because price elasticity is a ratio of the percent change in quantity demanded to a percent change in price.

6. Describe what a negative income elasticity of demand means. Give an example of a good or service that might have a negative income elasticity of demand.

Negative income elasticity of demand refers to a good whose demand becomes less as people's income goes up. That is because it is a good that is a cheaper version of something. An example of a good that has a negative income elasticity of demand is generic drugs. As people’s income goes up, they will be more willing to pay extra for the brand name drugs. However, it is true that people are forced to pay for the brand name drugs until the original patent runs out. (thanks to Kevin for that)

Honors: 7. Suppose the demand for a special type of colored corn is inelastic. Suppose there was a disease that uniformly killed 20% of all the cornstalks, but did not affect demand at all (i.e., the public was not scared by the disease). Explain if corn farmers are better or worse off due to the disease, and why.

Farmers are better off, because the price increases and so do their profits.

Write an essay of about 200 words total on one or more of the following topics:

8. Should there be a minimum wage law?

9. Does free trade add value or simply redistribute wealth?

10. Is economics almost always determinative of the outcome on political issues, such as elections?

Lecture Four Assignment

Introductory: 1. The total utility of a good represents the consumer’s _________________.

satisfaction

2. Conservatives say a bad effect of raising the minimum wage is that it causes more students to drop out of school. Why would that happen?

Students are often paid the minimum wage, and the higher that is, the more attractive jobs are to students. More students will want quick money now rather than stay in school and delay their ability to make (more) money later.

Intermediary:

3. A student likes swimming and playing the violin. The first hour she swims she improves by 6 units of utility, and then each successive hour she improves by half the rate of the hour before it. The first hour she practices the violin she improves by 4 units of utility, then each successive hour she improves at a rate of 90% the hour before it. In 3 total hours to practice, how should she maximize her utility?

Her first hour is best spent swimming, to gain 6 units of utility. But her utility from swimming a second hour would be only half, or 3 units. She earns more utility by playing the violin, gaining 4 units of utility. The third hour she has a choice between 90% x 4 = 3.6 units of utility from playing the violin, or 3 units of utility from swimming. She maximizes her utility by playing the violin.

4. How might one’s overall “utility” include religious goals that have nothing to do with money? Be specific.

Spiritual benefits can be part of one's utility. By helping others, it can advance utility with respect to God.

5. Suppose you manage a golf course for profit. You poll your customers and find that, each month, they value their first game at $30, their second game at $20, their third at $10, fourth at $0, and refuse to play any more in the same month. It is impractical to charge based on whether someone has previously played a round this month. How do you best charge your customers?

It's best to offer a monthly package

6. Bad British economic policies and a fungus wiped out the basic food supply of potatoes in Ireland between 1846 and 1849, killing 500,000 and sending many Irish to the United States. Do you think potatoes might have been an “inferior” good then? What would you expect the income effect of the shortage of potatoes to have been?

An "inferior good" is one that has increasing demand as income decreases. As income decreased in Ireland, it is easy to imagine greater demand for potatoes because that is all people could afford.

The income effect is the increased demand for a good, when its price decreases, due to the consumer having more cash (more real income) from the price decrease. The consumer has more money to spend when the price of the good declines, and he uses some of that extra money to buy more of the good. This effect is larger for goods that consumers depend heavily upon, such as certain foods and gasoline.

Honors:

7. Do you think a Giffen good really exists? Can you see any possible political bias in the claim that Giffen goods exist? Your views, please.

8. Suppose you are a rational consumer who makes purchases by maximizing marginal utility. One day you hear that the price on a good you purchase (e.g., milk), falls by 30%. The Law of Demand says you should buy more of it. Using only the assumption that you maximize marginal utility, prove the Law of Demand as best you can.

Proof of the law of demand (If the price of ‘a’ decreases then the demand for ‘a’ increases) is found through the law of equiproportional marginal benefit (MUa/Pa=MUb/Pb=MUc/Pc). When the price of good ‘a’ decreases (Pa decreases) the Marginal Utility of good ‘a’ (MUa) must also decrease to keep MUa/Pa equal to MUb/Pb and MUc/Pc. To decrease the marginal utility of good ‘a’ you (and all other rational consumers) buy more of it, and this increases the demand for good ‘a’. Therefore if the price of good ‘a’ decreases the demand for good ‘a’ increases. (thanks to Tim S. for that answer)

9. Suppose a friend of yours announced that when he has a choice between a cheaper good made in China and a more expensive good made here, he will buy the latter based on his opposition to communism. Is he being irrational?

Lecture Five Assignment

Introductory: 1. Your boss asked you to work overtime. Is that a short-run or long-run solution for him?

A short-run solution.

2. Explain briefly economic “efficiency”. Give an example of something that is efficient, and something else that is not.

Efficiency is the optimal use of time and resources. It has zero waste.

Homeschooling can be efficient. Public school is not.

Intermediate: 4. Your widget company has the following costs: Producing 10 widgets, your costs are $2000. Producing 8 widgets, your costs are $1800. Producing 6 widgets, your costs are $1500. Producing 4 widgets, your costs are $1200. Producing 2 widgets, your costs are $800. Producing 0 widgets, your costs are $400. What is your fixed cost? What is your MC for widgets 7 & 8? What are your average costs for producing 4 widgets?

The fixed cost is $400. The marginal cost for widgets 7 and 8 is $150 apiece, or $300 total. The average cost for producing 4 widgets is $300 per widget.

5. A regulator had to choose new regulation A or B: (A) imposed substantial new transaction costs on consumers, while (B) did not. Which option would the Coase Theorem tend to prefer? Say why.

The Coase Theorem states that the efficient result occurs when there are no transaction costs. Therefore the Coase theorem tends to prefer the absence of regulations, or option (B).

6. Explain why a businessman fixes his production or supply of goods at the point where his marginal cost equals his marginal revenue.

If marginal revenue (MR) exceeds marginal cost (MC), then the businessman should sell even more goods to make more profits. If MR is less than MC, then the businessman is losing money with each good and should sell less.

7. Explain the difference between marginal cost and average cost.

Marginal cost is a firm's additional cost for supplying one more good. Average cost is the firm's overall cost for supplying all his goods, averaged over the number of goods he supplies.

Honors: Write a 300-word essay on one or more of the following:

10. Democratic politicians complain about the gap between the rich and poor. Would the economy work any better if the gap were smaller? Assume the absence of transaction costs.

According to the Coase Theorem, this gap is meaningless.

11. The Fifth Amendment says “nor shall private property be taken for public use, without just compensation.” How does that benefit the economy?

The invisible hand is better than government planning, and this protects property for the power of the invisible hand.

12. “The pen is mightier than the sword.” Assuming that the sword is used mainly to seize property, explain a purely economic justification for that statement.

"While the sword can only be used to seize, kill, and destroy, the pen can be used to persuade, educate, and invent. Because of the destructive nature of the sword, the sword is wholly dependent upon what has or will be constructed. The sword can not sustain itself without seizing the property of others, and therefore is inherently dependent upon the pen. If the sword tries to take too much, then the people will despair, and cease producing, causing the sword to starve to death. On the other hand, the pen is not even limited to producing goods. The pen can also be used to persuade the people. For example, the pen can be used to convince the people to revolt, and kill the bearer of the sword, or to stop producing any more than they absolutely need to survive and by doing so to starve the sword to death." (thanks to prior student Eric J. for that)

Lecture Six Assignment

Introductory: 1. “Accounting profit” is ________ minus _________.

revenue minus explicit costs

2. Suppose your company spends $10,000 on labor and $30,000 on equipment for an output of 5000 widgets. You increase your labor costs to $15,000 and your equipment costs to $45,000, and your output increases to 8000. Describe your return to scale: increasing, constant, or decreasing?

This is increasing returns to scale, because your output increased by a larger percentage than your inputs did.

Intermediate: 3. Suppose the population doubled and the other utilized economic inputs (air, water, capital, etc.) doubled as needed. What would happen to economic output, such as new inventions and food production? In other words, what is the return to scale from increasing population (labor) and other inputs?

Should be increasing returns to scale due to the increased number of inventions and advances in technology by the larger population. Other views accepted, but it is incorrect that there is any shortage of land in the world.

4. Suppose you hire an employee who just took this course, and he says you should invest everything you have in a new facility to reap long-run efficiencies. Why might you say “no”?

This suggestion is risky. We need to know more about the market demand. We need to know whether we have increasing, constant, or decreasing returns to scale. We need to know if Wal-Mart is going to move into our market! As in real life, the best answer is this: we need more information before deciding.

5. In an online encyclopedia such as Wikipedia or Conservapedia, would you say that the marginal product of adding another contributor (editor) increases or decreases? What does that imply about the growth path of the project?

The instructor's view is that marginal product increases with each additional editor, because they can cross-link to each other's articles, discuss ideas with each other, and enjoy the cite more. On Wikipedia, about 410,000 articles were created in the first 5 years, but in the last two years 1.3 million articles have been created. We don't know how many editors they have had but I would guess that marginal product of an additional editor is greater the bigger the project is.

6. Is obtaining a medical, legal, accounting or other type of license to practice in a profession a short-run or long-run cost? Should the State require licenses for professions?

This is a long run cost. Most students said that state licensing is good. The instructor is skeptical: why not let the invisible hand handle this?

7. Suppose your classmate’s company grew and grew, until it had 1 million employees. But then the economy had a downturn, and you faced bankruptcy. You were in the legislature and your classmate begged you to sponsor legislation to give his company a special zero-interest government loan to make it through the tough times. Should you?

This was a debate topic in class, with one side arguing that if the business was valuable then private money would save it, and if not then it is a mistake to give it taxpayer's money. The other side argued that it was beneficial to the economy to save the jobs. The panel ruled against the government giving the company assistance.

Honors:

8. Suppose you invented fertilizer that is costly to make but has an ever-increasing marginal product. Suppose you own an acre of farmland in South Jersey, and now must decide between spending your money on buying more acres to use the fertilizer, or making more fertilizer. Which should you do? Explain.

9. A company’s stock price often rises when it announces taking a large one-time write-off (or loss) on its accounting books. Using one or more principles learned in this course, can you explain reasons for that effect on the stock price?

10. The tremendous economic growth of the 1980s and 1990s resulted from the “supply side” economic policies of President Ronald Reagan, which boosted production by cutting taxes and encouraging investment. Why might the supply side be more important than the demand side?

Lecture Seven Assignment

1. The best friend of free enterprise is ___________.

Competition.

2. Describe how you can use competition to help motivate yourself to accomplish a goal.

Trying to be the best in the class, or simply improve over how you did in a prior class or earlier homework or exam.

3. Until Conservapedia.com began, Wikipedia.com did not have any competition. What often happens to a firm or service when there is no competition? Why?

Without competition, motivation and quality decline. Inefficiency increases. People have less of a reason to try. A famous slogan of the car rental company Avis was, "We're number two. We try harder.

Intermediate: 4. Suppose you own a widget factory having fixed costs of $10,000. In addition to the $10,000, you have variable costs of $2,500 for each widget you make. Worse, the factory can make only 3 widgets in an entire year! Your widget sells for $5,000. Someone offered to buy your factory for $10,000. Should you sell it?

It depends on what portion of the fixed costs are recurring. There is a profit of $2,500 on every widget that is made, or $7,500 for each year. If less than $2,500 of the fixed costs are recurring on an annual basis (e.g, rental payments), then you would have an annual profit.

5. One day, you visit Wal-Mart to see if you can sell it some widgets. Wal-Mart said it has good new and bad news. The good news is that it wants high volume. The bad news is that it wants a price so low that your MC=MR for every unit sold to it. Should you agree? Explain.

Yes, you probably should agree. Even though your company is not making profits on this, Wal-Mart is paying for your costs (including salaries and advertising).

6. Suppose you own a company that has marginal cost (MC) = $9, average total cost (total cost divided by total output) = $11, average variable cost (average cost of variable inputs, like labor and materials) = $5 and price of the sold good (P) = $8. Should you make any additional goods at these numbers? Should you shut down your company?

Because MC>P, don't make any more goods. But don't shut down the company either, because P exceeds average variable cost. The owners are doing better than if they shut down.

7. Suppose you are running a dinner event at a free facility that has 24 tables seating 8 apiece. Your marginal cost (MC) is $15 per person. Suppose your speaker costs $3500 in fees and expenses. Suppose your demand curve is this: at price P=$15, quantity Q=200; at P=$35, Q=120; at P=$50, Q=70; at P=$60, Q=40; at P=$150, Q=7. How would you price and market your tickets?

The total cost at capacity seating is $3500 plus (24x8x$15=$2880) = $6380. P=$35 does not attract enough people to cover that expense. Only price discrimination, or charging different people different amounts, is going to reach the goal. We would charge for one person $150 and we would draw a maximum of 7 people for revenue of $1050. Perhaps they could sit with the speaker. For a couple or two people we could charge $50 each and we would draw 70 couples for revenue of $3500. Perhaps those couples could receive preferred seating and also meet with the speaker. For a group of four or more we would charge $35 each and we would get 120 people for revenue of $4200. With this approach we might be able to cover expenses and even have some money left over.

Honors:

8. “One of the greatest benefits of competition is accountability.” How?

Those who waste time and money are defeated by the competition.

9. Describe an industry where you think competition is nearly perfect, and another industry where competition is far from perfect, and explain why for both.

Competition in the stock markets and dairy industry is nearly perfect. Competition in cable television and education is far from perfect.

10. Is competition always a good thing?

Competition is usually a good thing, but not when it leads to wrongful conduct.

Lecture Eight Assignment

Introductory 1. A monopoly can be extraordinarily profitable because there is no __________.

competition

2. Provide three specific examples of monopolies and describe briefly what they do.

The United States Postal Service, which delivers mail; Microsoft, which sells Windows and application programs; the public school system, which pretends to educate students.

3. Given an example of how you lose time, money, or efficiency due to a specific monopoly.

The post office closes at 4:30 pm when most businesses stay open later, and this causes a loss in efficiency when we need to receive service afterwards.

Intermediate 4. “Monopolies may be bad, but government regulations of monopolies are even worse!” Do you agree? Explain.

According to the invisible hand government regulations on monopolies are worse than monopolies themselves. Suppose a monopoly is extravagantly taking advantage of the consumers by raising prices and such. There are two possible actions to take, have the government regulate the monopoly or allow the monopoly to run its course. At first the government regulations seem to be the better option, this, however, makes the monopoly acceptable and is only a short term solution. The monopoly is no longer extravagantly taking advantage of the consumers, but still the monopoly exists and it is taking advantage of its monopoly. Suppose the monopoly was allowed to run its course. If the consumers saw that it needed regulating, then they already know that the monopoly is taking advantage of them. The monopoly will get more and more inefficient and cost the society money. Rational consumers will soon stop purchasing the product that the monopoly has to offer or more likely someone will start up competition of the monopoly and the consumers will buy from them. Since the consumers already dislike the once monopoly they would purchase from the new competition instead. This in turn would encourage others to compete in the market, thus ending the monopoly on the industry. (thanks to Kris. T for that answer)

5. List ways that monopolies can be established.

Monopolies are established by operation of law, by licensing of professionals, by control of valuable resources, by large economies of scale, and by government-granted patents and copyrights that prevent selling substitutes.

6. Suppose Katie likes to paint for money or even for free, but will not pay extra to paint. Suppose also that the monthly demand for her paintings is P = $500 - 50Q. How many paintings does she create each month?

She paints 5 a month. We find this by determining what Q is when P=0, and taking half of that in order to find where MR=0.

7. List some differences between a monopoly and a competitive industry.

In a monopoly there is no competition, which is the #1 qualification in a competitive industry. A monopoly has market power, in which it can set its own prices, while a competitive firm must take the price consumers are willing to pay and thus had no market power. Additionally, a competitive firm will produce where MR=MC, P=MR (because of no market power) and P=MC. Conversely, a monopolistic firm will produce where MR=MC, but P>MC. (thanks to Rebecca B., who now runs her own business)

8. Suppose Anthony owns a company having marginal costs of $5 for all his units. If he sells only one, then he reaps $11; selling two fetches a price of $10 piece; selling 3 attains a price of $9; selling four reaps $8; Q=5 would have P=$7; Q=6 has P=$6, etc. A competitive firm would have the same cost and demand numbers. What does Anthony sell at, and what is the social cost of his monopoly?

If Anthony's company has monopoly and a marginal cost of $5 per widget, then using the described demand curve, his company should sell three widgets at $9 apiece or 4 widgets at $8 apiece. Either approach will give Anthony's company a profit of $12.

If Anthony sells only three widgets at $9, then that is four less than what a competitive market would sell. The social cost is the sum of (P-MC) over each of the withheld units, noting that the social cost for each withheld unit is different because the unit goes unsold at a different P.

We assume that society would have purchased the unit at slightly less than the higher price, such $6 minus an infinitesimal amount. When the price went from $5 to $6, one unit went unsold and the loss to society was almost (P-MC=$6-$5=$1). Likewise, another unit went unsold at $7 (P-MC=$2), another unit went unsold at $8 and another unit went unsold at $9. That total social cost is almost $1 + $2 + $3 + $4 = $10.

If instead Anthony sold 4 units at $8, then the social cost is almost $1 + $2 + $3 = $6. The "almost" is so close to the number that we drop the "almost" and simply provide the number as the estimated social cost.

Honors 9. Estimates are not very accurate about homeschooling, but some guess that 1 out of every 25 students is homeschooled. At what level or fraction would homeschooling end the public school monopoly? Discuss.

10. Suppose you live in a valley where water flows freely and abundantly from a spring. Suppose your entire family uses on average 80 gallons a day. But then a company bought the spring. If the demand curve is a straight line from P=$100, Q=0 to P=$0, Q=80, at what price and quantity would the company sell water?

The water company has a monopoly, and monopolies (like every company) price its good where marginal revenue (MR) equals marginal cost (MC). We have to assume that MC=0 here. So where is MR=0? By trial and error, if necessary, we we see that MR=0 when Q=40 and P=$50. Algebraically we can reach the same result as follows:

P = 100 − 1.25xQ
Revenue = PxQ = (100 − 1.25xQ)Q

Marginal Revenue = (change in revenue) divided by (change in sales) = (change in PxQ) divided by (change in Q)

The lecture says that "You will need this for several homework problems: when the demand curve is a straight line, the curve for the marginal revenue of a monopoly intersects the x-axis at exactly half the quantity of the demand curve."

The intersection of the x-axis is where MR = 0, which is what we seek here. That occurs at exactly half the quantity of the demand curve, which is Q= 80/2 = 40. Plugging that back into the demand equation yields P = $50.

We can also prove this result by using calculus. Marginal Revenue is the derivative of total revenue:

MarginalRevenue = 100 − 2.5Q

Setting MR = 0 yields:

MR = 0 = 100 − 2.5xQ

Thus

Q = 100 / 2.5 = 40

Plugging back into the first equation to find P yields:

P = 100 − 1.25x40 = $50

11. Monopolies: should the government regulate them? If so, how?

Yes: because monopolies impose social loss on society. Regulate them by breaking them up into competing companies.

No: because the "cure" of regulation is worse than the "disease" of the monopoly.

Lecture Nine Assignment

1. An oligopoly that illegally agrees to raise its prices is called a __________.

Cartel.

2. List three industries that are oligopolies and explain why.

EXAMPLE #1 – The Aircraft Industry. The aircraft industry is an oligopoly because the service is identical (you fly from point A to point B), and there are not very many competitors in the industry. Finally, these few competitors dominate the industry without fixing prices or outputs because the cost to entry is so great.

EXAMPLE #2 – The Computer Processor Industry. The computer processor industry is an oligopoly because although there are slight performance differences, the goods do virtually the same thing (process data), and there are only two main competitors (AMD and Intel). They dominate the industry without fixing prices or outputs.

EXAMPLE #3 – The Cigarette Industry. The cigarette industry is an oligopoly because all of their products are the same. There are less than two dozen competitors who dominate the industry, but those competitors do not fix prices or outputs. (thanks to Kevin)

3. As an industry becomes more competitive, what happens to price (P) compared to marginal cost (MC)? Explain.

The price P declines towards the marginal cost (MC). You can see this intuitively: as competition increases, firms must cut costs to stay up with the competition and still sell their product.

4. Suppose Daniel’s company sells goods in an industry having a demand curve with this set of Qs and Ps: (1,30), (2, 28), (3, 26), (4,24), (5, 14), (6, 8), (7,2). What type of industry is this, and what type of demand curve is this? If marginal cost equals $20 (MC=20), then what are the output and price in this industry?

Daniel’s company is in an industry that is an oligopoly and the demand curve for his goods is a kinked demand curve. The output would be 4 units at a price of $24, because this is the point right before the kink in the demand curve. It is the point at which the most money can be made. (Kevin)

5. Suppose you saw three different advertisements in three different industries: (1) “The lowest price in town is at Zack’s!”, (2) “Buy more channels from your cable service provider!”, and (3) “Matt is the smartest surveyor in town … call him to survey your property!” What type of industry would each ad likely represent?

The first ad is for a company in an industry with perfect competition. This is because it is advertising that Zack has the lowest prices which means that there is a perfect substitute for Zack’s goods. The reason that you should buy at Zack’s is because his prices are better.

The second ad is from an industry that is a monopoly. They are advertising that they want their customers to buy more, not because they want to win customers over from other companies. Also, cable companies generally have laws that there can be no competition in their territory.

The third ad would be in an industry of monopolistic competition because the advertisement says that Matt is the smartest surveyor, so there is no perfect substitute for his services if he is indeed the smartest surveyor. (Kevin)

6. What kind of industries are these: (1) one cleaners in town that sends the clothes out to be cleaned, (2) three car mechanics in town with hydraulic lifts and expensive electronic equipment, and (3) many apparel stores with distinctive fashions? Will consumers obtain the best prices?

EXAMPLE #1: The first industry is a monopoly because it is the only company in that market. Customers will not obtain the best prices because there is no alternative cleaner for their clothes.

EXAMPLE #2: The second industry is an oligopoly. It is an oligopoly because there aren’t very many companies, but there are high barriers to entry (expensive electronics, and hydraulic lifts) so competition cannot be easily created. Finally, the service of each company is exactly the same so they are all substitutes for each other. Customers will not obtain the best prices because there is not perfect competition; however, they will obtain good prices because there is still some competition.

EXAMPLE #3: The third industry is monopolistic competition because there are a lot of apparel stores, but none of the stores are substitutes for each other because they each have distinctive styles. Customers will not obtain the best prices because there is not perfect competition; however, they will still be able to obtain good prices because while there are no perfect substitutes, the substitutes are close enough that if one store raised its prices exorbitantly, they would lose business. (Kevin)

7. Suppose two students separately own the only widget companies in the entire world. They sell at the same price and have no plans to change that. But they might advertise. If both advertise, then they lost profits due to the advertising expenses. If neither advertises, then they make the largest profit by reducing expenses. But if one advertises and the other does not, then the one that advertised makes phenomenal profits. What happens?

The Nash Equilibrium is for both companies to advertise, because each individually can improve his own position by advertising. Note this is not the overall optimal result for the firms if they firms it were lawful for them to agree with each other not to advertise.

Lecture Eleven Assignment

Introductory:

1. A ________________ is one and only one buyer in a market.

monopsony

2. Why do you think an economics course spends so much studying monopolies and monopsonies?

Sellers strive to be like monopolies, and buyers strive to be like monopsonies. While they never attain the perfect ideal, many come close enough to justify studying the perfect monopoly and perfect monopsonies.

A perfect circle does not really exist. But so many things come very close to this, and thus a perfect circle is worth studying in geometry.

Intermediate: 3. What is the marginal factor cost of a monopsony when it increases is wage for 10 employees from $11 to $12 in hiring an 11th employee? Show your work.

This is the cost of the new employee ($12) plus the additional cost of ($12-$11) for all the existing employees in raising their salary to $12. The total is thus:

marginal factor cost = $12 + ($12-$11)x10 = $12 + $10 = $22

4. In terms of P, MP, and W, state when a company in a competitive market hires an additional worker at wage W.

When P times MP is greater than W: P x MP > W . This occurs when the marginal benefit (price times marginal product) exceeds the marginal cost (wage).

5. Max unionized all the employees in an industry and then tried to increase both their wages and the number of people employed. Is this possible? Are there conditions which would make it possible?

As wages increase, the demand for labor decreases, so it is unlikely that Max could both increase wages and the number of people employed. However, if the industry consists of a monopsony then this is possible if it is profitable.

6. Suppose you manage a monopoly, and want to know the short-run and long-run conditions for shutting down. Explain them in terms of average variable cost (AVC), average total cost (ATC) and price (P).

A monopoly shuts down in the short run if AVC>P, and it shuts down in the long run if ATC>P.

7. Sharon has to pay $10.50 to hire nine workers, and must increase the wage to $11 to hire a tenth worker. But the tenth worker will bring in $13 extra to the firm’s revenue. Does Sharon hire the tenth worker?

No, because the marginal factor cost of hiring the tenth employee is $11 for that worker, and also $.50 times 9 to increase the wages of all the other workers. This totals $15.50, which is greater than the $13 in additional revenue. Sharon would lose money by doing this, so she should not do it.

Honors: 8. “Marginal revenue product” is the change in total revenue resulting from a unit change in the quantity of a variable unit employed. Now redo and explain this question from the exam: “Factor of production” is any input (e.g., land, labor and capital) used to produce output. A monopolist will continue to purchase a particular factor of production until:
(a) average factor cost equals average revenue product
(b) marginal factor cost equals marginal revenue
(c) marginal factor cost equals marginal revenue product
(d) average factor cost equals marginal favor cost

The correct answer is (c), because the owner can increase profits by increasing his input until he does not make enough additional revenue (marginal revenue product) to cover his additional cost (marginal factor cost) for that additional input.

9. If our class is a monopsony with respect to hiring a dinner speaker for a special homeschool dinner we might hold, can we set the fee at whatever we like? If not, why not?

We would still have a supply curve for labor that will see decreased supply at lower fees. At zero fees, for example, we may not be able to find any experienced dinner speaker.

10. Explain: when consumer demand (demand for output) is more elastic, then demand for labor by a company tends to be more elastic.

If the demand for output is elastic, then a small change in price will have a large effect on demand for the good. This large effect then has a large effect on how much supply is of the good is desired, which in turn has a large effect on the demand for labor to produce the good. (this answer could be improved)

11. Imagine yourself as a powerful regulator who can set the price of a certain good in a certain industry wherever you want. Suppose that in the free market, competitive equilibrium would have price “P”. Where would you set the price if you diabolically wanted to cause a shortage of goods? Where would you set it if you diabolically wanted to cause a surplus of goods? Explain.

If you set the price lower than P, then you'll cause a shortage. If you set the price higher than P, then you'll cause a surplus.

Lecture Twelve Assignment

Introductory

1. Receiving $100 next year is not the same as receiving $100 today because of the _________________.

time value of money

2. “Free enterprise does not cause interest rates. Impatience does!” Explain both views.

Free enterprise explains interest rates as someone will not allow someone else to use his money unless he obtains something in return. The interest rate is the "price" for use of someone's money, just as goods and services have their own prices in free enterprise.

Impatience explains interest rates as the emotional desire to have something "right now" causes them to pay more than they would if they were patient and simply waited until they saved the money themselves.

Intermediate

3. I agree to pay you $1,000 in one year, if you pay me ______ today. The interest rate is 5%. Fill in the blank, showing your work.

If the interest rate is 5%, then money today is worth 5% more in a year, or 1.05 times its value today. Hence 1.05 times the money received today must equal $1000 for a year from now. In other words, the loan times 1.05 must equal $1000. Doing the math, the loan = $1000/1.05 = $952.38.

4. Elizabeth owns a clothing store. She can spend $100,000 today to increase her inventory of fancy clothes, which would increase her profits by $104,000 in one year without any further benefit. Interest rates are 5%. Should she make the investment?

Elizabeth would do better to invest her money at the 5% interest rate. By doing so she would end up with $105,000 rather than $104,000. (Chris J.)

5. If total utility is maximized, then (a) average utility is minimized (b) average utility is maximized (c) marginal utility is maximized (d) marginal utility is zero

Answer and explain.

The correct answer is (d), because total utility is maximized when no additional utility can be obtained. That is when marginal utility is zero. Average utility, the answer chosen by many students, may be maximized long before total utility is maximized, due to the Law of Diminishing Marginal Utility.

6. All of the following are fixed costs for starting a new school EXCEPT: (a) textbooks (b) electricity (c) rent (d) landscaping Answer and explain.

Only (a) is dependent on the amount of students, so the answer is (a).

7. During hurricane season a town’s power plant was completely destroyed. People wanted to buy kerosene to run their emergency generators. But the price of kerosene doubled! What is the effect of the price increase? Should a new law force the price of kerosene down by half?

Due to the Law of Demand, the increased price will reduce demand for the kerosene. But the demand for kerosene will be inelastic. Thus the most significant effect of the price increase will be to increase the profit and economic rent of the kerosene supplier. Because the price increase represents an increase in economic rent due to the crisis, price controls probably would not decrease supply in the short run, and might be desirable. In the long run, however, price controls could lead to shortages. (thanks to Chris J.)

Honors

8. Explain what “economic rent” is in your own words, using your own example.

Economic rent is supplier surplus. Just as consumer surplus represents the amount by which the utility of a good or service exceeds the cost, economic rent is the amount by which the price of a good or service exceeds the price at which it would be sold for zero economic profit to the supplier. By this definition nearly every good or service has some economic rent. Gold has economic rent because it is rare and highly valued, while food at the local supermarket has a small amount of economic rent because of its convenience. (Chris J.)

9. Explain which of these earn economic rent, and how much: Katrina earns $500 for playing her violin at events, but would play for free. Philip collects $800 for renting his basement, which equals the electricity, property, interest and costs of his time collecting the rent. Victoria, because of her special talent, earns $30,000 a year growing soybeans when others like her only make $20,000 with similar land.

Katrina makes $500 economic rent. Since she is willing to play for free, it can be inferred that the sum of her costs and utility is zero. Phillip does not earn economic rent, because his revenue does not exceed his costs. Victoria does earn economic rent. Definition two from the lecture states that economic rent is the amount that a payment exceeds the supply cost. If Victoria makes an accounting profit of $30,000 a year, her economic rent is that profit minus the opportunity cost of her most profitable alternative employment. Assuming that her most profitable alternative is to use the land after the method of those around her, who make $20,000, her economic rent is $10,000. (Chris J.)

10. Explain Jesus’ parable about the talents, using general principles learned during this course.

Jesus entrusted more to the servants who had been faithful with a little. This illustrates the principle of increasing returns to scale- when the first two servants demonstrated that they had put made profitable use of the inputs they were entrusted with, the master allowed them to continue their work with more inputs available, i.e., on a larger scale. When the master saw that the servant with the one talent had failed to make use of the inputs he was entrusted with, he recognized this as an inefficient allocation of resources which represented an opportunity cost for him. So he took the talent from the inefficient servant and entrusted it to the servant who had best demonstrated his ability to use it efficiently. (Chris J.)

Lecture Thirteen Assignment

Introductory:

1. The curve that illustrates how much a company or country can produce of multiple items is called the ________________________.

Production Possibility Curve.

2. A monopolistic competitive firm has the following characteristic that is lacking for a perfectly competitive firm:
(a) There are low barriers to entry
(b) MR = MC in the long run.
(c) P > MC
(d) There are many competitors.

Answer is (c). For a perfectly competitive firm, P=MC.

Intermediate

3. A customer to our imaginary homeschool dinner expected to pay $40, but we only charged him $25. An economist would call the $15 difference the ___________. (Hint: see Lecture #10 review list)

Consumer surplus.

Figures A and B

4. Look at Figure B (right). If the price of sale falls below P1 then the firm in the short run will:
(a) increase Q
(b) increase labor
(c) increase price
(d) shut down.
How much profit is it making at a price of P2?

The firm should shut down because when P<P1, then P<ATC and P<AVC.

At the higher price P2, the firm would be making zero overall profit but would stay in business because P>AVC and is making marginal profits.

5. Look again at Figure B (right). Assume the firm is perfectly competitive. Explain what AFC is, and use the labels on the graph to describe its amount.

AFC is average fixed cost, which is the difference between ATC and AVC: AFC=ATC-AVC. Using the labels on the graph, AFC = C-B.

6. Now turn to Figure A (right). What is the opportunity cost of shifting production from B to C?

The opportunity cost is 600 minus 200 cars, which equals 400 cars.

7. Suppose that is your firm in Figure A (attached). What changes might enable you to move production to point D?

A marvelous new invention for my factories to increase their production.

8. The term “normal profit” means “zero economic profits,” which occurs when total revenue equals explicit costs (like cash expenditures) plus implicit costs (like opportunity costs of wasted time). In Figure B (attached), at point A, what kind of profits does the company have: (a) more than a “normal profit”, (b) equal to a “normal profit” or (c) less than a “normal profit.”? Explain.

Less than a normal profit because at point A the price is below ATC.

9. Do you support “free trade” or “protectionism”? Explain your view.

Protectionism because although free trade may appear to have immediate short run benefits for consumers in lower costs for goods, it also imposes long run costs in weakening our industries and strengthening our nation's enemies.

Honors:

Figure C

10. Look at Figure C (right). Assuming it represents the long run, describe what type of industry this is (e.g., monopoly, oligopoly, monopolistic competition, or perfect competition). Explain your answer.

That looks like a monopoly because there is no supply curve, and the marginal revenue curve has twice the slope of the demand curve (i.e., the marginal revenue curve intersects the x-axis at one-half the quantity of the demand curve).

11. Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish. But, in fact, there is an abundance of food and profits have not vanished. Why is economics not so dismal after all?

Perhaps because mankind has increasing economies of scale: as population increases, output increases by a greater percentage due to inventions and improvements in production.

12. Look again at Figure C (attached). This question has three parts. (I) At what point is there an allocatively efficient quantity? (II) At what point is revenue maximized? (III) At what point is profit maximized? Explain your answers.

An allocatively efficient quantity is when P=MC. That is point B.

Revenue is maximized when marginal revenue is zero. That found by determining the market price on the demand curve corresponding to point E, which appears to be point D.

Profit is maximized when MR=MC. That is found by determining the market price on the demand curve corresponding to point A, which will be a little higher price than point D.

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