Economics Model Answers Eleven - 2013
1. Briefly define each of these terms: monopsony, economic rent, and economic profits.
- A monopsony is when there is only one buyer, as in the example of only one company to employ people (buy labor) in a small town.
- Economic rent is the extra revenue obtained above the minimum amount that would occur in a perfectly competitive market, as in the example of the extra profits a monopolist is able to earn due to his monopoly.
- Economic profit is the profit earned when opportunity costs are considered. It is usually less than the accounting profit, which is merely money received minus money paid.
- "A monopsony is when there is only one buyer, who has control over all purchases of one specific thing. Economic rent is the extra amount of money that a seller charges, above their costs. Economic profit is the revenue made from a product minus all the other costs such as opportunity costs and other hidden costs." (by student MS)
2. Define, in your own words, what a "production possibilities curve" is.
- A production possibility curve is a graph that illustrates the different combinations of goods that a nation can produce. Moving along the production possibilities curve represents transferring resources from one good (or service) to the other.
3. Review: how is the elasticity of demand for labor related to the price elasticity of demand for the product of that labor?
- If the good produced by the firm is highly price elastic, then a small increase in price causes a large decrease in demand for the good, and thus a large decrease in output by the firm. But this large decrease in output means there must be a large decrease in the number of workers needed to produce that output. Thus the demand for labor is highly elastic when there is high price elasticity of demand for the product of that labor. Notice how in economics it helps to consider the extreme case to get the right answer.
- "The more elastic the demand for a good is the more elastic the demand for labor is. If the demand for a good is prone to change drastically, the firm’s need for workers will also change. If the demand for a good is very inelastic the need for workers will inelastic as well." (by student CM)
4. Do you think that government policy should give high priority to the Lorenz curve? Explain the issue that a Lorenz curve addresses, and whether you think that should be a high priority of government economic policy.
- An example of a Lorenz curve is here.
- The Lorenz curve shows the actual distribution of income among people in society, compared with what an equal distribution of income in society. Thus the Lorenz curve illustrates inequality in wealth distribution. But if government tries to make wealth distribution equal, then it reduces opportunity and discourages people from working to making more money. The result is an overall loss in total wealth in society, as occurs in communist systems.
5. Look again at Figure A (on p. 3). What is the opportunity cost of shifting production from B to C?
- 350 cars.
6. Review: explain again what AFC, AVC and ATC are, and how they relate to each other. When should a firm shut down in the short run?
- AFC is average fixed costs, which are the total fixed costs divided by number of units produced. AVC is average variable costs, which are the total variable costs divided by number of units produced. AFC+AVC=ATC. Stated another way, ATC is average total costs, which is FC+VC/Q. If AVC>P, then a firm should shut down in the short run.
7. What is needed to reach point D in Figure A (on p. 3)? (In other words, what causes a production possibilities curve to shift outward?)
- There would need to be a shift in the production possibility frontier of the goods outward, due to an increase in the production and efficiency, in order for point D to be reached. This increase in overall output of goods could occur due to advances in technology, a reduction in taxation or regulation, an increase in the workforce, or better equipment available for businesses.
8. Look again at Figure C (on p. 1) in the lecture (the first graph in this Lecture). At what point is total revenue maximized?
- Total revenue is maximized when marginal revenue equals 0 (crosses the x-axis). This is the quantity at Point E, and the price on the demand curve corresponding to that quantity.
9. Explain why the production possibilities curve is convex (opening downward like the top of a circle) rather than concave (opening upward like the inside of a bowl) or a straight line.
- It is convex because it is inefficient converting a factory from the production of one good to another. The maximum total number of goods that can be produced will be near the mid-point, and the overall total declines as all the factories are converted to producing only one good or the other.
10. Suppose you are a monopsony, and you must pay $9 per hour ($9/hr) to hire nine workers, but in order to hire one more worker you must pay $10/hr. The tenth worker will bring in $15 extra per hour to the firm’s revenue. Do you hire the tenth worker?
- No, you do not hire the tenth worker. If you were to hire the tenth worker, then that hiring would end up costing you $19 an hour ($10 for the extra work plus an additional $1 per nine workers to raise their wage to $10 per hour), while resulting in revenue of only $15. That would be a loss of $4 an hour, and you would not want to incur that loss.
11. In the term "comparative advantage," to what does the adjective "comparative" refer? What is the term actually "comparing"? Explain.
- It is a "comparison of the comparisons." What really matters is how much more efficiently a nation can produce one good relative to another good, compared with how much more efficiently the other nation can produce one good relative to another good. But don't get too tangled up in this detail for purposes of the exam. Any comparison of nations and their production of two goods on the exam is likely a question about comparative advantage, and the correct answer will almost certainly be for the cheaper country to produce what it produces best.