Economics Model Answers Seven - 2013
1. Identify the four elements of perfect competition.
- 1. Many buyers (consumers) and sellers (firms).
- 2. Goods that are perfect substitutes for each other.
- 3. A market where there is perfect knowledge needed to choose what to buy
- 4. A market that has perfect mobility or access to resources.
2. Describe how you might use competition, perhaps even competing with yourself, to motivate yourself to achieve more.
- Set a goals for yourself each day. Write them down at the beginning of the day, and then "compete" with your list to see how many of the goals you achieve.
3. Write the equations for TC, FC, ATC, and AFC, and give an example of how they would be used.
- TC = FC + TVC , which is the sum of the fixed cost and variable cost. Example: the total cost of running a gas station is the cost of the building and the gas pumps and the wages for the workers and the gasoline itself, which includes both fixed and variable costs.
- FC = TC when the quantity Q produced by your firm is zero. Example: the fixed cost (FC) for a restaurant is the cost of renting or buying the building, cooking equipment, and utensils such as forks and spoons.
- ATC = TC / Q , which is the average total cost per unit of the good produced. For example, if the total cost for making 100 pizzas a day is $500, then the average total cost (ATC) is $500 / 100 = $5 per pizza.
- AFC = FC / Q , which is the fixed cost per unit of the good produced. For example, if the fix cost of the pizza palor (just the building, cooking equipment, and utensils such as forks and spoons) is $300 per day, then the average fixed cost (AFC) is $300 / 100 = $3 per pizza.
4. Do you think the converse of Gresham's Law is true with respect to speech and conversation? Specifically, does good speech or conversation (such as discussing the Bible) drive out bad speech? Explain.
- Yes, just as bad speech tends to drive out good speech, an effort at good speech (for example, talking about the Bible) does tend to drive out bad speech. But it takes effort, or else people seem to drive towards uninformative, unspiritual chatter.
5. Explain the difference between total cost, average cost, and marginal cost.
- Total cost is the entire expense that a firm has, including all fixed and variable costs. Average cost equals this total cost divided by the quantity of goods produced, which is TC/Q. Marginal cost is the additional expense for making one additional unit.
6. Suppose you decide you could profitably set the price for a homeschool dinner event at $15 per ticket, and it would have attracted 150 people. You also determine that 50 out of the 150 people who would have attended would have paid $20 per ticket and 10 out of the 150 would have paid $25 per ticket, and 5 out of the 150 would have paid $30 per ticket, because they would have enjoyed and benefited so much from it. However, this homeschool dinner event was never held because no one "got around to it." What is the loss in wealth or consumer surplus due to the fact that the event was not held?
- The loss in consumer surplus is the sum of the extra amount that everyone benefited above the $15 they paid for the tickets. The amount of this consumer surplus varies from individual to individual, and then it is all summed up. It is the extra amount that people would have paid, but did not have to because the ticket price was lower than what they would have paid.
- So the consumer surplus for this question is:
- 5 TIMES ($30 - $15) = $75
- 10 TIMES ($25 - $15) = $100
- 50 TIMES ($20 - $15) = $250
- The total sum is $75 + $100 + $250 = $425
- Thus the consumer surplus is $425.
7. Explain what the "CPI" is, and why the real price of a good is decreasing if its price remains constant while the CPI increases from year-to-year. An example of this might be the real price of laptop computers from 2012 to 2013.
- The CPI is the Consumer Price Index, which helps measure inflation from month-to-month, based on how prices change for a set of non-farming goods. A CPI of "100" was the average for the period 1982-84. In January 2004, the CPI was 185.2, and in July 2009, the CPI was 215.351. This means that a dollar in 2009 was worth less than 1/2 the value of a dollar in 1982-1984, because a typical good (like a candy bar) cost more than twice as much as a typical good in 1982-1984.
- Laptop computers cost about the same in 2013 as 2012, but the CPI increased over that same time. This means the value of a dollar decreased from 2012 to 2013. If the same number of dollars can buy the same laptop in 2013 as 2012, than the real price of that laptop computer decreased
8. Explain what the Producer Surplus is, and provide an example.
- Producer surplus is the wealth obtained by a seller (firm) because he was able to sell his good at a price higher than what he was willing to accept.
- Example: if supply equals demand for a new car at a price of $25,000, the car dealer will receive that price even though he would be willing to sell some of those new cars for less than $25,000. His producer surplus is the sum of all of the extra amounts he received above what he was really willing to sell each car for.
- On a supply-and-demand graph, the "producer surplus" is the area above the supply curve but below the line at the price where the good is sold.
9. Suppose the underlying labor market is perfectly competitive, but there is a minimum wage above the market rate. Then suppose that the supply of labor increases. Explain what the result is and why.
- Unemployment increases, because there are no available jobs for the additional supply of labor.
10. What is the firm's profit or loss when Q=0 in the honors discussion above? (Answer simply in terms of another cost measure.) Is the firm profitable?
- When Q=0 then the the firm's total cost (TC) is equal to its fixed cost (FC). The firm that shuts down is losing less money than if it stayed open and produced more Q, but the firm is still losing money. How much money does a firm that shuts down lost? Its total cost is equal its fixed cost: the firm has a loss of FC.
11. (Challenging, with extra credit) Prove mathematically that MC>MR for all Q>0 in the honors discussion above. (Hint: define MC in terms of the change in AVC, and then regroup the terms and draw conclusions about them to show MC>MR).
- MR=P, and in perfect competition, AVC=MC. Here, when Q>0, AVC>MR, which is why the firm shuts down. But if AVC>MR, then AVC>P because P=MR. Because AVC=MC, then MC>P and MC>MR, as the question asked.