With current technology suppose a firm is producing 400

Principles of Microeconics

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WEEK 1

Assignment:

1. Pham can work as many or as few hours as she wants at the college bookstore for $9 per hour. But due to her hectic schedule, she has just 15 hours per week that she can spend working at either the bookstore or other potential jobs. One potential job, at a café, will pay her $12 per hour for up to 6 hours per week. She has another job offer at a garage that will pay her $10 an hour for up to 5 hours per week. And she has a potential job at a daycare center that will pay her $8.50 per hour for as many hours as she can work. If her goal is to maximize the amount of money she can make each week, how many hours will she work at the bookstore?

2. Suppose you are on a desert island and possess exactly 20 coconuts. Your neighbor, Friday, is a fisherman, and he is willing to trade 2 fish for every 1 coconut you are willing to give him. Another neighbor, Kwame, is also a fisherman, and is willing to trade 3 fish for every 1 coconut.

a. On a single figure, draw budget lines for trading with Friday and for trading with Kwame. (Put coconuts on the vertical axis.)

b. What is the slope of the budget line from trading with Friday?

c. What is the slope of the budget line from trading with Kwame?

d. Which budget line features a larger set of attainable combinations of coconuts and fish?

e. If you are going to trade coconuts for fish, would you rather trade with Friday or Kwame?

3. Because investment and capital goods are paid for with savings, higher savings rates reflect a decision to consume fewer goods for the present in order to be able to invest in more goods for the future. Households in China save 40 percent of their annual incomes each year, whereas U. S. households save less than 5 percent. At the same time, production possibilities are growing at roughly 9 percent per year in China but only about 3.5 percent per year in the United States. Use graphical analysis of “present goods” versus “future goods” to explain the difference between China’s growth rate and the U. S. growth rate.

4. With current technology, suppose a firm is producing 400 loaves of banana bread daily. Also assume that the least-cost combination of resources in producing those loaves is 5 units of labor, 7 units of land, 2 units of capital, and 1 unit of entrepreneurial ability, selling at prices of $40, $60, $60, and $20, respectively. If the firm can sell these 400 loaves at $2 per unit, what is its total revenue? Its total cost? Its profit or loss? Will it continue to produce banana bread? If this firm’s situation is typical for the other makers of banana bread, will resources flow toward or away from this bakery good?

WEEK 2

Assignment:

1. Suppose that the demand and supply schedules for rental apartments in the city of Gotham are as given in the table below.

rental chart Monthly Rent $2500 $2000 $1500 $1000 $500 Apartments demanded: 10,000 12500 15000 17500 20000 Apartments Supplied 15000 12500 10000 7500 5000

a. What is the market equilibrium rental price per month and the market equilibrium number of apartments demanded and supplied?

b. If the local government can enforce a rent-control law that sets the maximum monthly rent at $1,500, will there be a surplus or a shortage? Of how many units? And how many units will actually be rented each month?

c. Suppose a new government is elected that wants to keep out the poor. It declares that the minimum rent that can be charged is $2,500 per month. If the government can enforce that price floor, will there be a surplus or a shortage? Of how many units? And how many units will actually be rented each month?

d. Suppose that the government wishes to decrease the market equilibrium monthly rent by increasing the supply of housing. Assuming that demand remains unchanged, by how many units of housing would the government have to increase the supply of housing in order to get the market equilibrium rental price to fall to $1,500 per month? To $1,000 per month? To $500 per month?

2. Suppose that you are the economic advisor to a local government that has to deal with a politically embarrassing surplus that was caused by a price floor that the government recently imposed. Your first suggestion is to get rid of the price floor, but the politicians don’t want to do that. Instead, they present you with the following list of options that they hope will get rid of the surplus while keeping the price floor. Identify each one as either could work or can’t work.

a. Restricting supply.

b. Decreasing demand.

c. Purchasing the surplus at the floor price.

3. Use marginal cost/marginal benefit analysis to determine if the following statement is true or false: “The optimal amount of pollution abatement for some substances, say, dirty water from storm drains, is very low; the optimal amount of abatement for other substances, say, cyanide poison, is close to 100 percent.”

4. Consider a used car market with asymmetric information. The owners of used cars know what their vehicles are worth but have no way of credibly demonstrating those values to potential buyers. Thus, potential buyers must always worry that the used car they are being offered may be a low quality “lemon.”

a. Suppose that there are equal numbers of good and bad used cars in the market and that good used cars are worth $13,000 while bad used cars are worth $5,000. What is the average value of a used car?

b. By how much does the average value exceed the value of a bad used car? By how much does the value of a good used car exceed the average value?

c. Would a potential seller of a good used car be willing to accept the average value as payment for her vehicle?

d. If a buyer negotiates with a seller to purchase the seller’s used car for a price equal to the average value, is the car more likely to be good or bad?

e. Will the used-car market come to feature mostly — if not exclusively — lemons? How much will used cars end up costing if all the good cars are withdrawn?

WEEK 3

Assignment:

1. Danny “Dimes” Donahue is a neighborhood’s 9-year-old entrepreneur. His most recent venture is selling homemade brownies that he bakes himself. At a price of $1.50 each, he sells 100. At a price of $1 each, he sells 300. Is demand elastic or inelastic over this price range? If demand had the same elasticity for a price decline from $1.00 to $0.50 as it does for the decline from $1.50 to $1, would cutting the price from $1.00 to $0.50 increase or decrease Danny’s total revenue?

2. Many apartment-complex owners are installing water meters for each apartment and billing the occupants according to the amount of water they use. This is in contrast to the former procedure of having a central meter for the entire complex and dividing up the collective water expense as part of the rent. Where individual meters have been installed, water usage has declined 10 to 40 percent. Explain that drop, referring to price and marginal utility.

3. John likes Coca-Cola. After consuming one Coke, John has a total utility of 10 utils. After two Cokes, he has a total utility of 25 utils. After three Cokes, he has a total utility of 50 utils. Does John show diminishing marginal utility for Coke, or does he show increasing marginal utility for Coke? Suppose that John has $3 in his pocket. If Cokes cost $1 each and John is willing to spend one of his dollars on purchasing a first can of Coke, would he spend his second dollar on a Coke, too? What about the third dollar? If John’s marginal utility for Coke keeps on increasing no matter how many Cokes he drinks, would it be fair to say that he is addicted to Coke?

4. One type of systematic error arises because people tend to think of benefits in percentage terms rather than in absolute dollar amounts. As an example, Samir is willing to drive 20 minutes out of his way to save $4 on a grocery item that costs $10 at a local market. But he is unwilling to drive 20 minutes out of his way to save $10 on a laptop that costs $400 at a local store. In percentage terms, how big is the savings on the grocery item? On the laptop? In absolute terms, how big is the savings on the grocery item? On the laptop? If Samir is willing to sacrifice 20 minutes of his time to save $4 in one case, shouldn’t he also be willing to sacrifice 20 minutes of his time to save $10?

WEEK 4

Assignment:

1. You are a newspaper publisher. You are in the middle of a one-year rental contract for your factory that requires you to pay $500,000 per month, and you have contractual labor obligations of $1 million per month that you can’t get out of. You also have a marginal printing cost of $0.25 per paper as well as a marginal delivery cost of $0.10 per paper. If sales fall by 20 percent from 1 million papers per month to 800,000 papers per month, what happens to the AFC per paper, the MC per paper, and the minimum amount that you must charge to break even on these costs?

2. Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000 per year if alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3,000 per year. Total annual revenue from pottery sales is $72,000. Calculate the accounting profit and the economic profit for Gomez’s pottery firm.

3. There are 300 purely competitive farms in the local dairy market. Of the 300 dairy farms, 298 have a cost structure that generates profits of $24 for every $300 invested. What is their percentage rate of return? The other two dairies have a cost structure that generates profits of $22 for every $200 invested. What is their percentage rate of return? Assuming that the normal rate of profit in the economy is 10 percent; will there be entry or exit? Will the change in the number of firms affect the two that earn $22 for every $200 invested? What will be the rate of return earned by most firms in the industry in long-run equilibrium? If firms can copy each other’s technology, what will be the rate of return eventually earned by all firms?

4. How can patents speed up the process of creative destruction? How can patents slow down the process of creative destruction? How do differences in manufacturing costs affect which industries would be most likely to be affected by the removal of patents?

WEEK 5

Assignment:

1. Critically evaluate and explain each statement:

a. Because they can control product price, monopolists are always assured of profitable production by simply charging the highest price consumers will pay.

b. The pure monopolist seeks the output that will yield the greatest per-unit profit.

c. An excess of price over marginal cost is the market’s way of signaling the need for more production of a good.

d. The more profitable a firm, the greater its monopoly power.

e. The monopolist has a pricing policy; the competitive producer does not.

2. How do network effects help Facebook fend off smaller social-networking rivals? Could an online retailer doing half as much business compete on an equal footing with Amazon in terms of costs? Explain.

3. Suppose you have been tasked with regulating a single monopoly firm that sells 50-pound bags of concrete. The firm has fixed costs of $10 million per year and a variable cost of $1 per bag no matter how many bags are produced.

a. If this firm kept on increasing its output level, would ATC per bag ever increase? Is this a decreasing-cost industry?

b. If you wished to regulate this monopoly by charging the socially optimal price, what price would you charge? At that price, what would be the size of the firm’s profit or loss? Would the firm want to exit the industry?

c. You find out that if you set the price at $2 per bag, consumers will demand 10 million bags. How big will the firm’s profit or loss be at that price?

d. If consumers instead demanded 20 million bags at a price of $2 per bag, how big would the firm’s profit or loss be?

e. Suppose that demand is perfectly inelastic at 20 million bags, so that consumers demand 20 million bags no matter what the price is. What price should you charge if you want the firm to earn only a fair rate of return? Assume as always that TC includes a normal profit.

4. Explain the general meaning of the profit payoff matrix below for oligopolists X and Y. All profit figures are in thousands.

a. Use the payoff matrix to explain the mutual interdependence that characterizes oligopolistic industries.

b. Assuming no collusion between

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WEEK 6

Assignment:

1. In 2009 General Motors (GM) announced that it would reduce employment by 21,000 workers. What does this decision reveal about how GM viewed its marginal revenue product (MRP) and marginal resource cost (MRC)? Why didn’t GM reduce employment by more than 21,000 workers? By fewer than 21,000 workers?

2. Suppose that a delivery company currently uses one employee per vehicle to deliver packages. Each driver delivers 50 packages per day, and the firm charges $20 per package for delivery.

a. What is the MRP per driver per day?

b. Now suppose that a union forces the company to place a supervisor in each vehicle at a cost of $300 per supervisor per day. The presence of the supervisor causes the number of packages delivered per vehicle per day to rise to 60 packages per day. What is the MRP per supervisor per day? By how much per vehicle per day do firm profits fall after supervisors are introduced?

c. How many packages per day would each vehicle have to deliver in order to maintain the firm’s profit per vehicle after supervisors are introduced?

d. Suppose that the number of packages delivered per day cannot be increased but that the price per delivery might potentially be raised. What price would the firm have to charge for each delivery in order to maintain the firm’s profit per vehicle after supervisors are introduced?

3. You are currently a worker earning $60,000 per year but are considering becoming an entrepreneur. You will not switch unless you earn an accounting profit that is on average at least as great as your current salary. You look into opening a small grocery store. Suppose that the store has annual costs of $150,000 for labor, $40,000 for rent, and $30,000 for equipment. There is a one-half probability that revenues will be $200,000 and a one-half probability that revenues will be $400,000.

a. In the low-revenue situation, what will your accounting profit or loss be? In the high-revenue situation?

b. On average, how much do you expect your revenue to be? Your accounting profit? Your economic profit? Will you quit your job and try your hand at being an entrepreneur?

c. Suppose the government imposes a 25 percent tax on accounting profits. This tax is only levied if a firm is earning positive accounting profits. What will your after-tax accounting profit be in the low-revenue case? In the high-revenue case? What will your average after-tax accounting profit be? What about your average after-tax economic profit? Will you now want to quit your job and try your hand at being an entrepreneur?

d. Other things equal, does the imposition of the 25 per-cent profit tax increase or decrease the supply of entrepreneurship in the economy?

4. Suppose that Sea Shell oil company (SS) is pumping oil at a field off the coast of Nigeria. At this site, it has an extraction cost of $30 per barrel for the first 10 million barrels it pumps each year and then $60 per barrel for all subsequent barrels that it pumps each year, up to the site’s maximum capacity of 90 million barrels per year.

a. Suppose the user cost is $50 per barrel for all barrels and that the current market price for oil is $90 per barrel. How many barrels will SS pump this year? What is the total accounting profit on the total amount of oil it pumps? What is the total economic profit on those barrels of oil?

b. What if the current market price for oil rises to $120 per barrel, while the user cost remains at $50 per barrel? How many barrels will SS pump and what will be its accounting profit and its economic profit?

c. If the current market price remains at $120 per barrel but the user cost rises to $95 per barrel, how many barrels will SS pump this year and what will be its accounting profit and its economic profit

WEEK 7

Assignment:

1. In the 1980s, PepsiCo Inc., which then had 28 percent of the soft-drink market, proposed to acquire the Seven-Up Company. Shortly thereafter, the Coca-Cola Company, with 39 percent of the market, indicated it wanted to acquire the Dr Pepper Company. Seven-Up and Dr Pepper each controlled about 7 percent of the market. In your judgment, was the government’s decision to block these mergers appropriate? Why?

2. What are the effects of farm subsidies such as those of the United States and the European Union on (a) domestic agricultural prices, (b) world agricultural prices, and (c) the international allocation of agricultural resources? (d) Use public choice theory to explain the persistence of farm subsidies in the face of major criticisms of those subsidies. If the special-interest effect is so strong, what factors made it possible in 1996 for the government to end price supports and acreage allotments for several crops?

3. Use quintiles to briefly summarize the degree of income in-equality in the United States. How and to what extent does government reduce income inequality?

a. Assume that Al, Beth, Carol, David, and Ed receive incomes of $500, $250, $125, $75, and $50, respectively. Construct and interpret a Lorenz curve for this five-person economy. What percentage of total income is received by the richest quintile and by the poorest quintile?

b. How does the Gini ratio relate to the Lorenz curve? Why can’t the Gini ratio exceed 1? What is implied about the direction of income inequality if the Gini ratio declines from 0.42 to 0.35? How would one show that change of inequality in the Lorenz diagram?

c. Why is the lifetime distribution of income more equal than the distribution in any specific year?

4. In July 2007 The Wall Street Journal (WSJ) reported that a growing shortage of skilled labor in Eastern European countries such as Slovakia was driving up wages in key industries and reducing business income. The reason for the shortages was a large migration of skilled Eastern European workers to Western European countries. Use the simple immigration model to demonstrate the key elements of the WSJ story as just described.

WEEK 8

Assignment:

1. Draw a domestic supply-and-demand diagram for a product in which the United States does not have a comparative advantage. What impact do foreign imports have on domestic price and quantity? On your diagram show a protective tariff that eliminates approximately one-half of the assumed imports. What are the price-quantity effects of this tariff on:

(a) domestic consumers

(b) domestic producers

(c) foreign exporters?

How would the effects of a quota that creates the same amount of imports differ?

2. What form does trade adjustment assistance take in the United States? How does such assistance promote political support for free-trade agreements? Do you think workers who lose their jobs because of changes in trade laws deserve special treatment relative to workers who lose their jobs because of other changes in the economy, say, changes in patterns of government spending?

3. What is off-shoring of white-collar service jobs and how does that practice relate to international trade? Why has off-shoring increased over the past few decades? Give an example (other than that in the textbook) of how off-shoring can eliminate some American jobs while creating other American jobs.

4. Suppose Super D’Hiver — a hypothetical French snowboard retailer — wants to order 5,000 snow-boards made in the United States. The price per board is $200, the present exchange rate is 1 euro = $1, and payment is due in dollars when the boards are delivered in 3 months. Use a numerical example to explain why exchange-rate risk might make the French retailer hesitant to place the order. How might speculators absorb some of Super D’Hiver’s risk?