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Questions and Answers of
Economics
A 2011 news headline read, "Stalled Recovery Hits Productivity." Assuming that the "productivity" referred to in this headline is the customary "average output per worker hour" that is usually
Marjorie Cplus wrote the following answer on her micro examination: "Virtually every production function exhibits diminishing returns to scale because my professor said that all inputs have
Answer question 5 using two specific production functions as examples:a. A fixed-proportions production functionb. A Cobb-Douglas production function of the formq = (K ( L.
Universal Gizmo (UG) operates a large number of plants that produce gizmos using a special technology. Each plant produces exactly 100 gizmos per day using 5 gizmo presses and 15 workers. Explain why
Continuing the prior question, suppose that Universal Gizmo devises a new plant design that uses 15 gizmo presses and 5 workers also to produce 100 gizmos per day. How would you construct an isoquant
Can a fixed-proportions production function exhibit increasing or decreasing returns to scale? What would its isoquant map look like in each case?
Frisbees are produced according to the production function q = 2K + L, Where q = Output of Frisbees per hour K = Capital input per hour L = Labor input per hour a. If K = 10, how much L is needed to
Trump Airlines is thinking of buying a new plane for its shuttle service. Why does the economist's notion of cost suggest that Trump should consider the plane's price in deciding whether it is a
Use Figure 7.1 to explain why a rise in the price of an input must increase the total cost of producing any given output level. What does this result suggest about how such a price increase shifts
Farmer McDonald was heard to complain, "Although my farm is still profitable, I just can't afford to stay in this business any longer. I'm going to sell out and start a fast-food business." In what
Explain why the assumption of cost minimization implies that the total cost curve must have a positive slope: An increase in output must always increase total cost?
Suppose a firm had a production function with linear isoquants, implying that its two inputs were perfect substitutes for each other. What would determine the firm's expansion path in this case? For
The distinction between marginal and average cost can be made with some simple algebra. Here are three total cost functions: i. TC = 10q ii. TC = 40 + 10q iii. TC = - 40 + 10q: a. Explain why all
Late Bloomer is taking a course in microeconomics. Grading in the course is based on 10 weekly quizzes, each with a 100-point maximum. On the first quiz, Late Bloomer receives a 10. In each
Beth is a mathematical whiz. She has been reading this chapter and remarks, "All this short-run/long-run stuff is a trivial result of the mathematical fact that the minimum value for any function
Taxes can obviously affect firms' costs. Explain how each of the following taxes would affect total, average, and marginal cost. Be sure to consider whether the tax would have a different effect
Accounting rules determine a firm's "profits" for tax and dividend-paying purposes. So why should any firm be concerned about its economic profits? Specifically, why should a firm be concerned about
Wildcat John owns a few low-quality oil wells in Hawaii. He was heard complaining recently about the low price of crude oil: "With this $70 per barrel price, I can't make any money-it costs me $90
Explain whether each of the following actions would affect the firm's profit-maximizing decision. (How would each affect MR and MC?) a. An increase in the per unit cost of a variable input such as
Sally Greenhorn has just graduated from a noted business school but does not have the foggiest idea about her new job with a firm that sells shrink-wrapped dog biscuits. She has been given
Two students are preparing for their micro exam, but they seem confused: Student A: "We learned that demand curves always slope downward. In the case of a competitive firm, this downward-sloping
Two features of the demand facing a firm will ensure that the firm must act as a price taker: a. That other firms be willing to provide all that is demanded at the current price, and b. That
Two economics professors earn royalties from their textbook that are specified as 12 percent of the book's total revenues. Assuming that the demand curve for this text is a downward-sloping straight
Show graphically the price that would yield exactly zero in economic profits to a firm in the short run. With the price, why are profits maximized even though they are zero? Does this zero-profit
Why do economists believe short-run marginal cost curves have positive slopes? Why does this belief lead to the notion that short-run supply curves have positive slopes? What kind of signal does a
Each day 1,000 fishing boats return to port with the fish that have been caught. These fish must be sold within a few hours or they will spoil. All of the fish are brought to a single marketplace,
"Firms don't pay taxes, only people pay taxes" is a favorite slogan of the Wall Street Journal. But our analysis in this chapter shows that in the long run (with an upward-sloping supply curve), at
"For markets with inelastic demand and supply curves, most short-run movements will be in prices, not quantity. For markets with elastic demand and supply curves, most movements will be in quantity,
In long-run equilibrium in a perfectly competitive market, each firm operates at minimum average cost. Do firms also operate at minimum long-run average cost when such markets are out of equilibrium
Dr. D. is a critic of standard microeconomic analysis. In one of his frequent tirades, he was heard to say, "Take the argument for upward-sloping, long-run supply curves. This is a circular argument
Dr. E. is an environmentalist and a critic of economics. On The Charlie Rose Show, he attacks this book: "That text is typical-it includes all of this nonsense about long-run supply elasticities for
The long-run supply curve for gem diamonds is positively sloped because increases in diamond output increase the wages of diamond cutters. Explain why a decision by people to no longer buy diamond
A fledgling microeconomics student is having some trouble grasping the concept of short-run producer surplus. In exasperation, he blurts out, "This is absolute balderdash. I can understand that
Suppose that all operators of fast-food restaurants must rent the land for their establishments from other landowners. All other aspects of the costs of fast-food establishments are identical. Why
"An increase in demand will raise a good's price and a fall in demand will lower it. That is all you need to know-general equilibrium analysis is largely unnecessary." Do you agree? How would you use
In most of the theoretical examples in this book, prices have been quoted in dollars or cents. Is this choice of currency crucial? Would most examples be the same if prices had been stated in pounds,
How does the approach to economic efficiency taken in Chapter 9 relate to the one taken here? How is the possible inefficiency in Figure 9.9 related to that in Figure 10.2?Figure 9.9Competitive
Why are allocations on the production possibility frontier technically efficient? What is technically inefficient about allocations inside the frontier? Do inefficient allocations necessarily involve
In Chapter 9 we showed that the imposition of a tax involves an "excess burden." How would you show a similar result with a general equilibrium diagram such as Figure 10.3?Figure 10.3How Perfectly
Suppose two countries had differing production possibility frontiers and were currently producing at points with differing slopes (that is, differing relative opportunity costs). If there were no
Use a simple two-good model of resource allocation (such as that in Figure 10.2) to explain the difference between technical efficiency and economic (or allocative) efficiency. Would you agree with
In Chapter 9 we showed how a shift in demand could be analyzed using a model of a single market. How would you illustrate an increase in the demand for good X in the general equilibrium model
Relative prices convey information about both production possibilities and people's preferences. What exactly is that information and how does its availability help attain an efficient allocation of
Suppose that the competitive equilibrium shown in Figure 10.3 were regarded as "unfair" because the relative price of X (an important necessity) is "too high." What would be the result of passing a
In everyday discussions, people tend to talk about monopoly firms "setting high prices," but in this chapter we have talked about choosing a profit-maximizing level of output. Are these two
What is a "natural monopoly"? Why does electric power distribution or local telephone service have the characteristics of a natural monopoly? Why might this be less true for electric power generation
Why are barriers to entry crucial to the success of a monopoly firm? Explain why all monopoly profits will show up as returns to the factor or factors that provide the barrier to entry.
"At a monopoly firm's profit-maximizing output, price will exceed marginal cost simply because price exceeds marginal revenue for a downward-sloping demand curve." Explain why this is so and indicate
"Monopolies perpetuate inflation. When wages rise, a monopoly simply passes on the increased cost in its price. Competitive firms would not be able to do that." Do you agree? What are the differences
Figure 11.3 illustrates the "deadweight loss" from the monopolization of a market. What is this a loss of?Figure 11.3Allocational and Distributional Effects of Monopoly
Suppose that the government instituted a per-unit tax on the output of a monopoly firm. How would you graph this situation? What would happen to the market equilibrium after implementation of such a
Describe some of the transactions costs that must be present if a monopoly is to be able to practice price discrimination successfully. Are different types of costs more relevant when the monopolist
Suppose that the Acme manufacturing company has a monopoly position in the market for the two principal types of roadrunner-catching equipment: roller skates and jet-assist backpacks. Describe in
Why is the intersection between firms' best-response functions in Figure 12.2 for the Cournot model or 12.3 for the Bertrand model with differentiated products a graphical illustration of the Nash
In Figure 12.8, the demand curve facing a firm in a monopolistically competitive industry is shown as being tangent to its average cost curve at q². Explain why this is a long-run
Commercial fishing is an industry that is often given as an example of quantity competition, as in the Cournot model. Can you think of others? Can you give examples of industries in which firms
The Bertrand Paradox relies on the assumption that the demand for any one firm's product is very responsive to pricing by the other firm. Why is this assumption crucial for the competitive results in
Find examples of informative and of persuasive advertising in your newspaper. Find examples in commercials during your favorite television show. Do the particular ads you picked out persuade you to
"No cartel in history has ever succeeded for very long. There is just too much opportunity to cheat." What does it mean for a cartel member to "cheat"? What would a member of, say, the OPEC cartel
Consider a two-stage game in which firms first make a strategic choice such as product design, location on a Hotelling line, capacity, advertising, etc., and, second, compete in prices or quantities.
Consider the market for high-definition televisions, which can be expected to grow in popularity over time as consumers become familiar with it and more programs are developed for it. If there is a
Explain the difference between entry deterrence through first-mover investments and entry deterrence through pricing. What assumptions are required for each of these entry-deterrence strategies to be
Suppose a firm is considering investing in research that would lead to a cost-saving innovation. Assuming the firm can retain this innovation solely for its own use, will the additional profits from
In the supply-demand model of input pricing, who are the demanders? What type of assumptions would you use to explain their behavior? In this model, who are the suppliers? What types of assumptions
"In a situation of bilateral monopoly, the two parties are more likely to agree on quantity than on price." Explain why this is the case.
Profit maximization implies that firms will make input choices in a marginal way. Explain why the following marginal rules found in this chapter are specific applications of this general idea: a. MRL
Explain why if a price-taking firm has only one variable input the MVP curve is also its demand curve for that input, but if the firm has two or more variable inputs, its demand curve for one of them
A fall in the price of an input induces a profit-maximizing firm to experience both substitution and output effects that cause it to hire more of that input. Explain how the profit-maximizing
Suppose the price of an input used by firms with fixed-proportions production functions were to fall. Why would such a change not cause any substitution effects for these firms' input demand? Would
Because input prices are explained by the forces of supply and demand, it is important to understand how various factors may shift these curves. For each of the following factors that may affect
In Chapter 9, we described the notions of consumer and producer surplus as they relate to a competitive equilibrium. How should similar areas be interpreted in a supply-demand graph of the
In Chapter 11, we showed the relationship between marginal revenues and market price for a monopoly to be given by MR = P(1 + 1/e), where e is the price elasticity of demand for the product. For a
How would you measure the strength of a monopsonist in an input market? Would a monopsony necessarily be very profitable? What would you need to add to Figure 13.5 in order to show a monopsonist's
Some economic variables are "stocks" in that they represent the total value of something at a point in time, rather than a per-period "flow." Explain the connection between the following flow and
Our theory of the pricing of exhaustible resources concludes that the prices of such resources should increase (relative to prices of other goods) at a rate equal to the real rate of interest. What
Explain why the intertemporal budget constraint pictured in Figure 14.1 can be interpreted as requiring that individuals choose C0 and C1 so that the present value of this consumption is equal to
Suppose that an individual obtains the same utility from a given level of consumption regardless of whether it is consumed now or next period. Suppose also that the marginal utility of consumption is
Sometimes retirement planners suggest that people set a "target" for retirement income. For example, the advice might be "Be sure to have accumulated $1,000,000 by the time you are 60." Assuming that
P. T. Blowhard is the CEO of Ditch Industries. He was heard to make the following statement about his choice of inputs for digging ditches: "We borrowed $100,000 to buy this Ditch Witch, and we're
CEO Blowhard continues his economic wisdom by discussing his rationale for calculating the present value of the rents he might save by purchasing a building to house his firm: "We could save $25,000
Figure 14.3 shows how the real interest rate is determined by the supply and demand for loans. Explain why this process also determines the rate of return that any capital owner should expect to earn
Suppose that a monopoly farmer of Wonder Grain must pay all of its costs of production in this year but that it must wait until next year to sell its output. Why would the farm's profit-maximizing
Why do scarcity costs occur only in the case of finite resources? Do producers of renewable resources such as fish or trees also incur scarcity costs? Explain the differences between these cases.
Consider the moral-hazard problem that arises when a risk-averse manager, whose effort is unobservable, runs a firm on behalf of shareholders. Explain how the tradeoff between incentives and risk
Suppose you invented a test that can easily measure worker productivity in Spence's signaling model. Who would be interested in paying for the test? Would workers pay to take it? Would firms pay to
Many contracts between professional athletes and the teams on which they play involve incentive provisions. Can you provide some examples? Do you think moral hazard is a serious problem for
For each of the following types of insurance, explain how the moral-hazard problem might arise. Explain how the adverse selection problem might arise. a. Life insurance b. Health insurance c.
A computer manufacturer offers an optional extended warranty on the laptops it sells. What signal does the fact that the manufacturer offers this warranty send to potential consumers about laptop
Consider the problem of a monopolist setting a menu of price/quantity bundles when there are two types of consumer and types are unobservable. The source of inefficiency in this setting is that the
The famous comedian Groucho Marx once quipped that "I would never join a club that would have me as a member." Modified to apply to market settings, the quote might be rewritten, "I would never buy
Why is it a good idea to bid your (known) valuation in a second-price, sealed-bid auction? Why is it a bad idea to bid your (known) valuation in a first-price, sealed-bid auction? Explain, with
Consider a signaling model in which the first player may be one of two types. What determines the other player's beliefs about the first player's type before observing the first-player's signal?
In the Spence model of education signaling we studied, what was inefficient about the equilibria? Why did the presence of asymmetric information (the fact that firms do not know the workers'
Ben assembles units of the iSpy, a surveillance device remotely controlled from an app on customers' mobile phones. By exerting effort E, he produces q = √E devices, implying that the marginal
A firm earns marginal revenue product of 100 from a low-ability worker and 200 from a high-ability worker. A quarter of the workers are low-ability and the rest are high-ability. a. If competitive
If one firm raises the costs of another firm by bidding against it for its inputs, that is not an externality by our definition. But, if a firm raises the costs of another firm by polluting the
Why would individuals or firms engage in rent-seeking behavior? How much will they spend on such behavior? How, specifically, can rent-seeking harm the allocation of resources?
Our general definition of economic efficiency focuses on mutually beneficial transactions. Explain why the presence of externalities may result in some mutually beneficial transactions being forgone.
The proof of the Coase theorem requires that firms recognize both the explicit and implicit costs of their decision. Explain a situation where a firm's failure to curtail pollution may cause it to
Explain why the level of emissions control R* in Figure 16.3 is economically efficient. Why would the levels of abatement given by RL and RH result in inefficiency? What kinds of inefficient trades
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