Professor Jones has just been hired by the economics department at a major university. The president of the board of regents has stated that the university is committed to providing top-quality education for undergraduates. Two months into the semester, Jones fails to show up for his classes. It seems he is devoting all his time to research rather than to teaching. Jones argues that his research will bring prestige to the department and the university. Should he be allowed to continue exclusively with research? Discuss with reference to the principal-agent problem.
> Suppose a profit-maximizing monopolist is producing 800 units of output and is charging a price of $40 per unit. a. If the elasticity of demand for the product is –2, find the marginal cost of the last unit produced. b. What is the firm’s percentage ma
> In Example 11.1, we saw how producers of processed foods and related consumer goods use coupons as a means of price discrimination. Although coupons are widely used in the United States, that is not the case in other countries. In Germany, coupons are il
> Suppose that an industry is characterized as follows: C = 100 + 2q2………….each firm’s total cost function MC = 4q………………..firm’s marginal cost function P = 90 – 2Q…………… industry demand curve MR = 90 – 4Q……industry marginal revenue curve a. If there is
> The following table shows the demand curve facing a monopolist who produces at a constant marginal cost of $10: Price…….……………………………………………………………Quantity 18………………………………………………………………………………...0 16..…………………………………………………………………………………4 14..………………………………………………………………
> A firm faces the following average revenue (demand) curve: P = 120 – 0.02Q where Q is weekly production and P is price, measured in cents per unit. The firm’s cost function is given by C = 60Q + 25,000. Assume that the firm maximizes profits. a. What
> A monopolist firm faces a demand with constant elasticity of –2.0. It has a constant marginal cost of $20 per unit and sets a price to maximize profit. If marginal cost should increase by 25 percent, would the price charged also rise by 25 percent?
> Caterpillar Tractor, one of the largest producers of farm machinery in the world, has hired you to advise it on pricing policy. One of the things the company would like to know is how much a 5-percent increase in price is likely to reduce sales. What wou
> Will an increase in the demand for a monopolist’s product always result in a higher price? Explain. Will an increase in the supply facing a monopsonist buyer always result in a lower price? Explain.
> Externalities arise solely because individuals are unaware of the consequences of their actions. Do you agree or disagree? Explain.
> Consider a market in which a firm has monopoly power. Suppose in addition that the firm produces under the presence of either a positive or a negative externality. Does the externality necessarily lead to a greater misallocation of resources?
> When do externalities require government intervention? When is such intervention unlikely to be necessary?
> Compare and contrast the following three mechanisms for treating pollution externalities when the costs and benefits of abatement are uncertain: (a) an emissions fee, (b) an emissions standard, and (c) a system of transferable emissions permits.
> If the demand for drive-in movies is more elastic for couples than for single individuals, it will be optimal for theaters to charge one admission fee for the driver of the car and an extra fee for passengers. True or false? Explain.
> A monopolist is producing at a point at which marginal cost exceeds marginal revenue. How should it adjust its output to increase profit?
> Which of the following describes an externality and which does not? Explain the difference. a. A policy of restricted coffee exports in Brazil causes the U.S. price of coffee to rise – an increase which in turn also causes the price of tea to rise. b. A
> Explain why the median voter outcome need not be efficient when majority-rule voting determines the level of public spending.
> Public television is funded in part by private donations, even though anyone with a television set can watch for free. Can you explain this phenomenon in light of the free rider problem?
> A village is located next to 1000 acres of prime grazing land. The village presently owns the land and allows all residents to graze cows freely. Some members of the village council have suggested that the land is being overgrazed. Is this likely to be t
> Public goods are both nonrival and nonexclusive. Explain each of these terms and show clearly how they differ from each other.
> Why does free access to a common property resource generate an inefficient outcome?
> An emissions fee is paid to the government, whereas an injurer who is sued and held liable pays damages directly to the party harmed by an externality. What differences in the behavior of victims might you expect to arise under these two arrangements?
> George and Stan live next door to each other. George likes to plant flowers in his garden, but every time he does, Stan’s dog comes over and digs them up. Stan’s dog is causing the damage, so if economic efficiency is to be achieved, it is necessary that
> To encourage an industry to produce at the socially optimal level, the government should impose a unit tax on output equal to the marginal cost of production. True or false? Explain.
> Four firms located at different points on a river dump various quantities of effluent into it. The effluent adversely affects the quality of swimming for homeowners who live downstream. These people can build swimming pools to avoid swimming in the river
> Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and arbitrage: a. Requiring airline travelers to spend at l
> Assume that scientific studies provide you with the following information concerning the benefits and costs of sulfur dioxide emissions: Benefits of abating (reducing) emissions: MB = 500 – 20A Costs of abating emissions: MC = 200 + 5A where A is the q
> A computer programmer lobbies against copyrighting software, arguing that everyone should benefit from innovative programs written for personal computers and that exposure to a wide variety of computer programs will inspire young programmers to create ev
> A number of firms have located in the western portion of a town after single-family residences took up the eastern portion. Each firm produces the same product and in the process emits noxious fumes that adversely affect the residents of the community.
> The Georges Bank, a highly productive fishing area off New England, can be divided into two zones in terms of fish population. Zone 1 has the higher population per square mile but is subject to severe diminishing returns to fishing effort. The daily fish
> Reconsider the common resource problem given in Example 18.7 given blow. Suppose that crawfish popularity continues to increase, and that the demand curve shifts from C = 0.401 – 0.0064F to C = 0.50 – 0.0064F. How does
> There are three groups in a community. Their demand curves for public television in hours of programming, T, are given respectively by W 1 = $200 – T, W 2 = $240 – 2T, W 3 = $320 – 2T. Suppose public television is a pure public good that can be produce
> A beekeeper lives adjacent to an apple orchard. The orchard owner benefits from the bees because each hive pollinates about one acre of apple trees. The orchard owner pays nothing for this service, however, because the bees come to the orchard without hi
> Refer back to Example 18.5 given below on global warming. Table 18.3 shows the annual net benefits from a policy that reduces GHG emissions by 1 percent per year. At what discount rate is the NPV of this policy just equal to zero? EXAMPLE 18.5 GLOBAL
> In a market for dry cleaning, the inverse market demand function is given by P=100−Q and the (private) marginal cost of production for the aggregation of all dry cleaning firms is given by MC=10+Q. Finally, the pollution generated by the dry cleaning pro
> The market for paper in a particular region in the United States is characterized by the following demand and supply curves QD =160,000−2000P and QS = 40,000+2000P, where QD is the quantity demanded in 100-pound lots, QS is the quantity supplied in 100p
> Consider a firm with monopoly power that faces the demand curve P = 100 – 3Q + 4A1/2 and has the total cost function C = 4Q2 + 10Q + A where A is the level of advertising expenditures, and P and Q are price and output. a. Find the values of A, Q, and P
> Medical research has shown the negative health effects of “secondhand” smoke. Recent social trends point to growing intolerance of smoking in public areas. If you are a smoker and you wish to continue smoking despite tougher anti-smoking laws, describe t
> Why might managers be able to achieve objectives other than profit maximization, which is the goal of the firm’s shareholders?
> Explain the difference between adverse selection and moral hazard in insurance markets. Can one exist without the other?
> If the used car market is a “lemons” market, how would you expect the repair record of used cars that are sold to compare with the repair record of those not sold?
> Why can asymmetric information between buyers and sellers lead to market failure when a market is otherwise perfectly competitive?
> What is an efficiency wage? Why is it profitable for the firm to pay it when workers have better information about their productivity than firms do?
> Why are bonus and profit-sharing payment schemes likely to resolve principal-agent problems, whereas a fixed-wage payment will not?
> How can the principal-agent model be used to explain why public enterprises, such as post offices, might pursue goals other than profit maximization?
> Joe earned a high grade-point average during his four years of college. Is this achievement a strong signal to Joe’s future employer that he will be a highly productive worker? Why or why not?
> Why might a seller find it advantageous to signal the quality of a product? How are guarantees and warranties a form of market signaling?
> A cable TV company offers, in addition to its basic service, two products: a Sports Channel (Product 1) and a Movie Channel (Product 2). Subscribers to the basic service can subscribe to these additional services individually at the monthly prices P1 and
> Describe several ways in which sellers can convince buyers that their products are of high quality. Which methods apply to the following products: Maytag washing machines, Burger King hamburgers, large diamonds?
> Faced with a reputation for producing automobiles with poor repair records, a number of American companies have offered extensive guarantees to car purchasers (e.g., a seven year warranty on all parts and labor associated with mechanical problems). a. I
> A major university bans the assignment of D or F grades. It defends its action by claiming that students tend to perform above average when they are free from the pressures of flunking out. The university states that it wants all its students to get As a
> Gary is a recent college graduate. After six months at his new job, he has finally saved enough to buy his first car. a. Gary knows very little about the differences between makes and models. How could he use market signals, reputation, or standardizati
> Many consumers view a well-known brand name as a signal of quality and will pay more for a brand-name product (e.g., Bayer aspirin instead of generic aspirin, Birds Eye frozen vegetables instead of the supermarket’s own brand). Can a brand name provide a
> A firm’s short-run revenue is given by R = 10e – e2, where e is the level of effort by a typical worker (all workers are assumed to be identical). A worker chooses his level of effort to maximize wage less effort w – e (the per-unit cost of effort is ass
> As Chairman of the Board of ASP Industries, you estimate that your annual profit is given by the table below. Profit (Î ) is conditional upon market demand and the effort of your new CEO. The probabilities of each demand condition occurring ar
> Two used car dealerships compete side by side on a main road. The first, Harry’s Cars, always sells high-quality cars that it carefully inspects and, if necessary, services. On average, it costs Harry’s $8000 to buy and service each car that it sells. Th
> You have seen how asymmetric information can reduce the average quality of products sold in a market, as low-quality products drive out high-quality products. For those markets in which asymmetric information is prevalent, would you agree or disagree wi
> Your firm produces two products, the demands for which are independent. Both products are produced at zero marginal cost. You face four consumers (or groups of consumers) with the following reservation prices: a. Consider three alternative pricing strate
> An insurance company is considering issuing three types of fire insurance policies: (i) complete insurance coverage, (ii) complete coverage above and beyond a $10,000 deductible, and (iii) 90 percent coverage of all losses. Which policy is more likel
> To promote competition and consumer welfare, the Federal Trade Commission requires firms to advertise truthfully. How does truth in advertising promote competition? Why would a market be less competitive if firms advertised deceptively?
> In the analysis of exchange using the Edgeworth box diagram, explain why both consumers’ marginal rates of substitution are equal at every point on the contract curve.
> In the Edgeworth box diagram, explain how one point can simultaneously represent the market baskets owned by two consumers.
> Why can feedback effects make a general equilibrium analysis substantially different from a partial equilibrium analysis?
> What are the four major sources of market failure? Explain briefly why each prevents the competitive market from operating efficiently.
> Do you agree or disagree with each of the following statements? Explain. a. If it is possible to exchange 3 pounds of cheese for 2 bottles of wine, then the price of cheese is 2/3 the price of wine. b. A country can only gain from trade if it can produc
> If Country A has an absolute advantage in the production of two goods compared to Country B, then it is not in Country A’s best interest to trade with country B. True or false? Explain.
> Why can free trade between two countries make consumers of both countries better off?
> Explain why goods will not be distributed efficiently among consumers if the MRT is not equal to the consumers’ marginal rate of substitution.
> You are selling two goods, 1 and 2, to a market consisting of three consumers with reservation prices as follows: The unit cost of each product is $30. a. Compute the optimal prices and profits for (i) selling the goods separately, (ii) pure bundling, an
> What is the marginal rate of transformation (MRT)? Explain why the MRT of one good for another is equal to the ratio of the marginal costs of producing the two goods.
> How is the production possibilities frontier related to the production contract curve?
> In the Edgeworth production box diagram, what conditions must hold for an allocation to be on the production contract curve? Why is a competitive equilibrium on the contract curve?
> How does the utility possibilities frontier relate to the contract curve?
> “Because all points on a contract curve are efficient, they are all equally desirable from a social point of view.” Do you agree with this statement? Explain.
> Jennifer and Drew consume orange juice and coffee. Jennifer’s MRS of orange juice for coffee is 1 and Drew’s MRS of orange juice for coffee is 3. If the price of orange juice is $2 and the price of coffee is $3, which market is in excess demand? What do
> Jane has 3 liters of soft drinks and 9 sandwiches. Bob, on the other hand, has 8 liters of soft drinks and 4 sandwiches. With these endowments, Jane’s marginal rate of substitution (MRS) of soft drinks for sandwiches is 4 and Bob’s MRS is equal to 2. Dra
> Using general equilibrium analysis, and taking into account feedback effects, analyze the following: a. The likely effects of outbreaks of disease on chicken farms on the markets for chicken and pork. b. The effects of increased taxes on airline tickets
> Suppose gold (G) and silver (S) are substitutes for each other because both serve as hedges against inflation. Suppose also that the supplies of both are fixed in the short run (QG = 75 and QS = 300) and that the demands for gold and silver are given by
> Suppose that country A and country B both produce wine and cheese. Country A has 800 units of available labor, while country B has 600 units. Prior to trade, country A consumes 40 pounds of cheese and 8 bottles of wine, and country B consumes 30 pounds o
> Some years ago, an article appeared in the New York Times about IBM’s pricing policy. The previous day, IBM had announced major price cuts on most of its small and medium sized computers. The article said: IBM probably has no choice but to cut prices per
> In the context of our analysis of the Edgeworth production box, suppose that a new invention changes a constant-returns-to-scale food production process into one that exhibits sharply increasing returns. How does this change affect the production contrac
> The Acme Corporation produces x and y units of goods Alpha and Beta, respectively. a. Use a production possibility frontier to explain how the willingness to produce more or less Alpha depends on the marginal rate of transformation of Alpha for Beta. b.
> A monopsonist buys labor for less than the competitive wage. What type of inefficiency will this use of monopsony power cause? How would your answer change if the monopsonist in the labor market were also a monopolist in the output market?
> Give an example of conditions when the production possibilities frontier might not be concave.
> In the analysis of an exchange between two people, suppose both people have identical preferences. Will the contract curve be a straight line? Explain. Can you think of a counter example?
> Fill in the missing information in the following tables. For each table, use the information provided to identify a possible trade. Then identify the final allocation and a possible value for the MRS at the efficient solution. (Note: there is more than o
> What is the Net Present Value (NPV) criterion for investment decisions? How does one calculate the NPV of an investment project? If all cash flows for a project are certain, what discount rate should be used to calculate NPV?
> What is the effective yield on a bond? How does one calculate it? Why do some corporate bonds have higher effective yields than others?
> How do investors calculate the net present value of a bond? If the interest rate is 5 percent, what is the present value of a perpetuity that pays $1000 per year forever?
> A firm uses cloth and labor to produce shirts in a factory that it bought for $10 million. Which of its factor inputs are measured as flows and which as stocks? How would your answer change if the firm had leased a factory instead of buying one? Is its o
> Look again at Figure 11.17. Suppose that the marginal costs c1 and c2 were zero. Show that in this case, pure bundling, not mixed bundling, is the most profitable pricing strategy. What price should be charged for the bundle? What will the firm’s profit
> What determines the supply of loanable funds? The demand for loanable funds? What might cause the supply or demand for loanable funds to shift? How would such a shift affect interest rates?
> What is meant by the “user cost” of producing an exhaustible resource? Why does price minus extraction cost rise at the rate of interest in a competitive market for an exhaustible resource?
> How does a consumer trade off current and future costs when selecting an air conditioner or other major appliance? How could this selection be aided by an NPV calculation?
> Suppose you are deciding whether to invest $100 million in a steel mill. You know the expected cash flows for the project, but they are risky – steel prices could rise or fall in the future. How would the CAPM help you select a discount rate for an NPV c
> What is meant by the “market return” in the Capital Asset Pricing Model (CAPM)? Why is the market return greater than the risk-free interest rate? What does an asset’s “beta” measure in the CAPM? Why should high-beta assets have a higher expected return
> How is risk premium used to account for risk in NPV calculations? What is the difference between diversifiable and non diversifiable risk? Why should only non diversifiable risk enter into the risk premium?
> What is the difference between a real discount rate and a nominal discount rate? When should a real discount rate be used in an NPV calculation and when should a nominal rate be used?
> You have noticed that bond prices have been rising over the past few months. All else equal, what does this suggest has been happening to interest rates? Explain.
> You are retiring from your job and are given two options. You can accept a lump sum payment from the company, or you can accept a smaller annual payment that will continue for as long as you live. How would you decide which option is best? What informati
> A bond has two years to mature. It makes a coupon payment of $100 after one year and both a coupon payment of $100 and a principal repayment of $1000 after two years. The bond is selling for $966. What is its effective yield?
