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CHAPTER 11—PERFORMANCE AND STRATEGY IN COMPETITIVE Se MULTIPLE 1.

In competitive market equilibrium, social welfare is measured by: a. the difference of net benefits derived by consumers and producers. the sum of net benefits derived by consumers and producers. c. net benefits derived by consumers. d. net benefits derived by producers. ANS:

2.

CHOICE

B

NOfexternalitie} exist when: a. private costs exceed social costs. Sx private costs and benefits equal social costs and benefits. c. private benefits are less than social benefits. d. private benefits exceed social benefits. ANS:

NAS

B tet ea policy that addresses market failures caused bydR positive externalities is:

patent grants.

b. c.

“subsidies for pollution reduction. tax policy.

d._

the establishment of operating controls.

ANS: 4.

The burden ofXper unit fox on a product will fall primarily on producers when: a. the tax is collected from customers. demand is highly elastic with respect to price. c. demand is highly inelastic with respect to price. d._ the tax is collected from producers. ANS:

5.

B

A per unit tax will cause output prices to increase least when:

a.

marginal cost is constant.

b. c.

marginal cost is falling. average cost is falling.

NA

narginal cost is rising.

ANS: 6.

A

D

Failure byl market structure|ean occur when: a. joint products are produced in variable proportions. b. joint products are produced in fixed proportions.

NS d\ ANS:

tematic few b

exist. s or sellers are present.

D

7. In competitive markets: “sa,_high-wage workers tend to be those that Ey

roductive.

MARKETS

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b. c. d.

companies earn excess profits by better serving customer needs. fairness is sacrificed in the interest of efficiency. firms dictate the quantity and quality of goods and services provided.

ANS: 8.

Consumer sovereignty reflects: buyer power. b. ~ failure by market structure. c. failure by incentive. d. externalities. ANS:

9.

A

Competition in the cable television service industry is furnished by: a. imports. potential entrants. c. large numbers of providers in local markets. d. government regulation. ANS:

10.

A

B

Producer surplus is the: a. amount paid to sellers above and beyond the value received by consumers.

SS Camount paid to sellers above and beyond the required minimum. c. d.

‘amount paid to sellers. cost of production.

ANS: 11.

The welfare loss a. deadweight b. deadweight deadweight d. ~ lost profits. ANS:

12.

C

A

Failure by market structure is caused by: a. positive spillover effects. b. positive externalities. c. negative externalities. none of these. ANS:

14.

triangle depicts: losses suffered by consumers. losses suffered by producers. losses suffered by consumers and producers.

Profits stemming from market power reflect: ~~ high prices. b. “superior efficiency. c. exceptional capability. d. rapid industry growth. ANS:

13.

B

D

Externalities are:

a.

differences between social costs and social benefits.

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\

ites between social benefits and private benefits. c. Social costs. d. social benefits. ANS:

15.

B

Undue market power is indicated when buyer influence results in: a. higher than competitive prices. b. less than competitive output. less than competitive costs. d. excess profits. ANS:

16.

C

Utility price and profit regulation is designed to address: a. failure by incentive. failure by market structure. c. ~ positive externalities. d. negative externalities. ANS:

B

1% A per unit tax on pollution: Nagin in deadweight loss. b. Nraises private benefits. c. lowers social benefits. d. lowers private costs. ANS: 18.

A

From an economic perspective, imposition of a per unit tax is only advantageous if: a. the social benefits derived from added tax revenues are sufficient to overcome the social costs at a risk-adjusted rate of return.. b. the social benefits derived from added tax revenues are sufficient to overcome the private costs at a risk-adjusted rate of return.. Ny the benefits derived from added tax revenues are sufficient to overcome the economic costs tied to the deadweight loss in social welfare. d. positive tax revenues are generated. ANS:

C

ON

right to a clean environment is asserted through:

fines. tradeable emission permits. subsidy policy. price and profit regulation.

c. d.

ANS:

20. “ b. c. d.

A

ays the economic cost of a tax is answered at the point of tax: burden. assessment. collection. incidence.

ANS:

A

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21.

The costs of pollutiongxepare shared by consumers and producers when: a. supply is perfectly elastic. b. supply is perfectly inelastic. Nx Seman is perfectly inelastic. ~~-rone of the above. ANS:

22.

A price ceiling is a costly and seldom used mechanism for: a. , restraining excess supply. Me restraining excess demand. c. counteracting the effects of falling productivity. d. counteracting the effects of rising productivity.

ANS: 23.

D

Economic rents are profits due to: a. Juck. uniquely productive inputs ¢. monopoly power. d. regulation. ANS:

25.

B

A price floor is a costly and commonly used mechanism for: a. restraining excess supply. b. restraining excess demand. c. counteracting the effects of falling productivity. -counteracting the effects of rising productivity. ANS:

24.

D

B

Above-normal returns earned in the time interval that exists between when a favorable influence on industry demand. or cost conditions. first transpires and the time when competitor entry or growth finally develops are called: f disequilibrium profits. b. anormal rate of return on investment. c. disequilibrium losses. d. economic rents. ANS:

A

PROBLEM 1.

Social Welfare Concepts. Indicate whether each of the following statements is true or false, and explain why. A.

Producer surplus tends to fall as the supply curve becomes more elastic.

B.

Consumer surplus tends to rise as demand becomes more elastic.

C.

The market demand curve indicates the minimum price buyers are willing to pay at each level of production.

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D.

The market supply curve indicates the minimum price required by sellers as a group to bring forth production.

E.

Consumer surplus is the amount that consumers are willing to pay for a given good or service above and beyond the amount actually paid.

ANS:

2.

A.

True. Whereas consumer surplus is closely related to the demand curve for a product, producer surplus is closely related to the supply curve for a product. It measures the amount by which the total revenues exceeds the marginal costs of production. As the supply curve becomes more elastic, the amount of producer surplus can be expected to fall.

B.

False. Consumer surplus is the area under the demand curve that lies above the market price. It represents the amount that consumers are willing to pay for a given good or service minus the amount that they are required to pay. As the demand curve becomes more elastic, the difference between perceived value and market prices tends to diminish, and consumer surplus falls.

C.

False. The market supply demand curve indicates the maximum price buyers are willing to pay to bring forth each level of production. The height of the market demand curve measures the maximum value placed on production by buyers at each production level.

D.

True. The market supply curve indicates the minimum price required by sellers as a group to bring forth production. The height of the market supply curve measures minimum production cost at each and every activity level.

E.

True. Consumer surplus is the area under the demand curve that lies above the market price. It represents the amount that consumers are willing to pay for a.given good or service minus the amount that they are required to pay. Consumer surplus represents value derived from consumption that consumers are able to enjoy at zero cost. It also describes the net benefit derived by consumers from consumption, where net benefit is measured in the eyes of the consumer. From the standpoint of society as a whole, consumer surplus is an attractive measure of the economic well-being of consumers.

Competitive Market Equilibrium. Suppose demand and supply conditions in the competitive market for unskilled labor are as follows: Qp = 66.25 - 5P

(Demand)

Qs = -27.5 + 10P

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour. A.

Calculate the industry equilibrium wage/employment combination.

B.

Confirm your answer graphically.

ANS: A.

Algebraically, Qo = Qs

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66.25 - SP = -27.5 +10P 1S5P = 93.75 P = $6.25 Both demand and supply equal 35 because: Demand: Qp = 66.25 - 5(6.25) = 35

Supply: Qs = -27.5 +10(6.25) = 35 B.

From the graph, it is clear that Qp = Qs = 35 at a wage rate of $6.25 per hour. Thus, P = $6.25 and Q = 35 is the equilibrium wage/employment combination. Unskilled Labor Demand and Supply Analysis Demand: Qp= 66.25 - SP drawn as P =$13.25 - $0. 2Qp

eS Price of Labor ($ per hour)

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$2.50

Supply: Qs= -27.5 + 10P drawn as

$1.00

P=

$0.00

+ 0

+ 5

10

$2 7540105

7 15

ir 20

+ 25

+ 30

35

40

45

. 50

Employment (millions of hours)

3.

Competitive Market Equilibrium. Assume demand and supply conditions in the competitive market for unskilled labor are as follows:

P =$15 -0.3Qp

(Demand)

P = $0.2Qs

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour. A. _ Illustrate the industry equilibrium wage/employment combination both graphically and algebraically. B.

Calculate the level of excess supply (unemployment) if the Federal minimum wage is raised

from $5.15 to $6 per hour. ANS:

A.

From the graph, it is clear that the competitive market equilibrium occurs when Qp = Qs = 30(000) at a wage rate of $6 per hour. Thus, P = $6 and Q = 30 is the equilibrium

wage/employment combination. Algebraically, P=P $15 - 0.3Q = $0.2Q

Mon 12 Apr @ docin.com

0.5Q= 15 Q=30 Both demand and supply equal 30 when P = $6 because: Demand: P = $15 - 0.3(30) = $6 per hour Supply: P = $0.2(30) = $6 per hour

Unskilled Labor Demand and Supply Analysis

si%

Demand: P =$15 - $0.3Qp

($ per hour)

$14

Price of Labor

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$13 $12

$11 $10 $9 $8 $7 $6 $5

$4 $3 $2 $1 0

10

20

30

40

50

Employment (millions of hours)

B.

4.

If the market equilibrium wage rate for unskilled labor is $6 per hour, an increase in the minimum wage from $5.15 to $6 will have no economic effect. The wage rate of $6 and the equilibrium employment of 30(000) million hours will be maintained.

Competitive Market Surplus. Suppose demand and supply conditions in the competitive market for unskilled labor are as follows: P =$15-0.3Qp

(Demand)

P= $3 + $0.1Qs

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour. A.

Illustrate the industry equilibrium wage/employment combination both graphically and algebraically. g y W-O4R © eon

Q

B.

5

&-bdbo

,»P~6

Calculate the level of excess supply (unemployment) if the Federal minimum wage is raised

from $5.15 to $7 per hour. ANS: A.

Algebraically,

P=P $15 - 0.3Q =$3 + $0.1Q 0.4Q = 12 Q=30

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Both demand and supply equal 30 when P = $6 because: Demand:

P = $15 - 0.3(30) = $6 per hour

Supply: P = $3 + $0.1(30) = $6 per hour From the graph, it is clear that the competitive market equilibrium occurs when Qp = Qs = 30(000) at a wage rate of $6 per hour. Thus, P = $6 and Q = 30 is the equilibrium wage/employment combination. Unemployment Caused By Minimum Wage Laws

$12 -

Demand: P =$15 - $0.3Qp Supply: P = $3 +$0.1Q5

&

$10 Price of Labor ($ per hour)

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0

5

10

15

20

25

30

35

40

45

50

Employment (millions of hours)

B.

Ifthe market equilibrium wage rate for unskilled labor is $6 per hour, an increase in the minimum wage from $5.15 to $7 will have a material economic effect on both employment and the wage received by low-wage workers. At a minimum wage of $7, supply of 45(000) million hours of unskilled labor is forthcoming, but demand falls to 25(000) million hours.

Unemployment of 20(000) million hours of unskilled labor is created (see graph). 5.

Competitive Market Surplus. Assume demand and supply conditions in the competitive market for unskilled labor are as follows:

Qp = 66.25 - SP

(Demand)

Qs = -27.5 + 10P

(Supply)

where Q is millions of hours of unskilled labor and P is the wage rate per hour. A.

Illustrate the industry equilibrium price/output combination both graphically and algebraically.

B.

How many low-wage workers will get laid off if the Federal minimum wage is raised from

$5.15 to $7.25 per hour? ANS:

A.

From the graph, it is clear that Qp =

Qs = 35 at a wage rate of $6.25 per hour. Thus, P =

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$6.25 and Q = 35 is the equilibrium wage-employment combination. Unemployment Caused By Minimum Wage Laws Demand: Qp= 66.25 - 5P drawn as P =$13.25 - $0205

$8.00 5

$7.50 4 $7.00 4

' ' ' ' ' ' ! '

$6.50 4 $5.00 4

$4.50 4 $4.00 + $3.50 4 $3.00 3 $2.50 3

Supply: O,= -27.5 + 10P

$2.00 4

drawn as

$1.50 4

P=$2.75+0.10,

$1.00 4 0

4

$0.50 4 $0.00 5

16

1S

T

T

20

25

30

1 1 1 1 1 ‘ ' 1 1 ' Tr

45

'

'

'

1 1 ' 1 1 '

&

$5.50 4

dese ecccwnsecccswnsesscsae

$6.00 +

th

Price of Labor ($ per hour)

7:46 PM

3O

Employment (millions of hours)

Algebraically, Qo = Qs 66.25 - 5P = -27.5 +10P ISP = 93.75 P = $6.25

Both demand and supply equal 35 because: Demand: Qp = 66.25 - 5(6.25) = 35 Supply: Qs = -27.5 +10(6.25) = 35

B.

6.

With an increase in the minimum wage from $5.15 to $7 per hour, 5(000) million worker hours will get laid off. If the market equilibrium wage rate for unskilled labor is $6.25 per hour, an increase in the minimum wage from $5.15 to $7 will have a material economic effect on both employment and the wage received by low-wage workers. At a minimum wage of $7.25, supply of 45(000) million hours of unskilled labor is forthcoming, but demand falls to 30(000) million hours. Unemployment of 15(000) million hours of unskilled labor is created. Total unemployment of 15(000) million hours is comprised of 5(000) million hours that get laid off plus 10(000) million hours of new labor looking for first-time employment. These are the unemployed that were never before hired, but are now looking for employment (see graph).

Per Unit Tax and Elastic Demand. Assume that the supply of tickets to an outdoor music festival in Thousand Oaks, California, is a function of price such that:

Qs = IP

(Supply)

where Q is the number of tickets (in thousands) and P is the ticket price. Also assume that the demand for such concert tickets is perfectly elastic at a price of $30. This means that the ticket demand curve can be drawn as a horizontal line that passes through $30 on the Y-axis.

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A.

Graph the ticket demand and supply curves using the price of tickets as a function of quantity (Q). On this same graph, draw another ticket supply curve based upon the assumption that a local municipality imposes a $5 tax on each ticket sold to pay for police

protection and clean-up costs. B.

Calculate the ticket price and quantity effects of the municipal tax. With perfectly elastic demand, who pays the economic burden of such a tax?

ANS:

A.

If Qs = IP, then P = $1Qs. Given a perfectly elastic demand at a price of $30, demand and

supply curves can be drawn as follows: Perfectly Elastic Ticket Demand Analysis $50 -

Supply With Tax Qs= 5 +1P drawn as P = $5+$1Q,

Ticket Demand

_"

drawn as

P=$30

a

iv

$40 -

t

T

T

5

10

15

20

35,

8

r

' ' ' ‘ t ' ' ‘ t ' t ' ' ' ' ' ' ' t ' ' t ' ' t ' t T

”

Ticket Price($)

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$10 +

$0 0

\ Supply Without Tax:

Qs= 1P drawn as P = $1Q;

xn

35

40

r

.

45

3

Quantity (thousands)

B.

7.

From the graph, it is clear that the equilibrium ticket price of $30 is maintained both before and after the local tax to pay for police protection and clean-up costs. However, because demand is perfectly elastic, the quantity demanded falls from 30 thousand to 25 thousand units. Price remains the same before and after the imposition of the local tax. Given the drop in output, producers bear the entire burden of paying for the local tax in the form of lost ticket sales opportunities. If ticket demand is less than perfectly elastic, and it surely is in the long run, then it is reasonable to expect both producers (through lost sales opportunities) and customers (through higher prices) to bear the costs of a tax imposed on producers.

Percentage Tariff and Elastic Demand. Assume that the supply of imported personal computers (PCs) from China is given by the expression: Qs = 0.03125P

(Supply)

where Q is the number of PCs sold (in thousands) and P is the PC price. Given the availability of PCs on the Internet, assume that the demand for PCs is perfectly elastic at a price of $800. This means that the PC demand curve can be drawn as a horizontal line that passes through $800 on the Y-axis. A.

Graph the PC demand and supply curves using price as a function of quantity (Q). On this

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same graph, draw another supply curve based upon the assumption imports form China are subject to an 25% import tariff (tax) that is not imposed on imports from other countries.

B.

Calculate the PC price and quantity effects of the 25% import tariff. With perfectly elastic demand, who pays the economic burden of such a tax?

ANS: A.

Percentage Tariff With Elastic PC Demand

Supply With Import Tariff: drawn as P = $400, $1,200 5

$1,100 4 $1,000 +

a

Computer Demand drawn as P =$300

$900 +

$800 PC Price($)

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“Ne

glia

$700 4

'

$600 4

'

$500 4

i

$400 4 $300 + $200 +

$100 +

ach

|

Supply Without Tariff:

! {

t i

Q;= 0.03125P drawn as P = $320,

1

'

'

t

From the supply curve, Qs = 0.03125P

P =$32Qs The effect of the 25% import tariff is to shift the supply curve upward. With the 25% tariff: P = 1,25($32Qs) = $40Qs

B.

From the graph, it is clear that the equilibrium PC price of $800 is maintained both before and after imposition of the import tariff. Because demand is perfectly elastic, the quantity demanded falls from 25 thousand to 20 thousand units. Price remains the same before and after the imposition of the import tax. Given the drop in output, Chinese producers bear the entire burden of paying for the import tariff in the form of lost sales opportunities. If PC demand is less than perfectly elastic, and it surely is in the long run, then it is reasonable to expect both producers (through lost sales opportunities) and customers (through higher prices) to bear the costs of any such tax imposed on producers.

8.

Sales Tax and Elastic Demand. Assume that the supply ofa best-selling book at local book stores throughout the United States is a function price such that:

Qs = -50 + 5P

(Supply)

where Q is the number of books sold (in thousands) and P is the book price. Given the availability of this book on amazon.com for $20, demand is perfectly elastic at a price of $20.

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A.

Derive the book supply curve where price is expressed as a function of output. Calculate the equilibrium level of output and local bookstore sales revenue.

B.

Derive a second book supply curve based upon the assumption local sales are subject to an 8% sales tax that is not imposed on Internet sales. Calculate the book price and quantity effects of the local 8% sales tax. With perfectly elastic demand, who pays the economic

burden of such a tax? ANS: A.

With perfectly elastic demand at a price of $20, the supply curve indicates the equilibrium level of output as:

Qs = -50 + 5P = -50 + 5(20) = 50(000) TR = 50($20) = $1,000(000) B.

From the supply curve, when price is expressed as a function of output:

Qs = -50 + 5P 5P =50 + Qs P=$10 + $0.2Qs The effect of the sales tax is to shift the supply curve upward. With the 8% sales tax, the new

supply curve is: P = 1.08($10 + $0.2Qs) = $10.8 + $0.216Qs 0.216Qs = -10.8 +P Qs = -50 + 4.63P With perfectly elastic demand at a price of $20, this post-tax supply curve indicates the equilibrium level of output as:

Qs = -50 + 4.63P = -50 + 4.63(20) = 42.6(000) TR = 42.6($20) = $852(000) = $852(000) It is clear that the equilibrium book price of $20 is maintained both before and after imposition of the sales tax. Because demand is perfectly elastic, the quantity demanded from local bookstores falls from 50 thousand to 42.6 thousand units. Price remains the same before and after the imposition of the sales tax. Given the drop in local sales, local bookstores bear the entire burden of paying for the sales tax in the form of lost sales opportunities. In the long run, demand tends to be somewhat elastic and it is reasonable to expect both producers (through lost sales opportunities) and customers (through higher prices) to bear the costs of any such tax imposed on producers.

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9.

Recycling Fee and Elastic Demand. Assume that the weekly supply of 16-ounce bottles of soda at convenience stores in the Twin Cities of Minneapolis and St. Paul is a function of price such that: Qs = -20 + 80P

(Supply)

where Q is the number of sodas sold in convenience stores (in thousands) and P is the soda price.

Assume demand is perfectly elastic at a price of $1. A.

te = Gxt 2G

Derive the soda supply curve where price is expressed as a function of output. Calculate the

equilibrium level of output and convenience store sales revenue. B.

_ jor YOct)

= AS

Derive a second curve based upon the assumption convenience store sales become subject to a 5 cent recycling fee. Calculate the price and quantity effects of the recycling fee. With perfectly elastic demand, who pays the economic burden of such a fee

ANS:

A.

With perfectly elastic demand at a price of $1, the supply curve indicates the equilibrium level of output as: Qs

= -20 + 80P

= -20 + 80(1) = 60(000)

TR = 60($1) = $60(000) B.

From the supply curve, when price is expressed as a function of output:

Qs = -20 + 80P 80P = 20+ Qs P = $0.25 + $0.0125Qs The effect of the recycling fee is to cause a parallel upward shift the supply curve. With the 5 cent recycling fee, the new supply curve is:

P = $0.25 + $0.0125Qs + $0.05 = $0.3 + $0.0125Qs 0.0125Qs = -0.3 +P Qs = -24 + 80P With perfectly elastic demand at a price of $1, this post-recycling fee supply curve indicates the equilibrium level of output as:

Qs = -24+ 80P = -24 + 80(1) = 56(000) TR =56($1) = $56(000) It is clear that the equilibrium soda price of $1 is maintained both before and after imposition of the recycling fee. Because demand is perfectly elastic, the quantity demanded from local

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convenience stores falls from 60 thousand to 56 thousand units per week. same before and after the imposition of the recycling fee. Given the drop convenience stores bear the entire burden of paying for the recycling fee sales opportunities. In the long run, demand tends to be somewhat elastic to expect both producers (through lost sales opportunities) and customers prices) to bear the costs of any such fee imposed on consumers.

Price remains the in sales, in the form of lost and it is reasonable (through higher

Franchise Tax and Inelastic Demand. Assume the supply of broadband services in the City of Williamsburg can be described as:

Qs = 1P

(Supply)

where Q is thousands of homes served per month with broadband service, and P is the price per month. Also assume that broadband service demand is perfectly inelastic at a quantity of 30(000). This means that the broadband demand curve can be drawn as a vertical line that passes through 30(000) on the X-axis. A.

B.

Graph the broadband demand and supply curves using price as a function of the quantity of service demanded (Q). On this same graph, draw another supply curve based upon the assumption that the City of Williamsburg imposes a franchise tax that increases provider costs by $5 per customer every month. Calculate the price and output effects of the City of Williamsburg franchise tax. With

perfectly inelastic elastic demand, who pays the costs of this tax? ANS: A.

If Qs = IP, then P = $1Qs if price is expressed as a function of quantity. Given a perfectly inelastic demand for broadband at a quantity of 30(000), broadband demand and supply curves can be drawn as follows: Perfectly Inelastic Broadband Demand

Demand drawn as

ey

10.

Price of Broadband Service ($ per month)

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>

Qp=30

BBY pone eneinnninctnntneetncinniinstinananincanettnntimnenttinninsy $30 4------------------------------------------5,

4

Before-tex Supply:

i e 2

Q5=-20+0.5P

$60 4

drawn as P = $40 + $2Q,

es

&

£

M4 $20 4 $0 0

5

T

r

T

10

15

a

25

r

T

T

T

30

35

40

45

50

Quantity (thousands)

B.

From the graph, it is clear that the equilibrium monthly output level of 25(000) homes served is maintained both before and after imposition of the City of Portland franchise tax. However, because the demand for sewer and water service is perfectly inelastic, the service

price rises from $90 to $100 per month. The number of homes served remains the same but consumer prices rise after the imposition of the City of Portland franchise tax. Given the $10 rise in service prices, consumers bear the whole burden of paying for the City of Portland franchise tax when demand is perfectly inelastic. In the long run, demand tends to be

somewhat elastic and it is reasonable to expect both producers (through lost sales opportunities) and customers (through higher prices) to bear the costs of any such tax imposed on producers. Of course, the theoretical case of perfectly inelastic demand is the polar opposite of the perfectly elastic demand curve faced by firms in perfectly competitive markets. Consideration of this polar extreme is a helpful means for understanding the effect of the price elasticity of demand on prices, marginal costs and supply in competitive

markets. 12.

Franchise Tax and Inelastic Demand. Assume the supply of sewer and water services in the City of Greenville, North Carolina, can be described as: Qs = -150 + 2P

(Supply)

where Q is thousands of homes served per month with sewer and water service, and P is the price per month. Also assume that sewer and water service demand is perfectly inelastic at a quantity of

50(000). A.

Derive the sewer and water service supply curve where price is expressed as a function of output. Calculate the equilibrium level of output and sewer and water utility sales revenue.

B.

Derive a second sewer and water service supply curve based upon the assumption that every month the City of Greenville imposes a $25 per customer franchise tax. Calculate the equilibrium level of output and sewer and water utility sales revenue with the tax. With perfectly inelastic demand, who pays the economic burden of such a tax?

ANS:

Ie