COMPARATIVE ADVANTAGE EXPLAINED: Suppose that Alberto and Isabella can produce both teaching content

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Academia Questions CHAPTER 1 COMPARATIVE ADVANTAGE EXPLAINED

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Gigi will specialise in picking apples due to having a comparative advantage in picking apples compared to Jie, whereas Jie will specialise in picking berries as he has a comparative advantage in picking berries compared to Gigi. Jie's opportunity cost of picking apples is 2.5berries (10/4). thus, Gigi will pick the fifth apple as she has a lower opportunity cost of 2 berries (6/3) per apple.

If Gigi was to pick apples, she would have an opportunity cost of 2 berries for every 1 apple. Jie would have an opportunity cost of 2.5 berries for every apple she picks. This means that Gigi has the comparative advantage when it comes to picking apples as she has a lower opportunity cost. As a result, according to the Principle of Increasing Opportunity Cost (low hanging fruit), we should exhaust Gigi's ability to pick apples first before allowing Jie to pick apples. As we wish to pick 5 apples, Gigi would pick the first 3 (exhausting her maximum amount of apples), and Jie would then continue to pick as many apples as required. As a result, Jie will pick the 5th apple.

Gigi has a lower opportunity cost of apples in terms of bananas at 2, while Jie has an opportunity cost of 2.5 of bananas. Therefore, gigi should use her comparative advantage to pick 3 apples, which means that the 4th and 5th apple will be picked by Jie. Gigi has the comparative advantage in picking Apples as his opportunity cost is lower at 2 (compared to Jie's at 2.5). Thus Gigi should specialise in Apples, and consequently Jie should specialise in Berries. As Gigi cannot physically pick 5 Apples in a day, the 5th Apple must be picked by Jie - he will have to sacrifice some of his berries to pick a 5th Apple. Thus the 5th Apple is picked by Jie. According to the table, the opportunity cost for Jie to produce apple is 10/4=2.5 and for Gigi is 6/3=2 , so Gigi has the caparative advantage in producing apples. Oppositely, Jie has the comparative advantage in producing Berriers. Gigi, who has CA in picking apples, can only pick 3 apples in one day. If we want to pick the 5th apple, Jie need to do pick the rest 2 of the apples. So Jie will pick the 5th apple.

CA: SPECIAL CASE Suppose that Alberto and Isabella can produce both teaching content and research.

Explain why it is not possible for either Alberto and Isabella to have a comparative advantage at producing both things.

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Not possible to have comparative advantage in both teaching content and research as comparative advantage is when you can produce a good or service at a lower opportunity cost than another producer.

A producer cannot have a comparative advantage in producing both goods, rather it can have an absolute advantage in producing all goods but not a comparative advantage.

It is not possible for both agents to have comparative advantage at producing the same good because there will be an agent who would have a lower opportunity cost than the other agent in either teaching content or research. If both have the same opportunity cost for both teaching content and research, they are better off on their own as both would not benefit from specialisation.

It is not possible for either Alberto and Isabella to have a comparative advantage at producing both things.

The comparative advantage of one goods is that this person has the lower opportunity cost to produce this goods. So he will have the comparative advantage. The opportunity cost is the value of the next best alternatives in particular situation. For this question, Alberto or Isabella can have comparative advantage

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in teaching content and research. However, if Alberto has comparative advantage in teaching content and research, this means the opportunity cost of doing these two action is lower than Isabella do. So Isabella will have no comparative advantage in teaching content and research as she has higher opportunity cost.

So there will be only one person who can have comparative advantage in teaching content and research.

Comparative advantage and opportunity cost points to the relationship between the production of two goods where their relationship is inverse. Teaching content and research cannot be quantified but is rather based off the quality. So time in this sense has no affect on the quantity but the quality.

OC: AN EXAMPLE Isabella is a student and also works part-time as a waitress earning $10 per hour. Isabella was invited to attend a play on Sunday afternoon. Attending the play will take 2 hours, and a ticket costs $60. If Isabella were to spend the time studying for an exam, she will receive an HD instead of a D. She values a HD over a D at $40. What is Isabella’s opportunity cost (OC) of attending the play? Explain your answer.

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OC

The opportunity cost of attending the play is the next best alternative, that is, studying for an exam and receiving a HD. The OC is therefore the value of the HD ($40) + the value of the ticket to the play ($60) that she saves in staying home = $100.

During the 2 hours in which Isabella attends the play, she could spend that time to either work or study.

Working will give her a benefit of $10 x 2 = $20 whilst studying will give Isabella a HD instead of D (for which she values the HD at $40). Opportunity cost is determined by the next best alternative, and in this case, it is studying ($40 (study)>$20 (job)). This means that her opportunity cost for attending the play is $40.

The next best alternative for Isabella is to study which she values at $40. Her opportunity cost of going to the play would be the valued $40 + $60 (the cost of the play ticket) = $100 According to the definition, opportunity cost is the value of the next best alternative to that action. In this case, apart from the value of Isabella's attending the play, which costs $60 and 2 hours, she could earn $20 by doing her part-time job, or study for a HD which worths $40 to her. Therefore, studying is the next best alternative that could've brought her $40. In addition to the cost of the ticket (as she would not need to pay for it if she chooses to study instead), the opportunity cost of attending the play would be $100.

The opportunity cost is the amount sacrificed of the next best option as such the opportunity cost for Isabella is 60 + 40 = $100. By contrasting the value of studying versus working, it becomes clear that studying is Isabella’s next best option (40>(10x2)). If she decides to study instead of attending the play, she also saves $60. As such the opportunity cost is $100.

Isabella's opportunity cost of attending the play would be $120 dollars. This is due to her being able to earn 20 dollars from work (2 hours, 10 dollars and hour), her receiving a HD in her exam which she values at 40 dollars and the tickets to the play($60). Hence, adding all these up, it will total to $120.

During the 2 hours in which Isabella attends the play, she could spend that time to either work or study.

Working will give her a benefit of $10 x 2 = $20 whilst studying will give Isabella a HD instead of D (for which she values the HD at $40). Opportunity cost is determined by the next best alternative, and in this case, it is studying ($40 (study)>$20 (job)). This means that her opportunity cost for attending the play is $40.

The next best alternative for Isabella is to study which she values at $40. Her opportunity cost of going to the play would be the valued $40 + $60 (the cost of the play ticket) = $100 Opportunity cost is defined as the value of the next best alternative, in comparison to the chosen action. If Isabella doesn’t attend the play, she could be a) working, or b) studying for her exam to achieve a HD. If she chooses to work, she will gain $20 in salary, plus the $60 she will save from the play ticket, totalling to $80. If she chooses to study, she will gain the $40 she values from a HD, and the $60 from the play ticket, totalling to $100. Thus, her opportunity cost of watching the play is the value of the next best alternativestudying, and is valued at $100.

Define the concept of Opportunity Cost and state the Low Hanging Fruit Principle (or Principle of Increasing Opportunity Cost). Explain these two concepts using a real-wold example.

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Opportunity cost refers to the value of the next best alternative to that particular action. The LHFP refers to how an economy must first employ those agents/producers with the lowest opportunity cost, and only once those have been exhausted, turn to the second lowest OC and once that is exhausted, repeating the process. A real world example would be collecting coconuts. There are people who inherently will have a lower opportunity cost for collecting coconuts as they are either taller, stronger or faster and hence the time spent collecting a coconut is less than others. By using the LHFP, the most efficient coconut collectors will be sent out first, and if the amount collected is not sufficient, the second most efficient will be sent out and so on until the amount collected is sufficient.

Opportunity Cost (OC) is the what is forgone when the next alternative is chosen. For example, if Nathan decided to make computers, he is forgoing the chance to produce phones. The Principle of the Low Hanging Fruit is concept where the producer with the lowest OC will be chosen to produce first until resources are depleted and then the next lowest OC will be chosen. In this scenario, say Nathan had a lower opportunity cost than Daniel to make computers, then Nathan would make all the computers he possibly could and then Daniel would start to produce computers.

Opportunity cost (OC) refers to the value of the next best alternative action which has been forgone. The Principle of Low Hanging-Fruit uses this concept to suggest when production of a good is to be increased, the resources with the lowest OC should be employed first. In order to illustrate this, let's consider an example where it's harvest season on Australian farms, and a particular farmer has 4 harvesting machines (A,B,C,D) to harvest either wheat or barley. Assume the farmer currently has machine A harvesting wheat, and the other 3 harvesting barley. However, the farmer realises that it is more profitable to harvest and sell the wheat first, and will need to reallocate 2 machines from barley harvesting to wheat harvesting. For this example, assume machine B in a week can harvest 2 tons of wheat, or 4 tons of barley. Machine C can harvest either 1 ton of wheat or 3 tons of barley in a week, and Machine D can harvest either 3 tons of wheat or 3 tons of barley. Since the farmer is choosing 2 of these machines to change to harvesting wheat, we calculate the OC of harvesting wheat instead of barley (how much barley could have been harvested instead of wheat). For Machine B, it costs 2 tons of barley for each ton of wheat, likewise for Machine C it will cost 3 tons of barley per ton of wheat, and Machine D will cost 1 ton of barley per 1 ton of wheat. In accordance with the Principle of Low Hanging Fruit, the farmer would first prefer to move machine D to wheat harvesting since it has the lowest OC to do so. The next machine the farmer chooses is machine B, which has the next lowest opportunity cost. Machine C will stay harvesting barley, since the farmer only needed to reallocate 2 machines, and C had the highest OC. Opportunity cost is the value of the next best alternative to that action. The low hanging fruit principle states that in the process of producing the production of any good, one must first employ the resources with the least opportunity cost and once they are exhausted, they turn to the resource with the next lowest opportunity cost. For example, if Agent A can produce 10kg of apples in a day and 1kg of fish in a day while Agent B can produce 3kg of apples in a day or 3kg of fish in a day, Agent A has a lower opportunity cost in producing apples while Agent B has a lower opportunity cost in producing fish. And hence, according to the hanging fruit principle, Agent B must start to produce more fish first until he has run out of resources (time), before Agent A starts to produce fish.

Opportunity costs refer to the loss of benefit/potential gain of other productive activities when one specific alternative has been chosen. An example, if you spend time and money to watch a movie, you cannot spend that time reading a book. The opportunity cost of watching the movie is the money spent and the pleasure you forgo by choosing not to read the book. The Low Hanging Fruit Principle refers to an approach business executives take to focus on more easily achievable/attainable goals, which typically leads to faster results. For example in the name itself, as a fruit picker in an orchard, it is much easier and requires less effort to gather fruit that is low-hanging or within reach. If you wish to pick fruits that are growing higher up in the tree, you would need to get a ladder and move from tree to tree as you proceed picking fruits, requiring more effort.

PPC: ADVANCED Suppose that Mitch and Jie live on an island and spend their time picking bananas and catching fish. The table below shows their productivity at each task.

A. Opportunity cost for producing 1kg of fish for Mitch is 1.3kg bananas (8/6) and for Jie is 1.5kg bananas (6/4). Mitch has lowest opportunity cost and therefore the comparative advantage.

B. Straight line from 6 to 8. All points on the PPC are efficient, so the opportunity cost of producing more of one good is the decrease in production of the other good.

C. If Jie specialises in bananas, then he will buy 1kg of fish in exchange for up to 1.5kg in bananas. If Mitch specialises in fish, then he will sell 1kg of fish for 1.3kg+ bananas. So the trade price is between 1.3kg and 1.5kg in bananas for 1kg of fish.

D. As Mitch specialised in fish (as per CA), she only produces 6 fish per day and therefore eats zero bananas.

A. Mitch's OC of producing fish = 8/6 = 1.33 banana Jie's OC of producing fish = 6/4 = 1.5 banana Mitch's OC of producing banana = 6/8 = 0.75 fish Jie's OC of producing banana = 4/6 = 0.67 fish Therefore, Mitch has a comparative advantage in producing fish, while Jie has a comparative advantage in producing banana.

B. The PPC shows what Mitch can produce if she works the whole day, which mean resources (time) are used efficiently. The downward slope of the PPC represents the concept of opportunity cost. Point A represents the combinations of rabbit and bananas, where Mitch can produce if he spends all his time producing bananas = (0,8). Her opportunity cost of producing 1 fish is 1.33 banana, thus at the point B he will produce 1 fish and (8 – 1.33) = 6.67 banana rabbit.

C. Mitch specialises in fish will want to sell to Jie at a price that higher or equal his opportunity cost of producing fish (≥1.33 banana). Meanwhile, Jie who specialises in bananas will want fish as long as the price of fish less than or equal her opportunity cost of producing fish (≤1.5 banana). Hence, 1.33 banana ≤ Price of fish ≤ 1.5 banana.

Similarly, 0.67 fish ≤ Price of banana ≤ 0.75 fish.

D. Following the principle of comparative advantage, Mitch will specialise in producing fish and Jie specialises in producing banana. If Match and Jie trade, he best Mitch can do is trade fish for banana at Jie's opportunity cost of producing fish, which is 1.5 banana for 1 fish.

Hence, Mitch could trade 6 fishes for 9 bananas.

(A) Jie has a comparative advantage in producing bananas since he has a lower opportunity cost of 2/3 as compared to Mitch’s ¾ Mitch has a comparative advantage in producing fish since he has a lower opportunity cost of 4/3 as compared to Jie’s 3/2.

(B) The PPC above illustrates the concept of opportunity cost as it is a graphical representation of Mitch’s opportunity cost in producing the two different goods. As noted in part (A), Mitch’s opportunity cost in producing bananas is ¾ fish, implying that he must sacrifice ¾ fish for every banana he wishes to produce. This is reflected in the PPC through its slope. The slope of Mitch’s PPC = rise/run = 6/8 = ¾, which is in accordance to his opportunity cost of bananas. Similarly, the reciprocal of the slope of the PPC is the opportunity cost for fish.

(C) Mitch has the comparative advantage in producing fish and thus would specialise in producing this particular good. Conversely Jie would specialise in producing bananas.

Fish: The price of fish that both Mitch and Jie would be willing to trade is: 4/3 bananas < price of fish < 3/2 bananas.

Mitch would be willing to trade if the price of fish is greater than his opportunity cost (ie 4/3 bananas). If this price was lower, he would be reluctant to trade with Jie and would rather benefit off by producing his own bananas.

Jie would be willing to trade if the price of fish is lower than his opportunity cost, since for him to produce fish on his own, he must sacrifice 3/2 bananas during that time. If by trading with Mitch, he has to pay more than 3/2 bananas, Jie would be better off producing fish on his own rather than relying on Mitch’s specialisation.

Thus by considering both opportunity costs, the price of fish is between 4/3 and 3/2 bananas.

Bananas: The price of bananas that both Mitch and Jie would be willing to trade is: 2/3 fish < price of bananas < ¾ fish Jie would like the price of bananas to be greater than his opportunity cost in order to have an incentive to trade with Mitch, or else he is better off producing fish on his own.

Similarly, Mitch would trade if the price of bananas is lower than his opportunity cost for bananas for if it was any higher, he would rather produce bananas on his own.

(D) Since Mitch and Jie specialise in their productive activities, both will produce solely the good that they have a comparative advantage in.

Mitch will solely produce fish and Jie would solely produce bananas.

Mitch can produce a maximum of 6 fish in a day from specialisation and since it is given he consumes 6 fish per day, there is no incentive/need for Mitch to trade with Jie. Hence the largest number of bananas that she could consume by trading with Jie = 0 bananas.

PPC AND OC The Production Possibilities Curve (PPC) and the concept of opportunity cost (OC) are connected. Explain how.

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The Production Possibility Curve (PPC) is a model that captures all the maximum output possibilities for two (or more) goods, given a set of inputs (or resources) that are used efficiently. Whilst the Opportunity Cost (OC) of a given action is the value of the next best alternative to that particular action. The PPC model is used to show the tradeoffs associated with allocating resources between the production of two goods and can be used to illustrate the concept of OC as the PPC represents the maximum output possibilities, making it clear that in order to produce more of one thing, we must produce less of something else. The slope of the PPC tells us the opportunity cost of an extra unit of a good because it tells us how much less of one good can be produced in order for one more unit of the other good to be produced.

A PPC is the curve that represents all the possible and efficient combinations of production. It can be used to show the trade-off between two goods. The trade-off can also be called the opportunity cost - which is the value of the next best alternative. Using a PPC, one can increase the quantity of a good (let's call it A) by one. The second good (let's call it B) will decrease and however much it goes down by is the opportunity cost of good A. The gradient of the PPC, B/A or A/B is the opportunity cost of A and B respectively. The shape of the PPC can determine whether the opportunity cost is increasing. A linear curve shows an economy in which the OC is constant (the more of good A you produce, the equal amount of good B you are forgoing per unit of A).

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A Production Possibilities Curve (PPC) captures all maximum output possibilities for two (or more) goods, given a set of inputs (or resources - i.e., time) if inputs are used efficiently. The Opportunity Cost of a given action is the value of the next best alternative to that particular action. A PPC can illustrate opportunity cost as opportunity cost is captured by the gradient of the line. In the example below, the gradient of the line is 1.33. A PPC also shows the specific opportunity cost as at any point on the line you can tell what is being given up. For example, at point A (3,4), the opportunity cost of 3 fish is another 4 bananas and the opportunity cost of producing 4 bananas is another 3 fish.

PPC EXPLAINED Suppose that Mitch and Jie live on a farm and spend their time weaving cloth and milking their cows. The table below shows their productivity at each task.

A. Who has an absolute advantage and who has a comparative advantage in producing milk?

B. Draw the “economy-wide” PPC for Jie and Micth’s farm. (Remember to show your work and label ALL relevant points) C. Explain how the shape of the economy-wide PPC illustrates the Low-Hanging Fruit Principle.

A. Mitch has absolute advantage in producing both goods.

OC Mitch cloth (in terms of milk) = 5 OC Jie cloth (in terms of milk) = 8 Mitch has comparative advantage in cloth, Jie has comparative advantage in milk.

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C. The Low-Hanging Fruit Principle (or Increasing Opportunity Cost) states that in the process of increasing the production of any good, we should first use the resources with the lowest opportunity cost and only once these are exhausted turn to resources with higher cost. In this economy, Mitch has comparative advantage in producing cloth, so in order to increase production from 0 units to 1 unit of cloth, we should first use Mitch – this is seen as the first gradient is 5, when Mitch is producing his maximum number of cloth per day (2), in order to further increase cloth we must turn to Jies labour, until she is producing her maximum cloth per day (1). The Low Hanging fruit principle makes the 2 agent economy bowed as the opporuntity cost to produce more increases due to scarcity.

A) Mitch has the absolute advantage in producing both milk. Jie has the comparative advantage in producing milk (1/8 opposed to 1/5).

B) The economy-wide PPC shows all possible combinations of two goods that an economy/country can produce.

C) The Low-Hanging Fruit Principle or Principle of Increasing Opportunity Cost states that in the process of increasing the production of any good, first employs those resources with the lowest opportunity cost, and only once these are exhausted, turn to resources with higher cost.

The economy-wide PPC bows from its origin since Jie who has a comparative advantage in producing milk will produce milk first before Mitch (Low-Hanging Fruit Principle). The slope of the PPC curve then increases (increasingly negative) past the kink point as more milk produced, meaning that the OC of producing milk is increasing (as Mitch has a higher OC in producing milk). The kink point is where both Jie and Mitch are fully specialised, where they produce only the good they have a comparative advantage in. The intercept points are where they both produce either milk or cloth the whole day.

PPC AND CPC 1. Explain why, for a closed economy, the production possibility curve (PPC) and the consumption possibility curve (CPC) are the same.

2. In addition, explain why, for an open economy, the CPC lies beyond (above and to the right of) the PPC. 1. A country is a closed economy, it means that it doesn’t trade internationally. This country will consume whatever they produce, so PPC and CPC are the same.

2. A country is an open economy. It means that it trades on the international market. This country produces an ne traded for other goods and services, which relieves the restrictions on consumption.

For a closed economy: - agents can only consume what they produce, therefore PPC = CPC For an open economy: - CPC >/ PPC as part of what agents produce can be traded for other goods in the international market, relieving restrictions on consumption

1. In a close economy the PPC and CPC are the same as the economy must consume what they produce as they are not trading with any other economy, so it is not possible to get any other product to consume 2. The CPC usually lies beyond the PPC as economies can usually consume more products through trade than what they produce

The production possibility curve represents all possible combinations of goods where currently available resources do not allow an increase in the production of one good without a reduction in the production of the other. The consumption possibility curve shows all the combinations of the two goods that the agents in the economy can consume. In a closed economy, agents are unable to trade with the international market, and the PPC and CPC are the same since the agents are only able to consume what they produce due to being unable to trade. In an open economy, agents are able to trade on the international market, the CPC lies

beyond the PPC because the products the agents produce can be traded indefinitely for other goods and services.

If a country is a closed economy (doesn’t trade internationally), the PPC and the CPC are the same because the agents must consume whatever they produce. If a country is an open economy (trades on the international market), the CPC is usually greater (above and to the right of) than the PPC because part of what the agents produce can be traded for other goods and services, which relieves the restrictions on consumption.

A closed economy is when the market doesn't open to international trade, and when it is a closed economy, PPC and CPC are the same, because they can only consume whatever they produce. Open economy is when they trade in an international market, and CPC is normally greater than PPC because they are able to sell the goods and trade with other goods, which increases their consumption.

PRINC. OF COMP ADV 1. State the Principle of Comparative Advantage, and 2. Explain what it means to have a comparative advantage in a productive activity.

3. Provide a real-world example that illustrates the Principle of Comparative Advantage, and explain how it does so.

Comparative Advantage is assigned to a person who produces a good/service with a lower opportunity cost than the competing parties. For example, if I produce 1 carrot or 1 apple each other, and my competitor produces 2 carrots or 1 apple each other, then I would have the comparative advantage in producing apples because I'm only sacrificing 1 carrot whereas they would be sacrificing 2 carrots.

An agent or an economy has a Comparative Advantage in a productive activity when he, she or it has a lower Opportunity Cost of carrying on that activity than another agent or economy. In terms of deciding which agent within an economy should specialise in producing which good or service, understanding which agent has a Comparative Advantage can inform us as to which agent should specialise in which good or service. When we calculate the Opportunity Cost for each agent, by calculating which agent has the lowest value of the next best alternative to producing said good, we can then establish who should specialise in what. If one firm within an economy has a Comparative Advantage in producing one of the many components required to build a new Light-Rail line, then that firm should be tasked with producing that component. In comparison, other firms within the economy may have Comparative Advantages in producing other components required to build the Light-Rail line, and thus they should be tasked with producing the component in which they have a Comparative Advantage. As a result of this specialisation, the city building the new Light-Rail line can guarantee the most efficient use of the firms within it's economy in order to build the new Light-Rail line in the most cost-effective and efficient way, thus costing the taxpayer the least amount of money and time

a. State the Principle of Comparative AdvantageThe principle of comparative advantage is that all agents are better off specialising in an activity they are more efficient in and trading with other agents. b. Explain what it means to have a comparative advantage in a productive activity. To have a comparative advantage in a productive activity means to be able to complete with a lower opportunity cost than another agent. c. Provide a real-world example that illustrates the Principle of Comparative Advantage, and explain how it does so. A real world example of the principle of comparative advantage is Australia’s strong factor endowment in natural minerals (the world's largest iron ore reserves). Australia maintains a comparative advantage because the iron ore is of high quality and close to the surface of ground, meaning fewer resources must be diverted from the rest of the economy to the mining industry in order to produce the same output as other countries. Australia is thus best off trading natural resources for goods that we do not have a

comparative advantage in, such as clothing and textiles, which require comparatively more resources than, say, China.

The Principle of Comparative Advantage states that everyone is better off if everyone specialises in the tasks in which they have a comparative advantage. To have a comparative advantage in some productive activity, an agent or an economy can perform the activity at a lower opportunity cost than other agents or economies.

For example, Australia could have the labour force and equipment to either efficiently produce 100 tonnes of iron ore or 20 tonnes of highly manufactured goods per week. On the other hand, China has the labour force and technology to either efficiently produce 200 tonnes of highly manufactured goods or only 25 tonnes of iron ore. The opportunity costs of Australia and China to produce 1 ton of iron ore are 0.2 tonnes and 8 tonnes of highly manufactured goods respectively. The opportunity costs to produce 1 ton of highly manufactured goods are also 5 tonnes and 0.125 tonnes of iron ore respectively. From these opportunity costs, we can see that Australia has the comparative advantage in producing iron ore, while China has the comparative advantage in producing highly manufactured goods.

Following the Principle of Comparative Advantage, both countries specialise in the activities in which they hold the comparative advantage (Australia produces iron ore, China produces highly manufactured goods), and then the two 'agents' can trade their outputs, resulting in a more efficient outcome than if each country produced both goods.

TERMS OF TRADE Tina and Harriet can produce bracelets and rings. Tina can make 0.5 bracelets in the time it takes her to make one ring, and Harriet can make 4 rings in the time it takes her to make one bracelet. Who should specialise in bracelets? For what range of prices in terms of rings would Tina and Harriet be willing to trade bracelets and rings? Explain your answer.

Tina should specialise in bracelets as she has a comparative advantage in producing bracelets. This is because she has a lower opportunity cost of 2 rings than Harriet's opportunity cost of 4 rings to produce one bracelet.

They would be willing to trade bracelets and rings at the range of between 2 rings and 4 rings. As Tina specialises in bracelets and Harriet specialises in rings, Tina will only be willing to trade her bracelets for more than 2 rings whilst Harriet will be willing to trade her rings for Tina's bracelets. Harriet's maximum production of rings per bracelet is 4. Therefore, they will be willing to exchange in between 2 and 4 rings.

TIina should specialise in Bracelet because her opportunity cost is only 1 ring compared to Harriet who's OC to make a bracelet is higher (4 rings). The range of price is defined by the opportunity cost of each agent, so here, the range of price will be between 2 and 4 rings for a bracelet.

Tina should specialise in bracelets as she can make 0.5 of a bracelet in the time it takes to make one ring, whereas it takes Harriet 4 rings to make one bracelet.

OCmaking a bracelet=(loss in rings)/(gain in bracelets) We calculate the OCmaking a bracelet for Harriet and Tina: For Harriet, OCmaking a bracelet=4/1=4 rings For Tina, OCmaking a bracelet=1/0.5=2 rings Tina has a comparative advantage in bracelet making as her opportunity cost of making a bracelet of 2 rings is less than Harriet’s opportunity cost of making a bracelet of 4 rings. Tina should therefore specialize in bracelet making.

Tina will sell her bracelets if: Pricebracelet≥Tina’s O.Cmaking a bracelet Pricebracelet≥ 2 rings Harriet will buy Tina’s bracelets if: Pricebracelet≤Harriet’s O.Cmaking a bracelet herself Pricebracelet≤4 rings We assume at the point of indifference (when marginal cost is equal to marginal benefit or the trading price is equal the opportunity cost in this case), the agents take the action and trading occurs.

Hence, trading will occur for a range of bracelet prices of between 2 rings and 4 rings per bracelet.

comparative advantage refers to the country's ability to produce a good and service at a lower oppprtunity cost compared to other country. In this case. Harriet has a comparative advantage in producing ring while tine has the comaprative of producing bracelets. the price range in terms of ring would be between 2 and 4 rings because these are the opportunity cost of the two countries

Tina specialises in making bracelets as she has a lower comparative advantage in producing bracelets.

The range of prices in terms of rings Tina and Harriet would be willing to trade bracelets and rings : 0.5 rings < price (bracelet) < 1 ring

CHAPTER 2

COST CURVES Wally’s Wagyu is a food stand that sells wagyu steak sandwiches. The table below lists Wally’s production costs per hour.

C) If Wally wants to continue to operate in the short run his production profits > fixed costs.

This accounts for the prices above the minimum of the average variable cost curve i.e. > $3 If he were to exit in the long run if his production profits < 0. This accounts for prices below the minimum of the Average total cost curve i.e. < $9 In order to continue to operate in the short run and exit in the long run, the red section of the marginal cost curve represents the possible supply curve. Thus, the price should be between $3 and $9, as illustrated on the graph.

(A)

(B)

(C)

A particular price at which Wally’s would continue to operate in the short run but would exit the market in the long run would be $6.

In the long run, a firm would exit the market if it is making a loss (profit < 0). This occurs at any price below the intersection of the average total cost curve and marginal cost curve since at the intersection (min of ATC), the firm makes exactly 0 profit. On the diagram above, the point of intersection is at a price of $9, where Wally’s produces 3 sandwiches.

Any price below $9 will result in Wally’s exiting the market.

In the short run, a firm would fail to operate if the market price is positioned lower than the intersection of the average variable cost curve and the marginal cost curve. Since below this

price, the firm is unable to cover the fixed costs involved in the production. In the above graph, the intersection of the AVC and MC curve occurs at a price of $3. Any price above $3 will allow Wally Wagyu to maintain operating in the market.

Hence the price must be between $3 and $9 where Wally’s would continue to operate in short run but exit the market in the long run. Although at a price of $6, the firm is making a loss, it would still continue to operate in the short run since this loss exceeds the firm’s fixed costs and is still able to cover it.

ELASTICITY OF SUPPLY IN ACTION Would you expect the price elasticity of supply for wooden tables to be greater if factories typically specialize in the production of either tables or chairs or if most factories produced both tables and chairs? Explain.

Price elasticity of supply for wooden tables would be greater if factories specialised in either tables or chairs as opposed to both tables and chairs. This is because factories specialising in tables only are likely to have a greater inventory of tables hence are able to increase supply more easily in response to demand creating elastic supply. Such factories should also mean there is a greater availability of raw materials required to produce tables also creating elastic supply.

The price elasticity of supply for wooden tables would be greater if factories produced both tables and chairs. This is because if they all produced tables and chairs, there would be larger inventories and availability of raw materials, to cater for both tables and chairs. The suppliers would be more responsive to price changes and can better shift factors such as quantity of raw wood and storage space between the tables and chairs. For example, there may be an increase in the price of tables, hence to producing more tables requires more wood and storage space. Hence the factories could start producing more tables and less chairs in response to the price changes.

I would expect the price elasticity of supply for wooden tables to be greater if factories produced both tables and chairs. One determinants of Elasticity is Factors mobility, it states that The more mobile the factors of production, the higher the elasticity. If a firm can easily divert its factors of production from one good to another, then it can rapidly increase

production of those goods which happen to be in demand, so If the foctories produces both tables and chairs, they may get higher price elasticity of supply.

Price elasticity of supply measures the responsiveness of supply to changes in price. It would be expected that price elasticity of supply would be greater if most factories produced both tables and chairs as both goods are produced from wood and require similar equipment and skills to build. Hence, the factors of production are highly mobile meaning firms are able to easily divert their factors of production from tables to chairs, vice versa. As a result, if the demand for tables increases and price rises, it can redirect resources towards producing more tables than chairs. The opposite occurs if the demand for chairs increase. However, if factories specialise in the production of tables and chairs they may also have large inventories of tables or chairs in storage to sell when demand increases, increasing the elasticity of supply.

ESSAY: SHUT DOWN CONDITION 1. Write down the shut down conditions in the long run and in the short run.

2. Consider a firm in the Short Run. Is it possible that the optimal choice for that firm is to continue production even if this implies making negative profits? Give a numerical example.

3. Consider a firm in the Long Run. Is it possible that the optimal choice for that firm is to continue production even if this implies making negative profits? Give a numerical example.

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1. Shut down condition in the short run: In the short run, the entrepreneur should shut down production if Profits < −Fixed Cost. Otherwise, she should hire the optimal number of workers and continue operations.

Shut down condition in the long run: In the long run, the entrepreneur should exit the industry if Profits < 0. Otherwise, she should hire the optimal number of workers and continue operations. 2. In the short run, that firm should continue production even if this implies making negative profits because fixed cost needs to be paid even when the firm shuts down, yet shutting down would yield an even worse result. In the long run, there is no sunk cost. By exiting the industry the entrepreneur gains nothing, but also loses nothing. Thus, it is impossible to continue production if this implies making negative profits.

The shut down condition in the short run is that the business should shut down if their profits are less than negative of their fixed costs (P < -FC). The business should exit the market in the long run if their profits are below zero (i.e. negative). If a firm is in the short run and is making negative profits, it may still be optimal to continue operations due to the fact that fixed costs still need to be paid in the short run, whether the firm continues operations or not. For example, if a business is doing their best and making a profit of negative $50 and their fixed costs are $100 , it is still better to continue operations so that the business can cover a portion of their fixed costs and negative 50 is higher than negative 100. On the other hand, a firm in the long run has no more fixed costs and if they exit the market, they gain and lose nothing. Therefore, the firm should continue operating in the long run only if their maximum profits are greater than zero (positive) and should exit the market if earning negative profit.

1. Shut-down condition in the short run is where profits from production < -Fixed Costs. Shut down condition in the long-run is where profits from production < 0 2. Yes, this is possible. Suppose a firm buys machinery that costs $100 to produce soda cans (the $100 is a fixed cost). The profits from production was $-40 (negative profits). Although the company is making a negative profit, the optimal choice would still be to continue production because if it were to shut down, the losses would be greater (-$100 which is a sunk cost). 3. No, it is not possible. In the long-run, there are no fixed factors of production for the company. Suppose the company made $-40 profit (negative profit), since there are no sunk costs, the optimal choice would be for the firm to shut down to minimise losses.

1. Shut down conditions. Long run - In the long run, the entrepreneur should exit the industry if total profits are less than 0. In other words, if the market price is below the minimum average total cost, it

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should exit the industry. Short run - In the short run, the entrepreneur should shut down production if the level of profits is less than the negative of fixed costs. In other words, if the market price is is below the minimum average total cost, but greater than the minimum average variable cost, it should keep operating. 2. Short Run- It is possible an optimal choice for the firm is to keep operating whilst yielding negative profits. This is because the fixed costs required to operate production during the short run are sunk costs. As these sunk costs are not recoverable, they may not out weight the value of negative profits.

3. Long Run - Given that the time frame is of the long run, this means that the firm operates where all factors of productions are variable. Therefore in the long run, a firm may choose to exit the industry (no sunken costs) or continue. Thus, in the long run, the firm should only operate if the largest profit achievable is positive. It is not an optimal choice for the firm is to keep operating whilst yielding negative profits in the long run.

A firm will shut-down production in different circumstances depending on if they're in the short-run or in the long-run. A firm will shut-down in the short-run (when at least one cost is fixed) if their marginal cost is equal to or less than their average variable cost for creating the good. This firm will however continue earning negative profits as long as it is earning above this curve as they are still better off producing at a lower negative profit then producing nothing and paying their fixed costs with no production (ie making no profit). ie if the firm had a fixed cost such as rent for the factory at 100 dollars, then then earning a loss at -$88 profit will still cause the firm to be better off, being able to pay off $12 off the fixed rent, better then shutting down and still having to pay the full 100. Producing negative profits is therefore the optimal choice. This is different in the long run however, when all costs are variable and there is a free exit in the market. The firm will feel indifferent about shutting down or continuing when their marginal cost is equal to their average total cost. Producing negative profits in this case (below the average total cost of production) is not optimal as they are now losing money with no benefit as there are no fixed costs to pay off. The optimal choice is to leave the market with 0 profit rather than producing a -88 profit.

PRICE ELASTICITY: SA Suppose that the supply curve for pizzas (in thousands per day) is given by P = 10 + Q. Calculate the price elasticity of supply if the price is equal to $30. Give and explain one factor that would cause the elasticity of supply for pizzas to increase. price elasticity = 1/m multiplied by price/quantity Here, P = 10 + Q where given P = 30 30 = 10 + Q Therefore Q = 20 also, m = 1 (understanding the equation in terms of y = mx + b) Thus, price elasticity = 1 multiplied by 3/2 = 3/2 The elasticity of supply for pizza would increase if the producers had a large amount of excess raw materials and capacity for pizza. That is, more goods hence easy to increase amount supplied. Having excess capacity means the producer is capable of producing more thus easy to increase production by increasing variable factors of production.

Price elasticity of supply = 30/20 x 1/1 = 3/2.

A factor that would cause the price elasticity of supply to increase is excess capacity/inventory as this allows firms to quickly increase output/supply in a relatively short

period of time in response to an increase in demand/prices, i.e. increases a firms responsiveness to a change in prices (elasticity of supply).

Price elasticity of supply = (1/slope) x (Pa/Qa) Price elasticity @P=30: (1/1) x (30/20)= 3/2 or 1.5 Slope: 1 Quantity: 20 (30=10+Q) Factor that would cause the elasticity of supply for pizzas to increase would increase elasticity would be an increase in time horizon. The longer the time horizon, the higher the elasticity. If the time horizon is long enough, producers can search for alternative inputs and revise the production plans for pizzas more conveniently.

From the given equation, when the price is equal to $30, Q = 20 (30 – 10).

We can also deduce from the equation that when Q = 0, P = 10.

We can calculate the price elasticity of supply through the equation: Price elasticity of Supply at A = (PA/QA) x 1/slope The slope can be calculated by (change in P)/(change in Q):

Hence, the elasticity of supply at P=$30 can be calculated:

Price Elasticity of Supply denotes the percentage change in the quantity supplied resulting from a very small percentage change in price. One factor that would cause the elasticity of supply for pizzas to increase would be if there is an increase in the availability of raw materials. If there was an increase in the availability of raw materials for the production of pizza, this will allow pizza produces to rapidly increase production of pizza if demand rapidly increases. Therefore, if there was a small change in price of pizza(which may affect demand), with more resources available, producers can quickly change the quantity supplied of pizza according to the change of price, therefore increasing the elasticity of supply for pizzas to increase.

-the formula for elasticity is (P/Q)*(1/slope), thus =1.5 -one factor might cause elasticity of supply for pizzas to increase would be that pizza supplier moved very close, thus the raw material for pizza production is largely available.

PROFIT-MAXIMISING Kenny’s Kebabs is a food stand that sells kebabs. The table below lists Kenny’s production costs per hour.

A. Complete the table above.

B. If the price of kebabs is $10, what is the profit-maximising number of kebabs that Kenny’s should produce? (Remember to show your work.)

C. At what price should Kenny’s shut down in the short run (i.e., after fixed costs have been paid)? At what price should Kenny’s exit in the long run? Explain your answers.

B. the marginal benefit (MB) is $10 and the number of kebabs can be determined by the marginal cost (MC). This is seen at 4 kebabs where the MC is equal to MB therefore the optimal number of kebabs to supply is 4 kebabs. The profit can be calculated by total revenues (TR) - total costs (TC). TR is 10 x 4 = 40 and TC is 28 at 4 kebabs. Therefore the profit is $12. (Note: at 3 kebabs the profit is the same however since the MB=MC and is indifferent you do take the action and produce 4 kebabs per hour to maximise profit).

C. Kenny's should shut down in the short term at $5 as at this price the π production < -FC. Fixed costs is $6 therefore at $5 the profit will be (5x4-28 = -8).At -8 < -6 the firm should shut down in the short term as in the short term fixed costs are in play. In the long term fixed costs are sunk (costs that cannot be taken back) therefore the variable cost at 4 kebabs is $22 at the price of $5 the profit will be (5x4 = 20 - 22 = -2). To shut down in the long term profit < 0 therefore -2 < 0 the firm should exit the industry in the long term.

B. If the price of kebabs is $10, what is the profit-maximising number of kebabs that Kenny’s should produce?

Profit is maximised when MC = $10. This is at a quantity of 4.

In other terms, profit is calculated by TR - TC. By calculating, we see profit at a quantity of 2; 2 x 10 - 12 = $8 of profit.

At 3; 3 x 10 - 18 = 12.

At 4; 4 x 10 - 28 = 12.

At 5; 5 x 1- 42 = 8.

Therefore 4 units maximises profit. Even though profit is the same at 3 and 4 units, we assume Kenny will produce the extra unit anyhow.

C. At what price should Kenny’s shut down in the short run (i.e., after fixed costs have been paid)? At what price should Kenny’s exit in the long run? Explain your answers.

In the short run, Kenny should shut down if profits are less than negative fixed costs, because he is better off just paying the FC than losing more money than this. At the price of $2, profit is maximised at 2 units with -$6 profit, which is equal to fixed costs. Therefore Kenny should shut down because he is no better off continuing operating.

In the long run he should exit if profits are < 0 as all fixed costs become variable. Max profit at the price of $6 is 0, meaning the firm should exit.

SUPPLY CURVE SHIFT Suppose that a heat wave is expected to hit Italy in a few weeks. It is expected to destroy much of the wineries there, causing the price of wine to increase in the future. Show on a graph and explain how you would expect this to affect the supply curve for wine today.

As a heatwave is expected to hit Italy in future, the sellers expect wineries will be destroyed and the price of wine will increase. Expected future price changes will make suppliers adjust their behaviour to take advantage of the new opportunities. If sellers expect the price for a certain good to go up, they might hold off the goods with the expectation that next period they will sell them for a higher price. Thus, the supply curve shift to the left.

Future expectations on the supply of wine decreasing is likely to cause the supply curve to shift to the left as supply will decrease. This is because sellers will be able to sell their wine at a higher price in the future and are therefore less incentivised to sell their wine currently.

MULTIPLE CHOICE*** OQX The supply curve represents the relationship between The price of a good or service and the quantity supplied of that good or service IUZ Consider the following graph: what is the price elasticity of supply when P=3 3 GVU If a perfectly competitive firm faces a price that is higher than its average total cost, then both b and c AST Which of the following are characteristics of a perfectly competitive market Both B and C

DIN A decrease in the price of labour used to harvest grapes will cause A rightward shift of the supply curve for grapes AUW A manufacturing plant adds employees to operate a fixed amount of machinery.

Eventually the productivity of each additional worker declines because there is not enough space for every worker to use the machinery at a given time. This is an example of Increasing marginal costs GQD A competitive firm is indifferent between exiting the market or continuing to produce in the long run. The price must be equal to The firm’s (minimum) average total cost EAC Which of the following factors will affect the price elasticity of supply for mobile phones? increase of battery OXC According to the vertical interpretation, the supply curve indicates The minimum amount of money the producer is willing to accept to offer the marginal unit DDM At a price of $5 a competitive firm will supply 10 units. Which of the following must also equal $5?

The firm’s marginal cost of producing the 10th unit LGM Which of the following are most likely to increase the price elasticity of supply for fish (by affecting the slope of the supply curve)? increase in time horizon PSM A market for a given good or service is defined as the set of All the buyers and sellers who are willing to buy and sell that good or service KLE The law of supply describes the tendency for a producer To offer more of a certain good or service when the price of that good or service increases DSA The figure below represents the costs of a competitive firm. When P=$15, this firm should continue short run, shutdown long run

PEY The cost benefit principle states that an action should be taken if The marginal benefit is greater than the marginal cost NYO Short run denotes a period of time during which ______. In the long run ______. At least of one factor of production is fixed; all factors of production are variable.

QHV Consider the diagram below, assume that the price is $7 for this market. Economic profits are None of these IOG Consider the following graph: supply is unit elastic if All are correct LJE Which of the following are most likely to increase the price elasticity of supply for mobile phones (by affecting the slope of the supply curve) Both b and c PHU Which of the following is an example of a variable cost? salary paid to an employee to produce certain amount of goods NKY Which one of the following is a characteristic of a perfectly competitive market the suppliers and the consumers are perfectly informed regarding the characteristic of the good ETN If a perfectly competitive firm faces a price that is lower than its average total cost and higher than its average variable cost, then The firm will operate in the short run and exit the market in the long run MQQ Downloaded by bella zileski (bellazileski@gmail.com) lOMoARcPSD|4844098 The marginal cost of producing a certain unit of a given good captures The opportunity cost of producing that unit BHQ The short run supply curve for a profit maximising firm in a perfectly competitive market is the proportion of the firm’s marginal cost curve that lies above average variable cost curve

KFV Which of the following is an example of a fixed cost warehouse costs OMC Which of the following is most likely to cause the supply curve for fish to shift All of the above will cause the supply curve to shift MOM We define the marginal cost of producing a certain unit of a given good as The extra cost of producing that unit QPT Consider the figure below and assume that the price is $7 for this market. The total revenue of this firm is denoted by the areas Area A+Area B+Area C CVH At the local burger bar, burgers sell for $7 each. Consider the following table. According to the cost benefit principle, the firm should hire ______ workers per day.

Three PEA According to the horizontal interpretation, the supply curve indicates How many units the producer is willing to supply at that price INL The economic surplus of a certain action is the difference between The marginal benefit and the marginal cost of taking that action HTO None BMS Rightward shift LEQ Unchanged LQS Unchanged CHAPTER 3 DOWNWARD SLOPING Using the concepts of the income effect and substitution effect, explain why the demand curve is usually downward sloping.

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The substitution effect captures the change in the quantity demanded of a given good following a change in its relative price. An increase in the price of the good will lead to a decrease in the demand of that good. An increase in the price of this other good can make the individual feel poorer. This is otherwise known as the income effect, which captures the change in the quantity demanded of a given good following a reduction in the purchasing power of the consumer. The income effect varies depending on whether the good is a normal or inferior good. For a normal good, a decrease in income will lead to. a decrease in the quantity demanded, however for an inferior good, a decrease in income will lead to an increase in the quantity demanded. Generally, the substitution effect is almost always stronger than income effect and so a decrease in the price of a good tends to reduce the quantity demanded of that good. Generally, price in quantity also move in opposite directions. This is known as the Law of Demand which states that the demand curve tends to be downward sloping.

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This is because everyone has limited disposable income but unlimited desire. It means that it is impossible for a person to get infinite goods he/she wants as the purchasing power is limited. As a person buys more of a product, that person is becoming poorer so it becomes less affordable for that person to keep buying the next product. Therefore, as the person's quantity bought increases, the price must decrease so that the person can afford more. This is the income effect. But income effect is relatively subtle for most of the time compared to the substitution effect. When a person keeps buying the same good, each unit of the good is providing the person fewer utils (Diminishing Marginal Utility), therefore, the good worth less to a person as he/she buys more of it. It means that other goods are becoming relatively cheaper relative to the price of the first good. In order to let the person buy more of the first good, the price of the first goods must decrease otherwise he/she will buy other goods. This is the substitutional effect.

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Income Effect is changes in the quantity demanded of a given good following the reduction in the consumer’s purchasing power. For example, a normal good decrease in income reduces the quantity consumed. For an inferior good, a decrease (and respectively an increase) in income increases (and respectively decreases) the quantity consumed. Substitution Effect is the change in the quantity demanded of a given good following a change in its relative price. However, even when the good is inferior, the substitution effect is almost always stronger than the income effect and so an increase in the price of a good tends to reduce the quantity demanded of that good. Hence, as price and quantity tend to move in opposite directions, causing the demand curve to usually be downward sloping.

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There are two concepts that govern the law of demand which essentially describes why the demand curve is usually downward sloping. They are the income effect and substitution effect. Income effect captures the change in the quantity demanded for a given good due to its impact upon consumer’s purchasing powers on consumption. It states that in the case that prices fall for a normal good, consumers have an increase in their purchasing powers (real income) and would subsequently increase their demand, assuming their budget is fixed. This exactly represents what is occurring in a demand curve. As the prices decrease on the y-axis of a demand curve, there is a linear increase in the demand from consumers. Via the income effect, with decreasing prices of a normal good, consumers are now able to better afford these goods and have higher purchasing powers. With greater real income on hands to purchase these goods, consumers will instinctively demand greater. Similarly with rising prices, consumers will have lower purchasing powers for a fixed budget and real income, forcing them to cut-back on their demand. This concept therefore explains why the demand curve is usually downward sloping. Substitution effect captures the change in the quantity of a given good demanded or the consumption patterns of consumers following a change to its relative price. It states that when the price of a given good increases relative to a cheaper good, consumers will divert their consumption and demand to the cheaper alternative, and hence the higher priced good will be demanded less. Thus putting this together, when the price of a good increases, it will be demanded less since consumers can find cheaper alternatives (ie other closely substituted goods) as per the substitution effect. This notion is in accordance to the law of demand and effectively explains why the demand curve is downward sloping (negative slope). For example, tea and coffee are close substitutes. If the price of coffee increases, consumers are likely to switch their option to tea, reducing the demand of coffee. We can similarly apply this to decreases in prices of a good. When a good has a lower price relative to others, it would attract more consumers and hence a greater demand for consumption. Both the income effect and the substitution effect are great concepts in explaining why the demand curve is downward sloping.

ELASTICITY OF DEMAND Suppose that the demand curve for pizzas (in thousands per day) is given by P = 12 – 0.5Q. Calculate the price elasticity of demand if the price is equal to $6. Give and explain one factor that would cause the elasticity of demand for pizzas to increase.

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elasticity of demand measures the responsiveness of the change in quantity given a change in price. when the price in 6, the quantity provided in 12 (Thousands). the equation for elasticity of demand is P/Q*(1/gradient) which for this case is equal to 1/1, unitary elastic. if there are more substitutes for pizzas, it would be more elastic, for example chips. once the price increases, there will be a great decrease in quantity as consumers would choose the alternative of chips.

Price elasticity of demand at $6 = 1 (unit elastic). This is because 1/0.5 x 6/12 = 1.2. The availability of substitutes is a factor that affects demand elasticity. That is the larger the number of substitutes, for example Italian Pasta (as a sub for Italian Pizza), the more elastic demand tends to be.

At P = $6, Q = 12 Price elasticity of demand = 1/slope * P/Q = 1/(-0.5) * 6/12 = -1 One factor that may cause the price elasticity of demand to increase is the availability of substitutes, such as burgers, fried chicken. The larger the number of substitutes, the more elastic demand tends to be. If there are many close substitutes for pizzas, consumers are likely to respond strongly to an increase in its price because they can easily switch to similar products.

ESSAY: SUPPLY CURVE AND ITS SLOPE 1. Write down the definition of "supply curve".

2. Is the supply curve positively sloped or negatively sloped?

3. Explain why by pointing out the foundamental economic assumption that determines the slope of the supply curve.

The supply curve plots the price of a certain good against the quantity supplied by that producer. Usually this quantity supplied is the quantity which maximises the profit of the producer. The supply curve is usually positively sloped, because an increase in the price of a good means the company is likely to offer more of said good (by the law of supply) - this is a fundamental assumption.

1.) Supply Curve: represents the relationship between the price of a given good or service and the quantity supplied of the good or service.

2.) A supply curve is a representation of the positive relation between price and quantity of a good or service, for which a supplier provides. As a result of this, the supply curve is upward sloping, as price and quantity are increasing.

3.) The 'Law of Supply' is the fundamental economic assumption for supply and it states that supply curves have the tendency of being upward sloping, where supply is said to be: 'Inelastic' if elasticity is less than 1 'Elastic' if elasticity is greater than 1 'Unit Elastic' if elasticity is equal to 1 These 3 different elasticity terms, under the law of supply determine the slope of the supply curve.

Supply curve represents the relationship between price and quantity supplied. As the law of supply states, the higher the price, the more quantity supplied, the supply curve tends to be upwards sloping in the short run, but will become perfectly elastic (horizontal) in the long run.

The supply curve is a graphic representation of the correlation between the cost of a good or service and the quantity supplied for a given period. The supply curve is positively sloped because as the price of a good increases, the quantity supplied will also increase. The fundamental economic assumption illustrates the concept of unlimited wants and limited resources, which explains why the demand curve is negatively pointed and supply curve is positively pointed.

The supply curve plots the price of a certain good against the quantity supplied by that producer. Usually this quantity supplied is the quantity which maximises the profit of the producer. The supply curve is usually positively sloped, because an increase in the price of a good means the company is likely to offer more of said good (by the law of supply) - this is a fundamental assumption.

1. Write down the definition of "supply curve".

The supply curve is a graphic representation of the correlation between the cost of a good or service and the quantity supplied for a given period.

2. Is the supply curve positively sloped or negatively sloped?

Positively sloped.

3. Explain why by pointing out the fundamental economic assumption that determines the slope of the supply curve.

The curve is positively sloped because of the fundamental economic assumption that the greater the profits in selling a good, the greater the incentive to sell it.

Supply curve demonstrates the relationship between the price of a good or service, and the quantity supplied of that good or service.

Supply curve is positively sloped.

Law of supply - tendency for a producer to offer more of a certain good or service when the price increases.

UTLITIY: A NUMERICAL EXAMPLE Alberto can drink Coke or Pepsi. Each additional bottle of Pepsi consumed provides Alberto with 1 unit of utility and costs him $1. If Alberto’s reservation price for the 7th bottle of Coke he consumes is $3, and consuming 7 bottles of Coke gives Alberto 90 units of utility. How many units of utility would drinking 6 bottles of Coke bring Alberto?

Marginal cost of consuming an additional Coke is always 1 util per dollar spent. Alberto should buy Coke at a price that gives him a minimum of 1 util per dollar spent. Alberto’s reservation price for the 7th bottle of Coke he consumes is $3, then the marginal utility of consuming the 7th bottle of Coke is 3 utils.

Hence, the total utility of consuming 6 bottles of Coke is 90 - 3 = 87 (utils).

If we first analyse Pepsi: Alberto has a constant marginal benefit of 1 utility for each Pepsi he consumes and a constant marginal cost of $1. Hence the 'exchange rate' between dollars and utils is 1 utility for each dollar he spends on Pepsi.

For Coke: Alberto's reservation price for the 7th bottle of coke is given to be $3. This implies that the maximum amount of money Alberto is willing to pay to consume the 7th bottle of coke is $3, and thus his marginal benefit for consuming this would correspond to 3 utils. Since the consumption of 7 bottles of coke equates to 90 utils (the total amount of utils gained) and as calculated earlier, the marginal benefit from the 7th bottle is 3 utils, the total number of utility Alberto would receive from drinking the 6th bottle of coke is 90-3 = 87 utils.

Given that Alberto’s reservation price for the 7th bottle of Coke he consumes is $3, this means that he must gain 3 units of utility from it as this is the maximum amount of money he is willing to pay for Coke. This is because the units of utility gained if he drank more Coke would be less than that if he drank an equal monetary amount of Pepsi. Thus we can conclude that if the total utility of drinking all 7 bottles is 90 units of utility the other 6 bottles must have added up to give him 87 units of utility (as we subtract the units of utility gained from the 7th bottled from the total utility gained for drinking 7 bottles of coke.

Alberto's reservation price for the coke is the maximum amount that he will pay for it given the amount of utility he gets from it. If he is willing to pay $3 for it, this means that the utility he derives from it is no more than $3 worth of the other bundle of goods, therefore he will get 3 utils of value from it. This means that if he were to only consume 6 bottles, his utility would be 87.

If the reservation price for the 7th bottle of coke is $3, that means that this must equal or be greater than the MB of consuming a Pepsi bottle. The util/$ gained for Pepsi is 1. Therefore, the utils gained from the 7th bottle of coke must be 3 utils at least. Therefore, to consume 6 bottles of Coke he gains 87 utils.

AAL What is the price elasticity of demand when P = 2?

-1/3 CHAPTER 4 ICE CREAM MARKET PROFITS Suppose that the local market for ice cream is competitive and that all ice cream parlors are identical.

A. Using graphs, illustrate a short-run equilibrium in the market in which ice cream parlors are earning a positive profit. Your graphs should show the market equilibrium price and quantity as well as the price, quantity, marginal cost and average total cost of a typical café. (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Using your graphs, explain why every ice cream parlor will produce the quantity for which average total cost is minimised in the long run.

B) Overtime, since many of the ice cream parlours are making profit, more firms would enter the ice cream parlour market which would shift to the supply curve to the right which will decrease the market equilibrium price of ice cream. This will keep on occurring until the equilibrium price is equal to the average total cost of making ice cream and will thus stabilise. This point occurs where the average total cost of ice cream is minimised hence the firms in the market would only produce the quantity for which average total cost is minimised in the long run.

MANGO SHOCK Suppose that a major cyclone in Queensland destroys a large number of mango trees and at the same time leads to a fall in many consumers’ incomes due to property damage and business closures. Explain how this will affect the equilibrium price and quantity of mangos in Queensland if mangos are a normal good.

The destruction of mango trees will lead to a fall in supply of mangoes, shifting the supply curve to the left. This will increase the equilibrium price form P0 to P1 and decrease the equilibrium quantity from Q0 to Q1.

Since mango is more likely to be a normal good, the income effect of a fall in many consumers’ incomes due to property damage and business closures will cause a fall in demand for mangoes. A shift in the demand curve to the left will result in a fall in the equilibrium price from P0 to P1 and also a fall in the equilibrium price from Q0 to Q1.

However, the effect of both factors on the market is not straightforward. Since a decrease in supply and a decrease in demand both cause the equilibrium quantity to fall, the combined effect of these two factors will be a fall in equilibrium quantity (from Q0 to Q1). Meanwhile, an increase in price due to lower supply and a decrease in price due to lower demand will have an ambiguous impact on the final equilibrium price. From the graph below, there is a slight increase in the equilibrium price.

The impact on destruction of mango trees will cause the supply curve to shift to the left, as it will be harder for producers to source the mangoes, resulting in the quantity supplied to reduce and equilibrium price to increase. The impact of the destruction of property damage and business closures will result in a fall in many consumers' incomes which would cause the demand curve to shift to left for a normal good. This would cause quantity demanded to reduce and equilibrium price to decrease. Thus, overall the combined effect will be a decrease in quantity, however, the equilibrium price is indeterminable.

The destruction of mango trees from a major cyclone will cause the supply of mangos to shift to the left leading to a decrease in supply quantity and increase in price.

The destruction of property damage and business closures will mean less income and decreased purchasing power. Since mangos are a normal good, an increase in price will result in a decrease in demand due to lower consumption.

The combined effect of these two factors will cause the equilibrium quantity to decrease.

The change in price is undetermined depending on which of the demand or supply curves had a greater shift.

The destruction of many mango trees will cause supply of mango trees to decrease, thus the supply curve will shift to the left (producers will decrease as mango trees are destroyed).

The property damages and business closures will make consumers relatively poorer and have less purchasing power, causing a fall in demand of mangos, thus causing the demand curve to shift left. This is due to mangos being a normal good, where a reduction in the consumers purchasing power will cause some consumers to leave the market, meaning that for a given price, consumers are only willing to purchase a smaller quantity of the good. The equilibrium price will decrease as suppliers reduce the quantity they produce. The resulting outcome is a decrease in the market equilibrium quantity and an indeterminate change in the equilibrium price as we are unsure whether the cyclone affects the consumers or producers more.

MARKET PRICE AND PARETO EFFICIECY Suppose that, in the market for cars, demand is given by P= 10 – Q and supply is given by P= Q. A. What is the market price that maximises total economic surplus?

B. Illustrate on a graph and calculate consumer and producer surplus at this price. Draw the graph on paper, take a picture with your phone and attach the picture here (Remember to clearly label any relevant prices and quantities.)

C. Explain why no other market price leads to a Pareto efficient outcome.

Pareto efficiency is a situation in which it is impossible to make any individual better off without making at least one other individual worse off. This can only be achieved at the market equilibrium because this is where total economic surplus will be maximised and where one action does not lead to another individual being worse off, hence the market equilibrium is the only price that leads to a Pareto efficient outcome.

A) This is at equilibrium price, ie. when 10-Q = Q. Therefore the equilibrium price is $5.

B) Consumer and Producer Surplus are the two areas labelled.

Consumer Surplus = $12.50 Producer Surplus = $12.50 C)In the circumstance that the price is greater or less thn the equilibrium price will generate a dead weight loss. A pareto efficient outcome is a situation in which it is impossible to make any individual worse off without making another individul worse off. Hence any attempt to move the price from its equilibrium will result in. reduction of total economic surplus and hence someone will be worse off

A) The market price that maximises total surplus is the equilibrium price. This is found by equating the demand and supply curves as follows: 10 - Q = Q 10 = 2Q Q=5 Substituting this value of the equilibrium quantity back into the supply curve equation gives: P=Q=5 Therefore, the equilibrium price (where total surplus is maximised) is the market price of $5

B) Consumer surplus = (10-5) x 5 x 0.5 = 12.5 Producer surplus = 5 x 5 x 0.5 = 12.5 C) A Pareto efficient outcome refers to a situation where it is impossible for any individual to be made better off without harming another individual. The equilibrium price is the only market price which is Pareto efficient. This is because, at higher prices, there is an excess supply - meaning sellers have an incentive to undercut each other and lower their prices to attract buyers. However, as sellers continue to drop prices, they eventually reach the market equilibrium where they all are able to sell (no excess supply) and sell at the same price - therefore reaching a Pareto efficient outcome. Similarly, if there is an excess demand, the same process will occur with buyers who continue to outbid each other in order to buy the good until they reach the market equilibrium where each buyer is served and all pay the same price (no excess demand) - again a Pareto efficient outcome. Any other price will have an excess supply or demand and therefore won't be Pareto efficient.

OUT OF EQUILIBRIUM PRICE Using a graph, explain why a competitive market in which the price is lower than the market equilibrium is not Pareto efficient. (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

Pareto efficiency can be defined as a situation where it is impossible to make an individual better off without making the other individual at a state of being worse off. This efficiency can be achieved when the price and quantity of the market is at equilibrium which will cause the total economic surplus to be maximised. In this case when the price is lower than the market equilibrium, this will not cause a Pareto efficient because the result from this will cause a higher consumer surplus over a lower producer surplus, hence, the total surplus will not be maximised efficiently.

Pareto efficiency is a situation in which it is impossible to make any individual better off without making at least one other individual worse off. In other words, a situation is Pareto efficient if there is no transaction that be can be arranged that would make someone better off without harming someone else.

As illustrated in the drawn graph, the total consumer surplus is equal to the area below the demand curve and above the market equilibrium price whilst the total producer surplus is equal to the area above the supply curve and below the market equilibrium price. We can see that sum of these two areas (total surplus) is maximized when the perfectly competitive market reaches its equilibrium price and quantity. At any other price, the corresponding total surplus is less than the one achievable at the market price equilibrium.

Therefore, a competitive market in which the price is lower than the market equilibrium is not Pareto efficient because any attempt to move the price from the equilibrium level results in a reduction of the total surplus, hence someone must be left worse off.

For a market to be Pareto efficient, it is impossible to make any individual better off without making at least one other individual worse off. As the market price decreases below the equilibrium market price, some producers will be unable to participate in the market as the market price falls below their reservation price (reducing producer surplus). As the number of producers in the market decrease, the number of consumers in the market also decrease as there is not enough supply despite their reservation prices being higher than the market price (decreasing consumer surplus), creating a deadweight loss.

In order to be Pareto efficient, the market must be at a place where it is impossible to make any individual better off without making at least one other individual worse off. Hence in order to understand if a situation is Pareto efficient, it is important to understand the surplus that results from certain price points.

The above diagram demonstrates what happens when the price is lower than the market equilibrium. This is represented by the green dotted line, whilst the black line represents the market equilibrium.

It is clear that at the green line the surplus is represented by the orange area, yet what is clear is that there is a deadweight, or loss when compared to the possible surplus of the market equilibrium. Thus we can consider that this point is not Pareto efficient as if the price is increased the total surplus will also increase and both consumers and producers will benefit. Thus you are able to make one person better off whilst not making another group worse off, meaning it is considered as not Pareto efficient.

A situation is Pareto efficient when it is impossible to make an individual made better off without making another individual worse off. In the image attached, we can see that when the price of the market (Pm) is less than equilibrium price (P*), the Quantity Demanded Qd > Q* and Quantity Supplied Qs < Q*. The consumers however can only purchase the quantity that is in the market (Qs). in an attempt to make the consumers better off we have made producers worse off (not a Pareto efficient transaction). We also made consumers that are no longer able to purchase this product due to less Quantity in the market worse off. We can also see in the graph that the Total Surplus is worse off at equilibrium Total Surplus = Consumer Surplus + Producer Surplus = A + B + C + D + E + F At Pm: Total Surplus = Consumer Surplus + Producer Surplus = A + B + C + D. and the Dead Weight Loss = E + F

CHAPTER 5

SUBSIDY AND DEAD WEIGHT Using a graph, explain how a per-unit subsidy can result in a deadweight loss even if both consumer and producer surplus increase, relative to the competitive equilibrium of the same market without the subsidy. (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

A subsidy is essentially the opposite of a tax. Assume, as before, that a per-unit $1 subsidy is applied to the sellers. Essentially, the government pays the sellers $1 for each unit sold in the market. Then the marginal cost-effectively decreases by $1. The supply curve shifts to the right and the market experiences a reduction in price and an increase in the quantity exchanged. Thus, even though consumer and producer surplus increase, there is still a deadweight loss.

A per unit subsidy can still cause a deadweight loss even if both consumer and producer surplus increase as the cost of the subsidy is greater than the increase in consumer and producer surplus. If the government provides a $1 subsidy to producers for every unit sold, the marginal cost of each unit for the producers decreases by $1, allowing the market to experience a decrease in the price and increase in the quantity sold increasing the consumer surplus from C to C’ and producer surplus from P to P’. However, as the cost of the subsidy (area highlighted yellow) is greater than the increase of consumer and producer surplus, the implementation of a subsidy would cause a deadweight loss shown as area D.

Subsidy - government cost to assist certain groups of consumers or producers. Makes certain goods more affordable.

Reasoning - in the future, industries will be sufficient and create surplus. In the LR cover deadweight loss.

To appreciate the change in surplus, compare areas C + P (initial total surplus) and areas C’ + P’ - S (final total surplus). The first is bigger than the former by area D. The subsidy therefore creates a deadweight loss.

AN EXAMPLE OF GOVERNMENT INTERVENTION Suppose that the demand for cars in Australia is given by Q= 400 – 0.4P, and the supply is given by Q= 0.4P. A. Illustrate the market equilibrium on a graph. (Calculate and clearly label the equilibrium price and quantity.) (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Calculate the consumer surplus, producer surplus and total economic surplus of the market when it is in equilibrium.

C. The Australian Government, wanting to protect consumers, imposes a price ceiling of $125. Using your graph, show and explain how this this intervention will affect the quantity supplied and demanded in this market.

D. Illustrate on your graph the consumer surplus and the deadweight loss in this market with the price ceiling. Overall, has the policy made consumers better or worse off?

Are all consumers better off? Explain your answer.

Price is equal to 200, quantity equal to 500 250*200 is equal to 50,000 (both consumer surplus and producer surplus) and total surplus is equal to 100,000 when the market is in equilibrium The price ceiling will greatly reduce the amount supplied but greatly increase the amount demanded. At the new price of $125 suppliers are only willing to produce 312 units whereas the amount demanded is 687 this leads to greater deadweight loss.

The consumer surplus has reduced dramatically due to less quantity being produced. Overall this policy has made consumers worse off, as now less consumers will be able to get this product, consumers who had higher reservation prices will benefit however those who had lower reservation prices will not.

a) 400-0.4P = 0.4P p=500 , q=200 b) consumer surplus: (1000-500)x200 / 2 = 50000 producer surplus= (500-0)x200 / 2 = 50000 total surplus = 100000 c)price ceiling is that maximum allowable price imposed by the government. When p=125, quantity supplied would decrease to 50 and quantity demanded will increase to 350. d)it has made the consumer worse off which consumer surplus decrease by 37500. consumer who are poorer will be benefit as they can consume the product at a cheaper price.

DEADWEIGHT AND TAXES Suppose that, in the market for soda drinks, demand is given by P= 48 – 0.6Q, and supply is given by P= 0.2Q. Further, suppose that the government decides to impose a $4 per soda drink.

A. On a graph, demonstrate the effect of the tax on the equilibrium price and quantity.

(Clearly label the value of each both before and after the tax.) (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Show on the graph and calculate the tax revenue and deadweight loss that result from the tax.

C. Who bears the greater burden of the tax, producers or consumers? Explain why this is the case.

c) The greater burden of tax falls upon the consumers. This is the case because the demand of soda is relatively inelastic. Because the demand is relatively inelastic, consumers will not change their market behaviour as much, and will therefore willingly take up the tax burden.

B）deadweight loss= (16-10.7)*(60-53.3)/2 =17.775 Tax revenue= (16-10.7)*53.3=282.49 c) Consumer bear the greater burden of the tax. Compare to the supply, the elasticity of demand is lower than the supply curve.

MORE PETROL Suppose that, in the market for litres petrol, demand is given by P = 5 – 0.3Q, and supply is given by P = 1 + 0.1Q. Further, suppose that the government provides a $1 per litre subsidy for petrol.

A. Calculate the effect of the subsidy on the equilibrium price and quantity.

B. Calculate the change in producer surplus and consumer surplus that result from the provision of the subsidy.

C. Does total surplus to everyone in the economy increase or decrease as a result of the subsidy? Explain why and calculate the amount of the change.

Part A: P=5-0.3Q=1+0.1Q, P=2 and Q=10. The equilibrium price is $2 and the quantity is 10.

P=5-0.3Q=0.1Q, P=1.25 and Q=12.5. The equilibrium price after subsidy is $1.25 and the quantity after subsidy is 12.5.

Part B: Consumer Surplus =($5−$2)×(10/2)=$15 Producer Surplus =($2−$1)×(10/2)=$5 Consumer Surplus after subsidy=($5−$1.25)×(12.5/2)=$23.4375 Producer Surplus after subsidy=($1.25-$0)×(12.5/2)=$7.8125 Change in producer surplus=$7.8125-$5=$2.8125 and change in consumer surplus=$23.4375-$15=$8.4375 Part C: Total surplus=consumer surplus +producer surplus=$15+$5=$20 Total surplus after subsidy=Consumer Surplus after subsidy+ Producer Surplus after subsidy=$23.4375+$7.8125=$31.25 the amount of the change is $31.25-$20=$11.25 Thus, the total surplus to everyone in the economy increases as a result of the subsidy.

A) The subsidy has resulted in a reduction in price by 75 cents from $2/L to $1.25/L, and an increase in quantity by 2.5L from 10 to 12.5.

B) Original Producer Surplus - $5. Producer surplus after subsidy - $7.81. Original Consumer Surplus - $15. Consumer surplus after subsidy - $23.44. Change in consumer surplus - $8.44.

Change in producer surplus - $2.81 C) Within the total economy, surplus will increase as a result of the subsidy. This is before more of a good can be provided at a lower price, satisfying more consumer's reservation prices, and hence increasing consumption domestically. In addition to this, domestic production increases as a lower domestic price will reduce import quantities entering the economy, hence stimulating domestic industries. This is encompassed with the $11.25 increase in total surplus.

A. Subsidy will cause the equilibrium price to decrease whilst the equilibrium quantity to increase.

To calculate the original equilibrium price/quantity 5 - 0.3Q = 1 + 0.1Q --> Therefore Q = 10 Thus P = 1 + 0.1(10) = $2 To calculate equilibrium price after subsidy has taken place 5 - 0.3Q = (1 + 0.1Q) -1 --> Therefore Q = 12.5 P = 1 + 0.1(12.5) - 1 = $1.25 So from the above calculations we see that the price goes from $2 to $1.25 and the quantity increases from 10 to 12.5 B. For the original equilibrium The consumer surplus = 1/2*(5 - 2)*10 = 15 The producer surplus = 1/2*2*10 = 10 For the equilibrium after subsidy The consumer surplus = 1/2*(5 - 1.25)* 12.5 = 23.4375 The producer surplus = 1/2 * 1.25 * 12.5 = 7.8125 Therefore the change in consumer surplus = |15 - 23.4375| = 8.4375 The change in producer surplus = |10 - 7.8125| = 2.1875 C. The total surplus in the economy decreases . This is due to the cost of suppliers producing over the equilibrium amount which is paid by the governments subsidy.

The change in total surplus is |(15+10) - (23.4375+7.8125)| = 6.25

Part A: P=5-0.3Q=1+0.1Q, P=2 and Q=10. The equilibrium price is $2 and the quantity is 10.

P=5-0.3Q=0.1Q, P=1.25 and Q=12.5. The equilibrium price after subsidy is $1.25 and the quantity after subsidy is 12.5.

Part B: Consumer Surplus =($5−$2)×(10/2)=$15 Producer Surplus =($2−$1)×(10/2)=$5 Consumer Surplus after subsidy=($5−$1.25)×(12.5/2)=$23.4375 Producer Surplus after subsidy=($1.25-$0)×(12.5/2)=$7.8125 Change in producer surplus=$7.8125-$5=$2.8125 and change in consumer surplus=$23.4375-$15=$8.4375 Part C: Total surplus=consumer surplus +producer surplus=$15+$5=$20 Total surplus after subsidy=Consumer Surplus after subsidy+ Producer Surplus after subsidy=$23.4375+$7.8125=$31.25 the amount of the change is $31.25-$20=$11.25 Thus, the total surplus to everyone in the economy increases as a result of the subsidy.

A) Equilibrium price decreases by $0.75 while equilibrium quantity increases by 2.5 units

(B) Producer surplus decreases 2.1875 by while consumer surplus increases by 8.4375 (C) Total surplus decrease due to the cost of the subsidy being larger than the increase in surplus. The loss in surplus for producers and the government is greater than the gain in surplus for producers. DWL = $1.25

CHAPTER 6 A TARIFF IN THE STRAWBERRIES MARKET Suppose that, in the market for strawberries, domestic demand is given by P= 40 – 0.5Q, and domestic supply is given by P = 0.5Q, where Q represents tonne of strawberry.

Further, suppose that the world price of strawberry is $5 per tonne, and the government decides to place a $10 per tonne import tariff on strawberries.

A. On a graph, demonstrate the effect of the tariff on the equilibrium quantity of imports.

(Clearly label the values both with and without the tariff.) (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Show on the graph and calculate the tariff revenue and deadweight loss that results from the imposition of the tariff.

C. Explain why the tariff results in a reduction in total surplus in the market. (I.e., what are the reasons for the appearance of deadweight loss?)

Part A: the equilibrium quantity of imports is 70-10=60 tones. The equilibrium quantity of imports after tariff is 50-30=20 tones.

Part B: tariff revenue equals to Tariff×Imports=$10×20=$200.

The deadweight loss is equal to ($15−$5)×(70−50)/2+($15−$5)×(30−10)/2=$200.

Part C: Because consumers lose more than what the producers and government gain - this is the deadweight loss of the tariff from consumers buying from the relatively expensive domestic producers and total consumption falls. a)The amount of strawberry imports after tariff has decreased from 60 to 20 as shown in the graph below.

B) The Tariff revenue is indicated above as the green area B, it equals 10*20 = $200 tariff revenue. However, A and C as the pink triangles above represent the deadweight loss which is equal to a total of $200.

C) There is decreased total surplus as there is deadweight loss that occurs which results in a loss of pink triangles A and C. Deadweight loss of A occurs because of the tariff resulting in increased prices set by domestic producers, while C is because of the decreased consumption by consumers as the price of strawberries increased.

A.

B. Since quantity demands is 50 but at the tariff price domestic suppliers can only offer 30, the last 20 will be imported. The government earns $10 for each import and therefore they will earn a total of $200 from tariff revenue.

Before the tariff, the consumer surplus contained the deadweight loss. After the tariff, the producer surplus gained while the consumer surplus dropped. The government also took away some of the customer surplus in the form of tax revenue. However, not all loss by the consumer surplus was taken by the producer surplus or the government becoming deadweight loss and reducing the total economic surplus in the economy. Although domestic producers end up selling more to the consumers than they did before the tariff, consumers do not end up purchasing as much from domestic producers and importers thereby creating a loss in total economic surplus.

Tariff Revenue (C) = $10 x 20 = $200 Deadweight Loss = ½ x $10 x 20 + ½ x $10 x 20 = 200 With free trade, the price is $5, and consumers purchase 70 tonnes of strawberries where 10 tonnes are supplied by domestic producers and 60 tonnes are imported. When the tariff is implemented, the price of all strawberries increases to $15, domestic consumers will lose areas A+B+C+D in surplus but domestic producers will gain A in surplus (as the market price rises above their reservation prices) and the government will gain C in revenue. Tariffs result in a reduction in total surplus because overall, consumers will lose more surplus than what is gained by the producers and government (areas B and D become deadweight losses). The dead weight loss in area D is created as some consumers are unable to participate in the market due to the price rising above their reservation prices. The deadweight loss in area B is seen as the cost in allowing relatively more expensive domestic consumers participate in the market.

Part A) (Attached) Part B)

(Attached) Total tariff revenue is $200 and deadweight loss is equal to 200.

Part C) The tariff results in a reduction in total surplus due to a shift away from the efficient equilibrium price and quantity highlighting pareto theory. The overall effect is it increases producer surplus by area D however consumer surplus decrease by area A + B + C + D. The deadweight loss labelled as A on the graph occurs due to buying from the relative expensive producers and deadweight loss C is caused because total consumption falls.

ITALIAN CARS AND QUOTAS Suppose that the world price of cars is less than the domestic market equilibrium price in Italy. Further, suppose that the government decides to impose an import quota to decrease the number of cars imported into Italy.

A. Using a graph, demonstrate the effect of the quota on the quantity demanded and supplied domestically and the equilibrium price, compared to the market equilibrium with free trade. (Draw your graph on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Illustrate on your graph the area that represents lost consumer surplus due to the quota.

C. Label on the graph and explain how the lost consumer surplus is (or is not) distributed to others in the economy.

Without the quota, the local market takes the price at the world price, P1. This means the quantity demanded will be equal to Q1, but the local producers will only supply quantity D1.

This results in cars being imported with quantities equal to Q1 - D1.

With the quota (the right most supply curve), the local market price becomes P2, allowing local producers to produce up to D2. Since there is a quota, consumers will only be able to purchase up to Q2, meaning the quantity imported will be equal to Q2 - D2.

The lost consumer surplus is shown on the graph as Areas A+B+C+D. Area D is gained by the local producers as they are now willing to produce more. Area C is gained by the importing agent, as they only need to pay the international car makers P1, but can sell the cars locally at price P2. Areas A and B are deadweight loss areas. The loss of Area A is due to consumers having to purchase from the relatively more expensive local producers. The loss of Area B is due to the import quota being reached.

ITALY PASTA AND IMPORTS Suppose that Italy wants to reduce imports of pasta. Would economists typically recommend the use of a tariff or quota, assuming that both policies would reduce imports by the same amount? Explain your answer.

In terms of total surplus, both quotas and tariffs can both lead to same prices and quantities, and have same deadweight loss. One of the key differences between a tariff and a quota is that the welfare loss associated with a quota may be greater because there is no tax revenue earned by a government. Because of this, quotas are less frequently used than tariffs.Also, with quotas it is unclear how someone is chosen to be the lucky import agent who gains from simply buying at a lower price and selling at higher price, leading to corruption. Also, it is much simpler to negotiate multi-country deals to reduce trade restrictions in terms of tariff percentages instead of units.

the Italian government would be suggested to implements tariffs as it allows the government to earn money at the same Time allow the imports to slow down.

Economist typically would recommend the use of tariffs since both quotas and tariffs generate the same deadweight loss or area I and K, however, with the use of quota there is less transparency on who gets the “bonus” for importing.

WOODEN TABLES AND TARIFFS Suppose the Australian government imposes a tariff on imported wooden tables.

A. Who benefits and who loses from this policy?

B. Are the overall benefits or costs of the tariff greater? Explain your answer.

A. Domestic producers and the government will benefit from the tariff, while domestic consumers lose from this policy.

B. Graphically, domestic consumers will lose area A+B+C+D because they buy less and at a higher price. Domestic producers gain A because they sell more at a higher price, and the government gains C from getting the tariff revenue, paid only on the imported wooden tables. Overall, consumers lose more than what the producers and government gain, which refers to the deadweight loss of the tariff represented by area B+D. In other words, overall costs are greater than benefits.

A - Domestic producers and the government benefit whilst domestic consumers lose.

B- The costs of the tariff are greater than the benefits. The decrease in consumer surplus is greater than the increase in producer surplus and government tariff revenue. This decrease is caused by consumers having to buy relatively expensive domestic goods and by the fall in total consumption (due to the increase in price).

Part a) A tariff is a tax imposed on imported goods. The implementation of the tariff is meant to help domestic producers from losing out from competitive international markets.

Therefore, domestic producers gain from the tariff as they would have more demand for their products in comparison to the less demand when they are exposed to internationally competitive market forces. As well as this, governments gain tax revenue (imports*tariff).

On the downside, consumers have increased prices and they are the losers.

Part b) The benefits of the tariff is that the domestic producers are protected from internationally competitive market forces and the government gets tax revenue. The costs of the tariff is mainly the consumers paying higher prices for goods and services, and the fact that there is a dead-weight loss which does not go to anybody. This is detrimental and therefore, the costs of a tariff are greater than their benefits

A. When the government imposes a tariff on imported wooden tables, domestic producers benefit because they gain from selling at a higher price. The government also gains from getting a tariff revenue. However, domestic consumers lose because they buy less and at a higher price.

B. The overall costs of the tariff are greater because consumers lose more than what the producers and government gain.

This is illustrated by the graph below where we see that domestic consumers will lose H+I+J+K because they buy less and at a higher price. Domestic producers gain H because they sell more at a higher price. The government gains from the tariff revenue which is represented by area J. Overall, we see that the consumers lose more than what the producers and government gain. This difference is denoted by the deadweight loss represented by I+K. The lost area, I, comes from the purchasing from relatively expensive domestic producers and K is lost because the total consumption falls.

a) With the imposition of a tariff, which is a tax placed on imported goods, consumers are forced to pay a higher price for products as they do not receive the world price, reducing their consumer surplus. On the other hand, a tariff provides protection to domestic producers making them more price competitive, increasing the total producer surplus.

Tariffs also generate government revenue. b) Free trade allows the supply and demand to reach equilibrium in a domestic economy, the point at which total surplus is maximized. Therefore, an artificially increase in the total producer surplus to protect domestic production, causes the reduction in the bargaining power of consumers, decreasing the total consumer surplus. Therefore, in relation to the trade of wooden tables, a tariff ultimately creates a deadweight loss and thus a reduction in the total surplus, meaning its costs are greater than its benefits.

A tariff on imported wooden tables would benefit domestic producers of tables by increasing equilibrium price which increases profit and decreasing the levels of imports which increases market share, both depicted below. Producer surplus will increase.

Government could also benefit from the tax revenue collected (labelled R), however this only occurs if WP + T is below domestic equilibrium. If it is equal or above, there is no tariff revenue.

Consumers lose because prices increase, quantity available decreases and consumer surplus is much smaller.

B. Are the overall benefits or costs of the tariff greater? Explain your answer.

Whilst some groups in the economy benefit, overall costs are greater because deadweight losses occur and cannot be recovered, and total surplus in the economy decreases.

Furthermore, even though some domestic employment and production may be protected, inferior quality of products may occur and domestic production will generally be less efficient because it is artificially protected. In the long term, the economy is better off allocating resources towards other industries where Australia maintains a comparative advantage (such as raw minerals) and exporting these as this is a more efficient use of resources.

A FIRM CREATES A NEW MARKET

CHAPTER 7

A firm develops a new consumable good with no other firms currently in the market and has the following cost curves:

a) What could be the determinants of market power for a firm like this? Is there a typical determinant of market power that would not apply in this case? b) What is the price and quantity the firm will trade at? What is the profit? (Draw the areas using the graph above as the starting point) c) How would these results change if the firm behaved as if it had no market power? (Draw the areas using the graph above as the starting point) d) Since the average total cost decreases (until the intersection with the MC curve) beyond the correct point in (b) why does the firm not produce additional units?

The firm receives feedback from its customers that they want a more affordable option. In response to this they release a new 6 pack version which is sold at a per unit price of between the prices in (b) and (c). It is assumed that anyone who can afford to purchase the smaller quantity of the good will also buy the 6 pack. e) What degree of price discrimination is this likely to represent? f) How do you predict total, producer and consumer surplus to change? Why? Using the diagram, show the new areas of surplus.

Part a) A firm has market power if it has the ability to set its own prices. The downward slope of the demand curve in this graph indicates, that it is a price maker and therefore is determinant of having market power.

Part c) if the firm had no market power, they would be a price -taker meaning that they would sell at the equilibrium price Part D) Part e) this is likely to represent the 2nd degree of discrimination as the difference in price is dependent on quantity and quality demanded (i.e. the bulk discount) Part f) this is likely to change

a) For a firm that has recently discovered a new product such as the one described in the example, government regulations and barriers such patents and intellectual property would allow this firm to gain market power. Also as the good is consumable, it is possible that the firm has control of a scarce recourse creating a barrier for entry and securing market power.

A typical determinant for market power is the idea of increasing return to scale. However, this usually occurs in natural monopolies such as utility companies. Thus, it is unlikely that the cost to produce an additional unit of the good will decrease as the firm gets larger, as a result, this determinant of market power likely does not apply to this firm. b) In an imperfectly competitive market, monopolistic firms are unlikely to produce at the socially optimal quantity without government intervention. Thus, they will produce at the point of maximum profit i.e. where MR==MC on the demand curve (indicated by graph 1).

Likewise, the firms profit is indicated by the shaded area on graph 1. The profit is the difference between the Revenue at the point where MR==MC on the demand curve and the ATC at that point which, is the same as the shaded area. c) If the firm had no market power this means that it is no longer a price-maker. Thus, the firm is a small player in the market and must produce at the market equilibrium, i.e. where MB == MC. This is indicated by the point where the marginal cost intersects the demand

curve on graph 2. The new profit is indicated on graph 2 by the shaded area and is notably smaller than the profit if the firm has market power. d) Consider if the firm produced additional units beyond the point marked in graph 1. An additional unit would increase the marginal cost by exactly that additional unit. Also notice that the marginal revenue also decreases past this point as producing an additional unit increases costs (e.g. more workers need to be hired). Thus, the firm is producing at a point where the MR < MC. As a result, based on the cost-benefit principle the firm doesn't produce additional units past the point in graph 1 although it seems reasonable since the ATC decreases slightly. e) This is a form of 2nd degree price discrimination where the firm can charge customers based on the quantity purchased. In this case, the firm offers a discount based on buying in bulk (the 6-pack). Although the firm cannot charge consumers at their reservation price, the assumption reveals that anyone with a high reservation price (ie. can afford a small quantity of the good) is likely to also buy a 6-pack, thus, the firm can take a small amount of the consumers surplus when they buy an additional 6-pack on top of a small quantity of the good. f) Originally, surplus as depicted by the market equilibrium in part A is shown by the shaded areas in graph 3, where, consumer surplus is the green shaded area and the producer surplus is the blue shaded area. Total surplus is both areas added together. The new total surplus after price discrimination are depicted by graph 4. Based on the price discrimination assumption that consumers are likely to buy in bulk if they can afford a lower quantity, the new producer surplus is likely to capture much more of the consumers surplus, however, since the firm is not selling at their reservation price, consumers still keep some surplus.

Again, in graph 4 consumer surplus is the green area, and producer surplus is the blue area.

Note that total surplus doesn't change only the allocation of surplus as the firm isn't charging a different price for an additional unit, consumers are just buying more in bulk.

A) The determinants for market power for a firm like this can be: - Control Over Scarce Resources: The company can have exclusive control over key inputs of production, making it impossible for other firms to join this market - Government-Creater Barriers for entry: This product could be patented with the government. As a result no other company can enter the market for this product - Economy of scale: This can be the curves of a market that is experiencing economies of scale, where the average total cost is decreasing with the increase in quantity sold and consumed (e.g. water supply company) Network Economies is a typical determinant of market power that does not apply here because the product is consumed (i.e. there is no users for it to be a market power due to a network economy) **B) ** Refer to Image 1 The price and quantity of the firm are marked as (P*,Q*). And the profit area is the Black box marked as Profit square C) Refer to image 2 If the firm behaved as if it had no market power, then the firm would produce a quantity where The Marginal Benefit = Marginal Cost. The profit at this point is shown in image 2 (rectangle with the word profit). when MB = MC, the quantity produced > Q* and the price it is sold at < P* D) The firm does not produce beyond Q* even though ATC is decreasing because the company has maximized its profits when it produced quantity Q*. any additional unit beyond Q* will have a Marginal Revenue < Marginal Cost. This means that units produced beyond Q* will result in a cost rather than a profit E) This is a second degree discrimination because the firm is providing a bulk discount to consumers. Consumers that purchase a 6 pack will technically pay less per unit than a consumer that purchases one. This way the firm was able to distinguish between consumers with high and low reservation price without having to know the information in advance F) Refer to Image 3 Both Consumer and Producer surplus would increase. Consumers can now purchase a 6 pack for a cheaper price per unit (i.e. we have this area as extra consumer surplus).

Producer Surplus also increases as the company is now producing more units at a price still higher than the ATC (i.e. we have this Area to be added to producer surplus CSold = A. CSnew = A+ C PSold = B. PSnew = B+D

COMPETITION IN A NATURAL MONOPOLY Explain why the government might not want to stimulate competition in a market with a “natural” monopoly. Give and explain one alternative policy that would increase total surplus in such a market. a natural monopoly is a monopoly as a result of increasing returns to scale, where the average total cost of the good decreases as the quantity supplied increases. Thus in a mark with natural monopoly there will be very few firms, mostly dominated by one. if the government wants to stimulate competitions mores firms will have to enter the market but by doing so, a large amount of cost would have to be inputted at the start and also there would already be a lot of resource available in the market (example, Sydney water system) thus is would not be effective. an alternative policy would be to apply the average cost policy in which the government forces the monopolist to set the price and quantity at the intersection of the market demand and average total cost curve. this eliminates any positive profit accrued to the monopolist, and will increase total surplus in the market.

As a 'natural' monopoly occurs when fixed costs are large in comparison to variable costs. As a result, one firm can supply the total quantity demanded within a market at a lower cost than two or more firms which may be involved. Therefore, if a government were to stimulate competition in a market with a 'natural' monopoly, it would lead to a rise in

average cost of production and in addition to this, consumers must then pay more, which is why governments should avoid stimulating any competition.

An alternative policy that would increase total surplus in such a market would be the 'first degree price discrimination', which allows the monopolist to acknowledge the reservation price that all consumers are willing to pay and then sell at this price to a range of different consumers, allowing a socially optimal quantity, which in turn maximises surplus. This maximal surplus however will be uneven as the monopolist charges the consumer exactly their Marginal Benefit and so they have zero surplus whilst the monopolist maintains it all.

A government may not want to stimulate competition because it may encourage inefficiency and increase prices for consumers. Natural monopolies usually occur due to barriers to entry such as complex infrastructure requirements or network requirements, for example the telecommunications industry. Therefore, in some markets it may be more efficient to have one, very large provider who can obtain the largest economies of scale rather than many smaller firms with massive infrastructure costs operating at losses.

An alternative policy available to the government is average cost pricing, which involves mandating a price where average cost is equal to demand. This eliminates the profit of the monopolist and increases consumer surplus by lowering the price.

The government may not wish to stimulate competition in a market with a natural monopoly, as it produces an inefficient economy. This is because if there is more competition, the costs will increase so it is impractical to have more than one firm dominate the economy and produce that good. Consequently, an alternative policy to increase total surplus in this market would be to implement price discrimination. By using price discrimination, it removes deadweight loss from a monopoly. This is because it allows producers to receive total surplus by selling to consumers at a price that matches their maximum willingness to pay.

A natural monopoly is an imperfectly competitive market structure wherein a singular firm has price setting powers due to increasing returns to scale. There are many reasons as to why the government may not want to stimulate completion in such a situation. Typically governments intervene so that production is increased to the socially optimum quantity, however there are also many associated drawbacks. In a natural monopoly, the high returns to scale often mean that increased competion results in greater levels of inefficiency, as marginal and total production costs are significantly larger for smaller firms with less of an economy of scale. Hence, it is often more efficient for governments to not intervene.

Even so, there are some policies that the Government Amy sue to increase total surplus. A key policy is average cost pricing, where the government stipulates that the firm must set its price at the intersection of average total cost and the demand curve. This will lead to an increase in consumer surplus, and reduced deadweight loss within the market, as the quantity supplied is increased and prices fall. However, it is often difficult for the government to accurately calculate ATC, and so the policies effectiveness is limited.

MONOPOLY AND TOTAL SURPLUS Suppose that a monopolist faces the following costs and demand for its product:

A. Complete the table above. (Draw the table on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Given that the monopolist wants to maximise profits, what price will it charge, and how many units will it produce?

C. What would be the quantity of output that would maximise total surplus?

D. Explain why this monopolist’s profit-maximising quantity is or is not equal to the quantity that maximises total surplus.

B – Where MR = MC 4 units at $7

C – where MB = MC 6 units at $5 D – In order to sell the extra units of the good and attract new consumers, the monopolist needs to reduce the price. This reduction in price affects every unit that is sold by the monopolist because the monopolist needs to charge all consumers the same price. Hence, there is an implicit cost in increasing the quantity sold, and this leads to an equilibrium production level that is lower than the socially optimal one. When the monopolist aims to profit-maximise, the invisible hand principle does not apply, which causes the disparity between quantity when maximising total surplus (MB = MC) and the quantity at which profit is maximised (MR = MC).

Part A

Part B The profit is greatest when the marginal cost is equal to the marginal revenue. This occurs somewhere between 4 and 5 units, so it will charge a price between $7 and $6.

Part C Total surplus is maximised when the marginal benefit equals the marginal cost. This happens at a quantity supplied of 6 units (as the price, or quantity demanded or marginal benefit, is equal to the marginal cost).

Part D Usually the profit maximising quantity is the same as the surplus maximising quantity due to the invisible hand principle in a perfectly competitive market. But in a monopoly, the amount that maximises surplus is not necessarily the same as the profit maximising quantity because the consumers and producers have conflicting needs - this is due to the fact that the producer has to lower the price in order to increase the quantity sold.

b) if the monopolist would like to maximise profits, then it must sell a quantity of 4 at $7 to make a revenue of $11 c) the firm would sell at equilibrium quantity d) total surplus is maximised at the equilibrium, whereas in order to maximise profits a monopolist will sell at their marginal cost which is a higher price than equilibrium

(B) to maximise profits, the monopoly will produce at the point where marginal revenue = marginal cost (or the closest) = 4 units at $7 per unit (C) to maximise surplus, production will need to be at the point where price = marginal cost = 6 units at $5 each (D) The profit maximising quantity is not equal to the quantity that maximises total surplus because to maximise profits, MC=MR but to maximise surplus, MC=Price. The reason for this is because in order to increase the number of units sold, the firm needs to decrease the

selling price for every unit sold (not just the next unit being sold) which reduces their total profit and marginal revenue per unit.

B) To maximise total profits, the firm will produce where the marginal cost is equal to marginal revenue. This will mean that the firm will produce approximately 3 units, sold at a price of $8 each.

C) To maximise total surplus, the firm will produce where demand in the economy intersects with marginal cost. This means finding the intersection between the demand (marginal benefit) and marginal cost curves.

D) The monopolist's profit maximising quantity is not the quantity that maximises total surplus because the monopoly only considers the benefit accrued to the monopoly itself, and not of the benefits to consumers. Hence, the Invisible hand principle fails and the monopoly will produce in order to maximise its own profits. This occurs at the point where marginal cost equals marginal revenues, because at this point, the firm will be able to make supernormal profit. Total surplus is not maximised here because at this point, the firm is not producing enough units to satisfy all consumer's demand. So, some consumers will miss out on the ability to consumer the product, consequently reducing total surplus. Where total surplus is maximised, when marginal benefit (or demand) is equal to marginal cost, the firm will produce at a point where it will earn negative profits. Hence, this is not maximising the profits of the monopoly. Therefore, the monopolist's profit maximising quantity is not equal to the quantity that maximises total surplus. Also, the monopoly's profit maximising quantity will never equal the quantity that maximises total surplus because the monopolist's and consumer's desires are in conflict. In order to sell extra goods, the monopolist would have to lower the price in order to attract consumers. But, this would mean having to reduce the price for all goods because the price must be the same. This means there is an implicit cost (of reducing the price) if the monopolist were to attempt to maximise total surplus, which would certainly not maximise the monopolist's on profits.

MONOPOLY AND PRICE DISCRIMINATION Suppose that a monopolist faces the following costs and demand for its product:

A. Complete the table above. (Draw your table on a piece of paper, take a picture with your phone and then attach the image to your answer here.)

B. Given that the monopolist wants to maximise profits, what price will it charge, and how many units will it produce?

C. Suppose that the monopolist is able to engage in first degree (perfect) price discrimination. How many units will it produce?

D. Using this monopolist as an example, explain how price discrimination by a monopolist affects profits, total surplus and consumer surplus. (Note: You are not required to calculate the values of each in order to answer the question.)

B. Profit is maximised when marginal revenue is equal to marginal cost (MR= MC). Thus, the monopolist will produce 4 units and charge $7 per unit.

C. If the monopolist is able to engage in first degree (perfect) price discrimination, he can charge each consumer exactly that consumer's reservation price. Thus, the monopolist will

want to admit more customers as long as the price is greater than marginal cost. Based on the table, the monopolist he will produce 5 units of good.

D. Perfect price discrimination will increase the monopolist's profit. Since consumers are charged at their reservation price, consumer surplus will be zero. Therefore, the monopolist will extract all the surplus from consumers, and total surplus will be equal to producer (monopolist) surplus, which is all the surplus available in the market.

Part B If the monopolist wants to maximize profits, Marginal Cost=Marginal Revenue. That is when the quantity equals to 4, $4=$4. 4units will be produced.

Part C The firm is able to charge the maximum possible price for each unit which enables the firm to capture all available consumer surplus for itself. That is when Marginal benefit (price) >= Marginal Cost, which is at quantity =5. 5units will be produced.

Part D By charging different prices, the firm is able to capture more consumer surplus — the difference between the price a consumer is willing to pay and the price the consumer actually pays. This additional consumer surplus adds to the firm's producer surplus.

Therefore, the profit will increase, the consumer surplus will decrease to 0 and the total surplus will stay the same.

To maximise profits, the monopolist would produce 4 units and price them at $7 each.

If the monopolist is able to engage in first degree price discrimination, it would produce 6 units.

When a monopolist engages in first degree price discrimination, it charges exactly their reservation price for every unit sold. This means the monopolist can sell as many units as it chooses without lowering market price to increase demand. To maximise profits, this monopolist will produce 4 units at $7, incurring $28 in total revenue. However, if it engages in first degree price discrimination, it will incur $30 as total revenue by producing 6 units.

This indicates the monopolist receives a higher total revenue by engaging in first degree price discrimination, meaning higher profits. The monopolist also produces more units when it engages in first degree price discrimination, which leads to higher consumer surplus.

Hence, the greater profits and consumer surplus mean that total surplus is maximised when monopolists engage in first degree price discrimination.

b) When a monopolist wants to maximise it's profit, it will find a point where the marginal revenue is equal tot he marginal cost. In this case, when the monopolist produces 3 units of output, it will reach the maximised profit because it is at that point where MR=MC. c) First degree price discrimination is when the monopolist essentially knows the reservation price of the consumers and so they charge each consumer at their marginal benefit or reservation price. This occurs when the marginal benefit or market price is equal to the

monopolist's marginal revenue, therefore, the monopolist would then produce 4 units of output because at this point MB=MR. d) By selling their units using first price discrimination enables the monopolist in selling the socially optimal quantity that maximises social surplus. However, the distribution of this surplus in the society is not evenly distributed. In this case, only the monopolist benefits from all the surplus which leads the consumers to drastically decrease its consumer surplus to absolutely nothing, leading all the extra surplus to the monopolist. This affects profit positively for the monopolist in gaining all the extra profits by accruing all the surplus available in the market.

B) marginal cost = marginal revenue or marginal cost being just below marginal revenue, so monopolist will produce 4 units.

C) 5 units (refer to table) D)A monopolist that can engage in first degree price discrimination is actually selling the socially optimal quantity, which maximises total surplus.

However, the distribution of surplus within the society is very uneven. The monopolist charges the consumers exactly their marginal benefit (or reservation price) and so leaves consumers with zero surplus. The monopolist is the one who accrued all the surplus available in the market The monopolist is maximising their profit by using first degree price discrimination.

CHAPTER 8 AEW Game theory is most helpful in understanding markets characterized by A few firms DOMINANT STRATEGIES Consider the following pay-off matrix for two players with two possible strategies. (Player 2’s pay-offs are depicted in italics). a) What is meant by the term “dominant strategy”? b) Does either player have a dominant strategy in this game? c) What will be the Nash equilibrium of this game? Explain how you found your answer.

1. Consider the following pay-off matrix for two players with two possible strategies. (Player 2’s pay-offs are depicted in italics). a) What is meant by the term “dominant strategy”?

The dominant strategy is the preferred strategy of a player irrespective of the other player's strategy. b) Does either player have a dominant strategy in this game?

Yes Player 1 has a dominant strategy because no matter what player 2 picks, High is the better choice. Player 2 does not because their optimal choice depends on the choice of player 1. c) What will be the Nash equilibrium of this game? Explain how you found your answer.

The Nash equilibrium occurs when no player can unilaterally gain by changing their strategy.

Player 1 will pick High because it always benefits them. Player 2, knowing Player 1 will always pick High, will pick Right. The Nash Equilibrium is (H,R)

a) A Dominant Strategy represents a strategy that is preferred by a player irrespective of the strategy selected by the other player. b) Player 1 has a dominant strategy to always select High. c) The Nash Equilibrium is High, Right. This is because the dominant strategy of Player 1 is to always select High (and they will do so regardless of Player 2's choice). Player 2 will also

receive the best outcome if Player 1 chooses High, and between choosing Left and Right, Right is more optimal for Player 2. Neither Player will benefit by unilaterally changing their choice from this point.

a) A Dominant Strategy represents a strategy that is preferred by a player irrespective of the strategy selected by the other player. b) Player 1 has a dominant strategy to go high as regardless of what player 2 does, they will be better off. Both 30 and 40 > 15 or 10. Player 2 does not have a dominant strategy. c) A Nash equilibrium is a strategy profile in which no player can benefit from unilaterally changing his or her strategy. The Nash equilibrium here is High, Right (40, 50). If Player 1 changes their strategy they will go from 40 --> 10 and if Player 2 changes their strategy they will go from 50 --> 45.

A dominant strategy is a course of action that a player will undertake irregardless of the other player's choice as it will result in a more favourable outcome in every possible scenario. Player 1 has such a dominant strategy in playing 'High' as it will result in a better outcome if Player 2 plays 'Left' (30>15) or if they play 'Right' (40>10). The Nash equilibrium can be found when considering that Player 1 is incentivised to only play 'High'. Player 2 has the choice to play either 'Left' or 'Right', however, knowing that Player 1 will almost certainly play his dominant strategy, Player 2 will gain 10 from switching from 'Left' to Right' (40>30) whereas they lose 10 by switching from 'Right' to 'Left' (30<40). Therefore, the Nash Equilibrium is (High, Right) as neither player can gain an advantage by switching their strategy if the other player doesn't shift their strategy.

a) A dominant strategy is a strategy taken by one player irrespective of what the other player will do b) Yes, player 1 has a dominant strategy to choose 'high'. His outcome from this would be either 30 or 40 depending on P2, compared to a 15 or 10 if he were to choose 'low' so therefore irrespective of what P2 does, P1 choosing high will deliver the best outcome.

P2 does not have a dominant strategy as the values of left (45 + 20) are equal to the values of high (50 + 15) if they were to cancel each other out, therefore he has no strategy irrespective of what P2 does. c) Nash equilibria is a strategy profile where no player can benefit from unilaterally changing their strategy. The nash equilibrium here is (high, right), where the values are (40, 50). If P1 was to instead choose low, they would only get 10, and if player 2 were to choose left, they would only get 45, therefore neither can improve by unilaterally changing their strategy and hence this is the nash equilibrium.

GAME THROY IN THE MARKET FOR PIZZA In an isolated town two pizza shops open. Their owners Mario and Luigi are deciding what price to set on the menu. Before the opening night of both stores they discuss their pricing and work out that a price of $15 is going to bring the greatest benefit to them. Both know that there are 100 potential customers on any given night and that if they decrease their price to $14 then everyone would buy from their shop. Pizza’s cost $10 to produce. a) Draw the payoff matrix of the game for the first day of opening b) What type of game does this represent? What are the key features (for example: Nash Equilibrium, Dominant Strategies)?

Changing the menu prices the night before open takes considerable time and so they would need to hire an additional casual staff member to assist with preparations in the morning costing $170. c) Reconstruct the payoff matrix of the game using the above information d) Do any of the key features change?

Reconsider the original case, now allow for a certain proportion of consumers to be loyal to one of the pizza shops (both have the same number of loyal customers). A loyal customer will always buy from their favourite pizza shop, even if the price is higher. e) What proportion of people need to be loyal in order for the socially optimal outcome to be the only Nash Equilibrium in this game? f) Is it possible to have a coordination game with any proportion of loyal customers? What proportion of customers need to be loyal in order for this to be a co-ordination game? Is it possible in the case where the cost of hiring the additional casual staff member to change prices is $100 instead of $170? If so for both, how do these two levels compare?

b) This is an example of a cartel game. The dominant strategy for both Mario and Luigi is $14. For Luigi, 1400 and 700 are greater than 750 and 0 respectively. For Mario, 1400 and 700 are greater than 750 and 0 respectively. The Nash Equilibrium is at ($14,$14). This is where neither Mario nor Luigi can unilaterally change with benefit.

d) Nothing changes. The dominant strategy for both Mario and Luigi is still $14. For Mario, 1230 and 530 are greater than 750 and 0 respectively, and for Luigi, 1230 and 530 are greater than 750 and 0 respectively. The Nash Equilibrium is still ($14, $14). e) The socially optimal outcome is at ($15,$15) because the total surplus of $1500 is the greatest out of all the other strategy outcomes. For ($15,$15) to be the Nash Equilibrium, the number at where both the $1230 is currently at (($14,$15) and ($15,$14)) must be at or below $750.

For ($14, $15): $1230 - $750 = $480. So at least $480 worth of customers must stay loyal to Luigi.

480/15 = 32. So at least 32 customers need to stay loyal to Luigi.

Likewise for ($15, $14), at least 32 customers need to stay loyal to Mario.

Thus, ($15, $15) becomes a Nash Equilibrium as neither Mario and Luigi can unilaterally change their strategy with benefit. f) The above game matrix is an example of a coordination game because there is no dominant strategy and two Nash Equilibriums (($15,$15) and ($14,$14)). Using this example, if we change the level of customer loyalty to 35 or both Mario and Luigi when the other changes their price, we get the following game matrix:

There is now a dominant strategy of $14 for both Mario and Luigi. This is no longer a coordination game. So it is not possible to have a coordination game with any level of loyal customers.

Not sure what the $100 is part is asking.

Payoff matrix Luigi - Decrease Don’t Decrease Mario - Decrease $200, $200 $400, 0 Don’t Decrease 0, $400 $250, $250 b) What type of game does this represent? What are the key features (for example: Nash Equilibrium, Dominant Strategies)?

This game represents the prisoner’s dilemma game, where firms or individuals might decide not to cooperate even though doing so would be beneficial to both of them. A feature of this type of game is that both players have a dominant strategy but both their dominant strategy will not be the one that maximises profit collectively where they cooperate.

Changing the menu prices the night before open takes considerable time and so they would need to hire an additional casual staff member to assist with preparations in the morning costing $170. c) Reconstruct the payoff matrix of the game using the above information Payoff matrix Luigi - Decrease Don’t Decrease Mario - Decrease $30, $30 $230, -$170 Don’t Decrease -$170, $230 $80, $80 d) Do any of the key features change?

No, none of the key feature change Reconsider the original case, now allow for a certain proportion of consumers to be loyal to one of the pizza shops (both have the same number of loyal customers). A loyal customer will always buy from their favourite pizza shop, even if the price is higher. e) What proportion of people need to be loyal in order for the socially optimal outcome to be the only Nash Equilibrium in this game?

50 people to each pizza shop would create a Nash equilibrium at the socially optimal outcome as both shops will have the dominant strategy to no decrease the price. This is shown in the table below Luigi - Decrease Don’t Decrease Mario - Decrease $200, $200 $200, $250 Don’t Decrease $250, $200 $250, $250 MIKE AND NORMAN COMPETE IN THE DONUTS MARKET Consider the market for donuts which is characterised by the following demand curve: P = 30 - Q where Q is in dozens per day. There are two suppliers for donuts, Mike and Norman, who each have the same marginal cost of $2 per dozen donuts and no fixed cost. a) If they collude (i.e. act together as a monopoly) how many donuts will they collectively sell and at what price?

Now assume that both Mike and Norman have an incentive to break their deal and lower their price by $4. If they do this, they will capture the whole donut market. b) Draw Mike and Norman’s profits in a payoff matrix.

c) What is the Nash Equilibrium of this game? Describe the nature of this game (for example, "entry game").

Now assume that a competition regulator decides that price changes can only occur once per month, otherwise Mike and Norman will be shut down for changing their prices too often. d) Draw a new payoff matrix showing Mike and Norman’s profits per month. e) What is the new Nash Equilibrium of the game? Describe the nature of this game (for example, "entry game"). a) If they collude, they will sell at the profit-maximising point (MC = MR). This would be 14 dozens of units at $16 per dozen. b) Top Left = Revenue (224/2) - Total Costs (2*7) = 98. Top Right & Bottom Left = Revenue (14 * 12) - Total Costs (14 * 2) = 140. Bottom Right = Revenue (7 * 12) - Total Costs (7 * 2) = 70.

c) Nash Equilibrium will be 70, 70. This is a cartel/prisoner's dilemma game. d) (multiplied profits by 30)

e) The new nash equilibrium is 2100, 2100. There still exists the incentive to 'cheat' the other player. If one drops the price and the other doesn't, the latter is stuck with 0 profit for the rest of the month. 'Prisoner's Dilemma'. Both are likely to cut their prices at the beginning of the month out of the fear of repercussions if one does not and the other does. (the losses cannot be regained until the subsequent month).

A) If they collude then they are considered a monopoly, They will produce a quantity that corresponds to the price that maximizes their profits i.e. MR = MC. MR = 30 - 2Q and MC = 2; therefore, 2Q = 28. Q = 14; P = 16 B) at P = 16, Revenue (R) = PxQ. R = 16x14. R = $224. Total Cost TC = MC x Q = 2 x 14. this means TC = $28 Profits are R - TC = $196 (at P = 16) shared between them. $98 each at P = 12, Q = 30 - 12 = 18.

R = 12 x 18 = $216. TC = 18 x 2 = $36. new profits are (216 - 36) = $180 shared between both at $90 each Refer to attached image 1 C) The Nash equilibrium of this game is (drop price, drop price) or ($90, $90) since they both have a dominant strategy of dropping price to increase their profits. This type is called Prisoner's dilemma.

D) Assume 30 days in a month Since they have a dominant strategy to drop prices, they will drop prices in the beginning of the month This means if they did not drop prices each will receive $98 x 30 = $2940 When they drop price they receive $90 x 30 = $2700 each Refer to attached image 2

E) In this case Norman and Mike are no longer playing a one shot game but rather they are playing a repeated game. We can see that in Image 2, If they both do not drop prices they can both maximize profits which they can realize through the repetition of the game monthly, also if one does the other will also drop their price making $2700 each. The Dominant strategy now is no longer to cut prices, instead we have 2 Nash equilibria due to this repetition, (drop price, drop price) or (don't drop price, don't drop price) . This type of game where we have 2 Nash equilibira is called Coordination

Part A In this case we can assume that the market supply curve is P=2Q as both Norman and Mike have the same conditions for production, in that their marginal cost is $2.

Hence we can find the equilibrium where the Demand curve intersects with the supply curve. This is shown below and says that collectively they will sell 10 dozen donuts at $20 a dozen.

Part B This is done with the assumption that their profits are split perfectly between each other when both at the high or low price.

Part C This is a cartel game in which whilst colluding produces the greater surplus the Nash Equilibrium is both choosing the strategy low price. The reason for this is as follows; If we take Norman, for example, is clear that when both have selected the higher price it is more beneficial for him to lower his price. By doing this Norman increases his profits by $60.

Mike can observe this and hence will assume that if Norman is acting in such a way to be profit maximising (or rationally) Norman will lower his price, thus it is in Mike's best interest to also lower his price, thus ensuring he generates a positive profit of $80. The reciprocal of this is also true.

Hence whilst both choosing the higher price is the best option, the Nash equilibrium will be with both choosing the lower price.

NASH EQUILIBRIUM a) Explain what is mean by the term “Nash Equilibrium”. b) Is it a requirement that games have one Nash equilibrium?

Nash Equilibrium is the result when each party does not benefit by unilaterally deviating from their strategies.

It is not a requirement for games to have one Nash equilibrium, they can have two or none.

Nash Equilibrium refers to the outcome in a strategy profile where no player will benefit from deviating from their current action It is possible for a game to have multiple Nash Equilibrium , such that said equilibria are all optimal outcomes for all players. This will likely vary depending on the context of the game.

Nash equilibrium is a strategy profile is a Nash Equilibrium if no player can benefit from unilaterally changing her strategy. When both parties make the decision simultaneously, and when no one is going to be benefited from changing their strategy after knowing each other's situation.

a) Nash equilibrium refers to a situation where no player can benefit from changing their strategy unilaterally.

b) it is not a requirement to have a nash equilibrium

a) a) Nash equilibrium is a strategy profile where no player can benefit from unilaterally changing their strategy. This means that if someone changes their strategy while the other keeps their strategy unchanged, then they (the person who changed strategy) will not benefit from this change. b) No, there is no requirement that games have one Nash equilibrium. Games can have even multiple Nash equilibrium, or no Nash equilibrium at all.

PRISONERS DILEMMA GAMES a) Explain what is meant by the “Prisoner’s Dilemma” game. Do players have a dominant strategy in this game? b) Create an example of a pay-off matrix for such a game c) Will the Nash equilibrium of this game result in the socially optimal outcome? Explain why/why not. a) the prisoner's dilemma game is a situation where two individuals are unaware of the decision that the other would make. b) a pay off matrix is a 2x2 matrix that shows all possible outcomes in a 2x2 oligopoly c) the nash equilibrium is a socially optimal outcome.

PART A Prisoners dilemma game is a type of game where firms may decide not to cooperate in a situation, although. The best outcome (i.e. the socially optimal outcome) is achieved when both credibly commit to cooperate. The dominant strategy for both players in a prisoners dilemma game is to confess, as they are unsure what decision the other person is going to make.

PART B Prisoner 1 and Prisoner 2 are arrested for a robbery. If they confess and say the other prisoner was involved in the crime, then they get a reduced sentence of 1 year, whilst the other prisoner gets a 10 years sentence. On the other hand, if both confess, they get 3 years each in prison, and if they both deny, they only get 2 years each in jail.

Prisoner’s 2 payoff is in blue.

PART C The socially optimal outcome is (deny, deny). This results in both prisoners going to jail for 2 years. This is the socially optimal outcome as the total number of years in jail, combined is

the lowest if both prisoners deny rather than confess. The Nash equilibrium in this case is also (confess, confess). If Prisoner 2 is going to confess, then Prisoner 1 is better off confessing as well to have less number of years in jail. Therefore the Nash equilibrium is not the socially optimal outcome in this prisoners dilemma game.

A. Prisoners dilemma game is when the individual quest for profit does not lead to socially optimal allocation of resources b. see image below for play off matrix c. the nash equilibrium of this game does not result in the socially optimal outcome due to the nature of the prisoners dilemma game

A) Prisoners Dilemma refers to the situation where players might decide not to co-operate even though doing so would be mutually beneficial. Both players have dominant strategies in this game. One can choose to confess, leaving to betray the other, with better outcomes for that person who confesses, in hopes that he gets off whilst the other person gets a heavier sentence.

B) displayed in image C) No. The nash equilibrium here is not the socially optimal outcome. The socially optimal outcome is for both players to NOT confess, but the nash equilibrium is that both will confess. Hence, the likely outcome is that both will confess because its the dominant strategy to do so, and its in their best self-interests to get the most for themselves.

a) The “Prisoner’s Dilemma” game is one where the options of the players are not Pareto optimal meaning that there is no option where both of the players gain more and therefore, the individual's quest for profits does not lead to a socially optimal allocation of resources.

There is no dominant strategy in this game as both options have negative impacts.

c) The Nash equilibrium of this game (50, 50 split) will result in the socially optimal outcome as both parties gain an equal amount.

a) A prisoner's dilemma game is a characteristic where firms have the same dominant strategy b) Attached C) No the Nash Equilibrium of Footy, Cricket (bottom left) and Cricket Footy (top right) result in a total surplus of 170, whilst Footy, Footy (bottom right) would result in a total surplus of 200 and is therefore the socially optimal result\

CHAPTER 9 AAP

Suppose that the market demand curve for electric cars in Sydney is given

by P = 60,000 – Q, and the market supply curve is given by P = 20,000 + 0.25Q. Further, suppose that electric cars reduce pollution on Sydney and this reduction in pollution is valued at $5,000 per car. What are the competitive market price and quantity of electric cars in Sydney?

P = 28K AND Q = 32K COASE THEOREM Ben produces chemical compounds that sell for $500 in the market. This production process generates waste which Ben can dispose of in the river for free, or he can pay $300 for professional waste disposal services. The river is also used by swimmers and fishermen, who value having a clean river at $120 and $190 each. Assume there are no negotiation or transaction costs. a) What is the socially optimal outcome in this situation? b) If there are no regulations on how Ben should dispose of his waste, how is the optimal outcome likely to be achieved? c) If Ben will be fined $500 for dumping his waste in the river, how does this change the optimal outcome? a) The socially optimal outcome would be to pay the professional waste disposal services.

(Ben would make a profit of $200 but swimmers and fishermen would collectively benefit by $310, this would accumulate to $510) <-- This is greater than the outcome of Ben disposing into the river which would be $500 b) If there are no regulations then Ben would dispose his waste in the river for free. To achieve the optimal outcome, the fishermen and swimmers would have to offer him a price above the difference between Ben's 2 possible outcomes (earning $500 or earning $200 [500-300[). The difference here is $300, thus the fishermen and swimmers must offer him a minimum of $301 to not pollute the river. c) If Ben is fined $500, then this would mean Ben's better choice (to retain greater profit) would be to pay $300 for the professional disposal services. [The outcome possibilities for Ben are now either $0 or $200]. The collective benefit would still be $510 but the other option would result in $0. The imposition of this fine would achieve the optimal outcome without the need for bargaining between fishermen/swimmers and Ben.

a) The socially optimal outcome will be if Ben uses a professional waste disposal service. b) Without any regulations, this outcome will be achieved through the negotiation between the two parties. The fishermen and swimmers will offer Ben $300 to not dump the waste into the river. c) If Ben is charged $500 for dumping in the river, he will decide to pay $300 himself for the wast disposal service. The fisherman and swimmers will not need to negotiate.

Answer to Part (A) The socially optimal outcome is for Ben to dispose the waste in the river for free. Ben's surplus when we disposes the waste in the river for free is $500 - $0 = $500. The total surplus of swimmers and fishermen if Ben does not dispose the waste in the river is $120 + $190 = $310. Since $500 is greater than $310, the socially optimal outcome is for Ben to dispose the waste in the river for free.

Answer to Part (B) If there are no regulations, and if Coase Theorem is not applicable (no negotiation and transaction cost), the outcome will remain the same. The option of swimmers and fishermen offering an payment between $310 and $500 is not valid, as Coase Theorm is not applicable in this case. The swimmers and fishermen will not be willing to "buy" Ben's preference to dispose the waste in the river because they value it less than Ben does, as calculated in Part A. Ben will therefore still dispose the waste in the river.

Answer to Part (c) If Ben is fined for $500 for his disposal, Ben will choose not to dispose wastes in the river.

Considering the fine, the surplus for Ben disposing his waste will be $0 ($500 - $500). His surplus of calling the professional waste disposal service will be $200 ($500 - $200), and the surplus of swimmers and fishermen when he does this will be $310 ($120 + $190). Either way, since Ben has a higher surplus when he decides to call the service, Ben will choose the option of calling the professional waste disposal service over paying the fine.

A) Socially optimal outcome: the swimmers and fishermen pay the cleaning fee of $300 (which is less than what they value having a clean river).

B) social optimal will be achieved due to the swimmer and fishers desire to having a clean river being greater than the cost of cleaning the river.

C) Being fined $500 is greater than the cost of disposing of the waste ($300), hence he would pay for this service.

PARTYIN VS SLEEPING Suppose that Trevor is a resident of The Bad Place who enjoys hosting loud parties late at night. This annoys Trevor’s neighbour Chidi, who likes going to sleep early. Suppose that Trevor enjoys each additional night of partying at $100, while Chidi values a good night’s sleep at $200. a) If there are no laws in The Bad Place limiting residents’ behaviour, will Trevor host parties every night? b) What is the socially efficient outcome in this situation? What transaction needs to take place for this outcome to be realised? c) What happens if they need to pay a translator $150 in order to be able to communicate, as Chidi can only speak French?

Go back to the original case, and suppose that Trevor’s friends Vicki and Shawn also get enjoyment out of attending Shawn’s parties, while Chidi’s friends Eleanor and Janet would rather enjoy a quiet night in. Vicki and Shawn benefit from the parties $240 and $300 per night respectively. Eleanor and Janet enjoy the quiet $50 and $400 respectively. d) What is the new socially optimal outcome? How will this outcome be achieved?

e) What does this tell us about the requirements for Coase Theorem to realise the efficient outcome? a) Yes, Trevor will host parties every night as he ignores the external effects on others. b) The socially efficient outcome is if to negotiate to have Chidi pays Trevor $100 to not party so Chidi can have a good night’s sleep. c) Trevor would continue to enjoy hosting loud parties as the for Chidi to negotiate with Chidi to shut down his parties would be $250 ($100 + $150), which exceeds the value of a good night’s sleep worth $200. d) If the party goes ahead the surplus is $100+$240+$300 = $640, meanwhile if the party doesn’t go ahead the surplus is $200+$50+$400. Therefore, the socially optimal outcome is for the party to go ahead and for those who want to party to give $240 to those who don’t want to party. e) This tells us about the requirements for the Coase Theorem as there is a trade in externality with no transaction costs and we can see how bargaining has led to an efficient outcome regardless of the initial allocation of property rights.

a) If there are no laws in The Bad Place limiting residents’ behaviour Trevor host parties every night as it gives him a marginal utility of $100 b) The socially efficient outcome in this situation is if there is no party, therefore being no noise. Therefore, Chidi needs to pay Trevor $101 as Trevor values partying at $100, and therefore, both agents are satisfied. c) If they need to pay a translator $150 in order to be able to communicate, as Chidi can only speak French, then that would exceed what they value respectively of $100 and $200 d) The new socially optimal outcome is that there is no party and no noise and the party people get paid ($100+$240+$300=$640). This can be achieved if those who want sleep pay the party people $641 to not have the party, as they value sleep at $650. e) Coase Theorem states that trade in an externality is viable through bargaining and will lead to a socially optimal outcome where the agent with the higher reservation price will pay the other agent their reservation price.

A. Yes, Trevor will host parties every night as it provides him with a marginal benefit of $100.

B. The socially efficient outcome if for Trevor to not host parties. In order for this to occur, Chidi must pay Trevor the amount he values the party ($100). Chidi will pay this as it is less than the amount he values a good night’s sleep ($200), thus he still experiences a surplus of $100 from this transaction.

C. If they need to pay a translator the cost to Chidi would be $150 + $100 (Trevor’s value of the party). This equals $250 which is greater than the amount Chidi value’s a good night’s sleep therefore this transaction is not beneficial to him and Trevor’s parties will continue.

D. The total benefit from having a party is: $640 The total benefit from no party is: $650.

Therefore, Chidi, Eleanor and Janet would be willing to pay Trevor, Vicki and Shawn $640 to not have a party as they value a quiet night more than the others value a party.

E. The Coase Theorem states that if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. Therefore, in the case of the translator (transaction cost) the socially optimal outcome was not realised however, in the other cases bargaining lead to an efficient outcome for all parties.

PART A Trevor values hosting loud parties at $100. Chidi values sleeping early at $200. Therefore as Chidi values sleeping more than Trevor values partying, then Trevor will have to buy Chidi’s right. However Chidi will not accept an offer less than $200 and Trevor will not offer an amount more than $100. Therefore Trevor won’t host parties every night.

PART B The socially optimal outcome is for Trevor to not host any parties and Chidi gets to sleep in early as she values sleep at $200 which is greater than Trevor’s value for hosting parties ($100). Trevor will have to buy Chidi’s right to be able to host parties however, he will not offer an amount greater than $100 and Chidi will not accept an amount less than $200.

Therefore no transaction can take place.

PART C If Chidi ahs to pay for a translator to be able to communicate with Trevor, then he value for sleeping decreases to $50 (i.e. 200 – 150 = 50). Trevor’s value for partying is $100. Therefore Trevor will continue hosting parties each night as his value is greater than Chidi value and Chidi is unable to buy Trevor’s right.

PART D The collective value of partying is now the combined value earned by Trevor, Vicki and Shawn which is: $100 + $240 + $300 = $640. The collective value of having quiet is Chidi, Janet and Eleanor’s value combined which is: $200 + $50 + $400 = $650.

Therefore both groups value partying and quiet at $650. Therefore no transaction or agreement can be made.

PART E The Coase Theorem states that states that if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. In this case, to be able to adhere to Coase Thereom and reach a socially optimal outcome, one party must value their activity more than the other party in order to negotiate.

PETROL IN SYDNEY Suppose the market demand curve for petrol in Sydney is given by P = 50 - Q And the market supply curve is given by P = 10 + Q Q is in millions of litres. Further, suppose that burning petrol produces an additional marginal cost to Sydney residents of $2 per million litres.

a) Calculate the socially optimal quantity for this market. b) Is this quantity higher or lower than the competitive market quantity? Why? c) Do you think Coase Theorem can be applied in this situation? Justify your response.

PART A market demand: P(D) = 50 - Q market supply: P(S) = 10 + Q marginal externality cost = $2/million litres (L).

As a result of above externality, the cost to society of producing petrol is larger than the cost to the producers and market. Therefore externality will impact the supply curve. socially optimal quantity: social supply curve: P = 10 + Q + 2 = 12 + Q 50 - Q = 12 + Q 38 = 2Q therefore Q(social) = 19 million L of petrol. at this quantity, Price(social) = 50 - 19 = $31/million L Socially optimal quantity in market is 19 million L of petrol.

PART B competitive market equilibrium: 50 - Q = 10 + Q 40 = 2Q therefore, Q(market) = 20 million L of petrol at market quantity: P(market) = 50 - 20 = $30/million L. The socially optimal quantity (19 million L) is less than competitive market quantity (20 million L). Burning petrol is a harmful production activity that can lead to increased air pollution, impacting others not involved in the production process, as this pollution can create health risks and respiratory illnesses to others. Therefore resulting in a negative production externality. Therefore social quantity of producing petrol decreases from Q(market) at 20 million L to Q(social) at 19 million L as shown in the graph.

PART C Coase thereom states that if trade in an externality is possible and there are no transaction costs, bargaining leads to an efficient outcome regardless of initial allocation of rights.

Therefore in the case of negative production externality, there are too many buyers and sellers in the market resulting in large transaction costs and therefore there are too many parties to negotiate with. Coase thereom therefore does not hold in this situation of negative production externality. Instead, the government can solve this externality by implementing a tax on producers of petrol equal to the marginal externality of $2/million litres. This shifts the market supply curve to the left, aligning with the social supply curve, resulting in a socially optimal outcome of 19 million litres at a price of $31/million litres (as shown in graph in part B).

A) The Socially optimal quantity is 19. The private optimal quantity is 20.

B) This quantity is lower as it takes into consideration the extra marginal cost incurred by society. As a result, a higher price must be sourced to ensure that MC = MB = P. And since price increases, the law of demand states that the quantity demanded will decrease.

C) I do not think it can be applied in this situation as there are simply too many people to obtain the required payment from. Furthermore, there is bound to transaction costs.

a) Calculate the socially optimal quantity for this market.

Socially optimum where MSC = MB 48 - Q = 10 + Q Q = 19 b) Is this quantity higher or lower than the competitive market quantity? Why? The quantity is lower than the competitive market quantity of 20. This is because consumption produces a negative externality which reduces total benefit from the good, so the socially optimal level will always be less than the competitive. c) Do you think Coase Theorem can be applied in this situation? Justify your response.

No it does not. There are too many consumers to deal with in Sydney (about 5 million) so private negotiation could not practically occur with everyone.

Part A Shown below demonstrates the socially optimal quantity of petrol.

Part B Below shows the competitive market price.T

Thus the competitive market quantity is greater than the socially optimal quantity of petrol.

This is because the additional marginal cost of $2 must be factored into the demand and supply curves. It can be considered as either as an extra marginal cost of production or a decrease in the marginal benefit of the product. in this case it would be considered to be a decrease in marginal benefit. However in both cases the effect on quantity is the same.

In the below graph this marginal cost is considered as an extra marginal cost of production.

Thus causing the social supply curve to be above and to the left of the competitive market supply curve. This increase is, as shown, precisely the marginal cost of $2. Which in this case is shown to move the original equilibrium Q1 to the left to Q2. In this case decreasing the quantity demanded by the consumers as the marginal cost is factored into the supply of the good. So to the consumer this good effectively becomes more expensive due to the marginal cost of $2.

Part C The Coase theorem states that "If trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights". However, in this case there are a small number of suppliers of petrol, namely the producers of petrol and owners of petrol stations, however there are a large number of consumers; everyone who drives a car. Hence this large number of

consumers is fairly difficult to bargain with as it will lead to transaction costs as people are required in order to complete the bargaining.

Thus in this case Coase theorem can not be applied due to the large number of people that would be involved with the negotiations leading to the presence of transaction costs.

a) To find the socially optimal quantity, the marginal external benefit is added to the demand curve. Hence, the MSB = 52 - Q. From here, we can conclude that the socially optimal quantity is 31 millions of litres. b) The competitive market quantity can be derived when the supply curve equal with the demand curve to find the equilibrium price and quantity of the market. The competitive market quantity is at 30 millions litres, which is lower than the socially optimal quantity by 1 million litre. This is because of the deadweight loss created that represents the lost surplus for which the marginal social benefit is above the marginal cost. c) The Coase theorem states that "if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.", in other words, to negotiate to arrive at a socially optimum outcome. The Coase theorem can be applied in this case to reach a state of a socially optimum outcome where it benefits equally of both consumer and producers.

PETROL IN SYDNEY 2 Suppose the market demand curve for petrol in Sydney is given by P = 50 - Q And the market supply curve is given by P = 10 + Q Q is in millions of litres. Further, suppose that burning petrol produces an additional marginal cost to Sydney residents of $2 per million litres. a) What type of externality is this? Justify your response. b) Draw a graph illustrating this market. (You can draw the graph on a piece of paper, take a picture and upload the picture here). c) Calculate the competitive market price and quantity of petrol in Sydney. a) Negative production externality. A Negative Production Externality represents a cost incurred by someone who is not involved in the production of a given good. In this case, the burning petrol imposes a cost of $2/million trees on Sydney residents.c)Competitive market quantity is 19 million L and price is $31 (from graph).

c)Competitive market quantity is 19 million L and price is $31 (from graph).

CHAPTER 10 MATT, RYAN, LIAM AND A PUBLIC GOOD Two flatmates Matt and Ryan are deciding how to best furnish their house. Furniture costs $100 per unit and can be considered both non-excludable and non-rival once purchased. They have the following demand curves: Matt: P=180-15Q Ryan: P=120-10Q a) Suppose that Matt and Ryan cannot come to an agreement to share the cost of the furniture. What will be the deadweight loss associated with competitive market outcome?

Calculate the surplus for Ryan in the competitive market outcome. b) Use the Samuelson condition to determine the efficient provision of this public good.

What is the socially optimal price and quantity?

Knowing that Ryan is going to free ride of his provision for furniture Matt decides it would be better to just move in elsewhere. So, Liam decides to move in with Ryan instead. Liam has exactly the same individual demand curve as Ryan. c) Suppose that Liam and Ryan cannot come to an agreement to share the cost of the furniture. Calculate the surplus for Ryan in the competitive market outcome. d) How has Ryan’s surplus changed relative to the previous part of the question? What is the reason for this change? Explain your answer.

a. (see graph) Aggregate demand curve: P = (180 + 120) + (-10-15)Q P = 300 -25Q If they cannot come to an agreement, it is likely that Matt, who has a higher marginal benefit, will pay and Ryan will free load.

When the price is $100, Matt is willing to pay for 5.33 units of furniture.

However, the socially optimal quantity is: 100 = 300 -25Q

Q= 8 Thus, the deadweight loss = ½ x (8-5.33) x (166.75-100) = $89.11 Ryan’s surplus = (5.33 – 2) x 100 = $333 b. The socially optimal price and quantity would be found at the intersection of the Marginal Cost curve and the aggregate demand curve. i.e. Sold 100 = 300 – 25Q Q= 8.

And the socially optimal price is $100. According to the Samuelson condition they could each pay their Lindahl prices i.e. they would pay their own marginal benefit at the efficient level. Matt would pay (180-15(8)) = $60 and Ryan would pay (120-10(8))=$40. c. If they cannot come to an agreement, Liam will likely pay for the furniture and since it is a non-excludable good, Ryan will once again free-load, this time on Liam’s provisions.

At a price of $100, Liam is willing to individually purchase 2 units of furniture.

For the same amount of units, Ryan would have also purchased 2 units but instead he only paid $0.

Therefore Ryan’s surplus = $0 d. Ryan’s surplus has decreased relative to when he was living with Matt. This is because Matt valued furniture much more than Ryan and hence he was willing to purchase more units compared to Liam, who purchases the same amount as Ryan. Hence, when Ryan free-loads with Liam he gets no surplus because they both value the good at the same price.

A) Surplus for ryan = 475, DWL = 120 B) Socially optimal price is $100, and quantity is 8 C) Surplus for ryan will be 240.

D) Surplus has decreased from 475 to 240. Reason is that Ryan was previously free riding Matt, but Ryan is now purchasing the good individually, hence, he is responsible for forking out the money out of his own pocket. a) DWL = $26.67 Surplus = $240 b) efficient provision means Q8 at P100 PROVISION OF PUBLIC GOODS

Scott and Peter share and apartment. They both enjoy having a clean apartment, regardless of who pays for the cleaner. The graph below show’s their individual and aggregate demand curves for apartment cleaning. a) Does cleaning meet the conditions of a public good? Why or why not? b) If the cleaner costs $2 per hour and Peter and Scott individually decide on cleaning, how many hours will they hire a cleaner for? c) Is this the socially optimal number of hours? d) Who will pay for the cleaner? Explain why.

A) Yes, cleaning meets the conditions of a public good. This is because it is non-rival, as both Scott and Peter can reap the benefits for a clean apartment as they share it. Further, the good is non-excludable, as it is impossible for one person to stop the other from consuming the benefits of a clean apartment.

B) If they individually decide on the cleaning, Scott will be willing to pay for around 7 hours of cleaning which is the intersection of the marginal cost and his individual marginal benefit.

Peter will see the opportunity to free ride, and not pay for the cost of the cleaner. Hence they will hire a cleaner for 7 hours.

C) This is not the socially optimal number of hours. The Samuelson condition tells us the socially optimal number of hours, is given by the intersection of the aggregate demand curve, and the marginal cost curve. In this case, the socially optimal number of hours is around 8.5 hours. The good is under-provided in the competitive market.

D) Only Scott will pay for the cleaner, this is because he values the cleaner more than Peter and pay for the number hours that is equal to his marginal benefit. Peter will see an opportunity to free ride on Scott’s provision, in this case, Peter will enjoy 7 hours of cleaning for free, and the good will be under provided.

A) Cleaning is a public good as it is both nonrival and non-excludable. Non-one can be excluded from the benefits of cleaning, whilst one's consumption and satisfaction of the cleanliness does not impede other individuals utility from consuming it as well.

B) Graph below. Peter will hire for 5 hours, Scott hires for 7 hours. c) This is not the socially optimal number of hours as 12 hours is more than both are willing to pay for with maximum of 10 hours. Socially optimal number of hours if found by Marginal Cost = Social Benefit, and here that equals to 8 hours a day. d) The cleaner, if socially optimal, will be payed

by Scott for 7 hours. This is as Peter will choose to free ride, and gain a greater surplus in doing so when compared to paying his Lindahl price.

Hence, Scott will pay for the entire 7 hours of cleaning, whilst Peter will choose not to pay for cleaning.

A) For a good to be considered a public good it must be non-rival and non-excludable. The cleaning meets the conditions of being a public good as Peter's/Scott's consumption of the cleanliness of the apartment will not result in a prevention of the other consuming it, and Peter and Scott cannot be excluded from consuming the clean apartment.

B) If the cleaner has a marginal cost of $2 and Peter and Scott individually decide on cleaning, the cleaner will be hired for 6.67 hours, or 6 hours, 40 minutes.

C) This is not the socially optimal number of hours.

D) If individually decided, Scott will be paying for the cleaner and Peter will free-ride off this provision. As Scott's marginal benefit from cleaning is valued higher than Peter's, the greatest amount of surplus is achieved when Scott hires the cleaner for 6.67 hours, rather than Peter hiring the cleaner for 3.2 hours.

The cleaner does meet the requirements of a public good as it is both non rival and non excludable. The consumption of the cleaner does not prevent others from consuming it as they will clean the apartment for all involved, and you can't prevent an individual from consuming the clean apartment via excluding them from the apartment.

If they individually decided on cleaning, the cleaner would be hired for 7 hours, this is not the socially optimal hour quantity due to the fact that it is not all marginal benefits = marginal cost, only the one of scott.

Scott will pay for the cleaner due to the greater reservation price and marginal benefit gained from the cleaner, rather then Peter who does not gain as much benefit from it and will free ride on whatever scott pays for it.

A) A public good is one that is both non-rival and non-excludable. In this case, the cleaning is non-rival- as Peter's satisfaction from having the service of cleaning does not impede on Scott- they both use the furniture. However cleaning is excludable as money needs to be payed for the service. Thus those who don't pay are excluded. As a result, cleaning does not meet the conditions of a public good.

B) With a marginal cost of $2, Peter can demand for 5 hours of cleaning, and scott wants 7 hours of cleaning. Since Peter only wants 5 hours of cleaning and Scott is already prepared to pay for 10, he will free ride- and reap the benefits of 7 hours of cleaning. As a result, they will hire a cleaner for 10 hours.

C) The aggregate demand curve reveals the marginal social benefit. In this case, if we follow the aggregate demand curve, at a price of $2, the optimal level of cleaning would be about 8 hours.

D) Scott's marginal benefit from cleaning is $6 whereas Peter's is only $4. As Scott values the cleaning more, he will pay for about 7 hours of cleaning. On the other hand, Peter only needs about 5 hours of cleaning- which will be covered when scott can pay for 7. As a result, Scott will pay for the cleaner, while Peter will free ride- and reap the benefits of 7 hours of cleaning.

PUBLIC GOODS AND SOCIAL OPTIMALITY Scott and Peter share and apartment. They both enjoy having a clean apartment, regardless of who pays for the cleaner. The graph below show’s their individual and aggregate demand curves for apartment cleaning.

a) If Peter and Scott collectively decide how long to hire the cleaner for, and the cleaner costs $2 per hour, how long will they hire the cleaner for? b) Is this the socially optimal number of hours?

a) From the aggregate demand curve (P = 10-Q), when P = $2, Q = 8 hours. Therefore, if Peter and Scott collectively decide how long to hire the cleaner for, and the cleaner costs $2, they should hire the cleaner for 8 hours. b) Yes, this is the optimal number of hours as the Samuelson Condition states that the efficient quantity of public good is found by setting the sum of the individual marginal benefits equal to the marginal cost.

a)Since Peter and Scott are collectively deciding on how long to hire the cleaner for, we analyse using the aggregate demand curve.

Equation of the aggregate demand curve: P=10-Q At a price of $2, 2=10-Q Q=8 hours They will hire the cleaner for 8 hours. **(B)**Yes this is the socially optimal number of hours they can hire the cleaner for.

A) They will hire the cleaner for a collective total of 8 hours.

B) Yes, this is the socially optimal number of hours. If they were to hire the cleaner individually, Peter would free-ride Scott,.

A) 6.67 hours B) No - 8 hours at $2 a) From the aggregate demand curve (P = 10-Q), when P = $2, Q = 8 hours. Therefore, if Peter and Scott collectively decide how long to hire the cleaner for, and the cleaner costs $2, they should hire the cleaner for 8 hours. b) Yes, this is the optimal number of hours as the Samuelson Condition states that the efficient quantity of public good is found by setting the sum of the individual marginal benefits equal to the marginal cost.

(a) Although the initial thought is that Scott and Peter will both pay their marginal benefit and hire the cleaner for the amount of time which the aggregate demand equals the marginal cost (known as Lindahl prices), this will not be the case. This is because Peter's demand curve is lower than Scott, meaning that he values cleaning less than Scott, and he has the opportunity to free ride on Scott. Therefore, the cleaner will be hired for the amount of time which Scott's marginal benefit equals the marginal cost ($2) which is approximately 7 hours. (b) This is not the socially optimal number of hours. The socially optimum number of hours is when the aggregate demand curve intersects the marginal cost curve, which would be 8 hours.

A) Peter will hire 5 hours, Scott will hire 6.67 hours.

B) The social optimal hour is 8 hours.

8. Yes because no one is free-riding.

PUBLIC GOODS a) Explain what is meant by the terms “non-excludable” and “non-rival”. b) Why does this result in a public good being under-provided by the market?

PART A Non-excludable means that an individual cannot be excluded or prevented from benefiting from a good or service or activity. An example is a lighthouse. No one can exclude a ship from benefiting from using the lighthouse. Non-rivalrous means that an individual can consume the same unit of good or service at the same time (i.e. one person’s consumption of the good doesn’t prevent another person from consuming it). Therefore the marginal cost of providing the good to an additional person is 0. An example of a public good is education, lighthouses and national defence.

PART B As public goods are defined as goods that are non-rivalrous and non-excludable, this could give rise to the free rider problem. When an individual makes the decision to buy a public good, other individuals incentive to buy the good decreases as they are able to benefit (or free-ride) from the person who is purchasing it. This is known as the free-rider problem. This results in the good being under-provided or a decreased amount of the good being produced than the efficient quantity. Due to the free-rider problem, a public good is underprovided by the market.

A) Non excludable means that it is not possible to prevent consumers from consuming the good. Non rival means that one consumer's consumption of the good does not prevent another consumer from also being able to consume and enjoy the good.

B) Because public goods are characterised as being non excludable and non rival, it means that consumers are able to free ride from their provision. This means that they are able to benefit from the consumption of a good without paying for it. This discourages firms from providing these goos in the market because they are unable to generate any profits because they are utilised by consumers even without paying for them. Therefore, private firms are not willing to produce them because it does not allow them to achieve their main goal of maximising profits. Thus they are often under-provided by the market. Because these goods are often needed by consumers, the government will interfere in the market to ensure they are somehow provided to consumers.

PUBLIC GOODS AND TAXATION Scott and Peter share and apartment. They both enjoy having a clean apartment, regardless of who pays for the cleaner. The graph below show’s their individual and aggregate demand curves for apartment cleaning. a) If the government were to ask Peter and Scott how much they value 8 hours of cleaning, in order to choose appropriate individual levels of taxation, is it likely that they would report truthfully? Why or why not? b) If they did report truthfully, what would their reservation prices be?

5. Scott and Peter share an apartment. They both enjoy having a clean apartment, regardless of who pays for the cleaner. The graph below show’s their individual and aggregate demand curves for apartment cleaning. a) If the government were to ask Peter and Scott how much they value 8 hours of cleaning, in order to choose appropriate individual levels of taxation, is it likely that they would report truthfully? Why or why not?

It is likely they would undervalue the cleaning in order to pay lower taxes and still gain the same level of utility, hoping to free ride on each other’s higher value prices than the ones they have stated. b) If they did report truthfully, what would their reservation prices be?

Reservation price is where MC = MSB Scott: MC = - 3/5Q + 6 =-⅗x8+6 = $1.2 Peter: MC = - ⅖ x 8 + 4 = $0.8

A) No, Peter and Scott are most likely to not report truthfully on how much they are value 8 hours of cleaning. The reason behind that is that cleaning is considered a non-excludable (people will benefit from an apartment being clean regardless of whether they paid for it or not); hence, Peter and Scott have an incentive to report a value less than their truthful value, which would result in under-providing B)For Peter, his demand curve is P = 4 - 0.4Q (from the graph). This means at Q = 8, the reservation price for Peter is Pp = 4 - 3.2. Pp = $0.8 For Scott, the demand curve is P = 6 - 0.6Q (from the graph). This means at Q = 8, Scott's reservation price is Ps = 6 - 4.8. Ps = $1.2

Ted, Fred and Urban Parkland Fred and Ted have the following demand curves for hectares of urban parkland: Fred: P = 10 − Q Ted: P = 1 − 0.1Q a) Find the aggregate demand curve for urban parkland, assuming it is a public good. b) Suppose that the marginal cost of maintaining urban parkland is $5/hectare. Calculate the quantity demanded individually by Fred and Ted. c) Now, calculate the socially optimal quantity of urban parkland. Explain why this amount is different from the individually demanded quantities.

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Find the aggregate demand curve for urban parkland, assuming it is a public good.

Adding the curves together we get: P = 11 - 1.1Q

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b) Suppose that the marginal cost of maintaining urban parkland is $5/hectare. Calculate the quantity demanded individually by Fred and Ted. Fred: 5 = 10 – Q Q=5 Ted: 5 = 1 - 0.1Q Q = - 40 therefore, he will not demand it at this price c) Now, calculate the socially optimal quantity of urban parkland. Explain why this amount is different from the individually demanded quantities.

Socially Optimum: 5 = 11 - 1.1Q Q =~5.5 The amount varies because the socially optimal quantity is obtained using the summation of individual demand curves and then calculating equilibrium with MC. This means the quantity is higher than either of the individual quantities.

A) The aggregate demand curve is P = -11/10Q+11 (adding up their graphs vertically). b) At P=$5, Fred’s Q = 5 and Ted wouldn’t be willing to buy c) The Samuelson Condition states that the efficient quantity of a public good is found by setting the sum of the individual marginal benefits equal to the marginal cost. The socially optimal quantity is calculated using the aggregate demand curve. When P = $5, Q = 60/11 = 5.45 (2dp).

Aggregate demand curve is given by P=11-1.1Q Individually, Fred would demand 5 hectares and Ted would demand 0 Sub 5 into the aggregate demand to work out the quantity. Thus, optimla quantity is 5.45 hectares. This amount is different to the individual demands because we are considerignt he intercept of the aggregate demand curve with the MC rather than each individual demand curve.

P = 11 - 1.1Q Fred will purchase 5 hectares, and Ted will free ride.

The socially optimal quantity is 50/11 hectares. Socially optimal quantity is achieved when marginal social benefit is equal to marginal social cost. As a result the aggregate demand curve is consulted. However, individual demand is achieved when marginal cost is equal to marginal private benefit. As a result, the individual demand curve is consulted. Consequently, the socially optimal quantity and the individually demanded quantities differ.

10-Q+1-0.1Q = 11-1.1Q=P 10-Q=5, 5=Q Individually they demand 5, as Ted will free-ride under Fred and not pay for anything, and Fred will demand 5 Hectares of urban parkland.

The Socially optimal quantity of urban parkland is 11-1.1Q=5

5.5=Q