Econ Exam 3 (11-15)
Suppose the typical buyer is willing to pay $6,000 for a plum and $3,000 for a lemon. If buyers assume that there is a 50-50 chance of getting a lemon or a plum, they are willing to pay
$4,500 for a used car.
In 2010, the U.S. Congress approved legislation to regulate the nation's health insurance markets and reduce the number of uninsured people. Which of the following is not true regarding the new law?
It will significantly reduce subsidies and tax credits for small businesses.
Dan and John are pricing managers for two competing broadband internet providers in a duopoly market. If Dan decides to charge a high price what is his risk?
John will charge a low price and take all Dan's customers.
n the game tree to the right, rectangle 2 is not a Nash equilibrium because if
Mona picks the small quantity, the best response for Doug is to enter.
Change in Preferences and Proposed Budgets. Consider the example of the governor's election shown in the figure to the right. Suppose, as predicted by the median-voter rule, two candidates running for governor are proposing education budgets essentially equal to the preferences of the median voter ($5 billion). Suppose that the preferences of the 4 voters who prefer a budget of $8 billion change, with each person preferring $15 billion instead. Will this change in preferences change the proposed budgets of the two candidates?
No, the two candidates will not change their proposed budgets.
The Cost of Celebrities. Consider a firm that hires an expensive celebrity to advertise its products. Does the firm have an incentive to prevent its customers from discovering how much it pays the celebrity?
No. Large spending for a celebrity endorsement signals that the producer expects the product to be popular.
Environmental Costs for Regulated Monopoly. The Bonneville Power Administration (BPA) is a regulated monopoly in the Northwest that uses dozens of hydroelectric dams to generate electricity. Unfortunately, the BPA's dams block the paths of migrating fish, contributing to the decline of several species. Suppose that the BPA spends $100 million to make its hydroelectric dams less hazardous for migrating fish. Who will bear the cost of this program?
The consumer will pay this cost since the average cost will increase.
Pepsi launches two new drinks: one is without a celebrity endorsement, the other endorsed by music star Lady Gaga. Which of the following statements is true?
The drink with Lady Gaga's sponsorship is expected to sell the best.
Draw the Cable TV Graph. Use a graph to show that the entry of satellite TV decreases the profit-maximizing price of a cable TV company from $40 to $35. Use the line drawing tool twice to draw new demand and marginal revenue lines illustrating the impact of satellite TV entry on the market for cable TV. Label the lines appropriately.
The entry of a satellite TV firm decreases the profit-maximizing output of cable TV, and decreases the profit-maximizing price.
How Many Bookstores? The city of Bookburg initially allows only one bookstore, which sells books at a price of $20 and an average cost of $11. Suppose the city eliminates its restrictions on bookstores, allowing additional stores to enter the market. According to an expert in the book market, "Each additional bookstore will decrease the price of books by $2 per book and increase the average cost of selling books by $1 per book."
The equilibrium number of bookstores is 4 stores.
Suppose firms in a monopolized market are earning economic profits and a second firm, producing a slightly different product, enters the market. Which of the following does not explain why the monopolist's profits fall?
The monopoly moves upward along its positively sloped average-cost curve.
Buzz and Moe are duopolists in the lawn-care market. The game tree to the right shows the possible pricing outcomes and their payoffs.
The outcome of the pricing game is that Buzz will pick the low price and Moe will pick the low price.
Which scenario would most likely cause the Department of Justice or the Federal Trade Commission to block a merger?
The two largest players in an oligopolic market decide to merge to control a dominant market share.
More Voters. Consider the example of the governor's election shown in the figure to the right. Suppose, as predicted by the median-voter rule, two candidates running for governor are proposing education budgets essentially equal to the preferences of the median voter ($5 billion). Suppose 18 new people move into the state and each newcomer has a desired budget of $9 billion. Predict the new proposed education budgets for the two candidates.
The two candidates' new proposed budgets will be roughly $6 billion.
Why would a firm offer a low price guarentee?
To guard against low priced competitors.
Word-of-Mouth Book Sales. Consider a publisher who earns a profit of $2 per book sold. An advertisement that costs $340 comma 000 would sell 120 comma 000 books directly.
To make the advertisement worthwhile, how many of the original buyers must each persuade just one other person to buy the book? 50,000
Politicians have an incentive to move to the median voter preference, so there is little difference between the politicians.
True
An insurance company assumes a 50-50 mix of low- and high-cost customers, and prices accordingly. If it turns out there are more than 50% high-cost customers, the company's average cost will
exceed its estimate and the company's profit will decrease.
In order to charge different prices to different firms, depending on the past medical bills of the firm's employees, most insurance companies use
experience rating.
A graphical representation of the consequences of different actions in a strategic setting is a
game tree.
To decrease the moral-hazard problem, many insurance policies
have a deductible or an insurance copayment.
A consumer with a relatively
high opportunity cost of search time will have a higher marginal cost of search and will naturally spend less time searching for lower prices.
Compared to a perfectly competitive market, average costs in a monopolistically competitive market are
higher due to the cost of many firms providing differentiated products.
With monopolistic competition, the average cost of production is
higher than the minimum, but there is more product variety.
A perfectly competitive firm has a ________ demand curve, whereas a monopolistic competitive firm has a ________ demand curve.
horizontal; downward sloping
In the figure to the right, rectangle 2 is not a Nash equilibrium because
if Adeline advertises, the best response of Vern is to advertise.
In the figure depicted to the right, it is not a Nash equilibrium for Jill to choose the low price and Jack to choose the high price (rectangle 2) because
if Jill picks a low price, the best response of Jack is to pick the low price.
The FTC approved the merger of the second and third largest office supplies superstores because of
increased competition in the market from general superstores and internet sellers.
Government regulations for kiwifruit
increased the average quality and increased the average price of kiwifruit.
The reservation price is the price at which the consumer is
indifferent about additional search, meaning that the marginal benefit of search equals the marginal cost.
The federal government receives more money from ________ than from any other source.
individual income taxes
While shopping for office equipment, an office manager sees a display of fire extinguishers. After making a single phone call, the manager decides not to buy a fire extinguisher. Given the moral-hazard problem, the manager most likely called her
insurance company and asked, "will my insurance cover the cost of a fire?"
A market with low entry and exit costs
is a contestable market.
Safety Rebate from the Insurance Company. In 2010, a leading insurance company started a policy that pays a policy holder a 5% rebate on his or her insurance premium in any year in which the driver does not file an insurance claim. For example, a household with an annual premium of $1,200 will get a $60 rebate check each year it does not file a claim. This rebate policy
is trying to decrease the moral-hazard problem by creating an incentive to drive safe and avoid claims.
Compared to a perfectly competitive market, a monopolistically competitive market produces
less at a higher average cost.
When a monopolized industry becomes monopolistically competitive, consumers pay
less for goods and services, and firms earn lower profits.
The dilemma in a duopoly around advertising occurs because firms make
less profits by advertising, but can't risk losing sales to the other firm, so they advertise anyway.
In some monopolistically competitive markets, differentiation is simply a matter of
location.
Firm A has lowered its price from $29.99 to $24.99. In a tit-for-tat situation, firm B will
lower its price to $24.99.
A discovered price is the
lowest price observed so far in a search process.
The natural monopolist chooses the output level where
marginal revenue equals marginal cost.
For a firm operating in a monopolistically competitive market at equilibrium, marginal revenue equals
marginal cost, and price equals average cost.
Studies of the market for used pickup trucks have shown
mixed results concerning the lemons problem.
In a cartel, the price that will be charged to consumers is the
monopoly price.
If you know you'll get your money back no matter what happens to the S&L, you may deposit your money there without evaluating the performance of the S&L and the riskiness of its loans to borrowers and investments in the stock market. The manager of an S&L will also be more likely to make risky investments knowing that if it doesn't pay off and the S&L goes bankrupt, the federal government will reimburse depositors. This is an example of
moral hazard.
When the government eliminated entry restrictions on the trucking industry with the Motor Carrier Act of 1980,
new firms entered the trucking market, and freight prices dropped by about 22 percent.
When a duopolists' dilemma occurs, to eliminate the possibility of underpricing, one firm can
offer a low-price guarantee.
Used car sellers can try to solve the lemons problem by
offering a money-back guarantee.
What provides the best example of product differentiation in a monopolistically competitive market?
opening a store in a highly convenient location
It is sensible for the government to subsidize worker training and education because some of the benefits from training go to
other firms.
Economists and political scientists have studied many dimensions of the decision-making processes underlying tax policies and spending policies and have found evidence that
people vote with ballots and their feet, and these two forms of voting make a difference.
Which of the following in not an external benefit of education?
personality externalities
What is the likely outcome of two firms competing when there is only room for a natural monopoly?
poor quality and a high price
An example of implicit pricing agreements is
price leadership.
A fire extinguisher is an example of a
private good that generates external benefits.
When the Sherman Act was passed in 1890 it
prohibited practices that result in restraint of trade.
The clearing of space debris is an example of a
public good that suffers from the free rider problem.
What is a method by which the government reigns in the power of a natural monopoly?
regulating prices through average cost pricing
The government subsidizes goods that generate external benefits such as
research at universities and other nonprofit organizations.
Entry deterrence won't be the best strategy for all insecure monopolists. The use of an entry deterrence strategy is more successful when
scale economies are relatively large.
An external benefit is experienced by
someone other than the person buying the good.
When asymmetric information causes a thin market,
some high-quality goods are sold, but not as many that would with perfect information.
Which of the following is not a way that a car buyer can avoid the lemons problem?
taking a quick test drive
The self-interest theory of government explains why many states have limits on
taxes and government spending.
Which of the following is not a way that monopolistically competitive firms use advertising?
test the market for new products
When there is a prisoners' dilemma,
the Nash equilibrium is that each of two prisoners would be better off if neither confessed, but both people confess.
In a Nash equilibrium, each player is doing the best he or she can, given
the action of the other players.
A second firm will not enter a natural monopoly market because
the firm wouldn't be able to cover their cost.
the government allowed people to choose how much money they wanted to pay in taxes,
the government would be forced to cut back spending dramatically.
As a consumer, it makes sense to search for a lower price if
the probability of finding a lower price times the money saved is greater than the cost of the search.
Consider a thin used-car market. Someone just developed a device that can instantly identify the nearest plum in a used-car lot. The device works only once. The maximum amount that a consumer would be willing to pay for the device equals
the willingness to pay for a plum minus the used-car price in the mixed market.
Going Out of Business Sales? Many firms have going-out-of-business sales with remarkable bargains. What insights does the material in the chapter provide about such sales? Firms going out of business underprice their rivals because
there is limited time for retaliation.
Firms spend money to line up celebrities for advertising spots because
this sends a signal to consumers that the product is appealing and likely to popular.
Which of the following is not a way that a consumer can avoid the lemons problem?
trial and error
It is illegal for firms to discuss pricing strategies or methods of punishing a firm that underprices other firms.
true
Suppose firms in a monopolistically competitive market are earning economic profits. Entry will occur until the
typical firm makes zero economic profit.
Professional baseball pitchers are like
used cars because there is asymmetric information. This is because a player's current owner has better information about the pitcher's health and likelihood of injury.
Between 1893 and 1940, Alcoa had a monopoly on aluminum production in the United States. During this period, Alcoa kept other firms out of the market by
using limit pricing.
Sellers can identify a car as a plum in a sea of lemons by offering
warranties.
To enter the motel market as the operator of a Motel 6, you'll pay a franchise fee of
$35,000 and royalties of 5 percent of sales.
Oligopolies occur for three reasons:
(1) the government may limit the number of firms in a market by granting patents or limiting the number of business licenses ; (2) large economies of scale in production ; and (3) to get a foothold in the market, large expenditures on advertising are required.
What is the best example of product differentiation that occurs in a monopolistically competitive market?
Apple's iPhone's built-in ability to back-up data to the iCloud.
In the figure depicted to the right, suppose Jack promises Jill that if she picks the high price, he will too. Is this promise credible?
No, because by instead picking the low price, Jack's profit will increase.
Airporter Price Fixing? Hustle and Speedy provide transportation service from downtown to the city airport. Assume that low-price guarantees are illegal. The average cost per passenger is constant at $10. Here are the possible outcomes: (Enter your responses as integers.) Hustle chooses a price first, followed by Speedy. A game tree for the price-fixing game with corresponding profits is depicted to the right. Predict the outcome.
Price-fixing (cartel). Each firm has 17 passengers at a price of $25. Corresponding profit for each firm will be $255. Duopoly (no price-fixing). Each firm has 22 passengers at a price of $18. Corresponding profit for each firm will be $176. Underpricing (one firm charges $18 and the other charges $25). The low-price firm has 37 passengers and the high-price firm has 2 passengers. Corresponding profit for the low-price firm will be $296, and profit for the high-price firm will be $30. a. Hustle and Speedy will both choose a price of $18.
Hotel Price Fixing? Waikiki Beach has two hotels, one run by Juan and a second run by Tulah. The average cost of providing rooms is constant at $30 per day. Assume low-price guarantees are illegal. Here are the possible outcomes: (Enter your responses as integers.) Juan chooses a price first, followed by Tulah. A game tree for the price-fixing game with corresponding profits is depicted to the right. Predict the outcome.
Price-fixing (cartel). Each firm has 32 customers per day at a price of $40. Corresponding profit for each firm will be $320. Duopoly (no price-fixing). Each firm has 38 customers per day at a price of $37. Corresponding profit for each firm will be $266. Underpricing (one firm charges $40 and the other charges $37). The low-price firm has 65 customers and the high-price firm has 10 customers. Corresponding profit for the low-price firm will be $455, and profit for the high-price firm will be $100. a. Juan and Tulah will both choose a price of $37. This is the correct answer.D.
The demand for a product in a monopolistically competitive market tends to be
elastic, because of the availability of many close substitutes.
If the choices made by the government match the preferences of the voter whose preferences lie in the middle of the set of all voters' preferences, the government's choice is consistent with the
median-voter rule.
In the market for insurance, the moral-hazard problem is that insurance encourages
risk-taking.
Monopolistic competition refers to a market in which old boys act naturally as they transport tight slacks in the back of Dodge Ram pickup trucks.
False
Which of the following is a way that some people can be encouraged not to be free riders and to contribute voluntarily to organizations that provide public goods?
All of the above.
Bonnie and Clyde have been accused of committing a crime. The police have given each an opportunity to confess to the crime. Bonnie and Clyde are put in separate rooms, and each must decide whether to confess or not without knowing the other's choice. Corresponding prison terms for each outcome are represented in the payoff matrix to the right. Predict the outcome of the game.
Bonnie and Clyde will both confess.
Deadweight Loss from a Merger. Consider a market that is initially served by two firms, each of which charges a price of $10 and sells 100 units of the good. The long-run average cost of production is constant at $4 per unit. Suppose a merger increases the price to $16 and reduces the total quantity sold from 200 to 150.
Compute the loss in consumer surplus associated with the merger: $1,050 Compute the gain in profit: $600 What is the net loss from the merger? $450
The logic of adverse selection does not apply to the markets for life insurance, home insurance, and automobile insurance.
False
Shuttle Deterrence? Consider the market for air travel between Boston and New York. The long-run average cost is constant at $100 per passenger, and the demand curve is linear, with a slope of minus$2 per passenger. The demand curve intersects the horizontal average-cost curve at a quantity of 120 passengers. The minimum entry quantity is 20 passengers. FirstShuttle currently has a monopoly, with 60 passengers at a price of $220. Another firm, SecondShuttle, is considering entering the market. If FirstShuttle is passive and lets the other firm enter, each firm will have 40 passengers at a price of $180. How would the predicted outcome change if the minimum entry quantity dropped to a quantity of 8?
Consider the game tree to the right. Predict the outcome of the game. FirstShuttle will respond to the threat of entry by producing a quantity of 100 , and SecondShuttle will stay out. a. FirstShuttle would produce 40 and SecondShuttle would enter.
Ninja Turtles versus Tai Chi Frogs. The demand for fantasy amphibians is linear, with a slope of minus$0.01 per amphibian. The average cost of production is constant at $3. The demand curve intersects the horizontal average-cost curve at a quantity of 600 amphibians. A firm selling ninja turtles currently has a monopoly, selling 300 turtles at a price of $6. A second firm is considering entering the market with tai-chi frogs, and the minimum entry quantity is 100 amphibians. If the turtle firm is passive and lets the frog firm enter, each firm will sell 200 amphibians at a price of $5. How would the predicted outcome change if the minimum entry quantity dropped to 50 amphibians?
Consider the game tree to the right. Predict the outcome of the game. The turtle firm will produce a quantity of 500 , and the frog firm will stay out. a.The turtle firm would produce 200 amphibians and the frog firm would enter.
Low-Price Guarantees for a Canopy Tour. Dip and Zip provide canopy tours in a rain forest. The average cost per rider is constant at $10. The game tree to the right shows the possible outcomes. Price-fixing (cartel) Duopoly (no price-fixing) Underpricing (one firm charges $18 and the other charges $15) Dip and Zip's pricing options and resulting profit are depicted in the game tree to the right. Dip chooses a price first, followed by Zip. a. Predict the outcome of the pricing game. b. Suppose both firms provide low-price guarantees. The new game tree is depicted to the right. Predict the outcome of the price-fixing game. c. Is the promise to match any lower price a substantive promise or an empty promise?
Each firm has 7 passengers at a price of $18 and earns corresponding profit of $56. Each firm has 8 passengers at a price of $15 and earns corresponding profit of $40. The low-price firm has 20 passengers with corresponding profit of $100, and the high-price firm has 3 passengers with corresponding profit of $24. a. Dip and Zip will both choose a price of $15. b. Dip and Zip will both choose a price of $18. c.It is an empty promise.
A horizontal merger involves two firms producing a similar product. A vertical merger involves two firms at different stages of the production process. In recent years, the analysis of proposed mergers has shifted from predicting how a particular merger would affect prices to counting the number of firms in a market.
False
Automobile Advertising. Consider two automobile companies that are considering advertising campaigns. If neither firm advertises, each will earn net revenue of $10 million. If each spends $9 million on advertising, each firm's net revenue will be $17 million. If one advertises and the other does not, the firm that advertises will earn $25 million in net revenue, while the firm that does not will earn $2 million. This is depicted in the game tree to the right. What is the outcome of the game? From the industry perspective, do the benefits of advertising exceed the costs?
Firm 1 and firm 2 will both advertise. No
Use the matrix above to fill in the blanks.
If Jill picks the high price, Jack's best choice is to pick the low price and earn $12,000 . If he picks the other price, he will earn $9,000 . If Jill picks the low price, Jack's best choice is to pick the low price and earn $8,000 . This is better than the $3,000 he can earn by picking the other price.
Cost Savings from a Merger. Consider the following statement from a firm that has proposed a merger between two companies: "The two companies could save about $50 million per year by combining our production, marketing, and administrative operations. In other words, we could realize substantial economies of scale. Therefore, the government should allow the merger." In light of the new guidelines concerning mergers, how would you react to this statement?
If the evidence for greater efficiency is convincing, the government might allow a merger that reduces the number of firms in a market
Which of the following is not one of the early conglomerates that the government broke up through antitrust policy?
Interstate Bakeries
Beware the Too-Easy Answer. Your city initially restricts the number of pizzerias to one. The existing monopolist sells 3 comma 000 pizzas per day. A pizzeria reaches the horizontal portion of its long-run average cost curve at an output of about 1 comma 000 pizzas per day. Suppose the city eliminates the entry restrictions.
In equilibrium, the number of firms will be greater than three.
The following table shows the prices and quantities in three different used-car markets
Is Market A in equilibrium? No . In Market A, the price for a used car will drop . Is Market B in equilibrium? Yes . In Market B, the price for a used car will stay the same . Is Market C in equilibrium? No . In Market C, the price for a used car will rise .
Vitamin Market Areas. Beta and Gamma produce vitamin A at a constant average cost of $5 per unit. Assume that low-price guarantees are illegal. Here are the possible outcomes: (Enter your responses as integers.) a. Suppose Beta chooses a price first, followed by Gamma. A game tree for the price-fixing game with corresponding profits is depicted to the right. What will be the outcome?
Price-fixing (cartel). Each firm sells 30 units at a price of $20 per unit. Corresponding profit for each firm will be $450. Duopoly (no price-fixing). Each firm sells 40 units at a price of $14 per unit. Corresponding profit for each firm will be $360. Underpricing (one firm charges $20 and the other charges $14). The low-price firm sells 70 units and the high-price firm sells 5 units. Corresponding profit for the low-price firm will be $630, and profit for the high-price firm will be $75. a. Beta and Gamma will both choose a price of $14. b. Suppose the firms agree to pick the high price. Once Beta picks the high price, how much more could Gamma earn if it cheated on the price-fixing agreement? $180 c. Suppose the firms divide the market into two areas of equal size and assign each firm one of the areas. Will this arrangement generate a successful cartel? Yes
What is the largest category in federal government spending?
Social Security
FDIC provided bank deposit insurance creates moral hazard because it
encourages savers to seek out the highest interest rate regardless of the bank's risk.
Auctioning Business Licenses. The following table shows the relationships between the number of firms in the market, the market price, the quantity per firm, and the average cost of production. A business license allows a firm to operate the business for one day. The city will auction up to seven business licenses to the highest bidders, and the auctioning of licenses will continue as long as someone bids a positive amount for one of the licenses. Assume that each firm can buy only one license.
What is the maximum amount you would be willing to pay for a license? $58
Education generates three types of external benefits:
Workplace externalities, civic externalities, and crime externalities.
An outcome of a game in which each player is doing the best he or she can, given the action of the other players, is
a Nash equilibrium.
A tie-in sale occurs when
a business requires a consumer of one product to purchase another product.
Under a price-leadership model, a sudden drop in price by the leader is unlikely to trigger a price war if other firms believe that the price cut was caused by
a change in consumer demand.
We can predict the equilibrium of the price-fixing game by
a process of elimination.
The marginal cost of expanding a highway is $58. The marginal benefit is approximately $35. The people who use this highway the most strongly express their views to the government to have the highway expanded, and the government complies. The people that expressed their opinion to the government to have the highway expanded are called
a special interest group.
Got Milk? Bessie and George are milk producers, and each must decide whether to spend $15 million on an advertising campaign. If neither advertises, each will earn $11 million in net revenue from sales (net revenue). If both advertise, each will earn $30 million in net revenue and $15 million in profit ($30 million minus $15 million for advertising). If only one producer advertises, that firm will earn $21 in net revenue, and the other firm will earn $19 million in net revenue. This is depicted in the game tree to the right. What is the outcome of the game? Is there an advertiser's dilemma? Does this dilemma differ from the advertisers' dilemma discussed earlier in the chapter? How might the dairy industry solve this dilemma? (Think white mustaches.)
a. Bessie and George will both not advertise. b. Yes. The dilemma is that Bessie and George would be better off if both would advertise but neither do. c.Yes. Earlier, the dilemma was that firms would be better off if neither would advertise but both do. d. Collect funds from firms for industry-wide advertising.
Willingness to Pay for Used Baseball Pitchers. Suppose a healthy baseball pitcher is worth $7 million per year to his team, compared to only $4 million per year for an unhealthy pitcher. Suppose that half the pitchers in the league are healthy, and half are unhealthy. According to an executive of a baseball team, "If my assumptions are correct, our team is willing to pay a maximum of $5.5 million for a pitcher in the free-agent market." a. What are the executive's assumptions?
a. Half of the pitchers available in the free-agent market are healthy and half are unhealthy. b. Are these assumptions realistic? No
Consider a market with two firms managed by Harry and Vera. Under a cartel (both firms pick the high price), each firm earns a profit of $80. Under a duopoly (both firms pick the low price), each firm earns a profit of $50. If the two firms pick different prices, the high-price firm earns a profit of $15 and the low-price firm earns a profit of $90. This is depicted in the payoff matrix to the right. The outcome of the pricing game is The outcome identified above is a Nash equilibrium because neither firm has an incentive to
a. Harry and Vera both pick the low price. b.pick the high price given that the other player is picking the low price.
Rising Insurance Rates. Consider an insurance company that provides group medical coverage for university employees. The company discovered that some of its younger employees had switched to other insurance companies. The company responded to the loss of customers by increasing its price. This is puzzling because you might think the insurance company would drop its price to prevent other employees from switching to other companies. a. What is the rationale for increasing the price? b. If you change one word in the second sentence, it would be logical for the insurance company to decrease rather than increase its price. What's the word, and why is it decisive?
a. The fraction of high-cost customers insured by the company has increased. b. "Younger," because younger workers typically have lower medical bills; conversely, if older workers left the plan, then the price would drop.
State Auto Insurance Pool. Consider a state in which automobile drivers are divided equally into two types of drivers: careful and reckless. The average annual auto insurance claim is $400 for a careful driver and $1 comma 200 for a reckless driver. Suppose the state adopts an insurance system in which all drivers are placed in a common pool and allocated to insurance companies randomly. An insurance company cannot refuse coverage to any driver it is assigned, but a driver who is unhappy with the insurance company has the option of being randomly reassigned to another insurance company. By law, each insurance company must charge the same price to all its customers. Predict the price of auto insurance under the two alternative policy scenarios: a. Under Policy M, auto insurance is mandatory. b. Under Policy V, auto insurance is voluntary.
a. The price of insurance will be $nbsp 800. b. The price of insurance will be above $nbsp 800.
Class Participation. Consider a course with 40 students, some of whom are confused after the professor explains a concept. The professor doesn't know whether students are confused, but will clarify the concept if one student asks a question. A student who asks a questionlong dashand reveals his or her confusionlong dashloses 16 utils. When the professor clarifies the concept in response to a question, each confused student gets a benefit of 1 util. c. Which of the following incentive systems would be most likely to generate efficient questioning?
a. A question from a confused student will be socially efficient if 17 students in the classroom are confused. b. In the absence of participation incentives, will a confused student ask a question when it would be socially efficient to do so? No c.All of the above.
Selling iPod Insurance. On the campus of Klepto College, half the iPods are expensive (replacement value is $800) and half are cheap (replacement value is $200). There is a 20 percent chance that any particular iPodlong dashexpensive or cheaplong dashwill be stolen in the next year. Suppose a firm offers iPod theft insurance for $100 per year: The firm will replace any insured iPod that is stolen. Suppose the firm sells 20 insurance policies.
a. Assume for the moment that the theft rate remains at 20 percent for both types of iPods. The firm's total revenue equals $2,000. (Enter your response as an integer.) The firm's costlong dashthe money paid out to replace stolen iPodslong dashwill be $1,600 to replace expensive iPods and $400 to replace cheap iPods, for a total of $2,000. The insurance firm will make zero economic profit with a price of $100. b. Is it realistic to assume that the introduction of insurance will not affect the theft rate? Which is a more plausible assumption, that the theft rate will decrease to 15 percent or increase to 30 percent? 30 percent is more plausible. For the more plausible theft rate, the zero-profit insurance price when insurance is purchased exclusively by the owners of expensive iPods is $240.
Skydiver Question. Several of your friends have offered to take you on a tandem skydiving adventure: Strapped together with a single set of parachutes (main and emergency), you jump out of an airplane and then either float to earth or crash. All your skydiving friends are equally skillful, and none of them has the thrill-seeking gene. You can ask each of them a single question. a. What's your question? b. What's the answer you're looking for in a skydiving mate?
a. Do you have life insurance? b. You're looking for someone without life insurance because they'll be more careful.
Equilibrium? In your city, there are currently three firms providing oil changes. For each firm, there is a fixed cost of $80 per day and a marginal cost of $10 per oil change. Each firm currently maximizes its profit by providing 15 oil changes per day.
a. For each firm, marginal revenue equals $10 b. This is a long-run, monopolistically competitive equilibrium if price equals $15.33.
Mix of Lemons and Plums in the Week-Old Car Market. Suppose the value of a high-quality week-old car (a plum) is $23 comma 000 (the same as the purchase price of a new car), while the value of a low-quality week-old car (a lemon) is $11 comma 000. Suppose that at a price of $19 comma 400 per car, 7 of 10 cars on the used market are plums and 3 of 10 are lemons. c. Suppose that for every 10 new cars sold by new-car dealers, 9 are plums and only 1 is a lemon. Why is the equilibrium mix in the used car market different from the mix of new cars sold?
a. How much is the typical buyer willing to pay for a used car in the mixed market? $19,400. b. Is the $19 comma 400 price an equilibrium price? Yes c.Owners of high-quality week-old cars worth $23 comma 000 are less likely to be willing to sell them for $19 comma 400.
Insurance and Fire Prevention. In a given year, there is a 10-percent chance that a fire in Ira's warehouse will cause $100,000 in property damage. If Ira spends $4 comma 000 on a fire-prevention program, the probability of a fire would drop to zero.
a. If Ira doesn't have fire insurance, will he spend the money on the prevention program? Yes b. If Ira has an insurance policy that covers 85 percent of the property damage from a fire (covering $85 comma 000 of the $100,000 worth of damage), will he spend the money on the prevention program? No
Money-Back-Plus Guarantee. The equilibrium price in the thin used-car market is $3 comma 000 without a money back guarentee. Suppose car sellers provide a special money-back-plus guarantee: A dissatisfied buyer can return a car for a refund plus $200.
a. If a lemon owner sells his or her car for $5 comma 000, the owner's gain from providing the guarantee is $negative 200. b. If a plum owner sells his or her car for $5 comma 000, the owner's gain from providing the guarantee is $2,000.
Crop Insurance. Consider a state in which farmers are divided equally into two types: high risk and low risk. The average annual crop loss (and possible insurance claim) is $400 for a low-risk farmer and $1 comma 200 for a high-risk farmer.
a. If all farmers were to buy insurance, what is the break-even price for the insurance company? $800 b. Suppose a farmer will purchase insurance only if the price (the annual premium) is no more than 50% higher than his or her average crop loss. What is the equilibrium price? $1,200
Lawn-Cutting Equilibrium. Consider the market for cutting lawns. Each firm has a fixed daily cost of $18 for equipment, and the marginal cost of cutting a lawn is $4. Suppose each firm can cut up to three lawns per day. The market demand curve for lawn cuts is linear, with a vertical intercept of $70 and a slope of minus$1 per lawn.
a. If each firm in the market cuts three lawns, what is the average cost per lawn? $10 b. What is the equilibrium price under monopolistic competition? $10 c. How many lawns will be cut in total, and how many firms will be in the market? 60 lawns, and 20 firms.
Paying for a WiFi Network. Consider a small town with 1,000 households. The town could install a wireless WiFi network that would give everyone in town access to the Internet. Each household is willing to pay a maximum of $50 per year for the network, and the cost of the system is $20 comma 000 per year.
a. Is the WiFi system efficient? Yes b. Suppose the town asks for voluntary contributions to support the network. Would you expect the total contributions to cover the $20 comma 000 cost? Maybe not c. Suppose the town keeps track of the contributions and issues passwords to people who contributed at least $20. Would you expect the total contributions to cover the $20 comma 000 cost? Yes
Stream Preservation. Consider a trout stream that is threatened with destruction by a nearby logging operation. Each of the 10,000 local fishers would be willing to pay $5 to preserve the stream. The owner of the land would incur a cost of $20 comma 000 to change the logging operation to protect the stream. c. Which of the following solutions would benefit the fishers and the landowner?
a. Is the preservation of the stream efficient from the social perspective? Yes b. If the landowner has the right to log the land any way he wants, will the stream be preserved? No c. Each of the 10,000 local fishers could contribute $4 to pay to the landowner to preserve the stream.
Defenders of Wildlife. Each of the 90 comma 000 citizens in a particular county is willing to pay $0.15 to increase the number of wolf litters by one. Each litter of wolves imposes a cost of $5 comma 000 in livestock losses to ranchers. b. Which of the following systems would most likely generate the socially efficient outcome?
a. Is the provision of an additional litter of wolves efficient from the social perspective? Yes b. Use contributions from the county's citizens to compensate ranchers for livestock killed by wolves.
Cost Sharing for Monitoring El Niño. Suppose the monitoring of El Niño's current costs a total of $12 billion per decade. Over a decade, early warning of the current's path would reduce its damages by $9 billion in the United States, $6 billion in Canada, and $3 billion in Mexico. a. Does any country, acting unilaterally, have an incentive to monitor El Niño? b. Do the social benefits of monitoring exceed the costs? c. A cost-sharing arrangement that will cause all three countries to support a monitoring system would be
a. No. No one country experiences damages more than the cost of monitoring. b.Yes, since the sum of the damages is greater than the monitoring costs. c.for each country to pay their portion of the combined expected damages.
Groucho Club. Consider a classic quip from Groucho Marx: "I won't join any club that is willing to accept me as a member." Suppose Groucho wants to associate with high-income people (the higher the income the better) and everyone else has the same preferences as Groucho. a. Which of the following statements best explains how this quip relates to adverse selection? b. Which of the following statements best relates this quip to the adverse-selection problem?
a. Only people with lower incomes than Groucho Marx are willing to associate with him. b. The presence of lower-income club members pulls down the value of a club, prompting higher-income club members to leave.
Bidding for Bookstore Licenses. Paige initially has the only license to operate a bookstore in Bookville. She charges a price of $10 per book, has an average cost of $6 per book, and sells 2 comma 001 books per year. When Paige's license expires, the city decides to auction two bookstore licenses to the highest bidders. Suppose the relevant variables (price, average cost, and output per firm) take on only integer valueslong dashno fraction or decimals.
a. Suppose Paige is optimistic and imagines the best possible outcome with a two-firm market. What is the maximum amount she is willing to pay for one of the two licenses? $4,000 b. Suppose Paige is pessimistic and imagines the worst possible outcome with a two-firm market. What is the maximum amount she is willing to pay for one of the two licenses? $0
Genetic Testing and Insurance Prices. Suppose the likelihood that a person will get disease X is determined in large part (but not exclusively) by his or her genes. Initially, it is impossible to determine who carries the gene for the disease, and many people spend $700 on special health insurance to cover the cost of treatment for the disease. Suppose scientists uncover the gene responsible for the disease and develop a simple test for the gene. b. Suppose the insurance companies have access to the results of genetic tests and they require all customers to get the test. How will the insurance company change its price of X insurance?
a. Suppose the government passes a law that prevents insurance companies from getting the results of a customer's genetic test for X. The new price of X insurance will be greater than $700. b. Raise the price above $700 for customers with the gene and reduce the price below $700 for those without the gene.
Paying for Information. You are willing to pay $7,000 for a high-quality carlong dasha plum. The current price of used cars is $4 comma 500, and 4 of 5 cars in the market are lemons, meaning that 1 in 5 is a plum.
a. Suppose you could pay a finder's fee to a personal shopper/mechanic who will find you a plum at a price of $4 comma 500. The maximum you are willing to pay as a finder's fee is $2,500. b. As you shop for a used car, you will bring each car you consider to your mechanic, who will thoroughly inspect the car and tell you for certain whether it is a plum or a lemon. If the price per inspection is $400, is it worth the money? Yes c. Would the inspection be worth the money if only 1 out of 10 used cars was a plum? No
Recovering the Acquisition Cost. In a regulated monopoly using average cost pricing, the long-run average cost of production is constant at $12 per unit. Suppose firm X acquires Y at a cost of $24 million and increases the price to $14. At the new price, X sells 2 million units per year.
a. The acquisition causes X's annual profit to increase by $4 million b. How many years will it take for X to recover the cost of acquiring Y? 6
Uniform Trade-Offs. A prominent feature of Mao's Communist China in the 1940s through the 1970s was the blue uniform worn by all citizens. a. Which of the following statements best describe the trade-off associated with the use of uniforms? b. Suppose people had a choice among five uniform colors rather than being required to wear blue uniforms. Would you expect the benefits of requiring uniforms to decrease by a little or a lot?
a. The benefit of a lower average cost of production means less variety for consumers. b. A little
Going Off Patent. Consider the producer of a branded drug that will soon go off-patent and compete with generic versions of the drug. The average cost of production is constant at $22 per dose. The producer could prevent the entry of generics by committing to a limit price of $24. At this price, the firm will sell 120 doses per day. Alternatively, the producer could charge a price of $26 and passively allow generics to enter the market. The price elasticity of demand for the branded drug is 2.0.
a. Under the passive approach (price = $26), the quantity of the branded drug demanded is 100.80. (Enter your response rounded to two decimal places.) The firm's profit is $403.20. (Enter your response rounded to two decimal places.) b. Under the entry-deterrence approach, the firm's profit is $240.00 c. The best approach is passive. d. If the price elasticity of demand for the branded drug were 6.0 instead of 2.0, the firm's profit under the passive approach would be $249.60, so the best strategy is passive.
Take the Pen Money and Run? Consider the example of Reynolds International Pen and the ballpoint pen. Suppose the unit cost of a ballpoint pen is $1.00. Reynolds has two options. 1. Passive. Pick the monopoly price of $13. In the first year, Reynolds will sell 100,000 pens. Over time as other firms enter the market with lower prices, the quantity sold by Reynolds will decrease by 20,000 per year, to 80,000 in the second year, and so on, down to zero in the sixth year. 2. Deterrence. Commit to produce 1 million pens per year, an amount large enough to deter entry. The limit price is $1.05.
a. Under the passive strategy, the profit per year is $1,200,000 in the first year (enter a numeric response using an integer), $960,000 in the second year, and so on, down to zero in the sixth year. The total profit over the six-year period would be $3,600,000. b. Under the deterrence strategy, the profit per year is $50,000. Over a 20-year period, total profit would be $1,000,000. c. Taking a 20-year perspective, the passive strategy is more profitable. d. If the limit price were $2.50 rather than $1.05, then deterrence would be the most profitable strategy.
Fireworks as Public Goods. A three-person city is considering a fireworks display. Bertha is willing to pay $105 for the proposed fireworks display, Marian is willing to pay $35, and Sam is willing to pay $25. The cost of the fireworks display is $120. c. Which of the following transactions would benefit all three citizens?
a. Will any single citizen provide the display on his or her own? No b. If the cost of the fireworks display is divided equally among its citizens, will a majority vote in favor of the display? No c. The fireworks display would be provided with Bertha paying $90, Marian paying $20, and Sam paying $10.
Check YellowPages.com? On Yellin's first day on the job as an economist with the FTC, she was put on a team examining a proposed merger between the country's second- and fourth-largest hardware store chains. Her job was to predict whether a merger would increase hardware prices. Her boss handed her some CDs with checkout scanner data from the second-largest chain. Each CD contained scanner data from one small town, listing the prices and quantities of hammers, wrenches, nuts, bolts, rakes, glue, drills, and hundreds of other hardware products. Her boss also gave her the Web address for YellowPages.com. How can she use the information in the disks and YellowPages.com to make a prediction? Yellin would use the CDs to Yellin would use YellowPages.com to Yellin would use the CDs and YellowPages.com to
a. compare the prices for specific items in each town and determine if the prices are nearly the same b. determine what specific hardware stores there are in each location c. do all of the above.
Related to Application: External Benefits from LoJack LOADING... LoJack and Insurance Companies. Consider the application "External Benefits from LoJack." Suppose that all vehicles in a state carry theft insurance. The benefit from reduced vehicle theft goes to insurance companies because they replace fewer stolen vehicles. Insurance companies do not offer any discounts for customers who install LoJack. The cost of LoJack is $100 per vehicle per year. The external benefit from fewer vehicle thefts is about $1,300 per LoJack per year. To simplify matters, assume that the private benefit of LoJack is zero, so the social benefit equals the external benefit. a. Suppose a single insurance company provides automobile insurance to all vehicles in the state. Will the insurance company provide free LoJacks to at least some of its customers?
a.Yes, because the entire $1,300 marginal social benefit of LoJack goes to the insurance company. b. Suppose that there are 20 companies in the state, each with a market share of 5 percent. Will the insurance company provide free LoJacks? No c. What is the threshold number of insurance companieslong dashthe number at which each insurance company will be indifferent about providing free LoJack systems? 13
The domination of the used-car market by lemons is an example of the
adverse-selection problem.
According to game theory, when it comes to advertising in the flour industry, Gold Medal should
advertise whether Pillsbury does or not.
In the case of Interstate Bakeries and Continental Bakery, the government
allowed the merger between the two companies but forced Interstate to sell some of its brands and bakeries.
As insurance companies cannot distinguish perfectly between low-cost and high-cost people, there will be
an adverse-selection problem where high-cost people are most likely to buy insurance.
When two firms would be better off if neither spent money on advertising, but each firm advertises, the firms are suffering from
an advertisers' dilemma.
Adverse selection requires the following two preconditions:
asymmetric information and a mixed market.
In the insurance market, potential buyers know whether they are a low cost or high cost customer. This is an example of
asymmetric information.
Public goods are
availlable for everyone to utilize regarless of who pays for it.
Under an average-cost pricing policy, the maximum price is shown by the intersection of the
average total cost curve and the demand curve.
There are three types of antitrust policies:
breaking up monopolies, blocking mergers, and regulating business practices.
In buying communities, like the online auction site eBay, buyers and sellers are held accountable because
buyers and sellers leave feedback for each other after a transaction is completed.
Insurance companies reduce the problem of moral hazard by
charging deductibles.
Dan and John are pricing managers for two competing broadband internet providers in a duopoly market. Using the Nash equilibrium theory, if Dan chooses the low price for his internet service, John's best action would be to
choose the low price.
In a simultaneous pricing game, if Firm A chooses the low price, Firm B will
choose the low price.
Additional searching is sensible if the
discovered price exceeds the reservation price.
In a monopolistically competitive market, firms continue entering the market until
economic profits equal zero.
