Econ Exam 3 (11-15)

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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.


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