Micro 4-6 - HW Questions

What are the distinguishing characteristics of "public goods"? Give two examples of a public good. Why are public goods difficult for markets to allocate efficiently?

-Public goods - Goods for which rivalry among consumers is absent and exclusion of nonpaying customers is difficult. -Non-private -No competition for supply -Cannot isolate no-paying customers -The overhead (cost to the government) for transferring payments from the private sector through the public sector is generally higher than the same overhead in the private sector. Inefficiencies are created.

Apply the economic efficiency criterion to the role of government. When would a government intervention be considered economically efficient?

A government intervention would be efficient if the benefits from the intervention exceeded the cost of the intervention. All opportunity costs (such as tax money required, resources utilized, and deadweight losses) would need to be considered in the comparison. A government intervention would be considered inefficient if the costs exceeded the benefits.

"We should impose a 20 percent luxury tax on expensive automobiles (those with a sales price of $50,000 or more) in order to collect more tax revenue from the wealthy." Will the burden of the proposed tax fall primarily on the wealthy?

A tax on luxury automobiles is not a good idea if the goal is to raise revenue from the rich. The demand for luxury automobiles is likely fairly elastic. As a result, sellers (and the workers in the luxury automobile industry) will tend to bear a larger share of the burden of the tax.

*To be meaningful, a price ceiling must be below the market price. Conversely, a meaningful price floor must be above the market price. What impact will a meaningful price ceiling have on the quantity exchanged? What impact will a meaningful price floor have on the quantity exchanged? Explain.

Agreement of both buyer and seller is required for an exchange. Price ceilings push prices below equilibrium and thereby reduce the quantity sellers are willing to offer. Price floors push prices above equilibrium and thereby reduce the quantity consumers with to buy. Both decrease the actual quantity traded in the market.

How will a substantial increase in demand for housing affect the wages and employment of carpenters, plumbers, and electricians?

An increase in demand for housing will also increase the demand for the resources required for its production, including the services of carpenters, plumbers, and electricians. This will lead to a higher wages and an increase in the employment for people in these groups.

What is a black market? What are some of the main differences in how black markets operate relative to legal markets?

Black market - A market that operates outside the legal system in which either illegal goods are sold or legal goods are sold at illegal prices or terms. Black markets are characterized by less dependable product quality and greater use of violence to settle disputes between buyers and sellers.

"The government can afford to take along view when it needs to, while a private firm has a short-term outlook. Corporate officers, for example, typically care about the next 3 to 6 months, not the next 50 to 100 years. Government, not private firms, should own things like forests, which take decades to develop." Evaluate this view.

Corporate officers, although they surely care about the next few months and the profits during that time, also care about the value of the firm and its stock price. If the stock price rises sufficiently in the next few months - as it will if investors believe that current investments in future-oriented projects (planting new trees, for example) are sound - then the officers will find their jobs secure even if current profits do not look good. Rights to the profits from those (future) trees are salable now in the form of the corporation's stock. There is no such mechanism to make the distant fruits of today's investments available to the political entrepreneurs who might otherwise fight for the future-oriented project. Only if the project appeals to today's voters, and only if they are willing to pay today for tomorrow's benefits, will the program be a political success. In any case, the wealth of the political officials is not directly enhanced by his or her successful fight for the project.

What are external costs? When are they most likely to be present? When external costs are present, what is likely to be the relationship between the market output of a good and the output consistent with ideal economic efficiency?

External costs - Spillover effects that reduce the well-being of nonconsenting third parties. External costs occur in situations with poorly defined and enforced property rights. Typically mitigating the cost of an externality increases the cost of production and reduces the output quantities produced.

"Voters should simply ignore political candidates who play ball with special-interest groups and vote instead for candidates who will represent all the people when they are elected. Government will work far better when this happens." Evaluate this view.

It is difficult for the voter to know what a candidate will do once elected, and the rationally ignorant voter is usually unwilling to spend the time and effort required to understand the issues because the probability that any single vote will decide the issue is exceedingly small. Special-interest voters, in contrast, will know which candidate has promised them the most on their issue. Also the candidate who is both competent and prepared to ignore special interests will have a hard time getting these facts to voters without financial support from special-interest groups. Each voter has an incentive to be a "free rider" on the "good government" issue. Interestingly, controlling government on behalf of society as a whole is a public good. As in the case of other public goods, there is a tendency for too little of it to be supplied.

What is market failure? If market failure is present, does this imply that government intervention will lead to a more efficient allocation of resources? Why or why not?

Market failure - A situation in which the structure of incentives is such that markets will encourage individuals to undertake activities that are inconsistent with economic efficiency. No. It is not certain that government intervention will lead to a more efficient allocation of resources. It may, but there are more ways to create economic inefficiencies that there are economic efficiencies with government intervention.

What are the necessary conditions for economic efficiency? In what four situations might a market fail to achieve ideal economic efficiency?

Necessary conditions: Rule 1: Undertaking an economic action is efficient if it produces more benefits than costs. Rule 2: Undertaking an economic action is inefficient if it produces more costs than benefits. Four situations: 1. Lack of competition 2. Externalities 3. Public goods 4. Poorly informed buyers or sellers

In response to the terrorist attacks of September 11, 2001, airline security screening increased dramatically. As a result, the travel time of airline passengers has increased substantially. Would it make economic sense to devote enough resources to completely prevent any such future attacks? Why or why not?

No, it would not make sense to completely prevent attacks. The costs of traveling under these absolutely safe conditions would be cost prohibitive.

"When an economic function is turned over to the government, social cooperation replaces personal self-interest." Is this statement true? Why or why not?

No. The government is merely an alternative form of organization. Government organization does not permit us to escape either scarcity of competition. It merely affects the nature of competition. Political competition (for example, voting, lobbying, political contributions, and politically determined budgets) replaces market competition. Neither is there any reason to believe that government organization modifies the importance of personal self-interest.

What is the difference between a price ceiling and a price floor?

Price ceiling A legally established maximum price sellers can charge for a good or resource (often below the equilibrium price). Price floor A legally established minimum price buyers must pay for a good or resource (often above the equilibrium price).

What is rent-seeking? When is it likely to be widespread? How does it influence economic efficiency? Explain.

Rent seeking is actions by individuals and interest groups designed to restructure public policy in a manner that will either directly or indirectly redistribute more income to themselves. The incentive to engage in rent seeking is directly proportional to the ease with which the political process can be used for personal (or interest group) gain at the expense of others. When a government attempts to favor some at the expense of others, counterproductive activities will expand while positive-sum productive activities will shrink. People will spend more time organizing and lobbying politicians and less time producing goods and services. Since fewer resources will be utilized to create wealth (and more utilized in rent-seeking activities), economic progress will be retarded.

The Federal Drug Administration will not approve new pharmaceutical products unless the developer can prove that its product is both safe and effective as a remedy for specified ailments. Do you think the "safe and effective" criterion would be a good one for Congress to adopt for the passage of new legislation? Why or why not? Do you think most government action would meet this criterion? Discuss.

The FDA (Federal Drug Administration) drug approval process is very expensive and may take up to 10 years to complete. Still occasionally we learn even upon approval that drugs may not be safe. Adapting a general (undefined) safe and effective context is similar to the Crony Capitalism practice of using warm and fuzzy goals to rally support for policies that are not easily enforced. Because safe and effective is not really defined, yes, many government actions may fit this criterion. It is effectively meaningless though.

Which of the following are public goods? Explain, using the definition of a public good. a. an antimissile system surrounding Washington, D.C. b. a fire department c. tennis courts d. Yellowstone National Park e. elementary schools

The antimissile system is a public good for the residents of Washington, D.C. Strictly speaking, none of the other items is a public good because each could be provided to some consumers (paying customers, for example) without being provided to others.

Suppose Congress were to pass legislation requiring that businesses employing workers with three or more children pay these employees at least $15 per hour. How would this legislation affect the employment level of low-skilled workers with three or more children? Do you think some workers with large families might attempt to conceal the fact? Why?

The employment level of low-skilled workers with large families would decline. Some would attempt to conceal the presence of their large family in order to get a job.

If a senator trades his or her vote on an issue for a $10,000 payment, would you consider this corruption? If a senator votes a certain way in "exchange" for a $10,000 contribution to his or her political campaign, would you consider this corruption? Is there a major difference between the two? Discuss.

The first case, a $10,000 payment, would be a campaign contribution or perhaps a bribe. The second case is one of logrolling. Logrolling - The exchange between politicians of political sup port on one issue for political support on another. Logrolling may assure that more policy is created as there are multiple policy benefactors. There is no guarantee that any of the policies involved would be beneficial for society.

"The political process sometimes leads to economic inefficiency because we elect the wrong people to political office. If the right people were elected, a democracy governed by majority rule would allocate resources efficiently." Evaluate this statement.

The problem is not so much that the "wrong guys" won the last election as it is the incentive structure confronted by political decision-makers. Even if the "right people" were elected, they would be unlikely to improve the efficiency of government, at least not very much, given the strong incentive to support special-interest and shortsighted policies and the weak incentives for operational efficiency when decisions are made by the political process.

What impact do government grants and loans to college students have on the cost of going to college? Are students the primary beneficiary of these subsidies? Discuss

The way this situation is drawn in the book, the students receive about half of the benefit from the subsidy. Depending on the slopes of the supply and demand curves, the gains to students could be greater or smaller.

Because government-operated firms do not have to make a profit, they can usually produce at a lower cost and charge a lower price than privately owned enterprises." Evaluate this view.

This can happen. Public budgets can embark on revenue generating ventures without necessarily costing out all the building and operational overhead through the revenue of the venture (operating at lower costs than are possible in the private sector). Also there are often incentives for agencies to 'use or lose' their annual operating expenses. This creates an incentive to spend funds that may not return a specific benefit.

Unless quality and price are regulated by government, travelers would have no chance for a fair deal. Local people would be treated well, but the traveler would have no way to know, for example, who offers a good night's lodging at a fair price. Is this true or false? Explain.

This question addresses Potential Market Shortcomings: Potential Information Problems. This problem addresses purchases of goods and services when it isn't always clear what one gets in the transaction. Conflicting interests, inadequate information, and unhappy customers can arise when goods are either (1) difficult to evaluate on inspection and seldom purchased from the same producer, or (2) there are potentially capable or serious lasting side-effects that cannot be predicted by a typical consumer.

"The average person is more likely to make a well-informed choice when purchasing a personal computer than when voting for a congressional candidate." Is this statement true? Why or why not?

True. Because each individual computer customer both decides the issue (what computer, if any, will be purchased) and bears the consequences of a mistaken choice, each has a strong incentive to acquire information needed to make a wise choice. In contrast, each voter recognizes that one vote, even if mistaken, will not decide the congressional election. Thus, a voter has little incentive to search for information to make a better-informed choice.

Why is it important for producers to be able to prevent nonpaying customers from receiving a good?

When payment is not demanded for services, potential customers have a strong incentive to attempt a "free ride." However, when the number of nonpaying customers becomes such that the sales revenues of sellers are diminished (and in some cases eliminated), the sellers' incentive to supply the good is thereby reduced (or eliminated).

"Public policy is necessary to protect the average citizen from the power of vested interest groups. In the absence of government intervention, regulated industries such as airlines, railroads, and trucking will charge excessive prices; products will be unsafe; and the rich will oppress the poor. Government curbs the power of special-interest groups." Evaluate this statement.

When the welfare of a special-interest group conflicts with that of a widely dispersed, unorganized majority, the legislative political process can reasonably be expected to work to the benefit of special interest.

English philosopher John Locke argued that the protection of each individual's person and property (acquired without the use of violence, theft, or fraud) was the primary function of government. Why is this protection important to the efficient operation of an economy?

Without protection of person and property, there is no assurance that one can benefit from either (1) current productive effort or (2) saving (and investing) for the future. Under such circumstances, the incentive of individuals to produce and plan for the future is greatly diminished. In contrast, protection of person and property provides individuals with assurance that they will be permitted to "reap what they sow." Under these circumstances, individuals sow far more abundantly.

Suppose that college students in your town persuaded the town council to enact a law setting the maximum price for rental housing at $400 per month. Will this help or hurt college students who rent housing? In your answer, address how this price ceiling will affect -the quality of rental housing; -the amount of rental housing available; -the incentive of landlords to maintain their properties; -the amount of racial, gender, and other types of discrimination in the local rental housing market; -the ease with which students will be able to find housing -whether a black market for housing would develop.

a. The quality of rental housing will tend to fall b. as will the amount of rental housing available (fall). c. The price ceiling will decrease the incentive of landlords to maintain their property. d. In addition, the amount of racial, gender, and other types of discrimination in the local rental housing market will rise. e. Students will be less able to find housing. f. Lastly, a "black market" for housing would develop.

Increase or Decrease: b. Employment of people previously earning less than $15 per hour c. the unemployment rate of teenagers d. the availability of on-the-job training for low-skilled workers e. the demand for high-skilled workers who are good substitutes for low-skilled workers

b. Decreases; c. Increases; d. Decreases; e. Increases

If a price ceiling for a good is set below the market equilibrium, what will happen to the quality and future availability of the good? Explain.

if a price ceiling is set below the market equilibrium (like rent), it will encourage non-markets solutions like favors and may lead to a black market developing.