econ final

Define and give an example of a common resource. Without government intervention, will people use this good too much or too little? Why?

A common resource is a good that is rival in consumption but not excludable. An example is fish in the ocean. If someone catches a fish, that leaves fewer fish for everyone else, so it is rival in consumption. But the ocean is so vast, you cannot charge people for the right to fish, or prevent them from fishing, so it is not excludable. Thus, without government intervention, people will use the good too much, because they do not account for the costs they impose on others when they use the good

6. Does a competitive firm's price equal its marginal cost in the short run, in the long run, or both? Explain

A competitive firm's price equals its marginal cost in both the short run and the long run. In both the short run and the long run, price equals marginal revenue. The firm should increase output as long as marginal revenue exceeds marginal cost, and reduce output if marginal revenue is less than marginal cost. Profits are always maximized when marginal revenue equals marginal cost.

5. Under what conditions will a firm exit a market? Explain.

A firm will exit a market if the revenue it would get from remaining in business is less than its total cost. This occurs if price is less than average total cost.

4. Under what conditions will a firm shut down temporarily? Explain.

A firm will shut down temporarily if the revenue it would get from producing is lower than the variable costs of production. This occurs if price is less than average variable cost.

2. Explain the difference between a firm's revenue and its profit. Which do firms maximize?

A firm's total revenue equals its price multiplied by the quantity of units it sells. Profit is the difference between total revenue and total cost. Firms are assumed to maximize profit.

3. Why is a monopolist's marginal revenue less than the price of its good? Can marginal revenue ever be negative? Explain.

A monopolist's marginal revenue is less than the price of its product because its demand curve is the market demand curve. Thus, to increase the amount sold, the monopolist must lower the price of its good for every unit it sells. This cut in price reduces the revenue on the units it was already selling.

Define and give an example of a public good. Can the private market provide this good on its own? Explain

A public good is a good that is neither excludable nor rival in consumption. An example is national defense, which protects the entire nation. No one can be prevented from enjoying the benefits of it, so it is not excludable. An additional person benefiting from it does not diminish the value of it to others, so it is not rival in consumption. The private market will not supply the good, because no one would pay for it because they cannot be excluded from enjoying it even if they don't pay for it.

4. Imagine that you are a nonsmoker sharing a room with a smoker. According to the Coase theorem, what determines whether your roommate smokes in the room? Is this outcome efficient? How do you and your roommate reach this solution?

According to the Coase theorem, you and your roommate will bargain over whether your roommate will smoke in the room. If you value clean air more than your roommate values smoking, the bargaining process will lead to your roommate not smoking. But if your roommate values smoking more than you value clean air, the bargaining process will lead to your roommate smoking. The outcome is efficient as long as transaction costs do not prevent an agreement from taking place. The solution may be reached by one of you paying off the other either not to smoke or for the right to smoke.

Explain what is meant by a good being "excludable." Explain what is meant by a good being "rival in consumption." Is a slice of pizza excludable? Is it rival in consumption?

An excludable good is one that people can be prevented from using. A good that is rival in consumption is one for which one person's use diminishes other people's use of the same good. Pizza is excludable, because a pizza producer can prevent someone who does not pay for the pizza from eating it. Pizza is also rival in consumption, because when one person eats it, no one else can eat it.

2. Define natural monopoly. What does the size of a market have to do with whether an industry is a natural monopoly?

An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. As a market grows, it may evolve from a natural monopoly to a competitive market.

2. What are corrective taxes? Why do economists prefer them to regulations as a way to protect the environment from pollution?

Corrective taxes are taxes enacted to correct the effects of a negative externality. Economists prefer corrective taxes over regulations as a way to protect the environment from pollution because they can reduce pollution at a lower cost to society. A tax can be set to reduce pollution to the same level as a regulation. The tax has the advantage of letting the market determine the least expensive way to reduce pollution. The tax gives firms incentives to develop cleaner technologies to reduce the taxes they have to pay.

5. Define economies of scale and explain why they might arise. Define diseconomies of scale and explain why they might arise.

Economies of scale exist when long-run average total cost decreases as the quantity of output increases, which occurs because of specialization among workers. Diseconomies of scale exist when long-run average total cost rises as the quantity of output increases, which occurs because of the coordination problems inherent in a large organization.

1. Give an example of a negative externality and an example of a positive externality.

Examples of negative externalities include pollution, barking dogs, and consumption of alcoholic beverages. Examples of positive externalities include the restoration of historic buildings, research into new technologies, and education. (Many other examples of negative and positive externalities are possible.)

3. List some of the ways that the problems caused by externalities can be solved without government intervention

Externalities can be solved without government intervention through moral codes and social sanctions, charities, merging firms whose externalities affect each other, or by contract.

4. Draw the demand, marginal-revenue, average-total-cost, and marginal-cost curves for a monopolist. Show the profit-maximizing level of output, the profit-maximizing price, and the amount of profit.

Figure 1 shows the demand, marginal-revenue, average-total-cost, and marginal-cost curves for a monopolist. The intersection of the marginal-revenue and marginal-cost curves determines the profit-maximizing level of output, Qm. The profit-maximizing price, Pm, can be found using the demand curve. Profit is shown as the rectangular area with a height of (PM - ATCM) and a base of QM.

3. Draw the cost curves for a typical firm. Explain how a competitive firm chooses the level of output that maximizes profit. At that level of output, show on your graph the firm's total revenue and total cost.

Figure 2 shows the cost curves for a typical firm. A competitive firm chooses the level of output that maximizes profit where marginal cost equals price (Q*), as long as price exceeds average variable cost at that point (in the short run), or exceeds average total cost (in the long run). Total revenue can be measured by the rectangular area with a height of P* and a base of Q*. Total cost can be measured by the rectangular area with a height of ATC' and a base of Q*.

3. Draw the marginal-cost and average-total-cost curves for a typical firm. Explain why the curves have the shapes that they do and why they intersect where they do.

Figure 6 shows the marginal-cost curve and the average-total-cost curve for a typical firm. There are three main features of these curves: (1) marginal cost is U-shaped but rises sharply as output increases; (2) average total cost is U-shaped; and (3) whenever marginal cost is less than average total cost, average total cost is declining; whenever marginal cost is greater than average total cost, average total cost is rising. Marginal cost is increasing for output greater than a certain quantity because of diminishing returns. The average-total-cost curve is downward-sloping initially because the firm is able to spread out fixed costs over additional units. The average-total-cost curve is increasing beyond some output level because as quantity increases, the demand for important variable inputs increases; therefore, the cost of these inputs increases. The marginal-cost and average-total-cost curves intersect at the minimum of average total cost; that quantity is the efficient scale.

1. Give an example of a government-created monopoly. Is creating this monopoly necessarily bad public policy? Explain

Government-created monopoly comes from the existence of patent and copyright laws. Both allow firms or individuals to be monopolies for extended periods of time—20 years for patents, the life of the author plus 70 years for copyrights. But this monopoly power is good, because without it, no one would write a book or a song and no firm would invest in research and development to invent new products or pharmaceuticals.

4. How and why does a firm's average-total-cost curve differ in the short run compared with the long run?

In the long run, a firm can adjust the factors of production that are fixed in the short run; for example, it can increase the size of its factory. As a result, the long-run average-total-cost curve has a much flatter U-shape than the short-run average-total-cost curve. In addition, the long-run curve lies along the lower envelope of the short-run curves.

8. Are market supply curves typically more elastic in the short run or in the long run? Explain.

Market supply curves are typically more elastic in the long run than in the short run. In a competitive market, because entry or exit occurs until price equals average total cost, quantity supplied is more responsive to changes in price in the long run.

6. Give two examples of price discrimination. In each case, explain why the monopolist chooses to follow this business strategy

One example of price discrimination is in publishing books. Publishers charge a much higher price for hardback books than for paperback books—far higher than the difference in production costs. Publishers do this because die-hard fans will pay more for a hardback book when the book is first released. Those who don't value the book as highly will wait for the paperback version to come out. The publisher makes a greater profit this way than if it charged just one price.

7. Does a competitive firm's price equal the minimum of its average total cost in the short run, in the long run, or both? Explain

The competitive firm's price must equal the minimum of its average total cost only in the long run. In the short run, price may be greater than average total cost (in which case the firm is earning a profit), price may be less than average total cost (in which case the firm is incurring a loss), or price may be equal to average total cost (in which case the firm is breaking even). In the long run, if firms are earning profits, other firms will enter the industry, which will lower the price of the good. In the long run, if firms are incurring losses, they will exit the industry, which will raise the price of the good. Entry or exit continues until firms are making neither profits nor losses. At that point, price equals average total cost.

7. What gives the government the power to regulate mergers between firms? Give a good reason and a bad reason (from the perspective of society's welfare) that two firms might want to merge.

The government has the power to regulate mergers between firms because of antitrust laws. Firms might want to merge to increase operating efficiency and reduce costs, something that is good for society, or to gain market power, which is bad for society

5. In your diagram from the previous question, show the level of output that maximizes total surplus. Show the deadweight loss from the monopoly. Explain your answer.

The level of output that maximizes total surplus in Figure 1 is where the demand curve intersects the marginal-cost curve, Qc. The deadweight loss from monopoly is the triangular area between Qc and Qm that is above the marginal-cost curve and below the demand curve. It represents deadweight loss, because society loses total surplus because of the monopoly. The deadweight loss is equal to the value of the good (measured by the height of the demand curve) less the cost of production (given by the height of the marginal-cost curve), for the quantities between Qm and Qc.

1. What are the main characteristics of a competitive market?

The main characteristics of a competitive firm are: (1) there are many buyers and many sellers in the market; (2) the goods offered by the various sellers are largely the same; and (3) usually firms can freely enter or exit the market.

1. What is the relationship between a firm's total revenue, profit, and total cost?

The relationship between a firm's total revenue, profit, and total cost is profit equals total revenue minus total costs.

2. Define total cost, average total cost, and marginal cost. How are they related?

Total cost consists of the costs of all inputs needed to produce a given quantity of output. It includes fixed costs and variable costs. Average total cost is the cost of a typical unit of output and is equal to total cost divided by the quantity produced. Marginal cost is the cost of producing an additional unit of output and is equal to the change in total cost divided by the change in quantity. An additional relation between average total cost and marginal cost is that whenever marginal cost is less than average total cost, average total cost is declining; whenever marginal cost is greater than average total cost, average total cost is rising.

8. Describe the two problems that arise when regulators tell a natural monopoly that it must set a price equal to marginal cost.

When regulators tell a natural monopoly that it must set price equal to marginal cost, two problems arise. The first is that, because a natural monopoly has a marginal cost that is always less than average total cost, setting price equal to marginal cost means that the firm will incur a loss. The firm would then exit the industry unless the government subsidized it. However, getting revenue for such a subsidy would cause the government to raise other taxes, increasing the deadweight loss. The second problem of using costs to set price is that it gives the monopoly no incentive to reduce costs.