Micro Final Exam

Explain the law of demand. Why does a demand curve slope downward? How is a market demand curve derived from individual demand curves?

- The law of demand states that products at a higher price leads to a lower quantity demanded vs those at a lower price, which leads to a higher quantity demanded. - The Demand curve slopes downward because as price increases, the quantity demanded declines., People buy more of a product when the price is lower. On the y axis is the price and the x axis is the quantity demanded. - A market demand curve is derived by horizontally adding individual demand curves.

Discuss the major barriers to entry into an industry. Explain how each barrier can foster either monopoly or oligopoly. Which barriers, if any, do you feel give rise to monopoly that is socially justifiable?

-Economies of scale are a barrier to entry because of the need for new firms to start big to achieve the low production costs of those already in the industry, causing them to go out of business. Natural monopolies give rise to monopoly that is socially justifiable. The economies of scale are sometimes such that having two or more firms serving the market would increase costs unreasonably. Two gas companies in the same city, for example, would be highly inconvenient and costly as long as transmission requires wires and pipes. -Patents and licenses are legal barriers to entry that are, to some extent, justifiable. If inventions were not protected from immediate copying, the urge to invent and innovate would be lessened and the costly secrecy that is enforced already would have to be much greater and more costly. -Unfair competition is a barrier and has no social justification, which is why price-cutting to bankrupt a rival is illegal.

"No firm is completely sheltered from rivals; all firms compete for consumer dollars. If that is so, then pure monopoly does not exist." Do you agree? Explain. How might you use Chapter 6's concept of cross elasticity of demand to judge whether a monopoly exists?

-I agree with the statement, "all firms compete for consumer dollars." Although it is rare, pure monopoly does exist. For example, If you want electric lights, you have to deal with a single company. It is a pure monopoly in that regard, even though you can switch to oil or natural gas for heating as a substitute, but these are hardly convenient options. -The concept of cross elasticity of demand can be used to measure the presence of close substitutes for the product of a monopoly firm. If the cross elasticity of demand is greater than one, then the demand that the monopoly faces is elastic with respect to substitute products, and the firm has less control over its product price than if the cross elasticity of demand were inelastic. In other words, the monopoly faces competition from producers of substitute products.

How does monopolistic competition differ from pure competition in its basic characteristics? From pure monopoly? Explain fully what product differentiation may involve. Explain how the entry of firms into its industry affects the demand curve facing a monopolistic competitor and how that, in turn, affects its economic profit.

-In monopolistic competition there are many firms but not as many as the very large numbers in pure competition. The products are differentiated, not standardized. There is some control over price, whereas the purely competitive firm has none. There is relatively easy entry; in pure competition, entry is completely without barriers. In monopolistic competition, there is much non price competition, such as advertising, trademarks, and brand names. In pure competition, there is no non price competition. -In pure monopoly there is only one firm. Its product is unique and there are no close substitutes. The firm has much control over price, being a price maker. Entry to its industry is blocked. Its advertising is mostly for public relations. -Product differentiation may only be in the eye of the beholder. This is all the monopolistic competitor needs to gain an advantage in the market. The real differences can be in quality, in services, or in location. -When economic profits are present, additional competitors will be attracted to the industry because entry is easy. As new firms enter, the demand curve faced by the typical firm will shift to the left (fall). Because of this, each firm has a smaller share of total demand and now faces a larger number of close-substitute products. This decline firm's demand reduces its economic profit.

Distinguish among land-, labor-, and capital-intensive goods, citing an example of each without resorting to book examples. How do these distinctions relate to international trade? How do distinctive products, unrelated to resource intensity, relate to international trade?

-Land-intensive products include agricultural products like corn and wheat. -Labor-intensive products require skilled labor in production, such as clothing. -Capital-intensive products are produced with a large amount of capital equipment and include manufactured items such as aircraft and automobiles. -These distinctions are important because if a nation has an ample supply of certain resources, it can produce items that are intensive in these resources with a comparative cost advantage. However, if it has a limit of resources, like land, then it will be relatively expensive to produce land-intensive products such as corn and wheat. -The difference in relative resource abundance among nations leads to a difference in comparative costs of production, which is the basis for international trade and specialization. -Distinctive products, those involved with a specific country can provide an export niche for a country.

How does the demand curve faced by a purely monopolistic seller differ from that confronting a purely competitive firm? Why does it differ? Of what significance is the difference? Why is the pure monopolist's demand curve not perfectly inelastic?

-The demand curve facing a pure monopolist is downward sloping and perfectly elastic. This is so for the pure competitor because the firm faces many competitors who all produce perfect substitutes. In these circumstances, the purely competitive firm may sell all that it wishes at the equilibrium price, but it can sell nothing. The monopolist, on the other hand, is the industry and therefore is faced by a normal downward sloping industry demand curve. Being the entire industry, the monopolist's supply is big enough to affect prices. By decreasing output, the monopolist can force the price up. Increasing output will drive it down.

Explain the law of supply. Why does the supply curve slope upward? How is the market supply curve derived from the supply curves of individual producers?

-The law of supply states that a higher price leads to a higher quantity supplied and that a lower price leads to a lower quantity supplied. -As prices rise because of increased demand for an item, producers find it more profitable to increase the quantity they offer for sale; that is, the supply curve will slope upward from left to right. -The market supply curve is derived by horizontally adding the individual supply curves.

What effect would a rule stating that university students must live in university dormitories have on the price elasticity of demand for dormitory space? What impact might this in turn have on room rates?

A rule stating that university students must live in university dorms makes the price elasticity of dormitories more inelastic. This is because the rule leaves the students with no option but to stay in the university dormitories. There are no substitutes to the university dormitories available for the students. Therefore, the demand for dormitory space will remain constant despite changes in the prices of the space. The room rates will also increase because the demand for rooms will increase since students cant stay anywhere outside of campus.

Research has found that an increase in the price of beer would reduce the amount of marijuana consumed. Is cross elasticity of demand between the two products positive or negative? Are these products substitutes or complements? What might be the logic behind this relationship?

Cross elasticity of demand between the two products is negative because these products are complements. People consume beer and marijuana together, so increase in beer's price lead to decrease in its consumption, as beer and marijuana are consumed together - marijuana consumption decreases as well.

"Monopolistic competition is monopolistic up to the point at which consumers become willing to buy close-substitute products and competitive beyond that point." Explain

If consumers favor and purchase one product over another regardless of prices, the seller of the product is a monopolist. But in monopolistic competition this is limited because there are many other firms producing similar products. When one firm's prices get "too high" consumers become less favorable to the product and find a better substitute or alternative. This is when firms begin to compete, which is why monopolistically competitive firms are always trying to find ways to differentiate their products and gain more monopoly price‑setting power.

Suppose that a Swiss watchmaker imports watch components from Sweden and exports watches to the United States. Also suppose the dollar depreciates, and the Swedish krona appreciates, relative to the Swiss franc. Speculate as to how each would hurt the Swiss watchmaker.

If the dollar depreciated relative to the franc, this means that it took more dollars to get the francs necessary to buy a watch. In other words, the watch becomes more expensive in dollar terms which would cause a decline in imported watches purchased in the United States. Second, if the krona appreciated relative to the Swiss franc, this is the same thing as saying that the franc depreciated relative to the krona. In other words, it took more Swiss francs to buy parts in Sweden than it did previously. As a result, the imported components for the watches became more expensive to the Swiss company. The Swiss watchmaker was hurt twice. Its costs rose while its export sales declined.

For each stock in the stock market, the number of shares sold daily equals the number of shares purchased. That is, the quantity of each firm's shares demanded equals the quantity supplied. So, if this equality always occurs, why do the prices of stock shares ever change?

Prices change in reaction to a mismatch between Quantity demanded and Quantity supplied. There are both buyers and sellers who are willing to buy or sell a certain number of shares depending on price. If at the current price the quantity of shares demanded exceeds the quantity of shares supplied, buyers must increase their price offers to induce sellers to offer enough shares. This will cause share prices to rise until quantity demanded equals quantity supplied.

Explain: "U.S. exports earn supplies of foreign currencies that Americans can use to finance imports." Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets: LO1 a. A U.S. airline firm purchases several Airbus planes assembled in France. b. A German automobile firm decides to build an assembly plant in South Carolina. c. A U.S. college student decides to spend a year studying at the Sorbonne in Paris. d. An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter. e. The U.S. economy grows faster than the French economy. f. A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person. g. It is widely expected that the euro will depreciate in the near future.

The U.S. demand for pesos is downward-sloping: When the peso depreciates in value (relative to the dollar) the United States finds that Mexican goods and services are less expensive in dollar terms and purchases more of them, demanding a greater quantity of pesos in the process. The supply of pesos to the United States is upward-sloping: As the peso appreciates in value (relative to the dollar), US. goods and services become cheaper to Mexicans in peso terms. Mexicans buy more dollars to obtain more U.S. goods, supplying a larger quantity of pesos. (a) The peso will appreciate. Mexican goods will become cheaper, so U.S. demand for pesos for will increase. (b) The peso will depreciate. The high rate of inflation in Mexico (relative the U.S.) will cause the price Mexican goods and services to increase (relative the U.S.). The U.S. demand for pesos will fall. The supply of pesos will also increase because U.S. goods are relatively cheaper. This will reinforce the depreciation of the peso. (c) The peso will depreciate. The reduction in U.S. tourism in Mexico reduces the demand for pesos. (d) The peso will depreciate. The recession in the U.S. economy will reduce imports from Mexico. This, in turn, will decrease the demand for the peso. (e) The peso will depreciate. The high interest rate in the U.S. will attract investors from Mexico. This will increase the demand for U.S. dollars or the supply of pesos. (f) The peso will appreciate. U.S. consumers purchase more goods from Mexico. This increases the demand for the peso. (g) The peso appreciates. The U.S. firms must purchase pesos to invest in Mexico. This increases the demand for pesos.

Compare the elasticity of a monopolistic competitor's demand with that of a pure competitor and a pure monopolist. Assuming identical long-run costs, compare graphically the prices and outputs that would result in the long run under pure competition and under monopolistic competition. Contrast the two market structures in terms of productive and allocative efficiency. Explain: "Monopolistically competitive industries are populated by too many firms, each of which produces too little."

The monopolistic competitor's demand curve is less elastic than a pure competitor and more elastic than a pure monopolist. Price is higher and output lower for the monopolistic competitor. Pure competition: P = MC (allocative efficiency); P = minimum ATC (productive efficiency). Monopolistic competition: P > MC (allocative efficiency) and P > minimum ATC (productive inefficiency). Monopolistic competitors have excess capacity; meaning that fewer firms operating at capacity (where P = minimum ATC) could supply the industry output.

Quantitatively, how important is international trade to the United States relative to the importance of trade to other nations? What country is the United States' most important trading partner, quantitatively? With what country does the United States have the largest trade deficit?

U.S. exports of goods and services are large in absolute terms (second only to Germany in 2003), but only about 10 percent of GDP, which is small relative to the proportion in many other industrialized nations. For example, the percentage is 62 percent in the Netherlands, 25 percent in United Kingdom, 29 percent in New Zealand, and 38 percent in Canada. Canada is the United States' most important trading partner (In 2004, 24 percent of U.S. exports, 18 percent of U.S. imports). The largest trade deficit is with China, $162 billion in 2004.

Explain: "The United States can make certain toys with greater productive efficiency than can China. Yet we import these toys from China." Relate your answer to the ideas of Adam Smith and David Ricardo.

We import these toys from China because the US has an absolute advantage in producing toys, but China has a comparative advantage. In producing toys, China does not need Smith's absolute advantage to specialize in toys rather it needs Ricardo's comparative advantage.

Explain why you agree or disagree with the following statements: a. A country that grows faster than its major trading partners can expect the international value of its currency to depreciate. b. A nation whose interest rate is rising more rapidly than interest rates in other nations can expect the international value of its currency to appreciate. c. A country's currency will appreciate if its inflation rate is less than that of the rest of the world.

a. This statement is true. If high rates of economic growth mean that the real incomes of a country's citizens are rising more rapidly than in other countries, its imports will rise more than its exports. The demand for foreign currency by its citizens will increase more than the supply of foreign currency, causing the value of the domestic currency to decline. b. This statement is true. If domestic real interest rates are increasing more quickly than those in other countries, foreign financial investment will be attracted to the country, causing a rise in the supply of foreign currency and therefore an appreciation of the country's currency. c. This statement is true. If a country's inflation rate is lower than rates in other countries, the foreign prices of its products will decline relative to foreign‑made products, increasing exports and the supply of foreign currency. At the same time, the domestic prices of foreign imports will increase relative to domestically made goods, decreasing the demand for foreign currency. Both factors will cause the country's currency to appreciate.