Microeconomics Chapter 12 & 4

- The market price of a basketball is $35 and the full cost of producing it is $20, then a basketball producing firm gets producer surplus of

$15

T/F: When one market reaches a new equilibrium, the general equilibrium condition has been satisfied.

False

- As cellular phones have become more popular, some families have chosen not to have a "land line" (wired phone) in their homes. This has led to a reallocation of labor between the labor market for cellular phone manufacturing and the labor market for telephone installers. o The new demand curve for workers who install land lines o The new demand curve for workers who install cellular phones

Shifts left Shifts right

T/F: Efficiency is the condition in which the economy is producing what people want at the least possible cost

TRUE

T/F: Consumer surplus describes a situation in which there is excess quantity supplied

false

- Firms stop producing tapes and start producing compact discs because people prefer compact discs to tapes. This will

improve efficiency

- If the most someone is willing to pay for ticket to see their favorite team is $100 and the market price of the ticket is $35, then this buyer will get consumer surplus of

o $65

- Resources are allocated efficiently among firms in a perfectly competitive market because

o Firms hire an input up until the marginal revenue product of the input is equal to its price

- Producer surplus:

o Is the difference between the current market price and the cost of production for the firm

- Consumer surplus

o Is the difference between the maximum amount a person is willing to pay for a good and its current market price

- Society will benefit from less of a good being produced when the price of a good is

o Less than the marginal cost to produce that good

- A condition is Pareto optimal when

o No change is possible that will make some members of society better off without making some members of society worse off

- Examining the equilibrium conditions of individual markets and for households and firms separately is referred to as

o Partial equilibrium analysis

- An example of a positive externality is

o The beauty of a home's well-kept lawn

- In an industry characterized by imperfect competition,

price is higher than marginal cost and output is less than it would be under perfect competition.

T/F: General equilibrium exists when all markets in an economy are simultaneously in equilibrium

true

- Assume that an economy producing two products, skateboards and in-line skates, is initially in equilibrium, and that skateboards and in-line skates are substitutes. o If consumer preferences shift away from skateboards and toward in-line skates, which of the following will NOT occur?

• Additional capital will begin to flow into skateboard production in the long run

- For the following story, what is likely to happen in labor and capital markets using the model of the whole economy that we developed over the course of the previous chapters. o A sharp drop in demand for automobiles raises the unemployment rate in Flint, Michigan, and cuts into the profits of local gas stations where your neighbor lost his job. • Capital supply (savings) will likely ________. This will ________ interest rates and _______ capital demand (investment)

• Decrease • Increase • Decrease

- It is essential to establish specific criteria to judge the performance of any economic system o Two such criteria are

• Efficiency and equity

- Suppose a policy change will generate $100,000 of benefits for low-income families and $120,000 of costs for high-income families. o This change can be described as

• Inefficient

- James lives on a cul-de-sac where he and all his neighbors park on the street. After his car was vandalized, James decided to install motion-sensitive lighting on the front of his house, and now any movement activates the lights, which shine across the entire parking area of the street. Explain why the installation of the lights might lead to an inefficient outcome. o The installation of the lights might lead to an inefficient outcome because

• James's neighbors also receive a benefit form his purchase of the lights, so their true social value will not be reflected in the price

- The commercial fishing industry is competitive. Hundreds of commercial fishing boats work along the coast of Maine. o Therefore, viewed as an example of an input market, we can conclude that

• Labor will be allocated efficiently among the firms

- The commercial fishing industry is competitive. Hundreds of commercial fishing boats work along the coast of Maine. o Each boat owner hires workers up to the point where

• Marginal revenue product of labor equals the wage rate

- There are several types of market failure, which may prevent an economy from allocating resources efficiently. Indicate which type of market failure describes each of the situations below. o Everyone in a neighborhood would benefit from spraying a nearby pond for mosquitoes, but some people are not willing to pay. o Charlie parks rusty old cars on his front lawn, thus reducing the neighbors' property values o Both of the pizza restaurants in a small town agree on a common price o Consumers use too little legal services since they are unsure of the quality

• Public good • Externality • Noncompetitive behavior • Imperfect information

- Suppose there is a permanent shift of consumer preferences away from pretzels and toward potato chips. o The most likely result would be

• Short-run profits in the potato chip market increase

- A major source of chicken feed in the United states is anchovies, small fish that can be scooped out of the ocean at low cost. Every 7 years, when the anchovies disappear to spawn, producers must turn to grain, which is more expensive, to feed their chickens. o What is likely to happen to the cost of chicken when the anchovies disappear? o What is a complement for chicken? o How are the markets for these complements affected when the anchovies disappear? o How might the allocation of farmland be changed as a result of the disappearance of anchovies?

• The cost of chicken will increase • Gravy AND rice • Demand shifts to the left: equilibrium price and quantity will both decrease • A greater amount of farmland will be devoted to goods that are substitutes for anchovies.

- The commercial fishing industry is competitive. Hundreds of commercial fishing boats work along the coast of Maine. o If wages are uniform in this industry, and all firms are maximizing profits, then the marginal product of labor will be

• The same on all boats

- Which of the following are examples of Pareto-efficient changes? Explain your answers. o Cindy trades her laptop computer to Bob for his old car o Competition is introduced into the electric industry, and electricity rates drop. A study shows that benefits to consumers are larger than the lost monopoly profit o A high tax on wool sweaters deters buyers. The tax is repealed. o A federal government agency is reformed, and costs are cut 23 percent with no loss of service quality.

• This exchange is Pareto-efficient because Cindy and Bob agree to the exchange voluntarily • The change is not Pareto-efficient because the monopoly is worse off • Repealing the tax is not Pareto-efficient because the government loses revenue • The reforms are Pareto-efficient because services are provided at lower cost without making any members of society worse off

- Which of the following are actual Pareto-efficient changes? Explain briefly. o You buy three oranges for $1 from a street vendor o You are near death from thirst in the desert and must pay a passing vagabond $10,000 for a glass of water o A mugger steals your wallet o You take a taxi ride downtown Manhattan during rush hour

• This exchange is Pareto-efficient because both you and the vendor agree to the transaction • This exchange is Pareto-efficient because both you and the vagabond agree to the transaction • This exchange is not Pareto-efficient because you are worse off • This exchange is Pareto-efficient because both you and the taxi driver are both better off

- Each instance that follows is an example of one of the four types of market failure discussed in this chapter. In each case, identify the type of market failure and defend your choice briefly. o An auto repair shop convinces you that you need a $2,000 valve job when all you really need is an oil change. o Everyone in a neighborhood would benefit if an empty lot were turned into a city park, but no entrepreneur will come forward to finance the transformation. o A bar opens next to your apartment building and plays loud music on its patio every night until 4 AM o The only two airlines flying direct between St. Louis and Atlanta make an agreement to raise their prices.

• This is an example of imperfect information because you lack enough information about cars to know the repair is unnecessary • This is an example of a public good because the park would bestow collective benefits to society, but it isn't provided • This is an example of a negative externality because bystanders outside the transaction are harmed • This is an example of imperfect competition because the airlines restrict output below the efficient level

- Identify whether the following represents a public good: o A new roller coaster at Cedar Point Amusement park in Sandusky, Ohio.

• This is not a public good

A/D: o Housing is a public good and should be produced by the public sector because private markets will fail to produce it efficiently.

• This statement is false because housing is not a public good since it does not bestow collective benefits on members of society

A/D: o Imperfect markets are efficient because as price-makers, firms in the markets can guarantee that price will always equal marginal cost.

• This statement is false because under imperfect competition prices will not typically equal marginal cost and an efficient mix of output is not guaranteed.

A/D: o Medical care is an example of a potentially inefficient market because consumers do not have perfect information about the product.

• This statement is true.