Economics – Tutorial Answers

1 Managerial Economics 2010 Answers to All Tutorial Questions

Topic 1 : What is managerial economics Questions from Chapter 1 of the Text (McTaggart, Findlay & Parkin) Review Question 1 (pp. 4) List some examples of scarcity in Australia today. An example of scarcity at the economy-wide level would be people with lower incomes being forced to choose between food and petrol due to high prices for both. An example of scarcity at an individual level would be a person unable to afford both life-saving (or life-enhancing) medicine and food.

At a more student-oriented level, examples of scarcity include not enough income to afford both tuition and a nice car, and not enough learning capacity to study for both an Economics exam and a Chemistry exam in one night.

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Review Question 2 (pp. 4) Use the headlines in today’s news to provide some examples of scarcity around the world. A headline in National Post in July 2008 was “Last-Frontier Forest is at Risk from Boom. ” This story discusses how the “global resource boom is threatening one of the world’s last tropical-forest frontiers: the Merauke region of Indonesia …”.

The story points out the scarcity of tropical rainforests as well as the scarcity of mineral reserves and how the two are colliding. Review Question 2 (pp. 9) Use headlines from the recent news to illustrate the potential for conflict between self-interest and the social interest. Your students’ examples will vary according to the headlines. One example of an issue concerns import restrictions.

Take the ethanol industry for an example and the February 4, 2008 headline from Reuters “Bush budget doesn’t alter ethanol import tariff”. When U. S. ethanol producers convince the government to limit or eliminate imports of ethanol from other nations such as Brazil, it helps the workers and businesses in the U. S. ethanol industry earn higher wages and profits, respectively. This outcome serves their self-interest. However, it hurts all companies that use ethanol in their products, as well as all consumers when they buy petrol with ethanol blended in. This decision does not serve the social interest. This is because consumers lose more than the combined gain of domestic ethanol producers (in higher wages and profits) and the government (in tariff revenue): real GDP falls.

Review Question 1 (pp. 2) Provide three everyday examples of tradeoffs and describe the opportunity cost involved in each.

Three examples are:

a) When a student sleeps late rather than of going to his or her early morning class, the student trades off additional sleep for study time. The opportunity cost of the decision is a lower grade on the exam.

b) When a student running late for class parks his or her car illegally, the student trades off saving time for the risk of a fine. The potential opportunity cost of the decision is the goods and services that cannot be purchased if the student receives the fine.

с) A student trades off higher income by taking a part-time job for less leisure time and study time. The opportunity cost is less leisure and lower grades.

Review Question 2 (pp. 12) Provide three everyday examples to illustrate what we mean by choosing at the margin. Three examples are: a) When a student faces both a Chemistry and an Economics exam in one day, the student must determine whether spending the last hour studying a little more chemistry or a little more economics will yield a better contribution (marginal benefit) to his or her aggregate marks. ) A university student who is buying a computer must decide whether the marginal benefit of adding 1 GB of additional memory is worth the marginal cost of the additional memory. c) A football fan with a choice of standing in the outer or a seat located under shelter with a better view of the game must determine whether the marginal benefit of watching the game from a seat is worth the marginal cost of the higher ticket price. Review Question 5 (pp. 14) What is the role of marginal benefit and marginal cost analysis in the use of economics as a policy tool?

To make good decisions, a decision maker must compare the marginal benefit of an action to its marginal cost. If the marginal benefit of an action exceeds its marginal cost, then the decision maker should undertake the action because the benefit of the action exceeds its cost and adds to net benefit. Conversely, if the marginal benefit is less than the marginal cost, then the decision maker should not undertake the action because the benefits of the action fall short of its costs and detract from net benefit.

3 Problems and Applications Question 2 (pp. 6) Which of the following pairs does not match: a. Labour and wages? Labour earns wages, so this pair matches. b. Land and rent? Land earns rent, so this pair matches. c. Entrepreneurship and profit? Entrepreneurship earns profit, so this pair matches. d. Capital and profit? Capital earns interest, so this pair does not match. Question 4 (pp. 16) The night before a test, you decide to go to the movies instead of staying home and working your MyEconLab Study Plan. You get 50 percent on your test compared with the 70 percent that you normally score. a. Did you face a tradeoff? Yes, you faced a tradeoff.

The tradeoff was between a higher test score and an evening with your friends at the movies. b. What was the opportunity cost of your evening at the movies? The opportunity cost of going to the movies is the fall in your grade. That is the 20 points forgone from choosing to see the movie rather than study.

Question 8 (pp. 16) How would you classify a movie star as a factor of production? As a factor of production, a movie star is labour.

4 Topic 2 : Demand, Supply, Market Equilibrium and Elasticity Questions from Chapter 3 of the Text (McTaggart, Findlay & Parkin) Problems and Applications Question 6 (pp. 9) In January 2007, the price of petrol was $1. 13 a litre. By September 2008, the price had increased to $1. 55 a litre. Assume that there were no changes in average income, population, or any other influence on buying plans. How would you expect the rise in the price of petrol to affect a. The demand for petrol? Explain your answer. The rise in the price of petrol does not change the demand for petrol. The demand for petrol changes only when some influence other than the price of the good changes. b. The quantity of petrol demanded? Explain your answer.

The rise in the price of petrol decreases the quantity of petrol demanded. A rise in the price of a good or service decreases the quantity of that good or service demanded. Question 10 (pp. 80) “As more people buy computers, the demand for Internet service increases and the price of Internet service decreases. The fall in the price of Internet service decreases the supply of Internet service. ” Is this statement true or false? Explain. The statement is false for several reasons. First, if the demand for Internet services increases and nothing else changes, the price of Internet service will rise, not fall.

Second, if the price of Internet services falls, the supply of Internet services does not change. Rather, there is a decrease in the quantity supplied, that is, a movement along the supply curve rather than a shift of the supply curve. Question 12 (pp. 80) The demand and supply schedules for bubble gum are given in the table. Price (cents per pack) Quantity demanded Quantity supplied 5 (millions of packs a week) 20 40 60 80 100 180 140 100 60 20 60 100 140 180 220 a. Draw a graph of the gum market, label the axes and the curves, and mark in the equilibrium price and quantity.

Figure 3. 5, on the next page, shows the demand and supply curves. The equilibrium price is 50 cents a pack, and the equilibrium quantity is 120 million packs a week. The price of a pack adjusts until the quantity demanded equals the quantity supplied. At 50 cents a pack, the quantity demanded is 120 million packs a week and the quantity supplied is 120 million packs a week. b. Suppose that the price of gum is 70? a pack. Describe the situation in the gum market and explain how the price adjusts. 6 At 70 cents a pack, there is a surplus of gum and the price falls.

At 70 cents a pack, the quantity demanded is 80 million packs a week and the quantity supplied is 160 million packs a week. There is a surplus of 80 million packs a week. The price falls until market equilibrium is restored at a price of 50 cents a pack. c. Suppose that the price of gum is 30? a pack. Describe the situation in the gum market and explain how the price adjusts. At 30 cents a pack, there is a shortage of gum and the price rises. At 30 cents a pack, the quantity demanded is 160 million packs a week and the quantity supplied is 80 million packs a week.

There is a shortage of 80 million packs a week. The price rises until market equilibrium is restored at a price of 50 cents a pack. d. A fire destroys some factories that produce gum and the quantity of gum supplied decreases by 40 million packs a week at each price. Explain what happens in the market for gum and illustrate the changes on your graph. As the number of gum-producing factories decreases, the supply of gum decreases. There is a new supply schedule and, in Figure 3. 6, the supply curves shifts leftward by 40 million packs at each price to the new supply curve S1.

After the fire, the quantity supplied at 50 cents is now only 80 million packs, and there is a shortage of gum. The price rises to 60 cents a pack, at which the new quantity supplied equals the quantity demanded (100 million packs a week). So the new equilibrium price is 60 cents and the new equilibrium quantity is 100 million packs a week. 7 e. If at the time the fire occurs in d, there is an increase in the teenage population, which increases the quantity of gum demanded by 40 million packs a week at each price. What are the new equilibrium price and quantity of gum?

Illustrate these changes in your graph. The new price is 70 cents a pack, and the quantity is 120 million packs a week. The demand for gum increases and the demand curve shifts rightward by 40 million packs at each price. Supply decreases by 40 millions packs a week and the supply curve shifts leftward by 40 million packs at each price. These changes are shown in Figure 3. 7 by the shift of the demand curve from D to D1 and the shift of the supply curve from S to S1. At any price below 70 cents a pack there is a shortage of gum. The price of gum rises until the shortage is eliminated. 8

Question 21 (pp. 1) There have been occasions in housing markets where as prices fall the number of houses offered for sale decreases. This happened in the United States in 2008, for example. a. Does this fact illustrate the law of demand or the law of supply? Explain your answer. It illustrates the law of supply because the quantity supplied falls when the price falls. b. Why would home owners hold off trying to sell? As the price falls, the opportunity cost of keeping the house goes down. Also, a falling price might increase the expectation that the price will increase in the future. Question 22 (pp. 1) Car maker Mitsubishi in February 2008 announced the closure of its Australian plant. In the following month, it reported a decrease in sales of the vehicles that had been made at the 9 closed plant, but it also reported an increase in the quantity of vehicles of one of the models that it imports into Australia. Explain whether these events illustrate a. A change in supply b. A change in the quantity supplied c. A change in demand d. A change in the quantity demanded These events illustrate a change in the supply of Australian made vehicles, leaving the unchanged demand to be filled by imports of similar vehicles.

The factory was not closed because of a fall in the demand for and price of cars, but rather because there was a greater profit to be made from making them in Japan and importing them into Australia. Questions from Chapter 4 of the Text (McTaggart, Findlay & Parkin) Problems and Applications Question 1 (pp. 101) Rain spoils the strawberry crop. As a result, the price rises from $4 to $6 a box and the quantity demanded decreases from 1,000 to 600 boxes a week. Over this price range, a. What is the price elasticity of demand? The price elasticity of demand is 1. 25.

The price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in the price. The price rises from $4 to $6 a box, a rise of $2 a box. The average price is $5 a box. So the percentage change in the price is $2 divided by $5 and then multiplied by 100, which equals 40 per cent. The quantity decreases from 1,000 to 600 boxes, a decrease of 400 boxes. The average quantity is 800 boxes. So the percentage change in quantity is 400 divided by 800, which equals 50 per cent. The price elasticity of demand for strawberries is 50 per cent divided by 40 percent, which equals 1. 5. ($2 ? $5) ? 100 b. Describe the demand for strawberries. The price elasticity of demand exceeds 1, so the demand for strawberries is elastic. Question 2 (pp. 101) If the quantity of dental services demanded increases by 10 per cent when the price of dental services falls by 10 per cent, is the demand for dental services inelastic, elastic, or unit elastic? Question 3 (pp. 101) 10 The demand schedule for hotel rooms is given in the table. Price (dollars per night) Quantity demanded (millions of rooms per night) 100 80 50 40 25 20 200 250 400 500 800 1000 a.

What happens to total revenue if the price falls from $400 to $250 a night? When the price is $400, the total revenue is equal to $400 ? 50 million rooms, or $20 billion. When the price is $250, the total revenue is equal to $250 ? 80 million rooms, or $20 billion. So the total revenue does not change when the price falls from $400 to $250 a night. b. What happens to total revenue if the price falls from $250 to $200 a night? When the price is $250, the total revenue is equal to $250 ? 80 million rooms, or $20 billion.

When the price is $200, the total revenue is equal to $200 ? 00 million rooms, or $20 billion. So the total revenue does not change when the price falls from $400 to $250 a night. c. At what price is total revenue at a maximum? Explain and interpret your answer. The total revenue is the same at all prices, $20 billion. Because a change in price does not change the total revenue at any price, the demand is unit elastic at all prices. d. Is the demand for hotel rooms elastic, unit elastic, or inelastic? The demand for hotel rooms is unit elastic at all prices. Question 19 (pp. 103) Australians are turning to scooters to combat escalating petrol prices.

After a slump in the March quarter this year, demand for scooters was up by more than 7 per cent in the first half of 2008, according to figures released today by the Federal Chamber of Automotive Industries (FCAI). 11 a. Do you agree that rising petrol prices are associated with the change in sales of scooters? What is the sign of the cross price elasticity of demand for new scooters with respect to petrol prices? Scooters are a form of personal transport for one or two persons which use much less fuel than a motor car for a given distance traveled, when also carrying one or two persons.

So one would expect a rise in the price of petrol to increase sales of motor scooters. The sign of the cross elasticity of demand for scooters with respect to petrol prices would be positive, meaning that the quantity of scooters demanded rises when petrol prices rise. Question 20 (pp. 103) When Alex’s income increased from $3,000 to $5,000, he increased his consumption of bagels from 4 to 8 a month and decreased his consumption of donuts from 12 to 6 a month. Calculate Alex’s income elasticity of demand for a. Bagels.

The income elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in income. The change in income is $2,000 and the average income is $4,000, so the percentage change in income equals 50 per cent. The change in the quantity demanded is 4 bagels and the average quantity demanded is 6 bagels, so the percentage change in the quantity demanded equals 66. 67 per cent. The income elasticity of demand for bagels equals (66. 67)/(50), which is 1. 33. b. Donuts. From part a, the percentage change in income is 50 per cent. The change in the quantity demanded is ? donuts and the average quantity demanded is 9 donuts, so the percentage change in the quantity demanded is ? 66. 67 per cent. The income elasticity of demand for donuts equals (? 66. 67)/(50), which is ? 1. 33. b. Donuts. Question 21 (pp. 104) Heinz Preparing for Food at Home Canned food giant Heinz says the business is ‘relatively recession proof.

Peter Widdows, the managing director of Heinz Australia, said ‘As family budgets tighten I think the number of visits to restaurants will shrink, and it will tend to increase the percentage of food that comes from groceries. a. What does this news clip imply about the income elasticity of demand for meals prepared at home and for restaurant meals? 12 The news clip implies that, as income falls, the quantity of restaurant meals demanded will fall, and the quantity of meals prepared and eaten at home will rise. This means that the income elasticity of demand for restaurant meals is positive, and that the income elasticity of demand for home cooked meals is negative. Question 22 (pp. 04) Movie rental companies are exploring the online delivery of movies in Australia. These movies would compete with the in-store DVD rental services. a. How will the offering of online movie viewing influence the price elasticity of demand for in-store movie rentals? Online delivery of movies represents the introduction of a new product into the area of ‘home entertainment’. Prior to the introduction of the new product, the closest substitute for in-store movie rentals would have been free-to-air television movies.

In that situation, there is no guarantee that, at any given viewing time, the movie available from the store would also be showing on television. Accordingly, TV movies would be a poor substitute for in-store movies, and the price elasticity of demand for in-store movies would be low. On the other hand, on-line movies would be a very close substitute for in-store movies because presumably the same menu of movies would be available. Thus we expect the price elasticity of demand for in-store movie rentals to increase substantially when online movies are offered. . Would the cross price elasticity of demand for online movies and in-store movies be negative or positive? Explain. A fall in the price of one product will reduce the demand for the other product, so the cross price elasticity of demand will be positive. c. Would the cross elasticity of demand for online movies with respect to the price of highspeed Internet service be negative or positive? Explain. Online movies and high-speed internet service are complementary products, since the quality and speed of internet service enhances the quality of the online movie.

So we expect a fall in the price of internet services to increase the quantity demanded of internet connections, and this will increase the demand for products which rely on internet services such as online movies. So the cross elasticity of demand will be negative. Question 24 (pp. 104) The table gives the supply schedule of long distance phone calls. Calculate the elasticity of supply when 13 a. The price falls from 40 cents to 30 cents a minute. b. The average price is 20 cents a minute. Price (cents per minute) 10 20 30 40 Quantity supplied (millions of minutes per day) 200 400 600 800 . The elasticity of supply is 1. The elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in the price. When the price falls from 40 cents to 30 cents, the change in the price is 10 cents and the average price is 35 cents. The percentage change in the price is 28. 57 per cent. When the price falls from 40 cents to 30 cents, the quantity supplied decreases from 800 to 600 calls. The change in the quantity supplied is 200 calls, and the average quantity is 700 calls, so the percentage change in the quantity supplied is 28. 7 per cent. The elasticity of supply equals (28. 57)/(28. 57), which is 1. b. The elasticity of supply is 1. The formula for the elasticity of supply calculates the elasticity at the average price. So to find the elasticity at an average price of 20 cents a minute, change the price such that 20 cents is the average price — for example, a fall in the price from 30 cents to 10 cents a minute. When the price falls from 30 cents to 10 cents, the change in the price is 20 cents and the average price is 20 cents. The percentage change in the price is 100 per cent.

When the price falls from 30 cents to 10 cents, the quantity supplied decreases from 600 to 200 calls. The change in the quantity supplied is 400 calls and the average quantity is 400 calls. The percentage change in the quantity supplied is 100 per cent. The elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in the price. The elasticity of supply is 1. 14 Topic 3 : Economics of the Consumer Questions from Chapter 12 of the Text (McTaggart, Findlay & Parkin) Review Quiz 1 (pp. 270) What does a household’s budget line show?

The budget line plots combinations of goods that require all a household’s income and describes the limits to its consumption choices. Review Quiz 3 (pp. 270) If a household has an income of $40 and buys only bus rides at $4 each and magazines at $2 each, what is the equation of the household’s budget line? Calculate the quantity of magazine when the household takes 2 busrides. The budget equation states that a consumer’s spending must equal his or her income. The budget equation is derived for two goods, bus rides and magazines. The amount spent on bus rides is (Pbus ride) ? Qbus ride), the amount spent on magazines is (Pmagazine) ? (Qmagazine), and the consumer’s income is y. We know that (Pmagazine) ? (Qmagazine) + (Pbus ride) ? (Qbus ride) = y. Rearrange this equation by subtracting the amount spent on bus rides from both sides to give (Pmagazine) ? (Qmagazine) = y – (Pbus ride) ? (Qbus ride). Finally, divide both sides by the price of magazine to give the budget equation Qmagazine = y/Pmagazine – (Pbus ride /Pmagazine)(Qbus ride). Substituting in our values, y = $40, Pbus ride = $4 and Pmagazine = $2, gives Qmagazine = $40/$2 – ($4/$2)(Qbus ride) which is equal to Qmagazine = 20 – 2Qbus ride.

Problems and Applications Question 5 (pp. 285) Draw figures that show your indifference curves for the following pairs of goods: Right gloves and left gloves Coca-Cola and Pepsi Cricket balls and cricket bats Panadol and acetaminophen (the generic form of Panadol) Eye glasses and contact lenses Desktop computers and laptop computers 15 Skis and ski poles a. For each pair, state whether the goods are perfect substitutes, perfect complements, or neither. Right gloves and left gloves are perfect complements. Skis and ski poles are also perfect complements.

The other combinations in the list are neither perfect substitutes nor perfect complements. b. Discuss the shape of the indifference curve you have drawn and explain the relationship between its shape and the marginal rate of substitution as the quantities of the two goods change. Right and left gloves: These are perfect complements, so the indifference curves are right angles, such as those in Figure 12. 3A. The marginal rate of substitution does not change moving down along the indifference curve except when moving around the 90 degree point where it goes from infinity to zero.

Coca-Cola and Pepsi: These are, for most students, almost perfect substitutes. The indifference curves should either be linear (for perfect substitutes, as shown in Figure 12. 3B or nearly linear. If the indifference curves are linear, then the marginal rate of substitution does not change moving down along the indifference curve; if the indifference curves are nearly linear, then the marginal rate of substitution falls slightly moving down along an indifference curve. 16 Balls and bats These are complements but probably not perfect complements. The indifference curves should be significantly bowed inward as in Figure 12. 3C. If a student says these goods are perfect complements, the indifference curves should be right angles, such as those in Figure 12. 3A. ) If the indifference curves are not right angles, then the marginal rate of substitution falls rapidly moving down along an indifference curve. (If the goods are perfect complements, the marginal rate of substitution does not change moving down along the indifference curve except when moving around the 90 degree point where it goes from infinity to zero. ) 17 Panadol and acetaminophen: These are, for most people, very close substitutes. For some consumers, they might be perfect substitutes.

The indifference curves should either be linear (for perfect substitutes, as shown in Figure 12. 3B or nearly linear as in Figure 12. 3D. If the indifference curves are linear, then the marginal rate of substitution does not change moving down along the indifference curve; if the indifference curves are nearly linear, then the marginal rate of substitution falls slightly moving down along an indifference curve. Eye glasses and contact lenses: These are substitutes, though probably not perfect substitutes. The indifference curve are slightly bowed inward toward the origin as in Figure 12. 3E.

The marginal rate of substitution falls slightly moving down along an indifference curve. 18 Desktop computers and laptop computers; These are substitutes, though not perfect substitutes. The indifference curve are bowed inward toward the origin as in Figure 12. 3F. The marginal rate of substitution falls moving down along an indifference curve. Skis and ski poles: These are perfect complements. The indifference curves are right angles, such as those in Figure 12. 3G. The marginal rate of substitution does not change moving down along the indifference curve except when moving around the 90 degree point where it goes from infinity to zero. 9 Question 9 (pp. 286) Figure out how much of the lower earner’s salary will be eaten by expenses incurred if both parents work. Childcare is the biggest. … Count the costs of going to work. … And you may not have as much time or energy to do the housework or make dinner. a. What is the opportunity cost of a parent staying home with her or his children? The opportunity cost of staying home with the children is the earned income forgone. b. What is the opportunity cost of a parent working instead of staying home? List some of the components of that opportunity cost.

The monetary opportunity cost of a parent working include the childcare cost, the cost of travel to work, the cost of a housekeeper, the clothes, the dry cleaning, the lunches, and the dinners out. Of course, the opportunity cost includes only the part of the cost of the clothes, the dry cleaning, the lunches, and the dinners out that was incurred because the person was working. An additional opportunity cost for a family with offspring is the time that is no longer spent with the child or children. c. Why does the opportunity cost of working increase as the number of children in a family increases?

The cost of childcare, an opportunity cost of working, increases as the number of children increases. 20 d. How does the number of children in a family influence the marginal rate of substitution between leisure and goods and services? The greater the number of children in a family, the higher the opportunity cost of working. Equivalently, the greater the number of children in a family, the lower the family’s income net of opportunity cost and hence the lower the net wage rate. The lower the wage rate, the smaller is the magnitude of the slope of the budget line.

At the equilibrium point of time allocation, the slope of the indifference curve is equal to the slope of the budget line. Hence the smaller the magnitude of the slope of the budget line, the smaller the slope of the indifference curve and so the smaller the marginal rate of substitution between leisure and goods and services at the equilibrium point of time allocation. Question 12 (pp. 287) Rashid buys only books and albums and Figure 12. 8 shows his preferences. a. If Rashid chooses 3 books and 2 albums, what is his marginal rate of substitution? Rashid’s marginal rate of substitution is 1 book per album.

Rashid’s marginal rate of substitution equals the magnitude of the slope of his indifference curve at his best affordable point. If Rashid buys 3 books and 2 albums, the slope of his indifference curve at this point is minus 1 book per album. b. If Rashid chooses 2 books and 6 albums, what is his marginal rate of substitution? Rashid’s marginal rate of substitution is 1/2. Rashid’s marginal rate of substitution equals the magnitude of the slope of his indifference curve at his best affordable point. If Rashid buys 2 books and 6 albums, the slope of his indifference curve at this point is minus 1/2 book per album. . Do Rashid’s indifference curves display a diminishing marginal rate of substitution? Explain why or why not. Rashid’s indifference curves display diminishing marginal rate of substitution because when moving along either indifference curve the slope becomes smaller as the consumption of albums increases. Question 15 (pp. 287-88) Jim has made his best affordable choice of muffins and coffee. He spends all of his income on 10 muffins at $1 each and 20 coffees at $2 each. Now the price of a muffin rises to $1. 50 and the price of a coffee falls to $1. 75 a cup. 21 a.

Will Jim now be able and want to buy 10 muffins and 20 coffees? Jim is able to buy 10 muffins and 20 coffees because this combination remains affordable. Jim will not want to buy this combination, however, because the relative price of muffins and coffee has changed. At his consumer equilibrium, Jim’s MRS equals the relative price of muffins and coffee and because the relative price has changed, Jim’s MRS has changed so Jim will change his consumption point. b. Which situation does Jim prefer: muffins at $1 and coffee at $2 a cup or muffins at $1. 50 and coffee at $1. 5 a cup? Jim prefers the $1. 50 per muffin/$1. 75 per coffee prices because he can attain a higher indifference curve. The new budget line goes through the old budget line at the initial consumption point. But, with coffee measured along the horizontal axis, the new budget line is flatter than the old budget line and lies beyond the initial budget line at all points below the initial consumption point. c. If Jim changes the quantities that he buys, will he buy more or fewer muffins and more or less coffee? Jim will buy more coffee and fewer muffins. d.

When the prices change, is there an income effect and a substitution effect at work or just one of them? Price changes can always be divided into an income effect and a substitution effect. Question 18 (pp. 288) Clare Collins, Associate Professor in Nutrition and Dietetics at the University of Newcastle, says the controversial idea of taxing fattening foods is still the best option in fighting obesity. ‘It’s always controversial, as is banning advertising of junk food to children. ’ a. Draw a budget line and a preference map for a household between fattening foods (suppose these to be fast foods) and fresh fruit and vegetables.

Comment on the degree of substitutability between the two types of foods. Figure 12. 13 shows the budget line and a household’s preferences. The degree of substitutability depends on the perceptions of the consumer. For extremely health conscious consumers, who also do not need or value the time saving offered by fast foods, they would not be substitutes at all. Likewise, for people ignorant or unconcerned about the impact of diet on health, and who place a very high value on the time saved by eating fast foods, the two forms of food would also not be regarded as close substitutes.

However, most people look for a balance in their choices between eating at home and outside the home, and between 22 eating fast food and ‘slow’ food. For them, the choice between devoting one more or one less meal per week (out of 21) to fast food or a home cooked meal with fresh fruit and vegetables would be a choice between close substitutes with very few health implications. b. Show the best affordable point, and use your graph to show the effect of a tax on fattening foods. A tax on fast foods raises their relative price and the substitution effect is to increase the demand for fresh fruit and vegetables. . Show possible effects of banning advertising of fattening (and fast) foods. Bans on the advertising of fast foods will make fresh fruit and vegetables relatively more attractive, changing the indifference curve map so that fewer fast foods are purchased at a given relative price. d. Subsidies for fruit and vegetables have also been suggested as a way of reducing obesity in children. Compare the impact of a fast food tax and a fruit and vegetable subsidy on the consumption of both types of foods. It is ossible to design a tax on fast foods which raises the relative price of consuming fast foods by exactly the same extent as a given subsidy on the consumption of fresh fruit and vegetables.

The slope of the budget line changes to the same extent in both cases. For example, consider a hamburger costing $1 and an apple also costing $1, so their relative 23 prices are 1/1 = 1. A tax of 10 per cent on the hamburger raises its price to $1. 10, and the relative price becomes 1. 10/1 = 1. 1. Likewise, with no tax on hamburgers, a subsidy of $0. 09 on consumption of the apple will lower its price to $0. 1, and the relative price is again 1/0. 91 = 1. 1. The implications for government finance are different: the tax raises its own revenue, while the subsidy would require other taxes to pay for it. e. Do you agree with Professor Collins that the fast food tax is the ‘best option’? In Australia, with the GST, there is already a tax on fast foods, along with all restaurant meals, of 10 per cent, while uncooked fresh fruits and vegetables are GST exempt. Government policy should focus on the problem at hand, which in this case is the minority of people who prejudice their health and that of their children by over-consuming fast foods.

Switching expenditures on advertising to explain the health benefits and economy of fresh fruit, education, and the offering and promotion of healthy alternatives in fast food restaurants would seem better solutions. 24 Topic 4 : Behaviour of the Firm Questions from Chapter 13 of the Text (McTaggart, Findlay & Parkin) Review Quiz 6 (pp. 292) What is the distinction between the short run and the long run. The short run is a period of time during which the quantity of at least one factor of production is fixed and cannot be changed.

The long run is a period of time ling enough so that the quantities of all factors of production can be varied. Review Quiz 2 (pp. 296) What is the law of diminishing returns? Why does marginal product eventually diminish? The law of diminishing returns states that: as a firm uses more of a variable factor of production with a given quantity of fixed factors of production, the marginal product of the variable factor eventually diminishes. Diminishing marginal returns arises from the fact that ever more workers are using the same capital and working in the same space. Review Quiz 1 (pp. 01) Describe the relationship between a firm’s short-run cost curves. The marginal cost (MC), average total cost (ATC) and average variable cost (AVC) curves are all related in the short run:

  • • When the MC curve lies above (lies below) the AVC, the AVC curve rises (falls) with output. This implies that as output increases, the MC curve cuts through the AVC curve at its lowest point.
  • • When the MC curve lies above (lies below) the ATC, the ATC curve rises (falls) with output. This implies that as output increases, the MC curve cuts through the ATC curve at its lowest point.

As output increases, the ATC curve becomes vertically closer to the AVC curve. Review Quiz 4 (pp. 301) What is the shape of the AFC curve? Why? 25 Average fixed cost (AFC) equals total fixed cost divided by total product. As the quantity produced increases, the fixed costs are spread over a larger and larger quantity of output so average fixed cost decreases. So the AFC curve slopes downward as the quantity produced increases. Problems and Applications Question 1 (pp. 309) Which of the following news items involves a short-run decision and which involves a longrun decision? Explain. 1 January, 2008: Starbucks will open 750 more stores worldwide. This decision is a long-run decision. It increases the quantity of all of Starbucks’ factors of production, labour and the size of Starbucks’ plant. 25 February, 2008: For three hours on Tuesday, Starbucks will shut down every single one of its 7,100 stores so that baristas can receive a refresher course. This decision is a short-run decision. It involves increasing the quality of Starbucks’ labour and so only one factor of production — labour — changes and all the other factors remain fixed. 2 June, 2008: Starbucks replaces some baristas with vending machines.

This decision is a short-run decision. It involves changing two of Starbucks’ factors of production, labour and one type of capital. But other factors of production, such as Starbucks’ land and other capital inputs such as the store itself, remain fixed. 18 July, 2008: Starbucks is closing 616 stores that are too close to others. This decision is a long-run decision. It decreases the quantity of all of Starbucks’ factors of production, labour and the size of Starbucks’ plant. Question 2 (pp. 309) The table sets out Sue’s Surfboards’ total product schedule. a. Draw the total product curve.

To draw the total product curve measure labour on the x-axis and output on the y-axis. The total product curve is upward sloping and is illustrated in Figure 13. 1 26 b. Calculate the average product of labour and draw the average product curve. The average product of labour is equal to total product divided by the quantity of labour employed. For example, when 3 workers are employed, they produce 120 surfboards a week, so average product is 40 surfboards per worker. As Figure 13. 2 shows, the average product curve is upward sloping when up to 3 workers are hired and then is downward sloping when more than 4 workers are hired. 7 c. Calculate the marginal product of labour and draw the marginal product curve. The marginal product of labour is equal to the increase in total product that results from a one-unit increase in the quantity of labour employed. For example, when 3 workers are employed, total product is 120 surfboards a week. When a fourth worker is employed, total product increases to 160 surfboards a week. The marginal product of increasing the number of workers from 3 to 4 is 40 surfboards. We plot the marginal product at the halfway point, so at a quantity of 3. 5 workers, the marginal product is 40 surfboards per worker per week.

As Figure 13. 2b shows, the marginal product curve is upward sloping when up to 2. 5 workers a week are employed and it is downward sloping when more than 2. 5 workers a week are employed. d. Over what output range does the firm enjoy the benefits of increased specialisation and division of labour? The firm enjoys the benefits of increased specialisation and division of labour over the range of output for which the marginal cost decreases. This range of output is the same range over which the marginal product of labour rises. For Sue’s Surfboards, the benefits of increased specialisation and division of labour occur until 2. workers are employed. e. Over what output range does the firm experience diminishing marginal product of labour? The marginal product of labour decreases when more than 2. 5 workers are employed. 28 f. Over what output range does this firm experience an increasing average product of labour but a diminishing marginal product of labour? The marginal product of labour decreases and the average product of labour increases between 2. 5 and 3. 5 workers. g. Explain how it is possible for a firm to experience simultaneously an increasing average product but a diminishing marginal product.

As long as the marginal product of labour exceeds the average product of labour, the average product of labour rises. For a range of output the marginal product of labour, while decreasing, remains greater than the average product of labour, so the average product of labour rises. Each additional worker, while producing less than the previous worker hired is still producing more than the average worker. Question 3 (pp. 309) Sue’s Surfboards, in problem 2, hires workers at $500 a week and its total fixed cost is $1,000 a week. a. Calculate total cost, total variable cost, and total fixed cost at outputs 30, 120 and 220 surfboards a week.

Plot these points and sketch the short-run total cost curves passing through them. Total cost is the sum of the costs of all the factors of production that Sue’s Surfboards uses. Total variable cost is the total cost of the variable factors. Total fixed cost is the total cost of the fixed factors. For example, the total variable cost of producing 120 surfboards a week is the total cost of the workers employed, which is 3 workers at $500 a week, which equals $1,500. Total fixed cost is $1,000, so the total cost of producing 120 surfboards a week is $2,500. Figure 13. 3 shows these total cost curves. 29 b.

Calculate average total cost, average fixed cost, average variable cost, and marginal cost at outputs of 30, 160 and 220 surfboards a week. Plot these points and sketch the short-run average and marginal cost curves passing through them. Average fixed cost is total fixed cost per unit of output. Average variable cost is total variable cost per unit of output. Average total cost is the total cost per unit of output. For example, take the case in which the firm makes 160 surfboards a week. Total fixed cost is $1,000, so average fixed cost is $6. 25 per surfboard; total variable cost is $2,000, so average variable cost is $12. 0 per surfboard; and, total cost is $3,000, so average total cost is $18. 75 per surfboard. Marginal cost is the increase in total cost divided by the increase in output. For example, when output increases from 120 to 160 surfboards a week, total cost increases from $2,500 to $3,000, an increase of $500. This $500 increase in total cost means that the increase in output of 40 surfboards increases total cost by $500. Marginal cost is equal to $500 divided by 40 surfboards, which is $12. 50 a surfboard. The table shows these data schedules and the curves are plotted in Figure 13. 4. 30 Output (surfboards) 30 70 120 160 190 210 220

AFC (dollars AVC (dollars ATC (dollars per per per surfboard) surfboard) surfboard) 33. 33 16. 67 12. 50 14. 29 14. 29 10. 00 8. 33 12. 50 12. 50 6. 25 12. 50 16. 67 5. 26 13. 16 25. 00 4. 76 14. 29 50. 00 4. 55 15. 91 MC (dollars per surfboard) 50. 00 28. 58 20. 83 18. 75 18. 42 19. 05 20. 46 c. Illustrate the connection between Sue’s AP, MP, AVC, and MC curves in graphs like those in Fig. 13. 6 in the textbook. The table sets out the AP and MP data used to draw the curves. Figure 13. 5 shows the curves and the relationships. When the AP is rising, the AVC is falling and vice versa. When the MP is rising, the MC is falling and vice versa. 1 32 Labour (workers) 1 2 3 4 5 6 7 Output AP MP AVC MC (surfboard (surfboard (surfboard (dollars (dollars s) s per s per per per worker) worker) surfboard) surfboard) 30 30. 0 16. 67 40. 0 12. 50 70 35. 0 14. 29 50. 0 10. 00 120 40. 0 12. 50 40. 0 12. 50 160 40. 0 12. 50 30. 0 16. 67 190 38. 0 13. 16 20. 0 25. 00 210 35. 0 14. 29 10. 0 50. 00 220 31. 4 15. 91 33 Topic 5 : Markets Questions from Chapter 10 of the Text (McTaggart, Findlay & Parkin) Review Quiz 1 (pp. 225) How does monopoly arise? Monopoly arises if a firm is selling a good that has no close substitutes and if the firm is protected from competition by a barrier to entry.

As a result, a monopoly is the only firm in its market. Review Quiz 2 (pp. 225) What is the goal of a monopoly, and what are the main constraints that it faces in pursuing its goal? A firm’s fundamental goal is to maximise its profit. If the firm fails to maximise profit it is either eliminated or bought out by other firms maximising profit. Monopolists are constrained by public perceptions of their behaviour, consumer protection legislation and by the possible presence of substitutes for their product. Problems and Applications Question 4 (pp. 09) Minnie’s Mineral Springs, a single-price monopoly, faces the market demand schedule shown in the table. a. Calculate Minnie’s total revenue schedule. Minnie’s total revenue schedule lists the total revenue at each quantity sold. For example, Minnie’s can sell 1 bottle for $8 a bottle, which is $8 of total revenue at the quantity 1 bottle. Minnie’s entire total revenue schedule is in the table in part b (on the next page). b. Calculate its marginal revenue schedule. Minnie’s marginal revenue schedule (and her total revenue schedule) is in the table below.

The marginal revenue schedule lists the marginal revenue that results from increasing the quantity sold by 1 bottle. For example, Minnie’s can sell 1 bottle for total revenue of $8. Minnie’s can sell 2 bottles for $6 each, for total revenue of $12. So by increasing the quantity sold from 1 bottle to 2 bottles, marginal revenue is $4 a bottle ($12 minus $8). This marginal revenue is placed midway between the quantities 1 bottle and 2 bottles. 34 Price (dollars per bottle) Quantity demanded (bottles per hour) 0 8 8 4 6 0 4 •4 2 •8 0 5 0 4 8 3 12 2 12 1 8 Total revenue (dollars) Marginal revenue(dollars per bottle) 0 0 c. Draw a graph of the market demand curve and Minnie’s marginal revenue curve. Minnie’s demand curve and marginal revenue curve are in Figure 10. 2 The demand curve intersects the vertical axis at a price of $10 and intersects the horizontal axis at a quantity of 5. The marginal revenue curve intersects the vertical axis at a price of $10 and intersects the horizontal axis at a quantity of 2. 5. 35 d. Why is Minnie’s marginal revenue less than the price? Minnie’s marginal revenue is less than her price because to sell an additional unit of output, Minnie must lower her price on all units sold.

So when Minnie sells an additional unit of output, her revenue consists of the price she receives for this extra unit minus what she loses on all previous units she sells now at the new, lower price. e. At what price is Minnie’s total revenue maximised? Interpolating along the demand curve, Minnie’s total revenue is maximised at a price of $5. At this price she sells 2. 5 bottles an hour for total revenue of $12. 50. This is where marginal revenue is zero. f. Over what range of prices is the demand for water from Minnie’s Mineral Springs elastic?

The demand for Minnie’s Mineral Springs water is elastic between $5 per bottle and $10 per bottle. Marginal revenue is positive. g. Why will Minnie not produce a quantity at which the market demand for water is inelastic? 36 Minnie will not produce a quantity at which the demand for her water is inelastic because producing at such a price does not maximise her profit. If Minnie is producing where her demand is inelastic, marginal 1 5 0 CHAPTER 1 0 revenue is negative, and she can decrease the quantity she produces and 1) increase her total revenue, and 2) decrease her total cost.

Because her total revenue increases and her total cost decreases, Minnie’s total profit increases. Anytime Minnie’s production is at a quantity at which demand is inelastic, she can always increase her total profit by decreasing her production. Questions from Chapter 14 of the Text (McTaggart, Findlay & Parkin) Review Quiz 1 (pp. 315) Why is a firm in perfect competition a price taker? One firm’s output is a perfect substitute for another firm’s output and each firm is a small part of the market. These points imply that each firm cannot unilaterally influence the market price at which it can sell its good or service.

It must accept, or “take” the market equilibrium price—hence the term, price taker. Review Quiz 2 (pp. 315) In perfect competition, what is the relationship between the demand for the firm’s output and the market demand? The market demand curve for the goods and services in a perfectly competitive market is downward sloping. However, no single firm in this market can influence the price at which it sells its output. This point means a firm that is a price taker must take the equilibrium market price as given, and the firm faces a perfectly elastic demand. Review Quiz 3 (pp. 15) In perfect competition, why is a firm’s marginal revenue curve also the demand curve for the firm’s output? A perfectly competitive firm’s demand curve is a horizontal line at the market price. This result means that the price it receives is the same for every unit sold. The marginal revenue received by the firm is the change in total revenue from selling one more unit, which is the constant market price. So a perfectly competitive firm’s demand curve is the same as its marginal revenue curve. Review Quiz 1 (pp. 319) 37 Why does a firm in perfect competition produce the quantity at which marginal cost equals price?

A firm’s total profit is maximised by producing the level of output at which marginal revenue for the last unit produced equals its marginal cost, or MR = MC. In a perfectly competitive market, MR is equal to the market price P for all levels of output. These points imply that a perfectly competitive firm will maximise profit by producing output where P = MC. Review Quiz 2 (pp. 319) What is the lowest price at which a firm produces an output? Explain why. The lowest price at which a firm will produce output is the price that equals the firm’s minimum AVC.

At this price the firm has just enough total revenue to cover its total variable costs. The firm’s loss is equal to its fixed costs. At any lower market price the firm’s loss would be greater than its fixed costs. In this case the firm can avoid losses that are greater than its fixed cost by shutting down. 2 1 2 CHAPTER 14 Review Quiz 3 (pp. 319) What is the largest economic loss that a firm will incur in the short run? The firm will produce output at which marginal cost equals marginal revenue. The firm incurs an economic loss if the market price is less than average total cost.

The firm will shut down in the short run if the market price is less than average variable cost. When it shuts down, it has no variable costs because it is producing zero output, but it still has fixed cost. So when the firm shuts down in the short run, it incurs an economic loss equal to total fixed cost. If the loss exceeds total fixed cost the firm exits the market. The largest loss that a firm will incur is equal to total fixed cost. Review Quiz 4 (pp. 319) What is the relationship between a firm’s supply curve, its marginal cost curve, and its average variable cost curve?

The firm will produce output as long as the price is greater than the minimum AVC. It will choose the level of output where MC = P, which means the firm’s supply curve is the firm’s MC curve above minimum AVC. Review Quiz 1 (pp. 323) How do we derive the short-run market supply curve in perfect competition? 38 The short-run market supply curve is the horizontal sum of each individual firm’s supply curve. That is, the amount supplied by the total market equals the sum of what each firm in the industry supplies at a given price. Review Quiz 2 (pp. 23) In perfect competition, when market demand increases, explain how the price of the good and the output and profit of each firm changes in the short run. When market demand increases, the market price of the good rises, and the market quantity increases. Because price equals marginal revenue, the rise in the price means marginal revenue rises. As a result, each firm moves up its marginal cost curve and increases the quantity it produces. The firm’s profit rises (or its economic loss decreases). If the firm had been making zero economic profit before the increase in demand, after the increase the firm earns an economic profit.

Problems and Applications Question 2 (pp. 309) Pat’s Pizza Kitchen is a price taker. Its costs are in the table. a. Calculate Pat’s profit-maximising output and economic profit if the market price is (i) $14 a pizza. (ii) $12 a pizza. (iii) $10 a pizza. (i) At $14 a pizza, Pat’s profit-maximising output is 4 pizzas an hour and economic profit is $2 an hour. Pat’s maximises its profit by producing the quantity at which marginal revenue equals marginal cost. In perfect competition, marginal revenue equals price, which is $14 a pizza. The marginal cost is the change in total cost when output is increased by 1 pizza an hour.

The marginal cost of increasing output from 3 to 4 pizzas an hour is $13 ($54 minus $41). The marginal cost of increasing output from 4 to 5 pizzas an hour is $15 ($69 minus $54). So the marginal cost of the fourth pizza is half-way between $13 and $15, which is $14. Marginal cost equals marginal revenue when Pat produces 4 pizzas an hour. Economic profit equals total revenue minus total cost. Total revenue equals $56 ($14 multiplied by 4). Total cost is $54, so economic profit is $2. (ii) At $12 a pizza, Pat’s profit-maximising output is 3 pizzas an hour and economic profit is $5.

Pat’s maximises its profit by producing the quantity at which marginal revenue equals marginal cost. Marginal revenue equals price, which is $12 a pizza. The marginal cost of increasing output from 2 to 3 pizzas an hour is $11 ($41 minus $30). The marginal cost of 39 increasing output from 3 to 4 pizzas an hour is $13. So the marginal cost of the third pizza is half-way between $11 and $13, which is $12. Marginal cost equals marginal revenue when Pat produces 3 pizzas an hour. Economic profit equals total revenue minus total cost. Total revenue equals $36 ($12 multiplied by 3).

Total cost is $41, so economic profit is $5. (iii) At $10 a pizza, Pat’s profit-maximising output is 2 pizzas an hour and economic profit is $10. Pat’s maximises its profit by producing the quantity at which marginal revenue equals marginal cost. Marginal revenue equals price, which is $10 a pizza. The marginal cost of increasing output from 1 to 2 pizzas an hour is $9 ($30 minus $21). The marginal cost of increasing output from 2 to 3 pizzas an hour is $11. So the marginal cost of the second pizza is half-way between $9 and $11, which is $10. Marginal cost equals marginal revenue when Pat produces 2 pizzas an hour.

Economic profit equals total revenue minus total cost. Total revenue equals $20 ($10 multiplied by 2). Total cost is $30, so economic profit is $10. b. What is Pat’s shutdown point and what is Pat’s economic profit if it shuts down temporarily? The shutdown point is the price that equals minimum average variable cost. To calculate total variable cost, subtract total fixed cost ($10—when output is zero, total variable cost is $0, so total cost at zero output equals total fixed cost) from total cost. Average variable cost equals total variable cost divided by the quantity produced.

The average variable cost of producing 2 pizzas is $10 a pizza. Average variable cost is a minimum when marginal cost equals average variable cost. The marginal cost of producing 2 pizzas is $10. So Pat’s shutdown point is a price of $10 a pizza. When Pat shuts down the economic “profit” is actually an economic loss equal to Pat’s fixed cost. In particular Pat’s economic loss is $10. c. Derive Pat’s supply curve. Pat’s supply curve is the same as the marginal cost curve at prices equal to or above $10 a pizza. The supply curve is the y-axis (0 pizzas) at prices below $10 a pizza. . At what price will firms with costs identical to Pat’s exit the pizza market in the long run? Pat’s and firms with the same costs as Pat’s will exit the pizza market if the price is less than $13 a pizza in the long run. Pat’s Pizza Kitchen and other firms with the same costs will leave the market if they incur an economic loss in the long run. To incur an economic loss, the price must be below the minimum average total cost. Average total cost equals total cost divided by the quantity produced. For example, the average total cost of producing 2 pizzas is $15 a pizza.

Average total cost is a minimum when it equals marginal cost. The average total cost of producing 3 pizzas is $13. 67, and the average total cost of producing 4 pizzas is $13. 50. Marginal cost when Pat’s produces 3 pizzas is $12 and marginal cost when Pat’s produces 4 pizzas is $14. At 3 pizzas, marginal cost is less than average total cost; at 4 pizzas, marginal cost exceeds average total cost. So minimum average total cost occurs between 3 and 4 pizzas—$13 at 3. 5 pizzas an hour. 40 e. At what price will firms with costs identical to Pat’s enter the pizza market in the long run?

Pat’s and firms with the same costs as Pat’s will enter the pizza market if the price is greater than $13 a pizza in the long run. The reasoning is essentially the reverse of the reasoning behind the answer to part d. Pat’s Pizza Kitchen and other firms with the same costs will enter the industry if they can make an economic profit. To make an economic profit, the price must be above the minimum average total cost. Average total cost equals total cost divided by the quantity produced. For example, the average total cost of producing 2 pizzas is $15 a pizza. Average total cost is a minimum when it equals marginal cost.

The average total cost of producing 3 pizzas is $13. 67, and the average total cost of producing 4 pizzas is $13. 50. Marginal cost when Pat’s produces 3 pizzas is $12 and marginal cost when Pat’s produces 4 pizzas is $14. At 3 pizzas, marginal cost is less than average total cost; at 4 pizzas, marginal cost exceeds average total cost. So minimum average total cost occurs between 3 and 4 pizzas—$13 at 3. 5 pizzas an hour. Questions from Chapter 15 of the Text (McTaggart, Findlay & Parkin) Review Quiz 1 (pp. 341) What are the distinguishing characteristics of monopolistic competition?

The distinguishing characteristics of monopolistic competition are: i) a large number of firms, each producing a differentiated product than its competitors, ii) firms compete on quality, price, and marketing, and iii) there are no barriers to entry into the industry. Review Quiz 2 (pp. 341) How do firms in monopolistic competition compete? Firms in monopolistic competition compete in three areas: Quality — the physical attributes of a product, including the product’s design and reliability, the service provided with the product, and the ease of access to the product; rice — because the firms produce differentiated products, each firm faces a downward-sloping demand curve for its own product; and marketing — firms must make consumers aware of the quality of their differentiated products through advertising and packaging. Review Quiz 3 (pp. 341) Provide some examples of markets near your university that operate in monopolistic competition (excluding those given on the text page in the figure). 41 Hamburger restaurants, coffee shops, and juice bars are examples of firms competing in their own respective industry, each industry being a market described by monopolistic competition.

Review Quiz 3 (pp. 345) Why do firms in monopolistic competition operate with excess capacity? A firm’s capacity output is the output at which average total cost is at its minimum. In monopolistic competition in the long run, MR = MC and P = ATC. At the long run equilibrium, it is the case that MC ; ATC, which means that the ATC curve is downward sloping in this range and so production occurs at an output level that is less than capacity output. Review Quiz 4 (pp. 345) Why is there a price markup over marginal cost in monopolistic competition?

A firm’s markup is the amount by which price exceeds marginal cost. There is a markup in monopolistic competition because P ; MR at all levels of output. Since the firm produces the quantity at which MR = MC, the fact that P ; MR means that P ; MC, so that there is a markup. Review Quiz 5 (pp. 345) Is monopolistic competition efficient? Monopolistic competition is not efficient by the requirement for allocative efficiency MSB = MSC. The price equals the consumer’s willingness to pay, which is the marginal social benefit and the firm’s marginal cost is the marginal social cost.

Product differentiation in monopolistic competition means that P ; MR, which implies that P ; MC at the quantity where MR = MC. Because P = MSB and MC = MSC, the result is that MSB ; MSC, which signals inefficiency. However, when compared to the perfectly competitive alternative that all goods are identical, the variety offered by monopolistic competition makes monopolistic competition potentially efficient. Review Quiz 1 (pp. 349) How, other than by adjusting price, do firms in monopolistic competition compete?

The two main ways through which firms in monopolistic competition compete, other than by adjusting price, is through innovation and product development and advertising. 42 Problems and Applications Question 1 (pp. 309) Sara is a dot. com entrepreneur who has established a Web site at which people can design and buy a sweatshirt. Sara pays $1,000 a week for her Web server and Internet connection. The sweatshirts that her customers design are made to order by another firm, and Sara pays this firm $20 a sweatshirt. Sara has no other costs. The table sets out the demand schedule for Sara’s sweatshirts. . Calculate Sara’s profit-maximising output, price, and economic profit. Sara produces the quantity that sets her marginal cost equal to her marginal revenue. Sara’s marginal cost is $20. Between the quantity of 20 and 40 sweatshirts, Sara’s marginal revenue is $40. Between 40 and 60 sweatshirts, Sara’s marginal revenue is $0. So at the quantity of 40 sweatshirts Sara’s marginal revenue is $20. To maximise her profit, Sara produces 40 sweatshirts. When Sara produces 40 sweatshirts, the price from the demand schedule is $60 per sweatshirt. Sara’s total revenue is $2,400.

Her total cost is $1,000 (fixed cost) plus $800 (variable cost), or $1,800. Sara’s economic profit equals $2,400 $1,800 or $600. b. Do you expect other firms to enter the Web sweatshirt business and compete with Sara? Sara is making an economic profit so other firms will enter the Web sweatshirt business and compete with Sara. c. What happens to the demand for Sara’s sweatshirts in the long run? What happens to Sara’s economic profit in the long run? As new firms enter the Web sweatshirt industry, the demand for Sara’s sweatshirts will decrease. In the long run Sara’s economic profit is zero — a normal profit. 3 Topic 6 : Basic Macroeconomic Concepts Questions from Chapter 18 of the Text (McTaggart, Findlay & Parkin) Review Quiz 1 (pp. 410) Define GDP and distinguish between a final good and an intermediate good. Provide examples. GDP is the market value of all the final goods and services produced within a country in a given time period. A final good or service is an item that is sold to the final user, that is, the final consumer, government, a firm making investment, or a foreign entity. An intermediate good or service is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service.

For instance, bread sold to a consumer is a final good, but wheat sold to a baker to make the bread is an intermediate good. Distinguishing between final goods and services and intermediate goods and services is important because only final goods and services are directly included in GDP; intermediate goods must be excluded to avoid double counting them. For example, counting the wheat that went into the bread as well as the bread would double count the wheat—once as wheat and once as part of the bread. Review Quiz 1 (pp. 413) What is the expenditure approach to measuring GDP?

The expenditure approach measures GDP by focusing on aggregate expenditures. Data are collected on the different components of aggregate expenditure and then summed. Specifically, the B

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