Economics3e-WEB_AObkTqf-188

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Labor Cost Machine Cost Total Cost
Cost of technology 1 10 × $40 = $400 2 × $50 = $100 $500
Cost of technology 2 7 × $40 = $280 4 × $50 = $200 $480
Cost of technology 3 3 × $40 = $120 7 × $50 = $350 $470
The firm should choose production technology 3 since it has the lowest total cost. This makes sense since,
with cheaper machine hours, one would expect a shift in the direction of more machines and less labor.
7.
Labor Cost Machine Cost Total Cost
Cost of technology 1 10 × $40 = $400 2 × $55 = $110 $510
Cost of technology 2 7 × $40 = $280 4 × $55 = $220 $500
Cost of technology 3 3 × $40 = $120 7 × $55 = $385 $505
The firm should choose production technology 2 since it has the lowest total cost. Because the cost of
machines increased (relative to the previous question), you would expect a shift toward less capital and
more labor.
8. This is the situation that existed in the United States in the 1970s. Since there is only demand enough for
2.5 firms to reach the bottom of the average cost curve, you would expect one firm will not be around in the
long run, and at least one firm will be struggling.
Chapter 8
1. No, you would not raise the price. Your product is exactly the same as the product of the many other firms
in the market. If your price is greater than that of your competitors, then your customers would switch to
them and stop buying from you. You would lose all your sales.
2. Possibly. Independent truckers are by definition small and numerous. All that is required to get into the
business is a truck (not an inexpensive asset, though) and a commercial driver’s license. To exit, one need
only sell the truck. All trucks are essentially the same, providing transportation from point A to point B.
(We’re assuming we not talking about specialized trucks.) Independent truckers must take the going rate
for their service, so independent trucking does seem to have most of the characteristics of perfect
competition.
3. Holding total cost constant, profits at every output level would increase.
4. When the market price increases, marginal revenue increases. The firm would then increase production
up to the point where the new price equals marginal cost, at a quantity of 90.
5. If marginal costs exceeds marginal revenue, then the firm will reduce its profits for every additional unit of
output it produces. Profit would be greatest if it reduces output to where MR = MC.
6. The firm will be willing to supply fewer units at every price level. In other words, the firm’s individual
supply curve decreases and shifts to the left.
7. With a technological improvement that brings about a reduction in costs of production, an adjustment
process will take place in the market. The technological improvement will result in an increase in supply
curves, by individual firms and at the market level. The existing firms will experience higher profits for a
while, which will attract other firms into the market. This entry process will stop whenever the market
supply increases enough (both by existing and new firms) so profits are driven back to zero.
8. When wages increase, costs of production increase. Some firms would now be making economic losses
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and would shut down. The supply curve then starts shifting to the left, pushing the market price up. This
process ends when all firms remaining in the market earn zero economic profits. The result is a
contraction in the output produced in the market.
9. Perfect competition is considered to be “perfect” because both allocative and productive efficiency are met
at the same time in a long-run equilibrium. If a market structure results in long-run equilibrium that does
not minimize average total costs and/or does not charge a price equal to marginal cost, then either
allocative or productive (or both) efficiencies are not met, and therefore the market cannot be labeled
“perfect.”
10. Think of the market price as representing the gain to society from a purchase, since it represents what
someone is willing to pay. Think of the marginal cost as representing the cost to society from making the
last unit of a good. If P > MC, then the benefits from producing more of a good exceed the costs, and society
would gain from producing more of the good. If P < MC, then the social costs of producing the marginal
good exceed the social benefits, and society should produce less of the good. Only if P = MC, the rule
applied by a profit-maximizing perfectly competitive firm, will society’s costs and benefits be in balance.
This choice will be the option that brings the greatest overall benefit to society.
Chapter 9
1. a. A patent is a government-enforced barrier to entry.
b. This is not a barrier to entry.
c. This is not a barrier to entry.
d. This is a barrier to entry, but it is not government-enforced.
e. This is a barrier to entry, but it is not directly government enforced.
2. a. This is a government-enforced barrier to entry.
b. This is an example of a government law, but perhaps it is not much of a barrier to entry if most people
can pass the safety test and get insurance.
c. Trademarks are enforced by government, and therefore are a barrier to entry.
d. This is probably not a barrier to entry, since there are a number of different ways of getting pure water.
e. This is a barrier to entry, but it is not government-enforced.
3. Because of economies of scale, each firm would produce at a higher average cost than before. (They would
each have to build their own power lines.) As a result, they would each have to raise prices to cover their
higher costs. The policy would fail.
4. Shorter patent protection would make innovation less lucrative, so the amount of research and
development would likely decline.
5. If price falls below AVC, the firm will not be able to earn enough revenues even to cover its variable costs. In
such a case, it will suffer a smaller loss if it shuts down and produces no output. By contrast, if it stayed in
operation and produced the level of output where MR = MC, it would lose all of its fixed costs plus some
variable costs. If it shuts down, it only loses its fixed costs.
6. This scenario is called “perfect price discrimination.” The result would be that the monopolist would
produce more output, the same amount in fact as would be produced by a perfectly competitive industry.
However, there would be no consumer surplus since each buyer is paying exactly what they think the
product is worth. Therefore, the monopolist would be earning the maximum possible profits.
Chapter 10
1. An increase in demand will manifest itself as a rightward shift in the demand curve, and a rightward shift
in marginal revenue. The shift in marginal revenue will cause a movement up the marginal cost curve to
the new intersection between MR and MC at a higher level of output. The new price can be read by drawing
a line up from the new output level to the new demand curve, and then over to the vertical axis. The new
price should be higher. The increase in quantity will cause a movement along the average cost curve to a
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possibly higher level of average cost. The price, though, will increase more, causing an increase in total
profits.
2. As long as the original firm is earning positive economic profits, other firms will respond in ways that take
away the original firm’s profits. This will manifest itself as a decrease in demand for the original firm’s
product, a decrease in the firm’s profit-maximizing price and a decrease in the firm’s profit-maximizing
level of output, essentially unwinding the process described in the answer to question 1. In the long-run
equilibrium, all firms in monopolistically competitive markets will earn zero economic profits.
3. a. If the firms form a cartel, they will act like a monopoly, choosing the quantity of output where MR =
MC. Drawing a line from the monopoly quantity up to the demand curve shows the monopoly price.
Assuming that fixed costs are zero, and with an understanding of cost andprofit, we can infer that
when the marginal cost curve is horizontal, average cost is the same as marginal cost. Thus, the cartel
will earn positive economic profits equal to the area of the rectangle, with a base equal to the
monopoly quantity and a height equal to the difference between price (on the demand above the
monopoly quantity) and average cost, as shown in the following figure.
b. The firms will expand output and cut price as long as there are profits remaining. The long-run
equilibrium will occur at the point where average cost equals demand. As a result, the oligopoly will
earn zero economic profits due to “cutthroat competition,” as shown in the next figure.
c. Pc > Pcc. Qc < Qcc. Profit for the cartel is positive and large. Profit for cutthroat competition is zero.
4. Firm B reasons that if it cheats and Firm A does not notice, it will double its money. Since Firm A’s profits
will decline substantially, however, it is likely that Firm A will notice and if so, Firm A will cheat also, with
the result that Firm B will lose 90% of what it gained by cheating. Firm A will reason that Firm B is unlikely
to risk cheating. If neither firm cheats, Firm A earns $1000. If Firm A cheats, assuming Firm B does not
cheat, A can boost its profits only a little, since Firm B is so small. If both firms cheat, then Firm A loses at
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least 50% of what it could have earned. The possibility of a small gain ($50) is probably not enough to
induce Firm A to cheat, so in this case it is likely that both firms will collude.
Chapter 11
1. Yes, it is true. The HHI example is easy enough: since the market shares of all firms are included in the HHI
calculation, a merger between two of the firms will change the HHI. For the four-firm concentration ratio, it
is quite possible that a merger between, say, the fifth and sixth largest firms in the market could create a
new firm that is then ranked in the top four in the market. In this case, a merger of two firms, neither in the
top four, would still change the four-firm concentration ratio.
2. No, it is not true. The HHI includes the market shares of all firms in its calculation, but the squaring of the
market shares has the effect of making the impact of the largest firms relatively bigger than in the 4-firm
or 8-firm ratio.
3. The bus companies wanted the broader market definition (i.e., the second definition). If the narrow
definition had been used, the combined bus companies would have had a near-monopoly on the market
for intercity bus service. But they had only a sliver of the market for intercity transportation when
everything else was included. The merger was allowed.
4. The common expectation is that the definition of markets will become broader because of greater
competition from faraway places. However, this broadening doesn’t necessarily mean that antitrust
authorities can relax. There is also a fear that companies with a local or national monopoly may use the
new opportunities to extend their reach across national borders, and that it will be difficult for national
authorities to respond.
5. Because outright collusion to raise profits is illegal and because existing regulations include gray areas
which firms may be able to exploit.
6. Yes, all curves have normal shapes.
7. Yes it is a natural monopoly because average costs decline over the range that satisfies the market
demand. For example, at the point where the demand curve and the average cost curve meet, there are
economies of scale.
8. Improvements in technology that allowed phone calls to be made via microwave transmission,
communications satellites, and other wireless technologies.
9. More consumer choice. Cheaper phone calls, especially long distance. Better-quality phone service in
many cases. Cheaper, faster, and better-quality data transmission. Spin-off technologies like free Internet-
based calling and video calling.
10. More choice can sometimes make for difficult decisions—not knowing if you got the best plan for your
situation, for example. Some phone service providers are less reliable than AT&T used to be.
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Chapter 12
1. a. positive externality
b. negative externality
c. positive externality
d. negative externality
e. negative externality
2. a. supply shifts left
b. supply shifts left
c. supply stays the same
d. supply shifts left
3. a. price will rise
b. price will rise
c. price stays the same
d. price will rise.
4. The original equilibrium (before the external social cost of pollution is taken into account) is where the
private supply curve crosses the demand curve. This original equilibrium is at a price of $15 and a
quantity of 440. After taking into account the additional external cost of pollution, the production becomes
more costly, and the supply curve shifts up. The new equilibrium will be at a price of $30 and a quantity of
410.
5. The first policy is command-and-control because it is a requirement that applies to all producers.
6. a. market-based
b. command-and-control
c. command-and-control
d. market-based
e. market-based
7. Even though state or local governments impose these taxes, a company has the flexibility to adopt
technologies that will help it avoid the tax.
8. First, if each firm is required to reduce its garbage output by one-fourth, then Elm will reduce five tons at a
cost of $5,500; Maple will reduce 10 tons at a cost of $13,500; Oak will reduce three tons at a cost of
$22,500; and Cherry will reduce four tons at a cost of $18,000. Total cost of this approach: $59,500. If the
system of marketable permits is put in place, and those permits shrink the weight of allowable garbage by
one-quarter, then pollution must still be reduced by the same overall amount. However, now the reduction
in pollution will take place where it is least expensive.
Reductions in Garbage Who does the reducing? At what cost?
First 5 tons Cherry $3,000
Second 5 tons Cherry $4,000
Third 5 tons Cherry $5,000
Fourth 5 tons Elm $5,500
Fifth and sixth 5 tons Elm and Cherry $6,000 each
Seventh 5 tons Maple $6,300
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	Answer Key
	Chapter 8
	Chapter 9
	Chapter 10
	Chapter 11
	Chapter 12