SupplementaryChapter

QuestionsandExercises
Chapter1Questions
11. Whyisitnonsensetotalkabouturgent,critical,crying,vital,basic,minimal,social,or
privateneeds?
12. Economistswoulddisappearonlyinauniversewheretimeisunlimited.Trueorfalse?
Explain.
13. IsitinconsistenttostatethattheUnitedStatesisthewealthiestnation,butscarcityisstilla
problem?Explain.
14. SomepeoplecontendthatAmericansliveinapostscarcityeconomy.Intermsofnormative
andpositiveeconomics,explainthestatement.
15. Theoryisokayforeggheads,butImahardboiledwoman.Givemethefactsandtheyll
speakforthemselves.Howdofactsspeakforthemselves?
16. Whatistheroleofassumptionsinmodelconstruction?
17. Whatisthedifferenceamongthetermspostulate,assertion,assumption,hypothesis,theory,
paradigm,andmodel?
18. Themajordifferencebetweennaturalsciencesandsocialsciencesisthatlaboratory
experimentationispossibleinthenaturalsciencesbutnotinthesocialsciences.Trueor
false?Explain.
19. Ifamodelpredicts,canitalsobeusedforcontrol?
20. Forprediction,atheorymustyieldempiricallyvalidatedpredictions.Assumeyouareasked
toevaluatea100yearoldtheorythathasnotyieldedanaccurateprediction.Supportersof
thetheoryadvocatethatnotenoughtimehaselapsedtovalidatethetheory.Shouldthis
theorybeacceptedorrejected?Explain.
Chapter1Exercises(none)
Chapter2Questions(none)
Chapter2Exercises

11. ConsideragroupofpeopleA,B,C,...andtherelationatleastastallas.
a. Isthisrelationtransitive?
b. Isitcomplete?
12. Whatisthemarginalrateofsubstitutionbetweennickelsanddimes?Illustratetheresult.
13. Demonstratewhichpreferenceaxiomsaresatisfiedandnotsatisfiedbythefollowing
statements.
a. IreachapointatwhichIamsatiatedwithonegoodbutnottheother.
b. ...topursuemathematicalanalysiswhileatthesametimeturningone'sbackonits
applicationsandonintuitionistocondemnittohopelessatrophy.R.Courant.
c. Ittakestwototango.
d. Ipreferamixtureoftownandcountrylifetobeingrestrictedtooneortheother.
e. Thereisnotenoughmoneytomakemeeatarawoyster.
f. Georgiaalwayseatshotdogsinabunwith1ounceofmustard.
g. ImayreachapointatwhichIamsatiatedwithbothgoodsIamconsuming.
h. Peanutbutterandjellygotogetherlikeahorseandcarriage.
i. Withanauto,themoregasolinethebetter.Withoutanauto,whocares?
j. Ipreferamixtureoftownandcountrylifetobeingrestrictedtooneortheother.
However,whicheverIchoose,IknowI'llbesorry.
k. Thereisaquantityforeachcommodityuptowhichitisagoodandbeyondwhichitisa
bad.
l. Popcornisaddictive;themoreyoueat,themoreyouwant.
m. Mosquitoesruinanicedayatthebeach.
n. Adaywithoutwineislikeadaywithoutsunshine.
o. Iamindifferentbetweenbrowneggsandwhiteeggs,butIamsuperstitiousandbelieve
terribleeventswillhappenifIpossessbothsimultaneously.
p. IdratherbeA,whereAcouldbegolfing,skiing,orbowling.
q. A13yearoldgirljuststartedsmoking.Itseemsthatasshesmokesshewantstogiveup
moreofothercommoditiesforonemoresmoke.
r. Ilikebothmilkandorangejuicebutgetlesspleasurefromamixtureofthetwo.
s. Idon'twantaMartiniunlessitisexactlyfivepartsgintoonepartvermouth.
t. TastetestsrevealthatBurpColaisexactlyasgoodasthenationallyknownBurpup
brand.
u. Livefast,lovehard,dieyoung,andleaveabeautifulcorpse.
v. IlikebothBurpandBurpupCola,butthemoreBurpIhavethemoreIamwillingtogive
upBurpuptogetonemoreBurp.
w. Ilikedrinkinganddrivingequallywell,butitisagainstthelawtomixthemsoInever
do.
x. Ilikeicecream,butfrozenyogurtmakesmesick.
y. Lovethyneighborasthyself.
z. IdonotcarewhetherIhaveregularcoffeeordecaffeinatedcoffee,aslongasitiscoffee.

Chapter3Questions
11. Considerapoorhouseholdonwelfareconsumingonlyfoodandhousing.Shouldwelfare
paymentsbeintheformofpaymentsinkind(weeklyallocationoffood)ormoney?Discuss.
Chapter3Exercises
11. Kimberlyiscrammingforfinalsineconomics,mathematics,andchemistryandonlyhassix
hoursofstudytimeremaining.Herobjectiveistoobtainthehighestaveragegradepossible
onthethreeexams.Thegradesdependonthenumberofhoursdevotedtoeachsubject
accordingtothefollowingschedule.
HoursofStudy
Economics
0
50
1
60
2
70
3
80
4
85
5
95
HowshouldKimberlyallocatehertime?Explain.

Grade
Mathematics
40
45
50
60
80
90

Chemistry
30
45
45
50
60
75

12. Demonstratethatifthickindifferencecurvesexist,utilitymaybemaximizedwithlessthana
householdstotalincome.Whichpreferenceaxiomrulesoutthepossibilityofthick
indifferencecurves?
13. Assumetheutilityfunction
U(x1,x2)=x13/5x13/5.
Ifp1=p2=2andI=14,howmuchx1andx2shouldbepurchasedtomaximizeutility?
14. Assumetheutilityfunction
U=Ax11/2x21/3.
Ifp1=4,p2=1,andI=20,howmuchx1andx2shouldbepurchasedtomaximizeutility?
15. Assumetheutilityfunction
U=x11/3x21/4.
Ifp1=3,p2=4,andI=7,howmuchx1andx2shouldbepurchasedtomaximizeutility?
16. Assumethefollowingutilityfunction
U=x11/4x21/2.
a. Graphtheindifferencecurves.

b. Thepriceofx1is$2,thepriceofx2is$1,andthehouseholdiscurrentlyconsumingone
unitofx1andtwounitsofx2.Whatshoulditdo?
17. Paul,anovicewineconnoisseur,has$500tospendonacheapFrenchwine,F,at$10per
bottleandaqualityCaliforniavarietalwine,C,at$50perbottle.Hispreferencesforthetwo
winesarerepresentedas
U(C,F)=CF1/4.
a. WhatistheutilitymaximizingallocationofCaliforniaandFrenchwines?
b. FortunatelyforPaul,thestoreiscurrentlyhavingasaleonthefineCaliforniawineattwo
bottlesforthepriceofone.Howdoesthissaleaffecthisutilitymaximizingallocation?
18. MissFragrantlikesbothbathpearls,B,andperfume,F,accordingtothefollowing
preferences
U(B,F)=lnB+ln(2+F).
AtpricespB=$5andpF=$35,andincomeI=$100,determineMissFragrantsoptimal
bundleofbathpearlsandperfume.
19. AssumetwoindividualsMarj,M,andTony,T,facebudgetconstraints
IM=pM1xM1+pM2xM2,
IT=pT1xT1+pT2xT2,
wherepM1/pM2>pT1/pT2andIM=IT.
a. Graphbothbudgetconstraintsonthesamesetofaxes.
b. AssumeMarjandTonymarryandformasinglehouseholdbypoolingtheirincomesand
consumption.Withtheabilitytocontinuepurchasingseparatelyatthetwosetsofprices,
determinethehouseholdbudgetconstraint.
c. WillMarjandTonyspecializeinpurchasingcommodities?Explain.
20. Asupermarketisconsideringtwopricingoptions.Thefirstoptionreducesthepriceofsoap
by50%foreveryunitsold.Thesecondoptionisbuyoneandgetonefree.Illustratethe
householdsbudgetconstraintsforthetwooptionsandtellwhichoptionahouseholdwould
prefer.
21. ConsiderEugenesutilityfunctionandnonlinearconstraint
U=3x1+x2,
s.t.x21+2x2=16.
a. Graphtheindifferencecurvesandbudgetline.
b. DerivetheLagrangianmultiplier,,andinterprettheresult.Howmuchx1andx2should
Eugeneconsume?
22. Douglascollectsbaseballcards.Sometimeshebuyscardsforhiscollectionandsometimes
hesellscardsfromhiscollection.Supposeheiscurrentlyinequilibrium,whereheisneither
buyingnorsellingbaseballcards.Showthathewillbebetteroffifpricesforbaseballcards
changebyeitherrisingorfalling.Explainwhythisisthecase.
23. Assumeahouseholdsutilityfunctionfortwocommoditiesx1andx2is

U(x1,x2)=(4/5)lnx1+(2/5)lnx2.
a. Doesthisutilityfunctionrepresentconvexpreferences?Explain.
b. Nowconsiderthetransformationofthisutilityfunction
V(x1,x2)={exp[U(x1,x2)]}5/2.
whereexp(x)=ex.Showthatthemarginalrateofsubstitutionisthesameasinpart(a).
24. Considertheutilityfunction
U=10x12/3x23/4+23.7.
a. Geometricallyillustratetheindifferencecurves.
b. Onthegraphinpart(a),illustratetheF.O.C.formaximizingtheutilityfunctionsubject
toanincomeconstraint,andthenderivetheassociatedmathematicalconditions.
c. Ifp1=8,p2=3,andthehousehold'sincomeis17,howmuchx1andx2shouldbe
purchasedtomaximizeutility?
d. ProvideamathematicalandeconomicinterpretationoftheLagrangianmultiplier,.
25. EveryschooldayBraineatslunchatschool.Heonlyeatsicecream,C,andapplewedges,A.
Brainsutilityfunctionforthesetwocommoditiesisrepresentedby
U(C,A)=CA.
a. Ifanicecreamcosts$0.50andanapplewedgecosts$0.25,howwillBrainmaximizehis
utilitywiththe$2.00hismothergiveshim?
b. Iftheschooltriestodiscourageicecreamconsumptionbyraisingthepriceto$1.00,by
howmuchwillBrain'smotherhavetoincreasehislunchallowancetoprovidehimwith
thesamelevelofutilityhereceivedinpart(a)?
26. Assumethatinadditiontopayingapriceperunitforacommodity,ahouseholdalsopaysa
transactionscostforusingamarket.Analyzetheimplicationsforthehousehold'soptimal
choice,assumingthetransactionscostispaidasafixedlumpsumnotdependentonthe
quantitiesofthecommoditiespurchased.
27. Assumethataperunitsubsidyoncommodityx1isonlyalloweduptosomemaximum
numberofunitspurchased,x1,andahouseholdwillalwayspurchasemorethanthis
maximumnumber.Showthatahouseholdisindifferentbetweenalumpsumsubsidythat
resultsinthesameincomeforthehouseholdastheperunitsubsidy.Generally,foodstamps
coverlessthanawelfarehouseholdstotalexpenditureonfood.
28. TimsfamilyrecentlyimmigratedtoAmerica,andhisfatherwantshimtounderstandthe
greatAmericanpastimeofbaseballbyattendingmoregames.Timspreferencesforbaseball
gamesareillustratedintheindifferencemap.Hisonlysourceofincomeisanallowancefrom
hisfatherandwiththisallowancehewillattendBobaseballgames.Illustratethevarious
alternativeshisfatherhasforencouraginghimtoattendbaseballgames.Whichalternatives
wouldTimprefer?Whichwouldhisfathermostlikelyselect?
a. Inkindgift.Hisfathergiveshimsomebaseballtickets.
b. Subsidy.Hisfatheriswillingtopaysomeportionoftheticketprice.

c. Allowance.Hisfatherprovideshimwithadditionalallowanceequaltothesamelevelof
satisfactionasthesubsidy.
d. Subsidyandallowancereduction.Hisfatherprovidesasubsidyalongwithanallowance
reductionsohissatisfactionremainsunchanged.

Chapter4Questions(none)
Chapter4Exercises(none)
Chapter5Questions
11. Ariseinthepriceofacommodityfrom$5to$10reducesquantitydemandedfrom40,000to
30,000units.Whatisthepriceelasticityofdemandatthemeanvaluesofpriceandquantity
demanded.
12. Whatistherelationshipbetweenthefactorsthataccountforadownwardslopingdemand
curveandtheelasticityofdemand?
13. Thepriceelasticityofdemandforagivencommodityislargerinabsolutevalueif
a. themorenumerousandcloserthesubstitutes.
b. ifitisaluxuryratherthananecessarygood.
c. ifitaccountsforalargeportionoftheconsumptionbudget.
d. athighpricesratherthanlow.
Whatistherationalforeachcase?
14. Saraisgivenachoicebetweenpaying$15,000foreitheracruisearoundtheworldora
brandnewcompactautomobile.Shechoosestheautomobile.However,justasSarais
abouttopayfortheautomobile,sheisinformedshecanhaveherchoiceatnocharge.
Giventhisinformation,Sarapromptlychangeshermindandchoosesthearoundthe
worldcruise.Why?
15. Theelasticityofdemandforautomobilesisgenerallyinelastic;however,foraspecific
makeandmodelitmaybeelastic.Why?
16. Arethefollowingstatementstrueorfalse?Explaineachanswer.
a. Alineardemandcurvehasconstantelasticityofdemandateveryquantitylevel.

b. Thedemandforcornisinelastic,sosocialwelfarecanbeenhancedbydestroying
10%oftheannualcornproduction.
17. Assumeyouareonthepresidentsstaffatalargeuniversity.Theuniversityiscurrently
facingdecliningenrollments,sothepresidentisconsideringalargedecreaseintuition.
Whatfactorswouldyouconsiderinforecastingtheeffectsofsuchatuitionreduction?
18. In1982,DeltaAirlinespostedaquarterlydeficitof$16million.Inthequarterly
statement,Deltastatedthepassengermileyielddidrespondtoincreasedairfares,
increasing4%,buttheyieldincreasewasnotenoughtooffsetthedeclineinairtraffic.
Wastheelasticityofdemandelasticorinelastic?Explain.
19. IftheelasticityofdemandforAmtrakpassengerserviceisunitaryandtherailroadis
operatingataloss,canthepassengerservicebemadeprofitablebychangingitsprice?
Explain.
20. Onaradioprogramdevotedtofarmnews,itwasreported,Farmersarereceivingahigh
priceforcotton,butunluckilyproductionissubstantiallyoffthisseason.Thus,farmerswere
notreceivingthefullbenefitofthehighprice.Analyzethisstatementintermsofeconomic
theory.
Chapter5Exercises
11. Aregionaltransitdistrictisinafinancialcrisis.Cityandstatesubsidiesforitsoperation
arebeingdiscontinued.Toavoidthiscrisis,thetransitauthorityincreasesfaresby100%.
Afteroneyearofthisfareincrease,thedistrictreportsarevenueincreaseof70%.
a. Estimatethepriceelasticityofdemand.
b. Estimatethepercentagedropinridershipasaresultofthefareincrease.
12. Forthelineardemandfunction
Q1=a+bp1+oI+dp2,
wherea,b,o,anddareparameters,showthatatanypointonthehousehold'sdemand
curvetheownelasticityofdemandisindependentofIandtheothercommoditysprice.
13. UseindifferencecurvesandbudgetconstraintstoillustratewhyWippie,wholoves
hamburgersandlikescola,hasaninelasticdemandcurveforhamburgers.
14. AssumeBriansincomeelasticityofdemandformilkis1,andhespends1%ofhis
incomeonmilk.Ifhispriceelasticityofdemandformilkis0.03,whatishis
substitutionpriceelasticity?
15. Giventhemarketdemandfunction
Q=abp,

wherebandaarepositiveconstants,whatistheelasticityofdemandatQ=0,Q=a/b,
andQ=b/a?
16. SoftredwheatisproducedintheSoutheasternUnitedStatesandprimarilyusedasflour
forpastries.Thus,thiswheatisconsideredaluxurygoodwithanincomeelasticity
greaterthan1say,2.Incontrast,hardredwheatproducedintheMidwesternUnited
Statesisusedasflourforbreadandthusisconsideredanecessarygoodwithanincome
elasticitylessthan1say,1/2.
AnewspaperarticleappearingintheAtlantaJournalstatedthattheincreased
consumptionofUnitedStateswheatbythethenUSSRwouldhavenoeffecton
SoutheasternwheatproducersbecausetheUSSRwasinterestedinpurchasinghardred
winterwheat.WiththeadditionalassumptionthattheUSSRsshareofexpenditures
betweenhardandsoftwheatis95%and5%,respectively,answerthefollowing.
a. Whatistheassumedcrosspriceelasticityofdemandforsoftwheat,givenaprice
changeinhardwheat?Issoftwheatagrosscomplementorgrosssubstituteforhard
wheat?
b. Whatisthecompensatedcrosspriceelasticityofdemandforsoftwheat,givenaprice
changeinhardwheat?Showthatitisimpossibleforsoftwheattobeanet
complementforhardwheat.
Chapter6Questions(none)
Chapter6Exercises
11. MissCorehasanappleorchardwithnoroomforavegetablegarden.Mr.Vegehasa
largevegetablegardenbutnoorchard.MissCoresMRS(applesforvegetables)is3.Mr.
VegesMRS(applesforvegetables)is1/2.Determinehowtradecanmakethetwo
individualsbetteroff.
12. AssumeRobinsonsandFridaysutilityfunctionsforbread,x2,andfish,x1,are
UR=min(x2,x1/2), andUF=4x2+3x1.
InitialendowmentsforRobinsonarex2=20,x1=60andforFridayx2=30,x1=40.Atthe
competitiveequilibrium,whatwillbetheequilibriumpriceratio?Whowillobtainthe
gainsfromcompetitivetrading?
13. RobinsonhaspreferencesrepresentedbytheutilityfunctionUR(x1,x2)=x1+x2,and
FridayspreferencesarerepresentedbyUF(x1,x2)=min(x1,x2).
a. IllustratethesepreferencesinanEdgeworthboxdiagram.
b. Whatistheequilibriumpriceratio?
c. Whatistheequilibriumallocation?
14. LemonsandlimesaredistributedbetweenMs.PulpandMr.Tart.Ms.Pulpsmarginal
rateofsubstitutionoflemonsforlimesis2andMr.Tartsmarginalrateofsubstitutionis

1/2.Inwhichdirectionshouldtradetakeplace?HowcanthistradeincreasebothMs.
PulpsandMr.Tartssatisfaction?
15. Consideratwohousehold,twocommodityexchangeeconomywithinitialendowments,
(eR1,eR2,eF1,eF2)=(25,100,250,10),andutilityfunctions
UR(xR1,xR2)=(xR1)2xR2 and
UF(xF1,xF2)=xF1(xF2)2.
a. Derivetheequationdefiningthecontractcurve.
b. Derivetheoffercurveequations.
c. Solveforthecompetitiveequilibriumallocationandprices.
Chapter7Questions
11. WhatdidJohnMaynardKeynesmeanwhenhewroteinthelongrunwearealldead?
12. Whywouldafirmeverkeepanyinputsfixedinthefaceofchangingmarketconditions?
Whatdetermineswhichinputsareheldfixedandwhichareallowedtovary?
13. Assumeyouarethemanagerofapizzaparlor.Howwouldknowledgeofyourproduction
functionaidinyourmanagementdecisions?
14. Afarmerpurchasesafertilizerplant,soshenowhasaccesstoalargeamountoffertilizer
andspreadsitoverafixedamountofland.Whatmayhappentothemarginalproductof
land?Explainhowinputproportionsaffectthemarginalproductsofinputs.
15. TheUnitedStatesistroubledmorebyagriculturalsurplusesthanshortages.Thisshows
thatMalthussLawofDiminishingMarginalReturnsisaninvalidconcept.Trueorfalse?
Explain.
16. Assumeyouhavealargeflowerpotandallthewater,seeds,sunlight,andnutrientsyou
required.Whywilldiminishingmarginalreturnsstillresult?
17. IftheLawofDiminishingMarginalReturnsdidnotexist,theentireworldssupplyof
foodcouldbegrowninaflowerpot.Trueorfalse?Explain.
18. Furthereffortswillbefruitlessbecauseyouhavereachedthepointofdiminishing
returns.Isthiscommonuseofdiminishingreturnscorrect?Explain.
19. Ifafirmisoperatingintheregionofdiminishingreturns,itshoulddecreaseitscurrent
levelofthevariableinput.True,false,oruncertain?Explain.

20. Astudentisobservednottostudybeyondthepointofdiminishingmarginalreturnswhile
preparingfortheCPAexamination.Doyouthinkthisstudentwillmakeagood
economist?
21. WhyisitfeasibletooperatesomewhereinStageIIofproductionwithoutknowingthe
costoftheinput?
22. Ifengineerspreparedanequationyieldingthetechnicallyefficientlevelofproductionfor
agivensetofinputs,cantheythenfindtheoptimumproportionofinputs?Explain.
23. Areisoquantsdrawnconvexduetotheoreticalandempiricalreasonsorbecauseitis
convenientformakingsecondorderconditionsforconstrainedcostminimizationvalid
forinteriorsolutions?Explain.
24. Dofirmstendtospecializeordiversifyintheemploymentofinputs?Areconvex
isoquantsconsistentwithyourconclusion?Whatwouldbeobservedifisoquantswere
concavetotheorigin?
25. Inthelongrun,considerafirmwithaproductionprocesscharacterizedbyperfectly
substitutableinputs.Isitpossibletodetermineifthemarginalrateoftechnical
substitutionishighorlow?Explain.
26. Arefixedproportionsproductionfunctionslinearhomogeneous?
27. Ifthereisonlyonetypeofinputinproduction,isitpossibleforconstantorincreasing
returnstoscaletoexist?Explain.
28. ComparetheLawofDiminishingMarginalReturnswiththeconceptofdecreasing
returnstoscale.
29. IstheLawofDiminishingMarginalReturnsapplicableinthelongrun?
Chapter7Exercises(none)
Chapter8Questions
11. Cantherebeproductionwithoutcosts?Explain.
12. IntheUnitedStates,alargepercentageoffoodisproducedonfamilyownedand
operatedfarms.Thisismoreefficientthancorporateownedfarms,becausefamilyfarms
donothavetopayformostofthelaborinput.Trueorfalse?Explain.

13. Ifafirmwantstoestimateitscostfunction,doesithavetoknowhowmuchprofitit
wouldmakeateachoutputlevel?Explain.
14. Ifafirmisproducingwherev1/MP1>v2/MP2,whatcanitdotoreducecostsbutmaintain
thesameoutputlevel?
15. Istheproblemofleastcostproductionforagivenlevelofoutputimportantonlyfor
producersorisitalsoimportantforconsumers?Explain.
16. Intermsofleastcostproduction,whichismoreefficient,Japaneseagriculturewithits
intensiveuseoflandorUnitedStatesagriculturewithitsfarlessintensiveuseofland?
Howhaverelativepricesinthetwocountriesresultedinalternativetypesoffarming?
17. DuringWorldWarIItheUnitedStatesconstructedairstripsinChinaemployinglocal
labor.Withoutmachinery,theworkersmixedconcreteandtransportedittoformthe
runway.Whywouldithavenotbeenmoreefficienttoinsteadusemachinery?
18. Wouldafirmalwayscontinuetoincreaseproductionaslongasitexperiencedeconomies
ofscale?
19. Ifafirmcouldproduceanoutputandmaintainconstanteconomiesofscaleatalllevels
ofoutput,whatwouldbetheshapeofthefirmslongrunaveragecostcurve?Wouldits
shortrunaveragecostcurveshavethesameshape?
20. Cantheconditionoflongruncostsdecliningandthenincreasingbeexplainedby
decreasesandincreasesininputprices?Explain.
21. Whatiswrongwiththefollowingstatementfromanindustrialplantmanager?
Myplantisworkingatitsmostefficientoutputlevel.However,ashortrunincrease
indemandcanbecoveredbyrunningthelinesatafasterrateanddeferringroutine
maintenance.Thus,intheshortrun,mymarginalcostisrealisticallyzero.
22. StateandexplaintheLawofDiminishingMarginalReturns.Whatbearingdoesthislaw
haveuponshortruncosts?
23. RefertoExercise3inChapter7,concerningprobabilityofatrafficaccident.Cautionis
costly,itrequirestimeandalertness.Explainwhydriverswillgenerallynottake
completecaution.
24. Longrunaveragecostinvolvesthefullcostofallinputswhereasshortrunaverage
variablecostinvolvesthecostofonlythosevariablefactors.However,shortrunaverage
variablecostmayexceedlongrunaveragecost.Doyouagreeordisagreewiththis
statement?Explain.

25. Forrailroads,approximately2/3oftotalcostsarefixed,withtheremaining1/3variable,
soSAVCisonlyonethirdofSATC.Thus,railroadswillimprovetheirprofitpositionby
increasingrailtrafficatrateslowerthanSATC.Isthisstatementvalid?Explain.
26. Wheretherearetwoormorevariableinputs,asupplycurveisbasedontheassumption
thatproductionisefficient.Trueorfalse?Explain.Whataboutonlyonevariableinput?
27. Whataretheimplicationsofaproductiveactivitywheremarginalcostneverincreases?
Chapter8Exercises
11. Considertheproductionfunction
q=K1/4L1/3.
DerivetheleastcostcombinationofKandLasafunctionofinputpricesandoutput.
Graphandexplaintheresult.
12. Arecentstudyestimatestotalfarmoutputwouldremainconstantif5tonsoffertilizer
weresubstitutedfor1acreofland.Ifthepriceof1tonoffertilizeris$150,whatisthe
lowestrentalpriceof1acreoflandthatinducefarmerstosubstitutelandforfertilizer?
13. Amanufacturerofautopartshiresitsassemblylinelaborfor$44anhour,andtherental
costofitsmachineryis$240perhour.Assumeanautopartcanbeproducedinfixed
proportionsof4hoursoflaborto1hourofmachinery.Ifthefirmiscurrentlyusing3
hoursoflaborfor1hourofmachinetime,isitminimizingitscostsofproduction?
Explain.
14. Afirmsexpansionpathisa45olinewhenq=KLand=,regardlessofthevalues
forand.Isthisstatementtrueorfalse?Explain.
15. Assumethelongruntotalcostfunctionforafirmis
LTC=q+q2+q3.
a. Whatislongruntotalfixedcost(LTFC)?
b. CalculateLMCandLAC.
16. Assumeafirmsproductionfunctionisgivenbyq=KLwith=.Isittruew/MPL=
v/MPK=LMCandLMCisaconstant?Explain.
17. Oftenthefollowinggraphwillbeobservedintextbooksandpresentedinlectures.
Unfortunately,therelationshipbetweenSAVCandSMCiswrong.Explainwhyitis
wrongandconstructthecorrectrelationship.Note,STVC1=SAVC1(q1),whichis
representedbythearea0(SAVC1)Aq1;however,STVC1alsomaybedefinedas
STVC1=q01SMCdq,whichisrepresentedbyarea0BAq1.

18. Deriveshortruntotalvariablecost,totalfixedcost,totalcost,averagevariablecost,
averagetotalcost,andmarginalcostcurvesunderthefollowingassumptions.
a. Productionexhibitsaconstantmarginalproductivityoflabor.
b. Production,atfirst,exhibitsincreasingmarginalproductivityoflabor,butthen
exhibitsdiminishingmarginalproductivityoflabor.
c. Allcostsarefixed.
d. Allcostsarevariable.
19. Assumetheshortruntotalcostfunctionforafirmisthecubicequation
STC=+q+q2+q3.
a. CalculateSATC.
b. CalculateSAVC.
c. CalculateSMC.
d. ShowSTCisconsistentwithUshapedSATC,SAVC,andSMCcurvesforatleast
somevaluesoftheparameters,,and.
20. GraphtheSATC,SAVC,TFC,SMC,LAC,andLMCfortheassociatedcostcurvesinthe
figure.

Cost

STC"
LTC

STC'
STC

Output

21.
GraphtheLTC,STC,STVC,SATC,TFC,SMC,LAC,andLMCforatechnologywith
allthreestagesofproductionandreturnstoscale.
22. Aperfectlycompetitivefirmhasacostfunctiongivenby
STC=(1/2)q2+10q+50.
a. Whatisitstotalvariablecostandtotalfixedcost?
b. Graphthemarginalandaveragecostcurves.

c. Doesthiscostfunctionrepresentincreasing,decreasing,orconstantmarginal
productivity?
23. Aproducerhastwofactoriesproducingidenticalproducts.Eachfactoryhasaproduction
unctiongivenby
qj=(KjLj)1/2, j=1,2.
Thefirmsdifferintheamountofcapitalwithfactory1havingK1=25andfactory2
havingK2=100.RentalrateforKandwagerateforLarew=v=1.
a. Howshouldoutputbeallocatedbetweenthetwofactoriestominimizeshortruntotal
costforagivenleveloftotaloutputQ?
b. Giventhatoutputisoptimallyallocatedbetweenthetwofactories,calculatetheshort
runtotal,average,andmarginalcostcurves.
24. Considerthefollowingshortruntotalcostfunction
STC(q,K)=q31/2q2Kq+K2.
a. Deriveshortrunaveragetotalcostandmarginalcostfunctions,whereKdenotesthe
leveloffixedinput.
b. Derivelongruntotalcost,averagecost,andmarginalcostfromtheshortruntotal
costfunctionyouderivedinpart(a).
c. Geometricallyillustratetheresults.
25. Assumeafirm'sfixedcostsare$100.Oneworkerproduces10unitsofoutput,andthe
marginalproductoflaborincreasesatarateof2additionalunitsofoutputperadditional
workerforthefirst5workersandthenfallsatarateof1peradditionalworker.Ifthe
wagerateis$20perworker,calculatealltheshortruncostsoverthefirst12workers
hired.
26. Considerthefollowingcostfunctions.
i. LTC(q)=3q36q2,
ii. STC(q)=8q2+800.
Foreachfunction,answerthefollowing
a. Whatisitstotalvariablecostandtotalfixedcost?
b. Atwhatoutputisaveragecostminimized?
c. Graphthemarginalandaveragecostcurves.
27. Inafamousarticle[J.Viner,"CostCurvesandSupplyCurves,"ZeitschriftFur
Nationalokonomie3(September1931):pp.2346],J.Vinercriticizedhisdraftsman
becausehecouldnotdrawafamilyofSATCcurveswhosepointsoftangencywiththe
LACcurvewerealsotheminimumpointsoneachSATCcurve.Thedraftsmanstatedthat
suchadrawingwasimpossibletoconstruct.Whowascorrect?Whatisthecondition
wherebothwouldbecorrect?

28. Foreachallowableshapeoftheaveragecostcurves,showtheimpliedshapeofthe
marginalcostcurves.
29. StateaSlutskytypeequationforafirmthatmaximizesprofitsubjecttoacostconstraint.
Chapter9Questions
11. Anairlineisconsideringaddinganadditionalroutetoitsschedule.Itdeterminesthatthe
ticketrevenuefromtheroutewillcoverfuel,maintenance,andlabor,butwillnotcover
allofthecosts.Shouldtheairlineaddtheroute?Explain.
12. Whyisitassumedthatafirmsobjectiveistomaximizetotalprofitratherthanmarginal
profit?
13. Whyisitnotsensibletocloseabusinessifitisearningzeropureprofits?
14. Aproducerwilldeterminewhethertooperateornotbyconsideringhershortrunaverage
variablecosts,herprofitlevelbyconsideringhershortrunaveragetotalcost,andher
optimallevelofoutputbyconsideringhershortrunmarginalcost.Trueorfalse?
Explain.
15. Thegreatermysales,thegreatermyprofits.Trueorfalse?Explain.
16. Explainwhyaperfectlycompetitivefirmdoesnotexpanditsoutputwithoutlimit,given
thatitcansellallofthisoutputatthesameperunitprice.
17. Douglassfirmiscurrentlyoperatingataloss.Iftheoutputpriceincreases,hewillnot
increasequantitybecauseifhedidmarginalcostwouldriseandhewouldbelosingeven
more.Trueorfalse?Explain.
18. Regardlessoftheamountofwaterused,thepricepercubicfootthepublicutilitycharges
isthesame.Whatthenistheelasticityofsupplyforwater?Explain.
19. WhenpricesontheTokyostockexchangefall,financialreportsindicatethatthecauseis
heavyselling.However,foreverysharesoldashareisbought.Whynotrefertoitas
heavybuying?
20. Kenyaisinterestedindiscouragingthepoachingofelephantsfortheirivory.When
contrabandivoryiscaptured,whatshouldthegovernmentdowiththeconfiscatedivory?
21. Itisclaimedthatonthefirstofthemonth,whenwelfareandSocialSecuritychecksare
paidincityghettos,storeownersneverdiscountpricesandthusearnhigherprofits.If
highprofitsareearnedbythesestoreowners,whatmayhappeninthelongrun?

22. Inaperfectlycompetitivemarket,whywillallthebenefitsfromatechnologychange
accruetoconsumersintheformoflowerprices?
23. Aperfectlycompetitivefirmcansellalltheoutputitcanatagivenmarketprice.Yet,
whentherewasanabundantcottonharvest,afarmerreceivedalowerpricewhenhesold
hislargeharvest.Whathappened?
24. TheU.S.DepartmentofAgriculturerecentlypredictedbumpercropsofcornandwheat,
buttheassistantsecretaryforeconomicswarnedconsumersnottoexpectpricesto
decrease.Hecitedtherisingcostofproductionandincreasedexportdemandrisingas
reasonsforhiswarning.Theassistantsecretarystated,Theclassicpatternofsupplyand
demandwontworkthistime.Ishisstatementtrueorfalse?Explain.
25. Assumeyourcurrenttotalrevenueinfarmingis$120,000peryearandyourcostsare
$10,000peryearforseedandfertilizer,$12,000forothersupplies,and$15,000interest
onmachineryloans.Youareofferedanotherjobthatwouldpay$50,000peryear.Ifyou
takeit,youwillsellyourfarmandmachineryandearn$70,000peryearinterestonthe
moneyyouhadinvestedinlandandmachines.Shouldyoutaketheotherjob?Explain.
26. Mr.Youngonlyhastheknackforalwaysplantingthebestcropandconsistentlyearns
higherprofitsthanotherfarmers.Arethesereallyhigherprofitsorsomethingelse?
Explain.
27. Hazelistheproductionmanagerofanassemblyline.Theequipmentonthelineisunder
alongtermleasingagreementwitharentalrateasafunctionoftheprimerateofinterest.
Recently,therentalratehasgoneupdramatically,soHazeldecidestoreducethe
productionratealongtheline.Didshemakethecorrectdecision?Explain.
28. Ifatanequilibriumprice,everyfirmintheindustryisearningazeropureprofit,does
thisimplythatafallinmarketpricewillresultinallfirmsshuttingdown?Explain.
29. Anagriculturalexperimentsstationdirectoratamajorcollegeofagricultureinthe
SoutheasternUnitedStatesstatedthatsoybeansarecurrentlynotprofitableduetolow
prices.Thus,economistsshouldinvestigatealternativecropsforsoutheasternfarmers.
Givencontinuedlowpricesforsoybeans,willsoybeanproductionremainunprofitable?
Explain.
30. SomeeconomichistoriansclaimtheIndustrialRevolutionwascausedbyrisingdemand
thatencouragedfirmstoexpandproductionwhileothersargueitwasduetorapid
technologicalchangeincreasingsupply.Whatwastheprobablemajorcauseandwhy?
31. Thesupplycurveforafirmintheshortrunistheshortrunmarginalcostcurve(above
thepointofminimumaveragevariablecost).However,thesupplycurveinthelongrun

isnotthelongrunmarginalcostcurve(abovethepointofminimumaveragetotalcost).
Why?
32. Inthelongrun,aperfectlycompetitivefirmalwaysoperatesattheminimumlevelof
averagecostsfortheoptimalplantsizetoproduceagivenamountofoutput.Trueor
false?Explain.
33. Why,intheshortrun,isperfectlycompetitiveequilibriumwherep=SMC,whileinthe
longrunequilibriumitiswherep=SMC=SATC.
34. Ifthelongrunequilibriumforafirmischaracterizedbyzeropureprofit,whywould
firmsadoptnewcostreducingtechnologies?
35. Itisarguedthatagriculturalresearchbenefitslowincomehouseholdsrelativelymore
thanthosewithhigherincomes.Why?
36. Diseconomiesofscaleareseldomobservedinanindustry.Why?
37. Economistshaveestimatedtheoptimumsizeofaplantbyinvestigatingtheexistingplant
sizes,assumingthatplantsthathavesurvivedmustbeclosetooptimumsize.Isthisa
reasonableassumption?Explain.
38. Assumethatanincreaseinthedemandformoviesincreasesthesalariesoffilmartists
substantially.Isthelongrunsupplycurveformovieslikelytobehorizontalorupward
sloping?Explain.
39. SupposeCongresspassesalawprovidingasubsidyforeveryacreoflandusedfor
growingtobacco.Howdoesthisprogramaffectthelongrunsupplycurvefortobacco?
40. Itisinconsistentwiththeperfectlycompetitivemodelforafirminalongrunequilibrium
toeverproduceapositivequantitywhereitslongrunaveragecostsarecontinuously
declining.Whataretheimplicationsofthisforanindustrywhereallfirmshavedeclining
averagecosts?
41. Intheearlypartofthelastcentury,chickenwasconsideredsomethingspecial,andwas
mainlyservedonlyonspecialoccasionsoronSunday.Today,chickenisquitecommon
andservedthroughouttheweek.Explainthisincreaseinthepopularityofchicken.
42. AnAtlantacabdriverappearstobemakingapureprofitinthelongrunafteraccounting
fortheoperatingandlaborcosts.Doesthisviolateeconomictheory?Explain.
43. Perfectlycompetitiveindustriesdonotreallyexist,sowhatisthepointofstudyingthem?

44.Assumethatafirmismaximizingprofit,intheshortrun,withvariablelaborinputanda
fixedlevelofcapital.Ifwagesdecline,whathappenstothefirmsuseofcapital?What
happenstothefirmslevelofprofit?
Chapter9Exercises
11. Supposethemarketdemandforfingernailpolishis
QD=3p+14,
andmarketsupplyis
QS=2p215p+30.
Whataretheequilibriumpricesandquantitiesforthismarket?Whichofthesepricesand
associatedquantitiesrepresentastableequilibrium?Explain.
12. Aperfectlycompetitivemarketiscomposedof1000firms.Theshortrunsupplyfunction
foreachfirmis
q=100+25p.
Themarketdemandfunctionis
QD=80,0005000p.
a. Calculatetheshortrunequilibriumpriceandmarketquantity.
b. Determinethedemandcurvefacinganyonefirm.
c. Attheequilibriumoutput,determinetheelasticityofmarketdemandandelasticityof
demandfacinganyonefirm.
13. Aperfectlycompetitivefirmhasacostfunctiongivenby
STC(q)=q2+8q+1.
a. WhatareitsSTVCandTFC?
b. Whatisitssupplycurve?
c. Whatistheelasticityofsupply?
d. AtwhatoutputisSATCminimized?
e. Ifthereare500identicalfirmsinthisindustry,whatistheindustry'ssupplycurve?
f. IfthemarketdemandfunctionisQD=50p+1000,whataretheequilibriumprice
andquantity?
g. Whatistheelasticityofmarketdemandandsupplyattheequilibriumpriceand
quantity?
h. Whatistheequilibriumlevelofoutputforanindividualfirm?
i. Whatistheelasticityofdemandfacingeachindividualfirm?
j. Isafirminthismarketearningapureprofit,anormalprofit,oroperatingataloss?
14. Twentyidenticalfirmsproducedecksofcardsinaperfectlycompetitivemarketeach
withthefollowingshortruntotalcostfunction
STC(q)=(1/4)q2+(1/10)wq+10.
a. Ifw=5,whatisthefirmsshortrunsupplycurve?

b. Whatisthemarketsupplycurve?
c. Howmanycarddeckswillbeproducedatamarketpriceof$2perunit?
15. Assumethatthetechnologyforproducingacommodityusingcapital,K,andlabor,L,is
q=f(K,L)=K1/2L1/2.Intheshortrun,letcapitalbefixedat4unitswiththerentoncapital
of1andawagerateof4.Thefirmisfacingthefollowingmarketdemandfunction
QD(p)=605p,
with10competitivefirmsinthisindustry.
a. Whataretheshortrunindividualfirmssupplyfunctionandtheindustrysupply
function?
b. Whatarethemarketequilibriumpriceandquantityandhowmuchdoeseachfirm
supply?Whatisthelevelofprofitforeachfirm?
16. Assumeafirm'sshortruntotalcostfunctionis
STC=(1/3)q34q2+22q+100.
a. Determinetheoutputlevelatwhichitmaximizesprofitsifp=10.
b. Isthefirmearningapureprofit,normalprofitoroperatingataloss?
17. Aperfectlycompetitivemarketiscomprisedof1000producers,eachwiththevariable
costfunction
STC(q)=0.5q2+0.2q+6.
Thefirmsarefacingthefollowingmarketdemandfunction
QD=7,8001,000p.
a. Derivetheshortrunsupplyfunctionforanindividualproducer.
b. Derivetheshortrunmarketsupplyfunction.
c. Whatarethemarketequilibriumpriceandquantity?
d. Whataretheoutputandprofitofeachproducer?
18. Acompetitiveindustryhas1,000firms.Inthemarketperiod,eachofthefirmshasa
fixedsupplyof50units,andthemarketdemandfunctionis
QD=75,0005,000p.
a. Calculatethemarketequilibriumprice.
b. Calculatethedemandfunctionfacinganyonefirm.
c. Attheequilibriumpriceandquantity,determinetheelasticityofmarketdemandand
theelasticityofthedemandfacinganyoneseller.
d. Whatarethenewequilibriumpricesifonesellerdecidestosellnothingorifone
sellerdoublesitsoutput?
e. Intheshortrun,assumeeachfirmssupplyfunctionisq=100+20p.
Giventhisindividualsupplyfunction,answerquestions(a)through(d).
19. Derivethefirstorderconditionsforaprofitmaximizingfirmandinterprettheresults
whenthefirmhasatotalexpenditureconstraint.

20. Provethataprofitmaximizingfirmwillalwaysminimizecost.
21. Todeterminetheprofitmaximizinglevelsofoutput,q,andinputs,LandK,wecanuse
thefollowingconstrainedmaximizationproblem
max=max(pqwLvK), s.t.q=f(L,K).
EmployingtheLagrangiangives
(q,L,K,)=pqwLvK+[qf(L,K)].
a. Showthatprofitmaximumcaninsteadbeachievedintwostepsbyfirstminimizing
costsubjecttoagivenlevelofqandthenmaximizingoverq.TheLagrangianis
=max(pqmin{wL+vK+[qf(L,K)]}).
b. Showthatprofitmaximizationimpliescostminimizationattheprofitmaximizing
levelofoutput.
22. Considertheutilitymaximizationproblem
maxU(maxU(pqwLrk), s.t.q=f(L,K).
(L,K,q)

AssumingtheutilityfunctionismonotonicallyincreasingindU/dderivethe
F.O.C.sformaximizingutility.DotheseconditionsdifferfromtheF.O.Csofafirm
maximizingprofits?Explain.
23. Consideracentralauthoritywhooperatestwofirmswiththeobjectiveofminimizing
shortruntotalcostforagivenlevelofaggregateoutput,Q.Specifically,
minSTC(Q)=min[STC1(q1)+STC2(q2)], s.t.q1+q2=Q.
a. Derivethefirstorderconditionsforthiscostminimizationproblem.
b. Showthatatthecostminimizingproductionallocation,SMC(Q*)=SMC1(q)=
SMC2(q).
c. Showforallprofitmaximizingfirmswithoutputpricep=SMC(Q*)thesamecost
minimizingallocationresults.
24. Assumethattheshortruntotalcostfunctionforeachcheeseproduceris
STC=q210q+100,
andthemarketdemandforcheeseis
QD=10p+300.
a. Foreachcheeseproducer,whatwillbethelongruncompetitiveequilibriumoutput
associatedwiththisSTCfunction?
b. Assumingthecheeseindustryexhibitsconstantcostsandallfirmsareidentical,what
willbethelongrunequilibriumpriceandmarketquantityofcheese?Howmany
firms,n,willbeinthischeeseindustry?
25. Illustratethelongrunequilibriumforaperfectlycompetitivefirmwitheconomiesof
scaleoveritsentirerangeofoutput.Whatistheequilibriumlevelofoutputandprofit?

26. Alocalgovernmentpassesalawthatprohibitsadditionalfirmsfromenteringaconstant
costindustry.TheexistingfirmsintheindustryhaveUshapedlongrunaveragecost
functions,andtheindustrywasinlongrunequilibriumbeforeentrywasblocked.
Determinethenewlongrunequilibriumoftheindustryandarepresentativefirmafteran
increaseinmarketdemand.
Chapter10Questions
11. Considertwosteelplants,oneinChinaandoneinEurope.Oneplantemploysfive
workerspertonofsteel;theotheremployssevenworkersperton.Canitbedetermined
whichplantismoreefficientintermsoftechnologicalefficiency?Howabouteconomic
efficiency?Explain.
12. InhisPrinciplestextbook,AlfredMarshallgavethefollowingmeasureforconsumer
surplus:
Theamountaconsumerwouldpayoverwhichhedoespayforagivenamountofa
goodratherthannoneatall.
Anotherconsumersurplusmeasureis
Themonetaryequivalentofthefallinutilityaconsumerwouldexperienceiftheright
topurchasethegoodatthemarketpriceweretakenaway.
Whatrelationship,ifany,existsbetweenthesetwomeasures?Discuss.
13. Assumethemarketsupplycurveisvertical,S=0.Whatisthedeadweightlossofasales
taxorasubsidy?
14. Whyisp=MCsuchabigdeal?
15. Whatissohotaboutperfectcompetition?
16. Inlongrunequilibrium,p=LAC=LMC.Ofwhatsignificanceisp=LAC?Howabout
p=LMC?Inanswering,distinguishbetweentechnological,allocation,andscale
efficiency.
17. Ifhalfofatropicalrainforestisdestroyedinaregion,thevalueoftheremainingforest
wouldbegreaterthanthevalueofthewholeforestpriortoitsdestruction.Thus,the
wholeisworthlessthanthehalf.Thisillustrateshowtheconceptofvalueisdistortedin
amarketeconomy.Trueorfalse?Explain.
18. Explaintheconceptofconsumersovereignty.
19. Woulditbecorrecttodefineanequilibriumpriceasthepriceatwhichthequantity
purchasedequalsthequantitysold?Explain.

20. Demandandsupplyareconstantlychangingtoreflectmarketconditionssuchas
changingpreferencesandtechnologies.Withchangingmarketconditions,whatismeant
whenthepopularpresstalksaboutshortagesofteachers,computerprogrammers,or
housing?
21. Discussthepossiblesocialadvantagesanddisadvantagesofariseinthepriceofwater
duringadrought.
22. ARomanemperordeclaredthereshouldbecheapness.Forwhereverhislegionsgo,
pricesforfoodincreasemanyfold.Whatwillbetheresultofhisdeclaration?Explain.
23. Whywouldanyonebeagainstimposingpricecontrolsonnecessarygoodstoprotectthe
poorwhenfacingrapidlyrisingprices?
24. Pricecontrols,designedforrationingavailablesupply,generallyworkashopedduringa
nationalemergency.However,oncetheemergencyhaspassed,suchpricecontrolsare
lesseffective.Trueorfalse?Explain.
25. Thedemandforillegaldrugsisgenerallyhighlyinelasticandmotivatesalarge
proportionofthecrimecommittedinU.S.innercities.Ifasocialworkersobjectiveisto
reducedrugusewithoutcausinganincreaseincrime,wouldshesupporttougher
penaltiesforusersordealers?Explain.
26. Ifitistruethatthedemandforillegaldrugsishighlyinelastic,wouldusersbeinfavorof
tighterorloosercontrolsoverdrugtraffic?Explain.
27. Willtheestablishmentofminimumhousingstandardsnecessarilybeinthebestinterest
oflowincomehouseholds?Whatwillbetheeffectofthesestandardsonthequantity,
quality,andpriceofhousing?
28. InthepastthegovernmentregulatedofU.S.petroleumindustrybyplacingapricefreeze
onoldoil,whereoldoilwasdefinedaspetroleuminexistingwells.Anydevelopmentof
newwellswouldbeconsiderednewoilandnotsubjecttothepricefreeze.Itwas
assumedthatpetroleumfromexistingwellswouldcontinuetobesuppliedevenasthe
priceofnewoilincreased,andthehigherpricefornewoilwouldencouragethe
developmentofnewwells.Wasthisassumptioncorrect?Explain.
29. Explainwhatmighthavehappenedifthegovernmenthadimposedapriceceilingon
coffeeinthelate1970safterthepricerose400%?
30. InFrance,rentcontrolfrom1914to1948resultedinlimited,ifany,residential
construction.Whydidthisresultoccur?

31. Givenaceilingprice,doestheblackmarketpriceindicatewhatthelegalmarketprice
wouldbewithouttheceilingprice?Explain.
32. Wouldthemafiadealinsummersquashifitbecameanillegalcommodity?Whyorwhy
not?
33. Howhasthelegalizationofabortioninfluencedthedemand,supply,price,quantity,and
qualityoftheservice?
34. Recentlyanumberofgovernmentshaveimposed(orproposeto)astrongerpenaltyfor
drugdealerswithaweakerpenaltyforusers.Whatwilllikelyhappentothepriceand
quantityofdrugsconsumed?Explain.
35. GreatBritainhasanationalhealthcareprogramwheremedicalservicesareprovidedfree
toindividuals,withthecostpaidthroughtaxes.Britishphysiciansgenerallycomplain
thatpatientsdemandtoohighalevelofservicesandpatientscomplaintheywaittoolong
forsuchservices.Asaresult,aprivatemedicalservicesmarkethasdevelopedalongside
withthepublicsystem.Issuchadualsystemefficient?
36. Whydidthegovernmentagriculturalpricesupportprogramsresultinhugestockpilesof
agriculturalcommodities?
37. Manyfarmersarguethatcroprestrictionprogramsdonotreallyimprovetheirincomes
becausethesubsidytheyreceiveperretiredacredoesnotoffsetthelossofincomefrom
producingless.Whatassumptionsaretheymakingaboutthepriceelasticityofdemand?
38. Withoutgovernmentpricesupports,farmerscouldnotaffordtogrowpeanuts,sowe
wouldnothaveanypeanutswithoutsuchsupports.Trueorfalse?Explain.
39. Assumethatlaborproductivityinagriculturegrowsattwicetheratefortherestofthe
economy.Giventhecontinuingproblemofsurplusesinagriculturalcommodities,would
decreasedproductivityinagriculturebeadesirablesolution?Explain.
40. Assumethatthesupplyofapartmentsisfixedinamarketperiod,sotheequilibriumrent
isdeterminedsolelybydemand.Ifthepropertytaxonapartmentsincreases,howmuch
ofthistaxwillbepassedontorenters?
41. Asalestaxisplacedonacompetitivefirmsoutput.Howwillthistaxaffectthecost
curvesforthefirm?Whatwillhappentothefirm'sprice,output,andprofitintheshort
run?Whatwillhappeninthelongrun?

42. Astandardindustryargumentforprotectivetariffsandquotasisthatitsoutputis
essentialfornationaldefense.Howdoesrestrictingimportsensuresuppliesofoutput
fromsuchanindustry?Whatalternativepoliciesareavailable?
Chapter10Exercises
11. Assumethefollowingmarketdemandandsupplyfunctions:
QD=5002p, QS=p100.
a. Determinethemarketequilibriumpriceandquantityalongwithconsumerand
producersurplusatthisequilibrium.
b. IfquantityisreducedtoQ=50fromthismarketequilibrium,whatwouldbethe
deadweightloss?AssociatedwithQ=50,atp=225whatistheproducerand
consumersurplus?Howaboutatp=150?
c. IfquantityisincreasedtoQ=150,whatwouldbethedeadweightloss?
12. AssumethedemandcurveinExercise11shiftsoutwardto
QD=8002p.
a. Determinethenewmarketequilibriumpriceandquantityalongwithconsumerand
producersurplusatthisnewequilibrium.
b. Ifaceilingpricepreventsanypricerise,howwouldthisshiftindemandaffect
consumerandproducersurplus?What,ifany,isthelevelofdeadweightloss?
13. Comparetheeffectonacompetitivefirm'soutputandpricedecisionsofa$1taxperunit
outputversusa$1000licensefeeregardlessofoutputlevel.
14. Inthelongrun,asalestaximposedonadecreasingcostindustrywillraisemarketprice
bymorethanthetax.Explainwhythiswilloccur.
15. Assumeacountryimportingagoodisfacingapositivelyslopingsupplycurvefor
imports.
a. Graphicallyillustratetheequilibriumprice,domesticsupplyanddemand,andlevelof
imports.
b. Illustratethechangesinconsumerandproducersurplusalongwiththedeadweight
lossfromtheimplementationofatariff.
Chapter11Questions
11. Explaintherelationshipbetweentheproductionpossibilitiesfrontierandthedefinitionof
economics.

12. Supposeanewinventioncausesaconstantreturnstoscaleproductionprocessforfoodto
becomeanincreasingreturnsprocess.Howdoesthischangeaffecttheproduction
contractcurveandproductionpossibilitiesfrontier?
13. Aperfectlycompetitivepricethatallagentstakeasgivenisthekeytoeconomic
efficiency.Trueorfalse?Explain.
Chapter11Exercises
11. Giventheproductionfunction,q21+q22=LK1/2,determinetheprofitmaximizinglevels
ofq1,q2,L,andK,ifp1=8,p2=4,w=1,andv=2.
12. Suppose1unitoffoodrequires3unitsoflaborandeachunitofclothingrequires2units
oflabor.Given24totalunitsoflabor,determinetheproductionpossibilitiesfrontier.
Whattypeofopportunitycostdoesthisfrontierrepresent?
13. Assumethattheallocationofcapitalandlabortotheproductionofcommoditiesq1andq2
isnotParetoefficient.Showwhattheinputpriceratiomustbeifthefirmthatproduces
q1isminimizingcostandifthefirmthatproducesq2isminimizingcost.Willthefactor
priceratiobedifferentforthetwofirms?
14. Completethefollowingtable.
Priceof
MarginalCostof
A
A
8
10

MarginalCostof
B
12

Priceof
B
48
30

16

12

15

32

15. Consideraneconomywiththefollowingtechnologyfortheproductionoffishandbread:
F=min(L,K), andB=min(L/2,K).
a. Assumethatcapitalisunlimited,butlaborislimitedto100.Deriveandgraphthe
productionpossibilitiesfrontier.Nowassumethatlaborisunlimited,butcapitalis
limitedto75.Deriveandgraphtheproductionpossibilitiesfrontier.
b. WithK=75andL=100,deriveandgraphtheproductionpossibilitiesfrontier.
c. Explaintheconvexityoftheproductionpossibilitiesfrontierinpart(b).
d. Explainwhyproductionoffishandbreadisexactlythesameforthepriceratios1/2<
pF /pB<1.

16. SupposeRobinsonproducesandconsumesbananas,B,andcoconuts,C.Also,assume
duringacertainweekhehasdecidedtowork32hoursandisindifferentastowhetherhe
spendsthistimegatheringbananasorcoconuts.RobinsonsproductionforbananasisB=
1B/2andforcoconutsisC=1C/2,whereBandCarethenumberofhoursspent
gatheringbananasorcoconuts.RobinsonsutilityforbananasandcoconutsisU=BC.
a. IfRobinsoncannottradewiththerestoftheworld,howwillhechoosetoallocatehis
labor?WhataretheoptimallevelsofBandC?WhatistheMRPT(BforC).Whatis
hislevelofutility?
b. NowassumethattradeispossibleandRobinsoncantradebananasandcoconutsata
worldpriceratioofpB/pC=2.IfRobinsoncontinuestoproducethequantitiesofB
andCinpart(a),whatwillhechoosetoconsume?Whatishisnewlevelofutility?
c. Howdoestheanswertopart(b)changeifRobinsonoptimallyadjustshisproduction
giventheworldpriceratio?
17. Consideraoneconsumer,oneproducereconomy.Determinetheequilibriumpricesand
consumption,giventhattheproductionfunctionforcommodityqisq=1/2,theutility
functionisU(h,q)=hq,andthetotalendowmentoftimeisT=27withT=+h.
18. Considerathreehousehold,threecommodityeconomy.Eachhouseholdisinitially
endowedwith1uniteachofthethreecommodities.HouseholdsAandBhaveidentical
preferencesandcareonlyaboutcommodity1,sotheydonotderiveanyutilityfrom
consumingcommodities2and3.Incontrast,householdCcaresonlyaboutcommodities
2and3.DeterminetheParetoefficientallocationsandthecompetitiveequilibrium
prices.
19. Fortheproductionpossibilitiesfrontier
125=q21+q22,
determinetheoptimaloutputlevelsforq1andq2,ifp1=1andp2=2.Illustratethe
solutiongraphically.
Chapter12Questions
11. FirmAisapricetakerandcansellallofitsoutputatapriceof$5.Incontrast,firmB
hastoloweritspricefrom$6to$5tosellmoreoutput.Whyisntthemarginalrevenue
forfirmAthesameasthemarginalrevenueforfirmB?
12. Whatistheconditionofasinglefirminanindustrysellingatalowerpricethanwouldbe
possibleifthereweremanysmallerfirms?Explain.
13. Thefollowinggraphismeanttodescribethesituationofamonopoly.Whatswrongwith
it?

14. Whyisthepriceofanextraunitsoldbyafirmwithmonopolypowergreaterthanthe
extrarevenuereceived?
15. Onmostweekdays,theatermatineesarealmostempty.Whydomanagersoftheatersnot
lowertheirticketpricestofilluptheirtheaters?
16. Afirmwithmonopolypowerwillchargethehighestpriceitcanget.Trueorfalse?
Explain.
17. Amonopolyhasnocompetition,soitcanchargewhateverpriceitwishesanditalways
enhancesprofitbyincreasingitsprice.Trueorfalse?Explain.
18. Aprofitmaximizingmonopolyneverproducesanoutputintherangewheretheprice
elasticityofdemandislessthan1inabsolutevalue.Why?
19. Assumeafirmknowsthedemandcurveforitsproduct.Ifthefirmsobjectiveisto
maximizeprofit,explainwhyitwillpriceitsoutputsothepriceelasticityofdemandis
lessthan1.Whatistheassumptionaboutthecostofproduction?Ifproductioncostis
zero,whatistheelasticityofdemandattheprofitmaximizingoutputlevel?Iftotalcost
declinesatadecreasingratewithincreasesinoutput,whatistheelasticity?
20. Amonopolyproduces10,000unitsofsomeoutput,andthepriceelasticityofdemandat
thislevelofoutputis1/2.Whatshouldthemonopolydoandwhy?
21. Themarketdemandcurveforcocaineissaidtobehighlyinelastic.Cocaineisalsosaid
tobemonopolizedbystreetgangs,anditisassumedtheyattempttomaximizeprofit.Are
thesetwoviewsconsistent?
22. WeknowthattheLernerIndex,LI,apercentagemarkupofpriceovermarginalcost,is(p
MC)/p.Whycanthismarkupbeviewedasameasureofmonopolypower?

23. Comparedtoamanagerofafirmwithmonopolypower,amanagerofaperfectly
competitivefirmhasaneasyjobbecauseshedoesnothavetobeconcernedabout
settingtheprice.Trueorfalse?Explain.
24. Themoreprofitableafirm,thegreateritsmonopolypower.Analyzethisstatement.
25. Ifastreetgangcaneffectivelymonopolizeanillegaldrug,wouldyouexpecttoobserve
moreorlesscrime?Explain.
26. Wouldamonopolyalwayscontinuetoincreaseproductionaslongasitisexperiencing
economiesofscale?
27. Afirmshouldalwaysproduceatanoutputatwhichlongrunaveragecostisminimized.
Trueorfalse?Explain.
28. Whatismeantbythestatement,Monopoliesconcoctscarcity?
29. Monopolyisbadforconsumersbutgoodforproducers.Thus,onbalancewecannot
determineifitlowerssocialwelfare.Trueorfalse?Explain.
30. Whatiswrongwithexercisingmonopolypower?Whatisrightaboutit?
31. Ifmonopoliesareinefficient,whydogovernmentsoftentrytoprotectcertainsellers
againstpotentialcompetitorswishingtoenteramarket?
32 Microsofthastakenadvantageofitsdominantpositionintheoperatingsystemsoftware
industryandmadehugeprofits.Thus,itwouldbeperfectlyjusttoimposeaspecialtax
onMicrosoftasawayofrecoveringforsocietysomeoftheexorbitantpastprofits.True
orfalse?Whowouldpayforthistax?Explain.
33. Thesoleobjectiveindealingwithmonopolypoweriseliminatingexcessprofit.Thisis
donebysettingpriceequaltoaveragecost.Trueorfalse?Explain.
34. Whatproblemsfacearegulatoryagencyattemptingtoforceamonopolytochargethe
perfectlycompetitiveprice?
35. TheSouthernPowerAdministration,apubliclyownedutility,determinedthata50%
increaseinrateswouldgenerateanadditionalrevenueof$729millionperyear.What
doesthisindicateaboutthepriceelasticityofdemand?Istheutilitymaximizingprofit?Is
itmaximizingsocialwelfare?Explain.
36. Regulatorycommissionsfrequentlyrequirepublicutilitiestosetapricethatyieldsthe
goingrateofreturnbyequatingpricetolongrunaveragecost.Intermsofefficiency,

economistssuggestinsteadthatpriceshouldequalmarginalcost.Whatproblemsexist
withtheselectionofeitherofthesetwopricingoptions?
37. Eventhroughtheirpricesareregulated,publicutilitiesgenerallyengageingovernmental
lobbyingefforts.Whydotheydosoandwhatdotheylobbyfor?
Chapter12Exercises
11. Assumethatfirmswithinanindustryarecharacterizedbyincreasingreturnstoscale.
Demonstratehowaprofitmaximizingmonopolymightchargealowerpricethanwould
acompetitiveindustrycomposedofanumberoffirmsearningzeroshortrunpure
profits.
12. SupposeamonopolyfacesthedemandfunctionQD=85p.IfitscostfunctionisSTC=
Q3+10,whatisitsoptimallevelofoutputandprice?
13. Dr.Outhasjustwrittenthefirsttextbookoninterplanetarytrade.Themarketdemand
functionforthisbookwasestimatedtobeQ=1000100p.Itwillcost$500infixed
costtotypesetthebookandamarginalcostof$1perbookforeverybookprinted.
a. DeterminethetotalrevenuefunctionforDr.Outsbook.
b. Determinethetotalcostfunctionforproducingthebook.
c. HowmanycopiesofthebookshouldbeprintedforDr.Outtomaximizeprofits?
Whatwillonecopyofthebooksellfor?
14. Assumingthepriceelasticityofdemandisequalateverylevelofquantity,graphthe
demandcurveandthemarginalrevenuecurve.Ifthemarginalcostofproductionis
positive,whatistheprofitmaximizingoutput?
15. SupposeCongresswantstocorrecttheinefficientallocationeffectsofamonopolywitha
subsidy.
a. Whywouldalumpsumsubsidy,S,notachieveCongresssobjective?
b. Graphicallyillustratehowaperunitsubsidy,s,onoutputmayachieveCongresss
objective.
16. Thepriceamonopolycanchargeisregulatedbysomegovernmentagency.Determine
whatregulatedpricemaximizesthetotalnumberofunitssold.Howmuchwouldafirm
bewillingtopayfortherighttobeamonopoly?
17. Ms.Opt,themanagerofamonopoly,mustnotonlymaketheoutputandpricedecisions
butalsothedecisionaboutinvestingincostreducingtechnologies,.Investinginwill
lowerherconstantshortrunmarginalcostofproduction,SMC().Theperunitcostof
theisv.
a. DerivethefirstorderconditionsforMs.OptsoptimallevelsofQand.

b. ComparethemonopolysoptimalchoiceofQandwiththatofagovernment
regulatorwhocancontrolbothQand.
c. IftheregulatorcanonlydeterminewiththemonopolybeingallowedtochooseQ,
howdotheoptimalvaluesofandQdifferbetweentheregulatorandthemonopoly?
Chapter13Questions
11. Mr.RurallivesinthecountryandMrs.Urbanlivesincitycentral.Moregasisrequired
todeliveranewspapertoMr.RuralthantoMrs.Urban,butthepriceofthepaperisthe
sameforboth.Isthisatypeofpricediscrimination?Explain.
12. Assumeallfirmsexceptoneareperfectlycompetitive,andtheremainingfirmisa
perfectlypricediscriminatingmonopoly.ExplainwhytheParetoefficiencyconditions
willstillbesatisfied.Whatdifferencesinallocationanddistributionofincomeresult
fromtheonefirmnotbeingaperfectcompetitor?
13. WillamonopolyeverprovideaParetoefficientlevelofoutputonitsown?
14. Assumeafirmsdemandcurveisbelowitsshortrunaveragetotalcostcurveatalllevels
ofoutput.Canyouconceiveofanycaseswhereproductionmaystillbeprofitable?
Explain.
15. Aphysicianstatesthatsheishelpingherlowincomepatientsbycharginglowerfees
thanshechargesherhigherincomepatients.Whoelseisshehelping?Explain.
16. Whydoidenticalbooksusuallysellforsomuchmoreinhardcoverthaninsoftcover?
Explain.
17. Whyisthepriceofticketstosportingeventsandconcertstypicallylowerforchildren
thanforadults?Explain.
18. Amanagerofalocalmovietheaterissettingthepricescheduleforthemoviesbasedon
thedayoftheweek,timeofday,andtypeofcostumer.Howshouldhesetprices?Would
thepricingschedulebedifferentifthetheaterwastheonlyoneintownratherthanoneof
anumberofcompetingtheaters?Explain.
19. Ispricediscriminationsociallydesirable?Explain.
20. Sandrasays,Amonopolywillproduceaproductofhigherqualitybecausecutthroat
competitionwillleadtoadeclineinquality.Paulsays,Amonopolyproducesasmaller
quantityofproductthanwouldacompetitiveindustryand,bythesamelogic,willalso
produceaproductoflesserquality.Whoiscorrect?Oraretheybothwrong?Explain.

Chapter13Exercises
11. Supposeamonopolycanproduceanylevelofoutputitwishesataconstantmarginaland
averagecostof$10perunit.Assumethemonopolysellsitsoutputintwoseparate
markets.Thedemandfunctioninthefirstmarketisq1=50p1,andinthesecondmarket
isq2=602p2.
a. Whatlevelofoutputwillthemonopolyproduceineachmarketandwhatwillbethe
prices?
b. Whatisconsumerandproducersurplusineachofthemarkets?Whatistheresulting
deadweightloss?
c. Whatistheeffectonconsumerandproducersurplusifthefirmalsoadoptedalinear
twoparttariff?
12. Anamusementparkhasamonopolywithinagivenregion.Thedemandfunctionfor
rideswithintheparkisillustratedinthegraph.Theperunitcostofsupplyingridesis
composedofc(thelaborandmaintenancecost)andd(thecostofprintingandcollecting
ticketsforeachride).Eachperunitcostisindependentofthenumberofridesofferedat
thepark.Themanagersoftheparkareconsideringthefollowingtwopricingstrategies
Strategy1.Anentrancefeeandaperunitchargeforeachride.
Strategy2.Justanentrancefee.
a. Giventhegraph,whatistheentrancefee,priceperride,totalnumberofrides
supplied,andtotalprofitsundereachstrategy?
b. Underwhatconditionswillprofitsunderstrategy2exceedprofitsunderstrategy1?

13. Amonopolysupplierofclothinghaszeroproductionandtransportationcostswithsales
locatedintwodifferentregions.Thedemandfunctionsforeachregionareq1=1p1,
andq2=1/2p2.
a. Assumingthemonopolymustchargeauniform(linear)pricetothetworegions,
calculatetheprofitmaximizinguniformpriceandquantity.Whatistheresulting
profit?

b. Nowassumethemonopolycanengageinthirddegreepricediscrimination.Calculate
theprofitmaximizingpriceandquantityforeachregion.Whatistheresultingprofit?
c. Assumethemonopolyissellingclothingatthewholesalelevel,sothedemand
functionsarederiveddemandsfortheintermediateproductoftwocompetitive
downstreamretailoutlets.Ifthirddegreepricediscriminationisnotpossible,show
thatthemonopolycanobtainthesameresultbyintegratingforwardintooneofthe
downstreammarkets.Inotherwords,insteadofonlysellingwholesale,itwillsellat
theretaillevelinoneofthemarkets.Whichoneshoulditintegrateinto?Why?
14. Amonopolysellsitsoutputtotwogroupshavingconstantelasticityofdemandcurves1
and2.Ifthemarginalcostofproductionisconstantatc,whatpriceischargedtoeach
group?
15.Internationaltraderestrictionsresultinanelectronicsmanufacturerenjoyingmonopoly
powerinitsdomesticmarket,butintheworldmarketfacesperfectcompetition.What
effectdoestheimpositionofasalestax,bothforeignanddomestic,haveonthedomestic
priceandquantity?
Chapter14Questions(none)
Chapter14Exercises
11. Considerthefollowinggame
PlayerB
PlayerA
Left
Right
Top
(2,2)
(1,1)
Bottom
(1,1)
(1,1)
a. DetermineallthepurestrategyNashequilibria.
b. DoanyofthepurestrategyNashequilibriadominateanyoftheothers?
c. SupposeplayerAmovesfirstandcommitstoeithertoporbottom.Arethestrategiesin
parts(a)and(b)stillNashequilibria?
12. Analternativetothemaximincriterionforselectingstrategiesistheminimaxregret
criterion.Forthiscriterion,amaximumregrettableisconstructedthatlists,foreachpossible
strategyoftheotherplayer,thedifferencebetweenthepayoffobtainableforagivenstrategy
andthehighestpayoffpossiblewithagivenstrategyfortheotherplayer.Afinalchoiceis
thendeterminedbychoosingthestrategywherethemaximumregretisassmallaspossible.
EvaluatethePrisonersDilemmagamewiththeminimaxregretcriterion.Doesthiscriterion
changethesolution?
13.Considerthefollowingpayoffmatrix.
Firm2
SharetheMarket

Cheat

SharetheMarket
(50,50)
(25,75)
Cheat
(75,25)
(35,35)
a. DeterminetheNashequilibrium.
b. Explainhowapolicyofmeetingacompetitorspricechangestheequilibriumoutcome.
Firm1

14. Twotigersarepoisedtosolelyclaimaterritory.Eachtigercanchoosetoeitherfightor
retreat,andatigersabilitytofightiseitherstrongorweakwithequalprobability.Eachtiger
knowshisownabilitybutnottheabilityoftheothertiger.TheterritoryisworthUifsolely
claimed.Atigercanclaimtheterritorybyeitherseizingtheterritorywhenitsrivaldoesnot
orfightingwhenheisstrongbuthisrivalisweak.Ifthetigersareofequalstrengthand
choosetofight,neithergetstheterritory.AtigerhasacostofTCsforfightingifheisstrong
andTCwifheisweakwithTCs<TCw.Thereisnocostofattackingifhisrivalretreats.
IdentifyallpurestrategyBayesianNashequilibriaforthisgame.
15. Twocouplesagreetomeetfordinnerand,priortoordering,eachcoupleagreestopaythe
averageofthetotalbill.Afterthecouplesreturnhome,theycomplainabouthowmuch
dinnercostandhowmuchtheyoverate.Whatisthecauseforthisresult?Howisthisrelated
toPrisonersDilemma?
16. DeterminealltheNashequilibriainthefollowinggameofmatchingpennies.
MarkTwain
Heads
Tails
HuckleberryFinn
Heads
(1,1)
(1,1)
Tails
(1,1)
(1,1)
17. ConstructanumericalexampleofaPrisonersDilemmagamewhereretaliationforbreaking
anagreementispossible.DoesthisresultinaNashequilibriumthatisParetoefficient?
18. Therearethreepossibleoutcomesinazerosumgame(ifoneplayergains,theotherplayer
mustlose)whereeachplayerhasbuttwostrategies:bothplayershaveadominatingstrategy,
onlyoneplayerhasadominatingstrategy,orneitherplayerhasadominatingstrategy.
Provideanexampleforeachofthesethreeoutcomes.
19. (Classgame.)Players(students)chooseanumberbetween0and100withtheobjectiveof
guessingthehighestintegerthatisnohigherthantwothirdsoftheaverageofalltheguesses.
Chapter15Questions
11. Wouldaperfectlycompetitivefirmengageinadvertising?Explain
12. Intheearly1980sNissanMotorspromotionforoneofitsautomobileswas,Youneed
thiscar!Whatwasthistypeofadvertisingdesignedtodo?

13. Monopolisticcompetitionisamonopolyuptothepointwherehouseholdsbecome
willingtobuyclosesubstitutesandcompetitivebeyondthispoint.Trueorfalse?Explain.
14. Inthepast,someindustrywatcherspredictedthatthebignationalbeercompanieswould
increasetheirmarketshareandthesmallerregionalcompanieswoulddisappear.
However,therearestillalarge(andpossiblygrowingnumber)ofsmallbeercompanies.
Why?
15. Whatstopsafirmwithmonopolypowerfromofferinganinfinitenumberofproduct
varieties?Underwhatcircumstanceswillonlyasinglevarietybeoffered?
16. Supposeallthefirmsinamonopolisticallycompetitiveindustryweremergedintoone
largefirm.Wouldthisnewfirmproduceasmanydifferentbrands?Woulditproduce
onlyasinglebrand?Explain.
17. Howdothecharacteristicsofmonopolisticcompetitionleadtotheexistenceofidle
capacity.
18. Comparemonopolisticcompetitionwithperfectcompetitionintermsofeconomic
efficiency.
19. Dooligopoliesproduceanefficientlevelofoutput?Explain.
20. Whyshouldfirmsinmonopolisticcompetitionallocateresourcestowardadvertisingifa
largeportionofadvertisinghascancelingeffects?
21. Acompetitiveindustryisinlongrunequilibrium,whereallfirmsareearningzeropure
profits.Allfirmsinthisindustryandpotentialentrantshaveidenticalaveragecost
curves.Alargeincreaseindemandisforecastedforthisindustry.Theindustry
association,concernedthatthisincreaseindemandcouldworsenpollutionemissionsby
theindustry,lobbiesgovernmentlegislatorstoadoptnewenvironmentalregulationsfor
thisindustry.Theassociationlobbiesthatanynewplantintheindustryshouldbe
equippedwithemissioncontrolsinvolvingacompletelydifferentplantdesignthanis
currentlyusedinexistingplants.Alsotheassociationsuggestsexistingplantsshouldbe
exemptedfromthisregulationbecauseitisnottechnologicallyfeasibletoretrofit.Why
wouldanindustryassociationsuggestthattheirownindustrybesubjectedtosuch
environmentalregulation?
22. Consideracartelwhereeachfirmhasidenticalandconstantmarginalcosts.Ifthecartel
maximizestotalindustryprofits,howwillitdivideoutputamongthefirms?Explain.

23. SupposeU.S.wheatproducersdecidetoformacartelandrestricttheiroutput.Willtheir
cartelresultinanincreaseintotalrevenueandprofitsforitsmembers?Explain.
24. DuringProhibitioninthe1920s,variousgangsinChicagofoughtforcontrolof
distributingillegalalcohol.Attimesthegangswouldmeettosettletheirdisputesand
determinewhowouldcontrolwhichpartsofthecity.Whydidthesesettlementsgenerally
notlastlong?
25. Someeconomistssaythatcartelscombinetheworstsocialresultsofmonopolypower
withnoneoftheadvantages.Doyouagreeordisagree?Explain.
Chapter15Exercises
11. Assumetherearethreeidenticalfirmsintheindustry.Themarketdemandisp=1Q,
whereQ=q1+q2+q3andfirmsmarginalcostsarezero.
a. ComputetheCournotequilibrium.
b. Showthatiftwoofthethreefirmsmerge,transformingtheindustryintoaduopoly,
theprofitofthesefirmsdecreases.Explain.
c. Whathappensifallthreefirmsmerge?
12. Theinversedemandfunctionforaproductisp=100QwithfouridenticalCournot
firmssupplyingthemarket.Theirindividualmarginalcostisconstantat5,andhalfofthe
firmsareforeignfirmssupplyinginthisdomesticmarket.Thegovernmenthasimposed
animportquotaonforeignsuppliersequaltotheircurrentimports.
a. WhataretheprofitmaximizingoutputandpriceforeachCournotcompetitor?
b. Willimposinganimportquotaontheforeignfirmsaffectthedomesticfirmsoutput
decisions?Explain.
13. AmonopolycanproduceataconstantaverageandmarginalcostofSAVC=SMC=5
withafixedcostof100.ThefirmfacesthemarketdemandcurveQ=35p.
a. Calculatethemonopolysprofitmaximizingpriceandquantityandtheresulting
profit.
b. Assumeasecondfirmentersthemarket.Letq1betheoutputoffirm1andq2the
outputoffirm2.Marketdemandisnow(q1+q2)=35p.Assumingfirm2hasthe
samecostsasfirm1andbothfirmsbehaveasCournotfirms,calculatetheprofit
maximizingquantitiesandpricealongwiththeresultingprofit.
14. Supposeeachduopolistexpectsitsrivaltomatchanychangeinitsoutput.Givenp=a
bQ,andMC1=MC2=c,whereQ=q1+q2,showhowthiswillresultinthemonopoly
output.
15. Lettheinversemarketdemandforwood,producedatzerocost,bep=60(q1+q2),
whereq1andq2representoutputsfortwofirms.

a. DeterminetheF.O.C.sforprofitmaximization.
b. SolvefortheCournotequilibrium.
c. StatetheStackelbergconjecturalvariations.
16. Supposeyouareaduopolistproducerofahomogeneouscommodity,andbothyouand
yourcompetitorhavezeromarginalcosts.Themarketdemandcurveisp=15Q,where
Q=q1+q2withq1asyouroutputandq2asyourcompetitorsoutput.
a. Youandyourcompetitormustannounceyouroutputsatthesametime.Once
announced,youcannotmakechanges.Whatwillbeyourlevelofoutputandyour
expectedprofit?
b. Supposeyouaretoldyoumustannounceyouroutputbeforeyourcompetitordoes.
Whatoutputlevelwillyouset,howmuchdoyouexpectyourcompetitortoproduce,
andwhatdoyouexpectyourprofittobe?Isannouncingfirstanadvantageor
disadvantage?Explain.
17. Consideranindustrywithanincumbentmonopolyandapotentialentrant.Therearetwo
possibleproductiontechnologiesforproducingthecommodity.TechnologyIhasa
marginalcostof1withanassociatedfixedcostof11,andtechnologyIIhasamarginal
costof3andfixedcostof3.Onceatechnologyisselected,itcannotbechanged.This
technologychoiceisknowntoallfirms.Therearetwoproductionperiods,withdemand
ineachperiodrepresentedasQ=9p.Inthefirstperiod,theincumbentfirmisa
monopoly.Themonopolybeginsthisperiodbyselectingitstechnologyandthen
producing.Inthesecondperiod,theentrantdecideswhethertoenterornot.Ifitdoes
enter,itselectsitstechnology,andthenthetwofirmscompeteasCournotfirms.Ifit
doesnotenter,thentheincumbentmaintainsitsmonopoly.Forsimplicity,assumeazero
discountrate.
a. Assumingnothreatofentry,whattechnologywouldthemonopolyselect?
b. Ifthemonopolyselectsthetechnologyinpart(a),willtheentrantenter?Ifso,with
whichtechnology?
c. Isthereatechnologytheincumbentcouldpickinthefirstperiodthatwouldblockthe
entryoftheentrant?
d. Giventhethreatofentry,whatistheoptimalcourseofactionforthemonopoly?
Chapter16Questions
11. Acompetitivefirmsignsa10yearleaseonabuilding.Thelandlordrequiresannualrent
increasesbasedontherateofinflationof3%peryear.Howwilltherentincreaseaffect
thefirmspricesforitsproducts?
12. Retailersinupscaleshoppingmallsoftenusetheirhighrentsasjustificationfortheirhigh
prices.Isthisacorrectstatementoftherelationshipbetweenrentandproductprices?
Explain.

13. WhydoesrockstarMadonnaearnmorethanafirefighter?
14. Providetwoexamplesofinputsreceivingeconomicrent,whereonereceivesalarge
economicrentandtheothersmall.Whatistherelationshipbetweeneconomicrentand
barrierstoentry?
15. Marginalproductivitydoesnotdeterminewages,itonlydetermineshowmanyworkers
willbeemployedatagivenwage.Thus,marginalproductivityanalysisisatheoryof
demandforlabor,notatheoryofdistribution.Whatdoesdeterminewages?Does
marginalproductivityaffectsuchdeterminants?Explain
16. Isthevalueofthemarginalproductequaltotheinputpriceafirmsinputdemandcurve?
Explain.
17. Employerspayunskilledworkerslowwagesandpaynomorethannecessary.This
indicatesthatlowpayhasnothingtodowithlowproductivity.Trueorfalse?Explain.
18. Thesupplyoflaborinaperfectlycompetitivemarketisreduced.Whataretheeffectson
thewagerate,thequantityoflaboremployed,andoutputmarketpriceandquantity?
Explain
19. Ifthemarginalrevenueproductof1kilowatthourofelectricpoweris$0.10andthecost
ofproducingthiskilowatthouris$0.15,whatshouldthefirmdo?Explain.
20. BabeRuthwasprobablythegreatestbaseballplayerofalltime.However,afteradjusting
forinflationevenbelowaverageballplayerstodayearnmoreinrealtermsthantheBabe
everdid.Why?
21. Howdoesperfectcompetitioncauseindividualstoreceiveincomeproportionaltotheir
effort?
22. Universityprofessorsarehighlyeducated,buttheirsalariesarelowrelativetothis
educationlevel.Isthisanexamplewhereeconomictheorydoesnotapply?Explain.
23. Explainwhywomenmighttendtohavefewerchildrenastheirwageratesincrease.
24. Whatdoesthedemandforlaborhaveincommonwiththedemandforaproduct?
25. Ifafirmhiresanunemployedworker,istheopportunitycostoftheworkersproductivity
zero?Explain.
26. Whyisafirmslabordemandcurvemoreinelasticwhenthefirmhasmonopolypowerin
theoutputmarketthanwhenthefirmisproducingcompetitively?

27. Consideraprofitmaximizingfirmproducingacommoditysoldinacompetitivemarket.
Whenthepriceoftheoutputincreases,thefirmhiresadditionalskilledworkersbutfewer
unskilledworkers.Iftheunskilledworkersunionizeandsucceedingettingtheirwage
increased,whatwillhappentothefirmsdemandforunskilledworkers?Whatwill
happentoitssupplyofoutput?
Chapter16Exercises(none)
Chapter17Questions
11. AgriculturalscientistsinCaliforniahavedevelopedavarietyoftomatoesthatcanbe
pickedbyamachine.Whobenefitsandwhoisharmedfromthisresearch?Explain.
12. Canademandcurveforaninputbederivediftheemployeroftheinputisamonopsony?
Whyorwhynot?
13. Underwhatconditionswillthewageratebeequaltothemarginalinputcost?Whenwill
itbelessthanitsmarginalinputcost?
14. Whenisafactorexploited?Whatismonopolyexploitationandwhatismonopsony
exploitation?
15. Firmswithmonopolypowerintheiroutputmarketpayawageratelessthanworkers
VMPandperfectlycompetitivefirmsintheiroutputmarketpayawageequaltoworkers
VMP,soworkersinthesamelabormarketwillreceivealowerwagefromtheformerand
ahigherwagefromthelatter.Trueorfalse?Explain.
16. Dolaborunionsreducewagesandincomeofsomeworkers?Explain.
17. Attimesunionofficialshaveaskedtheirmemberstotakeacutinwagesorbenefits.
Why?
18. TheClaytonActstates,Thelaborofahumanbeingisnotacommodityorarticleof
commerce.Asaresult,workersareallowedtoorganizeintounionsandjointlyseek
higherwages.Shouldsuchunionorganizationbeexemptedfromtheantitrustlaws?
Explain.
19. Alegislatureconcernedwiththenonunionizedworkerswelfaredecidestopassalaw
requiringallworkerstobeunionized.Whatwillhappentothewageratesofformerly
nonunionizedworkersandthoseworkerswhowereoriginallyunionized?What
assumptionscanbedrawnaboutaunionsbehavior?

20. Whyisiteasytobecomeamemberofsomeunionsandverydifficulttobecomea
memberofothers?
21. Whataresomeoftheeconomiceffectsoffeatherbedding?
22. Underwhatconditionswouldyouexpecttheimpositionofaminimumwagetohaveno
effectonwagesoronthenumberofworkersemployed.Increasewagesandleavethe
numberofworkersunchanged?Increasewagesanddecreasethenumberofworkers?
Increaseinbothwagesandthenumberofworkers?
Chapter17Exercises
11. Supposeafirmisamonopolyinthesupplyofsomeoutput.Usinglabor,L,thefirmcan
produceanoutputwiththetechnologyQ=2L.Theinversedemandforthemonopolys
outputisp=100Q,andthemonopolyisfacingtheinversesupplycurveforlaborw=
80+2L.
a. Whatistheprofitmaximizinglevelofoutput,numberofworkershired,outputprice,
andwagerate?
b. Ifthefirmbehavedcompetitivelyinboththeoutputandlabormarkets,howwould
thesolutionfrompart(a)compare?
12. Auniversityinasmallcollegetownhastheinversesupply,LS,functionforsecretariesw
=5000+50LS,andisfacingtheinversedemand,LD,functionw=20,00050LD.
a. Whatwagewillitpayandwhatistheelasticityofsupplyatthisequilibrium?
b. Couldanysupplycurveexistwheretheequilibriumoccursatanelasticityofsupply
lessthanunity?
13. SupposeamonopolyhasthemarginalrevenueandmarginalcostfunctionsMR=200
4QandMC=Q,respectively.
a. Determinetheequilibriumpriceandoutputforthemonopoly.
b. Whatwouldbethemonopsonypriceandoutput?
14. Acertainmonopsonyonlyemployslabor,L,toproduceoutput,q,whichisthensoldina
competitivemarketatp=5.Letthemonopsonysproductionandlaborsupplyfunctions
beq=120LL2andw=5L.
a. DetermineatwhatvaluesofL,q,andwthemonopsonysprofitismaximized.
Calculatethemonopsonyssurplusandlaborseconomicrent.
b. DeterminethevaluesofL,q,andwiflabororganizedwiththeobjectiveof
maximizingeconomicrent.Calculatethemonopsonyssurplusandeconomicrentfor
thiscase.
c. Determinetheperfectlycompetitivesolutionandcalculatetherents(monopsonys
surplusandlaborseconomicrent).

15. Giventhatq(X)=5X(1/2)X2,MC(X)=2+X,andtheoutputprice,p,forqis2,
comparepriceandoutputdecisionsalongwithanydifferenceinconsumersurplusand
economicrentofarevenuemaximizingsupplierofXfacingamonopsony.
Chapter18Questions(none)
Chapter18Exercises
11. Forecasterspredictthereisa50%probabilitytheupcominggrowingseasonwillbea
drought.Giventhisforecast,letafarmersexpectedutilityfunctionbe
U(IR,ID)=0.5lnIR+0.5lnID,
whereIRandIDrepresentherincomeinthestatesofnormalrainfallanddrought
conditions.Assumethefarmerhasthechoicebetweentwocropswiththepayoffs
(incomes)
Crop
IR
ID
Watermelon $50,000
$10,000
Tomatoes
$30,000
$18,000
a. Ifshecanonlyplantonecrop,whichcropshouldsheplant?
b. Assumethefarmercaninsteadplanthalfherlandwitheachcrop.Shouldshedoso?
Explain.
c. Whatmixofcropswouldmaximizeherexpectedutility?
d. Wouldwatermeloninsurance,whichcosts$20,000andpaysoff$40,000inadrought
causehertochangeherchoicesinparts(a)through(c)?
12. Assumeahouseholdwithaswimmingpoolhasaninitialwealthof$1millionwitha
1/1000probabilityofincurringahalfmilliondollarlossfromanaccidentaldrowning.
Thecostofinsuringagainstthislossis1/750perdollarofinsurance.Determinethe
optimallevelofinsuranceifthehouseholdhasalogarithmicutilityfunction.
13. Graphautilityfunctionthatexhibitsriskseekingpreferencesforsmallgamblesbutrisk
aversepreferencesforlargegambles.Issuchasetofpreferencespossible?
14. BernicehasalevelofutilityUofromdrivingandnotgettingaticketandU'when
obtainingaticket,soUo>U'.Theprobabilityofreceivingaticket,basedonBernices
speed,s,is
=3.140.11s+0.001s2, 25<s<90.
Ifherspeedistooslowortoofast,shewillreceiveaticket.
a. Show,inthiscase,maximizingexpectedutilityisthesameasminimizingtheriskof
receivingaticket.
b. Determinethespeedwhichwillminimizetheriskofgettingaticket.
15. Radardetectiondevisesvaryintheirabilitytodetectradarusedforhighwayspeed
enforcement.Asthequalityofthedetectorincreases,theprobabilityofgettinga

speedingticketdecreases.Letthisrelationshipberepresentedby=1/Q,whereQisthe
levelofradarquality.Assumingateenager(Erica)isriskneutral,iftheperunitpriceof
detectorqualityisp=50anddamagefromspeedingticketsis250,whatlevelofquality
detectionwillshepurchase?Whatistheprobabilityofhergettingspeedingtickets?
Chapter19Questions
11. Whataretheproblemsindefiningcapitalasaresourceandwhatdodifferenttypesof
capitalhaveincommon?Whatdoesthepriceofcapitalpayfor?
12. Whatdistinguishesanimpatientconsumerfromapatientconsumer?
13. If,asinmanydevelopingcountries,lendingandborrowingarenotpossible,whatwould
happentocurrentandfutureconsumptionforaborrowerandhislevelofutility?How
aboutforalender?
14. Incometaxesaresaidtobebiasedagainstlaborincomebyfailingtoallowany
deductionsfordepreciationofaworkersproductivityovertime.Whatwouldbethe
resultofallowingsuchdeductions?
15. Howcanpromotionalexpendituresberegardedasaninvestment?Howdoesthisrelateto
theconceptofsuchexpendituresoperatingtomaintainbarrierstoentry?
16. Doeconomistsviewthetotalreturnoncapitalinvestmentasprofit?Explain.
17. Moneyitselfisnotaresourceandisthusunproductive.Whyshouldagentsbewillingto
payaprice(interestrate)foracquiringit?
18. Areoutputandprofitmeasuredasafloworastock?
Chapter19Exercises
11. AssumeU(x1,x2)=x1x2.MaximizethisutilityfunctionsubjecttothewealthconstraintW
=x1+x2(1+i)1,whereW=10andi=10%.
12. Netbenefits,attheendofeachyear,fromaprojectlastingthreeyearsare$10,000,
$3000,and$7000inyears1,2,and3,respectively.Givena10%discountrate,whatis
thepresentvalueofnetbenefits?
Chapter20Questions

11. Considerarentsubsidyprogramthatvariestherentofanapartmentforhouseholds
basedonincome.Suchaprogramresultsininefficiency,withtheeconomyoperating
somewhereinsidetheproductionpossibilityfrontier.Cansuchaprogrambejustifiedon
thebasisofParetoefficiency?Canitbejustifiedonthebasisofasocialwelfare
function?Isthereanyprogramthatcannotbejustifiedonthebasisofsomesocial
welfarefunction?
12. AgriculturalscientistsattheUniversityofCalifornia,Davishavedevelopedatomato
varietythatcanbepickedmechanically.Howisthisanimprovementinproduction
efficiency?Isthisalsoanimprovementinsocialwelfare?
13. Ifpeoplewerereasonable,strikesandwarswouldnotoccur.Doyouagreeordisagree
withthisstatement?Explain.
14. Ismaximizingprofitanevilorbeneficialbehaviorinafreemarketsystem?Explain.
15. Underwhatcircumstancesmightgovernmentsubsidiesortaxesresultinanincreasein
socialwelfare?
16. Aneconomistcanidentifyinefficiencyandprovideoptionsforcorrectingthe
inefficiency.However,beyondthisherprofessionalexpertiseisexhausted.Evaluatethis
statementcritically.
17. Determiningapolicychoicewillalwaysinvolvetheadjudicationofconflictingclaims
amongagents.Trueorfalse?Explain.
18. Explainwhyeachofthefollowingstatementsiseithertrueorfalse.
a. Perfectcompetitionresultsinmaximumsocialwelfare.
b. TheinvisiblehandalwaysresultsinParetooptimality.
c. TheeconomycanbeataParetooptimalpointwhenhouseholdsarefreetoundertake
alltheexchangestheywish.
d. Societycanmovefromonepointonaproductionpossibilitiesfrontiertoanotherby
redistributingwealthusinganinheritancetax.
19. ArrowsImpossibilityTheoremstatesthatasocialwelfarefunctionmustbeeither
democraticorconsistent,butitcannotbeboth.Trueorfalse?Explain.
20. Capitalismanddemocracyareverycomplementaryinthesensethattheytogetherput
somerationalityintoequalityandsomehumanityintoefficiency.Analyzethisstatement.
21. SomecriticsthatarguemoderngovernmenthasbecomeRobinHood,takingfromthe
richandgivingtothepoor.ShouldgovernmentsplayRobinHood?Explain.

22. Whyshouldagovernmentpolicymakernotignoreeconomictheory?Explain.
23. IsanormativeargumentrequiredtostatethatperfectcompetitionwillgenerateaPareto
efficientallocation?Doesitrequireanormativeargumenttostatethatperfect
competitionisthebestforsociety?Explaineachanswer.
24. Withsomanyfaminestrickenpeopleintheworlditmaybeethicallywrongforusnotto
produceallthefoodwecan.ShouldU.S.farmersproduceallthefoodtheycan?Explain.
25. Whatismarketfailureandwhatcausesittooccur?Givenmarketfailure,shouldthefree
marketbereplacedwithgovernmentcontroloverpricesandoutput?
26. Whatisundesirableaboutvotingthatcycles?
27. Someadvocatesoffreemarketsandaminimalroleforgovernmentinaneconomystate
thatperfectcompetitionisanidealsystembecauseityieldstheconditionofthegreatest
goodforthegreatestnumberofpeople.Isthisconditionanefficiencyorequitycriterion
foreconomicwelfare?Willperfectcompetitiongeneratethiscondition?Explain.
28. Whyiseconomicefficiencyanecessaryconditionformaximizingsocialwelfare?Isit
theonlynecessarycondition?
29. Marketsocialistsstatethataneconomicplanningagencycouldsimulatecompetitive
marketforceswithequationsandsolvetheequationstoarriveatequilibriumpricesand
outputs.Thiswouldbemoreefficientthanthettonnementoffreemarkets.Trueor
false?Explain.
30. RonaldReaganstatedThetaxingpowerofthegovernmentmustbeusedtoprovide
revenuesforlegitimategovernmentpurposes.Itmustnotbeusedtoregulatethe
economyorbringaboutsocialchange.Commentonthisstatement.
Chapter20Exercises(none)
Chapter21Questions
11. Ifaneconomyisanorganizationalsystemforcoordinatingproduction,consumptionand
distributionofcommodities,whatroleisplayedbypropertyrights?Explain.
12. Howdoclassactionlawsuitscontributetotheimprovementofsocialwelfare?
13. Insomepastsocieties,entitlementsforusinglandcouldnotbetransferredtoanyoneelse.A
farmercouldacquireanewplotoflandbyclearingitandleavehisoldplotavailablefor

someotherindividual.Howwouldthistypeofentitlementaffectlandconservationcompared
withlandownershipentitlements?
14. Areabsenteelandlordsapotentialsourceofsoilerosionproblems?Explain.
15. Givenapositiveexternality,themarginalcostfunctionoffirmAshiftsdownwardwhenthe
outputoffirmBincreases.WhatistheappropriateperunitsubsidytoofferfirmB?
16. Monopoliesresultininefficientallocationsandthuscannegativelyimpactsocialwelfare.
Whataresomeofthemarketandsocialwelfarebenefitsofamonopolyinanindustrywhere
productionisassociatedwithanegativeexternality?
17. CriticscontendthattheexpansionofMARTA,themasstransitsysteminAtlanta,willnot
generatesufficientrevenuetocovercosts.Thus,expansionisnotfeasible.Isthisargument
validorinvalidiftheexternaleffectsgeneratedbythetransitsystemareconsidered?
Explain.
18. Anexternalityexistswhen,asaresultofgeneratingairpollution,afirmincreasesthecostof
anotherfirm.Incontrast,itdoesnotexistifthefirmincreasesthecostofanotherfirmby
biddingupthepriceofinputs.Explainthedifference.
19. Oneparticulartypeofexternalityiswherethereisonlyoneseatleft,say,onanairplaneor
foraparticularcollegecourse.Theagentswhoareleftoutaredirectlyaffectedbytheactions
oftheagentwhogetsthelastseat.DetermineamechanismdesignthatwillresultinaPareto
efficientoutcome.
20. Afarmerapplyingpesticideswithinacertainradiusofanendangeredspecieswilldisruptthe
specieshabitat.ApplytheCoaseTheoremtothissituation.Doesitmakeanydifferencein
theoutcomewhethertheendangeredspeciesorthefarmerhasthepropertyright?
21. Whyarethereoysterfarmsbutnosalmonfarms?Explain.
22. Airpollutionproblemscouldberesolvedbyspecifyingexclusiverightstoair.Evaluatethis
statement.
23. StevenKelmaninWhatPriceIncentives?EconomistsandtheEnvironment(AuburnHouse
PublishingCompany,1981)suggeststhatfromanethicalpointofview,theuseofeconomic
incentivesincludingemissionschargesoremissionspermitsinenvironmentalpolicyis
undesirable.Hearguesthattransformingourmentalimageoftheenvironmentfroma
sanctifiedpreservetoamarketablecommodityhasdetrimentaleffectsnotonlyonouruseof
theenvironmentbutalsoonourattitudetowardit.Hepointsoutthatapplyingeconomic
incentivestoenvironmentalpolicyweakensandcheapensourtraditionalvalueswithregard
totheenvironment.CommentonKelmansviewpoint.

24. Whydomanyfirmshaveanincentivetolobbyforpollutionstandardsasopposedtotaxes?
Chapter21Exercises
11. Acoalfiredpowerplantisgenerating6tonsofairpollutionperweek.Thefollowingtable
liststhetotalbenefitsandcoststosocietyofreducingthispollutiontolowerlevels.
Pollution
Pollution(tons)
TotalBenefit
TotalCost
5
$30
$5
4
50
9
3
64
23
2
74
42
1
80
72
0
84
116
a. Whatisthemarginalcostofreducingpollutionfrom5to4tons?Whatisthemarginal
benefit?
b. Fromsocietysperspective,whatistheoptimallevelofpollution?Explain.
c. Whyiszeronottheoptimallevelofpollution?
12. Achemicalplantonalakeproduces50unitsofoutputperday.Itsoutputissoldina
perfectlycompetitivemarketat$1perunitandtheplanthasSTCof$0.50perunit.Plantson
thislakerequirecleanwaterandanynewplantwillincreasethepollutionlevel,soallfirms
willincuranadditionalcosttocleanthewater.Thisexternalityis$0.10perunitofoutputfor
eachnewplant.
a. Lettingnequalthenumberofplants,determinehowmanynewplantswillbebuilt.
b. Whatnumberofplantswillmaximizetotalprofitsforallproducers?
13. Yourneighborhasaversivebarkingdogs.Youareabletomitigatethenoisefromthesedogs
byshuttingyourwindows.YourneighborsutilityfunctionisU1=6zz2,wherezmeasures
thedogsnoiselevel.YourutilityfunctionisU2=(x+3z/x),wherexisthenumberofshut
windows.
a. Determinetheindependentdecisionmakingchoicesforyouandyourneighbor.
b. Whatarethedependentdecisionlevelsofbarkingdogsandshutwindows?
c. Ifyouhavethepropertyrightstothelevelofnoise,whatfeewouldyouchargeyour
neighbor?Determinethesatisfactionlevelsforyouandyourneighbor.
d. Ifyourneighborhasthepropertyrights,howmuchwouldyoupaytohaveyourneighbor
hushthedogs?Again,determinethesatisfactionlevelsforyouandyourneighbor.
e. Whatwouldbetheoptimallevelofataxonbarkingdogsandhowisitrelatedtoyour
shuttingwindows?Whataretheutilitylevelsforyouandyourneighborassociatedwith
thistax?

Chapter22Questions
11. Inmanycases,lesserdevelopedcountriesreapthebenefitsoftechnologicaladvancesfrom
moredevelopedcountries.Isthisanexampleofthefreeriderproblem?
12. Considerthefollowingsolutiontotheallocationbetweentwoagentsofadiscretepublic
goodwithcostTC.Eachagentstatesabid,bj,j=1,2.Ifb1+b2>TC,thegoodisprovided
andeachagentpaystheirbidamount;otherwise,thegoodisnotprovidedandneitheragent
paysanything.Willthismechanismyieldanefficientallocation?Explain.
Chapter22Exercises
11. TherearethreehouseholdsinFundale.Eachhouseholdhasautilityfunctionfortheamount
consumedoftheprivategoodxjandapublicrecreationalareaRgivenby
Uj=xj4/R, j=1,2,3,
whereRisthenumberofacresoftherecreationalareaandxj=Q.Thecostofeach
additionalunitofRintermsoftheamountoftheprivategoodgivenupis1/12.Each
householdisendowedwith5unitsoftheprivategoodand0unitsofpublicrecreation.
a. WhatistheMRS(xjforR)foreachhouseholdandwhatistheMRPT(QforR)?
b. WhatistheoptimallevelofR?
c. Assumeeveryhouseholdpaysanequalshareoftherecreationalcost.IfthesizeisR
acres,itstotalcostisR/12anditscostperhouseholdwillthenbe1/3(R/12)=R/36.
Determinetheindividualsbudgetconstraint.
d. WhatvalueofRwouldeachhouseholdvotefor?
e. Isthereanunderoroversupplyoftherecreationalgoodrelativetotheefficient
allocationinpart(b)?Explain.
12. ConsidertheutilityfunctionsforthreeconsumersU1=2M1/2+x1,U2=M1/2+x2,andU3=
3M1/2+x3,whereMrepresentsmilesofascenicrivertobepreservedandthepriceis1for
eachgood.Determinetheequilibriummilesofscenicriverandthepriceeachconsumer
pays.
13. Considertheinversedemandfunctionsp1=20Q,p2=30Q,andp3=40Qforapublic
goodQbythreeconsumers
a. WithMC=78forthispublicgood,determinetheParetoefficientlevelofQand
associatedLindahlprices.
b. IfeachconsumerpaysonethirdofthemarginalcostforQ,whatwouldbetheamountof
theClarketaxandwhowillpayit?
Chapter23Questions
11. Commentonthefollowingstatement:Inapoolingequilibrium,onlyconsumerswho
unfortunatelypurchasealemonareharmed.

12. HowdoestheincidenceofAIDSaffectadverseselection?
13. Givenasymmetricinformationinbaseball,wouldyouexpectthesalaryofferedtoafree
agenttobelowerthanthatpaidtoasimilarplayerwhoremainedwithateam?
14. Isthenumberofcommoditiesproducedbyafirmasignalastothequalityofthe
commodities?
15. Whyissomedegreeofignoranceoptimal?
16. Theexpressionyougetwhatyoupayforsuggestsusingpriceasascreeningdevice.The
highertheprice,thebetterthequality.Underwhatconditionsisthisastrongscreening
device?Aweakscreeningdevice?
17. Relatethefollowinglawtoadverseselection:
GreshamsLaw:Badmoneydrivesoutgood.
Note:Thislawwasderivedfrommoneyintheformofgoldcoins,wherebadcoinsresulted
fromindividualsremovingsomeofthegoldfromacoin.
18. Dobrandnamesreduceasymmetricinformationbyprovidingasignalofqualityto
consumers?Explain.
19. HowdoestheFederalTradeCommissionsenforcementoftruthinadvertisingaffectfirms
signalingandParetoefficiency?
20. Giventheinefficiencyassociatedwithasymmetricinformation,shouldthegovernment
subsidizetheU.S.PostalServiceinsteadofrequiringittobenonprofit?Howabout
subsidizingtheInternet?
21. Commentonthefollowingstatement:Warrantiescanmitigateadverseselectionbutcause
moralhazard.
22. Determinewhichofthefollowingconditionswillresultinadverseselection,moralhazard,
orboth.
a. AnAIDSvictimpurchaseslifeinsuranceontheInternet.
b. Ahobolocatesinacitywithanoutstandingwelfaresystem.
c. Awrecklessdriverdrivesafullyinsuredtruck.
d. Auniversityiswillingtoacceptanystudentwithahighschooldegree.
e. Anairlinetravelerplanstoblowuptheplaneaftertakingoutaflightinsurancepolicy.
f. Anovelistprocrastinatesafterreceivinganadvanceonanovel.

23. CottonStatesInsuranceCompanyprovidesa$150discounttoanypolicyholderwhohasa
securitysystemthatnotifiesthepoliceinthecaseofanemergencyorthefiredepartmentin
theeventofafire.Assuminganactuariallyfairinsurancepolicy,whatistheexpected
reductioninlossassociatedwithsuchasystem?
24. Analternativetoaresidualclaimantcontractisarelativeperformancecontractwherea
managerssalaryistiedtotheperformanceofsimilarfirmswithinanindustry.Ingeneral,
whenprofitsforanindustryaredownthemanagerisnotpenalized,butsheispenalized
whenherfirmdoespoorlyrelativetotheindustryasawhole.Whataretheadvantagesof
relativeperformanceversusresidualclaimantintermsofshirking?
25. Afirmpaysalowwagerate,butgivesemployeesalargebonusattheendoftheyear.Why
wouldafirmadoptthispolicy?
Chapter23Exercises
11. Supposetherearetwotypesofundergraduatecollegedegrees,IvyLeaguedegreesandall
others.Oneemployerwhopays$60,000peryearusesanIvyLeaguedegreeasasignalfor
determiningemployeesabilitiesandwillonlyhirefromIvyLeagueschools.Other
employerswillhirefromanycollege,butonlypay$40,000peryear.
a. IfthecostofobtaininganIvyLeaguedegreeisequivalentforallpotentialemployees,is
thereaseparatingequilibrium?
b. WhatisthemaximumamountahighabilityworkerwouldpaytoattendanIvyLeague
school?
c. Underwhatconditionswillthissignalbydegreeprovideaseparatingequilibrium?
12. ReliableUsedCarsandAffordableUsedCarsaretwoautomobiledealerslocatedacrossthe
streetfromoneanother.Reliablesellsreliableusedcarsthat,afteranyrepairsandservicing,
costReliableonaverage$10,000.Affordablesellslemonsafteronlyminimalcosmetic
repair,soitscostisonly$9000.Consumersarewillingtopay$12,000forareliable
automobileand$10,000foralemon,andwithoutanypriorinformationonthetwo
dealershipsarewillingtopayonaverage$11,000foranautomobile.Assuminga90day
warrantywillcostReliableonaverage$100andAffordable$2500,willthewarrantyresult
inaseparatingequilibrium?
13. Fivefirmsbiddingonthesamepaintingjobofferthefollowingbids.
Firm
Bids
1
$470
2
480
3
500
4
530
5
570

a. Determinetheexpectedlowestbidforpaintingifahouseholdreceived1,2,3,4,or5
bids.
b. Whatisthemarginalbenefitofreceivingeachadditionalbid?
c. Ifahouseholdsmarginalopportunitycostforobtaininganadditionalbidis$10.00,how
manybidswillitrequest?
d. Whyisitgenerallyagoodpracticetoobtainatleasttwobids?
14. Thefollowingtableliststhethreeeffortlevelsforamanagerofafastfoodoutletalongwith
thefirmsprofitsandthemanagerstotalcostofeffort.
ManagersEffort
FirmsProfit
TotalCostofEffort
76
16
E1
146
64
E2
175
100
E3
a. Whatisthefirmsprofitmaximizinglevelwheneffortisobservable?
b. Ifeffortisunobservableandthefirmdoesnotconsideranincentivecompatibility
constraint,whatisthefirmsprofit?
c. Ifthemanagerbecomestheresidualclaimantonprofits,whatarethemanagersprofit
andthefeehepaysthefirm?