(1) If you were to examine where the USA might be on its Utility Possibilities Curve which say shows a trade-off in Utility between the Rich and the Poor sections of society (interms of what each sector consumes) where do you think we would lie on the curve?Given your opinion who do you think placed us where we are on the curve? Thegovernment? Certain people? Luck? Are you content with where you have placed us?Assuming that our markets are reasonably efficient could you draw an Edgeworth Boxthat shows where you think the two classes of consumers lie?(2)In lecture I mentioned Merit Goods. Can classical concerts public art and other publiclyprovided services be justified using the idea that merit goods are simply good for thecommunity?(3)Name and defend four reasons why might government intervention be needed in amarket?(4)Here is sort of a repeat question from an earlier homework/discussion for emphasis.Using the usual supply and demand curves (lines) please show how a tax on theconsumption of a product X MUST decrease welfare in the market even if all of the tax isgiven back to the people in the form of a cash payout. Show as well that if thegovernment is simply interested in raising money it is better off taxing products whosedemand curves are relatively steep.(5)Now here is a problem to work through. If you really understand it you will have a firmgrasp of the ideological justification for a free market exchange economy withoutovernment intervention.•••There have two consumers You and MeThere are two goods being produced by the private sector firms X and YThere are two factors of production used my firms L and KOkay:Using the usual graphs of microeconomic analysis (e.g. budget lines and indifferencecurves isoquant curves and production functions the Edgeworth Box contract curve and the Production Possibility Schedule or Frontier for the economy) work through thesteps to SHOW that in a competitive equilibrium for a two consumer two-good and twofactor market the conditions under which:Maximum welfare is achieved (supply equals demand-consumers maximize satisfactionand producers minimize costs).That is: show how:(a) each of the MRSs between the two goods of the two consumers are equal (b) the MRS of each consumer is equal to the price ratios of the two goods (c) each of the MRSs is equal to the ratio of the MCs of producing the two goods ANDequal to the MRT of the production possibility curve.When you have done this you should be able to understand that in a free exchangemarket for a PRIVATE GOOD in equilibrium MRS (of consumer #1) = MRS (ofconsumer #2) = MRT (the marginal rate of transformation). That is the opportunitycosts between the two good X and Y in our HEADS is the same as the costs implicatedby the society as a whole in terms of the market prices.PS: when all this happens you are maximizing consumer and producer surplus andtherefore total welfare in the market. If all markets work this way you maximize welfarein the total economy!(6)Why do we say that the Second Fundamental Theorem of Welfare Economics helps tojustify governmental attempts to alter income distribution with tax and spend policies aslong as markets can work normally once the tax and spend policies are in place?HW 9IntroductionWhat we see in the case of monopoly power is that the theory really addresses the issueof market power. That is whether or not there is only one large monopoly firm offeringa product that people want or a few dominant firms the fact that firms have the power toset price above MC is what is important.As we go through life as consumers we constantly face prices for what we choose to buyand for what we choose not to buy. In most cases we do not argue or haggle over theprice when we make the decision to buy or not. In most cases we simply decide and ifwe decide to part with our hard-earned cash we buy at the price listed. Of course thereare a few cases where we can debate price automobiles and houses being examples. Butnormally when we buy a coffee or go to the dentist office we simply “pay the price”.This being the case the producer or seller of the product we buy has some power over theprice charged. In the case of non-perfect competition this is certainly the case. Thus thedoor is opened for Price Discrimination (PD) – the arbitrary setting of prices with a goalto get increased revenues and sales when the firm knows or feels that its markets havesegments (or differing willingness to pay among potential buyer groups.)As consumers this is important for us as we have no choice other than to face pricesevery day.We have seen that there are three main types of Price Discrimination (PD). Third Degree– the seller divides up the market and prices differently to each market segment; SecondDegree –the seller divides up the price schedule and allows the customer base to selfelect from the schedule; First Degree – seller knows the demand curve (willingness topay) exactly and prices down the curve with the goal to capture the entire potentialconsumer surplus.We have seen that for each Degree-type of PD there are variations in strategy.In the pure competitive model prices are flexible supply and demand are equal consumers maximize their satisfaction and firms maximize their profits while minimizingtheir costs. Firms also know about and are using the best available technology to producetheir product. When firms use the best available technology to produce their products they are on the lowest possible cost curves and this is called Production Efficiency.Yet in the real world of business and firms competition involves the continuouslydifferentiating of potentially homogeneous products in order to capture brand-customerloyalty and market share. There are many ways of doing this of which the marketing(positioning) and sales effort are the most important. Thus for just about every productwe can think of the models of Monopoly the Dominant Firm and MonopolisticCompetition become an appropriate deviation from the purely competitive model.Now let’s get to the homework.(1)Using the monopoly diagram with an upward sloping MC curve (normal U shaped) showthe area of deadweight loss with monopoly pricing. Show the reduction in welfare to theProducers and Consumer surplus with monopoly pricing. How does this compare wit thecompetitive result?Now take the monopoly with a horizontal (constant AC) supply curve and show the areaof deadweight loss with monopoly pricing. How large is the producer surplus?What is the elasticity rule that applies to monopoly pricing? What is it about this rulethat makes sense from a strategic standpoint?Using the formula for MR where MR = P ( 1 – 1/e ) derive the elasticity rule.(2)If you had to argue that the diamond business in South Africa was a natural monopoly what reasons would you give? Why would you think that the South African governmentis keen on keeping the diamond monopoly intact?(3)Explain why it is that high-powered regulation encourages cost cutting by the regulatedfirms while low-powered regulation does not. What is meant by high and low-poweredregulation of monopolies or dominant firms?(4)What is regulatory capture? What is Rent-seeking? Why do you think that regulatorycapture is so prevalent in representative democracies where market power exists amonglarge firms?(5)Explain what we mean is when we say that the existence of monopoly prevents:inefficient use of resources (factors of production – K and L) and loss of consumerwelfare. What about dynamic efficiency? Would a monopoly or dominant firm alwaysprevent dynamic efficiency?(6)Let’s say a firm is a monopolist. Now this firm spends more on advertising to increasethe demand for its product. Show on a graph with a horizontal AC curve what happensbefore and after the new expenditure on advertising. Show what has to happen in thegraph to make sure that the firm maximizes its profits after the ad expenditure.(7)Would you classify a great popular artist like Michael Jackson as a monopolist withrespect to what he produces? If so would that be an adequate explanation of why Mr.Jackson was able to price his products way above his MC curve.How do you think Michael Jackson was able to achieve dominance in his field of musicexpression? Would you say that Michael Jackson’s product was perceived as unique?What type of demand curve do you think he faced from those who were his fans? Do youthink that the “elasticity rule” played a part in his getting rich? (Remember problem (1)above.)Thinking in terms of your answer to (7) so far what would Michael Jackson and theMicrosoft have in common? Nothing at all? Something?(8)Let’s say that you want to make a lot of money as a rock star. In fact you believe thatyou have a special talent for a specific type of beat music? How would you use yourtime in order to become a personal monopoly with respect to your type of music?(Remember the earlier graph that stressed the three factors that will determine how mucha wage salary or payment you can commend from providing your product.Now let’s say you are successful in your rock star adventure. Do you think it is likelythat your agents will ensure that concert ticket prices are above marginal cost? Wouldyou be taking advantage of the elasticity rule in your line of work? Graph a hypotheticaldemand and supply (horizontal MC curve) relation for your music business and show justhow the elasticity rule relationship might work out.(9)Often you find discount coupons for groceries in the newspaper. People can choose tocut out these coupons and take them to the market for the discount on specific products.If this is PD (Price Discrimination) what Degree of PD is it and what is the logic behindthe coupon strategy? Do you think that the company offering the discount coupons hasthe people who do not use the coupons in mind with this strategy? What strategy mightthe store or the producer use when it prices its products for those who do not choose touse the coupons?(10)Assume that in the market for branded cigarettes from one producer there are distinctcustomer groups whose intensity of demand differs between the groups. That is there aredifferent demand elasticities for different types of cigarettes produced by this onecompany. (Low filter high filer no filers long short sweet sours etc.) However thecompany charges one single price for any given package of cigarettes. Is this PD? If so what kind is it?(11)Assume that in the market for branded cigarettes from one producer there are distinctcustomer groups whose intensity of demand differs between the groups. That is there aredifferent demand elasticities for different types of cigarettes produced by this onecompany. (Low filter high filer no filers long short sweet sours etc.) The companycharges many different prices for any given package of cigarettes. Is this PD? If so whatkind is it? If this is PD what strategic rule of pricing should the cigarette company use?(12)Assume that a community has a constant- average cost monopolist that provides monthlypest control to residential homes. It wants to maximize profits. Illustrate what it wouldnormally do to accomplish this. What does this mean for community welfare in thenormal case?Now the pest control company decides to enact two-tier pricing. It charges an up-front“service charge” fee each year for the monthly service calls. Illustrate with a graph whatoptions are open to the company. What is the maximum fee it could reasonably expect tocharge? Is it possible that a two-tier pricing strategy could lead to economic efficiency(with respect to overall welfare) in the community’s pest control market?(13)You can fly on Air France from San Francisco to Paris in economy for as low as $600.00.You can fly in the same plane on the same route in the same time in business class for say $8000.00. What kind of PD is this? What human need is Air France trying to profitfrom? Illustrate with two demand curves and horizontal MC curves (markets foreconomy and business class flights) how the pricing of these two classes might work.(14)Determine what Degree of PD may be involved in each of the following cases:• A healthcare provider that is a monopolist prices its healthcare productsand doctor visits according to the income level of the buyer (higher income – higherprice).• A government imposes a progressive income tax (this is slightly a trick question)• Air France has 25 different prices for seats on its San Francisco – Paris route.• Century Movie Theaters has discounts for Seniors and Students• Let’s say that ATT Cellular charges no up-front fee for new users of the iPhone 5®version but a large fee for existing customers who want to upgrade from the 4g or the4gs version.(15)The hair shampoo industry has the following characteristics: individual products doessentially the same thing they wash and/or condition hair. However the differentshampoo products are highly differentiated by texture smell soapiness container shape and alleged benefits (volumizing color retention ease of use etc.) Entry into the hairshampoo industry is easy with many firms coming and going. Each firm behavesindependently from the others.(a) What type of industry is this? Explain your answer(b) Illustrate the short-run equilibrium position for a representative firm that is earningshort-run economic profit.(c) What would have to happen in this industry if the firm in (b) now suffers short-runeconomic losses?(d) What will happen to the number of firms in this industry in the long-run? Illustratethe long-run position of a representative firm in the hair shampoo business.(e) Is the long-run equilibrium in this industry efficient – is there allocative efficiency?(f) Can you argue that the consumer is better off in this long-run equilibrium?(g) In the long run should there be more or less firms in this industry?Why?(16)You go to a Frozen Yoghurt shop. The shop offers 16 flavors of yoghurt 3 different fatcontents in each flavor and 27 toppings to choose from. What is it about the scenedescribed here that would indicate that Monopolistic Competition is a fact of business lifetoday?
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