03 Jun Question HW8 (1) If you were to examine where the USA might be on
Question
HW8
(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 (in
terms 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? The
government? Certain people? Luck? Are you content with where you have placed us?
Assuming that our markets are reasonably efficient, could you draw an Edgeworth Box
that shows where you think the two classes of consumers lie?
(2) In lecture I mentioned Merit Goods. Can classical concerts, public art and other publicly
provided services be justified using the idea that merit goods are simply good for the
community?
(3) Name and defend four reasons why might government intervention be needed in a
market?
(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 the
consumption of a product X MUST decrease welfare in the market even if all of the tax is
given back to the people in the form of a cash payout. Show as well that if the
government is simply interested in raising money, it is better off taxing products whose
demand curves are relatively steep.
(5) Now here is a problem to work through. If you really understand it, you will have a firm
grasp of the ideological justification for a free market exchange economy without
government intervention.
There have two consumers, You and Me
There are two goods being produced by the private sector firms, X and Y
There are two factors of production used my firms, L and K
Okay:
Using the usual graphs of microeconomic analysis (e.g. budget lines and indifference
curves, isoquant curves and production functions, the Edgeworth Box, contract curve,
and the Production Possibility Schedule, or Frontier for the economy), work through the
steps 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 satisfaction
and 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, AND
equal to the MRT of the production possibility curve.
When you have done this, you should be able to understand that in a free exchange
market for a PRIVATE GOOD, in equilibrium, MRS (of consumer #1) = MRS (of
consumer #2) = MRT (the marginal rate of transformation). That is, the opportunity
costs between the two good X and Y in our HEADS is the same as the costs implicated
by the society as a whole in terms of the market prices.
PS: when all this happens, you are maximizing consumer and producer surplus, and
therefore total welfare in the market. If all markets work this way, you maximize welfare
in the total economy!
(6)
Why do we say that the Second Fundamental Theorem of Welfare Economics helps to
justify governmental attempts to alter income distribution with tax and spend policies as
long as markets can work normally once the tax and spend policies are in place?
HW 9
Introduction
What we see in the case of monopoly power is that the theory really addresses the issue
of market power. That is, whether or not there is only one large monopoly firm offering
a product that people want or a few dominant firms, the fact that firms have the power to
set price above MC is what is important.
As we go through life as consumers, we constantly face prices for what we choose to buy
and for what we choose not to buy. In most cases we do not argue or haggle over the
price when we make the decision to buy or not. In most cases we simply decide, and if
we decide to part with our hard-earned cash, we buy at the price listed. Of course there
are a few cases where we can debate price, automobiles and houses being examples. But
normally 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 the
price charged. In the case of non-perfect competition, this is certainly the case. Thus the
door is opened for Price Discrimination (PD) the arbitrary setting of prices with a goal
to get increased revenues and sales when the firm knows, or feels, that its markets have
segments (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 prices
every 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; Second
Degree 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 to
pay) exactly, and prices down the curve with the goal to capture the entire potential
consumer 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 minimizing
their costs. Firms also know about and are using the best available technology to produce
their 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 continuously
differentiating of potentially homogeneous products in order to capture brand-customer
loyalty 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 product
we can think of, the models of Monopoly, the Dominant Firm, and Monopolistic
Competition become an appropriate deviation from the purely competitive
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