12e TP CH16 - Duplicate Technical Problems with Answers PDF

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Duplicate Technical Problems with Answers...

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Chapter 16 Government Regulation of Business Duplicate Technical Problems 1. The market for bagels in Philadelphia is perfectly competitive. In Philadelphia, the daily demand for bagels is Qd = 15,000 – 5,000P, which is graphed as D in the figure below. The industry supply of bagels in Philadelphia is Qs = –6,000 + 10,000P, which is graphed as S in the figure.

a. What is the market-clearing price of bagels in competitive equilibrium? How many bagels are bought and sold daily in Philadelphia? (You can solve mathematically using the equations for demand and supply, or you can use the demand and supply lines in the figure, which are drawn precisely to scale.) b. Explain why the Philadelphia bagel market is expected to achieve productive efficiency in competitive equilibrium. c. Suppose that Philadelphia bagel businesses charged a price of $2.60 and sold 2,000 bagels per day. Explain carefully why society would benefit from an increase in bagel production. d. Suppose that Philadelphia bagel businesses produced 10,000 bagels per day and charged a price of $1.60. Explain carefully why society would benefit from a decrease in bagel production. Chapter 16 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

e. How does the market-clearing price found in part a serve to ration bagels to the consumers who place the highest value on them? f. Does the Philadelphia bagel market achieve social economic efficiency? Why? 2. Using the demand and supply conditions given in Technical Problem 1, answer the following questions concerning consumer, producer, and social surplus in the Philadelphia bagel market. a. For the 2,000th bagel sold each day in Philadelphia, compute the consumer surplus, producer surplus, and social surplus when the price of a bagel is $1.40. b. Compute total consumer, producer, and social surplus when 2,000 bagels per day are produced and consumed at a market price of $1.40. c. At the equilibrium price and quantity, compute social surplus. d. Is your computed value for social surplus in competitive equilibrium (part c) higher or lower than your computed value for social surplus at 2,000 bagels per day (part b)? Is this what you expected? Explain. 3. Under the demand and supply conditions given in Technical Problem 1, suppose that the mayor of Philadelphia asks the city council to impose a price ceiling on bagels sold in Philadelphia. If the ceiling price is set at $0.80 per bagel, answer the following questions (and assume that bagels are somehow rationed to the consumers possessing the highest values (i.e., demand prices) for bagels: a. Does the ceiling price cause a surplus or shortage of bagels in Philadelphia? What is the amount of the surplus or shortage? b. Calculate consumer surplus under the price ceiling. Are bagel consumers in Philadelphia better off with the mayor’s price ceiling on bagels? Explain carefully. c. Calculate producer surplus under the price ceiling. Are Philadelphia bagel producers better off with the mayor’s price ceiling on bagels? Explain carefully.

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4. Use the figure below, which shows the linear demand and constant cost conditions facing a firm with a high barrier to entry, to answer the following questions.

a. The profit-maximizing price is $________, and the firm will produce ________ units. The firm earns economic profit of $________. b. Suppose antitrust officials find a way to remove the entry barrier to this market, and the market becomes perfectly competitive. Assuming that demand and cost conditions remain the same, what price and quantity will result? How much consumer surplus will buyers in this market gain? c. How much deadweight loss is caused by the market power created by the high entry barrier?

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5. Suppose a municipal water utility must pay $360,000 per month for its quasi-fixed capital inputs, the water treatment plant and distribution lines to 12,000 homes. The figure below shows the demand and cost structure for this utility at various levels of water service. Quantity of water consumption is measured in 1,000-gallon units per month. AQFC is the average quasi-fixed cost curve, and LAC is long-run average cost. Long-run marginal cost, LMC, is constant and equal to $4 per 1,000-gallon unit. The inverse demand equation is P = 36 – 0.0004Qd.

a. Find the value of costs in each of the blanks a through d in the figure. b. When one firm produces 40,000 units of water service per month, the long-run total cost is $________ per month. c. If two equal-sized, but separate, water utilities were to provide the community with 40,000 units of water per month, the long-run total cost is $________. d. At 40,000 units per month, are costs subadditive for municipal water service? e. What is the minimum efficient scale (MES) for this municipal water service?

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6. If the monopoly municipal water utility in Technical Problem 5 does not face any kind of government regulation of price or output: a. The water utility will charge $________ per 1,000-gallon unit, sell units of water per month, and earn monthly profit of $________. b. At the price set in part a, the water market in this community will experience allocative inefficiency because price is not equal to ________ (LAC, LMC, AQFC), and this creates a deadweight loss of $________ per month. c. To maximize social surplus, the price of water must be $________, which results in monthly social surplus of $________. d. If the public service commission decides to impose the price on the water utility in part c that maximizes social surplus, the utility will earn ________ (profits, losses) equal to $________. The utility will require a subsidy of $________ to remain financially viable under this regulatory plan. e. If the public service commission decides to employ second-best pricing, it will impose a water price equal to $________ per 1,000-gallon unit, which results in a deadweight loss equal to $________. f. If the public service commission decides to design an optimal two-part pricing plan for the water utility, it will set the usage fee equal to $________ per 1,000-gallon unit and set the monthly access charge for each of the 12,000 households equal to $________ per month. The deadweight loss under this plan is $________.

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7. The firms in the competitive industry shown in the figure below generate a negative externality in the process of supplying the product. The marginal external cost imposed on society is given by the MEC curve, and the marginal private cost of production, MPC, is given by the industry supply curve, S. Industry demand, D, measures the marginal social benefits (MSB) of consuming this product, because there are no spillover costs or benefits caused by consuming this good.

a. For the 50,000th unit produced by this industry, the marginal external cost is $________, the marginal private cost is $________, and the marginal social cost is $________. b. Construct the marginal social cost curve and label it MSC. c. In competitive equilibrium, the industry will produce ________units. This level of output is not ________ (productively, allocatively) efficient because ________is greater than ________ . d. The competitive equilibrium results in a deadweight loss of $________. e. The socially efficient level of output for this industry is ________units, where marginal social benefit equals ________.

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8. The figure below shows the marginal damage (MD) curve and the marginal abatement cost (MAC) curve facing an industry that discharges a pollutant into the environment.

a. If environment regulations do not restrict pollution by this industry, the industry would discharge ________ tons per month. At this level of emissions, total damage caused by pollution would be $________ per month, and total abatement cost would be $________ per month. Total social cost of pollution in this industry would be $________ per month in the absence of any government restrictions on pollution. b. If environmental officials banned all pollution, forcing the industry to eliminate all pollution discharges, then total abatement cost for the industry would be $________ per month, and total social cost of zero pollution in this industry would be $________ per month. c. Why is zero pollution in this industry not optimal from society’s point of view? Explain carefully using the figure above. d. The socially optimal level of emissions for this industry is ________tons per month, which results in a total abatement cost of $________ per month, and total damage from pollution of $________ per month. Total social cost is $________ per month. e. At the optimal level of pollution in part d, exactly what is maximized or minimized? f. What is the optimal level of abatement from society’s point of view? g. If environmental authorities wished to control pollution in this industry by imposing an emission tax on pollution, the tax per ton of discharge should be set at $________ per ton. At this tax rate, the industry discharges ________ tons per month and pays a total tax bill of $________ per month. The industry abates ________tons per month and incurs a total abatement cost of $________ per month. Chapter 16 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

9. Evaluate: “Common property resources are over-consumed and under-produced because property rights to these resources are difficult if not impossible to assign and enforce.” 10. a. Explain the two properties that characterize a public good. b. What is the allocatively efficient price to charge for public goods? Explain. 11. How does imperfect information about product prices create market failure? Will too much or too little output be forthcoming in markets in which buyers do not know the prices charged by all sellers of the good? 12. In the figure below, consumers buy a service that is competitively supplied. Consumers are poorly informed about the quality of the service. Specifically, they believe the quality of the service is higher than the true quality of the service.

a. Curve A in the figure represents ________ (demand, marginal social benefit) for the service in this market, and curve B represents ________ (demand, marginal social benefit) for the service. b. In competitive equilibrium, the price is $________ and ________ units are produced and consumed. c. Allocative inefficiency arises because, at the competitive output level, the marginal social benefit is $________, which is ________ (smaller, larger) than $________, the marginal social cost in competitive equilibrium. d. The deadweight loss caused by imperfect information about service quality is $________.

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Answers to Duplicate Technical Problems 1. a. Find the intersection of demand, D, and long-run industry supply, S. On the graph, the intersection is found at $1.40 and 8,000 bagels per day. The same solution can be found mathematically by setting Qd equal to Qs and solving for equilibrium price P :

Qd = Qs 15,000 − 5,000P = −6,000 + 10,000P P = $1.40 Next, substitute $1.40 into either the demand or supply equation to find equilibrium quantity:

Q = 15,000 − 5,000($1.40) = −6,000 + 10,000($1.40) = 8,000 As you can see in the figure below, D and S intersect at $1.40 and 8,000 units.

b. Certainly, every bagel producer in Philadelphia knows that to maximize the firm’s profit, total costs must be minimized. Thus each firm will operate on its expansion path, and productive efficiency results. This argument is more compelling in the long run, because any firm that fails to operate on its expansion path will earn losses and be forced to get out of the bagel business Chapter 16 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

in Philadelphia. c. At 2,000 units, the marginal benefit to society of an additional bagel is $2.60, because demand price gives the marginal valuation or benefit to consumers of having an additional bagel. [Note: you can get the demand price by carefully examining the graph of demand or by using the demand equation with Qd set equal to 2,000.] At 2,000 units, the marginal cost of producing another bagel is $0.80, because competitive supply prices give the marginal cost of producing an additional bagel. [Note: you can get the supply price by carefully examining the graph of supply or by using the supply equation with Qs set equal to 2,000.] Since the marginal benefit exceeds the marginal cost, an increase in bagel consumption and production will increase society’s net benefit. d. At 10,000 units, the marginal cost is $1.60 and the marginal benefit is $1.00. Reducing bagel production and consumption by one unit will decrease total cost by $1.60 and decrease total benefit by $1.00, which results in a gain in net benefit of $0.60 for the one-unit reduction in bagel production and consumption. e. Since the market price is $1.40, only consumers with demand prices equal to or higher than the market price will choose to purchase bagels. These voluntary buyers are represented by the 8,000 buyers whose demand prices lie on the segment of demand between $3 and $1.40. The lower-valued buyers represented by the segment of demand between $1.40 and $0 will voluntarily choose not to buy bagels at the market price of $1.40, which insures that the 8,000 bagels end up being consumed by the consumers who place the highest values on the 8,000 bagels. To further drive home this important idea, let’s suppose that Jones is the 2,000th buyer who values a bagel at $2.60 and Smith is the 10,000th buyer who values a bagel at $1.00. Now suppose that instead of letting Smith consume this one bagel, we force Smith to give the bagel to Jones. There is no effect on social cost from this move because the same number of bagels are being produced. However, the total value of the bagels consumed in Philadelphia is reduced by moving the bagel from Smith to Jones because Smith loses $2.60 of value while Jones gains only $1.00, which creates lost value of $1.60. In other words, the total value of the bagels consumed cannot be maximized unless every bagel goes to the person who places the highest value on each and every bagel. Without any government intervention, the market for bagels automatically distributes every bagel to the highest-valued “user” of bagels because only people with values greater than or equal to $1.40 will choose to buy a bagel. f. Yes, because both productive efficiency and allocative efficiency are achieved at the point of competitive equilibrium, $1.40 and 8,000 bagels per day. 2. a. Consumer surplus of the 2,000th unit = $1.20 (= $2.60 – $1.40). Producer surplus of the 2,000th unit = $0.60 (= $1.40 – $0.80). Social surplus of the 2,000th unit = consumer surplus + producer surplus = $1.80. b. At 2,000 (total) units produced and consumed, the total surpluses are equal to areas of trapezoids. Recall that the area of a trapezoid is calculated by multiplying base by the average height of the two sides:

 ($3.00 − $1.40 ) + ( $2.60 − $1.40)  CS = 2,000 ×   = $2,800 2  

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 ( $1.40 − $0.360) + ( $1.40 − $0.80)  PS = 2,000 ×   = $1,400 2   Social surplus = consumer surplus + producer surplus = $4,200. c. At the competitive equilibrium price and quantity, $1.40 and 8,000 units, respectively: Consumer surplus = 0.5 × 8,000 × ($4.00 – $1.40) = $6,400 Producer surplus = 0.5 × 8,000 × ($1.40 – $0.60) = $3,200 Social surplus = consumer surplus + producer surplus = $9,600. d. Social surplus in competitive equilibrium ($9,600) is greater than social surplus at 2,000 units ($4,200). This is indeed as expected since social surplus is maximized at the intersection of demand and supply. In other words, $9,600 is the maximum social surplus possible for this demand and this supply curve, and any point other than market equilibrium must yield a smaller value for social surplus. 3. a. A shortage equal to 9,000 bagels per day (= 11,000 – 2,000), as shown in the figure above. b. Consumer surplus with the $0.80 price ceiling =

( $3.00 − $0.80) + ($2.60 − $0.80 ) CS = 2,000 ×   = $4,000 2   The 2,000 consumers who are able to buy bagels are better off because they pay only $0.80 instead of $1.40, and this increases their consumer surplus by $1,200. This small group of Philadelphia citizens will likely praise the mayor for imposing the price ceiling on bagels. However, the rest of the consumers in Philly who were willing and able to buy bagels prior to the price ceiling’s implementation (i.e., the other 6,000 buyers), are now worse off by the amount of the lost consumer surplus on those units: –$3,600 = 0.5 × 6,000 × ($2.60 – $1.40). Thus, the net change in consumer surplus is –$2,400 (= $4,000 – $6,400 or $1,200 –$3,600). c. Producer surplus with the $0.80 price ceiling = $200 = 0.5 × 2,000 × ($0.80 – $0.60). All producers are worse off since all sellers receive 60 cents less per bagel and they are selling fewer bagels. The change in producer surplus is –$3,000 (= $200 – $3,200). No doubt the mayor in Philly will crow to the glowing media that he has repatriated filthy profit from the evil bagel producers. A cynic might easily conclude that citizens in democracies get the governments they deserve while an optimist might conclude that European-style socialism is a refreshing change from old-fashioned free enterprise. Only in the city of brotherly love…

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