Microeconomics Exercises Block 3 PDF

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PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

CONTINOUS ASSESMENT EXERCICES (BLOCK 3) 3. A departure from equilibrium pricing usually causes a deadweight loss. Consider the diagram of a market that is at equilibrium at point e where price is Pe and quantity is Qe: a) At equilibrium, the consumer surplus is equal to the area k-e-g and the producer surplus is equal to the area g-e-a-g. b) Suppose that a price ceiling is imposed at p1 so that producers want to sell Q1 units and consumers want to buy Q2 units. Because Q1 units will be traded, consumers are willing to pay the price d but producers receive price c. Producer surplus now varies to area b-c-a-b and consumer surplus changes to area k-I-f-c-b-g-h-k. The sum of consumer and producer surplus is less than before the price ceiling, and deadweight loss is created equal to the area I-e-c-f-I. Can you tell who gains and who loses under a price ceiling? Consumers gains from a price ceiling. Meanwhile producers loose. As price ceiling is a price which is under the equilibrium price, it promotes a shortage, then, the Q demanded will be higher than the Q supplied, forcing that the market has to increase prices to reduce the Q demanded. c) Suppose instead that a price floor is imposed at p2 so that producers want to sell Q2 units and consumers want to buy Q1 units. Consumers are willing to pay the price i and producers receive the price j. Producer surplus is equal to the area h-I-f-c-a-b-g-h and consumer surplus is equal to the area k-I-h-k. The sum of consumer and producer surplus is less than before the price floor, and deadweight loss is created equal to the area I-e-c-f-I. Can you tell who gains and who loses under a price floor? Under a price floor, producers gain and consumers loose. A price floor is a price above equilibrium price, and it supposes a surplus. That means the Q supplied is higher than the Q demanded, forcing that the market has to decrease prices to reduce the Q supplied.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

4. The government decides to reduce air pollution by reducing the use of petrol. It imposes € 0.50 tax for each litre of petrol sold. a) Should it impose this tax on petrol companies or motorists? Explain carefully, using a supply and demand diagram. As we can appreciate in the graphs, a tax imposed on sellers or buyers acts equal. So, we can conclude that the tax would be imposed taking into account that is easier for the government to impose the tax on petrol companies, as there are more motorists than companies and the control is easier.

b) If the demand for petrol were more elastic, would this tax be more effective or less effective in reducing the quantity of petrol consumed? Explain with both words and a diagram. The more elastic is the demand curve, the more effective the tax is reducing the consume of petrol. As producers will be more damaged with this tax and the production of petrol will decrease.

c) Are consumers of petrol helped or hurt by this tax? Why? The consumers of petrol are really hurt by this tax because they obtain a smaller quantity of petrol paying a higher price to pay it as the tax causes an increment in petrol price. d) Are workers in the oil industry helped or hurt by this tax? Why? The workers will be also hurt by this tax because the reduction of the sale quantity of petrol promotes the decreasing of the demand for workers in the petrol industry. Then, the remuneration that workers received decreases as well as the employment for them

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

5. A case study discusses the minimum wage law: a) Suppose the minimum wage is above the equilibrium wage in the market for unskilled labour. Using a supply and demand diagram of the market for unskilled labour, show the market wage, the number of workers who are employed and the number of workers who are unemployed. Also show the total wage payments to unskilled workers.

b) Now suppose the minister for employment proposes an increase in the minimum wage. What effect would this increase have on employment? Does the change in employment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither? If the minister decides to increase the minimum wage, then, the effect would be a decrease of employment. The change on employment depends on the elasticity of demand. The more elastic the demand is, the higher the decreasing of employment is. c) What effect would this increase in the minimum wage have on unemployment? Does the change in unemployment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither? The increase in the minimum wave promotes an increasing of unemployment. Both curves, the demand curve and de supply curve, are related to unemployment changes. The more elastic both curves are, the higher increasing of unemployment is. d) If the demand for unskilled labour were inelastic, would the proposed increase in the minimum wage raise or lower total wage payments to unskilled workers? Would your answer change if the demand for unskilled labour were elastic? If demand for unskilled labour were inelastic, the proposed increase would increase total wage payments. However, if demand for unskilled labour were elastic, total wage payments would decrease.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

6. After your economics lecture one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. In what sense is taxing food a 'good' way to raise revenue? In what sense is it not a 'good' way to raise revenue? Taxing food is a good manner of increasing revenue, as the demand curve of food is too much elastic due to food is a basic need. Then, if the price increases people will not be able to find close substitutes to food and go on purchasing it. As a result, revenues will increase. However, taxing a basic need as food also can generates a huge discomfort among families, which will count with less money to obtain food, promoting a decreasing of the demand and prejudicing market revenues.

7. A subsidy is the opposite of a tax. With a € 0.5 0 tax on the bu yers of ice cream cornets, the government collects € 0.50 for each cornet purchased; with a € 0.50 subsidy for the buyers of ice cream cornets, the government pays buyers € 0.50 for each cornet purchased. a) Show the effect of a € 0.50 per cornet subsidy on the demand curve for ice cream cornets, the effective price paid by consumers, the effective price received by sellers and the quantity of cornets sold.

The subsidy per cornet on demand will shifts the demand curve to the right The price paid by consumers decreases from P1 to P3. The price received by sellers increases from P1 to P2. The Q of cornets sold increases from Q1 to Q2.

b) Do consumers gain or lose from this policy? Do producers gain or lose? Does the government gain or lose? Consumers will gain from the policy as they will purchase more at a lower price. Producers will also gain from the policy, as they will sell more quantity of cornets at a higher price. Then, the only loser is the Government, as they will pay the amount of 0.5 euros of the subsidy.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

8. Give an example of a positive production externality and an example of a negative production externality. And give an example of a positive consumption externality and an example of a negative consumption externality. (Different from the ones we have seen in class or in the textbook). POSITIVE EXTERNALITIES:  

Production: Searching a way to reduce the cost of the production of any product will decrease the selling price of this product. Consumption: consuming more bicycles will reduce the pollution.

NEGATIVE EXTERNALITIES:  

Production: The sale of fur clothing may end up with some animal species. Consumption: listening to music too loud at home can disturb your neighbours.

9. There are at least three negative externalities associated with driving. a) Which are these externalities? Does this explain why petrol is taxed so heavily? o Traffic. o Accidents o Pollution By taxing petrol, people will use other kinds of transports such as bicycles or public transport in order to spend less. As a consequence, traffic will decrease so there will be less accidents and pollution. b) Illustrate the market for petrol, labelling the demand curve, the social value curve, the supply curve, the social cost curve, the market equilibrium level of output and the efficient level of output.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

c) On your graph, shade the area corresponding to the deadweight loss of the market equilibrium and explain the intuition behind it. The deadweight loss is an area where production should also be located. However, due to market inefficiency, it is an inefficient allocation of resources (supply and demand are not in equilibrium).

10. Consider the market for fire extinguishers. a) Why might fire extinguishers exhibit positive externalities? Because they are used to extinguish fire when it spreads from the origin place to another, so they can safe lives an also material goods. b) Draw a graph of the market for fire extinguishers, labelling the demand curve, the social value curve, the supply curve and the social cost curve.

c) Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ. Fire extinguishers exhibit positive externalities because even though people buy them for their own use, they may prevent fire from damaging the property of others. The market equilibrium and efficient output quantities differ because in deciding to buy fire extinguishers, people don't take in account the benefits they provide to other people (which are represented in the social value curve); however, the efficient level of extinguishers does. d) If the external benefit is €10 per extinguisher, describe a government policy that would result in the efficient outcome. Government should give a subsidy of 10€ for every extinguisher bought.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

11. Do you agree with the following statements? Why or why not? a) 'The benefits of Pigovian taxes as a way to reduce pollution have to be weighed against the deadweight losses that these taxes cause.' It is false: Pigovian taxes decrease deadweight loss as they reduce the inefficiency of pollution by reducing the number of products produced. b) 'When deciding whether to levy a Pigovian tax on consumers or producers, the government should be careful to levy the tax on the side of the market generating the externality.' This statement is false as it doesn’t depend on the part you levy the tax as it will act as equal form, will lead to the same reduction of quantity and change in the prices producers receive or consumers pay.

12. What is the Coase theorem? Suppose that collectively, the 1000 residents of Green Valley value swimming in Blue Lake at 100,000€. A nearby factory pollutes the lake water, and would have to pay 50,000€ for non-polluting equipment. a) Describe a Coase-like private solution. When individuals or firms are taking into account externalities they are internalizing them, according to Coase an economy can reach an efficient solution once property rights are well defined and low transactions costs. So, in this case both part will deal about the problem and find an efficient solution that satisfies each part. b) Can you think of any reasons why this solution might not work in the real world? This could perfectly don’t work, and in fact, it doesn’t, as every part tends to think about their own interest and won’t take into account the other’s concern or problem if it does not damage their current situation. So, more current firms won’t try to solve the problem as the solution would increase cost much that it could benefit the firm.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

13. The Pristine River has two polluting firms on its banks. European Industrial and Creative Chemicals each dump 100 tonnes of effluent into the river each year. The cost of reducing effluent emissions per tonne equals €10 for European Industrial and €100 for Creative. The government wants to reduce overall pollution from 200 tonnes to 50 tonnes per year. a) If the government knew the cost of reduction for each firm, what reductions would it impose to reach its overall goal? What would be the cost to each firm and the total cost to the firms together? If the government knew the cost of reduction at each firm, it would make European Industrial eliminate all its pollution (10€ x 100 tonnes = €1000) and make Creative eliminate half of its pollution (100€ x 50 tonnes = €5000). This would minimize the total cost of reducing pollution to 50 tonnes, which will be 6000€. b) In a more typical situation, the government would not know the cost of pollution reduction at each firm. If the government decided to reach its overall goal by imposing uniform reductions on the firms, calculate the reduction made by each firm, the cost to each firm and the total cost to the firms together. If government wouldn't know the cost of pollution reduction, it will make both firms reduce it in the same way: 75 tonnes each one. The cost to European Industrial would be 75 x 10€ = 750€ and the cost to Creative would be 75 x 100€ = 7500€; so the total cost would be 8250€. c) Compare the total cost of pollution reduction in parts (a) and (b). If the government does not know the cost of reduction for each firm, is there still some way for it to reduce pollution to 50 tonnes at the total cost you calculated in part (a)? Explain. In part a, it costs €6,000 to reduce total pollution to 50 tonnes, but in part b it costs €8,250. So it is definitely less costly to have European Industrial reduce all of its pollution and have Creative cut its pollution in half. Even without knowing the costs of pollution reduction, the government could achieve the same result by auctioning off pollution permits that would allow only 50 tonnes of pollution. This would ensure that European Industrial reduced its pollution to zero (since Creative would outbid it for the permits) and Creative would then reduce its pollution to 50 tonnes.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

14. What kind of good is a road? Is it excludable? Is it rival in consumption? (Hint: the answer depends on whether the road is congested or not, and whether it is a toll road or not. Consider the different cases.) Road are usual a common good or service and not rival in consumption, however, a road could be excludable when it’s a toll road as you have to pay for enter it and for its circulation. And it’s a rival in consumption good in the case there’s lot of vehicles that make the road congested incapacitating the circulation and institutions apply some measures to control the access on it. Non-excludable goods suffer from this “free rider” problem: who benefits from a good or service don’t pay for it. This problem might be related hen property rights are not clearly defined and imposed, as in the case of public goods and common resources where its access can’t be excludable.

15. Both public goods and common resources involve externalities. a) Are the externalities associated with public goods generally positive or negative? Use examples in your answer. Is the free market quantity of public goods generally greater or less than the efficient quantity? Externalities associated with public goods are generally positive because people ignore the benefits they cause to other people when deciding whether to provide the good. For instance, building a new park next to an school will both improve the views of the urbanization and give children more places to play. As public goods generate positive externalities, the free market quantity is lower than the efficient quantity, as the social value is higher than the general one. b) Are the externalities associated with common resources generally positive or negative? Use examples in your answer. Is the free market use of common resources generally greater or less than the efficient use? Externalities associated with common resources are generally negative because when one person uses a common resource, he/she diminishes other people from enjoy it; therefore, common resources tend to be used excessively. For instance, when a firm clears a forest diminishes other people from getting benefit of the oxygen these trees produce. As common goods generate negative externalities, as we said, the free market use is higher than the efficient one.

PÉREZ CARRO, MIREIA INTERNATIONAL BUSINESS MICROECONOMICS, Block 3

17. What is the Tragedy of the Commons? What kind of policies can the government implement to prevent it? It’s the damage that innocent actions by individuals can inflict on the environment, the common resources have the problem that are not excludable and they are rival on consumption, so, even if you can’t stop from consuming the good, more consumption mean less availability of it....