Econ 211: Problem Set 2

Externalities

1. An environmentalist argues that all pollution must be eliminated. How would you try to convince her that her position is both unreasonable and impractical?
2. Take a perfectly competitive firm that produces external benefits for the community. Is this firm producing too much or too little?
3. Airport noise is certainly a negative externality. Why would people choose to live near airports?
4. Fishermen who use nets to catch tuna also sometimes net dolphins, which, because they are mammals, drown before they can be released. Currently, the price and quantity of tuna determined by the market does not take into account the cost to society of killing the dolphins (marginal external cost). Listed below are market demand and supply schedules for tuna as well as the marginal external social costs associated with dolphins killed in the process of catching tuna. All costs and values are listed in terms of dollars per pound of tuna.
   

Quantity of Tuna (1000s)	Consumers' Valuation of Tuna	Marginal Private Cost of Tuna	Marginal External Cost of Dolphins
1000	$5.50	$1.75	$2.05
2000	5.00	2.00	2.15
3000	4.50	2.25	2.25
4000	4.00	2.50	2.35
5000	3.50	2.75	2.45
6000	3.00	3.00	2.55
7000	2.50	4.50	2.65
8000	2.00	4.70	2.75

• What output and price would the free market generate? Why?
• What is the socially optimal output and price? Why?
• In order to obtain the socially optimal equilibrium, what would the appropriate per-pound tax on suppliers need to be? Of this tax, how much would consumers end up paying?

Productivity and Costs

5. A business executive claims a company should never hire another worker if the new person causes diminishing returns. Explain why this person is wrong.
6. The table below shows the output that various amounts of workers can produce. What is the marginal product of the third worker? Now, assume that labor is the only cost of production and the price of the firm's product is $5 per unit and the wage is $25 per worker. How many workers would a profit-maximizing firm would hire?

Number of Workers	0	1	2	3	4	5	6	7
Output	0	10	19	27	32	35	36	36

7. Suppose your factory faces the production technology described below. Complete the table assuming that labor costs are $2 per unit and you have fixed costs of $30.

Labor	Output	VC	FC	TC	AVC	ATC	MC
6	1	.	.	.	.	.	.
10	2	.	.	.	.	.	.
13	3	.	.	.	.	.	.
15	4	.	.	.	.	.	.
18	5	.	.	.	.	.	.
23	6	.	.	.	.	.	.
30	7	.	.	.	.	.	.
40	8	.	.	.	.	.	.

8. The Preservation Embalming Company's cost data have been partially entered in the table below. Following the sudden and unexpected death of the company's accountant, you are called on to fill in the missing entries.

Bodies	TC	FC	VC	ATC	AVC	AFC	MC
0	24	.	.	.	.	.	.
1	.	.	.	.	.	.	16
2	.	.	50	.	.	.	.
3	108	.	.	.	.	.	.
4	.	.	.	.	.	.	52
5	.	.	.	.	39.20	.	.
6	.	.	.	47	.	.	.

Entry and Exit

9. Suppose that you own a house that you are planning to be away from for one year. In a typical month when the house is occupied, you pay $350 in utility bills and $200 in taxes. If the house is vacant, the utility bills fall to $100, but the tax bill remains the same. Somebody wants to rent your house from you while you are away. What is the minimum rent she would have to pay before you would agree? Explain.
   
10. How are some firms able to earn economic profits year after year after year? Why doesn't the competitive process force economic profits to zero?
11. In the Woody Allen film Radio Days, a character who has never been able to succeed in the world of business decides to begin a career engraving gold jewelry. He argues that this should be especially lucrative because the engraver gets to keep the gold dust from other people's rings. What is wrong with this character's assessment of his potential career choice?

Monopolies

12. "Monopoly is good for producers but bad for consumers. The gains of the former offset the losses of the latter. On balance, there is no reason to think that monopoly is bad for the economy." Evaluate.
13. Is price discrimination harmful to the US economy? Explain why or why not. What three conditions are necessary for successful price discrimination?
14. Which of the following are monopolists: (a) your local newspaper, (b) the Cleveland Indians, (c) General Motors, (d) the US Postal Service, (e) Michael Jackson, (f) the American Medical Association? Explain why or why not.
15. A price discriminating seller will charge a higher price to those market segments which have the relatively more inelastic demand. For each of the markets below, indicate which segment you think will be charged the higher price. Explain why you think that segment has a lower elasticity of demand.
• Sales of new boats to those who presently own a boat, or those who do not own a boat.
• Sales of movie tickets to children or adults.
• Sales of airline tickets to business travelers or a couple on vacation.
• Sales of cosmetic surgery to the poor or the rich.
16. It has been argued that the development of the railroad in the middle of the nineteenth century substantially reduced the market power of many American manufacturing firms. Explain.
17. If an organization like the Mafia effectively monopolized illegal activity, would you expect to observe less crime than under competitive free entry into this "industry"?
18. A monopolist produces output at a constant marginal cost of $5 per unit and has no fixed costs. The demand schedule facing the price searcher is below:
    

Buyer Values	Number of Buyers
10	5
8	5
6	5
4	5

• What is the profit-maximizing output, price, and profit?
• Sketch a diagram of the firm's demand curve, MR curve and MC curve. Indicate the optimal output and price.
19. A monopolist produces 100 units of output where MR = MC and charges a price of $20. The average cost of 100 units is $12. Draw this situation on a graph.
• What is total revenue, total cost, and economic profit at this output level?
• Suppose the government imposes a lump-sum tax of $300 on the monopolist. How does the monopolist respond to this in terms of price and output? Illustrate graphically. What are its profits now?
20. The following table indicates the prices various buyers are willing to pay for a Miata sports car:
    

Buyer	A	B	C	D	E
Maximum Price	$50,000	$40,000	$30,000	$20,000	$10,000

The cost of producing the cars includes $50,000 in fixed costs and a constant marginal cost of $10,000 per car.

• Graph the demand, marginal revenue, and marginal cost curves.
• What is the profit-maximizing output and price for a monopolist? How much profit does the monopolist make?
• If the monopolist can practice first-degree price discrimination, how many cars will she sell? How much profit will she make?
• What techniques could the monopolist use to employ price discrimination?