Econ 360
Problem Set 1 Answers

1. This question attempts to get you to distinguish between a shift in a curve and a movement along a curve. The first sentence is correct: If the DEA intercepts 100 tons of cocaine, the supply curve will fall (shift left). The first clause of the second sentence is also correct: This (the shift in supply) will cause the price to rise. The second clause of the second sentence is incorrect: the rise in the price of cocaine will not shift the supply curve.

2. Automobile Market.
a. Demand for autos increases: P rises; Q rises.
b. Supply of autos increases: P falls; Q rises.
c. Supply of autos decreases: P rises; Q falls.
d. Demand for autos decreases and Supply of autos increases: P falls; Q ?.
e. Demand for autos increases; Supply of autos increases: P ?; Q rises.
f. Demand for autos decreases; Supply of autos decreases: P?; Q falls.

3. The decreased number of doctors and rising wage rate for doctors can be explained as due to a leftward shift in the supply of doctors, ceteris paribus.

4. A minimum wage imposed above the market clearing wage will cause a surplus of labor: labor demanders will reduce the number of workers hired while labor suppliers will increase their job search activities.

5. Judith's indifference curves:
a. Indifference curves will be upward sloping (with higher levels of utility to the northwest).
b. Indifference curves will be horizontal (with higher levels of utility to the north).
c. Indifference curves will be horizontal (with higher levels of utility to the south).

6. a)  budget line shifts outward (parallel to original); consumers jump up to higher indifference curve; consumption of X will rise (if it is a normal good)
b) budget line shifts inward along the X axis only; consumers jump down to lower indifference curve; consumption of X will fall
c) budget line shifts inward (parallel to original); consumers jump down to lower indifference curve; consumption of X will fall

7. The basic monopoly model from micro principles suggests that monopolists tend to produce less output than an otherwise competitive industry would. The monopolist produces less because it can make more profits that way. This suggests that the Mafia has an incentive to restrict the amount of crime below the amount that would occur under competitive free entry.

8. The profit maximizing output level in the short run occurs where P = MR = MC and P > AVC (the shutdown condition). We know that the market price is P = 8.  At the current output of Q = 200, we know that MC = 10.  Thus, the firm is not maximizing their profits: they should reduce their output.

9. Monopoly question.
a) Total Revenue = $2000; Total Cost = $1200; Profit = $800
b) A lump sum tax is a fixed cost; it does not alter the firm's marginal cost of production. Therefore, the firm will continue to operate where MR = MC, which occurs at 100 units of output and a price of $20. The only impact of the tax is to eat away at the firm's profits (which are now reduced to $500).

10.  This is for you to ponder.

11. Closing stores on Sunday have the benefit of saving on various costs (labor, electricity) for one day out of the week. Customers are induced to reallocate their shopping to the other 6 days of the week.  If all stores stay closed on Sundays, then the entire group might benefit from such a closing.  However, the temptation for a single store owner to open on Sunday could mean a sales windfall as all other stores are closed.  This temptation to cheat on the agreement to stay closed is an example of self-interest (e.g., a dominant strategy) prevailing over the cooperative outcome.

12. a)  A Pareto optimal outcome is one that maximizes the joint profits from a game.  Hence, the upper right hand corner of (High, Even) has a total payoff of 6.
b)    There is no Nash equilibrium to this game.  In every possible outcome to the game, one of the players has a unilateral incentive to change his decision, given the decision of the other.
c)    If B goes first and somehow commits herself to Odd (perhaps she makes a public declaration or spends oodles of money to prepare for Odd),  then A's best response is to go High.

13. Private versus public goods.
a. private
b. public
c. private
d. public
e. public

14. This is for you to ponder.

15. A move to no-fault divorce laws would reduce the implicit price of divorce. Consequently, you would expect to see more divorces occurring. I suspect you would see an increase in marriages since it would be easier to dissolve the marriage if things go bad. The quality of such marriages would be suspect also.

16. We might have done this one in class.

17. Travel problem.
a. The private marginal cost of taking the train is $2.50. The total cost of N people is ($2.50)N. The social marginal cost of the trip is $2.50.
b. The private marginal cost of taking a car must equal $2.50 (otherwise people would take the train). The cost of traveling by car is equal to C = 0.50 + 1.5 (t). C must be equal to $2.50, which means t = 1.33. If t = 1.33, then N equals 22.67.
c. Total Cost of N people traveling by car = 0.8N + 0.075N². The marginal social cost = 0.8 + 0.15N. This must equal the private marginal cost in a social equilibrium. Hence, the socially optimal number of car trips is N = 11.33.
d. Perhaps a tax on driving your car would do the trick (a gas tax perhaps). The tax should be designed as affecting the marginal cost of driving, not the fixed cost.

18. We did one similar to this in class (see the powerpoints).

19.a)  Event 1 = $11,000; Event 2 = $9,000
b)    EU = (.5)[√11000] + (.5)[√9000] = 99.87
c)    EU ≈ 100
d)    $10,000 either way
e)    EU = (.5)[√10000] + (.5)[√10000] = 100
f)    Clarence is indifferent.

20. This is easy to look up in the book.

21. In order, from lowest court to highest court:

State System:
trial courts: entry level courts where disputes are first heard and records are kept
appellate courts: trial decisions may be appealed
supreme courts

Federal System:
district courts: each state has at least one; 93 total
appellate courts
Supreme Court

22. When precedent does not provide a clear rule for resolving a dispute, the judges must create one. Review the Butterfield and Davies cases at the end of Chapter 3.

23. The fundamental purpose of property law is to encourage the efficient use of resources by creating rules that facilitate bargaining and exchange and that minimizes the loss when bargaining fails.

24. Review your notes and Chapter 4.

25. Read pages 89-91 in Chapter 4 for the answer.

26. The higher the level of transactions costs, the more likely that public intervention will be necessary to solve various problems.

27. This one is for you to ponder.

28. Calabresi and Melamed argued that if transactions costs (TC) are low, then an injunction is the preferred remedy since private bargaining is likely to work when TC are low. If TC are high, then damages are the preferred remedy since bargaining is unlikely to work well. Of course, one must also balance the information costs of determining damages by the courts versus the transactions costs of private bargaining. If information costs are too high then it may be difficult to calculate the appropriate damage award, and injunctions may be more efficient.

29. Patents create monopoly profits as a reward for invention, but monopoly has a static cost in terms of resource allocation. For efficiency, the reward should not last forever.

30. Consider the incentive effects of requiring an annual patent renewal fee that reflects the underlying marginal social costs of the patent. How about doing what the Germans do?

31. Trademarks signal quality based upon reputation. For efficiency, the signal should endure.

32. Consider circumvention and depletion costs in your answer to the second question. Consider general resource inefficiency in your answer to the third question.

33. Boomer is for you to ponder.

34. False. Why?

35. No, since the government has the incentive to take property from one citizen to give to another. (This could be argued as the justification for the taking of Poletown on behalf of GM.) The additional constraint placed on government taking is that the taking must be for a public purpose.

36. This is for you to ponder.

37. Re-read page 189, in particular, the two paragraphs above Section E.

38. A typical Coase Theorem situation.

39.  Judge Grim or Judge Smiley:
a) 12 months [ = .5(.5(36) + .5(12)) ]
b) 0 months [ = expected outcome at trial - 12 months that prosecutor is willing to give up]
c) 18 months [ = expected outcome at trail + 6 months that Lefty is willing to accept]
d) 18 months [ = difference between Lefty's willingness to accept and Prosecutor's willingness to give]
e) 9 months, which is the certain threat value of Lefty (from part b) plus one-half the cooperative surplus (from part d).
f) The prosecutor and defendant save trial costs. The defendant also avoids the risk of a 36 month sentence.
g) 24 months

40. This is similar to the FlexMag example.

41. Abe and Beth:
a) Expected value of going to trial to Abe = (.5)($1000) - 300 = $200
Expected value of going to trial to Beth = (.5)($400) - 300 = -$100
Thus, the value of the noncooperative outcome is 200 + (-100) = $100
b) The value of the cooperative outcome = $1000. If the parties cooperate, then they will settle out of court. The settlement will require Abe to pay Beth some amount S for settlement, and Abe will get the ring. The cooperative value of the game is the sum of the payoffs to both parites: (+S) + (-S+1000) = 1000.
c) The surplus from cooperation is $1000 - ($100) = $900
d) Reasonable solution would have Abe receive 1/2 of surplus plus his threat value: $450 + $200 = $650
Beth would receive 1/2 of surplus plus her threat value: $450 + (-$100) = $350;
In other words, Abe would pay Beth $350 for the ring: Abe ends up with 1000-350 = $650 and Beth ends up with -100 + 450 = $350.