Spring Problem Set 1 Solution

# Spring Problem Set 1 Solution - MICROECONOMICS PROBLEM SET...

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MICROECONOMICS PROBLEM SET SOLUTION – WPR #1 Spring 2006 Section I Concept Questions In three to four sentences each, answer the following: 1. Explain why firms in perfectly competitive markets face perfectly elastic demand curves, while monopoly firms face downward sloping demand curves. PC firms face PE D curves because they are price takers. There are so many buyers and so many sellers, that each firm makes up only a very small part of the market. They can sell all the goods they want at the equilibrium price that the market gives them. Because there are many sellers of the goods, they cannot sell any goods above the market price. Monopoly firms on the other hand, are responsible for satisfying the entire market demand. Because of this, they face downward facing demand curves typical of most markets. In order to sell more of a good, they must lower the price. 2. Using elasticities, explain why razors are usually inexpensive, but refills (blades) are fairly expensive. The market for razors is fairly competitive, there are many substitutes and thus demand is fairly elastic. Razor manufacturers compete in this market based on price- they expect TR to go up when they decrease their price. Once a razor is purchased however, the demand for refills is relatively inelastic (because normally there are few if any substitutes). Firms can increase the price of refills and expect TR to increase.

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3. Why do monopolies exist? Why do monopolists enjoy long term profits and why can’t perfectly competitive firms? Barriers to entry! Barriers to entry! PC firms have free entry/exit. When P>ATC there are positive profits and firms enter the industry, thus increasing supply, and lowering the Price until ultimately P=ATC and the profits have vanished. 1. (SOLUTION) – Interdependence and gains from trade A worker in China can produce 40 shirts or 5 tables per week. A worker in the US can produce 8 shirts and 4 tables per week. a. Draw China and US (PPF) for 1 worker over a 1 week time period. Assume that there is no specialization. Label x and y-axis, the efficient, attainable, and unattainable regions. China PPF US PPF EMBED PBrush EMBED PBrush Shirts 40 20 0 1 2 3 4 5 Tables Shirts 8 1 2 3 4 5 Tables Attainable (Inefficient) Attainable (Inefficient) Unattainable Unattainable Efficient Efficient
b. State the US and China opportunity cost of producing 1 shirt, producing 1 table. Who has the absolute advantage in producing shirts? In producing tables? Who has the comparative advantage in producing shirts? In producing tables? OC Cost Shirts Tables China has absolute advantage in both shirts US 1/2 tables 2 shirts and tables. China has comparative China 1/8 tables 8 shirts advantage in producing shirts. US in producing table. c. Describe the flow of trade between the two countries (i.e. who trades what).

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## This note was uploaded on 04/17/2008 for the course ECON SS201 taught by Professor Evans during the Spring '08 term at West Point.

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Spring Problem Set 1 Solution - MICROECONOMICS PROBLEM SET...

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