a05-part2 - Page 13 0f25 Long-run equilibrium for the...

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Unformatted text preview: Page 13 0f25 Long-run equilibrium for the typical monopolistically competitive firm is characterized by price equal to marginal cost at the chosen level of output marginal cost equal to average cost at the chosen level of output price equal to average cost at the chosen level of output marginal cost equal to average revenue at the chosen level of output price exceeding average cost. w/MPL (where w is the fixed wage rate) can be interpreted as the extra output obtained from hiring one more worker the extra workers required to produce one more unit of output the marginal cost of hiring one more unit of labour the marginal product from hiring one more unit of labour the marginal cost of producing one more unit of output by using additional labour. THE REST OF THIS PAGE IS BLANK 5. 5.1 Page 14 0f 25 CONSUMER THEORY (10) The Consumer Price Index Henri spends his whole income on X and Y. In 1999 he bought 25 units of X at $4 each and 10 units of Y at $10 each. In 2004 he bought 15 units of X at $8 each and 18 units of Y at $10 each. a) b) d) Compute a Laspeyres Price Index (LPI) for Henri. LPI = Compute a Paasche Price Index (PPI) for Henri. PPI = Using just the information above, and assuming no changes in preferences, what can we say about Henri’s situation in 2004 compared to 1999? He was: (better off / worse off / equally well off / can’t determine). My conclusion is based on this statement about the change in prices and his income: Use an indifference curve diagram to help you explain your conclusion in part c above. (You need not show the intercepts for the budget lines, but you do need to show the position of each one, label as BL99 and BL04, and show the consumption points in 99 and O4.) 5.2 b) Page 15 of 25 (10) Substitution and Income Effects In the diagram below, show the Substitution Effect (SE) and the Income Effect (IE) of a reduction in the price of X for a case in which X is a normal good and Y is an inferior good. You may use either the Hicks Method or the Slutsky Method. Briefly explain below the difference between Hicks Method and the Slutsky Method by completing the sentences: The Hicks Method judges real income to be the same when: The Slutsky Method judges real income to be the same when: Which concept of real income did you use in answering this question? (Hicks / Slutsky). Describe below how your choice is shown in the diagram above: 6.1 b) Page 16 0f25 LABOUR SUPPLY AND INTERTEMPORAL CHOICE (14) Labour Supply Peter can freely vary the hours he works in a week at a wage rate of $10 per hour. Currently he is very happy to work 40 hours per week. Illustrate his equilibrium in an indifference diagram below. Label both axes and all intercepts. (Hint: There are 24 x 7 = 168 hours in a week). Quickly redraw the original equilibrium of 40 hours per week in the diagram below. Now, Peter’s employer asks him to work 48 hours a week for a period of two months and offers to pay him time—and—a—half (i.e., $15 per hour) for all hours worked beyond 44 hours per week. Despite the offer, Peter states that he would be happier if he didn’t have to work overtime. In the diagram below, analyze Peter’s decision not to take up his employer’s offer to work overtime. Provide a brief explanation to support your diagram. Explanation Page 1 7 of 25 It has been argued that Ontario’s social assistance program (i.e., ‘welfare’) discourages people from working. Suppose that social assistance provides individuals who do not work and have no other income with a payment of $150 per week. Assume the work alternative is at a rate of $8 per hour up to a maximum of 30 hours per week. Could some people who are currently working be encouraged by the program to stop working? (Yes / No) In the diagram below, illustrate your answer, and provide a brief explanation. Explanation On the other hand, could some people who are currently working decide to keep on working? (Yes / No). In the diagram below, illustrate your answer, and provide a brief explanation. Explanation Page 18 0f 25 6.2 (6) Intertemporal Choice Assuming that current consumption and future consumption are normal goods and that there is no inflation, demonstrate in the diagram below that a borrower will borrow more if the rate of interest falls. Show the Substitution Effect and the Income Effect in your answer. (Use the Hicks Method). THE REST OF THIS PAGE IS BLANK Page 19 0f25 7. PERFECT COMPETITION AND MONOPOLISTIC COMPETITION 7.1 (6) Suppose the long run cost curves for two firms are as shown in the diagram below. The firm on the left is in a perfectly competitive industry, whereas the firm on the right is in a monopolistically competitive industry. Add additional elements (well labelled, of course) to each diagram below to show the long-run equilibrium in each case. P P MC MC AC AC Q Q Perfect Competition Monopolistic Competition 7.2 (8) Widgets are produced by a constant cost, perfectly competitive industry initially in long run equilibrium. Show that long run equilibrium in the diagrams below for a representative firm and the industry, using P1, Q1, etc. Now the government introduces a price ceiling at a level that exceeds the minimum point of each firm's Average Variable Cost Curve but is below the current market price. Show the short r_uy_ implications of this price ceiling in the diagrams, using P2, Q2, etc. “LL Industry What happens to the number of firms in the short run? (Rises / Falls / Stays the Same / Can’t Determine) 7.3 b) C) Page 20 of 25 (6) This question is about the Long Run Supply Curve for a perfectly competitive industry. In the diagram below, draw the Long Run Supply (LRS) curve for an increasing cost, perfectly competitive industry. Now provide a brief explanation of how this can occur in a competitive industry. Is there any relationship between the “law of diminishing returns” and increasing cost LRS? (Yes / N0). Give a brief explanation below. THE REST OF THIS PAGE IS BLANK Page 21 of 25 8. MONOPOLY AND DUOPOLY 8.1 (8) Monopoly “An increase in the price of a variable input used by a monopoly will lead to a) an increase in the price of the monopoly’s product; and b) an increase in the total amount of money spent on the product by demanders.” Evaluate this statement, with the help of the diagram below. Assume U-shaped cost curves. To summarize: I (agree / disagree) with part a) above; I (agree / disagree) with part b) above. Page 22 0f 25 8.2 (12) Duopoly Lily and Jamie are profit-maximizers who operate the only two firms in their industry. Each has a marginal cost of $40 at all output levels, and both have no other costs except the $3,000 per month each of them could earn by working for the Town instead of operating their firms. The market demand for the product that Lily and Jamie produce is Q = 1,000 — 10P, where Q is the quantity demanded per month and P is the price. Lily and Jamie behave as Coumot duopolists. a) Show Lily’s reaction curve in a diagram or write it as an equation. b) Fill in the table below for the Coumot equilibrium. _ — Each firm’s Profits * — * Economic Profits of course! d) Page 23 of 25 Lily has been reading about corporate takeovers in the Wall Street Journal and this has led her to think of trying to bribe Jamie to stop producing and leave the whole market to her. What is the maximum amount per month that Lily could afford to pay Jamie to stop producing without ending up worse off that she is in the Cournot equilibrium? (Explain your reasoning, of course.) Maximum Amount of the Bribe from Lily = What is the minimum amount that Jamie could accept from Lily without ending up worse off than she is in the Coumot equilibrium? (Explain your reasoning, of course.) ' Minimum Bribe Amount Acceptable to Jamie = 9.1 a) b) Page 24 of 25 INPUT MARKETS (10) This part of the question is about the expansion path. One point on the linear expansion path for a firm is K = 1, L = 1 and Q = 10. In a diagram below, label three points on the expansion path for this firm that correspond to the portion of its Long Run Average Cost curve that is increasing. One point on a (different) linear expansion path is Q = 100, K = 10 and L = 50. Now assume a very unusual occurrence: the government decides to restrict the use of K to no more than 10 units in order to encourage firms to hire labour. Assuming this policy can be enforced, show the old and new expansion path in the diagram on the left, labelled BF] and EP2. In the diagram on the right, show the impact on the Long Run Total Cost curve for this firm. (The firm has U-shaped Long Run Average and Marginal Cost curves; at Q = 100, Long Run Average Cost is at a minimum). 9.2 a) b) Page 25 of 25 (10) Consider now the employment decisions of a monopsonist. What is the meaning of the term “monopsonist” in the labour market? Use a fully labelled diagram (below) to explain the equilibrium wage rate and the quantity of labour employed in the case of a monopsonist. Assume that the firm is a price-taker in the output market. Suppose that the monopsonist employer is able to engage in perfect wage discrimination by paying the reservation wage to each and every worker. Put another way, the firm hires the first worker at the lowest wage, the second worker at a somewhat higher wage (without having to increase the wage to the first worker) and so on. Once again, assume the firm is a price-taker in the output market. Use a fully labelled diagram (below) to explain the equilibrium wage rate and the quantity of labour employed in these circumstances. ...
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a05-part2 - Page 13 0f25 Long-run equilibrium for the...

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