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Econ 100A Ans to PS3

Econ 100A Ans to PS3 - Department of Economics University...

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Department of Economics Spring 2008 University of California Prof. Woroch Economics 100A Problem Set 3 — Solutions Due Thursday, March 20, 2008, 9:30 AM (in lecture) 1 True/False Clearly answer the following questions with a response of true or false and provide a brief justification for your answer. 1. If each brewer in the U.S. beer industry exhibits decreasing returns to scale (e.g., due to the rising costs of distributing this heavy product over ever wider and more sparsely populated areas), then all firms taken together will constitute an increasing cost industry . Answer: False - Decreasing returns to scale refer to a production technology, whereas an increasing cost industry is one where the price of inputs depends on the level of output in the industry, and so describes a market structure not a technology. An industry can have increasing costs and not have decreasing returns to scale. This would happen when increase in demand would cause a Similarly, an industry can be characterized by a technology with de- creasing returns to scale but not have increasing costs. This would occur when the new firms that enter the market in response to greater demand adopt the latest information technology and brewing techniques given them lower costs than incumbents. 2. In the long run, firms in a competitive industry must be identical in size. Answer: False - Firms can have different costs due to access to/ownership of unique resources that are in limited supply. This will result in their earning rents on those inputs but all the firms will behave competitively as price takers 3. In a two-good world of food (F) and clothing (C), if a consumer’s demand for food has no income effect, then her “compensating variation” of an increase in the price of clothing will exactly equal her “equivalent variation” of that price increase. Answer: True - In general, compensating variation is the increment (positive or negative) in income necessary to maintain the consumer at the initial level of utility (achieved under old prices) when facing new prices. The definition of the equivalent variation is the incremental income necessary to maintain the consumer at the final level of utility but facing the old prices. The two measures are equal, and in turn they equal consumer surplus, when the consumer’s utility function is quasi-linear, e.g., U ( C, F ) = v ( C ) + F . The key property of such a utility function is that there are no income effects for the good that enters linearly, in this case, food ( F ). 4. The change in a U.S. oil company’s producer surplus that is caused by an increase in the world price of crude oil is equal to the change in the company’s profits. Answer: True - Profits take sunk costs into account whereas producer surplus does not. When a market price changes, however, the difference in profit is the same as the difference in 1
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producer surplus because sunk costs do not figure in calculating this difference.
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Econ 100A Ans to PS3 - Department of Economics University...

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