Econ 100A Ans to PS5 - Department of Economics University...

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Department of Economics Spring 2008 University of California Prof. Woroch Economics 100A PROBLEM SET 5 ANSWER SHEET I. TRUE or FALSE or UNCERTAIN and EXPLAIN 1. Regular and organic whole milk are vertically differentiated products, whereas 2% and nonfat milk are horizontally differentiated. True: If organic simply eliminates actual or perceived harmful substances from the milk, then we would expect that if the price was the same for a gallon of the two kinds, then all would choose organic. In comparison, if price of 2% and nonfat were identical, some may prefer one while other prefer the other type of milk. In that case the two varieties of milk would be horizontally differentiated. 2. For an individual firm in a monopolistically competitive industry, the firm can earn short-run economic profits but cannot earn long-run economic profits. True: A market that is monopolistically competitive has several key features. First, each firm produces a horizontally differentiated product. Second, consumers allocate their purchases symmetrically across all available brands. Third, there are many firms and in the long run, free entry and exit. Because the products are horizontally differentiated, each firm’s demand curve is downwards-sloping rather than flat as in the case of perfect competition, and so each firm operates much like a monopolist on its demand despite the existence of many competitors. Consequently, in the short run (which means fixed number of firms in the industry) each firm will earn positive economic profits as price exceeds average cost. Over the long run, this will attract new entrants who will garner their proportionate share of the sales, reducing residual demand facing each incumbent firm. Entry continues until each firm in the market earns zero profit. Hence, the firm can earn positive profits in the short run but, due to free entry, cannot earn profits in the long run. 3. The higher the interest rate, the easier it is for firms in the same industry to collude on the joint profit maximum. 4. According to the Coase Theorem, in the absence of bargaining costs, if polluters have the right to pollute, then they will fare better than when recipients of the pollution have right to clean air and water. . False: The Coase Theorem states that, regardless of how property rights are assigned with regard to an externality (i.e., whether the producer of the externality has the right to do so, or whether the receiver of the externality has the right to be free of it), the allocation of resources will be efficient when the parties can bargain costlessly with each other. Put differently, the Coase Theorem states that the social optimum can result from bargaining between the parties producing and receiving an externality if property rights are clearly defined. II. MULTI-PART QUESTIONS
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This note was uploaded on 07/15/2010 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at University of California, Berkeley.

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Econ 100A Ans to PS5 - Department of Economics University...

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