Download Answers to Questions in Chapter 10

Answers to Questions in Chapter 10
Note: No. before  indicates a page number
Page
228  When we were looking at wages in Chapter 9, were we talking about the price of
labour or the price of labour services? Is this distinction between the price of a factor
and the price of factor services a useful one in the case of labour? Was it in Roman
times?
The price of labour services. The distinction is not useful, given that workers
themselves are not sold. The distinction was useful in Roman times where some
workers were paid wages while others were sold as slaves.
230  (Box 10.1) Which of the following are stocks and which are flows?
(a) Unemployment.
(b) Redundancies.
(c) Profits.
(d) A firm's stock market valuation.
(e) The value of property after a period of inflation.
Stocks: (a), (d) and (e). They are measurements at a point in time.
Flows: (b) and (c). They are measurements over a period of time. (Note that (e) would
only be a flow if it were measuring the rise in the value of property over a period of
time.)
231  What is the present value of a machine that lasts three years, earns $100 in year 1,
$200 in year 2 and $200 in year 3, and then has a scrap value of $100? Assume that
the rate of discount is 5 per cent. If the machine costs $500, is the investment
worthwhile? Would it be worthwhile if the rate of discount were 10 per cent?
Using the formula on page 273 gives:
PV
= $100/1.05 + $200/(1.05)2 + $300/(1.05)3
= $95.24 + $181.41 + $259.15
= $535.80
Thus given that the machine costs $500, the investment is profitable at a discount rate
of 5 per cent.
If the rate of discount is 10 per cent, then the present value this time is given by:
PV
= $100/1.1 + $200/(1.1)2 + $300/(1.1)3
= $90.91 + $165.29 + $225.40
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Answers to questions in Economics by Sloman and Norris
= $481.59
With a 10 per cent discount rate, therefore, the investment would not be profitable.
232  Can a perfectly competitive firm earn a supernormal rate of return on capital if it
continuously innovates?
Yes. The long run never comes. By the time other firms have copied the innovations,
this firm has gone ahead with a new innovation, and thus continues to earn supernormal
profits.
233  What other factors will determine the MPP of land for industry?
Proximity to markets, raw materials and other plants; its geological structure and
physical relief.
234  (Box 10.2) 1. Will the market provide incentives for firms to research into energyconserving techniques, if energy prices at present are not high enough to make the use
of such techniques profitable?
It will provide some incentive. Even though energy-conserving techniques might not be
profitable at present prices, the continuing depletion of resources and the resulting
higher energy prices will probably make such techniques profitable in the future. Firms
could borrow now to finance the research and then use the future profits to repay the
loans. Then there is the point that if a firm does not fund such research, its rivals may
discover new profitable energy-saving techniques first: techniques which are denied to
the first firm because of patents.
There is a major weaknesses with this argument, however. It is concerned with risk and
uncertainty. The discovery of new energy sources or new energy-saving techniques by
other firms could mean that energy prices do not rise sufficiently in the future to yield a
profit on the research. Firms, fearing this, may be reluctant to borrow the money to
fund the research. Also there is the risk that interest rates may rise in the future, thus
increasing the cost of the borrowing. Finally, there is the uncertainty over the results of
the research. There is no guarantee that the research will lead to the discovery of the
desired amount of energy saving.
234  2. How will the existence of monopoly power in the supply of resources influence their
rate of depletion?
By leading to higher prices, it will reduce the rate of depletion (and encourage the
search for alternative sources of supply and the development of resource-saving
techniques and products).
235  1. We defined the factor of production `land' to include raw materials. Does the
analysis of rent that we have just been looking at apply to raw materials?
No. Raw materials are sold, not rented out.
235  1. What price would the same piece of land sell for if it still earned $1000 rent per
year, but if the interest rate was now 5%?
The price would increase to $20 000. At that price the yield of the investment in land
would be 5%, equal to the rate of interest.
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Chapter 10
235  2. What does this tell us about the relationship between the price of an asset (like land)
and the rate of interest?
It is an inverse relationship. This is explained (in the context of the link between bond
prices and the rate of interest) on page 237.
237  We know from Chapters 7 and 8 that monopolies and oligopolists will earn abnormal
profits. Will shares in such companies have high yields?
No. Remember that the yield on a share is the dividend payment as a percentage of the
price of the share. The high profits of these companies will be reflected in high
dividend payments. This will drive the share price up until the yield is more or less the
same as in other companies facing similar risk. You could check the validity of this
proposition by looking in the Australian Financial Review at the yield on the shares of
some monopolists and oligopolists.
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