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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 1 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. 2 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. 3