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1. You are given the following individual demand information that represents the demand for typing by students at a local college: Price per page $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 Tom 20 15 12 9 7 5 3 2 1 George 30 26 22 20 18 15 10 6 4 Lisa 7 6 5 3 2 1 0 0 0 Market ____ ____ ____ ____ ____ ____ ____ ____ ____ a. Give the market demand for pages per semester at each price. ANSWER Price per page $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 Tom 20 15 12 9 7 5 3 2 1 George 30 26 22 20 18 15 10 6 4 Lisa 7 6 5 3 2 1 0 0 0 Market _57___ _47___ _39___ __32__ _27___ _21___ _13___ __8__ __5__ b. What is the price elasticity of demand between $2.00 and $2.50? Price elasticity of demand is defined as the percentage change in quantity demanded divided by the percentage change in price. When the price is $2.00 the demand is 39 When the price changed to $ 2. 50 the demand becomes 32 The percentage change (decrease) in quantity demanded =17.94% The percentage change (increase) in price =25% So the price elasticity of demand between $2.00 and $2.50= 17.94/25=0.71 c. What is the relationship between price elasticity of demand and the effect of raising prices on total revenues? If elasticity is unity (e=1), the price change does not cause a change in total revenue. This is because the proportional change in price is exactly offset by the proportional change in quantity. If demand is inelastic then (e<1), then total revenue rises when price rises and total revenue falls when price falls. If demand is elastic (e>1), then total revenue falls when price rises and total revenue rises when price falls. 2. You are given the following individual supply information for typing: Price per page $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 Ann 10 20 25 30 40 48 55 62 70 Bob 0 8 14 19 23 26 29 33 35 Cory 0 0 0 2 4 8 10 14 19 Market ____ ____ ____ ____ ____ ____ ____ ____ ____ a. Give the market supply for pages per semester at each price. Price per page $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 Ann 10 20 25 30 40 48 55 62 70 Bob 0 8 14 19 23 26 29 33 35 Cory 0 0 0 2 4 8 10 14 19 Market _10___ _28___ _39___ _51___ _67___ __82__ _94___ _109___ __124__ b. What is the equilibrium price and quantity, using the demand curve in question #1? Equilibrium quantity is 39 and equilibrium price is $2.00 because at this price the quantity demanded and quantity supplied are equal. c. What happens to the supply curve and price and output if Ann dropped out of the market? S1 Price S $2 D 39 Quantity demanded & quantity supplied If Ann dropped out of the market then market supply will be less. The market supply curve will shift to the left, which is shown in the above figure. S1S1 is the new supply curve. As a result the quantity supplied will be less and the price will be high. 3. The following is taken from the San Jose Mercury News, July 27, 2000: “The Mexican arm of U.S. Internet giant America Online Inc. said on Wednesday it started a financing program to help aid in the purchase of personal computers, joining a list of companies that have launched similar programs to promote Internet use. “AOL will be joined in the program by computer giant Compaq Computer Corp. and Mexico’s second-largest banking group Banamex Accival, AOL said in a statement. “The program, known as ‘PC Facil’ (Easy PC) aims to help clients acquire a PC, enabling them to hook up to the Internet and the ‘unique benefits’ of AOL service, said AOL Director of Markets Erick Sydow. In Mexico there are only an estimated five personal computers per 100 people, which is one of the reasons that Internet use there is still low.” Using the concepts you learned in this class, explain: a. Why are AOL subsidizing computer sales in Mexico? In Mexico only 5% percent people have personal computers. So this is a large potential market for AOL. If they can increase the demand for personal computer they will be able to provide the unique benefits of AOL Internet service to a large number of potential buyers. In order to generate that demand they are interested to subsidized computer sales in Mexico. If computers are subsidized there, it will help to increase the demand for PC (as it becomes cheaper than before) and AOL will be able to incur huge amount of profit by providing Internet service to them. b. What do you conclude about the cross-elasticity of demand for AOL services and computer ownership? The computer ownership and the demand for AOL service are complementary. If the person does not have any computer he will not go for AOL service. The AOL service will be useless unless Computer ownership is there. So the cross price elasticity between the price of computer and the demand for AOL is negative. A decrease in the price of computer (i.e, an increase in the demand of computer) will increase the quantity demanded of the AOL service. c. Why would Compaq and Banamex also be interested in this effort? Compaq and Banamex also are interested in this effort because by this subsidy programmed they also can increase their business to a large extent and can have a share of a large amount of profit. 4. The automobile manufacturing industry is considered to be very competitive. Does that mean that the industry can be described as perfectly competitive (u sing the definition given in your text under “Competitive Markets”)? List the definitions of perfect competition and explain whether or not the automobile manufacturing industry meets each definition. If the industry is not perfectly competitive, what market structure best describes it and why? The notion of competition is very widely used in economics in general and in microeconomics in particular. Competition is also considered the basis for capitalist or free market economies. Markets are the heart and soul of a capitalist economy, and varying degrees of competition lead to different market structures, with differing implications for the outcomes of the market place. These elements are perfect competition, monopolistic competition, oligopoly, and monopoly. Based on the differing outcomes of different market structures, economists consider some market structures more desirable, from the point of view of the society, than others. In every competitive market of a market certain key characteristics differ. The characteristics are: (a) number of firms in the market, (b) control over the price of the relevant product, (c) type of the product sold in the market, (d) barriers to new firms entering the market, and (e) existence of nonprice competition in the market. So competitive market does not always imply perfectly competitive market structure. Same is the case for automobile manufacturing industry. The automobile manufacturing industry is considered to be very competitive- it does not imply that it is perfectly competitive. The four key characteristics of perfect competition are: (1) large number of small firms, (2) identical products sold by all firms, (3) freedom of entry into and exit out of the industry, and (4) perfect knowledge of prices and technology. These four characteristics mean that a given perfectly competitive firm is unable to exert any control whatsoever over the market. So far as the automobile industry is concerned, we are explaining below whether they are satisfying the requirements of perfect competition. (1) Large number of small firms- in an automobile industry there are small numbers of large firms, which is just opposite to perfect competition. (2) Identical products sold by all firms- the products sold by all the automobiles firms are not identical. They are differentiated in terms of the model, size, color, technology, price etc. (3) Freedom of entry into and exit out of the industry-In automobile industry there are huge barriers to entry. These barriers can involve large financial requirements, availability of raw materials, access to the relevant technology, or simply patent rights of the firms currently in the industry. (4) Perfect knowledge of prices and technology- it is also not applicable for automobile industry. The technology used by automobile industry is so advanced and as it changes everyday, it is not possible to have a sound and perfect knowledge of price and technology of the products produced by them. As the automobile manufacturing industry does not satisfy any of the characteristics of perfect competition, we can conclude that it does not belong to perfect competitive market structure. Automobile manufacturing industry belongs to the oligopoly market structure. An important characteristic of an oligopolistic market structure is the interdependence of firms in the industry. The interdependence, actual or perceived, arises from the small number of firms in the industry. However, unlike monopolistic competition, if an oligopolistic firm changes its price or output, it has perceptible effects on the sales and profits of its competitors in the industry. Thus, an oligopolist firm always considers the reactions of its rivals in formulating its pricing or output decisions. There are huge, though not insurmountable, barriers to entering an oligopolistic market. These barriers can involve large financial requirements, availability of raw materials, access to the relevant technology, or simply patent rights of the firms currently in the industry. The U.S. auto industry provides an example of a market where financial barriers to entry exist. In order to efficiently operate an automobile plant, one needs at least half a billion dollars of initial investment. An oligopolistic industry is also typically characterized by economies of scale. Economies of scale in production imply that as the level of production raises the cost per unit of product falls for the use of any plant (generally, up to a point). Thus, an economy of scale leads to an obvious advantage for a large producer. Once again, the automobile industry provides an example of a market structure where firms experience economies of scale. It should be noted that there might exist economies of scale in promotion just as there exist economies of scale in production. In the automobile industry, the promotion cost per unit of product falls as sales increase since promotion costs rise less than proportionately to sales.