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OFFICE OF INDEPENDENT STUDY Portland State University School of Extended Studies Portland, Oregon Sponsoring Institution: Portland State University Guidebook for Ec 201 Principles of Economics (Micro) Copyright 1992 by Office of Independent Study Portland, Oregon 97207 Revised September, 1996 Written and prepared by Helen Youngleson-Neal, Ph.D. Chair, Department of Economics Portland State University Portland, Oregon Ec 201 Principles of Economics 2 Ec 201 Principles of Economics TABLE OF CONTENTS INTRODUCTION ............................................................................................................. iii How to Approach This Class — A Suggested Study Method ................................iv Mechanics of the Course.........................................................................................iv Course Completion Time Allotment .......................................................................v Written Examinations .............................................................................................vi Credit and Uses of Credit .......................................................................................vi TOPICAL COURSE OUTLINE AND READING ASSIGNMENTS ......................... vii-ix SECTION I .........................................................................................................................1 PART 1: An Introduction to Economics and the Economy........................................1 Chapter 1 Chapter 2 Chapter 4 Chapter 5 PART 2: The Nature and Method of Economics ..................................................1 The Economizing Problem.....................................................................2 Pure Capitalism and the Market System ................................................3 The Mixed Economy: Public and Private Sectors..................................4 Microeconomics of Product Markets (1) .....................................................5 Chapter 3 Understanding Individual Markets: Demand and Supply ......................5 Chapter 7 Demand and Supply: Elasticities and Applications ...............................6 Chapter 8 Consumer Behavior and Utility Maximization ......................................7 Exercise # 1..........................................................................................................................9 Examination #1 Request Form ..........................................................................................19 Oregon Examination Locations .........................................................................................21 SECTION II .......................................................................................................................23 PART 3: Microeconomics of Product Markets (2) ...................................................23 Chapter 9 The Costs of Production......................................................................23 Chapter 10 Price and Output Determination: Pure Competition ..........................24 Chapter 11 Price and Output Determination: Pure Monopoly..............................26 Chapter 12 Price and Output Determination: Monopolistic Competition ............28 Chapter 13 Price and Output Determination: Oligopoly ......................................29 i Ec 201 Principles of Economics PART 4: Microeconomics of Resource Markets ......................................................30 Chapter 14 Production and the Demand for Resources ........................................30 Chapter 15 Pricing and Employment of Resources: Wage Determination...........31 Chapter 16 Pricing of Resources: Rent Interest and Profit ...................................32 Exercise # 2........................................................................................................................35 Examination #2 Request Form...........................................................................................47 SECTION III......................................................................................................................49 PART 5: Government and Current Economic Problems ..........................................49 Chapter 17 Chapter 19 Chapter 21 Chapter 22 Chapter 23 PART 6: Government and Market Failure ........................................................49 Antitrust, Regulation and Industrial Policy........................................50 Income Inequality and Poverty...........................................................51 The Economics of Health Care ..........................................................51 Labor Market Issues: Unionism, Discrimination, Immigration .........52 International Economics and the World Economy ....................................54 Chapter 6 The United States in the Global Economy ..........................................54 Chapter 24 International Trade .............................................................................56 Exercise # 3........................................................................................................................59 Final Examination Request Form ......................................................................................69 ii Ec 201 Principles of Economics INTRODUCTION Welcome to the study of the Principles of Economics. What is economics? It is a study of the process by which a society provides for the material wants of its inhabitants. This course will help you understand how people within the institutional structures developed by society make decisions concerning (1) what the society should produce; (2) how to produce the goods and services that satisfy the society’s wants; (3) how to distribute the goods and services that are produced within the general population; and (4) how to utilize resources for economic growth and full employment of its resources. This is a course in microeconomics analysis which focuses on how decisions are made by individuals and firms for the allocation of resources within the economy. In this course you will focus your study on small parts of the economy. You will be concerned with such issues as the effect of a change in the price of gasoline on the use of other sources of energy, or on policy issues such as the impact of a subsidy to public transportation on the use of private automobiles. A basic understanding of the principles of economics should enable you to see more clearly the process by which resource are allocated and utilized. For example, every individual, as well as every society, faces the problem of scarcity. All societies face a scarcity of the resources needed to satisfy the wants of their inhabitants and every person faces a scarcity of time, if not income, to satisfy their individual wants. Your choice in taking this course involves an economic problem because if you take this course, then you have sacrificed taking an alternative course or doing something else with your time. If tuition rises next year you may have an economic problem in deciding whether you have the financial resources to take additional courses. Economic problems affect you as: an individual, a resident of your city, a resident of your state, a citizen of your country, and finally as a part of nation within the world economy. For example, if you wish to purchase a new house, your decision is affected by the policies of your state and federal governments. Your state may make low-interest loans available to first-time home buyers or another group of which you are a member. A reduction in the federal debt by Congress will lower interest rates making it more affordable for you to obtain a mortgage on a new house. Finally, what happens in the rest of the world can affect you as an individual. Increasing global competition requires American businesses to focus on recruiting a well-educated and skilled labor force. If you finish college you will improve your chances of finding a high-paying job, but if you don't obtain a college degree it may be difficult to find a job and the job you do find is more likely to be low-paying. In this course you will learn a framework based upon an economic way of thinking that will allow you analyze solutions to economic problems. You can apply this way of thinking to economic problems such as how to allocate your time between work and going to school, whether your locality to should promote pubic transportation or build more roads, or whether America should stop illegal immigration or raise tariffs on foreign goods. iii Ec 201 Principles of Economics How to Approach This Class — A Suggested Study Method This Guidebook is intended to help you master the material covered in this course. Independent study is more difficult than the usual college course because it does not provide a chance for you to attend lectures, ask questions of your instructor, and interact with fellow students. This Guidebook is designed to help facilitate your learning by (1)coordinating your readings assignments in the text with the accompanying study guide; (2)suggesting useful studying strategies; and (3)identifying the important concepts and analyses in each chapter. For each of the three sections of this course, this Guidebook will provide you with reading assignments for each chapter covered and a graded exercise assignment to be handed in for feedback before the examination which covers that section. Within each chapter, this Guidebook will provide you with (1) a brief preview/summary of the chapter; (2) the text and study guide assignments that accompany the chapter; (3) study hints; and (4) learning objectives for each chapter assignment. If you have a procedure for study that works for you, disregard the following. However, if you are searching for a better way of studying, you might give the following strategy a try. I suggest that you read through each assigned reading in the textbook, either taking notes of or highlighting each of the major ideas and concepts as you go. The study hints in this Guidebook may help you focus on the crucial areas of the chapter. When you feel you fully understand the contents of the chapter, and could accomplish the learning objectives listed in the Guidebook as well as the more comprehensive list of learning objective listed in the Study Guide, you can check your understanding by answering all the questions and exercises related to the chapter contents in the Study Guide. It is very important to work through the relevant mathematical and graphic exercises in the Study Guide. It is difficult to judge whether you fully understand the theoretical concepts and analyses presented in a chapter until you work through a similar economic analysis for yourself. If you have difficulty with a section in the chapter, reread that section in the text and redo the related exercises in the study guide. Progress to the next chapter assignment only when you have fully understand the chapter contents you have just studied, because the concepts and analysis presented in the each chapter build upon the material covered in the previous chapters. To facilitate your efforts in this Independent Study course, you may contact the Office of Independent Study or the instructor by telephone or e-mail to answer any questions you may have. Questions concerning registration, fees, extensions and the coordination of exercise assignments and examinations should be directed to the Office of Independent Study. Questions relating to the course content should be directed to the instructor. iv Ec 201 Principles of Economics Mechanics of the Course The course is divided into three sections. In each section you will be required to read the chapters, complete the self-test and problems related to each chapter in the Study Guide, hand in a graded exercise, and take an examination covering the material presented in each section. The required books for this course include the textbook: Campbell R. McConnell, & Stanley L. Brue, Microeconomics: Principles, Problems, and Policy, (McGraw Hill), 13th ed. and the STUDY GUIDE to accompany the text: William B. Walstad, & Robert C. Bingham, Study Guide to Accompany McConnell and Brue Microeconomics (McGraw Hill), 13th ed. Your grade for the course will be based upon the grades received for the exercises and examinations. The three exercises are worth 5 points each and count for 15 percent of your final grade. The examinations are worth 100 points each and count for 85 percent of your final grade. The three examinations consist of multiple choice questions worth 50 points and a combinations of short essays and graphic problems worth 50 points. The final grade will be based upon the percentage of available points earned, according to the following grading scale: A 91-100 A- 88-90 B+ 85-87 B 81-84 B- 78-80 C+ 75-77 C 70-74 C- 65-69 D+ 60-64 D 55-59 D- 50-54 F 0-49 Course Completion --Time Allotment You have twelve months in which to finish the course. In the event you have not completed the course within 12 months from the date of your enrollment, you will automatically receive an expiration notice from the Office of Independent Study. If you wish to extend your enrollment for an additional six months, return the extension notice provided, along with the appropriate fee, to the Office of Independent Study. v Ec 201 Principles of Economics Written Examinations When you are ready for an examination, fill out the examination request form included in this study guide. You must have a proctor for your examination. Proctors may be school principals, counselors, school district superintendents, school or public librarians, or college and university testing and counseling centers. Exams must be taken at the school or agency. Mail the request form to the Office of Independent Study, P.O. Box 1491, Portland, OR 97207. The examination will be sent to the proctor you have indicated on the request form. THE EXAMINATION MUST BE TAKEN WITHIN SIX WEEKS OF THIS REQUEST OR IT WILL BE RECALLED. Proctors are instructed to return the examinations if not taken in the time period stipulated. Note: Please include a self-addressed, stamped envelope with each lesson, examination or any other correspondence so that your instructor may return the corrected papers to you. Be sure to use correct postage. Credit and Uses of Credit Upon completion of the requirements of this course, as evidenced by satisfactory scores on the assignments and examinations, the student will be granted four quarter-hours of college credit. If you intend to use this credit for graduation or for certification purposes, your final examination must be completed at least three weeks before you ask to have the credit filed with the school or certifying agency. No grade will be issued until the instructor certifies that all work has been completed and has assigned the final grade. vi Ec 201 Principles of Economics TOPICAL COURSE OUTLINE and READINGS AND ASSIGNMENTS SECTION I PART 1 An Introduction to Economics and the Economy: Chapter 1 Textbook, The Nature and Method of Economics, pp. 1-14 and appendix, pp. 14-20; Study Guide, pp. 1-15 Chapter 2 Textbook, The Economizing Problem, pp. 21-38; Study Guide, pp. 17-26 Chapter 4 Textbook, Pure Capitalism and the Market System, pp. 58-73; Study Guide, pp. 39-46 Chapter 5 Textbook, The Mixed Economy: Private and Public Sectors, pp. 74-95; Study Guide, pp. 5-58 PART 2 Microeconomics of Product Markets (1) Chapter 3 Textbook, Understanding Individual Markets: Demand and Supply, pp. 3957; Study Guide, pp. 27-37 Chapter 7 Textbook, Demand and Supply: Elasticities and Applications, pp. 119-137; Study Guide, pp. 71-82 Chapter 8 Textbook, Consumer Behavior and Utility Maximization, pp. 138-155; Study Guide, pp. 83-98 Exercise # 1 to be handed in Examination #1 SECTION II PART 3 Microeconomics of Product Markets (2) Chapter 9 Textbook, The Costs of Production, pp. 156-176; Study Guide, pp. 99-110 Chapter 10 Textbook, Price and Output Determination: Pure Competition, pp. 177-203; Study Guide, pp. 111-124 vii Ec 201 Principles of Economics Chapter 11 Textbook, Price and Output Determination: Pure Monopoly, pp. 204-235; Study Guide, pp. 125-135 Chapter 12 Textbook, Price and Output Determination: Monopolistic Competition, pp. 226-239; Study Guide, pp. 137-146 Chapter 13 Textbook, Price and Output Determination: Oligopoly, pp. 240-260; Study Guide, pp. 147-158 PART 4 Microeconomics of Resource Markets Chapter 14 Textbook, Production and the Demand for Resources, pp. 261-277; Study Guide, pp. 159-168 Chapter 15 Textbook, The Pricing and Employment of Resources: Wage Determination, pp. 278-298; Study Guide, pp. 169-181 Chapter 16 Textbook, The Pricing of Resources: Rent Interest and Profit, pp. 299-313; Study Guide, pp. 183-192 Exercise # 2 to be handed in Examination #2 SECTION III PART 5 Government and Current Economic Problems Chapter 17 Textbook, Government and Market Failure: Public Goods, the Environment, and the Information Problems, pp. 315-337; Study Guide, pp. 193-205 Chapter 19 Textbook, Antitrust, Regulation, and Industrial Policy, pp. 359-379; Study Guide, pp. 219-229 Chapter 21 Textbook, Income Inequality and Poverty, pp. 398-417; Study Guide, pp. 243-254 Chapter 22 Textbook, The Economics of Health Care, pp. 418-435; Study Guide, pp. 255-264 viii Ec 201 Principles of Economics Chapter 23 Textbook, Labor Market Issues: Unionism, Discrimination, and Immigration, pp. 436-456; Study Guide, pp. 265-276 PART 6 International Economics and the World Economy Chapter 6 Textbook, The United States in the Global Economy, pp. 96-117; Study Guide, pp. 59-69 Chapter 24 Textbook, International Trade. pp. 457-480; Study Guide, pp. 277-289 Exercise # 3 to be handed in Final Examination ix Ec 201 Principles of Economics 1 Ec 201 Principles of Economics SECTION I PART 1 AN INTRODUCTION TO ECONOMICS AND THE ECONOMY This section introduces you to economics. The first two chapters discuss the nature of economics and the how a society solves the central economic problem of scarcity. The remaining two chapters detail the characteristics of a market system and the mixed economy. Chapter 1 - The Nature and Method of Economics This chapter introduces you to the methodology of economics, why it is important to study economics, some pitfalls in studying economics and how economists think. Reading Assignment: Text: Study Guide: Chapter 1, pp. 1-14 and appendix, pp. 14-20 pp. 1-15 Study Hints: The appendix to this chapter is designed to prepare you for reading, analyzing and constructing simple graphs in later chapters. If you already can visualize and understand quantitative relationships, you may want to quickly review this material. If graphs are new to you, you’ll want to be sure you have mastered the graphic concepts before moving ahead. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. Define economics. Explain what are economic principles and how they are derived. Differentiate between micro and macroeconomics. Explain the importance of ceteris paribus. Be able to give examples of the "fallacy of composition" and "ad hoc" thinking. Be able to define the concepts of rational behavior, marginal costs, marginal benefits, and understand how these concepts are used in economic thinking. Be able to explain and illustrate both a direct and an indirect relationship between two variables, as well as define and identify a positive and a negative sloping curve. Identify independent and dependent variables. 1 Ec 201 Principles of Economics Chapter 2 - The Economizing Problem This chapter introduces you the central economic problem of every society and a number of important concepts that arise because we have limited resources to satisfy our unlimited wants. The chapter discusses economic efficiency and full employment, unemployment, and growth. The chapter also presents the concepts of productive and allocative efficiency, the production possibilities curve, and opportunity costs. The chapter concludes with a brief discussion of four economic systems: traditional, pure capitalism, command, and mixed economy. The circular flow model is introduced to provide an overview of the way a market system works. Reading Assignment: Text: Study Guide: Chapter 2, pp. 21-38 pp. 17-26 Study Hints: This chapter gives you the first opportunity to use your graphing skills. If you have a difficult time in understanding the graphic illustration of the production possibilities curve, go back to the appendix of Chapter 1. Be sure you understand the difference between productive and allocative efficiency. For example, assume an economy produces two goods: food and computers. It produces the maximum amount of both goods, given its level of technology and amount of resources, but produces more computers and less food than people want. In this case this economy has achieved productive efficiency, but not allocative efficiency. For an economy to achieve both productive and allocative efficiency, not only must it maximize its output, given its limited resources, but must also produce the combination of products that satisfy its inhabitants’ wants. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. Define the economic problem. Define economic resource and match factor incomes associated with resources. Explain the concepts of allocative and productive efficiency. Given information, graph a production possibility curve. Using a production possibilities curve, illustrate: economic growth, full employment, unemployment, and underemployment of resources; allocative and productive efficiency; and increasing costs. 2 Ec 201 Principles of Economics 6. 7. Highlight the major features of traditional, capitalistic, command, and mixed economic systems Using a circular flow diagram, identify the major groups of decision makers, and the major markets in a market system. Chapter 4 - Pure Capitalism and the Market System This chapter begins with a presentation of the institutional framework of American capitalism. The characteristics of capitalism are briefly discussed. These include: private property, free enterprise and choice, the role of self-interest, competition, markets and prices, and the limited role of government. The chapter ends with the authors addressing the five fundamental questions faced by every economic system and explaining how a market economic system answers to each one. Reading Assignment: Text: Study Guide: Chapter 4, pp. 58-73 pp. 39-46 Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. Explain the six major characteristics of capitalism. State the five fundamental questions faced by an economic system. Describe how the market system answers these five fundamental questions. Explain how the market system achieves economic efficiency. Explain the function of price in a market system. Explain the characteristics of the market system that promotes progress: technological improvements and capital accumulation. What is the concept of the "invisible hand"? 3 Ec 201 Principles of Economics Chapter 5 - The Mixed Economy: Private and Public Sectors This chapter describes the role of both the private sector (households and businesses) and the public sector (government) as decision makers in our mixed economic system. Reading Assignment: Text: Study Guide: pp. 74-95 pp. 47-58 Learning Objectives: After completing the reading you should be able to: 1. Define the four shares in the fundamental distribution of income and the three major categories of household income. Define and explain the difference between durable goods, non-durable goods, and services. Describe how the market system answers the five fundamental questions. Explain the difference between a plant, a firm, and an industry. Describe how the government enhance the operation of the market system. Explain how the government alters the income distribution. Explain the effects of spillover benefits and spillover costs and how the government can change these effects. Define public goods and why governments must provide these goods and services. Differentiate between government purchases and transfer payments. Define the major categories of spending and revenue for the federal, state and local governments and their relative importance. 2. 3. 4. 5. 6. 7. 8. 9. 10. 4 Ec 201 Principles of Economics SECTION 1, cont. PART 2 MICROECONOMICS OF PRODUCT MARKETS (1) Part 2 introduces you to the analysis of markets for good and services using the tools of microeconomic theory. The first two chapters examine applications of demand and supply analysis and the final chapter develops the theory of consumer behavior. Chapter 3 - Understanding Individual Markets: Demand and Supply This chapter provides a detailed introduction to how markets operate. The concepts of demand and supply and market equilibrium price and quantity are explained and illustrated. Reading Assignment: Text Study Guide: pp. 39-57 pp. 27-37 Study Hints: For you to correctly determine the impact of demand and supply on market equilibrium price and quantity, it is essential for you to be able to distinguish between a change in demand or supply and a change in the quantity demanded and quantity supplied. For example, an increase in demand, ceteris paribus, will cause an rise in the equilibrium market price, whereas an increase in quantity demanded results from fall in the equilibrium market price. A change in demand or supply results from a shift of the demand curve or supply curve. A change in quantity demanded results from a movement along a demand curve or supply curve. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. Differentiate between demand and quantity demanded and supply and quantity supplied. Graph demand and supply curves from demand and supply schedules. List the determinants of demand and supply. Explain and illustrate an equilibrium price and quantity. Explain and illustrate the impact of a change in demand and supply on the equilibrium price and on quantity in demand and supply. 5 Ec 201 Principles of Economics 6. Explain the effects of a change in price of one good on the demand for its substitutes or complements. Give an example of the rationing function of prices. 7. Chapter 7 -- Demand and Supply: Elasticities and Applications In this chapter, you will learn how to compute the values of elasticities of demand and the relationship between elasticity of demand and total expenditure. In addition to price elasticity of demand, you will learn how to measure other elasticities including the elasticity of supply, cross elasticity of demand and income elasticity of demand. Finally, you will be introduced to two important applications of supply and demand: price ceilings and price supports. Reading Assignment: Text: Study Guide: pp. 119-137 pp. 71-82 Study Hints: It is important to keep in mind that price elasticity of demand is a measure of the responsiveness of demand to a change in price. To ensure the elasticity is independent of the units of measurement expressed, the price elasticity of demand coefficient measures the percentage change in the quantity demanded in relation to a percentage change in price. As a result, the elasticity of demand cannot be judged by the steepness or flatness of the slope of the demand curve. Learning Objectives: After completing the reading you should be able to: 1. Define the price elasticity of demand and compute the coefficient of elasticity, given the appropriate data. Explain the meaning of elastic, inelastic, and unitary elasticity of demand. List the determinants of price elasticity of demand and how each of these determinants affect the elasticity coefficient. Define the price elasticity of supply and explain how resource shifts and time affect it. Explain the economic impacts of price ceilings and price floors. Define cross elasticity of demand and how it is used to determine substitute or complementary products. Define income elasticity and its relationship to normal and inferior goods. 2. 3. 4. 5. 6. 7. 6 Ec 201 Principles of Economics Chapter 8 - Consumer Behavior and Utility Maximization This chapter covers the theories of consumer choice. Theories of consumer behavior help us understand why consumers buy a particular bundle of goods and services rather than others. Thus, typical behavior of consumers determines the properties of demand curves. The authors present two explanations of consumer choice. The first explanation is based upon preference theory and explains the law of demand by use of income and substitution effects. The second explanation is based upon the theory of utility and explains the law of demand by the use of diminishing marginal utility. The chapter concludes with a discussion of the opportunity cost of time and the integration of time into the theory of consumer behavior. Reading Assignments: Text: Study Guide: pp. 138-155 pp. 83-98 Study Hints: In the presentation of utility theory, you should keep in mind that the author's mathematical illustration of the utility-maximizing rule is only used as a teaching technique and should not be viewed an attempt to portray the actual choice-making process of consumers. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. Define and distinguish between the income and substitution effects of a price change. Define marginal utility and state of the law of diminishing marginal utility. Explain why a consumer will buy more (or less) of a commodity when its price falls (or rises) using (a) income and substitution effects, and (b) the law of diminishing marginal utility. List four assumptions made in the theory of consumer behavior. Explain how the value of time fits in the theory of consumer behavior and give two examples of implications which result. Describe how the theory of consumer behavior helps us understand different values placed on time. 7 Ec 201 Principles of Economics 8 Ec 201 Principles of Economics Exercise # 1 To be handed in before taking Exam #1. Complete all problems. I. Society's production possibilities A society's economic possibilities are determined by the amount of available resources and the state of technology. The following exercise illustrates the quantitative determination of a society's production possibilities. Zilch is a small country that has only two industries: food and textiles. It also has only two resources: labor and machines. It takes both 10 labor-years and 1/10 of a machineyear to produce a ton of food, while it takes both 5 labor-years and 2 machine-years to produce a ton of textiles. Zilch has a labor force of 60,000 and a stock of 600 machines. Using the above information (assuming labor and machines can be transferred between the two industries) answer the following questions. 1. If Zilch puts all its resources into food production, it can produce a maximum of _____________ tons of food a year. 2. If Zilch puts all its resources into textile production, it can produce a maximum of _____________tons of textiles a year. 3. If Zilch puts half of its machines into food production, it can produce a maximum of ___________tons of food and a maximum of tons of textiles a year. 4. Draw Zilch's production possibilities curve on Graph 1.0. Label it AB and label the production combination from question 3, above, point R. Explain why AB is a straight line. 5. What would make the production possibilities curve become concave to the origin? Explain briefly why this would be the normal shape. 6. If Zilch were producing at point R and now wishes to produce an additional ton of textiles, it would have to give up ______________ tons of food. 9 Ec 201 Principles of Economics 7. Zilch receives a development loan from the World Bank to purchase 200 additional machines. With the addition of the 200 machines, answer the following: 10 a. If Zilch puts all its resources into food production, it can produce a maximum of ________ tons of food a year. b. If Zilch puts all its resources into textile production, it can produce a maximum of ________ tons of textiles a year. c. If Zilch puts half of its labor into food production, it could produce a maximum of ________ tons of food and ________ tons of textiles a year. d. Draw Zilch's new production possibilities curve on Graph 1.0. Label it AC, and label the production combination from question c, above, point S. e. Now Zilch can produce more textiles without giving up food, as it had to do before it purchased the additional machines. Explain briefly why this is so. f. What other factors would shift the production possibilities curve outward, enabling Zilch to produce more of both food and textiles? Explain. Ec 201 Principles of Economics GRAPH 1.0 7,000 6,000 Tons of Food 5,000 4,000 3,000 2,000 1,000 0 100 200 300 Tons of Textiles 400 500 11 Ec 201 Principles of Economics 12 Ec 201 Principles of Economics II. Market Equilibrium A market equilibrium is achieved when all the plans of buyers and sellers, as represented by demand and supply, are simultaneously achieved. The following numerical example illustrates the determination of market equilibrium price and quality. A suburb has the following demand and supply schedules for gallons of milk per day at the prices shown, both being relevant to the same market circumstances. Price (per gallon) $0.80 1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.40 Quantity demanded (gallons per day) 300 280 260 240 220 200 180 160 140 Quantity supplied (gallons per day) 60 100 140 180 220 260 300 340 380 13 Ec 201 Principles of Economics 14 Ec 201 Principles of Economics GRAPH 1.1 $5.00 Price of Milk per Day $4.00 $3.00 $2.00 $1.00 0 100 200 Gallons of Milk Per Day 300 400 15 Ec 201 Principles of Economics 16 Ec 201 Principles of Economics 1. Draw the demand and supply curves on Graph 1.1 and label them D1 and S1, respectively. 2. What is special about their shapes? 3. The equilibrium price of milk is $___________; the quantity of milk sold at this price is ___________ gallons. 4. The government decides to help milk producers by a policy which offers to buy all milk that cannot be sold to private consumers at a price of $1.80 per gallon. 5. a. Plot the new demand curve, including the government demand, and label it D2. (Hint: Does the government policy change the quantity demanded at the price of $2.00 per gallon? At $2.20 per gallon? b. The new equilibrium price of milk is $__________; the quantity of milk supplied at this price is ___________ gallons. c. The quantity of milk private consumers are willing to buy at this price is __________ gallons; the quantity the government will buy is ________ gallons. If, instead of helping milk producers, the government decides to help milk consumers by a policy that imposes a price ceiling (maximum price) on milk of $1.20 per gallon: a. The quantity of milk that consumers are willing to buy now is _______ gallons; the quantity of milk supplied will be ______ gallons. b. If lines for milk at the stores are to be avoided, the government will somehow have to ration __________ gallons of milk. c. If there were no effective rationing system, a _______ might develop and the price consumers would be willing to pay for milk under these circumstances would be $________ per gallon. 17 Ec 201 Principles of Economics 18 Ec 201 Principles of Economics EXAMINATION NOTICE At the bottom of this page is a cut-out section for you to use in making arrangements to take an examination for this course. You may take this exam at a time and place most convenient for you. You are responsible for finding a proctor acceptable to Independent Study. Officials who usually serve as proctors are: Counseling and testing office personnel in community colleges, colleges or universities Public school superintendents, principals or counselors County and city librarians Members of your family, co-workers and/or neighbors will not be approved. The Oregon State System of Higher Education offices that serve as proctors are listed in this publication. Check the Table of Contents for page number. If one of these locations is convenient for your testing, please call and make an appointment with that office in advance and list them as the proctor on this form. The examination will be sent to your proctor and must be taken within six weeks or it will be returned to the Office of Independent Study. Be sure to make arrangements with your proctor to allow 2 hours for the examination. REQUEST TO TAKE EXAMINATION Please cut out and mail to: Independent Study, PO Box 1491, Portland, OR 97207-1491 COURSE: EC 201 Principles of Economics EXAM: FIRST (1996) 2.0 hrs. Closed book STUDENT INFORMATION (please print) Date _________________ ___Check here if new permanent address Your Name _________________________________ S.S. Number __________________ Address _________________________________________ Day Phone ______________ City _____________________________ State _________ Zip __________________ PROCTOR INFORMATION Requested Test Date ___________________ Proctor Name _____________________________________Title ___________________ School or Library Name _____________________________________________________ Mailing Address ___________________________________________________________ City ___________________________ State _____________ Zip __________________ 19 Ec 201 Principles of Economics 20 Ec 201 Principles of Economics OREGON EXAMINATION LOCATIONS ASHLAND LA GRANDE Southern Oregon College Division of Continuing Education 200 Churchill Ashland, OR 97520 (541) 482-6331 Eastern Oregon State College DCE/223 Zabel Hall 8th and K Sts. La Grande, OR 97850 (541) 963-1378 or 963-1313 EUGENE MONMOUTH University of Oregon Continuation Center 333 Oregon Hall Eugene, OR 97403 (541) 346-4231 Toll free in Oregon 1-800-524-2404 ask for extension 4231 Western Oregon State College DCE & Summer Programs Administration Bldg., Room 305 Monmouth, OR 97361 (541) 838-1220, ext. 483 KLAMATH FALLS PORTLAND Oregon Institute of Technology OIT Learning Resource Center Academic Support Center ORETECH Br. Post Office Klamath Falls, OR 97601 (541) 885-1772 Office of Independent Study PSU/School of Extended Studies 1633 SW Park Ave. PO Box 1491 Portland, OR 97207 (503) 725-4865 Toll free 1-800-547-8887 Ask for extension 4865 SALEM PSU Salem Center 4061 Winema Place NE Salem, OR 97305 (503) 399-5262 21 Ec 201 Principles of Economics 22 Ec 201 Principles of Economics SECTION II PART 3 - Microeconomics of Product Markets (2) The remaining chapters in Part 3 examine the behavior of producers. In the market economy the control of production is exercised by a business enterprise, universally referred to in economics as the firm. The first chapter discusses the concept of costs essential in analyzing firm behavior. The remaining four chapters analyze firm behavior under four alternative market structures and how these actions are related to such broad issues as efficiency and the socially desirable output. Chapter 9 - The Costs of Production This chapter develops various costs of production concepts that are essential when analyzing a firm's behavior in the next three chapters. Various cost are distinguished (1) a firm’s implicit and explicit costs, (2) short-term and long-term costs of production, and (3) total, average, and marginal costs of production. Reading assignment Text: Study Guide: pp. 156-176 pp. 99-110 Study Hints: Marginal and average measurements are essential measurements in all economic analysis. In the previous chapter marginal utility measurement was developed, and in the next chapter average and marginal measurement will be related to revenue. In this chapter it is used in relationship to costs of production. However, it is important to distinguish between the concepts of average and marginal. An illustration may help you understand this relationship. Think of a final grade determined by the simple average of four examinations. On the first exam you receive a grade of 80 points. The average and marginal grade is 80. On the next exam you receive a grade of 70 points. The marginal grade of the second exam is 70 which lowers the average grade for the two exams to 75. On the third exam, you receive 75 points. The marginal grade of the third exam is 75 and the average grade is unchanged at 75. On the fourth exam you receive a grade of 87. When the marginal grade of the fourth exam is 87 and the average grade on all four exams rises to 78. Can you see the relationship between the marginal and average illustrated by this example. The marginal is higher than the average, the average rises; when the marginal is equal to the average, the average remains constant; and when the marginal is less than the average, the average falls. 23 Ec 201 Principles of Economics It is also important to understand long-run costs and the relationship between short-run and long-run costs of production. Keep in mind that when a firm is producing at a point on its long-run average cost and marginal cost curve, it will be on short-run average cost and marginal cost curve. It may help to think of the long-run average cost envelope curve illustrated in figure 9.8 on page 168 as a planning curve. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. Distinguish between explicit and implicit costs. Distinguish between normal profit and economic profit. Explain the law of diminishing returns. Differentiate between the short-run and the long-run. Explain the relationship between total, average, and marginal production, and compute between average and marginal product, given total product data. Distinguish between fixed, variable, and total costs. Explain the difference between average and marginal costs; and compute and graph AFC, AVC, ATC and MC when given total cost data. Relate average product to average costs and marginal product to marginal cost. List the factors that cause the cost curve to rise or fall. Explain the difference between short-run and long-run costs. Explain why long-run cost curve is U-shaped. List the factors to cause economies and diseconomies of scale. 6. 7. 8. 9. 10. 11. 12. Chapter 10 - Price and Output Determination: Pure Competition The material presented in this chapter is closely related to the next three chapters. The four chapters analyze firm behavior under four alternative market structures. The chapter begins by introducing four basic market conditions of perfect competition, monopoly, monopolistic competition, and oligopoly. The remainder of the chapter details the characteristics of a firm behavior in a perfectly competitive industry and implications of a perfectly competitive market for allocative and productive efficiency. Reading Assignment Text: Study Guide: Study Hints: 24 pp. 177-203 pp. 111-124 Ec 201 Principles of Economics Make sure that you know that the maximizing point for a firm is at that level of production where a firm’s marginal cost equals its marginal revenue (MC=MR). For a perfectly competitive firm this is coincident to the point where the firm's marginal cost equals price (MC=P), because a perfectly competitive firm faces a infinitely elastic (horizontal) demand curve for its output so that its marginal revenue coincides with the market price. For a firm facing a downward sloping demand curve because it is operating in another market structure, marginal cost will not equal the market price. It is important that you can not only measure and identify a firm's profit maximizing output graphically, but also that you thoroughly understand why profits are maximized at the output which equates marginal revenue (price) and marginal cost, rather than at an output where the difference between marginal costs and marginal revenue (price) is greatest. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. Describe the characteristics of the four basic market structures. Describe the characteristics of a purely competitive industry. Compute and graph the average, total and marginal revenue of a perfectly competitive firm when given the demand schedule for a perfectly competitive industry. Use both the total revenue-total cost and the marginal cost-marginal revenue approaches to determine the short-run profit maximizing price and output of a perfectly competitive firm. Explain and construct the short-run supply curve of perfectly competitive firm, given its short-run cost schedules. Based on this short-run supply curve, explain and construct the short-run supply curve for a competitive industry. Explain the long-run equilibrium of a perfectly competitive industry, using the entry and exit adjustments of firms. Explain the shapes of the long-run supply curves in constant cost and increasing cost competitive industries. Explain why allocative and productive efficiency are achieved when long-run equilibrium is achieved in a perfectly competitive industry. (Hint: where P=AC=MC.) 25 Ec 201 Principles of Economics Chapter 11 - Price and Output Determination: Pure Monopoly The material in this chapter covers the characteristics of pure monopoly; the barriers to entry which create and protect monopolies; price and output determination of a monopoly; the economic impact of monopoly; price discrimination under monopoly; and the government regulation of monopoly. Reading Assignment: Text: Study Guide: pp. 204-235 pp. 125-135 Study Hints: Remember from the last chapter that, under perfect competition, a firm maximizes profit at an output that equates its marginal cost with market price (MC=P) only because a perfectly competitive firm faces a perfectly elastic demand curve (a horizontal curve) so that marginal revenue always equals price (MR = P). In a monopoly, there is only a single firm that faces a downward sloping market demand curve. In this case marginal revenue will always be less then market price. As a result, a monopolist always maximizes profit at the output that equates marginal cost with marginal revenue. It needs to be stressed that a monopolist, even if though is the only firm in the market, cannot charge any price it likes. How much the firm can limit output and charge a higher price is determined by the degree of market power it possesses. This degree of market power is determined by the elasticity of the market demand curve the firm faces which, in turn, is determined by the amount of substitute goods it faces. For example, although the local electric power company has a monopoly providing electric power, its market power is limited by power substitutes such as natural gas and oil. Learning Objectives: After completing the reading you should be able to: 1. 2. 3 List the four characteristics of monopoly. List the three barriers to entry. Graph the demand curve facing a monopoly and show how it differs from the demand curve facing a perfectly competitive firm. Compute and graph the marginal revenue curve from a monopoly demand schedule. Discuss the economic effect of monopoly on allocative and productive efficiency, distribution of income, and technological progress. List the conditions necessary for price discrimination. 4. 5. 6. 26 Ec 201 Principles of Economics 7. Identify two pricing goals of monopoly regulation and explain the dilemma the regulators face in achieving their goals. 27 Ec 201 Principles of Economics Chapter 12 - Price and Output Determination: Monopolistic Competition Pure competition and pure monopoly, as discussed in the last two chapters, are the exception, rather than the rule in modern capitalism. In this and the next chapter the two market structures that fall between these two extremes are presented. This chapter discusses monopolistic competition, which is a market structure characterized by a many competitive firms, each of which possess only a small amount of monopoly power due to product differentiation. The chapter details the behavior of firms in a monopolistic competitive market and the implications for economic efficiency. Reading Assignment: Text: Study Guide: pp. 226-239 pp. 137-146 Study Hints: Be careful not to confuse monopolistic competition with monopoly. They are very different market structures. Under pure monopoly conditions, there is only one firm with no competition from other firms within the industry and with considerable market power. Under monopolistic competitive conditions, there are numerous firms producing similar products that are very close but not perfect substitutes. This product differentiation among the firms gives them only a small amount of monopoly power. Thus, the structure of monopolistic competition is much closer to the characteristics of perfect competition than to the characteristics of monopoly. Learning Objectives: After completing the reading you should be able to: 1. 2. List the characteristics of monopolistic competition. Determine the profit-maximizing price and output level for a monopolistic competitor in the short run, when cost and demand conditions are given. Identify the reasons for the wastes of monopolistic competition and explain how product differentiation may offset these wastes. Describe the principle types of non-price competition. Discuss the role of advertising and its effect on competition and economic efficiency. 3. 4. 5. 28 Ec 201 Principles of Economics Chapter 13 - Price and Output Determination: Oligopoly This chapter discusses the oligopoly, which is a market structure characterized by the presence of only a few firms in a market. The authors discuss alternative behavior patterns of oligopolistic firms, the role of non-price competition, and the impact of oligopoly on economic efficiency. The chapter concludes with a brief illustrative case study of the automobile industry. Reading Assignment: Text: Study Guide: pp. 240-260 pp. 147-158 Study Hints: The oligopoly market structure is very different from the previous three market structures discussed. Firms in perfect competition, monopoly, and monopolistic competition act independently of other each other. In each of these three market structures, a firm's profit maximization occurs at an output where marginal cost and marginal revenue are equalized. In contrast, an oligopolistic firm behaves strategically because it is only one of few firms in its market. The oligopolistic firm cannot act independently but must take into consideration the reaction of the other firms to its actions. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. 9. Describe the characteristics of an oligopoly industry. Differentiate between homogeneous and differentiated oligopolies. Identify and explain the causes of oligopolies. Identify four possible models of oligopolistic price-output behavior. Used the kinked demand curve to explain inflexible prices. List the major advantage of collusion for oligopolies, three types of collusion, and obstacles to collusion. Explain price leadership as a form of tacit collusion. Explain how firms use cost-plus pricing to determine prices of their products. Discuss why oligopolies may prefer non-price competition over price competition and list three forms of non-price competition. 29 Ec 201 Principles of Economics SECTION II, cont. PART 4 Microeconomics of Resource Markets Part 4 studies the markets for resources. Microeconomic analysis is used to study the determination of demand and supply for labor, land, capital, and entrepeneurship. Chapter 14 - Production and the Demand for Resources This chapter focuses its discussion of resource pricing on the determination of demand for productive resources. The basic analytical tools are the demand and supply analyses presented in Part 3 in this Section. Although the authors develop the graphic analysis of resource demand for both purely competitive and imperfectly competitive markets, the purely competitive market is emphasized. Reading Assignments: Text: Study Guide: pp. 261-277 pp. 159-168 Study Hints: In studying, you should keep in mind that although the same tools of analysis are used, the market for productive resources is very different from the market for final goods and services. A firm's demand for productive resources is a derived demand because it is based in part upon the demand the firm faces for its output. Keep in mind also that the market for productive resources plays a distinct role in the economy, which is different from the role played by the market for final products. The market for productive resources plays the primary role in income determination and the distribution of income in a society. Learning Objectives: After completing the reading you should be able to: 1. 2. Explain the concept of derived demand as it relates to resource pricing. Explain and determine the marginal-revenue product for a resource when given the appropriate data. Explain the profit-maximizing principle which firms use to determine the amount of a resource to use. 3. 30 Ec 201 Principles of Economics 4. 5. 6. 7. 8. Explain why the MRP schedule of a resource is the firm's demand schedule for a resource in competitive resource markets. List three factors that change a firm's resource demand, and predict the effect of a change in each of these factors on the demand for the resource. List four determinants of the price elasticity of demand for a resource and state how changes in each would affect the elasticity of demand. State the rule for determining the least-cost combination of resources. Explain the marginal productivity theory of income distribution and present two criticisms of the theory. Chapter 15 - The Pricing and Employment of Resources: Wage Determination Building upon the previous chapter, this chapter presents a comprehensive demand and supply analysis of wage determination in various labor markets. These include competitive, monopolistic, unionized, and bilateral monopoly markets. The authors provide both the theoretical and policy implications of the link between labor productivity and wage levels. Reading Assignments: Text: Study Guide: pp. 278-298 pp. 169-181 Study Hints: The concept of market power of the buyer rather than the seller is introduced in this chapter—that of monopsony or oligopsony power. This occurs when there is either only one major employer or a few major employers, respectively. In this imperfectly competitive labor market, the monopsonist faces a upward sloping supply curve of labor causing its marginal resource cost of hiring an additional worker to be greater than the market wage (average supply wage). Graphically, the marginal resource cost curve of labor lies above the supply curve for labor facing the monopsonist. This situation occurs because a monopsonist must not only pay each additional worker a higher wage. but must also pay all previously hired workers that higher wage. It may help you understand the marginal resource curve to note a parallel situation in an imperfectly competitive final product market. As you remember, a monopolist seller in the final product market faces a downward sloping demand curve for its product which causes its marginal revenue from selling an additional unit of output to be less than the market price for its product. Graphically, the marginal revenue curve lies below the demand curve facing the monopolist. This situation occurs because the monopolist must not only sell each additional units of its output at a lower price, but must sell all previous units of output at that lower price. You will notice that in both markets, the marginal curve, whether it measures 31 Ec 201 Principles of Economics marginal resource cost by a monopsonist or revenue received by monopolist, diverges from the average curve, whether it measures the market wage (resource price), represented by the resource supply curve facing a monopsonist, or the product price represented by the product demand curve, facing a monopolist. Learning Objectives: After completing the reading you should be able to: 1. Differentiate between nominal and real wages. 2. List several factors explaining the rise in real wages in the U.S. 3. Explain and illustrate graphically how wage rates are determined in competitive and monopsonistic labor markets. 4. Find the equilibrium wage rate and employment level in a competitive market, given the appropriate data. 5. List several methods used by labor unions to increase wages and the impact each has on employment. 6. Explain and illustrate graphically how both an inclusive (industrial) union and a exclusive (craft) union would affect wages and employment in a previously competitive market. 7. Explain and illustrate graphically wage determination in a bilateral monopoly model. 8. Summarize the empirical findings on how unions have affected U.S. wage rates. 9. Present the major case for and against minimum wages. 10. List three major factors causing wage differentials. Chapter 16 - The Pricing of Resources: Rent Interest and Profit In contrast to the detailed discussion of the determination of labor income the last chapter, this chapter presents a brief discussion of the determination of income receipts: rent, interest, and profits. Only the basic features of the markets for these other sources of income are covered because the theories of rent, interest and profits are unsettled and because they compose only a fourth of our national income. Reading Assignment: Text: Study Guide: 32 pp. 299-313 pp. 183-192 Ec 201 Principles of Economics Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. 9. Explain what determines economic rent. Explain why economic rent is a surplus. Describe how interest rates are determined. Explain how business firms make investment decisions. Distinguish between nominal and real interest rates. Distinguish between economic, nominal, and business profits. List three sources of economic profits. Describe the general function of profits. Present two view of the historical trends of labor’s and capital's shares of U.S. national income. 33 Ec 201 Principles of Economics 34 Ec 201 Principles of Economics Exercise #2 To be handed in before taking Exam #2. Complete all problems. I. Costs of production and profit maximization of a perfectly competitive firm A. Equilibrium in the Short Run The Fiasco Company is a firm in a perfectly competitive market whose costs of production in the short run are as follows: Output (per day) Total variable cost 0 1 2 3 4 5 6 7 8 9 10 $0 2 4 6 10 16 24 34 46 60 76 Total cost $ Average total cost $ Average variable cost $ Marginal cost $ Total fixed costs are $14 per day. 1. Fill in the rest of the columns of the cost table above. 2. On Graph 2.0, plot and label the average variable cost, average total cost, and marginal cost curves. Assume that this firm can produce any fraction of output per day, so you can connect the points to form continuous curves. 35 Ec 201 Principles of Economics 36 Ec 201 Principles of Economics GRAPH 2.0 $18 $17 16 15 14 13 Costs and Revenue per Day 12 11 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 Quality of Output per Day 37 Ec 201 Principles of Economics 38 Ec 201 Principles of Economics 3. How would you interpret the vertical distance between the average total cost and average variable cost curves? 4. Why does average total cost decline at first, then start rising? 5. The marginal cost curve intersects both average cost curves at their minimum points. Why? 6. If fixed costs were $28 instead of $14, how would the change affect the average variable cost and the marginal cost? Given the cost curves from question 2 for Fiasco corporation, and a market price for its output at $12 per unit: 1. Draw the average and marginal revenue on the graph above. 2. In order to maximize profits, Fiasco would sell _______ units at a price of $_______. Its average total cost would be $_______; its average revenue would be $_______. It would earn a per-unit profit of $_______ and a total profit of $_______ per day. 3. If, instead, the firm produced at the quantity that minimized its average total cost, it would sell _____ units at a price of $_______. Its average total cost would be $_______; its average revenue would be $_______. It would earn a per-unit profit of $_______ and a total profit of $_______ per day. B. Long-run equilibrium of a perfectly competitive industry The short-run cost conditions of a perfectly competitive firm are as follows: Output 1 2 3 4 5 6 7 8 9 10 1. Total Cost 9 13 18 24 31 39 48 58 69 81 Average Cost $ Marginal Cost $ Fill in the average cost and marginal cost columns. 39 Ec 201 Principles of Economics 2. The level of output at which average cost is at a minimum is __________; at this output average total cost is $_________. 3. What quantities would the firm be willing to supply at each of the following prices for its product? Price Quantity Supplied $6 7 8 9 10 11 12 4. In general, the short-run supply schedule (curve) of a perfectly competitive firm coincides with its ___________ schedule (curve) in the range where ___________ is rising and is greater than the __________. The market demand for this industry is as follows: 1. Price Quantity Demanded $12 11 10 9 8 7 6 2,000 3,000 4,000 5,000 6,000 7,000 8,000 Quantity Supplied If the firm in this exercise is one of 1,000 firms in the industry, all of which have identical cost functions: 40 a. Fill in the industry supply schedule in the column above. b. Explain briefly how the short-run supply schedule (curve) of a competitive industry is derived. Ec 201 Principles of Economics c. The equilibrium price for the industry is $________; the quantity sold is________ units. d. At this price, each firm will be making 1. zero profits 2. profits 3. losses 2. (Circle the correct choice from those given in parentheses.) Given the equilibrium price above, the number of firms in the industry in the long run will tend to (increase, decrease, remain constant) and the price will tend to (increase, decrease, remain constant). The output of the industry will tend to (increase, decrease, remain constant), while output per firm will (increase, decrease, remain constant). 3. If this is a constant cost industry, and firms cannot build larger or smaller plants than the initial one, the long-run equilibrium price for the industry will be $_________; output per firm will be_________ units; there will __________ firms in the industry; each earning $________ profits; industry output will be ____________ units. The equilibrium price coincides with the ____________ per unit cost of production. II. Equilibrium of a perfectly competitive firm in the factor market The production data for one of l,000 identical hypothetical firms in a perfectly competitive industry is given below. Number of workers 1 2 3 4 5 6 7 8 Marginal product per week (in tons) 14 12 10 8 6 4 2 0 The market price for the industry's output is $5 per ton and the supply of labor is as given on Graph 2.1. Based on the information given, answer the following questions: 1. Draw the industry's demand curve for labor on the graph 2.1. 41 Ec 201 Principles of Economics 42 Ec 201 Principles of Economics Graph 2.1 $75 70 SL 65 60 55 50 Wage Rate per Week 45 40 35 30 25 20 15 10 5 SL 0 1000 2000 3000 4000 5000 6000 7000 8000 Number of Workers per Week 9000 43 Ec 201 Principles of Economics 44 Ec 201 Principles of Economics 2. The equilibrium wage rate is $_________ per week; the number of workers employed in the industry is _________ ; total wages received by all workers is $____________per week. 3. If the government sets a minimum wage of $40 per week, the number of workers employed in the industry would be _________; the number of workers unemployed would be ___________; total wages received by all workers would be $__________ per week. 4. Are total wages generally higher under a minimum wage than they would be under the free market? Under what circumstances would total wages be higher under the free market? 45 Ec 201 Principles of Economics 46 Ec 201 Principles of Economics EXAMINATION NOTICE At the bottom of this page is a cut-out section for you to use in making arrangements to take an examination for this course. You may take this exam at a time and place most convenient for you. You are responsible for finding a proctor acceptable to Independent Study. Officials who usually serve as proctors are: Counseling and testing office personnel in community colleges, colleges or universities Public school superintendents, principals or counselors County and city librarians Members of your family, co-workers and/or neighbors will not be approved. The Oregon State System of Higher Education offices that serve as proctors are listed in this publication. Check the Table of Contents for page number. If one of these locations is convenient for your testing, please call and make an appointment with that office in advance and list them as the proctor on this form. The examination will be sent to your proctor and must be taken within six weeks or it will be returned to the Office of Independent Study. Be sure to make arrangements with your proctor to allow 2 hours for the examination. REQUEST TO TAKE EXAMINATION Please cut out and mail to: Independent Study, PO Box 1491, Portland, OR 97207-1491 COURSE: EC 201 Principles of Economics EXAM: SECOND (1996) 2.0 hrs. Closed book STUDENT INFORMATION (please print) Date _________________ ____ Check here if new permanent address Your Name _________________________________ S.S. Number __________________ Address _________________________________________ Day Phone ______________ City _____________________________ State _________ Zip __________________ PROCTOR INFORMATION Requested Test Date ___________________ Proctor Name _____________________________________Title ___________________ School or Library Name _____________________________________________________ Mailing Address ___________________________________________________________ City ___________________________ State _____________ Zip __________________ 47 Ec 201 Principles of Economics 48 Ec 201 Principles of Economics SECTION III PART 5 Government and Current Economic Problems The chapters in Part 5 expand and apply the principles of microeconomics presented in the last two parts to examine the issue of market failure, the role of government in business, the role of unions in the labor market, and important current microeconomic problems. You will explore in detail several of these problems: pollution, income inequality and poverty, health care, labor market issues of discrimination, and immigration. Chapter 17 - Government and Market Failure: Public Goods, the Environment, and the Information Problems This chapter extends the overview of government presented in chapter 6. The discussion will expand and deepen your understanding of the role of government in a market-oriented economy. The authors discuss extensively the issue of market failures and government solutions to these problem. Reading Assignment: Text: Study Guide: pp. 315-337 pp. 193-205 Study Hints: It is important for you to be able to differentiate between a public good and a private good and to grasp the concepts of externalities, spillover costs, and benefits. The existence of public goods and negative externalities lead to market failures. In this and similar cases, the government has a positive role to play. The detailed example in the text, looking at the owner of a forest who wants to contract with a logging company to clear-cut his land, will help you to understand the issues involved in market failure and successful corrective strategies. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. Describe graphically and explain the collective demand for a public good. Define the optimal quantity of a public good. Identify the purpose of benefit-cost analysis and explain the major difficulty in applying this analysis. Explain what is meant by spillovers and externalities. 49 Ec 201 Principles of Economics 5. Describe graphical or verbally how an overallocation of resources results when spillover costs are present and how this can be corrected by government action. Do the same analysis for underallocation of resources, which results when spillover benefit are present. Explain the Coase theorem, its significance, and the three conditions for it to work. Describe three policies that would reduce negative externalities. Briefly outline the Superfund law of 1980 and the Clean Air Act of 1990. Give two examples of how inadequate information about sellers can create a market failure. Explain moral hazard and adverse selection problems faced by sellers. 6. 7. 8. 9. 10. Chapter 19 - Antitrust, Regulation, and Industrial Policy In this chapter the authors broaden the strict definition of monopoly that was previously analyzed. The chapter investigates the cases for and against industrial concentration, antitrust regulations, and the trend toward deregulation in the 1970s and 1980s. The chapter concludes with a discussion of industrial policy and an analysis of government involvement with business. Reading Assignment: Text: Study Guide: pp. 359-379 pp. 219-229 Learning Objectives: After completing the reading you should be able to: 1. 2. 3. Explain the term industrial concentration. Discuss the major arguments for and against industrial concentration. Outline the major provisions of each of the following: Sherman Act, Clayton Act, Federal Trade Commission Act, Celler-Kefauver act, and patent laws. Identify three current economic goals that may conflict with strict enforcement of antitrust laws. Explain two major problems encountered in regulating natural monopolies. Differentiate between social and industrial regulation. Explain the intent of government industrial policy and summarize the views of proponents and critics of such policies. 4. 5. 6. 7. 50 Ec 201 Principles of Economics Chapter 21 - Income Inequality and Poverty This chapter provides you with statistical information and analysis of public policy alternatives that will help you better understand the controversial topics and issues concerning income distribution and poverty. The authors describe the degree of income inequality in the United States and discuss its causes; cover the debate over income inequality; analyze the problem of poverty; and finally discuss existing and alternative approaches to income-security programs. Reading Assignment: Text: Study Guide: pp. 398-417 pp. 243-254 Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. Describe in general terms the extent of income inequality in the United States. Explain how a Lorenz curve is used to describe income inequality. List seven causes for an unequal income distribution. State and evaluate the cases for and against income inequality, using the equality vs. efficiency argument. Identify the rate of overall poverty in the U.S.; the incidence of poverty for AfricanAmericans, Hispanics, and female-headed families; and the relationship between education and poverty. Identify the "invisible poor" and given three reasons for their invisibility. Contrast social insurance and public assistance (welfare) programs. Describe and evaluate the major social insurance and public assistance programs. Describe and evaluate the negative income tax, workfare, and other recent proposals. Chapter 22 - The Economics of Health Care This chapter addresses one of the most prominent and political issues of concern to Americans. The topics range from the rising costs of health care and gaps in health care insurance to the role of government involvement in providing health insurance. The chapter analyzes the economics of the health care industry, addressing in detail the many dimensions of the twin problems of costs and access, and the issue of reforming the health care system. Reading Assignment Text: pp. 418-435 51 Ec 201 Principles of Economics Study Guide: pp. 255-264 Learning Objectives: After completing the reading you should be able to: 1. Describe what is meant by the health care industry. 2. Identify the problems connected with rising health care costs. 3. Explain what is meant by the overallocation of resources to the health care industry. 4. Identify the special characteristics of the health care market. 5. List four factors that have contributed to the rise in health care demand. 6. Explain the moral "hazard problem" arising from health insurance coverage. 7. Identify three basic reform proposals designed to increase access to health care. 8. Explain how insurance company deductibles, copayments and preferred provider organizations might help contain health care costs. 9. Differentiate between health maintenance organizations and the traditional fee-forservice organizations, and how might help to contain health care costs. Chapter 23 - Labor Market Issues: Unionism, Discrimination, and Immigration This chapter provides a brief overview of three important but distinct labor market issues: Unionism, discrimination, and immigration. Most of the chapter is devoted to a survey of organized labor, collective bargaining, and the economic impact of unions. The remainder of the chapter outlines the economic dimensions and policy and cost issues of discrimination and immigration. Reading Assignment: Text: Study Guide: pp. 436-456 pp. 265-276 Learning Objectives: After completing the reading you should be able to: 1. 2. 3. Describe three historical phases of American unionism. Distinguish between craft and industrial unions. List the major provisions of the National Labor Relations Act (Wagner Act), the Taft-Hartley Act, and the Landrum-Griffin Act. Identify two factors that have lead to the decline of unions. Discuss the debate concerning the economic effects of unions. 4. 5. 52 Ec 201 Principles of Economics 6. 7. 8. Identify the dimensions of the discrimination against African-Americans, using four criteria. Explain the crowding market model of occupational discrimination. Illustrate graphically the predicted economic effects of migration and then discuss four difficulties related to this model. 53 Ec 201 Principles of Economics SECTION III, cont. PART 6 International Economics and the World Economy Part 6 examines the economics of the global economy. The chapters assigned describe the role of the United States in the global economy and provide a microeconomic analysis of international trade and international trade policy. Chapter 6 - The United States in the Global Economy This chapter introduces you to an overview of the basic principles underlying the global economy. The authors begin by providing facts describing the growth of world trade and the role of United States in the world economy. The rest of the chapter is devoted to an examination of the principle of comparative advantage as a basis for international trade, a discussion of the determination of foreign exchange rates, and an outline of restrictive trade practices of international trade agreements. Reading Assignments: Text: Study Guide: pp. 96-117 pp. 59-69 Study Hints: It is important to be able to distinguish between the concept of absolute advantage as a basis for trade and the concept of comparative advantage as basis for trade. Absolute advantage is based upon each nation producing a commodity of lower cost (more efficiently) than the same commodity is produced in other countries. In contrast, comparative advantage is based upon each nation producing one of its commodities at a relatively lower cost (more efficiently) than another commodity. An easy example to illustrate the difference between the two is as follows: Assume two nations, Alpha and Beta, both produce food and cloth. Both nations have the same technology and each uses labor as its only factor of production. The amount of food and cloth each country produces per day is as follows: 54 Ec 201 Principles of Economics Illustration of Absolute Advantage Country Alpha Beta Food (lbs. per day) 5 15 Cloth (lbs. per day) 10 5 In the above illustration, Alpha has an absolute advantage in producing cloth because it can produce in a day twice the amount of cloth as Beta. At the same time, Beta has an absolute advantage in producing food because it can produce three times the amount of food Beta can produce in a day. Illustration of Comparative Advantage Country Alpha Beta Food (lbs. per day) 5 15 Cloth (lbs. per day) 10 10 In the above illustration, Beta can produce three times as much food as Alpha and the same amount of cloth as Alpha. Thus, although Beta has an absolute advantage in both goods, it has a comparative advantage in food. Beta can produce relatively more of food (3 lbs. of food to 1 lb. of food) than cloth (1 lb. of cloth to 1 lb. of cloth) compared to Alpha. Although Alpha has an absolute disadvantage in both goods, it has a comparative advantage (least comparative disadvantage) in cloth. Alpha can produce relatively more cloth (1 lb. of cloth to 1 lb. of cloth) than food (1 lb. of food to 3 lb. of food) compared to Beta. Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. List four reasons for the growth in global trade. Explain the principle of comparative advantage and how it differs from absolute advantage. Explain how foreign exchange rates are determined and how they link the price levels of different countries. Describe four types of government interference with free trade. List at least five provisions of the 1993-94 GATT and define the World Trade Organization. Explain what is meant by a free trade zone and name two prominent regional trading organizations. 55 Ec 201 Principles of Economics Chapter 24 - International Trade This chapter builds upon the previous chapter, providing a more comprehensive analysis of international trade and protectionism. The chapter covers five areas: (1) statistics of world trade; (2) the gains from trade derived from international specialization based upon comparative advantage; (3) supply and demand analysis of the export and import markets; (4) economic impact of trade barriers and arguments for protectionism; and (5) the costs of protectionism and trade controversies. Reading Assignment: Text: Study Guide: pp. 457-480 pp. 277-289 Study Hints: The following example is designed to help you understand that international trade is a winwin situation when it is a result of specialization based upon the principle of comparative advantage. Below is reproduced the table illustrating comparative advantage used in the Study Hints for the previous chapter 6. Illustration of Comparative Advantage Country Alpha Beta Food (lbs. per day) 5 15 Cloth (lbs. per day) 10 10 Based upon the table above, the relative prices of food and cloth in each country are as follows: Country Alpha Beta Price of food in terms of cloth 1 food = 2 cloth 1 food = 2/3 cloth Price of cloth in terms of food 1 cloth = 1/2 food 1 cloth = 1/2 food The relative prices given in the table above are based upon the opportunity cost of each commodity. In Alpha, the relative price of food is 1 food = 2 cloth because the opportunity cost of 5 lbs. of food is 10 lbs. of cloth and the price of cloth is 1 cloth = 1/2 food because the opportunity cost of 10 lbs. of food is 5 lbs. of food. Although Alpha has an absolute disadvantage in food and equal advantage in cloth, cloth production is relatively cheaper than food production, and thus, Alpha has a comparative advantage in cloth. 56 Ec 201 Principles of Economics In Beta, the relative price of food is 1 food = 2/3 cloth because the opportunity cost of 15 lbs. of food is 10 lbs. of cloth and the price of cloth is 1 cloth = 1 1/2 food because the opportunity cost of 10 lbs. of food is 15 lbs. of food. Although Beta has a absolute advantage in food and an equal advantage in cloth, food is produced relatively cheaper than cloth, and thus, Beta has a comparative advantage in food. If the term of trade was set somewhere between the relative prices, before trade, in each countries, for example at 1 food = 1 cloth, both countries will gain from trading with each other. Alpha will gain by specializing in the production of cloth and exporting the cloth in exchange for cheaper imported food from Beta (1 lb. of food can be imported for only 1 lb. of cloth, instead of the cost of 2 lbs. of cloth if produced at home). Beta will also gain by specializing in the production of food and exporting the food in exchange for cheaper imported cloth from Alpha (1 lb. of cloth will can be imported for l lb. of food instead of the cost of 1 1/2 lbs. if produced at home). Learning Objectives: After completing the reading you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Determine comparative advantage, the direction of trade between two nations, and the gains from trade, given the relative costs of production. Determine the range of possible terms of trade from the appropriate information. State the economic case for free trade. Explain the international equilibrium price and quantity using a two-nation market for import demand and export supply. Identify four types of trade barriers. Describe the direct and indirect economic impact of a tariff. Contrast the economic impact of a quota with that of a tariff. Critically evaluate seven arguments in favor of protective barriers to trade. Describe the costs of projectionist policies and their effect on income distribution. List the major provisions of NAFTA and WTO (formally GATT) Describe U.S. policies designed to promote exports. 57 Ec 201 Principles of Economics 58 Ec 201 Principles of Economics Exercise #3 To be handed in before taking Exam #3. Complete all problems. I. The effect of labor unions on the market The effect of labor unions on the wages and employment of their members depends on the market structure as well as the elasticity of demand facing their workers. The following exercise illustrates some of these factors. The value of the marginal product and marginal revenue product of labor employed by a hypothetical monopolist are given in Graph 3.0. The monopolist uses one type of highly specialized labor not used in other industries. The supply of labor is fixed at 3,500 workers, and they are unionized. Based on this information, answer the following questions: 1. Which of the two curves on Graph 3.0 is the monopolist's demand curve for labor? Why? 2. Draw the supply curve of labor facing the monopolist on the graph. 3. If the union were completely ineffectual, the wage the union could obtain for its members would be $_________ per week. 4. The maximum wage the union would obtain by bargaining if it were to ensure employment for all its members would be $_______ per week. 5. If the union tried to obtain an additional $40 per week for its members, in addition to the maximum wage it obtained through bargaining in question 3, would it be successful? Explain. 6. If this industry were broken up into l,000 small perfectly competitive firms, its demand for labor then becomes the monopolist's VMP curve. Using the same information given above, 7. a. the maximum wage the union could obtain by bargaining if it were to ensure employment for all its members would be $__________ per week. b. If the union tried to obtain $260 per week for all its members, would it be successful? Why? In the situation in question 3, the ineffectual union under monopoly could only obtain the $260 weekly wage for its members at the expense of _______ workers unemployed. 59 Ec 201 Principles of Economics 8. In the situation in question 6, the highly successful union, under monopoly, or perfect competition, could only obtain the $260 weekly wage for its members at the expense of __________ workers unemployed. 9. Some unions have more success than others in obtaining higher earnings for their members. Give an example of a union that would be very powerful in this respect and an example of a union that would very weak in this respect. Why? 60 Ec 201 Principles of Economics GRAPH 3.0 $300 DL 280 DL 260 240 220 VMPL 200 Wage Rate per Week DL 180 160 140 120 100 80 MRPL 60 DL 40 20 0 500 1000 1500 2000 2500 3000 Workers per Week 3500 4000 4500 5000 61 Ec 201 Principles of Economics 62 Ec 201 Principles of Economics II. Free trade: The theory of comparative advantage There are two countries, Northland and Southland, each producing two commodities, wool and wine, at constant costs of production. In Northland, with a population of 12 million, it takes 2 workers to produce 1 ton of wool, and it takes 3 workers to produce 1 gallon of wine. In Southland, with a population of 4 million, it takes 1 worker to produce either 1 ton of wool or 1 gallon of wine. A. Before Trade 1. On Graphs 3.1 and 3.2 below, draw the production possibilities curves for Northland and Southland. 2. If Northland put all its workers into the production of wool, it could produce _______ tons of wool; if it put all its workers into the production of wine, it could produce _______ gallons of wine. 3. In Northland l ton of wool could be exchanged for _______ gallons of wine; 1 gallon of wine could be exchanged for _______ tons of wool. 4. If Northland wishes to produce and consume 3 million tons of wool, it should put workers into wool production. It would then have ______ workers left to put into wine production, producing and consuming _____ gallons of wine. Label this combination N on Northland's production possibilities curve on Graph 3.1. 5. If Southland put all its workers into the production of wool, it could produce ____ tons of wool; if it put all its workers into the production of wine, it could produce gallons of wine. 6. In Southland 1 ton of wool could be exchanged for ______ gallons of wine; 1 gallon of wine could be exchanged for _______ tons of wool. 7. If Southland wishes to produce and consume 1.6 million gallons of wine, it would put workers into wine production. It would then have _______ workers left to put into wool production, producing and consuming ______tons of wool. Label this combination S on Southland's production possibilities curve on Graph 3.2. B. After Trade If trade opens up between Southland and Northland: 1. Northland would have a comparative advantage in the production of _________ and, therefore, would export ___________ and import __________; Southland would 63 Ec 201 Principles of Economics have a comparative advantage in _____________ and, therefore, would export ________________ and import ______________. 2. If both countries agreed on terms of trade of 1 ton of wool in exchange for 4/5 gallon of wine: a. Draw the trading possibilities curve for each country on the graphs above. b. It would pay for Northland to put all its resources into wool production, producing tons. If Northland still wished to consume 3 million tons of wool domestically, it would have tons of wool left to export in exchange for ________ gallons of wine imports. Label this point T on the trading possibilities curve for Northland on Graph 3.1. c. It would pay for Southland to put all of its workers into wine production, producing gallons of wine. If Southland still wished to consume 1.6 million gallons of wine domestically, it would have _________ gallons of wine left to export in exchange for ________ tons of wool imports. Label this point U on the trading possibilities curve for Southland on Graph 3.2. 3. The gain from trade for Northland in terms of wine is _____________ gallons of wine. Northland is producing ________ tons of wool and consuming __________ tons of wool and __________ gallons of wine. 4. The gain from trade for Southland in terms of wool is ___________ tons of wool. Southland is producing _______ gallons of wine, consuming ______ gallons of wine and tons of wool. 64 Ec 201 Principles of Economics GRAPH 3.1 Northland 5 4 Millions of Gallons of Wine 3 2 1 0 1 2 3 4 5 6 Millions of Tons of Wool 65 Ec 201 Principles of Economics 66 Ec 201 Principles of Economics GRAPH 3.2 Southland 5 4 Millions of Gallons of Wine 3 2 1 0 1 2 3 4 5 6 Millions of Tons of Wool 67 Ec 201 Principles of Economics 68 Ec 201 Principles of Economics EXAMINATION NOTICE At the bottom of this page is a cut-out section for you to use in making arrangements to take an examination for this course. You may take this exam at a time and place most convenient for you. You are responsible for finding a proctor acceptable to Independent Study. Officials who usually serve as proctors are: Counseling and testing office personnel in community colleges, colleges or universities Public school superintendents, principals or counselors County and city librarians Members of your family, co-workers and/or neighbors will not be approved. The Oregon State System of Higher Education offices that serve as proctors are listed in this publication. Check the Table of Contents for page number. If one of these locations is convenient for your testing, please call and make an appointment with that office in advance and list them as the proctor on this form. The examination will be sent to your proctor and must be taken within six weeks or it will be returned to the Office of Independent Study. Be sure to make arrangements with your proctor to allow 2 hours for the examination. REQUEST TO TAKE EXAMINATION Please cut out and mail to: Independent Study, PO Box 1491, Portland, OR 97207-1491 COURSE: EC 201 Principles of Economics EXAM: THIRD (1996) 2.0 hrs. Closed book STUDENT INFORMATION (please print) Date _________________ ____ Check here if new permanent address Your Name _________________________________ S.S. Number __________________ Address _________________________________________ Day Phone ______________ City _____________________________ State _________ Zip __________________ PROCTOR INFORMATION Requested Test Date ___________________ Proctor Name _____________________________________Title ___________________ School or Library Name _____________________________________________________ Mailing Address ___________________________________________________________ City ___________________________ State _____________ Zip __________________ 69
