Download Problem Set 10 Solutions

Name: ______Solutions____
Cosumnes River College
Principles of Microeconomics
Problem Set 10
Due May 12, 2015
Spring 2015
Prof. Dowell
Instructions: Write the answers clearly and concisely on these sheets in the spaces
provided. Do not attach extra sheets.
1. Define “negative externality.”
A cost imposed on members of society who are not a party to the market
transaction. The cost is not reflected in the market price.
2. Define “positive externality.”
A benefit accruing to members of society who are not a party to the market
transaction. The benefit is not reflected in the market price.
3. Use the graph below that illustrates supply and demand for bulk paper to answer the
questions.
a. Label the equilibrium price and
quantity (if there are no externalities in
this market) as P0 and Q0 respectively.
b. The paper manufacturer creates a
negative externality for society as part
of paper production. Make an addition
to this diagram to reflect that negative
externality.
c. Given the change you made in part b,
label the socially-optimal price and
quantity as P1 and Q1 respectively.
d. Suggest a government action that
could make the paper manufacturer
take into account the negative
externality.
The government could tax suppliers by the amount of the externality, regulate the
amount of pollution or establish a system of marketable permits..
Principles of Microeconomics: Problem Set 10 Solutions
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4. New developments of townhouses are springing up in the ex-urban community of
Outland. The supply and demand curves for new townhouses are as follows:
Demand
Price=MPB
Quantity
$140,000
100
130,000
200
120,000
300
110,000
400
100,000
500
90,000
600
80,000
700
Price=MPC
$140,000
130,000
120,000
110,000
100,000
90,000
80,000
Supply
MSC
$160,000
150,000
140,000
130,000
120,000
110,000
100,000
Quantity
900
800
700
600
500
400
300
a. What is the market equilibrium quantity of townhouses and the corresponding
price?
P = $100,000
Q = 500
b. The new developments impose costs on other current residents for sewage,
transportation, and congestion. An estimate of the magnitude of these negative
externalities is $20,000 per townhouse. Find the efficient level of townhouse production
and the corresponding price.
Set MSC equal to MPB to get P = $110,000 and Q = 400
c. What public policy could be implemented to insure that the optimal quantity is
produced?
Impose a tax or fee of $20,000 per unit.
5. The marginal abatement cost and marginal social cost of pollution in the Northwest Air Shed
are as follows:
Marginal Abatement
Marginal
Pollution
Cost
Social Cost
10
$100
$0
20
80
0
30
60
5
40
50
10
50
40
20
60
30
30
70
15
50
Find the socially efficient level of pollution, and explain how a marketable permits scheme
can achieve the efficient outcome. How many permits should be issued?
(Pollution is measured as tons of sulfur-oxide.)
In this case the benefit is the elimination of the cost to society. (Marginal social cost is the
marginal benefit.) Set MC = MB to get 60 tons of pollution. Permits should be issued for 60
tons of pollution. If these permits can be exchanged (bought and sold) in a market, those
firms with high abatement costs will buy permits and those with low abatement costs will
abate potion and sell their permits. The equilibrium permit price will be $30.
Principles of Microeconomics: Problem Set 10 Solutions
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6. Use the data in the table below to answer the following questions:
Marginal
Marginal
Quantity
Private
Private Cost
Benefit
0
-$0
1
$10
2
2
9
3
3
8
4
4
7
5
5
6
6
6
5
7
7
4
8
8
3
9
9
2
10
10
1
11
Marginal
Social Cost
$0
4
5
6
7
8
9
10
11
12
13
a. What is the externality associated with each unit of production?
$2
b. What level of output will be produced if there is no regulation of the externality?
MPB = MPC at $6 for an equilibrium quantity of 5
c. What level of output should be produced to achieve economic efficiency?
MPB = MSC at a price of $7 and a quantity of 4
d. Calculate the dollar value of the net gain to society from correcting the externality.
MSC
P
S = MPC
8
DWL
7
D
6
D
4
Principles of Microeconomics: Problem Set 10 Solutions
5
Q
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The deadweight loss resulting from the externality is the area of the triangle which is 1 x 2
x ½ =1. Note that this is the same result you get if you simply recognize that we have
reduced production by one unit which eliminates $1 worth of externality.
7. Use the graph below that illustrates supply and demand for education to answer the questions.
a. Label the equilibrium price and
quantity (if there are no externalities in
this market) as P0 and Q0 respectively.
b. Education received by one person also
benefits that person’s family and
neighbors. Make an addition to this
diagram to reflect a positive
externality.
c. Given the change you made in part b,
label the socially-optimal price and
quantity as P1 and Q1 respectively.
d. Suggest a government action that
could make potential students take into
account the positive externality.
Government could subsidize education
for students.
8. With respect to labor supply, explain the following:
a. Substitution Effect
As wages rise, the opportunity cost of leisure rises as well, meaning people consume
less leisure (substituting consumption of all other goods which are now relatively
cheaper) and work more.
b. Income Effect
As wages rise, people’s income increases, meaning they can consume more of all
goods, including leisure. As a result, they work less.
Principles of Microeconomics: Problem Set 10 Solutions
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9. The data below show the relationship between the number of workers hired and the costs and
revenues for a small Italian restaurant in East Poughkeepsie, Eddie’s Eggplant Emporium.
Quantity
of Labor
Output
Marginal
Product
Price
Wage
Marginal
Revenue
(P)
Marginal
Revenue
Product
(MRPL)
(L)
(Q)
(MPL)
(W)
(MR)
0
0
--
$10
0
$11
$10
0
1
5
5
10
50
11
10
60
2
10
5
10
50
11
10
60
3
14
4
10
40
11
10
48
4
17
3
10
30
11
10
36
5
19
2
10
20
11
10
24
6
20
1
10
10
11
10
12
7
20
0
10
0
11
10
0
8
19
-1
10
-10
11
10
-12
MRPL
with
P=$12
a. Fill in the blanks in the above table.
b. At what point do diminishing returns set in? How do you know?
With the third unit of labor. This is where MPL starts to fall.
c. How many workers should be hired? How do you know?
5, because with any more, MRPL is less than the wage.
d. If fixed costs are $100 and labor is the firm’s only variable input, what is the firms profit? Explain.
TR=19x$10=$190
TC=(5x$11)+$100 = $155
Profits=TR-TC=$190-$155=$35
e. If the price of the product were to increase to $12, how many workers should be hired?
Explain?
Six. Again, we would have MRPL less than price with any more.
f.
If after the price increase wages were to increase to $15, how many workers should be hired?
Explain.
The same number, six. We still would have MRPL less than price with any more.
Principles of Microeconomics: Problem Set 10 Solutions
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10. You decide to start a house painting business next summer. The table below shows how
many houses you can paint over the summer, depending on the number of friends you hire to
work in your business.
Workers
0
1
2
3
4
5
6
Houses Painted
0
10
18
23
26
28
29
a. Are there diminishing returns to labor in the house painting business? How do you know?
Yes. Marginal Product of Labor diminishes with the second worker.
b. You get paid $500 for every house your business paints over the summer. You can hire as
many workers as you like for $1500 (for the entire summer).
i. What is the marginal revenue product of the fifth worker? Explain.
The marginal product of the fifth worker is 2 houses painted at $500 each for a MPL of
$1,000.
ii. How many workers do you want to hire for your business? Explain.
Four. This is where the MPL = w = $1,500
c. Draw your demand curve for labor on the axes below:
w
LD
L
d. How many workers will you hire at the given wage rate? Explain.
Four. This is where the MPL = w = $1,500
Principles of Microeconomics: Problem Set 10 Solutions
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11. Explain what each of the following is and why it might lead to people being paid different
wages.
a. Inherited Skills
Inherited skills, such as those of a professional basketball player are somewhat rare
or in short supply. As a result, those individuals who are fortunate enough to have
the skills generate a greater marginal revenue product of labor (MRPL) and
consequently command a higher wage in the labor market.
b. Human Capital
Increased human capital increases a persons marginal product and hence their
MRPL, resulting in a higher wage.
c. Working Conditions
For jobs with undesirable working conditions, labor supply may be less relative to
labor demand than for those jobs with more desirable working conditions. If this is
the case, we would expect to see higher wages for those workers holding the jobs
with less desirable working conditions.
d. Unions
Unions either restrict entry which reduces labor supply and increases wages or they
bargain for a wage above the market equilibrium, raising wages and generating
unemployment.
12. How would each of the following be likely to affect the wages and employment of unskilled
workers who work in automobile plant assembly lines? Draw a carefully labeled diagram
and give a full explanation of each answer. BE SURE TO USE THE TERMINOLOGY WE
HAVE BEEN DISCUSSING IN CLASS
a. Plant managers introduce new assembly line methods that increase the number of cars
that unskilled workers can produce in an hour while reducing defects.
w
LS
D
L
LD’
This increases the marginal revenue
product of labor for all levels of labor
input, increasing the amount of labor
demanded at every wage. The labor
demand curve shifts right, wages rise and
the quantity of labor demanded
increases.
L
Principles of Microeconomics: Problem Set 10 Solutions
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b. As a result of changing preferences, people become less willing to do factory work.
LS’
w
LS
The labor supply curve shifts to
the right. Wages rise and the
quantity of labor demanded
falls.
LD
L
c.
Robots are introduced to perform most basic assembly line tasks at a lower unit cost.
LS
w
Capital is substituted for labor. The
labor demand curve shifts left, the
wage falls and the quantity of labor
supplied falls.
LD
LD’
L
13. “Because firm’s demand curves for labor are downward sloping, raising the minimum
wage must reduce employment.” Why is this statement wrong? When would raising the
minimum wage reduce employment?
Raising the minimum wage reduces employment only if the resulting minimum wage is set
above the market equilibrium wage. A minimum wage set below market equilibrium has
no effect on the labor market.
Principles of Microeconomics: Problem Set 10 Solutions
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