Chapter 4

Question 1

Assumption of Perfect Competition

Answer 1

1. Consumers are perfectly informed about all goods (all private); aka ‘perfect information’
2. Producers (small or large ) have the same production functions and the same cost curves; not cost advantages with the diff. in size
3. Consumers want to maximize their satisfaction (max utility), Producers max profits
4. Price takers (homogenous products- cant distinguish one seller over another, can’t raise prices) + externalities (effects on 3rd parties – not a buyer or seller in mkt who is affected by what happens) among agents are ruled out mkts determine all prices

Question 2

Pareto Optimality

Answer 2

o Under these conditions you could have the Pareto Optimality-equilibrium cant make one better off w/out making another worse off
o P=MC in all markets
o Very difficult to come up with

Question 3

Compensation Principle (Hicksian)

Answer 3

– argues that if it is possible to make one person better off and compensate those who are made worse off then you have a net gain; does not make compensation a requirement

Question 4

Determination of Economic (Consumer & Producer) Surpluses

Answer 4

o Figure 4.1- Demand and Supply Curve in Det. Of Econ. Surplus (pg. 81)
 Demand is reflecting benefits of product and how much their willing to pay
 Supply – sum of marginal cost curves; based in a competitive market from the additional cost of making a product
 P* Q* total benefit
 Equilibrium – reflect all the marginal benefits of production and cost
 TC= adds all marginal costs together is the area 0,C, D, Q; everything under the MC curve up to how much is produced
 Total Benefits- form the demand; everything under the demand curve up to what is consumed so 0,A,D,Q
 Net Benefit- the diff. b/w the two 0ADQ* and OCDQ= CAD
 Net Gain
• Consumer + Producer surplus = CAD
• Consumer – diff b/w what there will ing to pay and what they paid (PAD)
• Producer- what their …see text (CP*D)
 At Q’ (prime) -
• MB=FQ’&raquo_space;»> MB>MC
• AtQ’ - MC=HQ’&raquo_space;»» MB>MC
 HFD = DWL (dead weight loss –>no one got it; didn’t get produced)

Question 5

Welfare Losses and Marginal improvements

Answer 5

See text

Question 6

Complications-Economics of Scale

Answer 6

• things that reduce costs as the size of the business operation b/c larger; when present it its possible that the monopoly will be more efficient, etc.

Question 7

Complications-Fig 4.3 Econ of Scale and Natural Monopoly

Answer 7

 See notes too
 LRAC-long-range avg. costs
 LRMC- Long-range marginal costs
 Where LRAC and LRMC meet is the lowest ; as long as the marginal is below the avg. it declines

Question 8

Complications-Product Differentiation

Answer 8

o In the long run the price goes down
o If co looses too much $ they leave – allowing for a greater share of the mkt available
o Perfect competition= all products the same
o Have down sloping demand curve
o Have product variation in monopolistic competition; ppl like choices; valuable
 Its impossible to get to the lowest avg cost

Question 9

Complications-Fig. 4.4 Mono. Competition

Answer 9

In the figure price exceeds marginal cost this is a signal that there’s a miss allocation of resources. The key issue is optimal amount of product variety and this is difficult and theory

Question 10

Complications-X-inefficiency

Answer 10

o Q1= avg cost of prod q1 at lowest possible avg cost; could prod. More expensively
o X-inefficiency -is producing at a higher avg cost than is necessary
o Monopolist bc no competitors are more likely to do this b/c of accidents or b/c there are no other competitors

Question 11

Complications-Rent Seeking Behavior

Answer 11

o Monopoly Induced Waste

o Using resources and not producing any goods and services

Question 12

Fig. 4.5 Technological Change and Production

Answer 12

• Dynamic efficiency- how you use your resources over time
o Solow Model (pg 94)
 Starts w/ basic prod function ( input, output); looks at relationship b/t capital and output
 T= given technology as you expand capital ; output is rising at a declining rate
 T=2; getting higher outputs for any level of capital usage
 Ksub1= capital ; amt of capital per worker
 AB- improvement in technology; with k1can produce more than you could before
 BC- more capital ;more production

Question 13

Scherer & Ross R&D Rivalry Model

Answer 13

• More time you take with R+D the lower the cost will be (present value costs)
• V= Value of innovation depending on the # of firms
o The first firm gets more out of it; quicker ; earn monopoly revenue b4 others arrive
o Even if you’re the only firm in you will still have down-sloping curve for revenues
o T= max diff. b/t max cost and max value
o The more competitors = faster innovation than that w/out competitors
o There is a limit to the # of firms allowed in the mkt for innovation