Lectures 1 - 6

Question 1

How is preference denoted?

Answer 1

A > B = A strictly preferred to B
A < B = B strictly preferred to A
A ~ B = A indifferent to B

Question 2

What are the key assumptions in preference analysis?

Answer 2

• Completeness
• More is better!
• Diminishing MRS
• Transitivity

Question 3

What is the slope of the budget line?

Answer 3

Market rate of substitution (-Px/Py)

Question 4

How can you decompose income and substitution effects?

Answer 4

First draw a budget line that is parallel with the new line so that it is tangential to the original IC curve. The difference between the starting point and this new tangent point is the SUBSTITUTION EFFECT! The residual effect is the INCOME effect.

Question 5

Is an in-kind gift optimal in terms of maximising utility?

Answer 5

Most likely no! This is effectively because the consumer end up consuming too much of good X (socks etc.) Ideally, he’d be better off receiving cash, spending some of it on socks, and having more money to spend on Y. NOTE: Exception is if, upon receiving money, the consumer spends all the money on good X.

Question 6

Is a gift card optimal?

Answer 6

Usually, although not always. Generally, the consumer will spend the gift card, but be able to use some of the money that he would have spent on X anyway, and devote it to buying more Y. The exception to this rule is if X is inferior - ie. the consumer wants less of it as his income increases - this is sub-optimal!

Question 7

How does an increase in income tax affect the number of hours employees wish to work?

Answer 7

Depends on the magnitude of the sub and income effects. If the negative income effect out ways the positive sub effect, then the worker will choose to work more hours. If the income effect is smaller, then the worker will decide to increase their consumption of leisure.

Question 8

What is the general forms of (a) Linear Isoquants (b) Leontief Isoquants, and (c) Cobb-Douglas Isoquants

Answer 8

(a) Q = aK + bL
(b) Q = min {bL,cL}
(c) Q = (K^a)(L^b)

Question 9

If a firm is profit maximising, how much capital and labour should it employ?

Answer 9

Where VMPL = w, and where VMPK = r

Question 10

What is the market rate of technical substitution?

Answer 10

The rate at which two inputs are substituted, whilst keeping output constant. (MPL/MPK)

Question 11

For cost minimisation, what must be true?

Answer 11

MPL/MPK = w/r (this is why the slopes of the indifference curve and the budget line must be the same.

Question 12

What are economies of scope?

Answer 12

Economies of scope exist where the costs of producing two products is less than the cost to two firms producing the goods individually.
C(Q1,Q2) < C(Q1,0) + C(0,Q2)

Question 13

What is cost complimentarity?

Answer 13

Cost complimentarities exist when the marginal cost of producing one good falls as output of another good increases.
dMC1(Q1,Q2) / dQ2 < 0

Question 14

In monopoly, how graphically can we obtain the profit maximising level of output?

Answer 14

If we have a TR and a TC curve, the point where the tangents of both curves are parallel will be the profit maximising level of output.

Question 15

Can monopolists make a loss?

Answer 15

Yes, if AC is above AR at the point where MC=MR then losses will be made.

Question 16

What is the problem with rate of return regulation?

Answer 16

Firms will tend to over employ capital to make sure (profit / capital) is within the required limits - this will not be optimal.

Question 17

Why are monopolies “bad”?

Answer 17

When compared to perfect competition, monopoly is bad because it creates deadweight loss - a loss in total surplus.

Question 18

What happens when firms can’t discriminate between differing markets?

Answer 18

The marginal revenue received from sales in both markets will NOT be equal. Thus, it would be beneficial if the firm could sell more to the group that provides it with more MR.

Question 19

What is second degree price discrimination?

Answer 19

Approximates first price discrimination. Charges different prices, deepening on how many units of a product are bought. This erodes some consumer surplus, but not all consumer surplus. Helps managers, as they don’t have to know the individual demands of various consumers.

Question 20

What is two part pricing?

Answer 20

Where firms charge consumers a fixed price that enables them to buy goods / services and then charge them a per-unit charge on each unit of consumption. If fixed fee = total CS, then clearly all CS is eroded.

Question 21

What is block pricing?

Answer 21

Where firms bundle identical goods together, and charge consumers a set “bundle price”, forcing consumers into an all-or nothing decision. Profit maximising price for the block = total value to the consumer.

Question 22

What is commodity bundling?

Answer 22

Where firms bundle different goods together, and then charge consumers a single price. NOTE: only works if consumers have differing valuations of the products in question.

Question 23

What is peak-load pricing?

Answer 23

Where a firm charges a different price in peak hours, than in off-peak hours. The classic example here is trains.

Question 24

What is cross-subsidy?

Answer 24

Where a firm uses the profits gained from the sale of one good to subsidise the sale of another good. Only effective if demand for the two products in question are interrelated.

Question 25

What is a transfer price?

Answer 25

Used by firms who have different divisions - an upstream division, and a downstream division. Ideally, the transfer price needs to be optimised, so double marginalisation doesn’t occur.

Question 26

What is the optimal transfer price?

Answer 26

Where NMRd (MRd-MCd) = MCu!