Microeconomics Assignment (December 2020)

Question 1

About 100 million pounds of jelly beans are consumed in the United States each year, and the
price has been about 50 cents per pound. However, jelly bean producers feel that their incomes
are too low and have convinced the government that price supports are in order. The
government will therefore buy up as many jelly beans as necessary to keep the price at $1 per
pound. However, government economists are worried about the impact of this program
because they have no estimates of the elasticities of jelly bean demand or supply.
a. Could this program cost the government more than $50 million per year? Under what
conditions? Could it cost less than $50 million per year? Under what conditions?
Illustrate with a diagram.
b. Could this program cost consumers (in terms of lost consumer surplus) more than $50
million per year? Under what conditions? Could it cost consumers less than $50 million
per year? Under what conditions? Again, use a diagram to illustrate.
c. What conclusions can you infer from point a and b on government’s price support in
competitive market? Explain.

Question 2

A monopsony is a market that has only one buyer but many sellers. Pure monopsony
is rare, but in many markets only a few buyers compete with each other.
a. What factors determine the amount of monopsony power an individual buyer is likely to
have? Explain each one briefly.
b. Why is there a social cost to monopsony power? If the gains to buyers from monopsony
power could be redistributed to sellers, would the social cost of monopsony power be
eliminated? Explain briefly.
c. How can government improve the outcome in monopsony market to be economically
efficient? Use diagram to illustrate

Question 3

a. Electric utilities often practice second-degree price discrimination. Why might this
improve consumer welfare?
b. Give some examples of third-degree price discrimination. Can third-degree price
discrimination be effective if the different groups of consumers have different levels of
demand but the same price elasticities?
c. Show why optimal, third-degree price discrimination requires that marginal revenue for
each group of consumers equals marginal cost. Use this condition to explain how a firm
should change its prices and total output if the demand curve for one group of consumers
shifts outward, causing marginal revenue for that group to increase.
Question 4

One of market structure that we frequently observe is oligopoly: a market in which only a
few firms compete with one another, and entry by new firms is impeded.
a. In many oligopolistic industries, the same firms compete over a long period of time,
setting prices and observing each other’s behavior repeatedly. Given the large number of
repetitions, why don’t collusive outcomes typically result?
b. We can think of U.S. and China trade policies as a prisoners’ dilemma. They are
considering policies to open or close their imports. The payoff matrix is shown below.
China

United States

I. Assume that each country knows the payoff matrix and believes that the other country
will act in its own interest. Does either country have a dominant strategy? What will
be the equilibrium policies if each country acts rationally to maximize its welfare?
II. Now assume that China is not certain that the United States will behave rationally. In
particular, China is concerned that U.S. politicians may want to penalize China even if
that does not maximize U.S. welfare. How might this concern affect China’s choice of
strategy? How might this change the equilibrium?

Question 5

Factor markets are markets for labor, raw materials, and other inputs to production.
Much of analysis on factor markets will be familiar because the same forces that shape
supply and demand in output markets also affect factor markets.
a. How is a computer company’s demand for computer programmers a derived demand?
b. Compare the hiring choices of a monopsonistic and a competitive employer of workers.
Which will hire more workers, and which will pay the higher wage? Explain.
c. A firm uses both labor and machines in production. Explain why an increase in the
average wage rate causes both a movement along the labor demand curve and a shift of
the curve.
Question 6

General Equilibrium and Market Efficiency

a. Why can feedback effects make a general equilibrium analysis substantially different
from a partial equilibrium analysis?
b. In the Edgeworth box diagram, explain how one point can simultaneously represent the
market baskets owned by two consumers.
c. In the analysis of exchange using the Edgeworth box diagram, explain why both
consumers’ marginal rates of substitution are equal at every point on the contract curve.

Question 7

What are the four major sources of market failure? Explain briefly why each prevents the
competitive market from operating efficiently.