ECO 110 – Introduction to Economics



ECO 110 – Introduction to Economics

Professor Mike Rizzo

Third COLLECTED Problem Set – This is an assignment that WILL be collected and graded. Please feel free to talk about the assignment with your friends or with your group and I strongly encourage you to submit your assignment as a group.

Assigned: Monday, April 25th

Due: Monday, May 2nd

COMPLETE ALL OF THE PROBLEMS

1. Income is a flow of receipts per unit of time: $240 per week or $30,000 per year. Wealth is a stock of assets: cash, shares of stock, skills, tools, buildings, and so on, How are income and wealth related in each of the following?

a. If you own an annuity that will pay you a $10,000 income for each of the next 20 years, what is the present value of the annuity? How much does the annuity contribute to your wealth?

b. What determines the market value of a house and this its contribution to the wealth of the owner? Do the expected benefits from living in the house (income) determine the value of the house (wealth)? Or does the price of the house determine the income received by living in it? Suppose someone happens to detest the house that he owns and occupies it because it has such distracting views of the bay and the mountains from every window. Would this idiosyncratic attitude reduce his income from living in the house? Would it reduce his wealth from owning the house? What behavior would this inconsistency between his income and his wealth probably induce?

c. Is an engineering degree wealth? What determines the value of such a degree, how hard you worked in college to get it? How could an engineer with a freshly minted degree who is just beginning her first job convert some of her wealth into current income in order to buy furniture for her apartment?

d. A successful and popular physician decides to retire and “sell his practice.” What is he actually selling? What will determine its value to a buyer?

2. Teachers began encountering serious job shortages in recent years after many years of rising demand for their services. An intensified interest in unionization followed. What can unionization accomplish for teachers in a highly unfavorable job market? Who is likely to benefit? Who will be harmed?

3. Do high wage rates in such strongly unionized industries as steel and automobiles pull up the general level of wages in non-unionized, lower-wage industries? If you think they do, what is the process by which this happens? If contracts that call for high wages reduce employment opportunities in the industries that must pay these wages, where do the excluded workers find employment?

4. “Comparable worth” is the name of a movement that began in the 1980s to determine the worth of different jobs and then to adjust relative wage rates to the relative worth of those jobs. The movement gains most of its support from the belief that women are unfairly discriminated against in the labor market. The jobs at which most of them work (e.g. secretaries and nurses) are widely and unfairly regarded as “women’s jobs” and so are allegedly paid less than their “comparable worth.” The comparison is with jobs traditionally held by men.

a. Can a job have an inherent worth? Can you think of any situation where the worth of a job is not its value to some particular party in a specific situation?

b. Imagine a medical clinic with twenty medical doctors, one nurse, and one laboratory technician. Is it plausible to suppose that an additional nurse or lab technician could have more worth to the clinic in such a situation than an additional doctor?

c. The worth or value that influences decisions is always marginal worth or value. Why is a secretary worth more to the economics department if it employs only one that if it employs eight? Describe a situation in which the worth of a secretary to the economics department would likely be greater than the worth of an economist fully armed with a Ph.D.

d. Why will an employer that follows the maximizing rule – do more if marginal revenue exceeds marginal cost, less if marginal cost exceeds marginal revenue – want to pay each employee a wage equal to his or her marginal worth? What would be implied by the assertion that an employer was paying employees less than their marginal worth?

5. This is a difficult question that asks whether you can apply the intuition gleaned from the price searching model (recall our Centre kid selling movie tickets) to other situations where individuals are price searchers.

What happens when BUYERS are not price takers, but price searchers? Suppose you own a business that receives $6.25 per 100 for distributing advertising flyers door to door. You have a very large territory so that your business is limited only by your ability to hire help. Your potential help consists exclusively of the teenagers in your neighborhood, each of whom can distribute 100 flyers per hour. They are all willing to work one hour for you, but each insists upon a different minimum wage (i.e. they would not work for less). Here are their minimum wage requirements:

Alan $3.00

Betty $3.50

Chuck $4.00

Donna $4.50

Ely $5.00

Frannie $5.50

Gomer $6.00

Herman $6.50

How many of these workers do you want to hire if your goal is to maximize your net revenue and all employees must be paid the same wage rate? (answer the following questions to help you)

a. What is your marginal revenue from hiring an additional worker? (Hint: you should recall the definition of marginal revenue. What is the action taken here?)

b. What is your marginal cost from hiring an additional worker when you hire Alan? When you hire Betty? Chuck? Which is the last worker you can hire if you want to keep marginal cost from exceeding marginal revenue? (Hint: you should recall the definition of marginal cost. What is the action taken here?)

c. Suppose a large hospital is in a similar position with respect to nurses. It can hire all the nurses it is likely to want, but it must offer a higher wage to attract additional nurses. Some will work for very little, others for a bit more, and so on, up to those who will work only if they can obtain a very high wage. Why might such a hospital find itself facing what it perceives to be a chronic shortage of nurses? How might it respond? (Hint: What do sellers attempt to do when additional sales would “spoil” their market?)

6. What is the difference between poverty and inequality? Why do you think they are talked about as if they were the same concept?

7. Suppose you were asked to choose a planet to live on – but you do not know which person you will be once you arrive to your new planet. On planet Keynesia, you would be one of 10 people. Half of the people earn $20,000 per year while the other half earn $19,000 per year. On planet Hayekia, you would also be one of 10 people. However, half the people earn $100,000 and the other half earn $20,000. On which planet would you choose to live? Would your answer be any different if instead I said: that on planet Keynesia half the people had to cook their own meals every day each week, see two movies per week and drive a used car each week while the remaining half got prepare all of their meals in a week, see one movie per week and drive similar used cars; while on planet Hayekia, half the people were able to eat out anytime they wanted, got to see a live music show, 4 movies, a ballgame and take a walk in the park, and drove new fuel efficient cars; while the other half could only eat out rarely – they had to cook their meals each week, they could see two movies each week and drive a used car each week? Why do you think many people choose Keynesia in the first example and Hayekia in the second? Is this rational?

8. Why do people sometimes disturb others by talking during movies? Do the talkers and those whom they disturb agree about the rights one acquires when purchasing a movie ticket? How could the owners of movie theatres resolve this conflict? Why don’t they do so?

9. Two children are quarreling about who gets to choose the program that will be watched on the family’s single television set. This is a case of conflicting property rights.

a. Should the parents tell them to work it out for themselves? Under what circumstances is this likely to produce a satisfactory resolution of the conflict?

b. How do poorly defined property rights make it more difficult in such a case to achieve a satisfactory resolution through negotiation?

10. History books often lament the destruction of the great herds of bison that roamed the western prairies before the arrival of white men.

a. Why were so many white men willing to shoot these animals and leave their meat and hide to rot? Wasn’t this highly wasteful? Why did so many people apparently place such a high value on a moment of sport as to kill these animals for other reason than the excitement of doing it?

b. Who bore the costs when a hunter shot a bison or “buffalo” from the window of a passing train?

c. Was the near extinction of the buffalo an irreversible act? Or could we bring those huge herds of buffalo back within a few years if the proper incentives existed?

d. What animal has replaced the buffalo on the western prairies? Why do the numerous vast herds of cattle that cover the country not suffer the fate of the buffalo? What do you think would happen to the relative size if cattle and buffalo herds if Americans lost their taste for beef and acquired an intense love of buffalo meat?

11. “Taxes can’t control pollution. They’ll just drive the little firms out of business while the big firms, who can afford to pay the taxes, go right on polluting.” Do you agree?

12. Here is a paragraph from a letter to the Wall Street Journal written by the chairman of the House Subcommittee on Health and the Environment:

”The cheapest and best way to clean air is to make sure that new industrial facilities are built clean. It is far easier to build a new coke oven or blast furnace clean than to try and retrofit an old facility with pollution controls. Just as replacing old, dirty cars with new, clean cars will lessen automotive pollution, so too will turning over America’s capital stock clean the air.”

A law that requires new cars or new industrial facilities to be “clean” raises the cost of producing new cars or new facilities and hence their price. How will that encourage longer use of old and “dirty” cars and facilities? Show how a law could result in dirtier air by setting excessively stringent and costly controls on new cars or industrial facilities.

13. Assume that the following graph shows how much it costs per year per car to reduce undesirable automobile emissions by various percentages through mandatory exhaust-control devices.

[pic]

a. Why does the curve rise slowly at first and increase more rapidly as emission levels decline? Is this a peculiar characteristic of automobile exhaust-control systems, or is it a more general relationship?

b. Does this curve tell us how much emissions ought to be reduced? Does it provide any guidance at all to those who make public policy in this area?

c. If you think of this curve as the marginal cost of supplying cleaner air, what kind of data would you want in order to construct the demand for cleaner air? What would be the significance of the intersection between these two curves?

d. Suppose you want to find out how much people in your area value cleaner air. So you commission a survey in which people are asked how much they would be willing to pay in order to obtain various levels of reduction in the amount of noxious automobile emissions in their community. Can you generally count on them to tell the truth? Remember that they know that they won’t be held to their valuation – that is, they won’t actually be required to pay. What are the major sources of bias in such a survey procedure?

e. Suppose that your survey is done for the government and that the people whom you ask know they will actually be required to pay an annual tax equal to the amount they say they are willing to pay for whatever level of reductions is finally decided on and enforced. What sort of bias will this introduce into your measurement of the community demand for cleaner air?

14. Suppose there are two firms, A and B, that make a mess when they produce. Firm A can clean up “mess” for $10/unit while firm B can only do it for $20/unit. Suppose further that firm A produces 100 units of mess per week while firm B produces 200 units of mess per week. The government decides that there should be no more than 150 units of mess produced per week.

a. What would the total costs of cleanup be if no firm was allowed to emit more than 75 units of mess per week?

b. What would the total costs of cleanup be if each firm was ordered to reduce emissions by half?

c. What would the total costs of cleanup be if each firm was ordered to reduce mess by 75 units?

d. How much mess would be reduced if the government instead instituted a tax that required firms to pay $15 per unit of mess that they created? How about from a tax of $30 per unit?

e. Describe what might happen if instead the government issued “marketable mess permits.” However, once you acquire the permit from the government, these rights are not transferable. Each permit would give the holder the right to make one unit of mess per week. If you don’t hold a permit, you are free to produce as long as you clean up your mess. If the government wanted to fully eliminate mess, it would offer 0 permits, however it only wants to reduce mess by ½. Therefore it makes 150 permits available. What is the most that firm A would be willing to pay the government for a permit? Firm B? Suppose the folks at firm A are really good at navigating the red-tape and manage to acquire 100 permits at a price of $5.00 each. That leaves only 50 more permits for Firm B, who will pay $5.00 each as well. What are the total costs of reducing mess in this scenario? How much revenue does this scheme generate for the government?

f. In thinking about part (e), ask yourself whether there are potential gains to be made from trade. If the government now allows firms to transfer property rights and also ensures all parties that no new permits will be issued, describe the process that would likely take place. What range of prices might these permits trade for on a pollution exchange market? How many units of mess would firm A end up cleaning up? Firm B? What are the total costs of reducing mess in this scenario?

15. Where is the best place to dispose of solid waste? The most common answer is NIMBY – Not in My Back Yard.

a. How does a city discriminate unfairly against some people whenever it chooses a new waste disposal site?

b. What makes people willing to let others dispose of solid waste in their “backyard”?

c. What would happen if a city “awarded” its new waste disposal site to the community that was most willing to accept it? How might such willingness be obtained and measured?

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