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Principles of Home Microeconomics - Assignment Example

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In the paper “Principles of Home Microeconomics” the author provides the case about Ivan who buys 2 cups of coffee and a sandwich for lunch. The price of coffee is $2 per cup and the price of a sandwich is $5. Ivan’s choice of lunch maximizes his utility and he spends only $9 on lunch…
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Principles of Home Microeconomics
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Principles of Home Microeconomics

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1. Every day, Ivan buys 2 cups of coffee and a sandwich for lunch. The price of coffee is $2 per cup and the price of a sandwich is $5. Ivan’s choice of lunch maximizes his utility and he spends only $9 on lunch. Compare Ivan’s marginal utility for coffee and his marginal utility from the sandwich.
For Ivan to take two cups of coffee, then the marginal utility of the first glass of coffee must exceed $2, while the marginal utility of second glass equals $2. Ivan’s marginal utility of sandwich is $5. Therefore, Ivan attaches a higher utility to sandwich than the second glass of coffee; however, the first glass of coffee might have provided a higher utility.
2. Newspaper vending machines are designed so that once you have paid for one paper you have access to all the papers in the machine and could take multiple papers at a time. However, other vending machines dispense only one item (the item you bought). You do not have access to all the goods (sodas, candy, snacks, etc.) at one time. Using the concept of marginal utility, explain why these vending machines differ?
News papers are mutually exclusive, once the first paper is picked; the marginal utility of picking a second paper is almost zero. Note that the news found in the second newspaper picked are the same as the first newspaper hence picking the second paper constitutes negligible utility gain hence no need for restriction. However, customers will always have an incentive to pick different goods from the other vending machines since every second good picked has a utility gain, hence the restriction. For instance a combination of soda and snacks yield to a higher utility than soda alone.
3. Briefly explain the relevant portions shown in a backward sloping labor supply curve. How are the various possibilities derived?
Contrary to the normal supply curve, labor supply curve is not purely positively sloped, but bends backwards changing to negative slope at higher wages. This is due to contradicting forces of substation effect and income effects as wage rises. Workers substitute working hours to leisure. Wage rise increases the incentive to work hence positive substitution effect. On the other hand, increase in wage implies that workers can achieve their target income by working less hours hence the negative income effect. At low wages, substitution effect is more than income affects hence the total effect s positive. However, as wages rise, income effect increases and at a certain point the total effect becomes zero, then negative, hence the backward turn.
4. The financial advisor Andrew Tobias described an incident that occurred when he was a student at the Harvard Business School: Each student in the class was given a large amount of information about a particular firm and asked to determine a pricing strategy for the firm. Most of the students spent hours preparing their answers and came to class carrying many sheets of paper with their calculations. Tobias came up with the answer after just a few minutes and without having made any calculations. When his professor called on him in class for an answer, Tobias stated, “The case said the XYZ Company was in a very competitive industry…and the case said that it had all the business it could handle.” Given this information, what price do you think Tobias argued the company should charge? Briefly explain. [Tobias says the class greeted his answer with “thunderous applause”.]
XYZ Company took the prevailing market price. Note that XYZ operated in a competitive market environment and thus had no power to change prices. With many sellers and buyers as well as perfect information flow, then any price above or below market price would result to zero sales.
5. Edward Scahill produced table lamps in a perfectly competitive desk lamp market.
a. Fill in the missing variables in the following table:
Output per Week
Total Cost
Total Fixed Cost
Total Variable Cost
AFC
AVC
ATC
MC
0
$100
100
0
-
-
-
-
1
150
100
50
100
50
150
-
2
175
100
75
50
38.5
88.5
25
3
190
100
90
33.33
30
63.33
15
4
210
100
110
25
27.5
52.5
10
5
240
100
140
20
28
48
30
6
280
100
180
16.67
30
46.67
40
7
330
100
230
14.29
32.86
47.15
50
8
390
100
290
12.5
36.25
48.75
60
9
460
100
360
11.11
40
51.11
70
10
540
100
440
10
44
54
80

b. Suppose that the equilibrium price in the desk lamp market is $50. How many table lamps should Scahill produce, and how much profit will he make.
In a competitive market, maximum profit is attained when Price = Marginal cost
Thus Q* = 7
Profit = (price * quantity) - Total cost = TR –TC
= (50 *7) - 330
= $20
c. If next week the equilibrium price of desk lamps drops to $30, should Scahill shut down? Explain.
At a price of $30, optimal Q= 5(where P=MC).
Maximum Profit attainable = 30*5 – 210 = -60
The firm should shut down since the market price is too low to cover production costs.
6. Suppose an assistant professor of economics is earning a salary of $75,000 per year. One day she quits her job, sells $100,000 worth of bonds that had been earning 5 percent per year, and uses the funds to open a bookstore. At the end of the year, she shows an accounting profit of $90,000 on her income tax return. What is her economic profit?
Economic profit = accounting profit – opportunity cost
Opportunity costs = $75000 (salary forgone) + 5% * $100,000 (bond interest forgone)
= $80,000
Economic profit = 90000-80000
= $10,000
7. Briefly explain why monopolists are not allocatively efficient and briefly describe what results from these circumstances.
Being a single producer, monopolists restrict quantity to attract higher prices. This is made possible by the negative relationship between quantity demanded and price. Monopolists MR curve is twice as steep as the AR(demand) curve, therefore at equilibrium quantity (where MC=MR), consumers are willing to pay a price higher than MR resulting economic profits. Consumer surplus is significantly reduced.
8. Briefly discuss the Herfindahl-Hirschman Index (HHI), including an explanation of what it is used for and how it is calculated.
HHI conventionally accepted measure of market concentration. Literally, HHI refers to the summation of squares of market shares of all firms existing in a particular market. A low HHI signifies high degree of market concentration. Notably, in market characterized by many suppliers, with each having a market share approximately equal to zero, the summations of squares will also be close to zero and hence the market will be close to perfect competition structure. A monopoly will have an HHI of 10,000 (i.e. 100%2)

Work cited
Mankiw, N G. Principles of Economics. Mason, OH: South-Western Cengage Learning, 2009. Print Read More
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