Why Does the GovernmentImpose a Minimum Wage - Assignment Example

Macro & Micro economics, Essay Contents Question 3 Question 2 6 Question 4 8 Question 6 10 Question A. Explain what happens when government imposes a minimum wage. Use a graph to explain your answer. Why does the government impose a minimum wage? Answer: The marginal cost of labor is same as the supply curve for the discriminating monopolist. The employment level at the competitive market is same as the employment level of discriminating monopolist. If the government imposes a minimum wage bar the results are same as in the competitive market. At the minimum wage level, the firm will only want to hire less than the competitive level as the minimum wage is the marginal cost in this situation. Therefore, imposition of minimum wage leads to a rise in wages but may lead to fall in employment in some situations. One of the foremost reasons of imposing a minimum wage is to boost the level of wages paid to the workers. In some cases imposition of minimum wage may not lead to reduction in the level of employment. In fact it can be welfare enhancing as well. B. The U.S. Department of Labor provides a comparison of the federal minimum wage and different state minimum wages at Minimum Wage Laws in the States. The U.S. Bureau of Labor Statistics provides updated information on average wages, by state, at 2000 State Occupational Employment and Wage Estimates. Compare the average wages of waiters in Texas, New York, and one state with a minimum wage below the federal level (this will be found in the category "Food Preparation and Serving Related Occupations"). If the minimum wage were to go up by $0.50, where do you think it would have the greatest effect on restaurant costs? on unemployment? What does this tell you about what stage in the business cycle (for example, during a recession or during a boom) an increase in the minimum wage is more likely to be approved? Answer: State Mean hourly wage Mean Annual wage Texas $9.17 $19,070 New York $11.45 $23,820 Montana $8.94 $18,590 (United States Bureau of Labor Statistics, 2011). It is difficult to judge the most significant effect of minimum wage. The effect is likely to vary depending on the phase of the business cycle. If the business cycle is experiencing the boom situation then the effect will be more on the cost of restaurants while in case of recession employment is more likely to fall. Question 2 Suppose that the government wants to raise money by imposing a tax. That is, in addition to whatever the supplier charges for the good, the consumer must pay some amount to the government. What will be the taxs effect on the price and quantity demanded? Illustrate with a graph. Answer: The answer will be clearer with the help of the following graph: The above graph shows the situations before and after implementation of tax. When a tax is imposed, the price of the product on which the tax is imposed rises. In a situation of ceteris paribus, the supply is expected to fall. The demand curve being downward sloping, the quantity demanded by the consumer will fall as well. The graph also shows the area of incidence of the producers as well as the consumers. Question 3 Draw the supply and demand curves for a good that is perfectly price elastic in demand and has normal supply elasticity. Suppose a tax is placed on this good. Explain who will pay this tax. Illustrate on the graph. Answer: The following diagram shows the supply and demand curves for a good that is perfectly price elastic in demand and has normal supply elasticity. The demand curve is horizontal in this case because the price elasticity is infinity. In case of perfectly elastic demand, a small change in price will lead to large increase in the demand conditions by the consumers which indicate that the consumers are very responsive to even small changes. Therefore the producers will have to pay much of the tax if imposed. So it can be concluded that a burden of tax will be more on the producers than the consumers if the demand is perfectly price elastic. Question 4 What are the costs for the producers of a contraband substance like illicit drugs? What are the costs for users of a contraband substance? How would this be different if this substance were legal? Answer: The costs of producing illicit drugs involve costs of raw materials and distribution. The costs for the consumers involve social costs, the price of the drugs, costs on health and policing cost of prohibition. If the drugs were legalized the trade of drugs will become less violent and the society will get benefited from the saving of social costs. Negative externalities are associated with the use of drugs. Social costs are also associated with the non market participants. There are some costs that accrue to the drug addicts but these are not taken into account by the users. Question 5 Two university graduates, Bill and Steve, worked for an advertising agency at an annual salary of $40,000 each for 3 years after they graduated. Then, they decided to quit their jobs and start a partnership that designs and builds Web sites. They rented an office for $12,000 a year and bought capital for $30,000. To pay for the equipment, Bill and Steve borrowed money from a bank at an annual interest rate of 6 percent. During their first year of operation, the partners total revenue was $100,000. The market value of their capital at the end of the year was $20,000. If Bill and Steve do not design Web pages, their best alternatives are to return to their previous job. A. What is the firms economic depreciation? B. What are the partnerships costs? C. What is the firms economic profit in the first year of operation? Answer: The market value of their capital at the end of the year was $20,000. Therefore the depreciation of the firm is (30,000-20,000) =$10,000 The interest rate is 6%. So amount to be paid after 1 year is $31800. Total cost=$12,000+$31800+$10000=$53800. Income of the partners if they continued in the company is $80,000. Difference=$26200 Partnership cost=$13100 The economic profit of the firm is $10000-53800=$43800. Question 6 We assume that competitive firms are "price takers." Explain what this means. What is keeping competitive firms from setting prices? Is this a plausible assumption? For which industries is it a likely assumption? For which is it not plausible? Answer: In a perfectly competitive market, firms can enter or exit at will and no firms have the ability to affect price. Moreover the firms produce identical products and consumers are well informed. The market has the potential to determine price but the firms do not. Therefore they are price takers. If a certain price initiates to increase the price of its products the buyers are aware that they can buy the same product at a cheaper price from other firms. Therefore the firms cannot set the price level. This is not a plausible assumption because the assumption of perfect information does not hold in reality. The market for food grains and vegetables can be taken as the perfectly competitive market as the products sold in this market are more or less similar and buyers in the market can be informed about the existing prices of the products. Question 7 When will the competitive firm shut down in the short run? When will it incur a loss but continue to produce? Draw a graph showing each scenario and explain. Answer: A competitive firm will close down its operation if price is less than the average variable cost. The firm will continue its production in spite of incurring losses when price is less than average total cost but greater than average variable cost. Question 8 A. Explain how economies of scale and the long-run cost curve influence firm size and firm concentration. B. Give an example of industries with the following: i. decreasing returns to scale ii. constant returns to scale iii. increasing returns to scale C. Give a real life example of economies of scope. Answer: If a small firm is taken into consideration, it will not be able to survive in the market as the competitors have already achieved economies of scale. If the firm is a large one and enjoys economies of scale then it can expand further and become a natural monopoly in its domain. The shape of the average total cost is determined by the economies of scale. The costs get reduced in the long run but it does not guarantee larger size of the firm. After a certain point as the firm gets large enough the costs of resources start to rise. The active management industry is one with decreasing returns to scale. The manufacturing industry of United States is one with increasing returns to scale. The transport industry is one with constant returns to scale. Economies of scope can be found between cable TV and internet service. Question 9 The table below summarizes information for a representative firm in a competitive industry that currently has 1,000 such businesses. Current market price is $6. Output (Q) Total Cost (TC) Total Revenue (TR) 0 5 0 1 6 6 2 8 12 3 11 18 4 17 24 5 25 30 A. Calculate marginal revenue and marginal cost for each output level. Graph them (See Figure 12.3 for guidance). (10 points) B. How much should the firm produce to maximize profit? (Hint: you need to set MR = MC) What is the total quantity supplied in the market? (5 points) C. Are firms in the industry earning positive or negative profits? (Hint: Profit = TR-TC at the profit maximizing quantity) (5 points) D. As this market makes the transition to its long-run equilibrium, will this industry experience entry or exit? Will the price rise or fall? (5 points) Answer: Output (Q) Total Cost (TC) Total Revenue (TR) MR MC 0 5 0 - - 1 6 6 6 1 2 8 12 6 2 3 11 18 6 3 4 17 24 6 6 5 25 30 6 8 In order to maximize profits the firm should produce 4 units of output. The firm is earning positive profit since at the profit maximizing quantity TR-TC=24-17=7 is positive. The firm will be able to enter the long run equilibrium but the profit will fall to zero as positive profits will attract new firms into the industry. Question 10 Suppose that an industry has high fixed costs to enter but, other than that, is competitive. A. What will be the effect of the high fixed costs to the number of firms in the industry? To the firm size? Is marginal cost higher or lower for a firm with high fixed costs? Is price higher or lower? Is quantity produced higher or lower? B. Give an example of a firm with a high fixed cost and a firm with a low fixed cost. Give an example of a firm with low variable costs and a firm with high variable costs. Answer: The high fixed costs will deter entry of new entrants into the industry. Therefore the other existing firms can take the advantage of the situation and increase their size. The market is remaining in the same but the number of competitors is not increasing. The firms with high fixed cost usually have a different pricing strategy or business strategy than the other firms with high variable cost. The breakeven point of such firms begins at a higher level than the other firms. The pricing strategies undertaken by these firms focus more on the volume and not the margins. In this type of firms the average total cost decreases with increase in output over a larger range of output. As the firms operating in the industry enjoy the advantage of few competitors, the price prevailing is likely to be higher. The firms will also have to produce large volumes of output in order to cover the fixed cost. Reference United States Bureau of Labor Statistics, 2011. “Food Preparation and Serving Related Occupations”. [online]. Available at: http://www.bls.gov/oes/current/oes353031.htm. [Accessed:13th September, 2012]. Read More