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If you were to examine where the USA might be on its Utility Possibilities Curve, which,
say, shows a trade-off in Utility between the Rich and the Poor sections of society (in
terms of what each sector consumes), where do you think we would lie on the curve?
Given your opinion, who do you think placed us where we are on the curve? The
government? Certain people? Luck? Are you content with where you have placed us?
Assuming that our markets are reasonably efficient, could you draw an Edgeworth Box
that shows where you think the two classes of consumers lie?
In lecture I mentioned Merit Goods. Can classical concerts, public art and other publicly
provided services be justified using the idea that merit goods are simply good for the
Name and defend four reasons why might government intervention be needed in a
Here is sort of a repeat question from an earlier homework/discussion for emphasis.
Using the usual supply and demand curves (lines) please show how a tax on the
consumption of a product X MUST decrease welfare in the market even if all of the tax is
given back to the people in the form of a cash payout. Show as well that if the
government is simply interested in raising money, it is better off taxing products whose
demand curves are relatively steep.
Now here is a problem to work through. If you really understand it, you will have a firm
grasp of the ideological justification for a free market exchange economy without
overnment intervention.

There have two consumers, You and Me
There are two goods being produced by the private sector firms, X and Y
There are two factors of production used my firms, L and K

Using the usual graphs of microeconomic analysis (e.g. budget lines and indifference
curves, isoquant curves and production functions, the Edgeworth Box, contract curve,
and the Production Possibility Schedule, or Frontier for the economy), work through the

steps to SHOW that in a competitive equilibrium for a two consumer, two-good, and twofactor market the conditions under which:
Maximum welfare is achieved (supply equals demand-consumers maximize satisfaction
and producers minimize costs).
That is: show how:
(a) each of the MRSs between the two goods of the two consumers are equal,
(b) the MRS of each consumer is equal to the price ratios of the two goods,
(c) each of the MRSs is equal to the ratio of the MCs of producing the two goods, AND
equal to the MRT of the production possibility curve.
When you have done this, you should be able to understand that in a free exchange
market for a PRIVATE GOOD, in equilibrium, MRS (of consumer #1) = MRS (of
consumer #2) = MRT (the marginal rate of transformation). That is, the opportunity
costs between the two good X and Y in our HEADS is the same as the costs implicated
by the society as a whole in terms of the market prices.
PS: when all this happens, you are maximizing consumer and producer surplus, and
therefore total welfare in the market. If all markets work this way, you maximize welfare
in the total economy!
Why do we say that the Second Fundamental Theorem of Welfare Economics helps to
justify governmental attempts to alter income distribution with tax and spend policies as
long as markets can work normally once the tax and spend policies are in place?

HW 9
What we see in the case of monopoly power is that the theory really addresses the issue
of market power. That is, whether or not there is only one large monopoly firm offering
a product that people want or a few dominant firms, the fact that firms have the power to
set price above MC is what is important.
As we go through life as consumers, we constantly face prices for what we choose to buy
and for what we choose not to buy. In most cases we do not argue or haggle over the
price when we make the decision to buy or not. In most cases we simply decide, and if
we decide to part with our hard-earned cash, we buy at the price listed. Of course there
are a few cases where we can debate price, automobiles and houses being examples. But
normally when we buy a coffee or go to the dentist office, we simply "pay the price".
This being the case, the producer or seller of the product we buy has some power over the
price charged. In the case of non-perfect competition, this is certainly the case. Thus the
door is opened for Price Discrimination (PD) the arbitrary setting of prices with a goal
to get increased revenues and sales when the firm knows, or feels, that its markets have
segments (or differing willingness to pay among potential buyer groups.)
As consumers, this is important for us as we have no choice other than to face prices
every day.
We have seen that there are three main types of Price Discrimination (PD). Third Degree
the seller divides up the market and prices differently to each market segment; Second
Degree the seller divides up the price schedule and allows the customer base to selfelect from the schedule; First Degree seller knows the demand curve (willingness to
pay) exactly, and prices down the curve with the goal to capture the entire potential
consumer surplus.
We have seen that for each Degree-type of PD, there are variations in strategy.
In the pure competitive model, prices are flexible, supply and demand are equal,
consumers maximize their satisfaction and firms maximize their profits while minimizing
their costs. Firms also know about and are using the best available technology to produce
their product. When firms use the best available technology to produce their products,
they are on the lowest possible cost curves, and this is called Production Efficiency.
Yet in the real world of business and firms, competition involves the continuously
differentiating of potentially homogeneous products in order to capture brand-customer
loyalty and market share. There are many ways of doing this of which the marketing
(positioning) and sales effort are the most important. Thus, for just about every product
we can think of, the models of Monopoly, the Dominant Firm, and Monopolistic
Competition become an appropriate deviation from the purely competitive model.
Now lets get to the homework.

Using the monopoly diagram with an upward sloping MC curve (normal U shaped), show
the area of deadweight loss with monopoly pricing. Show the reduction in welfare to the
Producers and Consumer surplus with monopoly pricing. How does this compare wit the
competitive result?
Now take the monopoly with a horizontal (constant AC) supply curve and show the area
of deadweight loss with monopoly pricing. How large is the producer surplus?
What is the elasticity rule that applies to monopoly pricing? What is it about this rule
that makes sense from a strategic standpoint?
Using the formula for MR where MR = P ( 1 1/e ) derive the elasticity rule.
If you had to argue that the diamond business in South Africa was a natural monopoly,
what reasons would you give? Why would you think that the South African government
is keen on keeping the diamond monopoly intact?
Explain why it is that high-powered regulation encourages cost cutting by the regulated
firms while low-powered regulation does not. What is meant by high and low-powered
regulation of monopolies or dominant firms?
What is regulatory capture? What is Rent-seeking? Why do you think that regulatory
capture is so prevalent in representative democracies where market power exists among
large firms?
Explain what we mean is when we say that the existence of monopoly prevents:
inefficient use of resources (factors of production K and L), and loss of consumer
welfare. What about dynamic efficiency? Would a monopoly or dominant firm always
prevent dynamic efficiency?
Lets say a firm is a monopolist. Now this firm spends more on advertising to increase
the demand for its product. Show on a graph with a horizontal AC curve what happens

before and after the new expenditure on advertising. Show what has to happen in the
graph to make sure that the firm maximizes its profits after the ad expenditure.
Would you classify a great popular artist like Michael Jackson as a monopolist with
respect to what he produces? If so, would that be an adequate explanation of why Mr.
Jackson was able to price his products way above his MC curve.
How do you think Michael Jackson was able to achieve dominance in his field of music
expression? Would you say that Michael Jacksons product was perceived as unique?
What type of demand curve do you think he faced from those who were his fans? Do you
think that the elasticity rule played a part in his getting rich? (Remember problem (1)
Thinking in terms of your answer to (7) so far, what would Michael Jackson and the
Microsoft have in common? Nothing at all? Something?
Lets say that you want to make a lot of money as a rock star. In fact, you believe that
you have a special talent for a specific type of beat music? How would you use your
time in order to become a personal monopoly with respect to your type of music?
(Remember the earlier graph that stressed the three factors that will determine how much
a wage, salary, or payment you can commend from providing your product.
Now, lets say you are successful in your rock star adventure. Do you think it is likely
that your agents will ensure that concert ticket prices are above marginal cost? Would
you be taking advantage of the elasticity rule in your line of work? Graph a hypothetical
demand and supply (horizontal MC curve) relation for your music business and show just
how the elasticity rule relationship might work out.
Often you find discount coupons for groceries in the newspaper. People can choose to
cut out these coupons and take them to the market for the discount on specific products.
If this is PD, (Price Discrimination) what Degree of PD is it and what is the logic behind
the coupon strategy? Do you think that the company offering the discount coupons has
the people who do not use the coupons in mind with this strategy? What strategy might
the store or the producer use when it prices its products for those who do not choose to
use the coupons?
Assume that in the market for branded cigarettes from one producer there are distinct
customer groups whose intensity of demand differs between the groups. That is, there are

different demand elasticities for different types of cigarettes produced by this one
company. (Low filter, high filer, no filers, long, short, sweet, sours, etc.) However, the
company charges one single price for any given package of cigarettes. Is this PD? If so,
what kind is it?
Assume that in the market for branded cigarettes from one producer there are distinct
customer groups whose intensity of demand differs between the groups. That is there are
different demand elasticities for different types of cigarettes produced by this one
company. (Low filter, high filer, no filers, long, short, sweet, sours, etc.) The company
charges many different prices for any given package of cigarettes. Is this PD? If so, what
kind is it? If this is PD, what strategic rule of pricing should the cigarette company use?
Assume that a community has a constant- average cost monopolist that provides monthly
pest control to residential homes. It wants to maximize profits. Illustrate what it would
normally do to accomplish this. What does this mean for community welfare in the
normal case?
Now, the pest control company decides to enact two-tier pricing. It charges an up-front
service charge fee each year for the monthly service calls. Illustrate with a graph what
options are open to the company. What is the maximum fee it could reasonably expect to
charge? Is it possible that a two-tier pricing strategy could lead to economic efficiency
(with respect to overall welfare) in the communitys pest control market?
You can fly on Air France from San Francisco to Paris in economy for as low as $600.00.
You can fly in the same plane on the same route, in the same time, in business class for,
say, $8000.00. What kind of PD is this? What human need is Air France trying to profit
from? Illustrate with two demand curves and horizontal MC curves (markets for
economy and business class flights) how the pricing of these two classes might work.
Determine what Degree of PD may be involved in each of the following cases:
A healthcare provider that is a monopolist prices its healthcare products
and doctor visits according to the income level of the buyer (higher income higher
A government imposes a progressive income tax (this is slightly a trick question)
Air France has 25 different prices for seats on its San Francisco Paris route.

Century Movie Theaters has discounts for Seniors and Students
Lets say that ATT Cellular charges no up-front fee for new users of the iPhone 5
version, but a large fee for existing customers who want to upgrade from the 4g or the
4gs version.
The hair shampoo industry has the following characteristics: individual products do
essentially the same thing, they wash and/or condition hair. However, the different
shampoo products are highly differentiated by texture, smell, soapiness, container shape,
and alleged benefits (volumizing, color retention, ease of use, etc.) Entry into the hair
shampoo industry is easy with many firms coming and going. Each firm behaves
independently from the others.
(a) What type of industry is this? Explain your answer
(b) Illustrate the short-run equilibrium position for a representative firm that is earning
short-run economic profit.
(c) What would have to happen in this industry if the firm in (b) now suffers short-run
economic losses?
(d) What will happen to the number of firms in this industry in the long-run? Illustrate
the long-run position of a representative firm in the hair shampoo business.
(e) Is the long-run equilibrium in this industry efficient is there allocative efficiency?
(f) Can you argue that the consumer is better off in this long-run equilibrium?
(g) In the long run, should there be more or less firms in this industry?
You go to a Frozen Yoghurt shop. The shop offers 16 flavors of yoghurt, 3 different fat
contents in each flavor, and 27 toppings to choose from. What is it about the scene
described here that would indicate that Monopolistic Competition is a fact of business life

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