Home » Exams Overview » Advanced Micro I – Williams Final Edition
1. An urban rapid-transit line runs crowded trains (200 passengers per car) at rush hours, but very empty trains (ten passengers per car) at off peak hours. A management consultant makes the following argument: “The cost of running a car for one trip on this line is about $50 regardless of the number of passengers. So the per passenger cost is about 25¢ at rush hour but rises to $5 per passenger in off peak hours. Consequently, we had better discourage off-peak hour business.” Explain the fallacy.
“Commutation tickets” sold by some transit systems (reduced-price, multiple-ride tickets) are predominantly used in rush hours. Are such tickets a good idea?
Explanations: Community, John’s Note, Wikia
While I agree that demand is less elastic during peak hours, it does not follow that off-peak hour prices should be reduced. There is no such thing as an optimal price elasticity. Efficiency is achieved by producing Q such that marginal benefit equals marginal cost at any particular moment.
It may be the case that the transit line should encourage or discourage off-peak demand, or it might be that off-peak services are already optimally priced. The economic consultant’s fallacy is not that he is necessarily wrong, it is that his reasoning is fallacious.
Wikia – http://economics.wikia.com/wiki/WEW-042
During peak hours, the demand for train service is less elastic, allowing for a possible price increase without a correspondingly large loss of passenger traffic. However, the demand for off-peak service will be more elastic, and therefore more sensitive to price increases or decreases. Therefore, off-peak business will be encouraged by a price reduction. Commutation tickets for rush hour are less effective than the same type of ticket offered for off-peak times. Since governments frequently in charge of transit systems, this is an example of inefficiency which could be resolved by the free market process.
2. The literature on the behavior of the firm poses it as a profit maximizer, a wealth maximizer, a growth maximizer, a sales maximizer, a sales maximizer subject to a prescribed profit rate.
Which of these do you use, why, and how do you manage to allow for these other assertions of firm behavior?
Investors consider corporations to be more valuable when they have high assets and low liabilities, and when corporations get more investors they can grow faster and earn larger profits.
Profit maximization is the most general criterion of efficiency because it compares the value of what is produced with its cost, rather than merely minimizing the cost of what may or may no be worth its costs. It is feasible for a firm to maximize sales, wealth or growth and still operate at a loss. Ideally, it should maximize these things while at the same time maximizing profit.
3. Give a brief answer to the following:
Collusions have the natural tendency to break down.
Firms have an incentive to cheat to gain extra profits and market share. Collusions are difficult to monitor. Can’t prevent firms outside the cartel from competing, and can’t compel them to join the cartel. Small and large firms have different cost structures making quantity agreement difficult.
4. Is the following statement true or false? Explain.
Price discrimination tends to be more common in the sale of services than in the sale of manufactured goods.
5. Is the following statement true or false? Explain your answer.
If you were a visitor in some underdeveloped country in which all lending and borrowing are effectively prohibited there would be no way to tell whether there were changes in the interest rate.
(#92, 2014 #2.c)
6. Is the following statement true, false, or uncertain? Explain.
A monopolist will never set price and quantity at a point where the demand is price-inelastic.
7. Do externalities offer unambiguous proof of market inefficiency or is it possible for externalities to be consistent with market efficiency?*
*Hint: Professor Williams takes the mainstream view that a situation is efficient iff it is pareto-optimal.
(#44, part 2)
Atomistic Markets == Alchain’s word for very competitive firms.
The first statement simply means that competitive markets will bring about a state of affairs where all mutually beneficial exchanges have been made, or that no more exchange can take place without making at least one individual worse off (Pareto optimal).
As far as externalities are concerned, they do not necessarily imply market inefficiency. Externalities arise in cases where property rights have not been defined, or are only defined ambiguously. However, this does not mean the situation is inefficient. For instance, as Demsetz explained, property rights institutions will arise only when it is economically efficient. Lack of property rights could mean that it is too costly to enfore said rights.
In addition to pareto-optimality, there are at least 3 other ideas of efficiency:
8. Give a brief answer to the following:
A person who loses his job through no fault of his own is also unemployed thereafter through no fault of his own.
John’s Note: Imho the best answer would be as follows:
However, I did not enable this as a choice because I expect Williams would mark such an answer wrong.
In Williams’ view, unemployment over time directly implies that the reserve wage is greater than the market wage.
In my view, it takes some amount of time and skill even to obtain an unpaid internship. So it’s not just the wage that matters.
A person who loses his job through no fault of his own could be said to be involuntarily unemployed. However, if he remains unemployed, then his unemployment is voluntary. This is possible due to the infinite wants and that his reservation wage is higher than the market wage. At less than his reservation wage, he prefers leisure to work.
9. State whether the following is true or false and explain your response:
Existing firms in a cartelized industry prefer to be regulated by government.
10. Give a brief answer to the following:
Cost minimization is the general criterion of economic behavior.*
*Hint: Williams implicitly assumes costs are accounting costs.
The general criterion for consumers is utility maximization, and for producers is profit maximization. Cost minimization alone does not guarantee profit. One can cost minimize by merely foregoing production.