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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. Some discount stores advertise that they can sell for less because they buy directly from the factory and sell to the consumer, thus eliminating middlemen. What is the flaw in that reasoning?
3. 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.
4. True or false: Cost curves are monetized reciprocals of product curves? Explain.
(#76, #104, 2014 2.b)
5. 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:
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. Which of the following images is a graph of the standard intertemporal 2-period model?
Enter your answer as a single capitalized letter.
8. State whether the following is true or false and explain your response:
Existing firms in a cartelized industry prefer to be regulated by government.
9. 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.
10. Give a brief answer to the following:
Laissez-faire capitalism encourages deceitful advertising, dishonesty, and faithlessness.
Importantly, markets achieve economic efficiency in spite of immoral preferences.
John’s Note: I consider the Wikia solution below to contradict itself. I agree with the statement “In repeated interactions people have to be truthful, honest, and faithful”, but I consider this to be opposite the statement “Laissez-faire capitalism does nothing to contribute to the morals of society.”
Instead, I affirm that laissez-faire capitalism tends to improve social morals and discourages deceitful advertising, dishonesty, and faithlessness.
Laissez-faire capitalism does nothing to contribute to the morals of society. It only allows people to exchange via price instead of other less efficient mechanisms. In repeated interactions people have to be truthful, honest, and faithful. If this type of capitalism prevails consumers can choose to frequent shops where these values are part of the price of the item. For example, sellers on Amazon.com have records of past interactions with customers. In an effort to minimize complaints the seller will often go out of his way to make amends for disgruntled customers. This raises the costs of operating a business. A customer has the choice to be price sensitive and take a risk, or pay a slightly higher price for a seller who has demonstrated honesty and faithfulness. Only when the cost of honesty and faithfulness are very high would we expect to see them cease to exist, and then only if the market is very underdeveloped.