Economics 58
Fall 2009
Solutions to PS # 8
1.
C = q2 + wq MC = 2q + w
a.
C = q2 + 10q
w = 10
MC = 2q + 10 = P
q = 0.5P − 5
1000
Industry Q = ∑ q = 500P − 5000
1
at 20, Q = 5000; at 21, Q = 5500
b.
Here, MC = 2q + .002Q
for profit maximum, set = P
q = 0.5P − 0.001Q
1000
Total Q = ∑ q = 500P − Q
Q = 250P
1
P = 20, Q = 5000
where
Supply is more steeply sloped in this case
Expanded output bids up wages.
P = 21, Q = 5250
2.
a.
The long-run equilibrium price is 10 + r = 10 + .002Q.
So, Q = 1050 -50(10 + .002Q) = 550 - .1Q so
Q = 500, P = 11, r = 1.
b.
Now Q = 1600 -50(10 + .002Q) = 1100 - .1Q
Q = 1000, P = 12, r = 2.
c.
Change in PS = 1(500) + .5(1)(500) = 750.
d.
Change in rents = 1(500) + .5(1)(500) = 750. The areas are equal.
e.
With tax PD = PS + 5.5 PS = 10 + .002Q
PD = 15.5 + .002Q
Q = 1050 -50(15.5 + .002Q) = 275- .1Q
1.1Q = 275
Q = 250 PD = 16
r = 0.5
Total tax = 5.5(250) = 1,375
Demanders pay 250(16 - 11) = 1,250
Producers pay 250(11 -10.5) = 125
f.
CS originally = .5(500)(21 -11) = 2,500
CS now = .5(250)(21 -16) = 625
PS originally = .5(500)(11 -10) = 250
PS now = .5(250)(10.5 -10) = 62.5
g.
Loss of rents = .5(250) + .5(250)(.5) = 187.5
This is the total loss of PS in part b. Occurs because the only reason for
upward sloping supply is upward slope of film royalties supply.
3.
The Ramsey formula for optimal taxation
a.
Use the deadweight loss formula from Problem 12.9:
n
n
⎛
⎞
L = ∑ DW (ti ) + λ ⎜ T − ∑ ti pi xi ⎟
i =1
i =1
⎝
⎠
∂L / ∂ti = .5[eD eS /(eS − eD )]2 ti pi xi − λpi xi = 0
n
∂L / ∂λ = T − ∑ ti pi xi = 0
i =1
Thus ti = −λ ( eS − eD ) / eS eD = λ (1 / eS − 1 / eD )
b.
The above formula suggests that higher taxes should be applied to goods
with more inelastic supply and demand. A tax on a good discourages the
consumption and production of that good. Thus, taxing a good with more
inelastic supply and demand would result in less change in the
consumption of the good. Therefore, the tax would produce smaller
distortions: the DWL would be smaller. c.
4.
This result was obtained under a set of very restrictive assumptions. First,
it was obtained under partial equilibrium (the welfare analysis is
undertaken in each market separately), ignoring the general equilibrium
interactions between markets. Also, income effects and cross-price
elasticities are not taken into account.
a.
Long-run equilibrium requires P = AC = MC.
k
k
AC = + a + bq = MC = a + 2bq Hence q =
P = a + 2 kb
q
b
b. Want supply = demand nq = n
Hence, n =
k
= A − BP = A − B( a + 2 kb )
b
A − B( a + kb )
.
k b
c. Apparently A has a definitely positive effect on n. That makes sense since A
reflects the “size” of the market. If a > 0, the effect of B on n is clearly negative.
d. If appears that fixed costs (k) have a negative effect on n. The effect of a is
also negative (assuming it is a positive constant). The effect of b also seems to be
negative. These results make sense. The first shows how greater fixed costs
increase the typical firm’s optimal size. The second and third show how higher
marginal costs raise price and therefore reduce the number of firms.
Economics 58 Solutions to PS # 8
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