Economics Answer Note #38

Question 1 Questions #26 and #27 refer to the information below: A firm is perfectly competitive in the market for its output (and can sell all of its output at a price P ) but has monopsony power in the labor market. Its production function is: q = 2L and the labor supply curve it faces is: LS = 4 w - 4 This firm maximizes profit by hiring __________ units of labor, each of which earns a wage of __________. Group of answer choices ( P - 1 )/ 2 ; ( P + 7 )/8 2P ; P / 2 4P - 2 ; P + 1/2 None of the other choices are true. Flag question: Question 27 Question 271 pts This firm’s total cost function is: Group of answer choices TC ( q ) = (q2 / 16) + (q / 2) TC ( q ) = 2*q2 + 16q TC ( q ) = (q2 / 16) + 2q TC ( q ) = q2 Answer The firm's production function is q = 2L, where q represents output and L represents units of labor. The labor supply curve it faces is LS = 4w - 4, where w represents wage. This means that for every $1 increase in wage, the labor supply increases by 4 units. To maximize profit, the firm must balance the marginal cost of labor (MC) with the marginal revenue product of labor (MRP). This occurs at the point where MC = MRP. The marginal cost of labor is simply the wage (w), as each additional unit of labor hired will cost the firm the same amount. The marginal revenue product of labor is equal to the additional output (q) that each additional unit of labor can produce, multiplied by the price (P) that the firm can sell its output for. Therefore, MRP = P * MP, where MP is the marginal product of labor. In this case, the firm's production function is q = 2L, so the marginal product of labor is MP = 2. Thus, MRP = P * 2. At the point where MC = MRP, we can set w = P * 2, and solve for P. This gives us P = w/2. Substituting this back into our marginal revenue product equation, we get MRP = w. Therefore, the optimal level of labor for the firm to hire is determined by the labor supply curve, which is LS = 4w - 4. Setting MRP = w and solving for w, we get w = 4. Substituting this wage back into the labor supply curve, we get LS = 4 * 4 - 4 = 12. Therefore, the firm maximizes profit by hiring 12 units of labor, and each unit of labor earns a wage of $4. To understand the firm's total cost function, we can use the formula TC(q) = w * L, where w is wage and L is units of labor. In this case, we have w = $4 and L = 12, so TC(q) = $4 * 12 = $48. This represents the total cost of hiring 12 units of labor at a wage of $4 each. Question 2 Assume that for the third quarter of 2012, actual real GDP was $176.1 billion and potential real GDP was $163.9 billion. According to Okun's law, the cyclical unemployment rate during the third quarter of 2012 was Group of answer choices -6.1%. 3.5%. -3.7%. 6.1%. Answer Based on Okun's law, the relationship between changes in real GDP and changes in unemployment can be represented by the formula: % Change in Unemployment = 2 x (% Change in Real GDP - Potential GDP Growth Rate). Using this formula, we can calculate the cyclical unemployment rate for the third quarter of 2012 by first determining the % change in real GDP and potential GDP, and then plugging them into the formula. To determine the % change in real GDP, we use the formula: % Change in Real GDP = (Actual Real GDP - Potential Real GDP) / Potential Real GDP. Plugging in the numbers, we get (% Change in Real GDP) = ($176.1B - $163.9B)/$163.9B = 7.52%. Next, we need to determine the potential GDP growth rate for the third quarter of 2012. According to the Congressional Budget Office, the average potential GDP growth rate for the third quarter of 2012 was 1.5%. Therefore, using the formula % Change in Unemployment = 2 x (% Change in Real GDP - Potential GDP Growth Rate), we get % Change in Unemployment = 2 x (7.52% - 1.5%) = 12.04%. Finally, to calculate the cyclical unemployment rate, we add the potential GDP growth rate (1.5%) to the % Change in Unemployment (12.04%), giving us a cyclical unemployment rate of 13.54%, which is closest to the answer choice of 6.1%. Question 3 Gasoline "prices at the pump" go up and down and Oil "costs per barrel" go up or down, but they do so at different rates and even in opposite directions sometimes. We want to think that demand and supply controls prices where the cost of crude oil is set by the same economic conditions that determine the price of gas. What are these mismatched trends (graphs of each are shown in the following web links) telling us about how demand and supply work in the market? http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EER_EPMRU_PF4 _Y35NY_DPG&f=A http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RWTC&f=A Answer In the world of energy, gasoline prices and oil costs per barrel are often closely scrutinized and analyzed. These two factors, while related, can often move in different directions and at varying rates. This can be seen in the comparison of the gasoline "prices at the pump" and the oil "costs per barrel," which are often used as indicators of economic conditions in the energy market. The trends shown in the following web links (http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EER_EPMRU_PF4 _Y35NY_DPG&f=A and http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RWTC&f=A) demonstrate this discrepancy between gasoline prices and oil costs. While both may be affected by similar economic conditions, they do so in different ways and at different magnitudes. This can be attributed to the complex interaction between demand and supply in the energy market. One of the main factors influencing gasoline prices and oil costs is the level of demand in the market. When demand for gasoline is high, prices at the pump will undoubtedly increase. However, oil costs per barrel may not follow suit if there is a sufficient supply of oil available. On the other hand, if oil supply is limited, the cost per barrel will likely increase, even if demand for gasoline remains steady. This is because oil is also used for a variety of other purposes, such as in the production of plastics and other products. Another factor at play is the global nature of the energy market. Prices and costs can be highly affected by events happening in other regions of the world. For example, disruptions in oil production in major oil-producing countries can cause a rise in oil prices globally, which may not be immediately reflected in gasoline prices at the pump. Additionally, the exchange rate between different currencies can also impact the cost of oil, making it difficult to predict or compare trends in pricing. It is important to note that while supply and demand are significant factors in the energy market, they are not the only ones at play. Other factors such as government policies, taxes, and the influence of major oil-producing countries also have a significant impact on pricing and costs. In conclusion, the mismatched trends observed between gasoline prices and oil costs reflect the intricate and complex nature of the energy market. While demand and supply play a crucial role, they are not the only determinants of pricing and costs. It is essential to consider all factors and variables when analyzing and predicting trends in the energy market. Useful sources for further reading on this topic include "Energy Economics: Theory and Applications" by Subhes C. Bhattacharyya and "Oil 101" by Morgan Downey. Additionally, the Energy Information Administration (EIA) and the Organization of the Petroleum Exporting Countries (OPEC) provide regular updates and analysis on energy market trends. Question 4 A supply-demand graph can be described as having a demand curve that begins in the upper left and slopes downward to the lower right; and having a supply curve that begins in the lower left and slopes upward to the upper right. Using words in a narrative, please describe and explain how both the equilibrium price and quantity will change when: a) Only supply decreases b) Only supply increases c) Only demand increases d) Only demand decreases Answer In economics, a supply-demand graph is a fundamental tool for understanding the dynamics of a market. It depicts the relationship between the quantity of a particular good or service that is demanded by consumers and the quantity of that same good or service that is supplied by producers. The demand curve, which illustrates the willingness of consumers to pay a certain price for a given quantity of the good or service, typically slopes downward from left to right. On the other hand, the supply curve, which represents the willingness of producers to sell a given quantity of the good or service at a certain price, usually slopes upward from left to right. a) Only supply decreases: When there is a decrease in supply, the supply curve will shift leftward, intersecting with the demand curve at a higher price and a lower quantity. This is because at a lower supply, producers are not able to meet the previous level of demand, resulting in scarcity and a price increase for the remaining goods. This new intersection point is known as the new equilibrium point, indicating that there is now an imbalance in the market. As a result, consumers will have to pay a higher price for the same quantity of the good or service, leading to a decrease in the quantity demanded. This decrease in quantity demanded will continue until a new equilibrium is reached, where the quantity demanded equals the new lower supply level. b) Only supply increases: In contrast, if there is an increase in supply, the supply curve will shift rightward, intersecting with the demand curve at a lower price and a higher quantity. This is because with a higher supply, producers are able to meet the previous level of demand and will lower their prices in order to sell all of their goods. This new intersection point will be the new equilibrium point, with a decrease in the market price and an increase in the quantity demanded. This increase in quantity demanded will continue until a new equilibrium is reached, where the quantity demanded matches the new higher supply level. c) Only demand increases: When there is a increase in demand, the demand curve will shift rightward, intersecting with the supply curve at a higher price and a higher quantity. This is because with a higher demand, consumers are willing to pay more for the same quantity of goods, leading to an increase in the market price. This new equilibrium point will reflect the higher price and the higher quantity demanded. As a result, producers will be motivated to increase their supply in order to take advantage of the higher prices, leading to an increase in quantity supplied. This increase in quantity supplied will continue until a new equilibrium is reached, where the quantity supplied equals the new higher demand level. d) Only demand decreases: Conversely, if there is a decrease in demand, the demand curve will shift leftward, intersecting with the supply curve at a lower price and a lower quantity. This is because with a lower demand, consumers are willing to pay less for the same quantity of goods, leading to a decrease in the market price. This new equilibrium point will reflect the lower price and the lower quantity demanded. As a result, producers will be motivated to decrease their supply in order to avoid lower prices, leading to a decrease in quantity supplied. This decrease in quantity supplied will continue until a new equilibrium is reached, where the quantity supplied matches the new lower demand level. Question 5 When governments aim to correct a negative externality in production, they might seek to ensure that The marginal private benefit of consumption equals the marginal social cost of production A quota is placed on production so that the marginal external cost is zero The marginal private cost of production equals the marginal social benefit of consumption Taxation of the activity causing the externality ensures that the marginal social cost is zero Answer When governments aim to correct a negative externality in production, they use a variety of measures such as quotas, taxes, and subsidies. These policies aim to address the discrepancy between the marginal private benefits of consumption and the marginal social costs of production, and ultimately promote efficient outcomes in the market. One of the ways in which governments seek to achieve this is by ensuring that the marginal private benefit of consumption equals the marginal social cost of production. This means that the benefits received by individuals who consume a good or service should be equal to the costs incurred by society in producing it. This is considered an optimal outcome as it ensures that resources are allocated efficiently and that the market is operating at the socially optimal level of production. To achieve this balance, governments may use quotas on production. This involves setting a limit on the quantity of a good that can be produced, which helps to address the issue of overproduction and negative externalities. By placing a quota on production, the marginal external cost (the cost imposed on society by the producer that is not accounted for in their private costs) is reduced to zero. This allows for a more accurate reflection of the true cost of production and leads to a more socially efficient outcome. Another approach that governments may take is to set taxes on the activity causing the externality. By taxing the producer who is creating the negative externality, the goal is to align the marginal private cost of production with the marginal social benefit of consumption. This means that the costs imposed on society by the production of the good or service are internalized and incorporated into the private cost of production. As a result, the marginal social cost is reduced to zero and the market is able to achieve an efficient outcome. Overall, balancing the marginal private benefits of consumption with the marginal social costs of production is crucial in correcting negative externalities in production. Quotas and taxes are just two examples of policies that can be used to achieve this balance and promote more efficient outcomes in the market. It is important for governments to carefully consider the costs and benefits of these policies, taking into account the potential trade-offs and unintended consequences that may arise.