Assignment:
True, False, or Uncertain
Explain why each of the following statements is True, False, or Uncertain according to economic principles. Use diagrams where appropriate. Unsupported answers will receive no marks. It is the explanation that is important.
1. The government recently increased the child benefit. This benefit sends cash to households with children regardless of how much they work. Given this increase in the benefit, a household who receives it will be better off, but there will be no effect on the labour supply of the household.
2. An increase in the wage faced by a household will lead to less labour supplied by that household if and only if leisure is considered to be a normal good.
3. Suppose the total product (output) of a firm changes from 100 to 150 to 180 as the firm changes from 10 to 11 to 12 workers. If it must pay all workers the same wage, the firm experiences increasing marginal cost over this range of output.
4. The short-run marginal cost curve passes through the minimum point of the short-run average total cost curve.
5. Suppose the price of a firm's fixed input rises. If it decides to maintain its production level, its average costs are lower in the long-run than they are in the short-run.
6. A firm earning positive economic profits must be earning positive accounting profits.
7. The difference between the short-run and long-run explains why many Canadian oil companies continued to produce output even though the low price of oil means that they were earning negative economic profits. [Hint: Assume that Canadian oil companies operate in a competitive world oil market.]
8. In the short-run, a decrease in the wage rate paid by the firms making up a perfectly competitive industry affects the cost curves of the firms but has no effect in the output market.
Problems
9. Suppose a household can expect to earn $2 M during its working life. Its problem is to allocate this income between present (working life) consumption (Cp) and saving for future consumption during retirement (Cf). Assume that the real after-tax interest rate between the two periods is 50%, and that both Cp and Cf are normal goods.
(a) What is equation of the household's budget line? Illustrate in a diagram being sure to identify the horizontal (Cp) and vertical (Cf) intercepts. What is the relative price (opportunity cost) of Cp?
(b) Suppose (when faced with this budget line) that the household would prefer to have equal consumption in both periods. How much does it consume in the present? How much does it save?
How much does it consume in the future? Illustrate this choice with an indifference curve and identify the level of saving in your diagram.
(c) Suppose that the real after-tax interest rate between the two periods falls to 0%. Illustrate the new budget line in your diagram. Suppose the household still chooses to consume the same amount during its working life. How much does it save? How much does it consume in the future?
Illustrate this choice with an indifference curve. What does this choice tell you about the income and substitution effects of the change in the interest rate with respect to Cp?
(d) Suppose that, given the low interest rate, the government becomes concerned that households are not saving enough for retirement and institutes a mandatory public pension plan that has the household paying a "contribution" of $0.4 M today, but with a promise of receiving a "benefit" of $0.4 M in the future. Is the household made better off? What happens to the amount of private saving?
10. Suppose the output (q) produced by different amounts of labour (L) hired by a firm is given below:
L 0 1 2 3 4 5 6
q 0 20 50 90 120 140 150
Calculate the marginal and average product labour levels from 1 to 6 (show your full calculations for L = 4). Graph the marginal and average products of labour. {Hint: Marginal numbers are often plotted halfway between levels since they apply to the move between these two levels (they are not a measurement at a level). This proves somewhat complicated later on, so just graph the marginal number at the "end" level, eg. plot MP for the first unit of labour at L = 1 instead of L = ½.)
(b) Assume the firm has fixed costs equal to $300 and that each unit of labour costs $150. For each of the 7 possible output levels calculate fixed cost (FC), variable cost (VC), and total cost (TC). Show your full calculations for the output level q =120. Graph the FC, VC, and TC curves.
(c) At each of the possible (positive) output levels calculate average variable cost (AVC), average total cost (ATC), and marginal cost (MC). Show your full calculations for the output level q =120. In a new diagram, graph these values. [Hints: (i) If X additional units cost Y additional dollars, then the appropriate MC number is Y/X. (ii) Graph MC numbers at the "end" output level.]
(d) Suppose this firm operates in a perfectly competitive market. How many units will the firm produce when the market price is: (i) $3.75, (ii) $5.00, (iii) $7.50, (iv) $15.00, per unit of output?
Suppose there are 50 identical firms operating in this market and that market demand schedule is given by:
P 3.75 5.00 7.50 15.00
Qd 7000 6000 5600 4500
What are the short-run equilibrium price and quantity in the market? Is this a long-run equilibrium situation? Explain.
(f) Assume that the short-run cost curves are drawn for the long-run efficient plant size. What are the long-run equilibrium price and quantity in the market? What is the long-run equilibrium number of firms in the industry? Explain.