SECTION VIII ANSWER TO QUESTIONS

Warm-up questions: A (0- (e). (a). D (e). E (c). F (c). G (c). H (c). 1 (a). J (a). (e). L (c). M (b). N (d).

General quesdons: 1 (d). Subsdoites. The price of cotton will rise. 2 (c). An increase in the wage late will raise total income only if demand curve is inelasdc. 3 (d). Opdon (c) is untrue because product supply will increase. 4 (a). Remember, average factor cost is simply the wage paid, which is less than marginal revenue product in monopsony. 5 (d). Movement along the demand curve. 6 (d). The cost of employing an addidonal worker, W, is less than his contribudon to revenues. 7 (d). The definidon of price-taking firms in product and labor markets. 8 (a). MFC = AFC = W in this case. 9 (b). Will increase the demand for the final product and hence its price. This will increase the demand for labor. 10 (b). This is somedmes called "exploitadon," and arises because MRP > AFC = wage. 11 (d). Perfect elasdcity means that the firm must be a price-taker, i.e. MFC = AFC. 1 2 (d). WUl tend to make product demand elasdc. 13 (a). Formula (3). 14 (b). Again use formula (3). Rado of factor prices remains vmchanged. 15(b). If labor markets were monopson-isdc, modest increases in the minimum wage would not cause unemployment. 16 (d). The demand for labor will increase. 17 (c). Employment will now be equivalent to that m a perfecdy compeddve uidustry. 18 (c). Implies that the demand for labor will be reladvely inelasdc. 19 (e). All we know is that the condidon for cost minimizadon is being met 20 (b). In such circumstances MFC = MRP = W = AFC; firm must be a price-taker in the labor market. 21 (d). Efiicienc\ requires (MPPi/Pi) = (MPPk/Pk). Again, it will help you master the new terminology ofthis secdon if you mentally read terms such as MPP3 as the marginal physical product -of labor instead of the diree letters. 22 (b). Price-taking means that all units can be hired at the same wage, so MFC = AFC. 23 (e). Refer to text 24 (b). Will reduce the demand for geologists. 25 (b). Multiply P times MPP]. This gives one firms demand. Then sum horizontal!). 26 (b). First get .MPP. Multiply by price to get MRP. Set equal to W = $20. 27 (e). Its $240. 28 (e). Option (d) is unuue of competition. 29 (e). Since diere are 100 firms, each will buy 8 laborers. MRP at 8 is P (MPP) = $9. 30 (c). At $15, each firm will want 6 laborers. So 100 firms will waiu 600. 31 (a). $15 > MRP. 32 (c). Similar to #29. 33 (e). How much do Type A demand? Find aggregate employment demanded at

$22. 34 (c). At a wage of $12, fu-ms of type A would employ 5 workers each (MRP = $12) and firms of type would employ 7 workers each (MRP= $12). The total demand for labor would therefore be 1900 which equals the supply 35 (a). First calculate TFC at each level of employment. 36 (b). MRP = MFC. 37 (e). Simply calculate the profit maximizing level of employment for one firm (MRP = $50) and multiply by 1000. 38 (a) Hell cut his non-price competition for workers. 39 (c). MPP] /Pi = 2. What is the MPPk per dollar spent? 40 (a). Its in the ratio of die marginal physical products, 5 to 4. 41 (e). The word price-taker says all, but see text if you dont recall why. 42 (c). See text 43 (d). Marginal physical products per dollar spent must be equal. 44 (c). Profit-maximizing competidve firms expand until MRP = MFC = W. 45 (d). One seller 46 (b). Calculate die MPP firom TPP, then multiply by price to get MRP. Calculate the MFC from TFC and dien equate MRP to MFC by hiring seven workers. The wage rate will be $18 (TFC/N) 47 (b). Increasing ridership of public transportation without reference to the costs and benefits is itself inefficient But given this objective, ridership will not be maximized within the budget unless the last dollar spent on capital (regardless of the source of the dollar) generates the same increase in ridership as the last . dollar spent on labor. Making the price of busses artificially cheap, distorts allocation toward busses. For example, to maximize ridership, there should perhaps be many small busses manned by many drivers, rather than big - but infrequent busses manned by few drivers. If so, the marginal physical physical product per dollar spent on capital is less than the marginal physical physical product per dollar spent on labor Of course, in this case the product is ridership of public transit 48 (d). If female labor is a perfect substitute for male labor the marginal physical products must be equal. That being the case, the marginal physical product per dollar spent on female labor must exceed that of male labor Consequendy, profit maximizing competitive firms could increase their profits enormously by substituting out of male labor and into female labor As firms rush to do so, the price of female labor would be bid up and that of male labor would be bid down. Thus, the sheer rapaciousness of profii-hungi capitalists assures that such wage differentials - or indeed any wage differentials - could not persist under the assumed conditions. To really examine the economics of discrimination, wc would have to develop the theory of human capital, something theres not enough time to do in a book of this kind. Ifyou want to find out, take labor economics or the economics of human behavior

SECTION IX: MARKET FAILURE

As wc noted in Secdon V, compeddve markets allocate resources efficiendy when all costs and benefits pass through the market Under the same conditions, monopoly does a subopdmal job: even though society values addidonal output more than the cost of producing it, more output is not produced. Monopoly therefore represents a case of market failure. In this secdon well consider three other causes of market failure: public goods, common property resources, and externalides.

PUBUC GOODS

Ifyou eat an apple, your consumpdon will be private consumption. Apples are private goods, meaning that consumption by one person necessarily excludes consumpdon by anyone else. All goods considered so far in this book have been private goods. With public goods, however, consumption by one person does not diminish the amount that others can consume. Nadonal defense is jui example. Whatever the level of military preparedness, all citizens in the defended area receive roughly the same amount Similarly, the services of lighthouses can also be public goods; if one shipping company has a lighthouse installed, others in the vicinity will likewise benefit. In such cases, they are said to be free-riding because they receive benefits they dont pay for.

The problem with private market provision of public goods lies in their financing. Obviously public goods will not be provided by the private market unless the cost of provision can be covered. For example, suppose you open up an apple cart and begin selling apples. After a little experimentadon with the price, you will soon fmd out if theres enough consumer demand for your product to justify operation. On the other hand, should you open a lighthouse, ships benefiting from the light will pay you nothing because they can receive this public good for free. Moreover, building the lighthouse only upon the condition that private shipping companies pay before the advent of construction may still leave you unable to recover the costs. After all, if die number of benefici2uries is large, each will know his ovi contribution will litde affect whether the lighthouse is built. Consequendy, each may be tempted to free-ride so that your private lighthouse may never be built even diough its potential benefits outweigh die costs.

Nonetheless, the private market does supply several public goods. For example, television and radio waves are privately provided public goods. Although the cost of provision could not be covered by pubUc donations from those receiving the signals, the good is provided by selling cominercial time to advertisers. The provision of a private good, commercial

time, enables the provision of the public good, radio and TV waves.

Now compare lighthouses and pay-per view TV programs. Both lighthouse signals and TV signals are pubhc goods in that if one person consumes the signal there is no less signal for other persons to consume. But lighthouses are provided by government agencies while TV programs are privately provided. The crucial disdncdon is in the cost of excluding unauthorized users of die signal. For lighhouses it is prohibitively high; for TV programs it is very low - all you need is a scrambler. So unauthorized users will steal the lighthouse signal and no private firms could earn a profit.

COMMON PROPERTY RESOURCES

Normally, ownership of a good comes with a property right to exclude others from using the good. You, for instance, have the right to exclude imautho-rized persons from using your car. In fact, without this right, no incendve to pay for or own a car would exist.

Certain resources, known as common property resources lack well-defined rights of exclusion. For example, nobody has property rights to blue whales, certain federal rangeland, or certain pools of oil until its brought from the ground. Moreover, because no right of exclusion exists, such resources tend to be abused. For example, while it is not in the interests of the whaling industry as a whole to wipe out the whale population, each individual whaler knows that he cannot exclude others from harvesting an animal he spares for breeding purposes. Consequently, since the benefits obtained from sparing an immature whale are captured by other whalers, each individual whaler has incentives to harvest as many as possible, even to the point of extinguishing the species. Consequendy, blue whales, but not chickens, are in danger of extinction. After all, it takes litde more than a few rolls of chicken whe to assert property rights over chickens.

Other examples of abused common property resources exist In many jurisdictions, nobody has the property right to oil until it is brought from the ground. Like the whaler, the oil company knows it cant prevent other companies from taking oil left for the future. For this reason, wildcatters often rush to produce new fields, even when the oil is more valuable when stored for future use.

Common pasture lands owned bv the federal government are also often similarly abused. Normally, a catdeman would not allow his own pasture to be grazed to the bare ground. A cattleman using federal pasture might well do so, however. Using the land

providently represents private costs to the individual cardemen. But because die benefits may be captured b\ other catdemen, it may not pay to do so.

Public areas of all types - beaches, the student union, the dorm lobbies - are other abused common property resources. After all, we rarely see people dropping beer cans in their own rooms the way they do at the beach. Here, once again, the users capture few of the benefits from using these resources providendy. \\ not assign private propert) rights - and above all the right of exclusion - for all goods? In some cases, for example that of the blue whales, it is not technically feasible to assign property rights to individuals. Any such assignment would be unenforceable and therefore meaningless. In other cases, for example those of federal pastures and minerals, litde rational reason for public ownership exists. Nevertheless, the public bureaucracies charged with administering these common property resources inevitably prefer to "manage" rather than sell the resource. This is not really surprising. Just as firms and individuals usually pursue their own interests, so do civil service bureaucrats administering public trusts. Private sale may mean the loss of their job.

EXTERNALTTIES

As we mentioned in Section V, externalities are costs and benefits affecting persons other than market transactors themselves. Thus, when nobody but the transactors receive benefits from trade, the marginal benefit (MB) to the buyer is also that of society. After all. by assumption, nobody else is affected. Similarly, when the supplier alone incurs costs, the marginal cost to the supplier is also that of societv, again because the marginal cost to everyone else is zero. However, many transactions occur in which benefits and costs are imposed on outside parties. Such costs and benefits are termed externalities. For example, painting my house will give me private benefits, while at the same time conferring benefits upon my neighbors. Thus, the dollar benefit to society, i.e. the social benefit, in this case is the sum of my own private benefit plus that of my neighbors. The dollar benefit to me (MB) is read from my demand curve as always; that to my neighbors would include their increased propert) values. Although we shall make no real inquiry concerning the dollar measurement of externahdes, in general, the marginal social benefits are the dollar sum of the marginal private benefits plus the external marginal social benefits, if any.