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Chapter 11
What is the free-rider problem? Why does the free-rider problem induce the government to provide public goods? How should the government decide whether to provide a public good?

The free-rider problem occurs when people receive the benefits of a good but avoid paying for it. The free-rider problem induces the government to provide public goods because the private market will not produce an efficient quantity on its own. The government uses tax revenue to provide the good, everyone pays for it, and everyone enjoys its benefits. The government should decide whether to provide a public good by comparing the goods costs to its benefits. If the benefits exceed the costs, society is better off.

why do governments try to limit the use of common resources?

Governments try to limit the use of common resources because one persons use of the resource diminishes others use of it. This means that there is a negative externality and people tend to use common resources excessively. Define and give an example of a public good. Can the private market provide this good on its own? Explain. A public good is a good that is neither excludable nor rival in consumption. An example is national defense, which protects the entire nation. No one can be prevented from enjoying the benefits of it, so it is not excludable, and an additional person who benefits from it does not diminish the value of it to others, so it is not rival in consumption. The private market will not supply the good, because no one would pay for it because they cannot be excluded from enjoying it if they don't pay for it. Chapter 13 Define total cost, average total cost, and marginal cost. How are they related? Figure 6 shows the marginal-cost curve and the average-total-cost curve for a typical firm. It has three main features: (1) marginal cost is rising; (2) average total cost is U-shaped; and (3) whenever marginal cost is less than average total cost, average total cost is declining; whenever marginal cost is greater than average total cost, average total cost is rising. Marginal cost is rising for output greater than a certain quantity because of diminishing returns. The average-total-cost curve is U-shaped because the firm initially is able to spread out fixed costs over additional units, but as quantity increases, it costs more to increase Draw the marginal-cost and average-total-cost curves for a typical firm. Explain why the curves have the shapes that they do and why they cross where they do. Total cost consists of the costs of all inputs needed to produce a given quantity of output. It includes fixed costs and variable costs. Average total cost is the of a typical unit of output and is equal to total cost divided by the quantity produced. Marginal cost is the cost of producing an additional unit of output and is equal to the change in total cost divided by the change in quantity. An additional relation between average cost and marginal cost is that whenever marginal cost is less than average total cost, average total cost is declining;

cost

total

whenever marginal cost is greater than average total cost, average total cost is rising. Nimbus, Inc., makes brooms and then sells them door-to-door. Here is the relationship between the number of workers and Nimbuss output in a given day:

a. Fill in the column of marginal products. What pattern do you see? How might you explain it? See the table for marginal product. Marginal product rises at first, then declines because of diminishing marginal product. b. A worker costs $100 a day, and the firm has fixed costs of $200. Use this information to fill in the column for total cost. See the table for total cost. c. Fill in the column for average total cost. (Recall that ATC = TC/Q.) What pattern do you see? See the table for average total cost. Average total cost is U-shaped. When quantity is low, average total cost declines as quantity rises; when quantity is high, average total cost rises as quantity rises. d. Now fill in the column for marginal cost. (Recall that MC = TC/Q.) What pattern do you see? See the table for marginal cost. Marginal cost is also U-shaped, but rises steeply as output increases. This is due to diminishing marginal product. e. Compare the column for marginal product and the column for marginal cost. Explain the relationship. When marginal product is rising, marginal cost is falling, and vice versa. f. Compare the column for average total cost and the column for marginal cost. Explain the relationship. When marginal cost is less than average total cost, average total cost is falling; the cost of the last unit produced pulls the average down. When marginal cost is greater than average total cost, average total cost is rising; the cost of the last unit produced pushes the average up.

Chapter 14
In the long run with free entry and exit, is the price in a market equal to marginal cost, average total cost, both, or neither? Explain with a diagram.

In the long run, with free entry and exit, the price in the market is equal to both a firms marginal cost and its average total cost, as Figure 1 shows. The firm chooses its quantity so that marginal cost equals price; doing so ensures that the firm is maximizing its profit. In the long run, entry into and exit from the industry drive the price of the good to the minimum point on the average-total-cost curve.

Does a firms price equal marginal cost in the short run, in the long run, or both? Explain. A firm's price equals marginal cost in both the short run and the long run. In both the short run and the long run, price equals marginal revenue. The firm should increase output as long as marginal revenue exceeds marginal cost, and reduce output if marginal revenue is less than marginal cost. Profits are always maximized when marginal revenue equals marginal cost. Consider total cost and total revenue given in the following table:
Quantity Total cost Total revenue 0 1 2 3 4 5 6 7 $8 9 10 11 13 19 27 37 $0 8 16 24 32 40 48 56

a. Calculate profit for each quantity. How much should the firm produce to maximize profit? Here is the table showing costs, revenues, and profits:

The firm should produce five or six units to maximize profit. b. Calculate marginal revenue and marginal cost for each quantity. Graph them. (Hint:

Put the points between whole numbers. For example, the marginal cost between 2 and 3 should be graphed at 212.) At what quantity do these curves cross? How does this relate to your answer to part (a)? Marginal revenue and marginal cost are graphed in Figure 4. The curves cross at a quantity between five and six units, yielding the same answer as in Part (a).

c. Can you tell whether this firm is in a competitive industry? If so, can you tell whether the industry is in a long-run equilibrium? This industry is competitive because marginal revenue is the same for each quantity. The industry is not in long-run equilibrium, because profit is not equal to zero.

Chapter 15
Explain how a monopolist chooses the quantity of output to produce and the price to charge.

A monopolist chooses the amount of output to produce by finding the quantity at which marginal revenue equals marginal cost. It finds the price to charge by finding the point on the demand curve that corresponds to that quantity. A publisher faces the following demand schedule for the next novel from one of its popular authors: The author is paid $2 million to write the book, and the marginal cost of publishing the book is a constant $10 per book. The following table shows revenue, costs, and profits, where quantities are in thousands, and total revenue, total cost, and profit are in millions of dollars:

a. Compute total revenue, total cost, and profit at each quantity. What quantity would a profit-maximizing publisher choose? What price would it charge? A profit-maximizing publisher would choose a quantity of 400,000 at a price of $60 or a quantity of 500,000 at a price of $50; both combinations would lead to profits of $18 million. b. Compute marginal revenue. (Recall that MR = TR/Q.) How does marginal revenue compare to the price? Explain. Marginal revenue is always less than price. Price falls when quantity rises because the demand curve slopes downward, but marginal revenue falls even more than price because the firm loses revenue on all the units of the good sold when it lowers the price. c. Graph the marginal-revenue, marginal-cost, and demand curves. At what quantity do the marginal-revenue and marginal-cost curves cross? What does this signify? Figure 2 shows the marginal-revenue, marginal-cost, and demand curves. The marginalrevenue and marginal-cost curves cross between quantities of 400,000 and 500,000. This signifies that the firm maximizes profits in that region.

d. In your graph, shade in the deadweight loss. Explain in words what this means. The area of deadweight loss is marked DWL in the figure. Deadweight loss means that the total surplus in the economy is less than it would be if the market were competitive, because the monopolist produces less than the socially efficient level of output. e. If the author were paid $3 million instead of $2 million to write the book, how would this affect the publishers decision regarding what price to charge? Explain. If the author were paid $3 million instead of $2 million, the publisher would not change

the price, because there would be no change in marginal cost or marginal revenue. The only thing that would be affected would be the firms profit, which would fall. f. Suppose the publisher was not profit-maximizing but was concerned with maximizing economic efficiency. What price would it charge for the book? How much profit would it make at this price? To maximize economic efficiency, the publisher would set the price at $10 per book, because that is the marginal cost of the book. At that price, the publisher would have negative profits equal to the amount paid to the author.

Chapter 16
Define oligopoly and monopolistic competition and give an example of each. Oligopoly a market structure in which only a few sellers offer similar or identical products Monopolistic competition a market structure in which many firms sell products that are similar but not identical

Describe the three attributes of monopolistic competition. How is monopolistic competition like monopoly? How is it like perfect competition? To be more precise, monopolistic competition describes a market with the following attributes: Many sellers: There are many firms competing for the same group of customers.

Product differentiation: Each firm produces a product that is at least slightly

different from those of other firms. Thus, rather than being a price taker, each firm faces a downward-sloping demand curve. Free entry and exit: Firms can enter or exit the market without restriction. Thus, the number of firms in the market adjusts until economic profits are driven to zero. Draw a diagram of the long-run equilibrium in a monopolistically competitive market. How is price related to average total cost? How is price related to marginal cost?
A Monopolistic Competitor in the Long Run
In a monopolistically competitive market, if firms are making profit, new firms enter, and the demand curves for the incumbent firms shift to the left. Similarly, if firms are making losses, old firms exit, and the demand curves of the remaining firms shift to the right. Because of these shifts in demand, a monopolistically competitive firm eventually finds itself in the longrun equilibrium shown here. In this long-run equilibrium, price equals average total cost, and the firm earns zero profit.

You are hired as the consultant to a monopolistically competitive firm. The firm reports the following information about its price, marginal cost, and average total cost. Can the firm possibly

be maximizing profit? If not, what should it do to increase profit? If the firm is profit maximizing, is the firm in a long-run equilibrium? If not, what will happen to restore long-run equilibrium? a. P < MC, P > ATC b. P > MC, P < ATC c. P = MC, P > ATC d. P > MC, P = ATC Chaptr 17 Compare the quantity and price of an oligopoly to those of a monopoly.

Firms in an oligopoly produce a quantity of output that is greater than the level produced by monopoly. They sell the product at a price that is lower than the monopoly price.
Consider trade relations between the United States and Mexico. Assume that the leaders of the two countries believe the payoffs to alternative trade policies are as follows:

a. What is the dominant strategy for the United States? For Mexico? Explain. If Mexico imposes low tariffs, then the United States is better off with high tariffs, because it gets $30 billion with high tariffs and only $25 billion with low tariffs. If Mexico imposes high tariffs, then the United States is better off with high tariffs, because it gets $20 billion with high tariffs and only $10 billion with low tariffs. So the United States has a dominant strategy of high tariffs.

If the United States imposes low tariffs, then Mexico is better off with high tariffs, because it gets $30 billion with high tariffs and only $25 billion with low tariffs. If the United States imposes high tariffs, then Mexico is better off with high tariffs, because it gets $20 billion with high tariffs and only $10 billion with low tariffs. So Mexico has a dominant strategy of high tariffs.
b. Define Nash equilibrium. What is the Nash equilibrium for trade policy?

A Nash equilibrium is a situation in which economic actors interacting with one another each choose their best strategy given the strategies others have chosen. The Nash equilibrium in this case is for each country to have high tariffs.
c. In 1993, the U.S. Congress ratified the North American Free Trade Agreement, in which the United States and Mexico agreed to reduce trade barriers simultaneously. Do the perceived payoffs shown here justify this approach to trade policy? Explain. The NAFTA agreement represents cooperation between the two countries. Each country reduces tariffs and both are better off as a result. d. Based on your understanding of the gains from trade (discussed in Chapters 3 and 9), do you think that these payoffs actually reflect a nations welfare under the four possible outcomes?

The payoffs in the upper left and lower right parts of the box do reflect a nations welfare. Trade is beneficial and tariffs are a barrier to trade. However, the payoffs in the upper right and lower left parts of the box are not valid. A tariff hurts domestic consumers and helps domestic producers, but total surplus declines, as we saw in Chapter 9. So it would be more accurate for these two areas of the box to show that both countries welfare will decline if they imposed high tariffs, whether or not the other country had high or low tariffs. Chapter 18
Define marginal product of labor and value of the marginal product of labor. Describe how a competitive, profit-maximizing firm decides how many workers to hire.

The marginal product of labor is the increase in the amount of output from an additional unit of labor. The value of the marginal product of labor is the marginal product of labor times the price of the good. A competitive, profit-maximizing firm decides how many workers to hire by hiring workers up to the point where the value of the marginal product of labor equals the wage. The Demand for Labor The wage of workers is determined by the supply and demand for workers.