Deck 14: A Managers Guide to Government in the Marketplace

Question 1

You are an industry analyst who specializes in an industry where the market inverse demand is P = 200 - 4 Q. The external marginal cost of producing the product is MC External =6 Q, and the internal cost is MC Internal = 12 Q.
a. What is the socially efficient level of output?
b. Given these costs and market demand, how much output would a competitive industry produce?
c. Given these costs and market demand, how much output would a monopolist produce?
d. Discuss actions the government might take to induce firms in this industry to produce the socially efficient level of output.

Answer 1

The industrial demand function is given by
. Firms in this industry are generating negative externality and therefore they face two types of cost: an external cost which is the cost of production and an internal cost which is the cost of the harm they create on society via externality.
a)The cost of the externality created by the industry is not internalized by the firms. From society's perspective, firms need to incorporate this internal cost in their cost analysis. Hence the socially efficient level of output is the one that equilibrates market demand to the marginal cost to the society.
Marginal cost to the society is the sum of both internal and external marginal cost, the industry is facing. Therefore, the social marginal cost is:
Compute the socially efficient level of output by equating
with marked demand
:
Thus the socially efficient level of output is 9.09 units.
b)A competitive industry produces a level of output by equating its Internal Marginal Cost with the Price (more precisely,
). This implies:
Hence a competitive industry produces 12.5 units.
c)A monopolist ignores the societal damage it causes through its actions and produces a level of output at which its Internal Marginal Cost equals the Marginal Revenue. The latter is the first derivative of Total revenue:
Compute the quantity produced by the incumbent monopolist by equating Marginal cost
and Marginal Revenue:
Therefore, a monopolist produces 10 units of output.
d)To encourage the monopoly to produce socially efficient level of output, government may force firms to internalize the costs of externality created by them. This can be done by targeted policies that shift the internal cost of production up to a point where it equals the social cost of production.
To force such internalization, taxing the monopolist for the externality created, imposing restrictions on the amount of a negative externality generated, enforcing property rights are some of the policy measures that the government can initiate.

Question 2

The U.S. International Trade Commission's committee in charge of the global safeguard investigation involving imports of steel has announced its recommendations to be forwarded to the president. Of the 33 steel product categories investigated, 12 have experienced a significant increase in the quantity of imported steel, causing serious injury or the threat of serious injury to the U.S. steel industry. The commission has recommended that the president impose a 20 percent tariff on these 12 categories of imported steel. If the president follows the commission's recommendations, what will happen to the supply of foreign steel in these categories? What impact will this have on the equilibrium quantity of steel sold (in these categories) in the United States? Will the equilibrium price for these categories of steel in the United States market increase or decrease? Explain

Answer 2

ITC's recommendation of imposing a 20 percent tariff on selective categories of imported steel, if implemented, will discourage domestic firms to import steel and will encourage them to buy from domestic steel manufacturers. Moreover, foreign firms will find it costly to supply in domestic market and hence supply of steel by foreign firms will fall.
This implies a fall in the total supply of steel in domestic steel market and a rise in domestic steel price. The quantity of steel sold in the domestic market will be reduced.

Question 3

There are two workers. Each worker's demand for a public good is P = 20 - Q. The marginal cost of providing the public good is $24. The accompanying graph summarizes the relevant information.

a. What is the socially efficient quantity of the public good?
b. How much will each worker have to pay per unit to provide the socially efficient quantity?
c. Suppose the two workers contribute the amount needed to provide the quantity of public good you identified in parts ( a ) and ( b ). A third worker values the public good just like the two contributing workers, but she claims not to value the good because she wants to "free ride" on the payments of the other two workers.
(1)?Given the three workers' true demands for the public good, is the amount of the public good provided by the two workers socially efficient?
(2)?Compare the level of consumer surplus enjoyed by these three workers. Which worker(s) enjoys the most surplus?

Answer 3

In case of a public good, same quantity of public good is provided to each consumer and they pay a price according to their demand schedule. In the case given, there are two workers and they have a same demand curve
. This implies that both the workers face the same price. The corresponding figure for this case is Figure A-1 below
Figure A-1
a)To determine the price and quantity of the public good, compute the combined demand of both workers:
The socially efficient level of public good occurs at a point where the marginal cost of producing it equals the total demand for it. Hence equilibrate total demand with the marginal cost:
Hence the socially efficient output level is 8 units.
b)Workers as individual can pay $12 for 8 units of public good but the marginal cost of providing 8 units is $24. Hence individually they are not able to pay for it.
But if each of them is willing to pay $12 jointly, they can together pay $24 and thus will be able to afford the socially efficient level of output.
Hence each worker will have to pay $12 per unit to provide socially efficient quantity.
c)If there is a third worker that values the public good like the other two contributing workers, then her individual demand for public good would be
. In that case the combined or total demand by three workers becomes:
As mentioned, the socially efficient level of public good occurs at a point where the marginal cost of producing it equals the total demand for it. Hence equilibrate total demand with the marginal cost:
Hence the socially efficient output level is 12 units
Notice that when two workers contribute for the provision of public good, the socially efficient level of public good is 8 units while when there are three workers to value the public goods, the socially efficient output becomes 12 units.
Hence the amount of public good provided by the two workers is not socially efficient given the three workers demand for public good.Consumer surplus is the area of the portion above the price line and below the demand curve. Individually, each of the two workers face a price line of $12 for 8 units of public good. Hence the consumer surplus of first two workers is:
Note that the third worker pays nothing but enjoys all 8 units of the public good. Hence he faces a price line of x-axis. Thus, her consumer surplus is:
Therefore, the first two workers enjoy a consumer surplus of $32 while the consumer that free rides , enjoys a consumer surplus of $128.

Question 4

Canada's forestry industry (composed mainly of those involved in the lumber industry) directly employs about 370,000 workers and indirectly employs an additional 510,000 people in support services. Forestry products account for nearly 3 percent of Canada's gross domestic product (GDP) and 14.1 percent of its exports. Lobbyists for the U.S. lumber and timber producers recently filed a complaint with the U.S. International Trade Commission (ITC) and the U.S. Department of Commerce (DOC) alleging that the Canadian government provided a subsidy to its lumber producers and caused harm to U.S. lumber and timber producers. As a result of these concerns, one U.S. lobbyist proposed the imposition of a 15 percent excise tariff on all Canadian forestry-products. Determine the likely impact of the proposed 15 percent excise tariff on the equilibrium price and quantity of lumber exchanged in the U.S. Would domestic consumers and producers benefit from the proposed tariff? Explain carefully.

Question 5

As the manager of a monopoly, you face potential government regulation. Your inverse demand is P = 40 - 2 Q, and your costs are C ( Q ) = 8 Q.
a. Determine the monopoly price and output.
b. Determine the socially efficient price and output.
c. What is the maximum amount your firm should be willing to spend on lobbying efforts to prevent the price from being regulated at the socially optimal level?

Question 6

Suppose that, prior to the passage of the Truth in Lending Simplification Act and Regulation Z, the demand for consumer loans was given by Q pre _ TILSA = 12-100 P (in billions of dollars) and the supply of consumer loans by credit unions and other lending institutions was Q pre _ TILSAS =5+100 P (in billions of dollars). The TILSA now requires lenders to provide consumers with complete information about the rights and responsibilities of entering into a lending relationship with the institution, and as a result, the demand for loans has increased to (in billions of dollars). However, the TILSA also imposed "compliance costs" on lending institutions, and this reduced the supply of consumer loans to Q post _ TILSA = 3+100 P ( in billions of dollars). Based on this information, compare the equilibrium price and quantity of consumer loans before and after the Truth in Lending Simplification Act.

Question 7

Consider a competitive market served by many domestic and foreign firms. The domestic demand for these firms' product is Q d = 600 - 2 P. The supply function of the domestic firms is Q SD = 200 + P, while that of the foreign firms is Q SF = 250.
a. Determine the equilibrium price and quantity under free trade.
b. Determine the equilibrium price and quantity when foreign firms are constrained by a 100-unit quota.
c. Are domestic consumers better or worse off as a result of the quota?
d. Are domestic producers better or worse off as a result of the quota?

Question 8

Evaluate this statement: "If the U.S. imposed a uniform excise tariff on all foreign imports, all U.S. businesses and workers would benefit. Consequently, if a bill to impose a uniform excise tariff were introduced in the U.S. Congress, it would unanimously pass."

Question 9

Suppose that the U.S. Congress passes legislation that imposes a one-time lump-sum tariff on the product that a foreign firm exports to the United States.
a. What happens to the foreign firm's marginal cost curve as a result of the lump-sum tariff?
b. Will the lump-sum tariff cause the foreign firm to export more or less of the good? Explain carefully.

Question 10

Moses Inc. is a small electric company that provides power to customers in a small rural area in the Southwest. The company is currently maximizing its profits by selling electricity to consumers at a price of $0.15 per kilowatt hour Its marginal cost is $0.05 per kilowatt hour, and its average cost is $0.15 per kilowatt hour. A government regulator is considering a proposal to regulate the firm's price at $0.05 per kilowatt hour. Would such a policy improve social welfare? Explain.

Question 11

The accompanying diagram depicts a monopolist whose price is regulated at $10 per unit. Use this figure to answer the questions that follow.

a. What price will an unregulated monopoly charge?
b. What quantity will an unregulated monopoly produce?
c. How many units will a monopoly produce when the regulated price is $ 10 per unit?
d. Determine the quantity demanded and the amount produced at the regulated price of $10 per unit. Is there a shortage or a surplus?
e. Determine the deadweight loss to society (if any) when the regulated price is $10 per unit.
f. Determine the regulated price that maximizes social welfare. Is there a shortage or a surplus at this price?

Question 12

Explain, using precise economic terminology, the economic rationale for laws against insider trading.

Question 13

Is "fairness" the economic basis for government laws and regulations designed to remedy market failures? If so, why; if not, what is the economic basis?

Question 14

Attorneys for Eastman Kodak argued in front of the U.S. Supreme Court to defend the company against charges levied by several independent firms that provide service for machines sold by Eastman Kodak. At issue was a decision by Kodak to limit the availability of replacement parts to these firms, making it more difficult for them to compete against Kodak in servicing Kodak machines. The suit alleged that Kodak unlawfully tied the sale of service for its machines to the sale of parts and, therefore, unlawfully monopolized and attempted to monopolize the sale of service and parts for such machines. Under which act do you think Kodak was charged?

Question 15

Between 1972 and 1981, Texaco sold gasoline to independent Texaco retailers at "retail tank wagon prices" but granted substantial discounts to distributors Gull and Dompier. Gull resold the gas under its own name. Dompier resold the gas under the Texaco brand name to retail stations and entered the retail market directly. Since neither Gull nor Dompier had significant storage facilities, both distributors picked up gas directly from the Texaco plant and delivered it to their retail outlets. As a result, the sales volume increased substantially at the retail stations purchasing gas from these distributors, while independent Texaco retailers suffered a corresponding sales decline. In 1976, independent Texaco retailers filed suit against Texaco. In 1990, the Supreme Court of the United States found that Texaco had indeed violated antitrust law. Which law do you think Texaco was found guilty of violating?

Question 16

Social Dynamo Corporation earned profits last year of $49 million on sales of $500 million. During the same period, its major competitor-EIO Corp.-enjoyed sales of $490 million and earned profits of $52 million. Currently, Social Dynamo is negotiating a deal in which it would acquire the assets of EIO in a transaction Wall Street values at $120 million. A successful merger between the two companies is expected to raise prices in the market by 2 percent. Is Social Dynamo obligated to notify the U.S. Justice Department and the Federal Trade Commission of its merger intentions? Explain.

Question 17

A well-known conglomerate that manufactures a multitude of noncompeting consumer products instituted a corporatewide initiative to encourage the managers of its many divisions to share consumer demographic information. However, since the initiative was implemented, the CEO has noticed that less information is available than ever. Why do you think the CEO's plan backfired?

Question 18

Your instructor may assign additional problem-solving exercises (called memos) that require you to apply some of the tools you learned in this chapter to make a recommendation based on an actual business scenario. Some of these memos accompany the Time Warner case (pages 561-597 of your textbook). Additional memos, as well as data that may be useful for your analysis, are available online at www.mhhe.com/baye8e.

Question 19

You are the manager of a paper mill and have been subpoenaed to appear before a joint session of the Senate Consumer Affairs and the Senate Environmental subcommittees. The Consumer Affairs Subcommittee is interested in your testimony about the pricing practices of your company because a recent news magazine reported that your markups are 250 percent. The Environmental Subcommittee is interested in exploring ways to reduce the pollution associated with your paper mill. In particular, you know that one senator on the Environmental Subcommittee will ask you to justify why the firm should not be charged a per-unit tax on the firm's output to compensate for the pollution it discharges into a major river. Devise a game plan for responding to the questions that will be raised in the joint session of the subcommittees.

Question 20

You are the manager in a market composed of eight firms, each of which has a 12.5 percent market share. In addition, each firm has a strong financial position and is located within a 100-mile radius of its competitors.
a. Calculate the premerger Herfindahl-Hirschman index (HHI) for this market.
b. Suppose that any two of these firms merge. What is the postmerger HHI?
c. Based only on the information contained in this question and on the Horizontal Merger Guidelines described in this chapter, do you think the Justice Department (or FTC) would attempt to block a merger between any two of the firms? Explain.

Question 21

Section 16(a) of the Securities and Exchange Act of 1934, as amended in 1990, requires that the officers, directors, and principal shareholders of companies disclose the extent of their ownership of equity securities of the company and any changes in the ownership. Section 16(b) permits companies to recover trading profits realized by such people arising from short-swing transactions in the company securities. Do you think that, as a result of these laws, the government will be forced to spend more money on its auditing and enforcement efforts? Explain.

Question 22

If your instructor has adopted Connect for the course and you are an active subscriber, you can practice with the questions presented above, along with many alternative versions of these questions. Your instructor may also assign a subset of these problems and/or their alternative versions as a homework assignment through Connect, allowing for immediate feedback of grades and correct answers.

Question 23

Enrodes is a monopoly provider of residential electricity in a region of northern Michigan. Total demand by its 3 million households is Q d = 1,500 - 2 P , and Enrodes can produce electricity at a constant marginal cost of $4 per megawatt-hour. Consumers in this region of Michigan have recently complained that Enrodes is charging too much for its services. In fact, a few consumers are so upset that they are trying to form a coalition to lobby the local government to regulate the price Enrodes charges. If all the consumers of this region joined the coalition against Enrodes, how much would each consumer be willing to spend to lobby the local government to regulate Enrodes's price? Do you think the consumers will be successful in their efforts? Explain.

Question 24

Use the accompanying graph to answer the questions that follow.

a. Suppose this monopolist is unregulated.
(1) What price will the firm charge to maximize its profits?
(2) What is the level of consumer surplus at this price?
b. Suppose the firm's price is regulated at $80.
(1) What is the firm's marginal revenue if it produces 7 units?
(2) If the firm is able to cover its variable costs at the regulated price, how much output will the firm produce in the short run to maximize its profits?
(3) In the long run, how much output will this firm produce if the price remains regulated at $80?

Question 25

China's entry into the World Trade Organization (WTO) is likely to create more competition between local and foreign firms, as well as provide China greater access to the market for exports. This is particularly true in the market for rubber since China is the world's second largest consumer of rubber. According to the WTO, China plans to eliminate its import quota on rubber over the next five years. What impact is the import quota reduction likely to have on the price of rubber and the quantity of rubber exchanged in China? What implications will the elimination of the quota on rubber have on China's social welfare?