ECON 1602 (B 09A): BASIC ECONOMIC CONCEPTS: MICROECONOMICS

Transcription

1 1 EXERCISE SHEET 4 ECON 1602 (B 09A): BASIC ECONOMIC CONCEPTS: MICROECONOMICS Here are some more questions, which reflect some of the work done in the final three lectures this term on the theory of the firm. 1. Give an account of the structure- conduct performance model and how it enables us to classify market structures in an economy. 2. Rothschild argued that military language is most appropriate for talking about oligopoly. Give an account of his five maxims. 3. Simple five firm concentration ratios are too simplistic. Consider the following data from the market shares of supermarkets in the United Kingdom in February 2006: Tesco 30.6%, Sainsbury 16.3%, Asda 16.6%, Morrison 11.1%, Somerfield 5.4%, Waitrose 3.7%, Iceland 1.8% and the rest 14.5% a) Calculate the Herfindhal- Hirschman index and explain what it means. b) Here are some market share data for two other markets: Market A Firm 1 70% Firm 2 30% Market B Firms 1 to 4 have 20% market shares and Firms 5 to 20 have 1% market shares. (i) (ii) Again calculate the HH index. Show how the HH index ranges from a maximum value or 10,000 to a minimum value of 0. Comment upon this way of calculating the degree of competitiveness in an economy. 4. There have been, and in fact are at present, many Competition Commission investigations of the supermarket sector in the United Kingdom. Comment on the following: a) The need to use isochrone analysis in the portrayal of market structure. b) The importance of studying the many forms of market conduct and behaviour such as price flexing, slotting payments, preferred supplier payments, wedding gifts, retrospective discounting, pay to stay fees etc. c) The significance of the many performance measures: turnover per square metre, turnover per employee, operating margin as defined as operating profit divided by turnover and percentage change in market share. 5. What are the advantages and disadvantages of what may be called Tescopoly? 6. To what extent is the number of firms in a wide variety of industries in the British Economy determined by the relationships between the industry demand curve and the point where the long run average cost curve flattens out? Give factual illustrations from the broad variety of market structures, which exists at present. 7. Far from being mere toys, the notions of consumer surplus and producer surplus are invaluable in economic analysis. a) Discuss this statement with respect to the analysis of welfare loss, drawing upon Harberger s work. b) Show how this apparatus may be used to demonstrate the view that an innovating monopolist can generate gains rather than losses for society, with reference to Littlechild s work. 8. Derive Harberger s dead-weight loss formula W = 1/2PQed 2. What data would you need to make an empirical estimate of W for the United Kingdom? 9. Here is a numerical illustration of some of the notions explored in Q.7 and Q.8. This also provides some revision on the work we have done on pricing strategy. The demand curve for a market may be written as P = Q and the cost relationship is MC = AC = 6. a) Draw the demand curve on a diagram and the constant MC = AC as well. b) Obtain the TR function and then the MR function. You can do the latter by simple calculus but otherwise you could use the twice as steep rule c) As a monopolist, find the output and price combination which maximizes profit and find the level of maximum profit. At the same time find the consumer surplus under monopoly. d) Find the output and price if the firm were in a perfectly competitive industry. What is profit now? What is the consumer surplus now? e) Explain the concept of deadweight loss and calculate it for this problem. f) What if it were decided to set P = 0? What would the profit be now? What would the consumer surplus be now?

2 2 g) Use this problem to comment upon the following pricing strategies: setting a single price as a monopolist, two part pricing in monopoly, setting a single price as a perfect competitor, two part pricing under perfect competition, setting P = 0 yet mulcting (milking) the consumer surplus. h) What is the Lerner index in this case? What is its value? It may clarify ideas if you draw this up as a diagram as well. 10. Outline the properties of both indifference curves and isoquants. 11. a) Set out the conditions for profit maximisation for the perfectly competitive firm, with illustrative diagrams. b) Under what circumstances would a loss minimising firm continue production? c) Carefully explore the notion of long run equilibrium. How helpful is it when looking at entry into a perfectly competitive industry? d) Outline the processes which eliminate economic profits in (i) a perfectly competitive industry, (ii) a monopolistically competitive industry. 12. Carefully describe the conditions, which must be satisfied where the firm and the industry are in long run equilibrium. 13. Apply the long-run equilibrium concept to the following two situations: (i) an industry (like semiconductors) where technical change is lowering costs, (ii) an industry (like coal) where falling demand is causing long-term decline. 14. Draw a diagram which shows the dilemma facing policy makers when they compel a natural monopoly to adopt a marginal cost pricing. What are the alternatives? 15. To what extent is it difficult for the public to understand why a government committed to controlling the market power of a monopoly could well end up subsidizing it? 16. Examine whether the following statements are true or false, with appropriate reasoning and diagrams: - a) Firms that make losses should be closed down at once. b) The long run average cost curve passes through the lowest point on each short run average cost curve. c) The long run marginal cost curve passes through the lowest point on each short run marginal cost curve. d) Operating strategies of average cost minimisation and profit maximising always lead to identical levels of output. 17. What do statistical cost curves show about the actual shape of short run and long run average cost? curves? 18. a) Identify the problems which must be first addressed in the estimation of short run statistical cost curves. b) The following equations were based on data from weekly razor output (in thousands of units) and TVC (in dollars per week) for the most recent 6 month period so the number of observations was n = 26. Note that the t-ratios are in brackets. TVC Models Linear TVC = $2, $ Q R 2 = 0.75 (5.15) (8.44) S.E.E = $ Quadratic TVC = $6, $ Q + $7.712Q 2 R 2 = 0.93 (10.78) (-5.05) (7.72) S.E.E. = $ Cubic TVC = $2, $ $19.211Q 2 + $0.359Q 3 R 2 = 0.96 (1.60) (2.01) (-2.50) (3.52) S.E.E = $ a) Obtain the AVC and MC curves in all cases, roughly sketching and briefly commenting. b) Compare and contrast these results in general sense, stating which equation you would prefer. c) Compare and contrast these results from the point of view of the partial regression coefficients, again stating which equation you would prefer. d) There are very good a priori reasons for thinking that short run AVC and MC curves will be quadratic. Explain why this is so.

3 3 e) There are also very good reasons for thinking that the linear TVC function is to be preferred. Explain why this is so. f) What may be the advantage of trying a double logarithmic specification? 19. a) Identify the problems which must be addressed in estimating long run statistical cost curves and compare your answer to part a) in Q.18. b) IBM derived the following equation for producing one of its specialist electronic computers, where TC = total cost in dollars, Q = the number of machines and t ratios are in brackets. TC = 28,303, ,800Q R 2 = (6.32) (7.42) (i) (ii) (iii) (iv) (v) If the entire market for this type of machine is 1,000 machines, and if all firms have the same long run cost function, to what extent would a firm with 50% of the market have an advantage over one with 20% of the market? Does there appear to be economies of scale? What is the long run marginal cost of producing such a machine? What is the relationship between long run average cost and long run marginal cost? Sketch and comment. The data are forecasts of costs using engineering data. Distinguish these costs from total systems costs. 20. Let us say an economist has estimated a cost function of the form TC = 5 + q. Sketch the derived marginal and average cost curves on a diagram. 21. Carefully outline the sources of economies of scale, distinguishing between technical and managerial economies. To what extent can they be estimated by the use of a) cost functions, b) production functions? 22. You are given a cost function of the form C = AQ b where C = total cost and Q = output. How would you establish whether there existed increasing, constant or decreasing returns to scale 23. You are given a production function of the form Q = AK α L β where Q = output, K = capital input and L = labour input. How would you find whether there existed increasing, constant or decreasing returns? to scale? Verify that the specific production function Q = 100K 0.25 L 0.75 exhibits diminishing returns to a factor and constant returns to scale. 24. Consider the specific production function for brickmaking where Q = L 0.75 K 0.25 a) What is the output of bricks per annum if we know that L = 500,000 labour hours per annum and K= $2,000,000 capital installed? b) Verify that L = 550,000 labour hours per annum and K = $1,502, will give us the same output. Draw the isoquant and calculate the marginal rate of transformation. c) What is the elasticity of output with respect to (i) capital and (ii) labour? d) Distinguish between diminishing returns to a factor and decreasing returns to scale. e) What happens to the level of output if technical progress yields a new production function of the form Q = 250 L 0.75 K 0.25? 25. Explain what is meant by economies of scope, with illustrative examples. Derive an expression, which shows how joint cost is less than the sum of the individual costs. 26. a) What are learning curves? Generate a numerical learning curve by using the expression log (L) = log (N/10) where L = unit labour input and N = cumulative output. b) Use the semi-conductor industry to show that firms are continually innovating in order to chase each other down the learning curve. 27. What do you understand by the term contestable markets? How does Baumol s concept provide a good line of reasoning giving guidelines for the effective exercise of public policy with respect to merger and monopoly control? 28. Draw up a check list for the regulator of a chosen utility which has been privatized.

4 4 29. Consider the equation log (L) = -0.44log (N/50) where L = unit labour input and N = cumulative output. This equation has been used to generate some of the numbers in the table below. Cumulative Output (N) Per unit labour requirement for Total Labour Requirement each 50 units of output (L) x = x = a) Use the equation above to complete the numbers in the table above and sketch the learning curve. Put per unit labour requirements on the vertical axis and cumulative output on the horizontal axis. b) Identify the sources of learning in the manufacture of commercial jet aircraft and explain how they may give first mover advantage. c) Explain the clear distinction between economies of scale and learning, with the use of an appropriate diagram. This question is adapted from a question in the B09A Examination in a) What do you understand by the concept of the accelerationist hypothesis, with reference to both the commercial aircraft industry and the manufacture of semi conductors? b) Explain how the development cost is both an exogeneous sunk cost and a barrier to entry. c) Now explain how further R & D expenditure to ramp up production in these industries may be regarded as an endogeneous sunk cost. Explain how this term may be applied to the role of advertising as well. d) Once the commitment to produce is made, firms can engage in Bertrand or Cournot type competitive behaviour. Explain. This question is adapted from a question in the B09A Examination in It is popular to talk about learning curves, but there are also forgetting curves. Explain what these are, with a suitable sketch, mathematical function and examples. John Mark March 2008.

5 a) 5