S. Klepper, Economics 73-100, Fall 2008

 

Solutions to Exam III

 

1. Nothing is changed for buyers except for the commission, hence the market demand curve is basically the same as in the version of the experiment conducted in class. Except for the size of the commission on the fourth and higher units, nothing is changed for the sellers who continue to be offered a payment of $.99 if they sell no output in round 2.  They would still be willing to supply up to four units of output at a price of $69, but would not sell any output at a price less than $0.69. For the sellers offered a payment of $1.39 if they sold no output in round 2, their cost of the first unit would be $1.39 + $.23 = $1.62 and their total, average, and marginal cost schedules would be:

 

Quantity

Total Cost

ATC

MC

 

 

 

 

1

$1.62

$1.62

$1.62

2

  1.96

  0.98

  0.34

3

  2.47

  0.823

  0.51

4

  3.16

  0.79

  0.69

5

  4.06

  0.812

  0.90

6

  5.26

  0.878

  1.20

7

  6.91

  0.987

  1.65

 

Their minimum average total cost is $0.79, which is realized at four units of output.  Therefore, if the price per unit was less than $0.79, they would sell no output as if they sold output their profits would be less $1.39.  If the price per unit in round 2 was $0.79, the sellers would have to sell four units of output to earn $1.39 in profit.  They would want to sell four units of output rather than none as they would also earn a commission of $.01 on the fourth unit sold and hence a total profit of $1.40 if they sold four units of output in round 2 (they would actually be willing to sell three units at $0.79 and one at $0.78, which would enable them to earn exactly $1.39).

 

In the version of the experiment conducted in class, the price in round 2 was $0.69 and buyers each purchased four units of output and three out of every five sellers sold four units of output.  But if only two out of every five sellers were offered a payment of $.99 if they sold no output in round 2, then this could not be the equilibrium price in round 2 as only two out of every five sellers would sell four units of output at a price of $0.69 and hence the total quantity supplied would be less than the total quantity demanded.  The price would have to rise above $0.69 to $0.79 to get additional units of output supplied.  In that case, buyers would each buy three units of output (the commission would induce them to buy the third unit if the price equaled $0.79), so the total quantity demanded would be 72 units.  At a price of $0.79, all sellers would have wanted to sell four units of output.  Sellers offered a payment of $.99 if they sold no output would have earned over $.99 in profit if they sold at least two units of output in round 2 at a price of $0.79 per unit.  Even if they each sold only two units of output and thus in total sold 32 units of output (16 of the 40 sellers would have been offered a payment of $.99), this would only allow (72-32)/4 = 10 sellers offered a payment of $1.39 to sell four units of output each in round 2.  Hence in round 2 some sellers would not sell any output.

 

Buyers would earn less profits in round 2 than in the version of the experiment conducted in class as they would buy less units at a higher price than in the version of the experiment conducted in class.  The price would have exceeded $0.69, which is the marginal cost of the fourth unit of output, and no seller would have sold more than four units of output, hence the price would have exceeded the marginal cost of the last unit sold for every seller that sold a unit in round 2. Sellers offered a payment of $0.99 not to sell any output in round 2 would have earned profits of over $.99 in round 2 if they sold at least two units of output at $0.79 and hence would have earned positive economic profits.

 

Based on this discussion, the answers to the individual questions, with the points allotted to them in brackets, are:

 

[3] 1. False

 

[3] 2. True

 

[5] 3. False

 

[5] 4. True

 

[5] 5. False

 

[5] 6. False

 

[6] 7. True

 

[5] 8. False

 

[7] 9. True

 

[6] 10. True

 

2. The world demand and supply curves of oil are just the aggregation of the demand and supply curves of oil in each country.  In the figure below, the world situation is depicted in the right panel and the rest of the world except the U.S is depicted in the left panel.  The tax on gasoline decreases the demand for gasoline, which in turn causes the U.S. demand for oil to decline at every price.  This causes the world market demand curve for oil to shift to the left but has no effect on the demand curve for oil outside the U.S.  The costs of producing oil are unchanged, hence the short run world supply curve of oil is unchanged as is the supply curve for oil outside the U.S.

 

As the world figure on the right indicates, the world price of oil declines from P0 to P1  and the world consumption of oil decreases from Q0 to Q1.  The figure on the left for all countries except the U.S. indicates that total consumption of oil outside the U.S. rises from QD0 to QD1 and the world production of oil outside the U.S. decreases from QS0 to QS1.  If world consumption of oil falls but consumption outside the U.S. rises, then U.S. consumption must fall.  If consumption outside the U.S. rises and production outside the U.S. falls then exports of oil to the U.S., which equals the difference between production and consumption outside the U.S., must decline.  If the price of oil declines and the costs of producing oil do not change, then the profits of oil producers in every country must decline.

 

Based on this discussion, the answers to the individual questions, with points allotted in brackets, are:

 

[4] 11. False

 

[6] 12. True

 

[6] 13. False

 

[3] 14. True

 

[6] 15. True

 

[5] 16. True

3. Each policy is considered in turn. First, suppose a tariff is imposed on cars produced by foreign producers.  This will increase the price of foreign cars. Since foreign cars are an imperfect substitute for U.S. cars, this will cause the demand for U.S. cars to shift to the right.  This will increase both the price and output of U.S. producers, with the increase in output necessitating the hiring of additional employees.  Therefore, employment will rise.

 

Offering a subsidy payment to each U.S. producer equal to 10% of last year’s payroll will effectively lower the short-run fixed costs of production.  This will not affect the marginal cost of production, hence it will not affect the short-run supply curve.  It has no effect on demanders and hence will not affect the market demand curve either. Consequently, there will be no change in price or output, hence employment will not change. 

 

Shutting down one of the firms will cause the market supply curve to shift to the left, which will cause price to rise and output to fall.  Therefore, total employment will fall.

 

Offering a subsidy payment to make the net price of U.S. automobiles equal to $17,000 contingent on total sales rising from 2 million to 2.2 million will not affect buyers in the next year even though buyers collectively would purchase 2.3 million cars at a price of $17,000. If buyers would only purchase 2 million U.S. automobiles on their own without the subsidy, then buyers of .2 million additional U.S. automobiles would be willing to pay less than the unsubsidized price for these automobiles.  Hence prospective buyers of the .2 million additional automobiles would be asked to make a “contribution” to get a greater benefit, but the benefit would materialize only if a sufficient number of other buyers also made the contribution.  This is a classic social dilemma and buyers would be expected to respond in their own self interest by not making the contribution, in which case the number of U.S. automobiles produced and hence total employment would not change.

 

Based on this discussion, the answers to the individual questions, with points allotted to the questions, are:

 

[5] 17. True

 

[5] 18. False

 

[4] 19. False

 

[6] 20. False