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The market exercises

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Instructor’s Manual
Intermediate Microeconomics
Ninth Edition
Instructor’s Manual
Intermediate Microeconomics
Ninth Edition
Instructor’s Manual
by
Hal R. Varian
Answers to Workouts
by
Hal R. Varian and Theodore C. Bergstrom
W. W. Norton & Company • New York • London
c 2014, 2010, 2002, 1999, 1996, 1993, 1990, 1988 by W. W. Norton & Company
Copyright All rights reserved
Printed in the United States of America
Typeset in TEX by Hal R. Varian
NINTH EDITION
ISBN 978-0-393-93676-6
W. W. Norton & Company, Inc., 500 Fifth Avenue, New York, N.Y. 10110
W. W. Norton & Company, Ltd., Castle House, 75/76 Wells Street, London W1T 3QT
www.wwnorton.com
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CONTENTS
Part I Chapter Highlights
1. The Market
1
2. Budget Constraint
4
3. Preferences
7
4. Utility
10
5. Choice
13
6. Demand
16
7. Revealed Preference
18
8. Slutsky Equation
21
9. Buying and Selling
23
10. Intertemporal Choice
26
11. Asset Markets
29
12. Uncertainty
31
13. Risky Assets
33
14. Consumer’s Surplus
35
15. Market Demand
37
16. Equilibrium
39
17. Measurement
42
18. Auctions
44
19. Technology
46
20. Profit Maximization
48
21. Cost Minimization
50
22. Cost Curves
52
23. Firm Supply
54
24. Industry Supply
56
25. Monopoly
59
26. Monopoly Behavior
61
27. Factor Markets
63
28. Oligopoly
65
29. Game Theory
68
30. Game Applications
71
31. Behavioral Economics
75
32. Exchange
78
33. Production
81
34. Welfare
83
35. Externalities
85
36. Information Technology
88
37. Public Goods
92
38. Information
95
Part II Answers to Workouts
1. The Market
1
2. Budget Constraint
5
3. Preferences
17
4. Utility
33
5. Choice
49
6. Demand
67
7. Revealed Preference
81
8. Slutsky Equation
97
9. Buying and Selling
111
10. Intertemporal Choice
131
11. Asset Markets
147
12. Uncertainty
161
13. Risky Assets
175
14. Consumer’s Surplus
181
15. Market Demand
191
16. Equilibrium
201
17. Measurement
219
18. Auctions
221
19. Technology
239
20. Profit Maximization
251
21. Cost Minimization
267
22. Cost Curves
279
23. Firm Supply
285
24. Industry Supply
295
25. Monopoly
311
26. Monopoly Behavior
317
27. Factor Markets
331
28. Oligopoly
335
29. Game Theory
351
30. Game Applications
365
31. Behavioral Economics
381
32. Exchange
391
33. Production
407
34. Welfare
417
35. Externalities
427
36. Information Technology
439
37. Public Goods
455
38. Asymmetric Information
469
Chapter 1 1
Chapter 1
The Market
This chapter was written so I would have something to talk about on the first
day of class. I wanted to give students an idea of what economics was all about,
and what my lectures would be like, and yet not have anything that was really
critical for the course. (At Michigan, students are still shopping around on the
first day, and a good number of them won’t necessarily be at the lecture.)
I chose to discuss a housing market since it gives a way to describe a number
of economic ideas in very simple language and gives a good guide to what lies
ahead. In this chapter I was deliberately looking for surprising results—analytic
insights that wouldn’t arise from “just thinking” about a problem. The two
most surprising results that I presented are the condominium example and the
tax example in Section 1.6. It is worth emphasizing in class just why these results
are true, and how they illustrate the power of economic modeling.
It also makes sense to describe their limitations. Suppose that every condominium conversion involved knocking out the walls and creating two apartments. Then what would happen to the price of apartments? Suppose that the
condominiums attracted suburbanites who wouldn’t otherwise consider renting
an apartment. In each of these cases, the price of remaining apartments would
rise when condominium conversion took place.
The point of a simple economic model of the sort considered here is to focus
our thoughts on what the relevant effects are, not to come to a once-and-for-all
conclusion about the urban housing market. The real insight that is offered by
these examples is that you have to consider both the supply and the demand
side of the apartment market when you analyze the impact of this particular
policy.
The only concept that the students seem to have trouble with in this chapter
is the idea of Pareto efficiency. I usually talk about the idea a little more than
is in the book and rephrase it a few times. But then I tell them not to worry
about it too much, since we’ll look at it in great detail later in the course.
The workbook problems here are pretty straightforward. The biggest problem
is getting the students to draw the true (discontinuous) demand curve, as in
Figure 1.1, rather than just to sketch in a downward-sloping curve as in Figure
1.2. This is a good time to emphasize to the students that when they are given
numbers describing a curve, they have to use the numbers—they can’t just sketch
in any old shape.
2 Chapter Highlights
The Market
A. Example of an economic model — the market for apartments
1. models are simplifications of reality
2. for example, assume all apartments are identical
3. some are close to the university, others are far away
4. price of outer-ring apartments is exogenous — determined outside the
model
5. price of inner-ring apartments is endogenous — determined within the
model
B. Two principles of economics
1. optimization principle — people choose actions that are in their interest
2. equilibrium principle — people’s actions must eventually be consistent
with each other
C. Constructing the demand curve
1. line up the people by willingness-to-pay. See Figure 1.1.
2. for large numbers of people, this is essentially a smooth curve as in Figure
1.2.
D. Supply curve
1. depends on time frame
2. but we’ll look at the short run — when supply of apartments is fixed.
E. Equilibrium
1. when demand equals supply
2. price that clears the market
F. Comparative statics
1. how does equilibrium adjust when economic conditions change?
2. “comparative” — compare two equilibria
3. “statics” — only look at equilibria, not at adjustment
4. example — increase in supply lowers price; see Figure 1.5.
5. example — create condos which are purchased by renters; no effect on
price; see Figure 1.6.
G. Other ways to allocate apartments
1. discriminating monopolist
2. ordinary monopolist
3. rent control
H. Comparing different institutions
1. need a criterion to compare how efficient these different allocation methods
are.
2. an allocation is Pareto efficient if there is no way to make some group
of people better off without making someone else worse off.
3. if something is not Pareto efficient, then there is some way to make some
people better off without making someone else worse off.
4. if something is not Pareto efficient, then there is some kind of “waste” in
the system.
I. Checking efficiency of different methods
1. free market — efficient
2. discriminating monopolist — efficient
3. ordinary monopolist — not efficient
4. rent control — not efficient
Chapter 1 3
J. Equilibrium in long run
1. supply will change
2. can examine efficiency in this context as well
Chapter 1
NAME
The Market
Introduction. The problems in this chapter examine some variations on
the apartment market described in the text. In most of the problems we
work with the true demand curve constructed from the reservation prices
of the consumers rather than the “smoothed” demand curve that we used
in the text.
Remember that the reservation price of a consumer is that price
where he is just indifferent between renting or not renting the apartment.
At any price below the reservation price the consumer will demand one
apartment, at any price above the reservation price the consumer will demand zero apartments, and exactly at the reservation price the consumer
will be indifferent between having zero or one apartment.
You should also observe that when demand curves have the “staircase” shape used here, there will typically be a range of prices where
supply equals demand. Thus we will ask for the the highest and lowest
price in the range.
1.1 (3) Suppose that we have 8 people who want to rent an apartment.
Their reservation prices are given below. (To keep the numbers small,
think of these numbers as being daily rent payments.)
Person
Price
= A
= 40
B
25
C
30
D
35
E
10
F
18
G
15
H
5
(a) Plot the market demand curve in the following graph. (Hint: When
the market price is equal to some consumer i’s reservation price, there
will be two different quantities of apartments demanded, since consumer
i will be indifferent between having or not having an apartment.)
2
THE MARKET
(Ch. 1)
Price
60
50
40
30
20
10
0
1
2
3
4
5
6 7
8
Apartments
(b) Suppose the supply of apartments is fixed at 5 units. In this case
there is a whole range of prices that will be equilibrium prices. What is
the highest price that would make the demand for apartments equal to 5
units?
$18.
(c) What is the lowest price that would make the market demand equal
to 5 units?
$15.
(d) With a supply of 4 apartments, which of the people A–H end up
getting apartments?
A, B, C, D.
(e) What if the supply of apartments increases to 6 units. What is the
range of equilibrium prices?
$10 to $15.
1.2 (3) Suppose that there are originally 5 units in the market and that
1 of them is turned into a condominium.
(a) Suppose that person A decides to buy the condominium. What will
be the highest price at which the demand for apartments will equal the
supply of apartments? What will be the lowest price? Enter your answers in column A, in the table. Then calculate the equilibrium prices of
apartments if B, C, . . . , decide to buy the condominium.
NAME
3
Person
A
B
C
D
E
F
G
H
High price
18
18
18
18
25
25
25
25
Low price
15
15
15
15
18
15
18
18
(b) Suppose that there were two people at each reservation price and 10
apartments. What is the highest price at which demand equals supply?
18.
Suppose that one of the apartments was turned into a condo-
minium. Is that price still an equilibrium price?
Yes.
1.3 (2) Suppose now that a monopolist owns all the apartments and that
he is trying to determine which price and quantity maximize his revenues.
(a) Fill in the box with the maximum price and revenue that the monopolist can make if he rents 1, 2, . . ., 8 apartments. (Assume that he must
charge one price for all apartments.)
Number
1
2
3
4
5
6
7
8
Price
40
35
30
25
18
15
10
5
Revenue
40
70
90
100
90
90
70
40
(b) Which of the people A–F would get apartments?
A, B, C, D.
(c) If the monopolist were required by law to rent exactly 5 apartments,
what price would he charge to maximize his revenue?
(d) Who would get apartments?
$18.
A, B, C, D, F.
(e) If this landlord could charge each individual a different price, and he
knew the reservation prices of all the individuals, what is the maximum
revenue he could make if he rented all 5 apartments?
$148.
(f ) If 5 apartments were rented, which individuals would get the apartments?
A, B, C, D, F.
1.4 (2) Suppose that there are 5 apartments to be rented and that the
city rent-control board sets a maximum rent of $9. Further suppose that
people A, B, C, D, and E manage to get an apartment, while F, G, and
H are frozen out.
4
THE MARKET
(Ch. 1)
(a) If subletting is legal—or, at least, practiced—who will sublet to whom
in equilibrium? (Assume that people who sublet can evade the city rentcontrol restrictions.)
E, who is willing to pay only
$10 for an apartment would sublet to
F,
who is willing to pay $18.
(b) What will be the maximum amount that can be charged for the sublet
payment?
$18.
(c) If you have rent control with unlimited subletting allowed, which of
the consumers described above will end up in the 5 apartments?
A,
B, C, D, F.
(d) How does this compare to the market outcome?
It’s the
same.
1.5 (2) In the text we argued that a tax on landlords would not get
passed along to the renters. What would happen if instead the tax was
imposed on renters?
(a) To answer this question, consider the group of people in Problem 1.1.
What is the maximum that they would be willing to pay to the landlord
if they each had to pay a $5 tax on apartments to the city? Fill in the
box below with these reservation prices.
Person
A
B
C
D
E
F
G
H
Reservation Price
35
20
25
30
5
13
10
0
(b) Using this information determine the maximum equilibrium price if
there are 5 apartments to be rented.
$13.
(c) Of course, the total price a renter pays consists of his or her rent plus
the tax. This amount is
$18.
(d) How does this compare to what happens if the tax is levied on the
landlords?
It’s the same.
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