ch13-18
ch 13
Quick Quizzes
1. Farmer McDonald’s opportunity cost is $300, consisting of 10 hours of lessons at $20 an hour that
he could have been earning plus $100 in seeds. His accountant would only count the explicit
cost of the seeds ($100). If McDonald earns $200 from selling the crops, then McDonald earns a
$100 accounting profit ($200 sales minus $100 cost of seeds) but incurs an economic loss of $100
($200 sales minus $300 opportunity cost).
2. Farmer Jones’s production function is shown in Figure 1 and his total-cost curve is shown in
Figure 2. The production function becomes flatter as the number of bags of seeds increases
because of the diminishing marginal product of seeds. The total-cost curve gets steeper as the
amount of production increases. This feature is also due to the diminishing marginal product of
seeds, since each additional bag of seeds generates a lower marginal product, and thus, the cost
of producing additional bushels of wheat rises.
Figure 1
Figure 2
3. The average total cost of producing 5 cars is $250,000/5 = $50,000. Since total cost rose from
$225,000 to $250,000 when output increased from 4 to 5, the marginal cost of the fifth car is
$25,000.
The marginal-cost curve and the average-total-cost curve for a typical firm are shown in Figure 3.
They cross at the efficient scale because at low levels of output, marginal cost is below average
total cost, so average total cost is falling. But after the two curves cross, marginal cost rises above
average total cost, and average total cost starts to rise. So the point of intersection must be the
minimum of average total cost.
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Figure 3
4. The long-run average total cost of producing 9 planes is $9 million/9 = $1 million. The long-run
average total cost of producing 10 planes is $9.5 million/10 = $0.95 million. Since the long-run
average total cost declines as the number of planes increases, Boeing exhibits economies of
scale.
Questions for Review
1. The relationship between a firm's total revenue, profit, and total cost is profit equals total revenue
minus total costs.
2. An accountant would not count the owner’s opportunity cost of alternative employment as an
accounting cost. An example is given in the text in which Caroline runs a cookie business, but she
could instead work as a computer programmer. Because she's working in her cookie factory, she
gives up the opportunity to earn $100 per hour as a computer programmer. The accountant
ignores this opportunity cost because money does not flow into or out of the firm. But the cost is
relevant to Caroline’s decision to run the cookie factory.
3. Marginal product is the increase in output that arises from an additional unit of input. Diminishing
marginal product means that the marginal product of an input declines as the quantity of the
input increases.
4. Figure 4 shows a production function that exhibits diminishing marginal product of labor. Figure 5
shows the associated total-cost curve. The production function is concave because of diminishing
marginal product, while the total-cost curve is convex for the same reason.
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Figure 4
Figure 5
5. 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 cost 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 total cost and marginal cost is that 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.
Figure 6
6. Figure 6 shows the marginal-cost curve and the average-total-cost curve for a typical firm. There
are three main features of these curves: (1) marginal cost is U-shaped but rises sharply as output
increases; (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 increasing for output greater than a certain
quantity because of diminishing returns. The average-total-cost curve is downward-sloping
initially because the firm is able to spread out fixed costs over additional units. The
average-total-cost curve is increasing beyond some output level because as quantity increases,
the demand for important variable inputs increases; therefore, the cost of these inputs increases.
The marginal-cost and average-total-cost curves intersect at the minimum of average total cost;
that quantity is the efficient scale.
7. In the long run, a firm can adjust the factors of production that are fixed in the short run; for
example, it can increase the size of its factory. As a result, the long-run average-total-cost curve
has a much flatter U-shape than the short-run average-total-cost curve. In addition, the long-run
curve lies along the lower envelope of the short-run curves.
8. Economies of scale exist when long-run average total cost decreases as the quantity of output
increases, which occurs because of specialization among workers. Diseconomies of scale exist
when long-run average total cost rises as the quantity of output increases, which occurs because
of the coordination problems inherent in a large organization.
Quick Check Multiple Choice
1. a
2. d
3. d
4. c
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5. b
6. a
Problems and Applications
1. a. opportunity cost; b. average total cost; c. fixed cost; d. variable cost; e. total cost; f. marginal
cost.
2. a. The opportunity cost of something is what must be given up to acquire it.
b. The opportunity cost of running the hardware store is $550,000, consisting of $500,000 to
rent the store and buy the stock and a $50,000 implicit cost, because your aunt would quit
her job as an accountant to run the store. Because the total opportunity cost of $550,000
exceeds the projected revenue of $510,000, your aunt should not open the store, as her
economic profit would be negative.
3. a. The following table shows the marginal product of each hour spent fishing:
Hours
0
1
2
3
4
5
Fish
0
10
18
24
28
30
Fixed Cost
$10
10
10
10
10
10
Variable Cost
$0
5
10
15
20
25
Total Cost
$10
15
20
25
30
35
Marginal Product
--10
8
6
4
2
b. Figure 7 graphs the fisherman's production function. The production function becomes flatter
as the number of hours spent fishing increases, illustrating diminishing marginal product.
Figure 7
c.
The table shows the fixed cost, variable cost, and total cost of fishing. Figure 8 shows the
fisherman's total-cost curve. It has an upward slope because catching additional fish takes
additional time. The curve is convex because there are diminishing returns to fishing time
because each additional hour spent fishing yields fewer additional fish.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Figure 8
4. Here is the completed table:
Workers
Output
0
1
2
3
4
5
6
7
0
20
50
90
120
140
150
155
Marginal
Product
--20
30
40
30
20
10
5
Total
Cost
$200
300
400
500
600
700
800
900
Average
Total Cost
--$15.00
8.00
5.56
5.00
5.00
5.33
5.81
Marginal
Cost
--$5.00
3.33
2.50
3.33
5.00
10.00
20.00
a. See the table for marginal product. Marginal product rises at first, then declines because of
diminishing marginal product.
b. See the table for total cost.
c.
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. 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. When marginal product is rising, marginal cost is falling, and vice versa.
f.
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.
5. At an output level of 600 players, total cost is $180,000 (600 × $300). The total cost of
producing 601 players is $180,901. Therefore, you should not accept the offer of $550, because
the marginal cost of the 601st player is $901.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
6. a. The fixed cost is $300, because fixed cost equals total cost minus variable cost. At an output
of zero, the only costs are fixed cost.
b.
Quantity
0
1
2
3
4
5
6
Total
Cost
$300
350
390
420
450
490
540
Variable
Cost
$0
50
90
120
150
190
240
Marginal Cost
(using total cost)
--$50
40
30
30
40
50
Marginal Cost
(using variable cost)
--$50
40
30
30
40
50
Marginal cost equals the change in total cost for each additional unit of output. It is
also equal to the change in variable cost for each additional unit of output. This
relationship occurs because total cost equals the sum of variable cost and fixed cost
and fixed cost does not change as the quantity changes. Thus, as quantity increases,
the increase in total cost equals the increase in variable cost.
7. The following table illustrates average fixed cost (AFC), average variable cost (AVC), and average
total cost (ATC) for each quantity. The efficient scale is 4 houses per month, because that
minimizes average total cost.
Quantity
0
Variable
Cost
$0.00
Fixed
Cost
$200.00
1
2
3
4
5
6
7
10.00
20.00
40.00
80.00
160.00
320.00
640.00
200.00
200.00
200.00
200.00
200.00
200.00
200.00
Total
Cost
$200.0
0
210.00
220.00
240.00
280.00
360.00
520.00
840.00
Average
Fixed Cost
---
Average
Variable Cost
---
Average
Total Cost
---
$200.00
100.00
66.67
50.00
40.00
33.33
28.57
$10.00
10.00
13.33
20.00
32.00
53.33
91.43
$210.00
110.00
80.00
70.00
72.00
86.67
120.00
8. a. The lump-sum tax causes an increase in fixed cost. Therefore, as Figure 10 shows, only
average fixed cost and average total cost will be affected.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Figure 10
b. Refer to Figure 11. Average variable cost, average total cost, and marginal cost will all be
greater. Average fixed cost will be unaffected.
Figure 11
9. a. The following table shows average variable cost (AVC), average total cost (ATC), and
marginal cost (MC) for each quantity.
Quantity
0
1
2
3
4
5
6
Variable
Cost
$0.00
10.00
25.00
45.00
70.00
100.00
135.00
Total
Cost
$30.00
40.00
55.00
75.00
100.00
130.00
165.00
Average
Variable Cost
--$10.00
12.50
15.00
17.50
20.00
22.50
Average
Total Cost
--$40.00
27.50
25.00
25.00
26.00
27.50
Marginal
Cost
--$10.00
15.00
20.00
25.00
30.00
35.00
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
b. Figure 12 shows the three curves. The marginal-cost curve is below the average-total-cost
curve when output is less than four and average total cost is declining. The marginal-cost
curve is above the average-total-cost curve when output is above four and average total cost
is rising. The marginal-cost curve lies above the average-variable-cost curve.
Figure 12
10. The following table shows quantity (Q), total cost (TC), and average total cost (ATC) for the three
firms:
Quantit
y
1
2
3
4
5
6
7
Firm A
TC
ATC
$60.00
70.00
80.00
90.00
100.00
110.00
120.00
$60.00
35.00
26.67
22.50
20.00
18.33
17.14
Firm B
TC
ATC
$11.00
24.00
39.00
56.00
75.00
96.00
119.00
$11.00
12.00
13.00
14.00
15.00
16.00
17.00
Firm C
TC
ATC
$21.00
34.00
49.00
66.00
85.00
106.00
129.00
$21.00
17.00
16.33
16.50
17.00
17.67
18.43
Firm A has economies of scale because average total cost declines as output increases. Firm B
has diseconomies of scale because average total cost rises as output rises. Firm C has economies
of scale from one to three units of output and diseconomies of scale for levels of output beyond
three
ch14
Quick Quizzes
1. When a competitive firm doubles the amount it sells, the price remains the same, so its total
revenue doubles.
2. A profit-maximizing competitive firm sets price equal to its marginal cost. If price were above
marginal cost, the firm could increase profits by increasing output, while if price were below
marginal cost, the firm could increase profits by decreasing output.
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A profit-maximizing competitive firm decides to shut down in the short run when price is less than
average variable cost. In the long run, a firm will exit a market when price is less than average
total cost.
3. In the long run, with free entry and exit, the price in the market is equal to both a firm’s 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 market drive the price of the good to the minimum point on the
average-total-cost curve.
Figure 1
Questions for Review
1. The main characteristics of a competitive firm are: (1) there are many buyers and many sellers in
the market; (2) the goods offered by the various sellers are largely the same; and (3) usually
firms can freely enter or exit the market.
2. A firm’s total revenue equals its price multiplied by the quantity of units it sells. Profit is the
difference between total revenue and total cost. Firms are assumed to maximize profit.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
3. Figure 2 shows the cost curves for a typical firm. A competitive firm chooses the level of output
that maximizes profit where marginal cost equals price (Q*), as long as price exceeds average
variable cost at that point (in the short run), or exceeds average total cost (in the long run). Total
revenue can be measured by the rectangular area with a height of P* and a base of Q*. Total cost
can be measured by the rectangular area with a height of ATC’ and a base of Q*.
Figure 2
4. A firm will shut down temporarily if the revenue it would get from producing is lower than the
variable costs of production. This occurs if price is less than average variable cost.
5. A firm will exit a market if the revenue it would get from remaining in business is less than its total
cost. This occurs if price is less than average total cost.
6. A competitive firm's price equals its 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.
7. The competitive firm's price must equal the minimum of its average total cost only in the long run.
In the short run, price may be greater than average total cost (in which case the firm is earning a
profit), price may be less than average total cost (in which case the firm is incurring a loss), or
price may be equal to average total cost (in which case the firm is breaking even). In the long run,
if firms are earning profits, other firms will enter the industry, which will lower the price of the
good. In the long run, if firms are incurring losses, they will exit the industry, which will raise the
price of the good. Entry or exit continues until firms are making neither profits nor losses. At that
point, price equals average total cost.
8. Market supply curves are typically more elastic in the long run than in the short run. In a
competitive market, because entry or exit occurs until price equals average total cost, quantity
supplied is more responsive to changes in price in the long run.
Quick Check Multiple Choice
1. c
2. b
3. d
4. a
5. d
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
6. c
Problems and Applications
1. a. As shown in Figure 3, the typical firm's initial marginal-cost curve is MC1 and its
average-total-cost curve is ATC1. In the initial equilibrium, the market supply curve, S1,
intersects the demand curve at price P1, which is equal to the minimum average total cost of
the typical firm. Thus, the typical firm earns no economic profit. The rise in the price of crude
oil increases production costs for individual firms (from MC1 to MC2 and from ATC1 to ATC2)
and thus shifts the market supply curve to the left, to S2.
Figure 3
b. When the market supply curve shifts left to S2, the equilibrium price rises from P1 to P2, but
the price does not increase by as much as the increase in marginal cost for the firm. As a
result, price is less than average total cost for the firm, so profits are negative.
In the long run, the negative profits lead some firms to exit the market. As they do so, the
market supply curve shifts to the left. This continues until the price rises to equal the
minimum point on the firm's average-total-cost curve. The long-run equilibrium occurs with
supply curve S3, equilibrium price P3, total market output Q3, and firm's output q3. Thus, in
the long run, profits are zero again and there are fewer firms in the market.
2. Once you have ordered the dinner, its cost is sunk, so it does not represent an opportunity cost.
As a result, the cost of the dinner should not influence your decision about whether to finish it.
3. Bob' total variable cost is his total cost each day less his fixed cost ($280 - $30 = $250).
His average variable cost is his total variable cost each day divided by the number of
lawns he mows each day ($250/10 = $25). Because his average variable cost is less
than his price, he will not shut down in the short run. Bob's average total cost is his
total cost each day divided by the number of lawns he mows each day ($280/10 = $28).
Because his average total cost is greater than his price, he will exit the industry in the
long run.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
4. Here is the table showing costs, revenues, and profits:
Quantity
0
Total
Cost
$8
Marginal
Cost
---
Total
Revenue
Marginal
Revenue
---
Profit
$-8
$0
1
9
$1
8
-1
$8
2
3
4
5
6
7
10
11
13
19
27
37
1
1
2
6
8
10
16
24
32
40
48
56
8
8
8
8
8
8
6
13
19
21
21
19
a. The firm should produce five or six units to maximize profit.
b. 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).
Figure 4
c.
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.
5. a. Costs are shown in the following table:
Q
0
1
2
3
4
5
6
TFC
$100
100
100
100
100
100
100
TVC
$0
50
70
90
140
200
360
AFC
---$100
50
33.3
25
20
16.7
AVC
---$50
35
30
35
40
60
ATC
---150
85
63.3
60
60
76.7
MC
---50
20
20
50
60
160
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b. If the price is $50, the firm will minimize its loss by producing 4 units, where price is equal to
marginal cost. When the firm produces 4 units, its total revenue is $200 ($50 x 4 = $200) and
its total cost is $240 ($100 + $140). This would give the firm a loss of $40. If the firm
shuts down, it will earn a loss equal to its fixed cost ($100). The CEO did not make a wise
decision.
c.
If the firm produces 1 unit, its total revenue is $50 and its total cost is $150 ($100 + $50), so
its loss will still be $100. This was also not the best decision. The firm could have reduced its
loss by producing more units because the marginal costs of the second and third unit are
lower than the price.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
6. a. Figure 5 shows the curves of a typical firm in the industry, with average total cost ATC1,
marginal cost MC1, and marginal revenue equal to price P1. The long-run-supply curve is the
marginal cost curve above the minimum point of ATC1.
b. The new process reduces Hi-Tech’s marginal cost to MC2 and its average total cost to ATC2,
but the price remains at P1 because other firms cannot use the new process. Thus Hi-Tech
produces Q2 units and earns positive profits.
c.
When the patent expires and other firms are free to use the technology, all firms’
average-total-cost curves decline to ATC2, so the market price falls to P3 and firms earn zero
profit.
Figure 5
7. Since the firm operates in a perfectly competitive market, its price is equal to its marginal revenue
of $10. This means that average revenue is also $10 and 50 units were sold.
8. a. Profit is equal to (P – ATC) × Q.
$200.
Price is equal to AR. Therefore, profit is ($10 – $8) × 100 =
b. For firms in perfect competition, marginal revenue and average revenue are equal. Since
profit maximization also implies that marginal revenue is equal to marginal cost, marginal
cost must be $10.
c.
Average fixed cost is equal to AFC /Q which is $200/100 = $2. Since average variable cost is
equal to average total cost minus average fixed cost, AVC = $8 − $2 = $6.
d. Since average total cost is less than marginal cost, average total cost must be rising.
Therefore, the efficient scale must occur at an output level less than 100.
9. a. If firms are currently incurring losses, price must be less than average total cost. However,
because firms in the industry are currently producing output, price must be greater than
average variable cost. If firms are maximizing profits, price must be equal to marginal cost.
b. The present situation is depicted in Figure 6. The firm is currently producing q1 units of output
at a price of P1.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Figure 6
c.
Figure 6 also shows how the market will adjust in the long run. Because firms are incurring
losses, there will be exit in this industry. This means that the market supply curve will shift to
the left, increasing the price of the product. As the price rises, the remaining firms will
increase quantity supplied; marginal cost will increase. Exit will continue until price is equal to
minimum average total cost. Average total cost will be lower in the long run than in the short
run. The total quantity supplied in the market will fall.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
10. a. The table below shows TC and ATC for a typical firm:
Q
TC
ATC
1
2
3
4
5
6
11
15
21
29
39
51
11
7.5
7
7.25
7.8
8.5
b. At a price of $11, quantity demanded is 200. With marginal revenue of $11, each firm will
choose to produce 5 pies where their marginal cost is closest to the marginal revenue without
exceeding marginal revenue. Therefore, there will be 40 firms (= 200/5). Each producer will
earn total revenue of $55 ($11  5), total cost is $39, so profit is $16.
c.
The market is not in long-run equilibrium because firms are earning positive economic profit.
Firms will want to enter the market.
d. With free entry and exit, each producer will earn zero profit in the long run. Long-run
equilibrium will occur when price is equal to minimum average total cost ($7). At that price,
600 pies are demanded. Each firm will only produce 3 pies (the quantity at which, MC is
closest to MR without exceeding MR) meaning that there will be 200 pie producers in the
market.
11. a. Figure 7 illustrates the situation in the U.S. textile market. With no international trade, the
market is in long-run equilibrium. Supply intersects demand at quantity Q1 and price $30,
with a typical firm producing output q1.
Figure 7
b. The effect of imports at $25 is that the market supply curve follows the old supply curve up to
a price of $25, then becomes horizontal at that price. As a result, demand exceeds domestic
supply, so the country imports textiles from other countries. The typical domestic firm now
reduces its output from q1 to q2, incurring losses, because they were breaking even (profit
equal to zero) in long-run equilibrium when the price was $30 and their average total cost has
not decreased.
c.
In the long run, domestic firms will be unable to compete with foreign firms because their
costs are too high. All the domestic firms will exit the market and other countries will supply
enough to satisfy the entire domestic demand.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
12. a. The firms' variable cost (VC), total cost (TC), marginal cost (MC), and average total cost
(ATC) are shown in the table below:
Quantity
1
2
3
4
5
6
VC
1
4
9
16
25
36
TC
17
20
25
32
41
52
MC
1
3
5
7
9
11
ATC
17
10
8.33
8
8.20
8.67
b. If the price is $10, each firm will produce 5 units. There are 100 firms in the industry, so there
will be 5  100 = 500 units supplied in the market.
c.
At a price of $10 and a quantity supplied of 5, each firm is earning a positive profit because
price is greater than average total cost. Thus, entry will occur and the price will fall. As price
falls, quantity demanded will rise in accordance with the law of demand. This entry will
continue until price is equal to minimum average total cost, $8, and each firm is producing
the quantity at which marginal revenue ($8) is equal to marginal cost (4 units if we assume
units are not divisible). Therefore, the quantity supplied by each firm decreases.
d. Figure 8 shows the long-run market supply curve, which will be horizontal at minimum
average total cost, $8. Each firm produces 4 units.
Price
and
Costs
Market
Firm
MC
ATC
P=$8
P=$8
S
q=4
Figure 8
ch15
Quick Quizzes
1. A market might have a monopoly because: (1) a key resource is owned by a single firm; (2) the
government gives a single firm the exclusive right to produce some good; or (3) the costs of
production make a single producer more efficient than a large number of producers.
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Examples of monopolies include: (1) the water producer in a small town, who owns a key
resource, the one well in town; (2) a pharmaceutical company that is given a patent on a new
drug by the government; and (3) a bridge, which is a natural monopoly because (if the bridge is
uncongested) having just one bridge is efficient. Many other examples are possible.
2. 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. The monopolist wants to charge the highest possible
price but still sell his profit-maximizing level of output.
3. A monopolist produces a quantity of output that is less than the quantity of output that maximizes
total surplus because it produces the quantity at which marginal cost equals marginal revenue
rather than the quantity at which marginal cost equals price. This lower production level leads to
a deadweight loss.
4. Examples of price discrimination include: (1) movie tickets, for which children and senior
citizens get lower prices; (2) airline prices, which are different for business and leisure travelers;
(3) discount coupons, which lead to different prices for people who value their time in different
ways; (4) financial aid, which offers college tuition at lower prices to poor students and higher
prices to wealthy students; and (5) quantity discounts, which offer lower prices for higher
quantities, capturing more of a buyer’s willingness to pay. Many other examples are possible.
Compared to a monopoly that charges a single price, perfect price discrimination reduces
consumer surplus to zero, increases producer surplus, and increases total surplus because there
is no deadweight loss.
5. Policymakers can respond to the inefficiencies caused by monopolies in one of four ways: (1) by
trying to make monopolized industries more competitive; (2) by regulating the behavior of the
monopolies; (3) by turning some private monopolies into public enterprises; or (4) by doing
nothing at all. Antitrust laws prohibit mergers of large companies and prevent large companies
from coordinating their activities in ways that make markets less competitive, but such laws may
keep companies from merging and generating synergies that increase efficiency. Some
monopolies, especially natural monopolies, are regulated by the government, but it is hard to
keep a monopoly in business, achieve marginal-cost pricing, and give the monopolist an incentive
to reduce costs. Private monopolies can be taken over by the government, but the companies
are not likely to be well-run. Sometimes doing nothing at all may seem to be the best solution,
but there are clearly deadweight losses from monopoly that society will have to bear.
Questions for Review
1. Government-created monopoly comes from the existence of patent and copyright laws. Both
allow firms or individuals to be monopolies for extended periods of time—20 years for patents,
the life of the author plus 70 years for copyrights. But this monopoly power is good, because
without it, no one would write a book or a song and no firm would invest in research and
development to invent new products or pharmaceuticals.
2. An industry is a natural monopoly when a single firm can supply a good or service to an entire
market at a smaller cost than could two or more firms. As a market grows, it may evolve from a
natural monopoly to a competitive market.
3. A monopolist's marginal revenue is less than the price of its product because its demand curve is
the market demand curve. Thus, to increase the amount sold, the monopolist must lower the
price of its good for every unit it sells. This cut in price reduces the revenue on the units it was
already selling.
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A monopolist's marginal revenue can be negative because to get purchasers to buy an additional
unit of the good, the firm must reduce its price on all units of the good. The fact that it sells a
greater quantity increases the firm’s revenue, but the decline in price decreases the firm’s
revenue. The overall effect depends on the price elasticity of demand. If demand is inelastic,
marginal revenue will be negative.
4. Figure 1 shows the demand, marginal-revenue, average-total-cost, and marginal-cost curves for
a monopolist. The intersection of the marginal-revenue and marginal-cost curves determines the
profit-maximizing level of output, Qm. The profit-maximizing price, Pm can be found using the
demand curve. Profit is shown as the rectangular area with a height of ( PM – ATCM) and a base of
QM .
Figure 1
5. The level of output that maximizes total surplus in Figure 1 is where the demand curve intersects
the marginal-cost curve, Qc. The deadweight loss from monopoly is the triangular area between
Qc and Qm that is above the marginal-cost curve and below the demand curve. It represents
deadweight loss, because society loses total surplus because of the monopoly. The deadweight
loss is equal to the value of the good (measured by the height of the demand curve) less the cost
of production (given by the height of the marginal-cost curve), for the quantities between Qm and
Q c.
6. One example of price discrimination is in publishing books. Publishers charge a much higher price
for hardback books than for paperback books—far higher than the difference in production costs.
Publishers do this because die-hard fans will pay more for a hardback book when the book is first
released. Those who don't value the book as highly will wait for the paperback version to come
out. The publisher makes a greater profit this way than if it charged just one price.
A second example is the pricing of movie tickets. Theaters give discounts to children and senior
citizens because they have a lower willingness to pay for a ticket. Charging different prices helps
the theater increase its profit above what it would be if it charged just one price.
Many other examples are possible.
7. The government has the power to regulate mergers between firms because of antitrust laws.
Firms might want to merge to increase operating efficiency and reduce costs, something that is
good for society, or to gain market power, which is bad for society.
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8. When regulators tell a natural monopoly that it must set price equal to marginal cost, two
problems arise. The first is that, because a natural monopoly has a marginal cost that is always
less than average total cost, setting price equal to marginal cost means that the firm will incur a
loss. The firm would then exit the industry unless the government subsidized it. However, getting
revenue for such a subsidy would cause the government to raise other taxes, increasing the
deadweight loss. The second problem of using costs to set price is that it gives the monopoly no
incentive to reduce costs.
Quick Check Multiple Choice
1. d
2. b
3. d
4. a
5. b
6. c
Problems and Applications
1. The following table shows revenue, costs, and profits:
Price
Quantity
$100
90
80
70
60
50
40
30
20
10
0
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
1,000,00
0
Total
Revenue
$0
9,000,000
16,000,000
21,000,000
24,000,000
25,000,000
24,000,000
21,000,000
16,000,000
9,000,000
0
Marginal
Revenue
---$90
70
50
30
10
-10
-30
-50
-70
-90
Total Cost
Profit
$2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
7,000,000
8,000,000
9,000,000
10,000,000
11,000,000
12,000,000
$-2,000,000
6,000,000
12,000,000
16,000,000
18,000,000
18,000,000
16,000,000
12,000,000
6,000,000
-2,000,000
-12,000,000
a. 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. Marginal revenue is 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.
Figure 2 shows the marginal-revenue, marginal-cost, and demand curves. The
marginal-revenue and marginal-cost curves cross between quantities of 400,000 and
500,000. This signifies that the firm maximizes profits in that region.
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Figure 2
d. 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, 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 firm’s profit, which would fall.
f.
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.
2. a. Figure 3 illustrates the market for groceries when there are many competing supermarkets
with constant marginal cost. Output is QC, price is PC, consumer surplus is area A, producer
surplus is zero, and total surplus is area A.
Figure 3
Figure 4
b. Figure 4 illustrates the new situation when the supermarkets merge. Quantity declines from
QC to QM and price rises to PM. Consumer surplus falls by areas D + E + F to areas B + C.
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Producer surplus becomes areas D + E, and total surplus is areas B + C + D + E. Consumers
transfer the amount of areas D + E to producers and the deadweight loss is area F.
3. a. The following table shows total revenue and marginal revenue for each price and quantity
sold:
Price
Quantity
24
10,000
Total
Revenue
$240,000
Marginal
Revenue
----
Total
Cost
Profit
$190,000
$50,000
22
20,000
$20
440,000
20
30,000
18
40,000
14
60,000
150,000
450,000
200,000
520,000
250,000
550,000
300,000
540,000
12
720,000
50,000
340,000
16
600,000
16
100,000
8
800,000
4
840,000
b. Profits are maximized at a quantity where MR=MC. The quantity at which MC is closest to
MR without exceeding it is 50,000 CDs at a price of $16. At that point, profit is $550,000.
c.
As Johnny's agent, you should recommend that he demand $550,000 from them, so he
receives all of the profit (rather than the record company). The firm would still choose to
produce 50,000 CDs because their marginal cost would not change.
4. a. The table below shows total revenue and marginal revenue for the bridge. The
profit-maximizing price will occur at the quantity at which marginal revenue equals marginal
cost. In this case marginal cost equals zero, so the profit-maximizing quantity occurs where
marginal revenue equals 0. This occurs at a price of $4 and quantity of 400,000 crossings.
The efficient level of output is 800,000 crossings, because that is where price is equal to
marginal cost. The profit-maximizing quantity is lower than the efficient quantity because the
firm is a monopolist.
Price
$8
7
6
5
4
3
2
1
0
Quantity
(in Thousands)
0
100
200
300
400
500
600
700
800
Total Revenue
(in Thousands)
$0
700
1,200
1,500
1,600
1,500
1,200
700
0
Marginal
Revenue
---$7
5
3
1
-1
-3
-5
-7
b. The company should not build the bridge because its profits are negative. The most revenue
it can earn is $1,600,000 and the cost is $2,000,000, so it would lose $400,000.
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c.
If the government were to build the bridge, it should set price equal to marginal cost to be
efficient. Since marginal cost is zero, the government should not charge people to use the
bridge.
Price
$8
Area
= 1/2 x 8 x 800,000
= $3,200,000
Demand
800,000
Quantity of Crossings
Figure 5
d. Yes, the government should build the bridge, because it would increase society's total
surplus. As shown in Figure 5, total surplus has area ½ × 8 × 800,000 = $3,200,000, which
exceeds the cost of building the bridge.
5. Larry wants to sell as many drinks as possible without losing money, so he wants to set quantity
where price (demand) equals average total cost, which occurs at quantity QL and price PL in
Figure 6. Curly wants to bring in as much revenue as possible, which occurs where marginal
revenue equals zero, at quantity QC and price PC. Moe wants to maximize profits, which occurs
where marginal cost equals marginal revenue, at quantity QM and price PM.
Figure 6
6. a. Figure 7 shows the firm’s average-total-cost curve and marginal-cost curve. (The
marginal-cost curve is a horizontal line at $0 because there are no variable costs.) Because
average total cost falls continuously as output rises, this firm is a natural monopoly.
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Figure 7
b. If price is equal to $0, each person would visit the museum 10 times (= 10 – 0). Figure 8
shows the consumer surplus each resident would get. The benefit to each resident would be
consumer surplus (½  10  $10 = $50) minus the tax ($24) or $26.
Figure 8
c.
The table below shows the total revenue and profit for the town at various prices:
Price
$2
3
4
5
Qd per resident
8
7
6
5
Total Revenue
1,600,000
2,100,000
2,400,000
2,500,000
Profit
-800,000
-300,000
0
100,000
A price of $4 would allow the town to break even.
d. At a price of $4, each consumer would earn consumer surplus equal to ½  6  6 = $18. (See
Figure 9.) Consumers would be worse off. The town would gain revenue of $24 per person,
but it would not offset the drop in consumer surplus. Therefore, there would be a deadweight
loss.
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Figure 9
e. In the real world, it is unlikely that all residents have the same demand. Thus, an admission
price would push more of the cost on those who would use the museum.
7. a. A monopolist always produces a quantity at which demand is elastic. If the firm produced a
quantity for which demand was inelastic and the firm raised its price, quantity would fall by a
smaller percentage than the rise in price, so revenue would increase. Because costs would
decrease at a lower quantity, the firm would have higher revenue and lower costs, so profit
would be higher. Thus the firm should keep raising its price until profits are maximized, which
must happen on an elastic portion of the demand curve.
b. As Figure 10 shows, another way to see this is to note that on an inelastic portion of the
demand curve, marginal revenue is negative. Increasing quantity requires a greater
percentage reduction in price, so revenue declines. Because a firm maximizes profit where
marginal cost equals marginal revenue, and marginal cost is never negative, the
profit-maximizing quantity can never occur where marginal revenue is negative. Thus, it can
never be on the inelastic portion of the demand curve. Total revenue is maximized where
marginal revenue is equal to zero (QTR on Figure 10).
Figure 10
8. a. The profit-maximizing outcome is the same as maximizing total revenue in this case because
there are no variable costs. The total revenue from selling to each type of consumer is
shown in the following tables:
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Price
10
9
8
7
6
5
4
3
2
1
0
Price
10
9
8
7
6
5
4
3
2
1
0
Quantity of Adult
Tickets
0
100
200
300
300
300
300
300
300
300
300
Quantity of Child
Tickets
0
0
0
0
0
100
200
200
200
200
200
Total Revenue from Sale
of Adult Tickets
0
900
1,600
2,100
1,800
1,500
1,200
900
600
300
0
Total Revenue from Sale
of Child Tickets
0
0
0
0
0
500
800
600
400
200
0
To maximize profit, you should charge adults $7 and sell 300 tickets. You should
charge children $4 and sell 200 tickets. Total revenue will be $2,100 + $800 =
$2,900. Because total cost is $2,000, profit will be $900.
b. If price discrimination were not allowed, you would want to set a price of $7 for the tickets.
You would sell 300 tickets and profit would be $100.
c.
The children who were willing to pay $4 but will not see the show now that the price is $7 will
be worse off. The producer is worse off because profit is lower. Total surplus is lower. There
is no one that is better off.
d. In (a) total profit would be $400. In (b), there would be a $400 loss. There would be no
change in (c).
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9 a. The monopolist would set marginal revenue equal to marginal cost and then
substitute the profit-maximizing quantity into the demand curve:
10 – 2Q = 1 + Q
9 = 3Q
Q=3
P = 10 – Q = $7
Total revenue = P  Q = ($7)(3) = $21
Total cost = 3 + 3 + 0.5(9) = $10.5
Profit = $21 – $10.5 = $10.5
b. The firm becomes a price taker at a price of $6 and no longer has monopoly power.
In a competitive equilibrium, the price equals marginal cost so,
10 - Q = 1 + Q
10 = 1 + 2Q
9 = 2Q
Q = 4.5
P = 5.5
The firm will export soccer balls because the world price is greater than the
domestic price (in the absence of monopoly power). As Figure 11 shows, domestic
production will rise to 5 soccer balls, domestic consumption will rise to 4, and
exports will be 1.
Figure 11
c. The price actually falls even though Wiknam will now export soccer balls. Once
trade begins, the firm no longer has monopoly power and must become a price
taker. However, the world price of $6 is greater than the competitive equilibrium
price ($5.50) so the country exports soccer balls.
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d. Yes. The country would still export balls at a world price of $7. The firm is a price
taker and no longer is facing a downward-sloping demand curve. Thus, it is now
possible to sell more without reducing price.
10. a. Figure 12 shows the firm’s demand, marginal revenue, and marginal cost curves. The firm’s
profit is maximized at the output where marginal revenue is equal to marginal cost.
Therefore, setting the two equations equal, we get:
1,000 – 20Q = 100 + 10Q
900 = 30Q
Q = 30
The monopoly price is P = 1,000 – 10Q = 700 Ectenian dollars.
Figure 12
b. Social welfare is maximized where price is equal to marginal cost:
1,000 – 10Q = 100 + 10Q
900 = 20Q
Q = 45
At an output level of 45, the price would be 550 Ectenian dollars.
c.
The deadweight loss would be equal to (0.5)(15)(300) = 2,250 Ectenian dollars.
d. i.
A flat fee of 2000 Ectenian dollars would not alter the profit-maximizing price or
quantity. The deadweight loss would be unaffected.
ii.
A fee of 50 percent of the profits would not alter the profit-maximizing price
or quantity. The deadweight loss would be unaffected.
iii.
The marginal cost of production would rise by 150 Ectenian dollars if the
director was paid that amount for every unit sold. The new marginal cost
would be 100 + 10Q + 150. The new profit-maximizing output would be 25,
the marginal cost at that level would be 500, and the price would rise to 750.
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The deadweight loss would be smaller. With the new marginal cost
function, the quantity at which social welfare is maximized changes. Now,
price is equal to marginal cost when Q = 37.5:
1,000 - 10Q = 250 + 10Q
750 = 20Q
Q = 37.5
As a result, the deadweight loss would be equal to (0.5)(37.5-25)(750-500) =
1,562.50 Ectenian dollars rather than 2,250 Ectenian dollars.
iv.
If the director is paid 50 percent of the revenue, then total revenue is
500Q – 5Q2. Marginal revenue becomes 500 – 10Q. The profit-maximizing
output level will be 20 and the price will be 800 Ectenian dollars. The
deadweight loss will be greater.
11. a. Figure 13 shows the cost, demand, and marginal-revenue curves for the monopolist. Without
price discrimination, the monopolist would charge price PM and produce quantity QM.
Figure 13
b. The monopolist's profit consists of the two areas labeled X, consumer surplus is the two areas
labeled Y, and the deadweight loss is the area labeled Z.
c.
If the monopolist can perfectly price discriminate, it produces quantity QC, and has profit
equal to X + Y + Z.
d. The monopolist's profit increases from X to X + Y + Z, an increase in the amount Y + Z. The
change in total surplus is area Z. The rise in the monopolist's profit is greater than the change
in total surplus, because the monopolist's profit increases both by the amount of deadweight
loss (Z) and by the transfer from consumers to the monopolist (Y).
e. A monopolist would pay the fixed cost that allows it to discriminate as long as Y + Z (the
increase in profits) exceeds C (the fixed cost).
f.
A benevolent social planner who cared about maximizing total surplus would want the
monopolist to price discriminate only if Z (the deadweight loss from monopoly) exceeded C
(the fixed cost) because total surplus rises by Z – C.
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g. The monopolist has a greater incentive to price discriminate (it will do so if Y + Z > C) than
the social planner (she would allow it only if Z > C). Thus if Z < C but
Y + Z > C, the monopolist will price discriminate even though it is not in society's best
interest.
ch16
Quick Quizzes
1. Oligopoly is a market structure in which only a few sellers offer similar or identical products.
Examples include the market for breakfast cereals and the world market for crude oil.
Monopolistic competition is a market structure in which many firms sell products that are similar
but not identical. Examples include the markets for novels, movies, restaurant meals, and
computer games.
2. The three key attributes of monopolistic competition are: (1) there are many sellers; (2) each firm
produces a slightly different product; and (3) firms can enter or exit the market freely.
Figure 1 shows the long-run equilibrium in a monopolistically competitive market. This equilibrium
differs from that in a perfectly competitive market because price exceeds marginal cost and the
firm does not produce at the minimum point of average total cost but instead produces at less
than the efficient scale.
Figure 1
3. Advertising may make markets less competitive if it manipulates people’s tastes rather than being
informative. Advertising may give consumers the perception that there is a greater difference
between two products than really exists. That makes the demand curve for a product more
inelastic, so the firms can then charge greater markups over marginal cost. However, some
advertising could make markets more competitive because it sometimes provides useful
information to consumers, allowing them to take advantage of price differences more easily.
Advertising also facilitates entry because it can be used to inform consumers about a new
product. In addition, expensive advertising can be a signal of quality.
Brand names may be beneficial because they provide information to consumers about the quality
of goods. They also give firms an incentive to maintain high quality, since their reputations are
important. But brand names may be criticized because they may simply differentiate products
that are not really different, as in the case of drugs that are identical with the brand-name drug
selling at a much higher price than the generic drug.
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Questions for Review
1. The three attributes of monopolistic competition are: (1) there are many sellers; (2) each seller
produces a slightly different product; and (3) firms can enter or exit the market without
restriction. Monopolistic competition is like monopoly because firms face a downward-sloping
demand curve, so price exceeds marginal cost. Monopolistic competition is like perfect
competition because, in the long run, price equals average total cost, as free entry and exit drive
economic profit to zero.
2. In Figure 2, a firm has demand curve D1 and marginal-revenue curve MR1. The firm is making
profits because at quantity Q1, price (P1) is above average total cost (ATC). Those profits induce
other firms to enter the industry, causing the demand curve to shift to D2 and the
marginal-revenue curve to shift to MR2. The result is a decline in quantity to Q2, at which point the
price (P2) equals average total cost (ATC), so profits are now zero.
Figure 2
3. Figure 3 shows the long-run equilibrium in a monopolistically competitive market. Price equals
average total cost. Price is above marginal cost.
Figure 3
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4. Because, in equilibrium, price is above marginal cost, a monopolistic competitor produces too
little output. But this is a hard problem to solve because: (1) the administrative burden of
regulating the large number of monopolistically competitive firms would be high; and (2) the
firms are earning zero economic profits, so forcing them to price at marginal cost means that
firms would lose money unless the government subsidized them.
5. Advertising might reduce economic well-being because it manipulates people's tastes and
impedes competition by making products appear more different than they really are. But
advertising might increase economic well-being by providing useful information to consumers and
fostering competition.
6. Advertising with no apparent informational content might convey information to consumers if it
provides a signal of quality. A firm will not be willing to spend much money advertising a
low-quality good, but may be willing to spend significantly more to advertise a high-quality good.
7. The two benefits that might arise from the existence of brand names are: (1) brand names
provide consumers information about quality when quality cannot be easily judged in advance;
and (2) brand names give firms an incentive to maintain high quality to maintain the reputation of
their brand names.
Quick Check Multiple Choice
1. b
2. d
3. a
4. d
5. a
6. c
Problems and Applications
1. a. Tap water is a monopoly because there is a single seller of tap water to a household .
b. Bottled water is a monopolistically competitive market. There are many sellers of bottled
water, but each firm tries to differentiate its own brand from the rest.
c.
The cola market is an oligopoly. There are only a few firms that control a large portion of the
market.
d. The beer market is an oligopoly. There are only a few firms that control a large portion of the
market.
2. a. The market for wooden #2 pencils is perfectly competitive because pencils by any
manufacturer are identical and there are a large number of manufacturers.
b. The market for copper is perfectly competitive, because all copper is identical and there are a
large number of producers.
c.
The market for local electricity service is monopolistic because it is a natural monopoly—it is
cheaper for one firm to supply all the output.
d. The market for peanut butter is monopolistically competitive because different brand names
exist with different quality characteristics.
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e. The market for lipstick is monopolistically competitive because lipstick from different firms
differs slightly, but there are a large number of firms that can enter or exit without restriction.
3. a. A firm in monopolistic competition sells a differentiated product from its competitors.
b. A firm in monopolistic competition has marginal revenue less than price.
c.
Neither a firm in monopolistic competition nor in perfect competition earns economic profit in
the long run.
d. A firm in perfect competition produces at the minimum average total cost in the long run.
e. Both a firm in monopolistic competition and a firm in perfect competition equate marginal
revenue and marginal cost.
f.
A firm in monopolistic competition charges a price above marginal cost.
4. a. Both a firm in monopolistic competition and a monopoly firm face a downward-sloping
demand curve.
b. Both a firm in monopolistic competition and a monopoly firm have marginal revenue that is
less than price.
c.
A firm in monopolistic competition faces the entry of new firms selling similar products.
d. A monopoly firm earns economic profit in the long run.
e. Both a firm in monopolistic competition and a monopoly firm equate marginal revenue and
marginal cost.
f.
Neither a firm in monopolistic competition nor a monopoly firm produces the socially efficient
quantity of output.
5. a. The firm is not maximizing profit. For a firm in monopolistic competition, price is greater than
marginal revenue. If price is below marginal cost, marginal revenue must be less than
marginal cost. Thus, the firm should reduce its output to increase its profit.
b. The firm may be maximizing profit if marginal revenue is equal to marginal cost. However,
the firm is not in long-run equilibrium because price is less than average total cost. In this
case, firms will exit the industry and the demand facing the remaining firms will rise until
economic profit is zero.
c.
The firm is not maximizing profit. For a firm in monopolistic competition, price is greater than
marginal revenue. If price is equal to marginal cost, marginal revenue must be less than
marginal cost. Thus, the firm should reduce its output to increase its profit.
d. The firm could be maximizing profit if marginal revenue is equal to marginal cost. The firm is
in long-run equilibrium because price is equal to average total cost. Therefore, the firm is
earning zero economic profit.
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6. a. Figure 4 illustrates the market for Sparkle toothpaste in long-run equilibrium. The
profit-maximizing level of output is QM and the price is PM.
Figure 4
b. Sparkle's profit is zero, because at quantity QM, price equals average total cost.
c.
The consumer surplus from the purchase of Sparkle toothpaste is areas A + B. The efficient
level of output occurs where the demand curve intersects the marginal-cost curve, at QC. The
deadweight loss is area C, the area above marginal cost and below demand, from QM to QC.
d. If the government forced Sparkle to produce the efficient level of output, the firm would lose
money because average total cost would exceed price, so the firm would shut down. If that
happened, Sparkle's customers would earn no consumer surplus.
7. a. As N rises, the demand for each firm’s product falls. As a result, each firm’s demand curve will
shift left.
b. The firm will produce where MR = MC:
100/N – 2Q = 2Q
Q = 25/N
c.
25/N = 100/N – P
P = 75/N
d. Total revenue = P  Q = 75/N  25/N = 1875/N2
Total cost = 50 + Q2 = 50 + (25/N)2 = 50 + 625/N2
Profit = 1875/N2 – 625/N2 – 50 = 1250/N2 – 50
e. In the long run, profit will be zero. Thus:
1250/N2 – 50 = 0
1250/N2 = 50
N=5
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8. Figure 5 shows the cost, marginal revenue and demand curves for the firm under both conditions.
Figure 5
a. The price will fall from PMC to the minimum average total cost (PC) when the market becomes
perfectly competitive.
b. The quantity produced by a typical firm will rise to QC, which is at the efficient scale of output.
c.
Average total cost will fall as the firm increases its output to the efficient scale.
d. Marginal cost will rise as output rises. Marginal cost is now equal to price.
e. Profit will not change. In either case, the market will move to long-run equilibrium where all
firms will earn zero economic profit.
9. a. A family-owned restaurant would be more likely to advertise than a family-owned farm
because the output of the farm is sold in a perfectly competitive market, in which there is no
reason to advertise, while the output of the restaurant is sold in a monopolistically
competitive market.
b. A manufacturer of cars is more likely to advertise than a manufacturer of forklifts because
there is little difference between different brands of industrial products like forklifts, while
there are greater perceived differences between consumer products like cars. The possible
return to advertising is greater in the case of cars than in the case of forklifts.
c.
A company that invented a very comfortable razor is likely to advertise more than a company
that invented a less comfortable razor that costs the same amount to make because the
company with the very comfortable razor will get many repeat sales over time to cover the
cost of the advertising, while the company with the less comfortable razor will not.
10. a. Figure 6 shows Sleek’s demand, marginal-revenue, marginal-cost, and average-total-cost
curves. The firm will maximize profit at an output level of Q * and a price of P *. The shaded
are shows the firm’s profits.
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Figure 6
b. In the long run, firms will enter, shifting the demand for Sleek’s product to the left. Its price
and output will fall. Firms will enter until profits are equal to zero (as shown in Figure 7).
Figure 7
c.
As consumers become more focused on the stylistic differences in brands, they will be less
focused on price. This will make the demand for each firm’s products more price inelastic.
The demand curves may become relatively steeper, allowing Sleek to charge a higher price.
If these stylistic features cannot be copied, they may serve as a barrier to entry and allow
Sleek to earn profit in the long run.
d. A firm in monopolistic competition produces where marginal revenue is greater than zero.
This means that firm must be operating on the elastic portion of its demand curve.
ch17
Quick Quizzes
1. If the members of an oligopoly could agree on a total quantity to produce, they would choose to
produce the monopoly quantity, acting in collusion as if they were a monopoly.
If the members of the oligopoly make production decisions individually, self-interest induces them
to produce a greater quantity than the monopoly quantity.
2. The prisoners’ dilemma is the story of two criminals suspected of committing a crime, in which the
sentence that each receives depends both on his or her decision to confess or remain silent and
on the decision made by the other. The following table shows the prisoners’ choices:
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Bonnie’s Decision
Confess
Clyde’s
Decision
Confess Bonnie gets eight years
Clyde gets eight years
Remain Bonnie goes free
Silent Clyde gets 20 years
Remain Silent
Bonnie gets 20 years
Clyde goes free
Bonnie gets one year
Clyde gets one year
The likely outcome is that both will confess, since that is a dominant strategy for both.
The prisoners’ dilemma teaches us that oligopolies have trouble maintaining the
cooperative outcome of low production, high prices, and monopoly profits because
each oligopolist has an incentive to cheat.
3. It is illegal for businesses to make an agreement about reducing output or raising prices.
Antitrust laws are controversial because some business practices may appear
anti-competitive while in fact having legitimate business purposes. An example is
resale price maintenance.
Questions for Review
1. If a group of sellers could form a cartel, they would try to set quantity and price like a monopolist.
They would set quantity at the point where marginal revenue equals marginal cost, and set price
at the corresponding point on the demand curve.
2. 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.
3. Firms in an oligopoly produce a quantity of output that is less than the level produced by a
competitive market. They sell the product at a price that is greater than the competitive price.
4. As the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more
like a competitive market. The price approaches marginal cost, and the quantity produced
approaches the socially efficient level.
5. The prisoners’ dilemma is a game between two people or firms that illustrates why it is difficult for
opponents to cooperate even when cooperation would make them both better off. Each player
has a great incentive to cheat on any cooperative agreement to make herself or itself better off.
Thus, firms in an oligopoly have a difficult time maintaining a cooperative agreement.
6. The arms race and common resources are some examples of how the prisoners’ dilemma helps to
explain behavior. In the arms race during the Cold War, the United States and the Soviet Union
could not agree on arms reductions because each was fearful that after cooperating for a while,
the other country would cheat. When two companies share a common resource, they would be
better off sharing it. But, fearful that the other company will use more of the common resource,
each company ends up overusing it.
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7. Antitrust laws prohibit firms from trying to monopolize a market. They are used to prevent
mergers that would lead to excessive market power in any firm and to keep oligopolists from
acting together in ways that would make the market less competitive.
Quick Check Multiple Choice
1. d
2. c
3. a
4. d
5. c
6. d
Problems and Applications
1. a. If there were many suppliers of diamonds, price would equal marginal cost ($1,000), so the
quantity would be 12,000.
b. With only one supplier of diamonds, quantity would be set where marginal cost equals
marginal revenue. The following table derives marginal revenue:
Price
$8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Quantity
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
Total Revenue
$40,000,000
42,000,000
42,000,000
40,000,000
36,000,000
30,000,000
22,000,000
12,000,000
Marginal Revenue
---2,000,000
0
–2,000,000
–4,000,000
–6,000,000
–8,000,000
–10,000,000
With marginal cost of $1,000 per diamond, or $1 million per thousand diamonds,
the monopoly will maximize profits at a price of $7,000 and a quantity of 6,000.
Additional production beyond this point would lead to a situation where marginal
revenue is lower than marginal cost.
c.
If Russia and South Africa formed a cartel, they would set price and quantity like a
monopolist, so the price would be $7,000 and the quantity would be 6,000. If they split the
market evenly, they would share total revenue of $42 million and costs of $6 million, for a
total profit of $36 million. So each would produce 3,000 diamonds and get a profit of $18
million. If Russia produced 3,000 diamonds and South Africa produced 4,000, the price would
decline to $6,000. South Africa’s revenue would rise to $24 million, costs would be $4 million,
so profits would be $20 million, which is an increase of $2 million.
d. Cartel agreements are often not successful because each party has a strong incentive to
cheat to make more profit. In this case, each could increase profit by $2 million by producing
an extra 1,000 diamonds. However, if both countries did this, profits would decline for both of
them.
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2. a. OPEC members were trying to reach an agreement to cut production so they could raise the
price.
b. They were unable to agree on cutting production because each country has an incentive to
cheat on any agreement. The turmoil is a decline in the price of oil because of increased
production.
c.
OPEC would like Norway and Britain to join their cartel so that they could act as a monopoly.
3. a. Buyers who are oligopolists try to decrease the prices of goods they buy.
b. The owners of baseball teams would like to keep players’ salaries low. This goal is difficult to
achieve because each team has an incentive to cheat on any agreement, because they will be
able to attract better players by offering higher salaries.
c.
The salary cap would have formalized the collusion on salaries and helped to prevent any
team from cheating.
4. a. 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. 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.
The NAFTA agreement represents cooperation between the two countries. Each country
reduces tariffs and both are better off as a result.
d. The payoffs in the upper left and lower right parts of the box do reflect a nation’s 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.
5. a. Synergy does not have a dominant strategy. If Synergy believes that Dynaco will go with a
large budget, it will also choose a large budget. However, if Synergy believes that Dynaco
will go with a small budget, it will want a small budget as well.
b. Yes, Dynaco has a dominant strategy of going with a large budget.
Dynaco to follow no matter what Synergy chooses.
c.
The Nash equilibrium is that both firms will choose a large budget.
dominant strategy so Synergy will choose a large budget as well.
It is the best strategy for
Dynaco will follow its
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6. a. The payoffs are:
Your Decision
Work
Classmate’s
Decision
Shirk
You get 15 units of
happiness
Work
Classmate gets 15
units of happiness
You get 30 units of
happiness
Classmate gets 5
units of happiness
You get 5 units of
happiness
Shirk
Classmate gets 30
units of happiness
You get 10 units of
happiness
Classmate gets 10
units of happiness
b. The likely outcome is that both of you will shirk. If your classmate works, you’re better off
shirking, because you would rather have 30 units of happiness than 15. If your classmate
shirks, you are better off shirking because you would rather have 10 units of happiness than
5. So your dominant strategy is to shirk. Your classmate faces the same payoffs, so she will
also shirk.
c.
If you are likely to work with the same person again, you have a greater incentive to work, so
that your classmate will work, and you will both be better off. In repeated games,
cooperation is more likely.
d. The payoff matrix would become:
Your Decision
Work
Classmate’s
Decision
Shirk
You get 15 units of
happiness
Work
Classmate gets 55
units of happiness
You get 30 units of
happiness
Classmate gets 25
units of happiness
You get 5 units of
happiness
Shirk
Classmate gets 50
units of happiness
You get 10 units of
happiness
Classmate gets 10
units of happiness
Work is a dominant strategy for this new classmate. Therefore, the Nash
equilibrium will be for you to shirk and your classmate to work. You would get a B
and thus would prefer this classmate to the first. However, she would prefer
someone with a dominant strategy of working as well so that she could get an A.
7. a. The decision box for this game is:
Braniff’s Decision
Low Price
High Price
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American’s
Decision
Low
Pric
e
Low profit for Braniff
Low profit for American
Very low profit for Braniff
High profit for American
High
Pric
e
High profit for Braniff
Very low profit for
American
Medium profit for Braniff
Medium profit for
American
b. If Braniff sets a low price, American will set a low price. If Braniff sets a high price, American
will set a low price. So American has a dominant strategy to set a low price.
If American sets a low price, Braniff will set a low price. If American sets a high
price, Braniff will set a low price. So Braniff has a dominant strategy to set a low
price.
Because both have a dominant strategy to set a low price, the Nash equilibrium is
for both to set a low price.
c.
A better outcome would be for both airlines to set a high price; they would both get higher
profits. That outcome could only be achieved by cooperation (collusion). If that happened,
consumers would lose because prices would be higher and quantity would be lower.
8. a. The playoff matrix for this game is:
Player One’s Decision
Take Drug
Player
Two’s
Decision
Don’t Take Drug
Take Player 1 gets 5,000 – X
Drug Player 2 gets 5,000 – X
Player 1 gets 0
Player 2 gets 10,000 – X
Don’t Player 1 gets 10,000 – X
Take Player 2 gets 0
Drug
Player 1 gets 5,000
Player 1 gets 5,000
b. Taking the drug will be a dominant strategy for each player as long as X is less than 5,000.
c.
Making the drug safer (lowering X) raises the likelihood of taking the drug because it
increases the payoff.
9. a. If Kona enters, Big Brew would want to maintain a high price. If Kona does not enter, Big
Brew would want to maintain a high price. Thus, Big Brew has a dominant strategy of
maintaining a high price.
If Big Brew maintains a high price, Kona would enter. If Big Brew maintains a low
price, Kona would not enter. Kona does not have a dominant strategy.
b. Because Big Brew has a dominant strategy of maintaining a high price, Kona should enter.
This is the only Nash equilibrium.
c.
Little Kona should not believe this threat from Big Brew because it is not in Big Brew’s interest
to carry out the threat. If Little Kona enters, Big Brew can set a high price, in which case it
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makes $3 million, or Big Brew can set a low price, in which case it makes $1 million. Thus the
threat is an empty one, which Little Kona should ignore; Little Kona should enter the market.
d. If the two firms could successfully collude, they would agree that Big Brew would maintain a
high price and Kona would remain out of the market. They could then split a profit of $7
million.
ch18
Quick Quizzes
1.
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 output.
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.
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338 ❖ Chapter 18/The Markets for the Factors of Production
2.
A brain surgeon has a higher opportunity cost of enjoying leisure than a janitor because the
surgeon’s wage is much higher. That is why doctors work such long hours because leisure is
very expensive for them.
3.
An immigration of workers increases labor supply but has no effect on labor demand. The
result is an increase in the equilibrium quantity of labor and a decline in the equilibrium
wage, as shown in Figure 1. The decline in the equilibrium wage causes the quantity of labor
demanded to increase. The increase in the equilibrium quantity of labor causes the marginal
product of labor to decrease.
Figure 1
4.
The income of the owners of land and capital is determined by the value of the marginal
contribution of land and capital to the production process.
An increase in the quantity of capital would reduce the marginal product of capital, thus
reducing the incomes of those who already own capital. However, it would increase the
incomes of workers because a higher capital stock raises the marginal product of labor.
Questions for Review
1.
Events that could shift the demand for labor include changes in the output price,
technological change, and changes in the supply of other factors.
2.
A firm's production function describes the relationship between the quantity of labor used in
production and the quantity of output from production. The marginal product of labor is the
increase in the amount of output from an additional unit of labor. Thus, the marginal product of
labor depends directly on the production function. The value of the marginal product of labor is
the marginal product of labor multiplied by the market price of the output.
A competitive, profit-maximizing firm hires workers up to the point where the value of the
marginal product of labor equals the wage. As a result, the value-of-marginal-product curve is
the firm’s labor-demand curve.
3.
The wage can adjust to balance the supply and demand for labor while simultaneously
equaling the value of the marginal product of labor. Supply and demand for labor determine
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Chapter 18/The Markets for the Factors of Production ❖ 339
the equilibrium wage. Firms maximize profits by choosing the amount of labor where the
wage is equal to the value of the marginal product of labor.
4.
A large immigration would increase the supply of labor, thus reducing the wage. With more
labor working with capital and land, the marginal product of capital and land is higher, so
rents earned by owners of land and capital would increase.
5.
Events that could shift the supply of labor include changes in tastes, changes in alternative
opportunities, and immigration.
Quick Check Multiple Choice
1. c
2. b
3. a
4. b
5. d
6. d
Problems and Applications
1. a. If Congress were to buy personal computers for all U.S. college students, the demand for
computers would increase, raising the price of computers and thus increasing the value
of marginal product of workers who produce computers. This is shown in Figure 2 as a
shift in the demand curve for labor from D1 to D2. The result is an increase in the wage
from w1 to w2 and an increase in the quantity of labor from L1 to L2.
Figure 2
b.
If more college students major in engineering and computer science, the supply of labor
in the computer industry rises. This is shown in Figure 3 as a shift in the supply curve from
S1 to S2. The result is a decrease in the wage from w1 to w2 and an increase in the quantity
of labor from L1 to L2.
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340 ❖ Chapter 18/The Markets for the Factors of Production
Figure 3
c.
Figure 4
If computer firms build new manufacturing plants, this increases the marginal product of
labor and the value of the marginal product of labor for any given quantity of labor. This
is shown in Figure 4 as a shift in the demand curve for labor from D1 to D2. The result is an
increase in the wage from w1 to w2 and an increase in the quantity of labor from L1 to L2.
2. a. The law requiring people to eat one apple a day increases the demand for apples. As
shown in Figure 5, demand shifts from D1 to D2, increasing the price from P1 to P2, and
increasing quantity from Q1 to Q2.
Figure 5
b.
Because the price of apples increases, the value of marginal product increases for any
given quantity of labor. There is no change in the marginal product of labor for any given
quantity of labor. However, firms will choose to hire more workers and thus the marginal
product of labor at the profit-maximizing level of labor will be lower.
c.
As Figure 6 shows, the increase in the value of marginal product of labor shifts the
demand curve of labor from D1 to D2. The equilibrium quantity of labor rises from L1 to L2,
and the wage rises from w1 to w2.
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Chapter 18/The Markets for the Factors of Production ❖ 341
Figure 6
3. a. Because the firm can sell all of the milk it wants to at the market price of $4 per gallon,
Smiling Cow Dairy operates in a perfectly competitive output market.
b. Since the firm can rent all the robots it wishes at the market price of $100 per day,
Smiling Cow Dairy rents robots in a perfectly competitive market.
The table below shows the MP and VMP for robots:
c.
# Robots
0
1
2
3
4
5
6
Total Output
0 gallons
50
85
115
140
150
155
MP
VMP
---50 gallons
35
30
25
10
5
---$ 200
150
120
100
40
20
d. The firm should rent robots up to the point where VMP is equal to the wage. Therefore,
it should rent 4 robots.
4. a. The marginal product of labor is equal to the additional output produced by an additional
unit of labor. The table below shows the marginal product of labor (MPL) for this firm:
Days of Labor
0
1
2
3
4
5
6
7
b.
Units of Output
0
7
13
19
25
28
29
29
MPL
VMPL
-7
6
6
6
3
1
0
-70
60
60
60
30
10
0
The value of the marginal product of labor (VMPL) is equal to the price multiplied by the
marginal product of labor ( MPL). It is also reported in the table.
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342 ❖ Chapter 18/The Markets for the Factors of Production
c.
The labor demand schedule for the firm is:
Wage
$0
10
30
60
60
60
70
d.
Quantity of Labor Demanded
7
6
5
4
3
2
1
The labor demand curve is the same as the value-of-the-marginal-product curve. It is
shown in Figure 7.
Figure 7
e.
If the price of the output rises to $12, the demand for labor will shift to the right because
the value of the marginal product will be higher at each level of labor hired.
5.
Because your uncle is maximizing his profit, he must be hiring workers such that their wage
equals the value of their marginal product. Because the wage is $6 per hour, their value of
marginal product must be $6 per hour. Because the value of marginal product equals the
marginal product times the price of the good and because the price of a sandwich is $3, the
marginal product of a worker must be two sandwiches per hour.
6.
a. The firm’s demand for labor is the same as its value of marginal product. The firm will set
wage equal to VMP:
w = VMP = P
MPL = 2(100 – 2L) = 200 – 4L
The market demand curve for labor will be the horizontal summation of the 20 firm demand
curves (summed across L).
Rearranging the firm’s demand, we get L = 50 – 0.25w. Thus, the market demand curve
must be L = 20(50 – 0.25w) = 1,000 – 5w.
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Chapter 18/The Markets for the Factors of Production ❖ 343
b.
If labor supply is inelastic at 200, then we can solve for wage by determining the market
equilibrium:
200 = 1,000 – 5w
w = 160.
Each firm will hire 10 workers and produce Q = 100(10) – (10)2 = 900 apples. Total revenue
for each firm will be (2)(900) = 1,800. Assuming that wages are the firm’s only costs, total
costs will be (160)(10) = 1,600, leaving each firm with profit = 200. Total income for the
country will be (200)(160) + (20)(200) = 36,000.
c.
If the world price of apples rises to $4, the value of marginal product (and thus each firm’s
demand for labor) rises.
w = VMP = P
MPL = 4(100 – 2L) = 400 – 8L
Rearranging for L, we get L = 50 – 0.125L. Thus, the market demand for labor becomes:
L = 20(50 – 0.125L) = 1,000 – 2.5w. Finding the new equilibrium wage, we get:
200 = 1,000 – 2.5w
w = 320
Each firm will still hire 10 workers and produce 900 apples. Thus total revenue will be
(4)(900) = 3,600. Total cost will be (320)(10) = 3,200. Profit will be 400.
d.
Total income will be (320)(200) + (400)(20) = 72,000.
Now there are 10 orchards, so the market demand is 10 times the individual firm demand
curves:
L = 10(50 – 0.25w) = 500 – 2.5w. Solving for the equilibrium wage, we get:
200 = 500 – 2.5w
w = 120
Each firm will now hire 20 workers and produce Q = 100(20) – (20)2 = 1,600.
Total revenue = (2)(1,600) = 3,200
Total cost = (120)(20) = 2,400. So profit = 800.
Total income in the country equals (120)(200) + (800)(10) = 32,000. Thus, income has
fallen in the country.
7.
a.
Leadbelly should hire workers up to the point where VMP is equal to the wage of $150
per day.
b.
Since VMP is equal to $150 at the profit-maximizing level of output, and VMP = MP × P,
the price of pencils must be $5 per box.
c.
As Figure 8 shows, the market wage is determined in the labor market ($150 per day).
The firm takes this wage as given and chooses its level of labor where VMP is equal to
$150 per day.
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344 ❖ Chapter 18/The Markets for the Factors of Production
Figure 8
d.
The decrease in the supply of labor will raise the equilibrium wage rate (see Figure 9).
The increase in wage will reduce the profit-maximizing level of labor hired. The value of
marginal product of workers will rise to the level of the new wage.
Figure 9
8.
9.
a.
When a freeze destroys part of the Florida orange crop, the supply of oranges declines,
so the price of oranges rises. Because there are fewer oranges in a given area of orange
trees, the marginal product of orange pickers declines. The value of the marginal product of
orange pickers could rise or fall, depending on whether the marginal product falls
more or less than the price rises. Thus, you cannot say whether the demand for orange
pickers will rise or fall.
b.
If the price of oranges doubles and the marginal product of orange pickers falls by just
30%, the value of marginal product for a particular quantity of orange pickers increases,
shifting the demand for orange pickers to the right, and increasing the equilibrium wage
of orange pickers.
c.
If the price of oranges rises by 30% and the marginal product of orange pickers falls by
50%, the value of marginal product for a particular quantity of orange pickers decreases,
shifting the demand for orange pickers to the left, and reducing the equilibrium wage of
orange pickers.
a.
A union is like a monopoly firm in that it is the only supplier of labor, just as a monopoly
is the only supplier of a good or service.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 18/The Markets for the Factors of Production ❖ 345
b.
Just as a monopoly firm wants to maximize profits, a labor union may wish to maximize
the labor income of its members.
c.
Just as the monopoly price exceeds the competitive price in the market for a good, the
union wage exceeds the free-market wage in the market for labor. Also, the quantity of
output of a monopoly is less than the quantity produced by a competitive industry; this
means that employment by a unionized firm will be lower than employment by a nonunionized firm, because the union wage is higher.
d.
Unions might wish to maximize total labor income of their members, or they might want
the highest wage possible, or they might wish to have the greatest employment possible.
In addition, they may wish to have improved working conditions, increased fringe benefits,
or some input into the decisions made by a firm’s management.
10. a.
Figure 10 shows the U.S. capital market when there is an inflow of capital from abroad.
The inflow of capital shifts the supply curve to the right, from S1 to S2. The result is a
reduction in the rental rate on capital from r1 to r2 and an increase in the quantity of
capital from K1 to K2.
Figure 10
b.
The increase in capital increases the marginal product of labor and the value of marginal
product of labor for any given quantity of labor. Figure 11 shows this as a shift in the
demand for labor from D1 to D2. As a result, the wage rate rises from w1 to w2 and the
quantity of labor rises from L1 to L2.
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346 ❖ Chapter 18/The Markets for the Factors of Production
Figure 11
11. a.
If a firm already gives workers fringe benefits valued at more than $3, the new law would
have no effect. But a firm that currently has fringe benefits less than $3 would be affected
by the law. Imagine a firm that currently pays no fringe benefits at all. The requirement
that it pay fringe benefits of $3 reduces the value of marginal product of labor effectively
by $3 in terms of the cash wage the firm is willing to pay. This is shown in Figure 12 as a
downward shift in the firm's demand for labor from D1 to D2, a shift down of exactly $3.
Figure 12
b.
Because the supply curve has a positive but finite slope, the new equilibrium will be one
in which the new wage, w2, is less than the old wage, w 1, but w2 > w1 $3. The quantity of
labor also declines.
c.
The preceding analysis is incomplete, of course, because it ignores the fact that the
fringe benefits are valuable to workers. As a result, the supply curve of labor might
increase, shown as a shift to the right in the supply of labor in Figure 13. In general,
workers would prefer cash to specific benefits, so the mandated fringe benefits are not
worth as much as cash would be. But in the case of fringe benefits there are two
offsetting advantages: (1) fringe benefits are not taxed; and (2) firms offer cheaper
provision of health care than workers could purchase on their own. Thus, whether the
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 18/The Markets for the Factors of
Production ❖ 347
fringe benefits are worth more or less than $3 depends on which of
these effects dominates.
F
i
g
u
r
e
1
3
Figure 13 is drawn under the assumption that the fringe benefits are worth
more than $3 to the workers. In this case, the new wage, w2, is less than
w1 – $3 and the quantity of labor increases from L1 to L2.
If the shift in the supply curve were the same as the shift in the demand curve,
then w2
= w1 – $3 and the quantity of labor remains unchanged.
If the shift in the supply curve were less than the shift in the demand curve,
then w2 >
w1 – $3 and the quantity of labor decreases.
In all three cases, there is a lower wage and higher quantity of labor than
if the supply curve were unchanged.
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d.
Because a minimum-wage law would not allow the wage to decline when greater fringe
benefits are mandated, it would lead to increased unemployment, because firms would
refuse to pay workers more than the value of their marginal product.
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the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.