Questions	ECON100A SPRING 2001
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  Q&A: academic and administrative questions

Questions about economics sent to Professor Perloff by e-mail will be answered personally.  These questions and answers will be posted on this page anonymously to be shared among the class. Please see Q&A to find who to see when you have academic or administrative questions.

Q: Solved Problem 3.2 asks about an inelastic supply curve. However, on p. 69 (first full line), you talk about a perfectly elastic supply curve. Why?

A: Ooops! You've found a typo. The vertical supply curve in the figure is perfectly INelastic. Sorry about that. Thanks for pointing it out.

Q: Please explain again why a monopoly never operates in the inelastic section of its demand curve.

A: If the monopoly increases its price, the quantity it sells falls (Law of Demand). The total cost of producing goods will be no higher and probably will be lower if quantity falls. In the inelastic part of the demand curve, when price increases, quantity falls less than in proportion. Therefore, revenue = price x quantity must rise. If revenue rises and cost falls, profit = revenue + cost must rise. Therefore, in the inelastic section of the demand curve, raising price always increases profit. Therefore, a firm will increase price until it is no longer in the inelastic portion of its demand curve.

Q: In lecture, you said that Cobb-Douglas production functions, could have constant (CRS), increasing (IRS), and decreasing (DRS) returns to scale depending on whether the exponents add to = 1, greater than 1 or less than 1. However, in macro last semester we were told that the coefficients must always equal one.

Q: Your macro instructor may have assumed that the Cobb-Douglas had CRS. That assumption is not in general true for firms or industries (as I illustrated with Canadian data for several sectors). Indeed, even at the macro level, not everyone assumes CRS. There is a large literature that estimates the parameters of an "economy-wide production function." This literature does find that this "production function" can be reasonably approximated as a Cobb-Doublas with nearly CRS (but not necessarily exactly CRS).

Q: I find it hard to believe that production can ever exhibit increasing returns to scale (IRS).

A: IRS is very common in industries like cement (because of high shipping costs, the product is sold locally and scale is limited). In these industries, we never see firms operating in anything but the IRS section. See the Exxon example in the textbook/lecture. With the same inputs, Exxon could run two small pipelines or one larger one. The larger one has enough capacity to more than doubles output (throughput). When Exxon increases its scale, it uses the larger pipeline, thereby greatly reducing its costs and/or increasing its output.

Q: I have a question regarding chapter seven. I am not sure I understand the relationship between returns to scale and economies of scale. Can you please explain their relationship to me?

A: Returns to scale means that doubling inputs more than doubles output. Consequently, it leads to economies of scale (AC falls as output expands) because it takes fewer inputs per unit of output. However, you can get economies of scale for other reasons as well. Thus, returns to scale is not a necessary condition for economies of scale. Consider a farmer. When the farm is small, all the tilling, etc., is done with labor. As the farm gets bigger, it pays to use a tractor (so the K/L ratio increases). The cost of producing per unit of output could fall as a consequence. This cost savings (downward sloping AC curve) could occur even if the production process has CRS or DRS. Also look at the example on p. 207.

Q: Is there a typo on the PowerPoint slides for Chapter 7 on page 8 (if you print them six to a page) where it says, "in LR, firm may change ratio of K/L as it expands output so could have economies of scale in costs without decreasing returns of scale in production." Should it not be increasing returns of scale in production?

A: Oops. You're right. Thanks.

Q: In Figure 7.6, when the wage falls, the isocost curve has a different slope and different intercepts. However, in Figure 5.1a, the budget line rotates when price of beer changed. Why is there such a difference when both graphs are holding y-axis constant, and I think budget line and isocost are similar in properties, right???

A: The budget line and isocost curves are similar in appearance, but different in concept. In particular, we are not holding the "y-axis constant" in Figure 7.6. In the consumer problem when the price of one input changed, we held income constant, so the budget line rotated (the y-axis intercept remained unchanged). In the firm's cost-minimizing problem, we want to hold output fixed, so we allow cost (the analog to income) to change. Look at the figure. You'll see that, not only did the wage rate change (which affects the slope), but the total cost changed so both axes' intercepts changed.

Q: I had a question while I was reading the chapter on competitive firms. In agricultural markets, there are many small suppliers, but there are also firms such as Dole or Del Monte that are bigger than many of the small distributors. So are they able to influence the market price?

A: In agricultural produce markets (fruits, vegetables,...) there are many (typically) small firms that cannot influence price. In food processing and retailing, there are fewer, larger firms such as Dole and Del Monte that produce differentiated products and can set prices. We'll look at this issue in more detail when we get to noncompetitive firms.

Q: The textbook on the page 133 at line 12 says, "When leisure is a normal good, the substitution and income effects work in opposite directions." However, the figure on p. 118 shows that substitution and income effects go in same direction: positive or negative depending on the price rises or falls. What's the difference between these examples?

A: In the usual example on p. 118, we're looking what happens if the price of the good on the horizontal axis falls (rotation of the budget line around a point on the vertical axis). In the example on p. 133, we're asking what happens if the price rise for labor so that there's a rotation of the budget line around a point on the horizontal axis.

Q: The textbook on the page 133 at line 12 says, "When leisure is a normal good, the substitution and income effects work in opposite directions." However, the figure on p. 118 shows that substitution and income effects go in same direction: positive or negative depending on the price rises or falls. What's the difference between these examples?

A: Both examples are correct. In the usual example (e.g., p. 118), we're looking what happens if the price of the good on the horizontal axis falls (rotation of the budget line around a point on the vertical axis). In the example on p. 133, we're asking what happens if the price rise for labor so that there's a rotation of the budget line around a point on the horizontal axis.

Q: I'd like more information about the cartel shown in the movie.

A: If you're interested, a speech about the cartel movie is available at the website for my other textbook: http://occ.awlonline.com/bookbind/pubbooks/carlton_awl/chapter5/deluxe.html. Look at the material entitled "A Cartel at Work".

Q: The answer at the back of the book for Chapter 9, problem 8, says that the consumer surplus falls by more than tax revenue increases and that that result should be clear from just the graphs in Solved Problem 8.3. Please explain.

A: The brief answer at the back of the book does require some explanation. Look at the figure in Solved Problem 8.3 (p. 258). The lump-sum tax per firm equals a rectangle (not shown) in panel a with a length = q_2 and a height equal to the difference between the two average cost curves at q_2. In panel b, the lost consumer surplus equals the area between p_2 and p_1 and to the left of the demand curve. That area consists of a rectangle and a triangle. The tax on all n_2 firms is a smaller rectangle with length Q_2 and the same height as in panel a. Thus, as promised, the loss to consumers exceeds the increase in tax revenue.

Copyright Jeffrey M. Perloff, 2000.  All federal and state copyrights reserved for all original material presented in this course through any medium, including lecture or print.