Questions	ECON100A SPRING 2004
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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.

MyEconLab

Q: What is the course ID number?

A: The course ID number is perloff48153.

Chapter 2

Q: Why might a demand curve rotate?

A: The slope of the curve depends on tastes and other factors that we hold constant when we plot the quantity demanded versus the price. Suppose that tastes change or information change so that consumers decide that "can't live without" the product. Then, the demand curve will rotate and become much steeper: even if price rises, the quantity demanded won't fall much.

Q: In lecture, you said that a downward sloping supply curve was possible. What industries currently have a downward sloping supply curve?

A: We discuss reasons why supply curves may slope down in Chapter 8. Determining the slope of the supply curve in a particular market requires careful study of that market. Shea (Review of Economics and Statistics, 1993) examined the slopes of the supply curves in 26 American manufacturing industries (which he assumed to be competitive--which may be a questionable assumption). Only three of these industries have downward-sloping long-run supply curves: prepared feeds, construction equipment, and aircraft. Of the rest, more than twice as many are upward sloping as are flat. Sixteen industries have upward-sloping long-run supply curves, including lumber, drugs, paints, tires, cement, electronic components, and stone, clay, and glass. Seven industries, among them plumbing and heating products, floor coverings, and animal and marine fats and oils, have flat supply curves. On average across all these industries, the long-run supply curves have a moderate upward slope. The supply elasticity is 5.5 on average across all these manufacturing industries, so a 1% increase in price leads to a 5.5% increase in quantity.

Chapter 3

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.

Chapter 4

Q: On p. 99 and in class, you said, "If French meals were relatively more expensive than American meals in Paris, the French budget line would cut the American budget line from below rather than from above as shown. However the analysis would be essentially unchanged." Do you mean that the result will be different, but the method for doing this analysis is the same?

A: The outcome is unchanged if American food is relatively inexpensive in Paris. Just redraw the picture accordingly. You'll see that Alexx always benefits from substituting toward the relatively less expensive product. It doesn't matter which one is cheaper. Alexx MUST be at least as well off because he can always buy his original bundle.

Q: I have a quick question about solved problem 4.2 on page 91-92. When there is a quota like this one, does that cause the y-intercept of the budget line to increase? My reasoning is as follows... since there is a quota at 10, then people lose the pink-highlighted triangle and this is extra income for "other goods." So the y-intercept of the budget line instead of being y, should be y+z, where z is the amount of goods that can be purchased with the extra income that is equal to the pink triangle.

A: The y-intercept is determined by the amount of income divided by the price of all other goods. A binding restriction on buying one good doesn't give you more income to spend on another -- it forces you to allocate more of your existing income to the other good.

Chapter 5

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.

Chapter 6

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.

Chapter 7

Q: 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: 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 understand that, in Fig. 7.6, a relative change in the prices of K and L causes the slope of the isocost line to change, and that the new relevant isocost line is the one that is tangent to the original isoquant curve. However, given what we (those reading the textbook) know about the Norwegian printing firm, should we have been able to figure out on our own that the new isocost line is at 1032 kr, and that the new input quantities are 52 K and 77 L? I can draw a change in factor price graphically, but I cannot see how I would be able to derive these numbers.

A: It can be done with just the information you have (after all, I did it when I drew the diagram). I used the information about the firm's Cobb-Douglas production function. Once the prices change, the slope of the isocost line changes (the slope depends only on the relative prices). I then asked at what combination of labor and capital would the isoquant have that slope (MRTS). Then to find the level of the isocost, I calculated wL + rK for those particular values of L and K.

Q: In Chapter 7, p.199 of the book, it says that by shifting one krone from capital to labor, output will fall by 0.017 due to the decreas in capital but will rise by 0.1 due to increased labor. I'd think that this would result in an increase in output of 0.1 - 0.017 = .083 for the same cost. But the book says the increase in output is 0.983. I was hoping you could explain to me where that number came from.

A: I think you bought an older book. The first printing had a mistake there. The more recent version shows 0.083. Sorry about that.

Chapter 9

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.

Chapter 13

Q: I want to go into corporate law and am interested in the idea of mergers and acquisitions. Is there a way to show the effects of mergers and acquisitions on consumers in a market for a specific good or industry? For example, if a market was mostly competitive, but one company becomes involved in a large series of mergers or acquisitions so as to gain a significant percentage of the market share but without becoming a monopoly. Is there a way to predict the percentage decrease of consumers' say/ influence in pricing as the market share of one of the industry's firms increases? i.e., as the firm moves from being any old firm toward oligopoly and monopoly.

A: Briefly: There are two main reasons why firms merger. One is that a merger may lead to greater efficiency (particularly vertical mergers, where a firm buys another one that supplies it with an important factor of production -- see Chapter 15). The other is that a merger may create "market power, which allows the firm to charge higher prices because it has eliminated some of its competition. Thus, whether consumers benefit or are harmed by a merger turns on the reason for the merger. U.S. law charges the Justice Dept. and the FTC to monitor mergers to try to limit the second type. They use information about the structure of the market, facts about the firms, and economic analysis to predict the effects of the merger on prices. If a great deal of market power is likely to be created by the merger they will challenge it.

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".

Copyright Jeffrey M. Perloff, 2000, 2001, 2002, 2003, 2004.  All federal and state copyrights reserved for all original material presented in this course through any medium, including lecture or print.