Ch03-AK

1A) In a perfectly competitive market economy, any person who values the good more than the cost to produce it will be able to consume it. Since perfectly competitive firms produce products until the price they receive equals the marginal cost of production, any person with a marginal willingness to pay for the good exceeding the marginal cost of production will receive it.

 

1B) Healthcare is scarce. Willingness (or ability) to pay is not the only method for determining who consumes the resources. The government could tax citizens to fund healthcare programs, and then allow customers to receive services without paying out-of-pocket expenses. However, systems like this must still decide how to allocate services to people who want them. One clear advantage of the market is that it provides information about how much people truly value the service, as well as the cost of providing it. Most economists are likely to argue that the free market should allocate the services (since this is most likely to lead to an efficient solution), but that society can choose to reallocate wealth to make ability to pay more comparable across individuals. In this way, people would still buy the goods and services the value, rather than those that are convenient. Here are some alternatives:

System

Benefits

Costs

Market

Fair rules of the game.

Low income people are less likely to receive care.

 

(The rules are well-known and apply to everyone).

 

 

People who value healthcare the most will receive it.

 

 

All who value the service above the cost of its

 

 

   provision will receive it.

 

 

Incentive to conserve (only use services when

 

 

   needed).

 

 

 

 

First Come, First Serve

Fair rules of the game.

People who consume the service might value

 

Poor people have equal access.

   it less than the cost of providing it.

 

Incentive to conserve (only use services when

Massive waste of time.

 

   needed).

People who value time more will not consume

 

 

   the service.

 

 

 

Medical Need

Poor people have equal access.

People who consume the service might value

 

 

   it less than the cost of providing it.

 

 

Suppliers susceptible to bribes to move people

 

 

   to the head of the line.

 

 

Patients have an incentive to hurt themselves more

 

 

   in order to receive speedier service.

 

 

 

Lottery

Fair rules of the game.

People who consume the service might value

 

Poor people have equal access.

   it less than the cost of providing it.

 

 

It provides no information to the market about

 

 

   how much healthcare is truly desired.

 

 

 

Fist Fights

Fair rules of the game.

Women, children, and economics professors are

 

Poor people have equal access.

   at a decided disadvantage.

 

Encourages people to be healthy and strong.

People who consume the service might value

 

 

   it less than the cost of providing it.

 

 

It provides no information to the market about

 

 

   how much healthcare is truly desired.

 

 

 

Command and Control

Poor people have equal access.

People who consume the service might value

 

 

   it less than the cost of providing it.

 

 

It provides no information to the market about

 

 

   how much healthcare is truly desired.

 

 

The centralization of power will lead to massive

 

 

   corruption. Suppliers susceptible to bribes

 

 

   move people to the head of the line.

 

 

2A) When people go from being very poor to having some disposable income, they will definitely want to buy cars.

 

2B) The increased demand for cars (and driving) will also increase the demand for gasoline. This is a good illustration of how it is important to know the nature of the shock. Although gas and cars are complements, and the prices of complements usually move in opposite directions, the income shock in this case will increase the demand for both.

 

3)    Tax breaks make it less expensive to produce high tech goods.

4A) Add the quantity demanded at each price level.

Price ($)

Quantity

2

50

6

40

12

30

18

20

 

 

4B) My willingness to pay for the second product in $30 (this is much like the doughnut example in class). If the price is $40, my wife will buy five products. Notice that she places a greater value on many of these products than she actually has to pay. This is called “consumer surplus”, I topic we will discuss in greater detail in future chapters.

 

5A) Set Supply and Demand equal to each other.

       3*Q = 1000 – Q

       4*Q = 1000

       Q=250; P=750

 

5B) Demand is as before: P = 1000 – Q

       Supply is shifted up by 200: P = 200 + 3*Q

       Set them equal to find equilibrium.

       200 + 3*Q = 1000 – Q

       4*Q = 800

       Q = 200

       To find the price paid by consumers, substitute Q=200 into the demand curve.

       PConsumer = 1000 – 200 = 800

       Producers must pay $200 of this to the government, however, so they only earn $600.

       PProducer = 800 – 200 = 600

 

5C) Supply is the same as the original supply curve: P = 3*Q

       Now that the tax is on consumers, it will reduce their willingness to pay for TVs. It shifts demand to the left; subtract 200 from demand.

       Demand is now: P = 800 – Q

       Set them equal.

       3*Q = 800 – Q

       Q = 200

       By substituting this quantity into the supply curve (or new demand curve), you will find the price earned by producers.

       PProducer = 3*200 = 600

       Consumers pay this price plus the $200 tax.

       PConsumer = 600 + 200 = 800

 

5D) The incidence of the tax is the same in each case. Producers earn $600 per unit, consumers pay $800 per unit, and 200 units are sold. The main difference is conceptual. Part B is more common in Europe. Governments tax suppliers, so the cost of production increases. The sticker price and the price paid by consumers are the same thing. Part A is more common in the US. The sticker price on a good is the price that firms earn, but once the cashier rings up the price on the register, consumers see the price of their good with the sales tax.