Buy Economic Efficiency and Public Policy

Buy Economic Efficiency and Public Policy
Buy Economic Efficiency and Public Policy
Question 2
a) productively; allocatively
b) more; less
c) perfect competition
d) price exceeds marginal cost
e) maximized
f) less; consumers; the producer; the deadweight loss of monopoly
Question 4
a) See the diagram below. At the free-market equilibrium in the labour market, consumer
surplus (earned by the firms who hire workers) is the light shaded area. Producer surplus
(earned by the workers who sell their labour services to firms) is the dark shaded area.
b) The establishment of a minimum wage at w
M raises the wage that firms must pay and
thus reduces the quantity of labour demanded by firms to LM. So LM is the new level of
employment. At the new wage, there is unemployment equal to LML′.
c) With the minimum wage in place, consumer surplus falls by the trapezoid w*wMAC.
Producer surplus rises by the rectangle w*wMAD but falls by the triangle BDC. The
rectangle w*wMAD is simply a redistribution from firms to those workers who are lucky
enough to remain employed after the policy comes into effect. The triangle ABC is the net
loss in consumer and producer surplus as a result of the policy, and reflects the extent of
the allocative inefficiency of the minimum-wage policy.
© 2005 Pearson Education Canada Inc.
Question 6
a) All points on the production possibilities boundary reflect productive efficiency both
for firms and industries. Thus if lime producers are not minimizing costs (productive
inefficiency), then only point A could represent this situation.
b) All points on the production possibilities boundary reflect productive efficiency both
for firms and industries. Thus points B, C and D are possible.
Buy Economic Efficiency and Public Policy
 
c) At point B there is a monopolized lime industry but a competitive coconut industry.
Since point B is on the production possibilities boundary, we know that it is productively
efficient. But the monopoly in the lime industry means it is not allocatively efficient. At
point B there are too few limes being produced (and thus too many coconuts being
produced).
d) At point D there is a monopolized coconut industry but a competitive lime industry.
Since point D is on the production possibilities boundary, we know that it is productively
efficient. But the monopoly in the coconut industry means it is not allocatively efficient.
At point D there are too few coconuts being produced (and thus too many limes being
produced).
e) If point C is allocatively efficient, we know that price equals marginal cost in all
industries simultaneously. In each industry, we are at the intersection of the competitive
demand and supply curves, and total surplus is maximized.
Question 8b) Since at Q1, price exactly equals average cost, the natural monopoly firm would be
earning zero economic profits.
© 2005 Pearson Education Canada Inc.
c) Since with price p1 and quantity Q1 the price would exceed marginal cost (equal to c1),
society would benefit by having more units of this good. The outcome is allocatively
inefficient.
d) For regulation that forced marginal-cost pricing, price would be p2 and quantity would
be Q2.
e) In this case, price would be less than average total cost (equal to c2) and the firm would
make losses (negative economic profits) shown by the shaded area.
f) Since price equals marginal cost in this case, the outcome would be allocatively
efficient since society values the last unit exactly the same as it costs to produce it. But
the losses (if they persist) ensure that the firm will eventually shut down, so this outcome
is unsustainable without some form of financial support to the firm. This shows the basic
problem of achieving efficiency in cases of natural monopoly.
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