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foundations of microeconomics

Questions and Answers of Foundations Of Microeconomics

The actual price level Pt is stochastic (of course, since it depends on the stochastic supply shock Ut ). By substituting (3.10) into (3.6), the expression for Pt is obtained:Pt =ao – bo ( 1
The final expression is the rational expectations solution for the expected price level.
Chapter 3: Rational Expectations and Economic Policy But the REH states in (3.5) that the objective expectation, Et_iPt, and the subjective expectation, Pt, coincide. Hence, by substituting Et_iPt =
vel must fall in order to is can also calculate (3.6) Pt – (1 – )1/4.)Pt-i= rao – bo) al – = rao – bo) )ai _Pt = rao – 110) + al bali (Pt – ( 1 – X)Pf-i)- ai (Ut – A) Ut_i(—ob
The third term can be simplified by making use of our knowledge concerning the distribution of Ut . Since Ut is not autocorrelated, the conditional expectation of it is equal to its unconditional
Consider the three terms on the right-hand side of (3.8) in turn. The first term is obvious: the conditional expectation of a known constant is that constant itself. The second term can similarly be
(3.8)
Equation (3.6) is crucial. It says that the actual price in period t depends on the price expected to hold in that period, and the realization of the stochastic shock Ut . More precisely, a higher
How does the REH work in our simple model? First, equilibrium outcomes are calculated. Hence, (3.3) is substituted into (3.1) and (3.2), which can then be solved for Pt and Qt in terms of the
where Et_1 is short-hand notation for E(. I Qt---1.), which is the conditional expectation operator. In words, equation (3.5) says that the subjective expectation of the price level in period t
The Foundation of Modern Macroeconomics but the REH states in expectation, coinc L.c solution for The final expression The actual price levc,;ply shock Ut ). By si(3.9)
The REH can now be stated very succinctly as:Pt = E [Pt I Qt_i] (3.5)luces a higher price level wage, employment, and-cant role. In a macroe-Lich as fluctuation in the, n reunification, OPEC i lot
Figure 3.3. Fourth, past realizations of the error terms are, of course, known. Agents know past observations on Qt_ i and Pt_i, and can use the model (3.1)-(3.3) to find out what the corresponding
Recall from first-year statistics that the normal distribution looks like the symmetric bell-shaped curve drawn in
Hence, the model parameters c/o, al , bo, and b1 are known to the agents as is the structure of the model given in (3.1)-(3.3). Third, although the actual realization of the stochastic error term Ut
What does this mean? First, the agents know all prices and quantities up to and including period t - 1 (they do not forget relevant past information). Obviously, the information set Qt-i does not
In other words, the agents know the price of the good, and there are no stochastic events occurring on the demand side of the market, such as random taste changes, income fluctuations, etc. Equation
Equation (3.1) shows that demand only depends on the actual price of the good.
Ut could summarize all the random elements introduced in the supply decision by the weather, crop failures, insect plagues, etc.
where Pt is the price of the good in period t, Qtli is the quantity demanded, Qis is the quantity supplied, and P; is the price level that suppliers expect in period t - 1 to hold in period t. The
In order to clarify these postulates, consider the following example of an isolated market for a non-storable good (so that inventory speculation is not possible). This market is describe IQ4D = ao _
(i) information is scarce and the economic system does not waste it, and (ii) the way in which expectations are formed depends in a well-specified way on the structure of the system describing the
in which stochastic elements play a role. The basic postulates of the REH are:
context one could think of stochastic events such as fluctuation in the climate, natural disasters, shocks to world trade (German reunification, OPEC shocks, the Gulf War), etc. In such a setting,
3.2. Expectational errors under adaptive expectations The Foundation of Modern Macroeconomics the agents. They realize that a higher money supply induces a higher price level and thus adjust their
Since there is no uncertainty in the model, forecasting is not difficult for onsistent expecta-'Pa° for the coney-ineffectiveness specify and use ution?ich he argued ational assump-L Muth's
supply (11 = P1), and supply the correct amount of labour. As a result, the economy jumps from E0 to E1, output is equal to Y* and the price level is P i . Of course, this adjustment story amounts to
With respect to the model illustrated in Figure 3.1, this would mean that agents hear at time to that the money supply has been increased from M0 to M1, use the relevant economic theory (equations
This is very unsatisfactory, Muth (1961) argued, because it is diametrically opposed to the way economists model human behaviour in other branches of economics. There, the notion of rational decision
The adjustment path of expectations is very odd, however, because agents(e.g. households supplying labour) make systematic mistakes along this path. The time paths for the actual and expected price
In the diagram this is represented by a gradual movement along the new AD curve towards point El , which is the new full equilibrium.
Figure 3.1. Monetary policy under adaptive expectations actual price level. This discrepancy is slowly removed by an upward revision of the expected price level, via the adaptive expectations
AEH that was discussed in Chapter 2. Consider Figure 3.1, which illustrates the hear at time to effects of monetary policy over time. The initial equilibrium is at point E0, with out- relevant econo
More than three decades ago, John Muth published an article in which he argued result, Muth pi forcefully that economists should be more careful about their informational assump- future events, a
4. What is the lasting contribution of the rational expectations revolution?
3. What are the implications of the REH for the way in which we specify and use The adjustm, macroeconometric models, and what is the Lucas critique? (e.g. household
2. What are the implications of the rational expectations hypothesis (REH) for the con - expected pricy A, duct of economic policy? What is the meaning of the so-called policy-ineffectiveness In the
1. What do we mean by rational expectations (also called model-consistent expectations)?actual price It
7. Which of the following statements about a nonrenewable natural resource market is incorrect?A. The demand for the resource is determined by its value of marginal product.B. The supply of the
6. To maximize profit, a firm .A. uses the quantity of land at which the rental rate equals the value of marginal product of land B. balances the rental rate of capital against the wage rate of labor
5. A union will if it can .A. raise the wage rate of its members; decrease the marginal product of its union members B. raise the wage rate of its members; introduce minimum qualifications, which
3. An individual’s supply of labor curve is .A. horizontal at the market wage rate B. upward sloping as the wage rate rises C. upward sloping at low wage rates but becomes downward sloping at high
2. The value of marginal product of labor increases if .A. more labor is hired B. more of the good is produced C. the market price of the good produced rises D. using a new technology reduces the
1. A firm’s demand for labor is determined by .A. the market wage rate B. the price of the good that the firm produces and the wage rate it pays C. the marginal product of labor and the market wage
. Hong Kong is much more densely populated than is the United States. Compare the rental rate on land in Hong Kong with that in Chicago. Explain why the percentage of commercial buildings that are
8. Suppose that Bananaland is the world’s largest grower of bananas. Bananaland plans to double its population in 3 years by hiring well-educated people from the United States. To increase the
7. Explain how the Bureau of Labor Statistics expects the market for coders to change in the future and draw a graph to show the expected changes.
6. Explain what happened in the market for coders after 2007 to demand, supply, and the quantities demanded and supplied and draw a graph to show the changes that occurred in the market for coders.
An ex-Google coder makes twice as much freelancing James Knight quit a well-paid job writing software for Google to go freelance and is now earning about double his Google pay as a freelancer.In a
4. If the price of a cup of coffee rises from $4 to $5 and the coffee shop continues to hire workers at the competitive wage rate, explain how the value of marginal product and the number of workers
2. In the years after World War II, the birth rate increased and the so-called baby boom generation was created. That generation is now beginning to retire. Draw a demand-supply graph to illustrate
Use the following information to work Problems 5 to 7 .MyEconLab Homework, Quiz, or Test if assigned by instructor
Use the following information to work Problems 3 and 4 .A new coffee shop opens and to maximize profit it hires 5 workers at the competitive wage rate. The price of a cup of coffee is $4 and the
10. Read Eye on the Coach and then draw demand-supply graphs to illustrate the markets for football coaches and economics professors. Explain the differences in the equilibrium wage rates and the
9. Explain how the widespread use of farm robots will create better paying farm jobs.
8. Explain how the widespread use of farm robots will change the rental rate of farm land.
7. Explain the effects of new farm robotic technologies on the value of marginal product of farm capital, farm labor, and farm land.
Source: Modern Farmer, December 31, 2015 USDA to grant $3 million for robots to roam farmlands The USDA’s National Robotics Initiative (NRI) will give $3 million in grants to farm robotics
6. Is it true that the opening of a new diamond mine in the Yukon in Canada will lower the world price of diamonds and lower the wage rate paid to diamond workers in South Africa? Use a graph to
4. If soccer becomes more popular in the United States and basketball becomes less popular, is it true that professional basketball players will earn more than they earn today? Use the laws of demand
7. Each of the following practices violates U.S. antitrust law except.A. an agreement to sell one good only if the buyer purchases another good B. an agreement between the manufacturer and the seller
6. In an advertising prisoners’ dilemma game, .A. both firms will advertise and end up with lower profits than if neither advertises B. only one firm will advertise because the other firm sees the
5. A Nash equilibrium .A. is the outcome that delivers maximum economic profit B. is the outcome in which each player takes the best action given the other player’s action C. changes each time the
4. In the prisoners’ dilemma game, each player .A. consults the other player to determine his best action B. chooses the best outcome for the other player C. chooses the best outcome for himself D.
3. The oligopoly dilemma is whether to .A. act together to restrict output and raise the price B. raise the price to the monopoly profit-maximizing price C. cheat on others in the cartel to take
2. If firms in oligopoly form a cartel, it will likely break down because .A. firms cannot agree on how to share the economic profit B. the price set by the cartel is too low C. with price exceeding
1. Which of the following statements is incorrect. In oligopoly, .A. barriers to entry prevent new firms entering B. each firm’s profit is influenced by each other firms’advertising C. each
7. Describe the fare-fixing scheme as the equilibrium outcome of an oligopoly cartel game played by the airlines. Explain why the cartel survived.Multiple Choice Quiz
6. Explain how limiting the increase in capacity could lead to greater profit for the airlines, smaller consumer surplus, and deadweight loss. Illustrate your explanation with a graph.
5. Explain how limiting the increase in capacity could lead to higher airfares.
It is alleged that Southwest Airlines, American Airlines, Delta Air Lines, and United Airlines have been colluding to limit the increases in their capacity with the intent of increasing airfares. The
Use this information to work Problems 5 to 7 .DOJ investigation prompts lawsuits alleging that airlines are fixing airfares
Wanabe enter or not? Explain.Source: The Dallas Morning News, July 8, 2015
Agile warns Wanabe to stay out and threatens to cut the price to the point at which Wanabe will make no profit if it enters.Wanabe does some research and determines that the payoff matrix for the
4. Agile Airlines is making $10 million a year economic profit on a route on which it has a monopoly. Wanabe Airlines is considering entering the market and operating on this route.
Is this game a prisoners’ dilemma? Table 1
Is the equilibrium efficient?
What is the equilibrium of this game?
Create the payoff matrix for this game.
Verizon incurs an economic loss of $100 million; if AT&T sets a high price and Verizon sets a low price, AT&T incurs an economic loss of $50 million and Verizon makes an economic profit of $250
1. AT&T and Verizon have two pricing strategies: Set a high(monopoly) price or set a low (competitive) price. Suppose that if they both set a competitive price, economic profit for both is zero.If
The United States claims that Canada subsidizes the production of softwood lumber and that U.S. imports of Canadian lumber damage the interests of U.S. producers. The United States has imposed a
Use the following information to work Problems 2 and 3 .
. Read Eye On the Wireless Oligopoly and then explain the effects of economies of scale and demand on the market for smartphone plans and illustrate it with a graph based on Figure 18.1
7. With two strategies—8-ounce can and 12-ounce can—and with assumed payoffs, create a payoff matrix for the game if the equilibrium outcome is for both firms to choose 8-ounce cans.
6. Describe the cola wars that Coca-Cola and PepsiCo play as a game. What type of game is it? What are some of the strategies in the game?
cola wars between Coca-Cola and PepsiCo may become even tougher as consumers seek out healthier alternatives to sugary soft drinks. But both Coke and Pepsi are getting higher prices for soda, thanks
Use the following information to work Problems 6 and 7 .Coke, Pepsi and the new front in the cola wars
5. Suppose that Ann and Zack have two strategies: collude, fix the monopoly price, and limit the number of rides or break the collusion, cut the price, and produce more rides. Create a payoff matrix
Would Ann and Zack have an incentive to collude and raise their price? Explain why or why not.
3. If Ann and Zack produce the same quantity of rides as would be produced in perfect competition, what are the quantity of rides, the price of a ride, and the economic profit of Ann and Zack?
2. Describe the changing barriers to entry in the automobile industry and explain how the combination of market demand and economies of scale has changed the structure of the industry over the past
1. Sketch the average total cost curve and the demand curve for automobiles in 1901 and in 2016.
Use the following information to work Problems 3 to 5 .Isolated Island has two taxi companies, one owned by Ann and the other owned by Zack. Figure 1 shows the market demand curve for taxi rides, D,
Over the years, the production line has become ever more mechanized, and today robots replace people in many tasks.
Study Plan Problems and Applications Use the following information to work Problems 1 and 2 .When the first automobiles were built in 1901, they were made by skilled workers using hand tools. Later,
18.4 Describe the antitrust laws that regulate oligopoly.Key Terms MyEconLab Key Terms Quiz Antitrust law Cartel Duopoly Game theory Nash equilibrium Payoff matrix Predatory pricing Prisoners’
The Federal Trade Commission examines and possibly blocks mergers if they would restrict competition too much.Use game theory to explain how output and price are determined in oligopoly.18.3
Predatory pricing might bring temporary gains.Tying arrangements can facilitate price discrimination.
The Sherman Act (1890) and the Clayton Act (1914) make pricefixing agreements among firms illegal.Resale price maintenance might be efficient if it enables a producer to ensure the efficient level of

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