Micro-economics assignment questions
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Question 2: Import Tariffs and Quotas In the 1980's the Australian government imposed quotas on the importation of cars without imposing restrictions on the construction of foreign-owned car factories in Australia. This question is intended for you to analyze a potential rationale for these policies. The demand for cars in Australia has the following form: QD ( P) = (1) where Qo(P) is in millions of cars and P is in units of $10,000. The domestic supply of cars in Australia takes the following form: Qs(P) = P (2) (a) What is the price elasticity of demand of this function when P = 2? What is the price elasticity when P = 3? (Hint: 292 -pz) [1 mark (b) As you can see by your answers in (a), the demand function is unique because it has the same elasticity along the entire demand curve. We call demand functions with this property "isoclastic." Use the formula for elasticity to show that the elasticity is always equal to your answer in part 1 regardless of the P chosen. (1 mark (c) Suppose the economy is closed to imports. What is the price of cars in a closed economy? What is the quantity of cars sold at this price? In a demand/supply graph indicate the equilibrium price and quantity and show the arca representing consumer surplus and the area representing producer surplus. 1 mark] (d) Now suppose that the international price of cars is Pe = 2 and that there is an infinite supply of cars at this price. If there were no restrictions, how many cars would be imported? How many would be produced domestically? How many would be consumed? On your graph, show what the change in consumer surplus would be relative to the case of the closed economy. Show the change in producer surplus for the domestic car company. (Both consumer and producer surplus can be shown graphically - you don't need to solve them.) [2 marks] (e) Suppose Australia imposes a quota on imports of 1.1 million cars from abroad. What is the price paid by consumers to buy a car in Australia following the introduction of the quota? Assume that the quota rights are assigned to Japanese car producers and that these producers always find it in their interest to produce for any price at or above 2. What is the change in domestic producer surplus with respect to the open trade outcome considered in part (d)? what is the change in consumer surplus in this market relative to the open trade outcome considered in part (d)? What is the dead- weight loss caused by the introduction of the quotas? (Again, do the producer surplus, consumer surplus, and deadweight loss graphically.) [2 marks] (f) Imagine that due to the high Australian price for cars, some Japanese car producers open plants in Australia. So now the supply of cars in Australia is the sum of (1) the domestic supply from Australian owned producers, (2) the imported cars from Japan, 2and (3) the new domestic supply from Japanese owned producers. Assume that the quota of imports remains 1.1 million but that cars produced in Australia by foreign producers does not influence the cap. The supply of Japanese cars produced in Australia (Japanese Domestic) is given by: Q3" (P) = .7P (3) Calculate the supply of cars and the demand of cars at P = 2 and show that this is the equilibrium price. What is the change in consumer surplus in this market relative to part 5 where imports were capped at 1.1 million? What is the change in consumer surplus in this market relative to part (d) where there was no cap on imports? [2 marks] (g) Most arguments that are used to argue against free trade is that free trade leads to a reduction in jobs. Explain how import quotas combined with allowing foreign direct investment are likely to be easier to justify as a politician than fully free markets. Can you think of some potential issues that might arise when allowing firms to circumvent quotas with foreign owned domestic plants? [1 mark] 3ATTACHMENT 1 Pricing the surge: the microeconomics of Ubers attempt to revolutionise taxi markets, The Economist, March 29, 2014 NEW competitors always ruffle a few feathers. The unique thing about Uber, a new taxi- market player, is that it seems to have annoyed some of its customers as much as the incumbent cabbies it threatens. The problem is its "surge pricing", which can make the cost of Uber rides jump to many times the normal fare at weekends and on holidays. Gouging customers like this, critics reckon, will eventually make them flee, denting Uber's business. Microeconomics suggests that although Uber's model does have a flaw, its dynamic pricing should be welcomed. Taxi markets have long needed a shake-up. In theory, entry should be easy all that is needed is a car and a driving licence-with new drivers keeping cab fares close to costs. Yet in many cities, cabs are far from that competitive ideal. Decades of regulation conspire to keep entrants out. In New York a pair of taxi medallions sold at a 2013 auction for $2.5m; many other cities have similar schemes. In London "the knowledge", a test of familiarity with the citys streets which GPS has made redundant but drivers still have to pass, can take four years to complete. Taxi markets often end up suspiciously clubby, with cabs in short supply and fat profits for the vehicle owners. Antitrust concerns have been raised in Australia, Ireland and Bulgaria among others. Uber aims to change all this. Launched in San Francisco in 2010 it lets passengers hail drivers from their smartphones-a move requiring even less effort than extending your arm. Some vehicles are not so much taxis as private cars that Uber has vetted. The convenience of hailing a cab from the comfort of a sofa or bar stool has given the service a loyal fan-base, but it comes at a cost. Most of Ubers prices are slightly cheaper than a street-hailed cab. But when demand spikes, the surge prices kick in: rates during the busiest times, such as New Years Eve, can be seven times normal levels, and minimum fares of up to $175 apply. Critics of Uber's pricing are treading a well-worn path: setting tailored prices for the same good price discrimination-often causes howls from consumer groups. It seems unfair when the charges for drugs vary across countries, the price of train tickets varies with the buyers age, or, as in Uber's case, the price varies depending on the time that the journey is booked. But price discrimination is not necessarily a bad thing, as a 2006 paper by Mark Armstrong of Oxford University explained. A firm offering a single price to all customers faces a trade- off: lowering prices raises sales but means offering a cut to customers prepared to pay more. Maximising profits can often mean lowering supply: goods are not provided to cheapskate shoppers so that more can be made from high-rollers. Customers who value the good at more than it costs to produce might miss out in a one-price-fits-all system as many punters who have tried to find a regular cab on New Year's Eve will know. Uber's price surge aims to solve this. Like many technology companies Uber is a middleman. It links independent cab drivers with customers wanting a ride in the same way that Google links searchers and advertisers or eBay links sellers and bidders. The business model only works when successful matches are made. Because price spikes raise the pay Uber's drivers receive (they get 80% of any fare, if they drive their own car) more cars are tempted onto the roads at times of high demand. Prices are high at 2am at the weekend not just becausepunters are willing to pay more, but also because drivers don't want to work then. This strategy is common for firms that operate platforms or "two-sided" markets which link buyers and sellers, according to a 2006 paper by Jean-Charles Rochet and Jean Tirole of Toulouse University. Firms often tilt the market to give one side a particularly sweet deal: nightclubs let women in free to justify charging men a hefty fee, telephone directories are given away to create a readership which advertisers pay to access. The theory predicts each side's deal depends on two things: price sensitivity and how well-stocked each side of the market is. Uber's price surge fits perfectly: Friday-night revellers are hit by a double whammy since they are willing to pay up precisely when the pool of cabs is low. There is some evidence Uber's surge pricing is improving taxi markets. The firm says drivers are sensitive to price, so that the temptation to earn more is getting more Uber drivers onto the roads at antisocial hours. In San Francisco the number of private cars for hire has shot up, Uber says. This suggests surge pricing has encouraged the number of taxis to vary with demand, with the market getting bigger during peak hours. However, the inflexibility of Uber's matchmaking fee, a fixed 20% of the fare, means that it may fail to optimise the matching of demand and supply. In quiet times, when fares are low, it may work well. Suppose it links lots of potential passengers willing to pay $20 for a journey with drivers happy to travel for $15. A 20% ($4) fee leaves both sides content. But now imagine a Friday night, with punters willing to pay $100 for a ride, and drivers happy to take $90: there should be scope for a deal, but Uber's $20 fee means such journeys wont happen. Despite the revenues a matchmaking fee generates, it may not be Uber's best strategy. A fixed membership charge is often firms' best option in two-sided markets. By charging drivers a flat monthly fee Uber would generate revenue without creating a price wedge that gets in the way of matches. Since stumping up cash might put infrequent divers off, they could be offered a cheaper category of membership. Uber should keep its surge pricing in place. But to make the market as big as possible, and really revolutionise taxi travel, it might need to retune its fees. 5ECON10004: INTRODUCTORY MICROECONOMICS ASSIGNMENT 1: SEMESTER 1, 2018 Due: Monday, April 16, 14:00 . Assignments must be submitted via the LMS subject webpage. . Remember to keep a copy of your assignment. . This assignment will account for 10% of your final grade in the subject. . Limit: 750 words (diagrams do not count toward the word limit.) Question 1: Ride Hailing Apps Ride-hailing apps are widely used globally today. In this question, we examine questions surrounding this popular technology. Read the attached article from The Economist (attachment 1) before attempting the following questions. (a) According to the article, "in theory, entry [into taxi markets] should be easy yet in many cities, cabs are far from that competitive ideal". Using what you have learnt so far, do you think taxi markets can be thought of as perfectly competitive? Explain. [2 marks (b) Given your answer to part (a), how does the creation of ride-hailing apps (in particu- lar, the introduction of their driver-partners) make the process of getting a successful customer-driver match more competitive? What additional role does surge pricing play in this regard?" Assume that the ride-hailing market is perfectly competitive and use a demand/supply diagram to substantiate your answer. 3 marks] (c) According to the article, "customers who value the good at more than it costs to produce might miss out in a one-price-fits-all system as many punters who have tried to find a regular cab on New Years Eve [when demand spikes] will know". Identify these customers on a demand/supply diagram, assuming that the taxi market is perfectly competitive and prices for taxis are fixed. Using the same diagram, show that the creation of ride-hailing apps (thus the introduction of their driver-partners and surge pricing) can affect consumers and producers (hence society's) welfare on New Year's Eve. [3 marks] (d) Suppose the opportunity costs of supplying rides is so high on New Years Eve that drivers simply do not respond to price changes. How would this change your answer to (c)? Explain using a demand/supply diagram. [2 marks] Continue to the next page 1
