2009 Microeconomics FRQ #1

2009 Microeconomics FRQ #1

Watch me answer it here

https://youtu.be/eGp7_Osduyg

(A) Draw a CLG for CableNow and show each of the following.

(i) The profit maximizing quantity of cable services, labeled as Q*

(ii) The profit maximizing price, labeled as P*

(iii) The area of economic profit, completely shaded

(iv) The socially optimal level of cable service, assuming no externalities, labeled as Q_S

(B) Assume that the government grants CableNow  a lump sum subsidy of $1 million. Will this policy change CableNow’s profit maximizing quantity of cable service? Explain. (Explain means Why??)

If the government grants a $1 million lump sum subsidy CableNow’s quantity produced will not change. Why? A lump-sum subsidy will not affect CableNow’s marginal costs.

Why? 

A lump-sum subsidy is given to a firm whether the firm produces the good or not. If I own a coffee shop, and the government decides to give all coffee shop owners a $10,000. Does this increase the amount of coffee I sell? No. If I don’t sell anymore coffee then I don’t need to hire more employees. If I don’t hire more employees my marginal cost curve doesn’t shift. Lump-sum subsidies are often thought of as fixed costs. If your rent (a fixed cost) decreases would this cause you to employee less people? No. The demand for your coffee doesn’t change due to a change in fixed costs, so no one will be hired or fired. But, a decrease in your fixed costs or a lump-sum subsidy will cause your profits to increase or your losses to decrease.

Lets look at a graph using the above information.

In the graph above, notice that the ATC curve decreased as the lump sum subsidy is granted but the profit maximization point MR = MC wasn’t affected and therefore quantity didn’t change.

(C) Instead of a subsidy, the government requires CableNow to produce the quantity at which CableNow earns zero economic profit. On the graph you drew in part (a), label this Q_R.

Obviously, if you don’t know where the point is where zero economic profit is earned you can’t answer this question.

Know all the points on the graph below. You should be able to draw a monopoly graph and label each of these possible points. Practice, practice, practice and then do it again.

If we use the information in the question, and the graph in the question. Zero economic profit for a monopoly is at the Fair Return or Break-Even point where

P = ATC = Zero Economic Profit

(D) At Q_R, is the firm’s accounting profit, positive, negative or zero? Explain.

If a firm is earning zero economic profit it must be covering its accounting profit. Why?

Profit = TR (total revenue) minus (TC (total costs)

Total Costs = Explicit + Implicit Costs

Explicit costs are the costs that you can see; wages, electricity, rent, materials.

Implicit Cost is the monies that the entrepreneur demands to stay in this industry.

Accounting Costs are explicit costs, so as long as the firm is covering its explicit costs it is breaking even according to the accountant. If the firm is covering (earning) its explicit costs and covering its implicit costs then firm is making an accounting profit but only earning zero economic profit.

Confusing? Ok, lets back up and take a little trip.

Charles (the entrepreneur) has $50,000 and he wants to start a business. Charles can either invest the $50,000 into a new business or he can put the 50k in the bank where he will earn interest on his money.

$50,000 x .01 = $500 a year earned with zero risk and nothing to worry about.

$50,000 x .05 = $2,500 a year (that is $208 a month guaranteed) enough to pay for Yoga and Coffee

$50,000 x .08 = $4000 a year ($333 a month) that will pay your payment for a very nice car.

So, Charles has options and the higher the interest rate he can earn the more attractive it may be to keep the money in the bank.

Lets say the Bank will pay us 8% on our savings.

But Charles wants to open a coffee shop.

Our dismal Economist (David) looks at Charles and says, “ Charles, you must consider the opportunity cost of any action you take.”

“No I don’t”, says Charles, as he is naturally cantankerous and politically a libertarian and hates to be told what to do.

David - “Well sorry old chap, but economists look at any choices made and evaluate your next best alternative.”

Charles - “Well, I have two choices, I can put the money in the bank or I can invest the money in the coffee shop”. “If I invest in the coffee shop, I will spend the $50,000 and hopefully make 10% a year on my investment.

David -  “If you only make 10% or $5,000 a year then an economist will say that you have really only earned 2% on your investment because you could have earned 8% of that 10% by keeping your cash in the bank.” “That 8% is the implicit cost that must be paid to keep you in the business of supplying coffee to people.” “If, Charles, you invested your $50,000 in the coffee shop and only made 8%, an economist would have said you broke-even as you just covered your explicit & implicit costs”. The accountant would have said that you had earned a profit as your explicit costs were paid and monies are left over.

Charles – “So let me get this straight. If I invest my $50,000 in the coffee shop, I pay all the wages to my employees, the rent, the electricity and I have $2,500 left over to pay to myself, an economist would say I have incurred an economic loss but the accountant would say I have made a profit. Who is right?

David – We both are? The accountant only looks at explicit costs, (rent, electricity, wages) the economist looks at explicit costs and implicit costs (what could have been earned by doing the next best alternative). “Really those accountants are far to optimistic and don’t look at the whole picture.”

The College Board wants you to understand that as economists we must consider the choices we didn’t take and consider them as a cost.

Accountant Loss – Can’t pay your rent, electricity or wages, or some combination.

Accountant Break-Even or Zero Accountant Profit– Can pay all the bills

Accounting Profit – Anything amount earned over the explicit costs

Economic Loss – Earnings below the sum of your explicit and implicit costs

Economic Break-Even – Earnings cover the explicit costs and implicit costs

Zero Economic Profit - Earnings cover the explicit costs and implicit costs

Positive Economic Profit – Earnings more than the explicit & implicit costs

Abnormal Economic Profit - Earnings more than the explicit & implicit costs

(E) Assume that a new study reveals that there are external benefits (externalities) associated with watching TV. Will the socially optimal quantity of cable service now be larger than, smaller than, or equal to the Q_S, you identified in part (A)(iv).

College Board bastard,, tricky.

If a positive externality is occurring you can know, that the market is producing to little of the good/the price is to high. Understand that producing to little/price is to high is the same thing. The market will produce the quantity where P = MC/ quantity of QS.

If the market is producing at QS but is producing to little then the Socially Optimal Quantity must be a larger quantity than QS.

Thanks Nadia, good times in Vancouver.

2008 B Macro FRQ #3

2008 B Macro FRQ #3

Watch me answer it here

https://youtu.be/rbnxY6mXN0o

(A) Calculate this year's nominal gross domestic product (GDP).

The GDP Cheat Sheet here.

Nominal GDP is simply this years GDP,    

Price of the goods this year multiplied by the quantity produced

(B) Assume that in Gala Land the GDP deflator (GDP price index) is 100 in the base year and 150 this year. Calculate the following.

(i) The inflation rate, expressed as a percentage, between base year and this year.

It should be clear that inflation increased by 50%. I don't know how to say this differently or better or clearer. Someone should help me.

(ii) This years real GDP.

So, if they had gave us base year prices and another years quantity, we would have used this formula.

but they didn't so,

We have to understand that Real GDP means taking into account the level of inflation. Prices have risen by 50% this year.

It is easy to think that since prices rose by 50% that we should just half the 6000 and say that the real GDP is 3000 (and that would be incorrect)

BUT, recognise that $4000 x 50% rise in prices would be, $4000 x .5 = $2000 and $2000 + $4000 = $6000.

(C) Since the base year, workers have received a 20% increase in their nominal wages. If workers face the same inflation rate as was calculated in (b) (ii) (50%), what has happened to real wages? Explain.

If workers get a 20% raise but prices of all the things they buy rise to 50%, then their real wages have dropped by 30%. Remember that real wages take into account inflation.

from the cheat sheet.

Real Wages (Purchasing Power) post

(D) If the GDP deflator in Gala Land increases unexpectedly, would a borrower with a fixed interest rate loan be better or worse off? Explain.

If the GDP deflator increases then inflation has increased. A borrower would be paying back money that is able to purchase less goods, therefore the borrower would  be better off. You bought a good that would now, cost you, significantly more money. 

2008 Micro FRQ #3

2008 Micro FRQ #3

(A) For a competitive market for which there is a binding (effective) price ceiling , draw a CLG and label the price ceiling Pc & the quantity sold, Qa, and the socially efficient output Qb.

(B) (i) Using the labelling in the graph, identify the profit-maximising output and the socially efficient output. (Output means Quantity)

(B) (ii) At the socially efficient output is the monopoly making a profit or incurring a loss. Identify the area of profit or loss.

2008 B Macro FRQ #2

2008 B Macro FRQ #1

(A) Will each of the following groups benefit from the decrease in the tariff rate?

(i) Mexican consumers

If the Mexican government reduces the tariffs (tax) on cars being imported from other countries then importers will be able to sell those cars for less. This means Mexicans will be able to buy cars at a cheaper price and be able to spend the surplus savings on other goods like, education, healthcare, entertainment, food, clothing. Yes, I would say that this is a benefit.

(ii) Mexican automobile manufacturers. Explain.

No Mexican automobile manufacturers would like tariffs to be higher not lower. If tariffs were higher then the Mexican manufacturers would be able to raise the prices of their domestically produced cars. Mexican automobile manufacturers would not benefit. 

If tariffs are reduced then importers can charge less for each car. Consumers will be able to buy cheaper cars. Domestic producers of cars will have to lower their prices to compete with the imports.

(B) How would the decrease in the tariffs rate affect each of the following in Mexico?

(i) Current Account Balance. Explain.

We must first know what the Current account is.

If the current account balance is (imports & exports) goods and services.

If Mexico lowers its tariffs on automobiles imported then the price of imported automobiles will fall and more automobiles will be imported. Therefore their will be a current account deficit as imports will be increasing relative to exports..

(ii) Capital (financial) account balance.

If the current account is in a deficit, and therefore the capital account must be in a surplus. 

Think of it like this - If you buy food from the grocery store you have imported goods into your household and therefore your current account is in a deficit. When you paid for the food you bought at the store that money is counted in the financial (capital account). The grocery store will take this cash and spend it at your advertising firm by buying your services.

When Americans buy cars from Germany our current account goes into a deficit but we paid for the cars with cash, and this cash will be used to buy property and goods from America. 

(C) Given the change in Mexico's current account in part (B)(i), what will happen to the aggregate demand in Mexico.

If Imports increase then net exports must decrease and therefore AD will decrease as Net exports is a component of AD.

2008 B Micro FRQ #3

2008 B Micro FRQ #3

watch me answer it here

https://youtu.be/g0Adx3-66Ts

(A) After which worker do diminishing marginal returns begin?

Make a chart.

What is Diminishing Marginal Returns?

From the Resource Costs (Labor) Cheat Sheet here.

The MRP, marginal revenue product increases to $20 with the hiring of the 1st worker. The second worker brings in $32. The third worker brings in $20 and every worker hired after the second brings in less revenue. The returns fall after hiring the second worker.

(B) Calculate the Marginal Physical Product of the 5th worker.

What is the marginal physical product?

For the AP exam, where the input of labor (number of workers hired) increases by one at a time you should use MP marginal product and Marginal Physical Product interchangeably. MP & MPP are different when hiring more than one labourer at a time.

The marginal product (product produced by the 5th worker) is 5 units of the good.

Understand that the change in production from the 4th worker to the hiring of the 5th worker created an additional 5 hats.

Again, the question is simply asking how many hats are produced by the 5th worker.

(C) Calculate the marginal revenue product of the 3rd worker.

Chart - 

3rd worker - MP(10) X P(2) = $20

The 3rd worker brings in $20 and costs us $15

(D) How many workers will be hired to maximise profit?

Profit Max for hiring is where MRP  = MRC

Or as close as possible without losing money.

**hiring the 4th worker makes us $1 of profit.

but

**hiring the 5th worker would cost us $5, a loss

(E) If GW has fixed costs equal to $20, what will be the company's show-run profit from hiring 

two workers?

Remember don't you, that MC (wage) is a variable cost and VC+FC = TC

So, if the wage of each worker is $15 then the wage for the two workers is $30. This is the VC. The fixed cost is $20. ((This is not $20 per worker so don't double it.)) 

VC ($30) + FC ($20) = TC ($50)

Remember that Profit = TR - TC

The MRP or Total Revenue earned from hiring two workers is ($20 + $32) = $52

So, TR($52) - TC($50) = Profit of $2

(F) If the price of hats increases, what will happen to the number of workers hired in the short-run? Explain.

MRP (additional revenue per additional worker hired) The formula for MRP is MP x P = MRP.

So if either the MP (productivity) or the P (price of the good) increases then the MRP will increase.

If the MRP increases then more workers will be hired as now it will be more profitable to hire an additional worker.

I had answered this problem in an earlier post, here.