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Microeconomics Module 5
Module at a Glance
Topic Overview
We have already seen the negative effects of market imperfections. In this module we look at total
market failure, where the markets cannot be relied upon to even approximate optimal outcomes
even with public regulation. These are the cases of public goods, where the benefits and costs get
separated and where the benefits or costs often get diffused throughout the broader society, where
microeconomic policies are requisite to obtaining more optimal outcomes. Added to this mix is the
increasing concentration of income and wealth and the ability of all to share in the social output.
Here too, policymakers play an increasingly important role in establishing an appropriate balance
through entitlement programs.
Learning Objectives
To recognize the characteristics that make goods public goods. To understand the inherent
problems in public choice processes such as the “free rider problem”, the short term myopia of
political processes, and the problems with voting systems. At the analytical level, this module
presents some new technical challenges and learning opportunities as graphical processes require
rethinking where social benefits and costs are concerned and where externalities play a major role in
resource allocation decisions.
Readings
Text Chapters 16-18
Learning Activities
There are Learning Curve and Homework assignments for Chapters 16 through 18 on the
LaunchPad testing site. ‘Check Your Understanding’ questions in each chapter section.
Discussions
Externalities and public goods are becoming more important in the new global economy where fast
growth of emerging economies is stressing the resource base and an increasingly shared
environment. Increased concentrations of income and wealth and power within and among countries
is making the sharing of the benefits of national and global growth through public policies
increasingly important, especially as the developed economies age and experience shrinking
workforces relative to their retirement populations. The discussion should focus on these major
policy issues and options as they relate to equity and efficiency incentives and the operation of
market processes and microeconomic decisions in the new global economy.
Instructor’s Commentary
Externalities cause less than optimal resource allocations unless policies are used to cause the
markets to reflect the external costs and benefits. Public goods occur when market processes
completely break down and public decision processes are thus required to enable the benefits to be
had. Beyond externalities and public goods, increasing concentrations of income and wealth
worldwide and the aging of populations in the developed world are making the redistribution of
benefits through entitlement programs paramount microeconomic issues. Geopolitical issues related
to resource shortages and controls and environmental concerns are adding to the mix of
microeconomic policy options. What the new microeconomic structures will look like in the new
global economy, especially with advancing technologies and information systems, is an emerging
economic question.
Market Failure and Public Goods
Market failure occurs when the benefits and costs cannot be isolated to the individuals and firms
making the immediate transactions. These extra benefits and costs are often referred to as
“externalities” and they can take any number of forms. We are most familiar with them in the form of
environmental damage that occurs in the production process. But there are many other examples
such as the benefits of a good education of one individual benefiting the rest of the community or the
potential harm of someone with a contagious disease to the rest of the community.
The “exclusion principle” is the extreme case of the above, where an individual who refuses to pay
for a good cannot be excluded from the benefits of the good. A prime example is national defense.
This is the case of a pure “public good”. In this case market processes completely break down and
the usual course of action is to rely on the public sector to direct the resource allocation process
through executive and legislative decisions. This may involve private sector contractors, as with road
or bridge repair, but the funding is through taxes and public priorities are established at the ballot
box.
On the other hand, any number of goods and services provided by the public sector are not pure
public goods based on the above definition. Examples include: public golf courses, state parks,
public schools, and even toll highways. A big controversy currently exists over national health care.
In all of these cases people not willing to pay can be excluded, though they often are not.
Entitlements
Entitlements such as Medicaid, Medicare and Social Security are becoming increasingly large parts
of state and federal budgets as incomes and wealth become increasingly concentrated and as aging
populations in developed countries are supported by relatively smaller workforces. The growth of
these entitlement programs is not being reflected properly in budget projections and many fear that
the economy will not be able to afford the promises made by its leaders.
M5 Discussion Topic
Active discussion participation is a requirement for this course, which means you need to be posting
at least two contributions per week and those can either be original threads or responses to other
postings.
Listed below are possible discussion topics for this module, but if you have personal experiences or
examples that relate to the topics presented in the assigned readings, please feel free to add those
to this discussion as well. In developing your thoughts and opinions here, please look to incorporate
citations and statistics both from the textbook and other outside sources. Lastly, let’s always
remember to keep these discussions civilized and respectful, even when we disagree on certain
topics.
Module 5:
Module 5:
Respond to this question on your first post, the first week of the discussion:
Do people really care about the environment, if it means higher price levels? Does recycling
work? Has anyone hugged a tree recently? Installed solar panels?
Respond to this question on your second post, the first week of the discussion and respond
to your classmates:
Are “developing” nations really concerned about the environment? Why or Why not? How do
the decisions made by these nations impact us?
Respond to this question on your third post, the second week of the discussion and respond
to your classmates:
In our present society, people demand and expect more from the government but very few
people are willing to pay higher taxes, explain this paradox? Can this situation work?
Respond to this question on your fourth post, the second week of the discussion and
respond to your classmates:
Are you confident that the Social Security system will still be running smoothly when you
retire?
Respond to this question on your fifth post, the third week of the discussion and respond to
your classmates:
Is Social Security necessary? Isn’t this just a way of the government saying that individuals
are not responsible enough to plan for their retirement, so they have to set our money aside
for us? Do people need this safety net?
Have you saved enough for retirement? How would you fix the Social Security system in the
United States?
1. The key distinction between a factor of production and an input is that:
an input earns income from selling its services over and over again, but a factor of
production cannot.
a factor of production earns income from selling its services over and over again, but
an input cannot.
a factor of production has limited earning potential.
an input is an enduring source of income, but a factor of production is used up in
production.
2. When labor is hired in a competitive market, the value of the marginal product of labor is
computed by:
multiplying the price of the output by the wage paid to labor.
multiplying the price of the output by the marginal product of labor.
multiplying the wage paid to labor by the marginal product of labor.
dividing the marginal product of labor by the price of the output.
3. Which of the following statements is TRUE?
The value of the marginal product is the marginal product times the price.
The marginal cost is equal to the average total cost.
The marginal product is the change in total revenue divided by a one-unit change in a
factor.
The marginal revenue is the change in total output divided by the change in output.
4. Mary is considering hiring another worker in an assembly line for MP3 speakers. Mary
knows the average product of labor is 15 speakers per day. She also believes that the next
worker hired will produce an extra 12 speakers per day. A speaker sells for $10. Assuming
that the market for speakers is perfectly competitive, Mary should hire another worker:
since the marginal product is below the average product.
only if the new worker’s daily wage is $120 or less.
only if the new worker’s marginal product is 12 or more.
only if the new worker’s daily wage is $150 or less.
5. If a firm hires labor such that W < VMPL, then profit:
can be increased by increasing the wage.
can be increased by hiring less labor.
can be increased by hiring more labor.
is maximized.
6. Phil's Copy Studio pays its workers $60 per day and sells poster-size copies for $10 per print.
If the market wage rises to $70:
the quantity demanded of labor increases, but the demand for labor curve does not
shift.
the quantity demanded of labor decreases, but the demand for labor curve does not
shift.
the demand for labor decreases.
the demand for labor increases.
7. A shift in demand for a given factor of production will NOT occur if:
the productivity of that factor increases.
the price of that factor falls.
there is a decrease in the price of a substitute factor.
the productivity of that factor decreases.
8. The equilibrium value of the marginal product of a factor is the additional value produced by
the _____ unit of that factor employed in the factor market as a whole.
least productive
most productive
first
last
9.
Reference: Ref 19-5
(Table: Workers and Corn Output) Look at the table Workers and Corn Output. Laura is a
price-taking farmer who produces corn. Assume the wage rate for workers is $250 and the
price per bushel of corn is $20. Laura should hire _____ workers to maximize profits.
seven
one
two
four
10. Figure: The Value of the Marginal Product Curve
Reference: Ref 19-7
(Figure: The Value of the Marginal Product Curve) In the figure The Value of the Marginal
Product Curve, if a technological advance makes labor more productive and everything else
stays the same, then the profit-maximizing quantity of labor:
will increase.
cannot be determined.
will stay the same.
will decrease.
11. Figure: The Demand for Bricklayers
Reference: Ref 19-9
(Figure: The Demand for Bricklayers) Look at the figure The Demand for Bricklayers. The
equilibrium market wage for bricklayers is $100. For a profit-maximizing firm at the
equilibrium level of output, the VMPLbricklayers:
is $200.
cannot be determined from the information provided.
is irrelevant, since the firm is a price taker.
is equal to the market wage rate.
12. Which of the following is most likely an example of wage disparity due to differences in
talent and ability?
Nick Saban, the football coach at the University of Alabama, earns more than the
local high school football coach.
People with graduate degrees usually have higher earnings than people who did not
graduate from high school.
The median earnings of White men are more than the median earnings of African
Americans.
Crab fishermen on the Bering Sea earn more than clerks who sell goldfish at a pet
store.
13. According to the efficiency wage model, all of the following are correct EXCEPT that
efficiency wages:
are a type of market failure.
reduce unemployment.
may reduce worker turnover.
are above the equilibrium wage.
14. Tim works 51 hours per week, and his wage is $35 per hour. If his wage increases to $70
per hour:
the substitution effect implies that he will work less.
the substitution effect implies that he will work more.
if leisure is a normal good, the income effect will reinforce the substitution effect and
he will work more.
if leisure is a normal good, the income effect implies that he will work more.
15. Which of the following will NOT shift the labor supply curve?
changes in expectations about future wealth
a change in the wage rate
a change in attitude toward work
changes in a spouse’s income
16. Alex’s boss notices that with each course Alex takes, he becomes a more knowledgeable
and efficient worker. This is an example of:
derived demand.
value of marginal product.
income effects.
human capital development.
17. The firm’s value of marginal product curve slopes downward:
because of diminishing returns.
only if the firm is a perfect competitor in the product market.
only if the firm is a perfect competitor in the labor market.
only if the firm is a perfect competitor in both the labor and product markets.
18. Scenario: The Decision to Hire Labor
Assume that both the product market and the labor market are perfectly competitive. The
price of this firm’s product is $5. The firm’s total product with respect to labor is given in
the table that follows.
Reference: Ref 19-13
(Scenario: The Decision to Hire Labor) Look at the scenario The Decision to Hire Labor.
How many workers will this perfectly competitive, profit-maximizing firm choose to hire if
the equilibrium wage is $30?
three
two
four
one
19.
King Estate makes an award winning Pinot Noir and hires workers to harvest the grapes.
The diagram below shows the value of the marginal product of vineyard workers (VMPL).
Several studies are published that show that red wine is very high in antioxidants. This
increases the demand for Pinot Noir and its price. Use the copy tool to show what happens
to the value of the marginal product of vineyard workers because of this change. Label the
new curve VMPL2. Hint: make sure that VMPL2 is parallel to VMP.
20.
The diagram below shows Derrick’s labor supply curve (LS). Derrick bought a very
expensive house at the very end of the housing boom and paid a premium price for the
house. Now that the housing market has crashed, the house has lost substantial value and
Derrick has lost substantial wealth. Use the copy tool to show the change that occurs in
Derrick’s labor supply curve due to this change in Derrick’s real wealth. Label the new
curve LS2. Hint: make sure that LS2 is parallel to LS.
1. Micah is considering turning pro before his senior year basketball season. If he turns pro,
Micah expects a pro contract worth $2 million in present value. If he does not turn pro,
there is a 50% chance an injury will prevent him from playing professionally and a 50%
chance he will get a pro contract worth $4 million in present value. What is the expected
present value of Micah’s pro contract if he stays in college for his senior year?
$5 million
$0
$3.5 million
$2 million
2. A friend of yours owes you $10, and he wants to flip a coin for double or nothing. If the coin
lands heads, he will pay you $20. If the coin lands tails up, he will pay you nothing. As the
coin is in midair, what is your expected value of this wager?
$20
$0
$30
$10
3. Figure: Differences in Risk Aversion
Reference: Ref 20-1
(Figure: Differences in Risk Aversion) Look at the figure Differences in Risk Aversion.
Which of the following statements is CORRECT?
Salvatore will gain less utility from an increase in income than Ernest but will lose
more utility than Ernest from a fall in income.
If either Ernest or Salvatore buys insurance, adverse selection will occur.
Ernest is more risk-averse than Salvatore.
Ernest will gain more utility from insurance than will Salvatore.
4.
Reference: Ref 20-4
(Table: Income and Utility for Whitney) Look at the table Income and Utility for Whitney.
Whitney’s income next year is uncertain: there is a 40% probability she will make $40,000
and a 60% probability she will make $80,000. Whitney’s expected utility is _____ utils.
120
135
124
130
5.
Reference: Ref 20-9
(Table: Choice with Uncertainty) Look at the table Choice with Uncertainty. Suppose that
the probability that the sitcom does not make it to television is 60%, the probability that it
makes it to television but is not the most viewed show in its time slot is 30%, and that the
probability that it makes it to television and is the most viewed show in its time slot is 10%.
Norman’s expected total utility is _____ utils.
2,150
2,000
2,350
2,650
6. Mary and Bob are trying to decide how much auto insurance to buy. They share the same
expectations of an accident, with the same dollar loss. They also have the same income
levels. However, Mary would rather buy very little insurance, while Bob would rather buy
much more insurance. This suggests that:
Bob is risk-averse and Mary is risk-loving.
Bob is more risk-averse than Mary.
Mary is risk-averse and Bob is risk-loving.
Mary is more risk-averse than Bob.
7. Why might the supply curve of insurance policies shift to the right?
Premiums increase.
Risk aversion increases.
Diversification increases.
The wealth of the sellers of insurance increases.
8. Scenario: Diversification
Morris is considering investing $10,000 in a sunglass company or a rain poncho company. If
it is a rainy year and he invests only in the sunglass company, he will lose $5,000. However,
if it is a rainy year and he invests only in the rain poncho company, he will earn $10,000. If it
is a sunny year and he invests only in the sunglass company, he will earn $10,000; if he
invests only in the rain poncho company, he will lose $5,000 in a sunny year. There is a 50%
chance of a sunny year and a 50% chance of a rainy year.
Reference: Ref 20-13
(Scenario: Diversification) Look at the scenario Diversification. If Morris invests half of his
money in the sunglass company and half in the rain poncho company, what is his expected
gain or loss?
to break even
a loss of $2,500
a gain of $2,500
a gain of $10,000
9. The problem of adverse selection:
is also referred to as the moral hazard problem.
occurs when sellers (who know more than buyers about the quality of the product)
deliberately select inferior products to sell.
can result in an overall increase in the gains from trade.
occurs when an employer fires the wrong person.
10. Used-car dealers will often advertise how long they have been in business as a means of
_____ their long-term _____.
revealing; moral hazard
screening; customers
signaling; reputation
insuring; capital at risk
11. McDonald’s and other fast-food chains rely mainly on franchisees to operate the restaurants
to avoid the problem of:
moral hazard.
insurance.
deductibles.
adverse selection.
12. An individual finds that as his income increases, his total utility also increases but at a
decreasing rate. This can be attributed to:
efficient allocation of risk.
expected values.
diminishing marginal utility.
being risk-neutral.
13. Warranties that cover the cost of a repair or replacement will:
decrease the consumer’s expected utility from consuming the good.
increase the consumer’s expected utility from consuming the good.
reverse the consumer’s diminishing marginal utility.
have no impact on the consumer’s expected utility from consuming the good.
14. Economic growth that is not industry-specific is most likely to:
have no effect on most businesses.
result in many businesses doing well.
result in many businesses not doing well.
affect only a few select businesses.
15. Insurance premiums often fall substantially if a buyer purchases a policy with a high
deductible, and such a policy is often purchased by individuals who self-identify as:
low-risk drivers.
neither high- nor low-risk drivers.
drivers who do not care what their premium costs are.
high-ris …
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