CP 6031 Assignment 2

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Georgia Institute Of Technology *

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6031

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Economics

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Feb 20, 2024

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qwCP 6031 - Spring 2024 Assignment #2 Due 2/15/2023 @ 8:00pm There are 8 graded questions worth 50 points in total. You may work together, but if you do you must write the names of the individuals you worked with at the top of your assignment. Provide complete, thoughtful answers for full credit. You may earn partial credit if you show your work. You may upload your answers to Canvas in any way you prefer but if you write by hand and scan, please make sure your writing is legible. Genius Scan is a free app that works well for scanning and creating PDFs. Check your scans, though. Paper copies not accepted. 1. Suppose you are given the following information about a particular industry: Assume that all firms are identical and that the market is characterized by perfect competition. You have not seen the last two equations (MC and C) before, but you are fully capable of applying them as I outline below. a) Find the equilibrium price (P) and the equilibrium quantity (Q) (2 points) EP= QD – QS EQ= QS-1200P 1200P * 5 = 6000 6500-100P = 1200P 6500/ 1300P = 5 The equilibrium price is 5 and the equilibrium quantity is 6000. b) Find the output (q) supplied by the firm. Remember, at the profit maximizing production choice, firms’ marginal cost equals marginal revenue. We did not cover this, but it turns out that at this point, MR=MC=Price as well. (1 point) P= MC (q) 5 – 200/2q q-500 Output supplied by the firm is 500. 1

c) Calculate total profit for the firm (  ). Recall, you were given the profit function in class. (1 points) Profit= P * Q – TC 5 * 500 – 722 + 500^2/200 2500 - (722 + 1250) 2500 - 1972 =528 The firm ends $528 in profit. 2. Suppose the supply curve for a good is completely inelastic. If the government imposed a price ceiling below the market-clearing (i.e., competitive market) level, would a deadweight loss result? Explain why and what the means in plain English. (4 points) This would not result in deadweight loss as the supply curve is completely inelastic, meaning the market-clearing quantity supplied and price ceiling quantity supplied are the same. Therefore, imposing a price ceiling transfers the loss in the producer surplus to the consumer and no deadweight loss would result. 3. In 2022, Portland, Oregonians consumed (rode for) 20 million hours of electric scooters. They paid an average price of $25.00 per hour. a. Given that the elasticity of supply is 0.5 and the elasticity of demand is -0.7, derive linear demand and supply curves for electric scooters. (Remember, we did this toward the beginning of the semester). (4 points) Q= a + bP -0.7 = 25/20 Change Q / change P Change Q/ change P = -0.70(20/25) = -0.56 = b 20= a -0.56 * 25 = 34 = a QD= 34M – 0.56M*P 0.5 = 25/20 Change Q / change P Change Q/ change P = 0.5(20/25) = 0.4 20= c + 0.4 * 25 = 10 QS = 10M + 0.4M*P b. The local planning board is considering strategies to limit externalities caused by electric scooters and propose a local tax of $3.00 per hour. What does this tax do to the market-clearing price and quantity? Show graphically and describe. (3 points) 2

Qs= 10 + 0.4P 10 + 0.4 (P-3) 10 + 0.4P- 1.2 8.8 + 0.4P Qs- QD 8.8 + 0.4P – 34 – 0.56P 0.4P + 0.56P – 34 – 8.8 0.96P- 25.2 P= 25.2/0.96= $26.25 $26.25-$3= $23.25 QD= 34- 0.56 (26.25) 34-14.7 =19.3 (M) The tax would have a differing effect on consumer and producer prices per hour. The price for the consumer would be $26.25 and the price for the producer would be $23.25. The tax would also impact the quantity which would decrease from 20 million hours of usage to 19.3. 4. (Short answer: 200-400 words) Open and read the accompanying PDF article from the Atlantic by James Kwak. Then, first explain the predicted welfare effects of setting a minimum wage as we discussed in class, using plain English. Next, use the Kwak article to make an argument against the predictions of this simple model. (10 points) When we analyze the impact of implementing a minimum wage solely through the lens of supply and demand, it appears that the quantity demanded falls short of the quantity supplied, indicating a market inefficiency. However, this observation alone doesn't determine whether the policy is beneficial or detrimental. Various other factors must be considered, particularly when evaluating the setting of a minimum wage. The argument often made against implementing a minimum wage suggests that it leads to reduced employment opportunities, as employers may hire fewer workers to compensate for increased labor costs. Nevertheless, recent research challenges the simplistic assumptions of the supply and demand model. Historical examples, such as the period between 1967 and 1969 when the minimum wage was relatively high and unemployment remained low, indicate that real-world outcomes can diverge from theoretical predictions. Additionally, many businesses, especially small firms, lack the financial means to invest in labor-replacing technologies, as suggested by some critical of implementing a minimum wage. Consequently, even if smaller firms desired to lay off workers due to increased wages, they may not have viable alternatives. Moreover, raising the minimum wage can have several positive effects. Higher wages incentivize individuals to work more, reduce employee turnover rates, and increase disposable income, consequently stimulating economic activity. Furthermore, it lifts many workers above the poverty line, lessening their reliance on government assistance and 3

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narrowing income inequality. While the supply and demand model suggests potential drawbacks to implementing a minimum wage, a nuanced understanding reveals a more complex picture where the benefits of higher wages outweigh the perceived costs. <Questions 5-7 correspond to game theory and Nash equilibrium, covered 2/8/24> 5 . (Short answer: 200-400 words) Navigate to this article, “The True Costs of Working from Home”: https://www.bloomberg.com/news/articles/2021-02-26/why-remote-workers-spend- more-on-housing-and-rent . Describe what the Nash equilibrium in location means and its relation to prices. How does this concept help explain why “remote workers spend more on rent and housing costs than those who stay in the office”, as the article describes? (9 points) Nash equilibrium in location means is achieved when the price of a home reflects its desirability, such as proximity to attractive features like parks or undesirable factors like factories. For instance, a home next to a well-funded park commands a higher price compared to one near a less appealing location like a chicken factory. This higher price near the park compensates for its better location. If two individuals agree that the park home should be $600 more expensive than the factory home, the equilibrium price for the park home should be $600 above that of the factory home. Prices adjust to ensure comparable satisfaction levels across locations. In urban areas, rents tend to be higher due to increased opportunities, while in smaller cities, they are typically lower. These adjustments dissuade people from relocating by aligning prices with satisfaction levels, thus maintaining equilibrium. This idea is explained in the article which notes that individuals tend to spend more money while working from home compared to when they were working in the office. This is explained by the fact that when working remotely, people often find themselves in need of additional space, resources, or rooms to facilitate their work. As a result, investing in larger or better-equipped living spaces becomes a desirable priority and helps to provide higher satisfaction. However, in a traditional office setting, these additional factors are often deemed less essential, leading people to opt for housing with lower rent or to commute from areas that might be less appealing to those working remotely. Despite the higher costs, remote workers are willing to pay more for suitable accommodation if price adjustments reflect the shifting demand. This situation reaches a Nash equilibrium in location, where housing prices adapt to align with individuals' preferences and satisfaction levels. This equilibrium discourages significant relocations while balancing supply and demand in the housing market. Consequently, remote workers often incur higher rent and housing expenses to secure accommodations that meet their unique needs and preferences in a remote work environment. 6. You are a planner working for the Georgia Dept. of Transportation (GDOT). Your agency would like to expand lanes on the northeast I-285 corridor. Expanding the highway would have an impact that can be quantified by an increase in the number of users (cars driven on the road) per day. You learn that MARTA is planning an east-west expansion that will cover most of this same stretch of highway. This expansion would also have an impact that can be measured by the 4

number of users (riders per day). Assume both agencies want to increase users (ignoring externalities of increased users) and will not cooperate due to longstanding personality conflicts in leadership (sigh). If both agencies expand this corridor, daily ridership by GDOT will be increased by 100,000, while MARTA ridership will increase by 10,000. If both decide not to expand, daily ridership will decrease by 3000 for GDOT as drivers simply cannot handle the traffic anymore (-3,000) and make other arrangements. In this situation, MARTA increases by 0 riders. If one agency expands and the other does not the situation is different. If GDOT expands and MARTA does not expand, GDOT gains 70,000 riders and MARTA increases by 0 riders. If MARTA expands and GDOT does not expand, GDOT ridership decreases by 2,000 and MARTA ridership expands by 5,000 riders. a. Fill in the payoff matrix based on the information above. (2 points) b. Is there a dominant strategy for GDOT and/or MARTA? Is there a Nash equilibrium? What strategy should you suggest GDOT pursue? (4 points) Yes, they both have dominant strategies and should choose to expand no matter what the other does. If GDOT chooses to expand, MARTA should expand. IF GDOT does not expand, MARTA should expand. If MARTA expands, GDOT should expand. If MARTA does not expand, GDOT should expand. Therefore, there is Nash equilibrium with a choice of expansion. Despite my objections to adding one more lane, GDOT should choose to expand in this model. 7. We can think of U.S. and Japanese trade policies as a prisoners’ dilemma. The two countries are considering policies to open or close their import markets. The payoff matrix is below. Japan Open Close U.S. Open 12, 12 6, 6 Close -70, 7 2, 2 a) Assume that each country knows the payoff matrix and believes that the other country will act in its own interest. Does either country have a dominant strategy? What will be the equilibrium policies if each country acts rationally to maximize its welfare? (3 points) 5 MARTA Expand Does not expand GDOT Expand 100,000, 10,000 70,000, 0 Does not expand -2,000, 5,000 -3000, 0

Choosing open is the dominant strategy for both countries. If Japan chooses open, the US should choose open. If Japan chooses close, the US should choose open. Therefore, no matter what Japan does, the US should choose open. If the US chooses to close, Japan should open. If the US chooses to open, Japan does best by choosing open. Therefore, the equilibrium is for both countries to choose open. b) Now assume that Japan is not certain that the United States will behave rationally. In particular, Japan is concerned that U.S. politicians may want to penalize Japan even if that does not maximize U.S. welfare. How might this concern affect Japan’s choice of strategy? How might this change the equilibrium? (3 points) If the US wants to penalize Japan, they should choose close. Japan’s strategy should not change because open is their dominant strategy. This could change the strategy to close (US), and open (Japan), and therefore, no equilibrium. <Question 8 corresponds to externalities, covered 2/13/24> 8. Provide two examples of positive externalities and two examples of negative externalities of urban growth. You may provide these as a bulleted list, but also describe them if you think a description is needed. (4 points) Positive  Increased diversity of thought, people, culture, etc.  Agglomeration- more businesses and skilled workers. Negative  Traffic congestion  Increased unaffordability in housing Extra Practice Questions (not graded) 1. Describe the marginal principle. What is the difference between total benefit, average benefit, and marginal benefit from engaging in an activity? 6

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2. Would you consider Wikipedia a public good? Does it provide any positive or negative externalities? 3. Externalities arise solely because individuals are unaware of the consequences of their actions. Do you agree or disagree? Explain. 4. Draw two supply and demand curves where the market is in equilibrium in one case where supply is relatively elastic and in the other where supply is relatively inelastic. a) Show the equilibrium price and quantity in each case. b) Compare the effects on price when there is a positive demand shock. 7

CP 6031 Assignment 2

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