Posted by AliceP on Wednesday, October 18, 2006 at 2:27am.
Can someone please help with this question...
a) Outline the various roles played by prices in a market economy.
b) In what way does the presence of externalities result in price information being inaccurate? Illustrate by considering:
i) the case of research and development expenditures, and
ii) the problem of traffic congestion.
Good fundamental microeconomic questions. Take a shot. I or someone else will be happy to critique your answer.
Well I was thinking with a) prices in a competitive market determines only the output which firms must sell to maximise profits, where in a imperfect market prices determine the amount that the market is demanding.
b) I have no idea…. I know what externalities are but how does it relate to answering I) and ii)
Lets start with some fundamentals -- the definition of Economics. Economics is the study of how scarce resources are allocated. That is, who gets what, when, and how.
In a market, goods and services are exchanged for one another. The use of money only facilitates the exchange. However, not all prices are measured in money. (In the case of traffic congestion, price is measured in time). Further, in a market, the "seller" of a good wants to get as much as he can. The "buyer" wants to pay as little as he can. Further, in a competitive market, there will be lots of buyers and lots of sellers. As an example, take a typical food court in a big shopping mall; lots of buyers lots of sellers. The price(s) at which each individual seller charges are always moving towards an equilibrium price. If the seller charges too much, buyers will go someplace else, and the seller makes little or nothing. Further, if his initial asking price is above his marginal cost, he would certainly be willing to lower his price. He will keep lowering his price as long as lowering generates more net profit for himself. Finally, each seller will find an optimal price; where by either raising or lowering his price(s), the seller will make less profit. Buyers, in this market, are doing the opposite. They are looking for the seller that is offering the best deal. In a competitive market, all the sellers will be selling at the same or very competitive prices. (When I (rarely) go to a mall food court, I can get an equally satisfying meal for about $7, regardless of whether its a burger, chinese, or pizza.)
So, in short, what did prices DO in this market. Well, they allocated the scarce resources. The buyers get food. The sellers give up their labor and capital in exchange for money (which they, in turn use to buy the stuff they want). Further, and very importantly, the benefit going to the marginal buyer (the very last person willing to pay for the food at the market price) exactly equals the marginal cost of producing that food. Any additional sales would cost more to make than would provide a benefits.
Bottom line--who gets the food? Answer: the group of people willing to pay at the current price. The market price, in the final analysis, determined who got the scarce resource (food). Further, at the market price for this pure private good, marginal benefits are ZERO. Any other buyer would have to pay more than he/she is willing and any additional seller would have to receive less than he is willing to accept.
In the case of food, the buyer gets the complete and sole benefit of the food. The buyer's consumption does not benefit or add costs to anybody else. Not true when externalities are present. In the case of a negative externality, one person's consumption imposes costs or discomfort on somebody else. The price paid by the consumer did not account for this additional cost. The consumer is either unaware of the additional costs or is unconcerned. In the case of a positive externality, one person's consumption benefits somebody else. This added benefit is not reflected in the price.
Research and development is an example of a positive externality. Spending money to research and develope one problem or product often causes learning which could be used to solve some other problem. However, the buyer of the R&D would not benefit from solving this other problem; someone else would benefit. And that someone else is not contributing to the cost of the R&D.
In the case of traffic congestion, by one additional car entering the highway, he slows the travel time of everybody else. Again, the additional costs are not borne by the marginal driver, but by all current drivers.
Whew. I usually hate to write this much. I hope this helps.
In the last part you said the additional costs are not brone by the marginal driver but by all current driver.
In this case the marginal driver is the last or newest driver who entered the street. So isen't he too experiencing more travel time?
so that means he is also baring the cost ?
Can someone please help me with the following questions? thanks a lot
1. The cranberry market is perfectly competitive. Reports that consuming cranberries can lead to improved health result in a permanent increase in the demand for cranberries and an immediate upward jump in the price of cranberries. As time passes, the supply of cranberries will increase, so that the price of cranberries ____ and the firms' economic ____.
A.falls; profit will be eliminated
B.rises still higher; loss will be eliminated
C.rises still higher; profit will not change
D.falls; loss will be increased
2. During the winter, theme parks in Orlando often close at dusk even though they have much later closing times during the summer. The early closing times during the winter is because during that season the marginal revenue from staying open later is ____ the marginal cost.
d.zero compared to
3. If steel workers obtain a substantial wage increase, employment in the steel industry will be likely to fall the most if
a.the demand curve for steel is highly inelastic.
b.the demand curve for steel is highly elastic.
c.the demand curve for steel workers is highly inelastic.
d.there are no good substitutes for steel.
4. Generally, the supply of a resource in the short run will be
a.more elastic than in the long run.
b.less elastic than in the long run.
c.equally elastic as the supply of the resource in the long run.
d.directly related to the elasticity of demand for the product that the resource helps produce.
5. (I)A firm should continue to hire workers until the marginal revenue product (MRP) is equal to the wage rate.
(II)The marginal revenue product (MRP) of a resource will rise as employment expands.
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