Welfare and efficiency

For each of the following methods of financing radio and television programs, indicate how the resulting structure of programs differs from the optimum: and under what conditions, if any, it would be an optimum. In interpreting “optimum”, assume that the only consideration is direct private benefit from the programs; neglect distributional effects, i.e., treat it as a purely allocative problem; and assume that there are no such public issues involved as “education” or “indoctrination”. On the technical side, assume throughout that there are a narrowly limited total number of frequencies or channels available in any one area. Make your answer as definite as possible in terms of the kind of people whose tastes are or are not catered to appropriately, the kinds of programs that are too numerous or too sparse, etc. In answering the question, assume throughout that it is possible without cost to know exactly the number and kind of people who listen to each program.

The existing U.S. method of selling time to advertisers.

Imposition of an annual license tax or fee on each set; auctioning off of time to private program producers; compensation of these producers by giving to each a share of the total tax collection equal to the fraction of total listener time devoted to his programs. Assume that advertising is forbidden.

Some mechanical method whereby a subscriber can receive a particular program only if he pays through a coin-box arrangement for that particular program. The programs are to be provided by private producers who receive the payments, who buy time on the stations, as in the preceding case, and who can determine the amount charged for the programs they produce. Once again, assume that advertising is forbidden.

With reference to federal legislation assuring to every resident in the U.S.A. medical care by the physician and hospital of his choice, free and with no special taxation: Appraise the proposal as to effects upon general welfare, assuming that the alternative is the sale of medical insurance, not subsidized, but with the same distribution of personal income effected by cash “relief”.

Indicate briefly the meaning of each of the following phrases, identify the economist (or economists) associated with each, and state his major contribution to economics:

Pareto optimum

Pigou effect

Walrasian equilibrium

Schumpeterian innovators

Cobb-Douglas production function

Conspicuous consumption

Wicksellian natural rate of interest

Contract curve

If there are empty seats on a train then marginal cost pricing requires that new passengers should ride free.

True, False, or Uncertain. In each case write a few sentences explaining your answer. Your grade will depend heavily on your explanation.

If the United States exports one tenth of its coal, the elasticity of supply of domestic coal being unity, the elasticity of supply of U.S. coal exports must be at least 10.

If the price of X rises while the price of X stays constant, the amount of Y demanded will always increase, so long as X and Y are substitutes. (Assume money income and other prices remain unchanged.)

The own-price elasticity of demand for a commodity must always equal or exceed, in absolute value, the cross elasticity of demand for that commodity with respect to the price of any other commodity.

The own-price elasticity of demand for a commodity must always equal or exceed, in absolute value, the marginal propensity to consume that commodity.

When the production function is such that factors of production combine with each other in fixed proportions to produce a product, the own price elasticity of demand for the use of any of the factors in the production of the product must be less than the price elasticity of demand for the product. (Assume that the production of the product in question is competitive.)

The income elasticity of demand for a commodity is the marginal propensity to consume that commodity divided by the average propensity to consume that commodity.

The elasticity of demand for labor in the production of automobiles will be lower in the case in which the quantities of other factors are given than in the case in which the prices of other factors are taken as given.

The elasticity of demand facing a monopolist will be lower than the elasticity of demand facing the same industry if it were competitive.

The welfare cost of a 5 percent tax on automobiles is the same as the welfare cost of a 5 percent subsidy on all goods and services other than automobiles.

The welfare cost per dollar of tax receipts of a 5 percent tax on automobiles is the same as the welfare cost per dollar of tax receipts of a 5 percent tax on all goods and services other than automobiles.

If, at a point in a production function which is homogeneous (of degree 1), the marginal product of factor B is negative, the marginal product of factor A will be rising (in the sense that the marginal product of A will be higher when the proportion of factor A to factor B is slightly increased). Assume that A and B are the only two factors.

The supply curve of labor can be backward bending only if leisure is an inferior good.

The demand for the services of a factor of production in a particular industry will be more elastic, the larger is the share of that factor in the total costs of the industry in question.

All short run average cost curves are tangent at (at least) one point to the long run average cost curve.

Indicate, using supply and demand diagrams, what is the welfare cost of a tariff. Assume that the tariff is on a product (woolen cloth) in which the domestic demand is partly met by domestic supplies and partly met by imports. The tariff, of course, is a tax only on the imports. Assume that the imported product and the domestic product are for all relevant purposes homogeneous. What role does the elasticity of domestic demand for woolen cloth play in your measure of welfare cost? The elasticity of domestic supply of woolen cloth? The ratio of domestic supply to domestic demand?

State whether each of the following statements about the U. S. economy is true, false, or uncertain, and explain your answers briefly.

Consumers decide what will be produced.

All consumers participate equally in determining what will be produced.

The government influences the composition of output in the private consumer goods sector.

The government determines the level of investment for the economy as a whole.

The difference between the price of foreign crude oil and the price of domestic crude oil (landed at the same U.S. port) times the quantity of oil consumed in the U.S. is roughly $5 billion. This has been cited as an estimate of the cost to the U.S., in terms of wasted resources, of the whole set of governmental measures special to oil (oil import quotas, percentage depletion allowances, prorationing of oil, etc.). Indicate as specifically as you can the defects, if any, in this measure, and the information needed to set a dollar value on each defect.

There has recently been renewed interest in the social optimality of various devices for the public regulation of pollution. Among popular proposals to deal with the problem: emission taxes, subsidies for pollution control, transferable rights to emit pollutants, maximum limits on pollution discharges from each source. Assume that the optimality conditions for public regulation have been met. Evaluate the relative efficiency of these four devices and any others you wish to add to the list.

An excise tax affects the allocation of resources among different uses, whereas an income tax does not.

Resources are seriously misallocated in the broadcasting industry in the U.S., through the fact that the cost of broadcasts is borne by advertisers rather than by listeners and viewers directly.

Take it as a fact that grade one cocoa commands a premium on world markets over inferior grades; that the Nigerian Cocoa Marketing Board (which is the sole purchaser from producers) has set a differential between grades in prices paid to producers wider than the world market differential; and that they have succeeded in this way in raising sharply the proportion of Nigerian production which is grade one. By so doing, they have greatly improved the efficiency of the Nigerian economy.

II. (60 points)

The competitive private enterprise form of economic organization is regarded by many economists as a sort of ideal which it would be desirable to approximate in practice.

(a) On a purely theoretical level, use the tools of economic analysis to explain to a skeptic precisely in what way(s) and why the competitive private enterprise form is so good. State whatever assumptions and define whatever terms you require, and state explicitly the criteria of excellence that you are using.

(b) Assume an economy that is perfectly competitive. What important economic problems, if any, may still be unsolved despite the fact that perfect competition has been achieved? Explain in each case why the problem is important and why perfect competition does not solve it, or explain why there are no unsolved problems.

(15 points) The University City Art Theater, a motion picture house showing foreign films, has the following price policies: The basic admission price is $1.00 for evening performances and 60 cents in the afternoon. Registered university students are admitted at half price at all times. A member of the University’s economics department has complained that the theater is a discriminating monopolist and should be required by local ordinance to follow a one-price policy. Comment on the desirability of this recommendation.

(25 points)

Industry X is composed of 10 firms, and organized as a cartel. The pricing policy of the cartel is determined by the following rule: each firm will produce one-tenth of the output of the whole industry, and the price set for the final product will be just equal to the marginal cost of production in the firm with the highest marginal cost. Show how you would measure the welfare cost of this arrangement, as compared with a competitive equilibrium.

The firms now merge into a single monopoly firm, the previous 10 firms now becoming 10 divisions of the new company. All ten divisions continue to operate and have the same marginal cost functions as they did when operating separately. Show how you would measure the welfare costs of this new arrangement. Under what circumstances, if any, would these welfare costs be lower than those of case A?

The government now intervenes to break up the monopoly. The same 10 firms as existed in case A are reconstituted; collusion is somehow prevented; and merger is precluded by a requirement that no firm shall expand the total volume of its capital. Assume that the firms begin operating under this new arrangement with each of them having the amount of capital resulting from a long-run equilibrium under case B, and that the firms behave competitively. How would you measure the welfare costs of this arrangement? Under what circumstances, if any, would these welfare costs exceed those measured under case B?

Indicate whether statement is true, false, or uncertain, and briefly give your reason.

A firm has a monopoly in its home market and also sells in a perfectly competitive world market; if its home-market price is 50% above the world market price, the elasticity of demand in the home market must be 3.

If a multiplant firm has to produce a given quantity of output, it will never pay it to produce in more than one of its plants if that plant has decreasing marginal costs.

The development of more rapid urban transport will inevitably raise the aggregate rental value of urban residential property.

If the number of acceptable applicants for admission to medical schools is less than the number that could be accepted, the medical profession cannot be raising its earnings by artificially restricting entry.

The rate of interest is determined by the marginal productivity of capital.

If a particular commodity is subject to a special tax not imposed on other commodities, removal of that tax will always increase economic welfare.

If the supply curve of a competitive industry has a positive slope, it means that the industry is subject to decreasing returns to scale.

If wage rates, on the average, increase at the same rate as average product per worker, this means that the marginal return on investment declines over time.

Entrepreneurs in a competitive industry may realize short term gains or profit as a result of an increase in the price of an input (due to a shift in the supply function for the input), even if the demand curve for the industry remains unchanged.

(40 minutes) It appears that the Federal Communications Commission will be given the power to compel manufacturers of television sets to build them in such a way that they will receive ultra-high frequency broadcasts (at an additional cost of about $25 per set). Then every community can have (say) a dozen channels. Will consumers be benefitted?

“A central planning authority may or may not decide to weight equally the welfare of the future generation and the welfare of the present generation. This is essentially an ethical question. But if equal weights are to be applied, the appropriate rate of discount (interest) to use in comparing the costs and benefits from alternative public investments is a zero rate.”

The competitive private enterprise form of economic organization is regarded by some economists as a sort of ideal which it would be desirable to approximate in practice.

On a purely theoretical level, use the tools of economic analysis to explain to a skeptic precisely in what way(s) and why the competitive private enterprise form is optimal. State whatever assumptions and define whatever terms you require, and state explicitly the criteria of excellence that you are using.

Are there any conditions under which the competitive organization form may fail to produce the results promised above?

What other important economic problems of a modern state, if any, may still be unsolved despite the fact that perfect competition has been achieved? Explain in each case why the problem is important and why perfect competition does not solve it, or explain why there are no unsolved problems.

The New York, Ridgewood, and Exurban Railroad operates a commuter passenger service. Two kinds of reduced fares are offered: (1) children under 12 years of age ride at half-fare at all times. (b) on Wednesdays there are special half-fare tickets for adults good on trains leaving after 10:00 a.m. and returning before 4:30 p.m. The railroad has been accused by the New Jersey Commerce Commission of being a discriminating monopolist. Can you defend it against this charge with respect to either or both of its half-fare arrangements? If it is in fact a discriminating monopolist with respect to either arrangement, is it promoting an inefficient use of resources by its pricing practices?

Ontario imposes a tax of 30 percent on the sale or bequest of any land to non-Canadians. What are the effects of such a tax on:

Landowners, Canadian and non-Canadian;

Non-landowners, Canadian and non-Canadian.

What will the effect be if leases are not regulated?

The accompanying diagram showing a set of indifference curves between income and work is part of a diagram given by Boulding in Economic Analysis in his discussion of the effects of various types of direct taxation, and reproduced by Schwartz and Moore in the March 1951 American Economic Review. The latter write, “Given O Q2Q5 as a rate of pay, the equilibrium position is P1 where the rate of pay is equal to the MRS between leisure and income. Let us assume that we are to collect a tax from this individual equal to OL. One method of collecting the tax would be to levy a poll tax, leaving the rate of pay unaltered, as LP5. Another direct tax would be a proportional income tax represented by OSP2 which would have the effect of lowering (flattening) the rate of ‘take-home’ pay. To extract the same amount of revenue as the poll tax does, this rate of pay must be tangent to an indifference curve at an intersection with LP5. Thus P2Q2 = OL. Since the rate of ‘take-home’ pay is flatter, P2 must lie below and to the left of P5; i.e. less effort is expended and the worker enjoys a smaller net income. More important, his welfare is diminished because he must be on a lower indifference curve…Given the premises of the conventional indifference curve pattern, this must necessarily be true.”

(a):

(1) Why do the indifference curves in the diagram slope positively?

(2) How can you justify their being drawn concave upwards?

(3) The statement that OQ2Q5 is “a rate of pay” is of course wrong. OQ2Q5 is a line. Reword the statement so it is accurate.

(4) What do the authors mean by MRS?

(b) If we suppose the diagram to stand for a “representative” individual, or one of a society of identical individuals all to be taxed alike, the last sentence in the quotation is false: the authors' welfare conclusion does not follow from their premises and arguments. Point out the fallacy in the proof.

(c) Under what conditions is the authors' welfare conclusion valid? Can you give a proof of your statement?

Suppose the earnings of military personnel were set below the price that would make the number of volunteers equal to the demand by the military, and that draft calls were sent out strictly at random to males aged 18-26 to bring the number entering up to demand

a.

1. How would the composition of drafted personnel compare with those that would enter if military earnings were raised sufficiently to make the number of volunteers equal to demand?

2. How would the total tax burden and its distribution among the population compare?

b. Assume now that drafted personnel could buy a substitute or substitute for someone else (as during the Civil War) instead of entering as a draftee. Assuming the capital market for substitutes works well, in equilibrium

1. How would the composition of men entering and the tax burden compare with that under a drafted and a fully voluntary system?

2. What determines the price that substitutes can get?

(a) Is it possible to have a situation of general equilibrium without having all individual optimality conditions fulfilled? Explain.

(b) Is it possible to have all individual optimality conditions fulfilled without the state of the system as a whole being Pareto optimal? Explain.

The concept of marginal utility is subject to the objection that it implies a numerical measurement of total utility. How can we overcome this difficulty? Translate into terms which do not involve the cardinal measurement of utility:

(a) The law of diminishing marginal utility.

(b) The Pareto optimality condition that the ratio of the marginal utilities of two goods must equal for all individuals in a free-exchange economy.

(a) Is it possible to have a situation of general equilibrium without having all individual optimality conditions fulfilled? Explain.

(b) Is it possible to have all individual optimality conditions fulfilled without the state of the system as a whole also being Pareto Optimal? Explain.

Many shopping centers provide zero price parking for their clients. Some have argued that such policy leads to inefficient location of resources since to insure sufficient parking for center clientele space must be provided for “freeloaders” who shop at stores near the center. Who gains from the zero price parkings? How? Would it be economically more efficient for centers to allocate parking space by price?

(a) Is it possible to have a situation of general equilibrium without having all individual optimality condiions fulfilled? Explain.

(b) Is it possible to have all individual optimality conditions fulfilled without the state of the system as a whole being Pareto optimal. Explain telling what you mean by Pareto optimal.

Economists sometimes say that monopoly is “inefficient”. Explain the meaning of “inefficiency” in this context. Show analytically how this inefficiency comes about.

Atomistic markets are supposed to permit the achievement of Pareto optimality where externalities are absent. Explain the meaning of this statement. Do externalities offer unambiguous proof of market inefficiency or is it possible for externalities to be consistent with market efficiency? Explain.

Perfect (pure or price-takers) markets is supposed to permit achievement of Pareto Optimality, where externalities are absent. Explain the meaning of this statement. Do externalities offer unambiguous proof of market inefficiency or is it possible for externalities to be consistent with market efficiency?

Price-takers markets are supposed to permit the achievement of Pareto Optimality where externalities are absent. Explain the meaning of this statement. If externalities exist will optimality necessarily be denied? Why?

“Perfect (price-takers’) markets is supposed to permit achievement of Pareto Optimality, where externalities are absent.” Explain the meaning of this statement. If externalities exist will the optimality be denied? Why?

“Monopolistic competition is inefficient.” Explain and evaluate that assertion. Then defend the proposition that neither Pareto optimality nor efficient allocation is a relevant criteria for real decision making in the honest-to-god world.

(a) In a competitive (atomistic) industry, suppose that a maximum wage law lower than the equilibrium wage is imposed and enforced. Indicate graphically the implication for employment in the industry, the areas representing distributive transfer(s) and those areas representing social gains or losses.

(b) Do the same, but assume now that the industry is empowered to conscript laborers at the specified maximum wage.

Explain what is meant by “Pareto optimal.” Why is it used so widely? (Do not state all the conditions that must hold for it to exist.) Is it consistent with compulsory licensing of doctors, prescriptions for drugs, approval by the Securities and Exchange Commission before securities are sold, tariffs, franchises for public transportation, minimum wage laws, non-exchangeable rights to be a U.S. citizen, anti-discrimination laws and anti-murder laws? Explain.

Is it possible to have a situation of general equilibrium without having all individual optimality conditions fulfilled? Explain. Is it possible to have all individual optimality conditions fulfilled without the state of the system as a whole being Pareto optimal?

Economists sometimes say that monopoly is “inefficient.” Explain the meaning of “inefficiency” in this context. Show analytically how this inefficiency comes about.

Price discrimination may lead to more efficient allocation of resources. Do you agree or disagree? Explain first what you mean by efficient allocation of resources.

Both monopolists and purely competitive firms are assumed to behave as if they seek to maximize profits, yet monopoly is held to result in an inefficient allocation of resources as compared to pure competition. Explain. Marginal costs serve as a guide as to how much of a good product, while average variable costs help indicate whether to produce at all. Explain.

Evaluate: “The fact that some airplanes collide is evidence there is ‘too little air traffic control’.” (Be sure to explain what too little might mean.)

Explain the concept of externality. What does it have to do with the efficient allocation of resources?

Suppose a frost kills a large portion of an orange crop, with a resulting higher price of oranges. It has been said that such an increase in price benefits no one since it cannot elicit a supply response; the higher price, it is said, simply “lines the pockets of profiteers.” Analyze this proposition. (Hint: be sure to focus on the rationing function of market price.)