Check Yourself Solutions for Chapter 9 through Chapter 12

Chapter 9-1

1. Domestic producers gain from a tariff and domestic consumers lose.

2. Trade protectionism leads to wasted resources because it shifts production from the lowest-cost producers to higher-cost producers.

3. You hear more often about people who gain from trade restrictions than people who lose because the gains from trade restrictions are concentrated on a few winners, while the losses are diffused over many losers. Even though the total gains are smaller than the total losses, the concentrated benefits mean that the winners have a greater incentive to argue for trade restriction than the losers do to argue against it.

4. In Figure 9.3, area C represents the deadweight loss; it results from the lost gains from trades not happening.

Chapter 9-2

1. The movement of the garment trade overseas has been a net benefit for the United States because clothing is now much cheaper for U.S. consumers and U.S. workers specialize in the fields in which they are most productive.

2. If the U.S. government subsidized the Silicon Valley computer industry, it would encourage more computer chip manufacturing, but at a higher cost (production would not be as efficient). This would be a waste of resources. Foreign competitors would be pushed out of the industry. Consumers of computer chips would benefit from the subsidy, but they would benefit by less than the cost to U.S. taxpayers.

Chapter 10-1

1. If the government overshoots and sets a Pigouvian tax that is too high, it will result in an equilibrium quantity that is lower than the efficient equilibrium. A tax that is too high will create a deadweight loss from too few trades. If the tax is much too high, it can be worse than leaving the externality alone.

2. If the government undershoots and provides a subsidy that is too low, the equilibrium quantity will be lower than the efficient equilibrium. In this case, there will be an undersupply.

Chapter 10-2

1. Using the Coase theorem, a solution to the prospect of elderly neighbors complaining about your party is to buy the elderly couple tickets to a movie or to a night away at a hotel. Transaction costs are low in this case: You can easily contact your neighbors and you might even pay for the gift by collecting contributions from the partygoers.

2. A solution to the polluting factory problem depends on the transactions costs. Are there many neighbors or only a few? Are the victims of the pollution located nearby or are they spread out? Is it clear whether the factory has the right to pollute, say, because it was there first and everyone moved into the area knowing about the pollution? Transaction costs are key here, because even if the factory has the right to pollute, if you can negotiate with your neighbors, you may be able to pay off the factory if it has certain property rights.

Chapter 10-3

1. A falling price for tradable pollution allowances tells us that the value of the allowance has fallen. This means that the costs of eliminating pollution have fallen—perhaps because of technological developments in clean energy.

2. If a local government sets tradable allowances for pollution in the neighborhood, some groups that would press for a large total quantity of allowances would be the big polluters: chemical factories, meat-processing plants, sometimes automobile repair shops. Some groups that would press for a smaller total quantity of allowances would be homeowners, parents sending their children to local schools but who live outside of the immediate vicinity, the elderly. Unfortunately, there is no theorem that says the rough-and-tumble of the political process will result in an efficient equilibrium. If the political process gets it approximately right and the externality is serious, the tradable allowance system will improve social welfare but this is not guaranteed.

Chapter 11-1

1. In a competitive market, if a firm prices its product above the market price, no one will buy the firm’s product. Why should anyone pay more for the same product? In a competitive market, if a firm prices its product below the market price, it will sell everything it produces, but why should it set price below the market price when it can sell the same amount at the market price?

2. Demand for a competitive firm’s product is perfectly elastic, portrayed as a horizontal demand curve for the firm’s product. It can sell all it wants at the competitive price.

3. If there is more than one firm in the industry, then the demand for a particular firm’s product is always more elastic than the demand for the product itself. The demand for each stripper well’s oil is very elastic even though the demand for oil is inelastic because there are very good substitutes for the oil from a particular firm, namely the oil from any other firm.

Chapter 11-2

Chapter 11-3

1. Profit equals (price minus average cost) times quantity, π = (P – AC) × Q. Another way of saying this is that profit per unit is price minus average cost (the cost for each unit), and profit per unit times the number of units sold gives you total profits.

2. Assuming that the firm produces the optimal quantity (found where P = MC), then at any price greater than average cost, the firm is making a profit and at any price less than average cost, the firm is taking a loss.

Chapter 11-4

1. In the early stages, an automobile manufacturing industry is a decreasing cost industry because as the industry expands, it can draw on economies of scale both in auto manufacturing and in steel, plastic, and other input industries. Economies of scale, however, don’t increase forever, so once the industry matures, it becomes an increasing cost industry. Today, for example, the automobile industry is an increasing cost industry because greater demand for autos means an increased demand for steel and plastic, which will drive up the price of steel and plastic, thus increasing costs in the auto industry.

2. The U.S. film industry is clustered around Hollywood because the central location leads to lower costs. Perhaps only in Hollywood could a movie director easily arrange to interview four movie stars in a single afternoon.

Chapter 12-1

Chapter 12-2

1. In competitive markets, profits are a signal for new firms to enter. It is as if entrepreneurs see a sign flashing “Profits, Profits, Profits.”

2. In competitive markets, because a firm has no control over price, its best opportunity for profits is to keep its costs low.