Microeconomics Externalities, Market Power Assignment

Introductory* Micro*economics 316-102 *Sem 1*,2010 Assignment 2: Genevieve Blanch QUESTION 1. Externalities in this situation exist where the Government, Country or Private Organisation decides to launch a new satellite causing costs and benefits to other members of society which do not impact on the G,C or PO. Such externalities include: NEGATIVE (Costs to other members of society) Hazard to the useful working satellites that surround Earth. Threat to our dependence for communications, broadcasting and surveillance. Debris from one collision causing a second, which creates still more debris and collisions. A socially optimal outcomes occurs when then the social maximal benefit equals social marginal cost meaning the surplus to society is maximized. At the same time efficient market equilibrium is needed where the private marginal benefit (PMB) equals Private marginal cost (PMC). {draw:line} {draw:line} {draw:line} SMC=PMC {draw:line} {draw:line} SMB=PMB Q* For each active satellite a certain amount of debris is released into space. Because the debris is a hazard to other working satellites it is considered a negative externality. Due to this negative externality in production, the social cost (SMC) of producing active satellites exceeds the private cost (PMC). This means the socially desirable number of active satellites, Q optimum, is smaller than the equilibrium quantity Q* (As seen below). Graph: Debris and the social optimum {draw:line} * {draw:line} * SMC {draw:line} {draw:line} * *Price of satellites. {draw:line} (Demand) PMC * {draw:line} {draw:line} * Optimum {draw:line} (Supply) PMB=SMB {draw:line} Q optimum* *Q * * *Q=No. of satellites launched We could conclude from the article that the socially optimal outcome is not being achieved due to the negative externalities. b) The article suggests as solution*s* to achieve socially optimal amou*nt of space debris* to: Create â€Å"International civil satellite-awareness system†. â€Å"Countries should comply with international guidelines to minimize the amount of debris created by launches† A moratorium on debris-creating anti-satellite tests Satellite launchers buying insurance. By agreeing to the policies the main aim would be to ‘internalize the externality’. Meaning the satellite producers taking into account the social costs and benefits of their decisions. The first policy would work by increasing the awareness of the problem of debris in space and therefore giving an incentive for producers to think twice on a moral level before producing the satellites. If this worked the PMC would decrease in quantity to meet the optimum at SMC. The second policy would work by governments implementing a tax which will equate PMC and SMC. By putting a tax on a certain amount of debris released through launches the SMC is forced to meet PMC, and has low cost to society. This tax should give producers of active satellites and the launches an economic incentive to reduce the amount of debris being released into space. Another option from the second policy would be to regulate the quantity of satellites being launched or to regulate the quantity of debris being released. This could involve the government telling the producers of satellites to reduce the quantity of satellites launches or debris being released. The third policy would work by the government placing a ban on all anti-satellite tests which are heavy releasers of debris. Banning one type of satellite would reduce the overall amount of satellites launched causing the PMC to approach the social optimum. The fourth policy would works by the insurance acting like a tax. Buying insurance acts like a tax that will increase PMC to social optimum. . c) The free rider problem: The free rider problem in the article is where the ‘orbit is open to anyone with a launch-rocket handy’, therefore some countries may improve their own well being by ‘bearing the costs of wellbeing’ while leaving other countries to pay for the debris, and causing those ‘bearing the costs’ to ‘reap the benefits’. The free rider problem comes from the fact that a public good is â€Å"non-excludable†. It’s when decision makers own well being can be improved by making others pay for the good. Satellite launches are public goods because they are neither excludable nor rivalrous in consumption. People cannot be prevented from using a satellite launcher and one persons use does not reduce another persons use of it. Solutions: Government supplies satellite launches. The government takes over as supplier of satellite launches. They must calculate the SMB and SMC deciding on an efficient quantity, keeping in mind the willingness to pay of satellite launch consumers. Then, using the Lindahl tax the government could finance provision of the satellite launchers by asking consumers with higher revenue to pay more. This means that consumers share of the Social marginal benefit is multiplied by the cost of the launcher. (SMB x Cost=Lindahl tax). The government provides increased incentive to supply clean satellite launchers by assigning property rights. Involves assigning ownership of launchers to certain suppliers who can charge other consumers for using the launchers. QUESTION 2: Relative importance of fixed costs and variable costs in the retail grocery industry? A key part of knowing how much to produce to be profitable comes from how the costs will vary with the level of production. In a large scale firm like coles and Woolworths, it is necessary to produce large quantities. The average fixed costs will decrease as the quantity produced increases. Eg. Say we are looking at labour as a fixed cost. As volume of foods produced increases, there is a diminishing marginal cost of labour as the increase in total cost that arises from extra units of food produced is gradually getting smaller. If both variable costs and average costs are kept to a minimum the total cost will be most profitable. By keeping the fixed costs down using methods of productivity improvement such as electronic self service, the Average fixed cost will be at a minimum causing the average total cost to be at a minimum therefore cost saving. Variable costs are inevitably going to rise with the increase in quantity of sales, however with the total revenue should still outweigh the total costs if the fixed costs are kept at a minimum and the sales volume kept high. {draw:line} ATC AVC AFC {draw:line} Small quantity Large quantity Why structure of costs in retail grocery industry is important for understanding the profitability of firms? For large scale companies like Coles and Woolworths to be profitable the amount of fixed costs needs to balance with the sales volume. These companies are forever trying to maximize their profits; a good strategy to do this is by focusing on cost savings rather than cutting costs. By cost saving, the retail grocers will invest to gain productivity, therefore becoming more efficient and offering the customers more. Eventually in the cycle sales growth increases therefore expanding the profitability. Investing to gain productivity will bring the fixed costs down in the long run and as a result produce a smart distribution chain. If Coles/woolworths has a high fixed cost and the sale volume is decreasing, the company’s profitability will be difficult to maintain hence a high fixed cost must have large sales volume. QUESTION 3: a) Why private schools would want to increase school fees in response to an increase in teacher *saleries*? If we assume that demand for private school remains the same but the schools costs increase we can examine what will happen to profit using MB/MC rule. draw:line} {draw:line} {draw:line} {draw:line} $ MC $ MC {draw:line} {draw:line} {draw:line} {draw:custom-shape} {draw:line} {draw:custom-shape} {draw:line} {draw:line} Price * ATC* ATC {draw:line} * * D {draw:line} ATC D MR {draw:line} {draw:line} MR q q No increase in teacher salaries Increase in teacher salaries Profit equals the Price minus average total cost X the quantity. If the teachersâ €™ salaries increase, this will cause the Average total cost(ATC) to increase causing the firms overall costs to increase. Therefore the profit being derived from the Price minus the newly high ATC multiplied by the quantity the total profit, will result in the school receiving less profit. By increasing the price of school fees, the increase in costs is equalised by the increase in price, therefore, with a higher price, the profit of the school will remain the same. â€Å"With the impact of the economic downturn tempering fee rises Here we assume the demand will change with the impact of the economic downturn however we will assume that costs remain the same. The economic downturn will cause an inward shift in the demand curve as there is a decline in demand for private school education. The Marginal revenue will shift with the demand curve as a decrease in demand also results in a decrease in marginal revenue. Therefore, this shift in demand will cause the price of Private School fees to decrease {draw:line} {draw:line} {draw:line} $ MC {draw:line} {draw:line} {draw:line} {draw:custom-shape} {draw:line} {draw:line} Price {draw:line} ATC * D1* {draw:line} ATC D2 {draw:line} MR q QUESTION 4: Main explanations for why market power of the ‘big four’ banks in Australia has* increased? *Reduction in competition. * In a more competitive situation, which we hope will occur again soon, competition between the big 4 banks, smaller banks and their customers is consistent causing the prices to be competitive and the market power at a reasonable medium level. The big 4 banks have recently been less of a threat to each other mainly due to the financial crisis taking â€Å"out the non-bank lenders for housing† which means the larger banks have more necessity. And by taking over two smaller banks, they have reduced the smaller competition. The necessity of the banks and lack of smaller bank competition means the market power for the ‘big four’ increases. *More constraint. * People are keeping with their current banks due to being â€Å"expensive and time-consuming† to shift loans and bank accounts between the ‘big four’. This financial burden holds them to their banks taking the power away from the consumers and giving the banks control over market prices. Explain how the banks greater market power allows them to ‘raise their rate of profit’. Reduction in competition means that if the banks increase their prices, such as the variable mortgage rate (0. 2 percentage points) they will not lose customers. Because of the lack in competition the banks have heightened their market power to the point where the banks can increase their prices(mark up), without impacting on their customers. Thus, the quantity demanded for banks responds little to the price deeming it relatively price inelastic. With higher prices, the Price minus the ATC will be higher therefore raising their profit. More constraint means that other firms are less price competitive because their customers will be unlikely to switch banks due to it being ‘expensive and time consuming to shift loans and bank accounts’. The constraint to banks causes the consumer demand to become very price inelastic, this is because an increase in price would not severely impact on the demand to switch to another bank because of the cost in doing so. PART 2 â€Å"Why are Melbourne University Colleges significantly more expensive than other colleges when they offer similar *services? † The on campus catered residential housing, otherwise known as ‘colleges’ prove to show some vast differences in fee pricing. When comparing ANU’s colleges to the University of Melbourne’s, Melbourne proved to have significantly higher fees. To attend a Melbourne University College as an undergraduate the prices range from $18,200 to $21,051 over the year1 which can be to a $505. 55 to $58 4. 84 weekly fee1. At an ANU college the undergraduate weekly fee is from $297. 50(Ursula Hall) to $305 (Burgmann College)2. Considering they both offer similar services, food, bedrooms, amenities, gym, library, on campus, tutorial services, social and sporting events we can look to the market forces of demand and supply, as well as elasticity for an economic explanation. DEMAND The Melbourne University colleges to many students about to begin university are considered an essential to forming strong relationships as well as giving extra support academically (especially being in a whole new academic system). They offer many services from full food and board to a gym and intercollege sporting events. College is commonly referred to as ‘the best years of your life’ and so many want to experience it. Most students come from regional areas and some from foreign countries, these students have the necessity to find accommodation in Melbourne so college responds to this need. Putting these aspects together we can understand why there in an increase in demand for a place at a Melbourne University College (see below). {draw:line} {draw:line} {draw:line} {draw:line} P S {draw:line} {draw:line} {draw:line} P*2 {draw:line} {draw:line} P* {draw:line} D1 D2 Q? Q2 Q Consequently an increase in demand for Melbourne Uni College results in an increase in price/fees and an increase in the quantity of places demanded. ANU Colleges offering the same or similar services and opportunities as Melbourne Uni also has a high demand to get into college, however they differ in the number of places available and the elasticity. BOTTLENECK Despite the heavy demand for a place at college there are a limited number of places available. With more people willing to get in than places, a bottleneck is placed on supply and increases the prices (similar to a firm with monopoly power). This can be represented like a quota, with the quota as the restriction on available accommodation. *Accommodation at Melbourne Uni* Colleges {draw:line} {draw:line} {draw:line} P {draw:line} S {draw:custom-shape} {draw:line} {draw:line} P Quota Melb Uni {draw:line} {draw:line} P*ANU {draw:custom-shape} {draw:line} D {draw:line} {draw:line} Q*ANU Q Q Quota, Melb uni. At ANU, there is a guarantee that all interstate or regional students will be given accommodation, so the restriction on accommodation doesn’t exist hence the price being lower than Melbourne Uni. Also, the price of land in Parkville, close to the city in the heart of Melbourne automatically means the price of land will be ELASTICITY The Melbourne University Colleges in some cases are filled by privileged students who come from high income families whose parents consider college a necessity, are willing to support them in college despite large fees. Other students work to be able to support themselves, both categories are relatively unaffected by the price. This means there is an inelastic demand for Melb Uni colleges. The quantity demanded of a place at Melb Uni Colleges does not respond hugely to the increase in college fees. Hence, the colleges can increase their prices and the demand will not be effected. Conversely, at ANU, despite the demand still being rather inelastic, it is more elastic than Melbourne Uni Colleges. ANU has a wider socio economic intake, spreading wider than Melb Uni from high income families to low income families so the quantity demanded in their colleges will more likely be swayed by pricing. Hence it is more important to maintain a competitive and lower price. draw:line} {draw:line} {draw:line} {draw:line} {draw:line} {draw:line} {draw:line} {draw:line} {draw:line} {draw:line} P2 P1 {draw:line} {draw:line} {draw:line} D(UM) D (ANU) {draw:custom-shape} {draw:custom-shape} Q2 Q1Q1Q2 REFERENCES: http://www. colleges. unimelb. edu. au/assets/uploads/Comparative-Costs-2010. pdf University of Melbourne, ICC (2010). _Comparative Costs. _ http://accom. anu. edu. au/UAS/2340/ver sion/1/part/4/data/ANU%20Hall%20and%20College%20Fee%20Summary%202010%20v5. pdf? branch=main&language=default Australian National University, 2010. ANU Hall and fee summary.