# Homework Problems for Part I: Prices and Substitution Effects (additions to the print edition)

(see pages 73-75 for problems 1-7)

8)    A railroad charges passengers for each ride, and offers a per-ride discount for passengers that pay a monthly membership fee.

a.     A passenger without the membership fee takes n rides per month and notices that n rides would cost the same on the membership plan.  Did he make a mistake by not buying the membership?

b.     Could eliminating the membership plan increases total rides?  Does your answer depend on the degree of competition for passengers?

c.     Does the standard fare by itself reduce total rides?  What about the members' fare?  The membership fee?

d.     Describe how the monthly number of rides would vary as income gradually increases from a low level to a high level.

e.     Describe the choice pattern you described in part (c) in terms of the Marshallian and Hicks demand curves for this individual.

9)    An industry has many suppliers of the same good.  Each supplier's production capacity is the same (you may normalize it to one).  Each supplier produces with the same two production factors, but with a different production function.

f.      Describe how an individual supplier's factor demands vary with the output price and the factor rental rates.

g.     If the suppliers were using the two factors in fixed proportions, what is the relationship between the industry's factor demand and individual producer's factor demands?

h.     What does the cost function look like for this industry?

10) True, False, or Uncertain: The introduction of new expensive prescription drugs tends to increase the rate of inflation as measured by a price index designed to measure the cost of living.

11) True, False, or Uncertain: A borrower is harmed by an increase in the interest rate.

12) When famous people wear expensive designer clothes, other people are more willing to pay for such clothes.  True, False, or Uncertain: The purchase decisions of famous people are the source of a negative externality.

13) True, False, or Uncertain: The demand for assembled toys is less price elastic than the demand for toys that customers have to assemble.

# Homework Problems for Part II: Market Equilibrium (additions to the print edition)

(see pages 150-152 for problems 1-6)

7)    Assume for the moment that consumers pay manufacturers directly for pharmaceutical products, with manufacturers charging price p for each prescription.  The market demand curve reflecting their preferences is D(p). On the supply side, each prescription drug is produced under patent protection for T years, after which time any number of manufacturers may legally sell the drug.

a.     What happens to the quantity of drug sales, summed over all manufacturers of that drug, after a patent expires?  Are there any reasons that the drug’s sales might decrease?

b.     Now we recognize that most prescription drugs are purchased through “prescription drug plans” (PDPs) that pay manufacturers while charging consumers (i) a monthly “premium” that is independent of the number and type of prescriptions purchased and (ii) “coinsurance” at the time of purchase that is a fixed percentage of the “list” price owed by consumers who have not joined a PDP.  Assuming free entry of PDPs, what do you predict about the relationship between list price, premium, and coinsurance?

c.     Given that PDPs are “middlemen” whose operations involve labor and capital costs, what are some of the reasons why a consumer would voluntarily join a PDP?

d.     What are some of the reasons why the coinsurance payment for a drug might exceed its marginal cost?  Could it be less than its marginal cost?

e.     PDPs and their members usually pay manufacturers less than list price for the drug, especially when the drug is still protected by patent.  Their discount from list price is known as a “rebate” and is paid by the manufacturer to the PDP.  Can you explain why generic drug manufacturers do not pay rebates?

f.      Do you expect that manufacturers would require PDPs to modify their plans in order to “earn” the rebate?  If so, give some examples of plan modifications.

g.     How would a prohibition of rebates affect the total and average revenue received by manufacturers?  Would consumers be better or worse off? How do these effects relate the the aggregate amount of rebates that were paid absent the prohibition?

8)    Consider an economy with two regions, the north and the south.  Exterior temperatures are warmer in the south than in the north.  Individuals care about the temperature in their house, H, and their consumption of a single consumption good, X.  Houses are kept warm through the use of insulation and energy.  The energy cost of increasing the house temperature K degrees above the outside air temperature is K*C(I), where C'(I)<0 and I is the amount of insulation.  Wages in each market depends negatively on the number of people that live in that market and all goods are sold in a national market.

a.     If the amount of insulation in each house is fixed at the same level in the north and the south, how will the regions differ in terms of wages, interior house temperatures and consumption of the good X?

b.     How would a uniform increase in the amount of insulation in both locations affect wages and house temperatures in the two regions?

c.     Now assume that the amount of insulation can be adjusted by the individuals in each region and that insulation can be purchased on a market at a fixed price, PI.  How will the amount of insulation used, interior temperatures, energy costs, and consumption of X differ across regions now?

9)    A particular fringe benefit is available from some employers, but not from others.  Providing the fringe benefit is more common when an employer has more employees, but number of employees is not a perfect predictor of benefit provision.

A new law is passed requiring employers to provide the benefit or pay a fine of \$4000 per employee per year.  Small employers – those with less than 50 employees – are exempt from the new law’s requirement.

a.     Absent the law, why might benefit provision increase with employer size?

b.     Might an employer that would have offered the fringe benefit drop it because of the new law?  Does your answer depend on employer size?

c.     Do you expect that, with the law in place, a remarkable number of employers would have exactly 49 employees (employees are measured in integers)?  What about exactly 48 employees?  Relate your answer to an employer’s cost function.

d.     With the law in place, what would the size distribution of providing firms look like?  What about the size distribution of not-providing firms?  [size is measured as the number of employees]

e.     How does your answer to (d) depend on the average skill of the employees normally hired by the firms?

f.      What is the effect of the law on aggregate employment?  Output per worker?  Compare your predictions to a tax of \$4,000 per employee-year.

g.     If you learned that the employment effect of the law was negligible, how should you reassess your estimate of the effect on output per worker?

10) True, False, or Uncertain: A minimum wage law may cause people to work more hours per week.

11) True, False, or Uncertain: If white workers do not like working with black workers, that would tend to depress black workers' wages.

12) True, False, or Uncertain: In a society in which people are altruistic and otherwise care about how other people are treated, businesses will not merely maximize profits but instead will make social responsibility one of their objectives.