Homework 6

Intro Micro--

1. Suppose that, in the Madison area, gasoline service stations (not oil companies of course) can be described as a monopolistically competitive industry with free entry.

   1. Describe briefly how you might come up with a rough estimate of the average salary gas station owners are able to pay themselves in long run equilibrium (no numbers required). Answer

   2. Show graphically and briefly explain the short run effects on gas stations of an increase in the wholesale price of gasoline. Be sure to show any change in price, output and profit. Use as many graphs as you need to make your results clear. Answer

   3. Continuing with the analysis from part (b), show graphically and briefly explain the long run effects on the gas stations of an increase in the wholesale price of gasoline. Be sure to show any change in price and output. Will the total number of gas stations increase or decrease? Use as many graphs as you need to make your results clear. Answer

   4. Explain why (in long run equilibrium)--at most times during the day--it is easy to pull into a gas station and find an available pump. Answer

2. Suppose the plain metal paper clip industry is perfectly competitive. However, whenever consumers' incomes increase, they tend to use more designer paper clips, which are produced by firms in another industry.
   1. Explain how the characteristics of (i) many small firms and (ii) homogeneous products together cause the firm to behave as if it faces a horizontal demand curve at the market price. Explain briefly what is meant by ``price taking.'' Answer

   2. Explain the how free entry and exit enables us to predict the long run profitability of firms in a perfectly competitive industry. Answer

   3. Show graphically and briefly explain the short run effects on the plain metal paper clip firms and industry, of a decrease in consumer income. Be sure to show any change in price, output and profit. Answer

   4. Continuing with the analysis from part (c) show graphically and briefly explain the long run effects of a decrease in consumer income on the plain metal paper clip firms and industry. Be sure to show changes in price and output. Does the number of paper clip firms increase or decrease? If possible, explain whether the final price and output for the typical firm is larger or smaller than in the initial equilibrium. How does output for the industry change? Answer

3. Suppose, as always, that the gem quality diamond industry is a monopoly. Also, suppose that most people prefer their diamonds set in precious metal (gold, silver, platinum) settings. ( Important: The diamond monopoly only supplies the diamonds, it is not involved in making the jewelry.)
   1. Show the impact on a diamond monopoly of an increase in the cost of precious metals. Be sure to show any change in price, output and profit. Use as many graphs as you need to make your results clear. Answer

   2. Show graphically and briefly explain the impact on a diamond monopoly of an increase in annual liability insurance premiums. Be sure to show any change in price, output and profit. Answer

   3. Explain the role of barriers to entry in explaining the long run profitability of a monopoly. Show graphically and briefly explain the range of prices that a monopolist might consider depending on whether it considers entry a serious threat or not. Answer

   4. Other than pricing strategies, discuss two other barriers to entry over which firms can reasonably be expected to exert some control. Explain how these can be used to forestall entry by a potential rival. Answer
      

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