(i) If a person decides to have a flu vaccination, it creates a positive externality as they won’t contract the flu and thus won’t pass it on to other members of the public.
(ii) Conversely, if they opt against the vaccination, a negative externality arises via the increased risk of the person gaining the flu and infecting other members of society.
The article suggests that the elderly gain more benefit per flu vaccine than children because they are at the “greatest risk of dying if they contract influenza”, whereas children “rarely die of seasonal influenza”. Socially however, it would be more beneficial to vaccine more children over elderly as it could “reduce the spread of flu, thus saving lives”.
Thus, as Figure 1.1 shows, it is more efficient for (i) less older people and (ii) more children to be vaccinated as this provides the greatest positive externality. This is represented by the bigger increase from PMB to SMB.
With the positive externality PMB shifts to SMB, creating a larger price and quantity traded. As Q* < Q**, this shows that there is too little of the activity done in the market equilibrium compared to efficiency.
$
PMC=SMCFigure 1.1
P**
P*
SMB
Q* Q**
Amount of the positive externality
PMB
Q
The government could employ direct regulation to ensure there is a minimum level of flu vaccines produced (in accordance with the socially desirable amount). They could also provide consumer subsidies to allow more elderly people or struggling young families to afford flu vaccines. This is represented below.
P
A subsidy provided by the government will shift the demand curve from D(Pc) to P (Ps) by the amount of the subsidy. With consumers now willing to pay more for flu vaccines, a greater equilibrium quantity is traded, brining it closer to the socially optimal level.
S(Ps)Figure 1.2
Ps
P*
Pc
Q
D (Pc)
P (Ps)
Q* Qsubs
QUESTION TWO
An alternative to the constant fee is to allow the competitive forces of market demand and supply to determine a new equilibrium.
Excess supply
This shows the situation of excess supply. Here there are too many bikes in the racks and so they can’t be dropped off. Competitive forces will drive trade to occur at a price less than P, therefore price will decrease towards P*. There is a movement along the demand curve to Q*, making an efficient outcome.
S
PFigure 2.1
P
P*
D
QD Q* QS
Q
This shows the situation of excess demand. Here there are too few bikes in the racks and so they can’t be hired. Excess demand will drive the price up P to P*.This results in a movement along the supply curve to Q*, achieving equilibrium.
S
PFigure 2.2
P*
P
Q
Excess demand
QS Q* QD
D
QUESTION THREE
For the paper system the main costs will be marginal costs from the labor costs of producing the tickets. They will also comprise of the costs of the paper. The fixed costs will be very small, comprising of the cost of the printer.
In contrast the e ticket method will largely comprise of fixed costs of the initial costs of setting up the computer system. The e ticket will only have a very small MC, the small labor costs required in maintaining the website.
SRATC
Figure 3.1 – e tickets Figure 3.2 – paper tickets
MC
SRATCC
MC
Q
Q
MC is increasing as labor costs and the cost of paper (inputs) increase with output.
SRATC curve follows the traditional U shape
MC intersects SRATC at its minimum value.
Both MC and SRATC are higher for paper tickets.
MC is horizontal as it does not change as the quantity of output increases (eg more labor is not required as more tickets are purchased).
The first half of the SRATC curve follows the traditional U shaped structure, as it is largely the fixed costs of the website / computer. However it then flattens out as it has minimal variable costs.
A profit maximizing firm would opt for the e tickets as although fixed costs are initially high overall the costs of the tickets will be significantly lower via the e tickets system. This is portrayed in the lower SRATC.
Yes, a larger airline would experience bigger gains from switching to the e ticket system as it costs less per ticket. This allows for greater profits, especially in the long run.
QUESTION FOUR
In the home loan market the “switching costs” related to the exit fees incurred when changing home loan companies. In the equity underwriting market in the UK it relates to the costs of getting an investment bank other than the company’s corporate broker to underwite the issue.
The costs make it impossible to switch or leave if the fees are too high, effectively creating a monopoly. Firms can deny the ease of entry and exit in to the market as the customers cannot afford to leave. This allows the companies to charge whatever they want as they know they can retain the customers, effectively giving them market power.
With greater market power, these firms would be able to charge higher prices and thus receive larger profits. This means the size of the box in red shown below would increase due to the increase in prices charged.
Costs and revenue
MCFigure 4.1
ATC
Monopoly price
ATC
Q
D
Monopoly profit
Qmax
MR
QUESTION FIVE
A decrease in the demand for sugar cane results in a shift leftward in the demand curve (Fig 5.1 D1 to D2). This lowers the price to P*2, and the quantity supplied goes from Q*1 to Q*2, decreasing the quantity of suppliers.
S
PFigure 5.1
P*1
P*2
Q
Q*2 Q*1
D2
D1
Increases in the cost of production of sugar cane from rising fuel and fertilizer costs decreases the profits of firms. As firms are intent on profit maximization, they are less willing to supply sugar cane. This sees a reduction in the number of suppliers in the market (Fig 5.2 shift from S1 to S2, resulting in a lower equilibrium quantity traded Q*2).
S2
PFigure 5.2
S1
P*2
P*1
D
Q
Q*2 Q*1
PART B
In Victoria water is provided to households and consumers by a company called Melbourne Water. This is the sole provider of water in Victoria, making it a monopoly in that it is the only supplier of water; a basic necessity. Recently the company (run by the government), announced price increases. In some areas prices will increase by as much as 97% by 2013 (The Australian).
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In attempting to explain these fairly dramatic price movements, we can examine the structure of the firm. Melbourne Water is a monopoly – meaning it has an extremely high degree of market power. This essentially means that the company can charge whatever prices it wants, within reason obviously. Monopoly’s take the market demand curve. This is unlike a firm in a competitive market, which has a horizontal demand curve.
Other market variations include firms in competitive markets, where because there are many suppliers of a product they are unable to have an impact in setting the price they charge. These firms take the prevailing market price that is determined by the forces of market demand and supply. Thus they are referred to as price takers, because they are forced to take the price offered. In contrast, monopolies and firms with a high degree of market power are able are called price makers – as they can influence the price that they charge.
PIn this situation, Melbourne Water have increased the price of water charged to Victorian residents. As they are the sole provider of water in Victoria, and given the significance and degree of necessity that water possesses, they know that they can do this without losing a great amount of customers. This is because the demand for water is essentially inelastic, represented in the diagram below.
Q
Dinelastic
In increasing the prices, the monopoly’s profits will increase. A monopoly’s profit is determined by PROFIT = (price – ATC) x Q , which can be visualized in the diagram below. The shaded area will increase as the price of water increases.
Costs and revenue
MC
ATC
Monopoly price
ATC
Q
D
Monopoly profit
Qmax
MR
The reason they don’t charge an extremely high is because the demand curve restrains the price the monopoly charges. That is, even in the case of water if the price was too unreasonable people would start to seek alternatives such as international trade or filtering sea water.
Melbourne Water have ownership of a key natural resource and thus have an extremely high degree of market power. As such they are able to increase the price they charge for water, and in doing so increase their profits.
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