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ECON 100

Assignment 1
[Type the document subtitle]
[Type the author name] 7/24/2011

Assignment # 1 Principles of Economics

1. You own a local sub shop in a college town. You primarily serve two groups of people: local residents (both students and other local residents) and visitors to your town. Devise a price discrimination strategy that will increase your revenues compared to a single-pricing strategy.

The best price discrimination strategy that I can think of is to offer students a discount if they present there student ID cards from their college or university. Since student income is more elastic than other locals, it would be beneficial to proceed with such a plan. As for the other locals, I will entice them by providing a rewards program for their purchases. Purchasing ten products will earn them one free product; however, the products are at a regular menu price. Moreover, the rewards program provides discounts for an initial fee to be a member in the local sub shop. As for visitors, since they are not local students or residents, they are charged the full menu price (OSullivan et al., 2010: Price discrimination).

2. Suppose the cable TV industry is currently unregulated. However, due to complaints from consumers that the price of cable TV is too high, the legislature is considering placing a price ceiling on cable TV below the current equilibrium price. If the government does make this price ceiling law, diagram and explain the effects with supply and demand analysis. If the cable TV company is worried about disgruntling customers, suppose that the company may introduce a different type of programming that is cheaper for the

company to provide yet is equally appealing to customers. Explain what would be the effects of this action.

The price ceiling would in fact create excess demand at the new lower price, and that would yield into shortage, as the cable providers (due to variable costs) are not able to produce that specific quantity for that specific price. If the cable company produces a different type of programming that is cheaper and yet equally appealing, then by that sense they have lowered their variable costs, and are able to accommodate a lower price, for the same level of quality or appeal. Therefore, the excess demand would no longer exist, and we are back at the equilibrium quantity and price points (OSullivan et al., 2010).

3. Consider a perfectly competitive market. Analyze and explain in detail using graphical tools to show what you expect to happen to the number of firms and firm profitability in the short run and long run a) if demand for the product falls and b) if demand for the product rises.

If demand for the product falls, in the short run, the demand curve will drop down, thereby squeezing profits. So long as the price i.e. demand curve is above the average cost curve, the choice for the firm is to operate in the short-run. As soon as the price is lower than the AC curve, then the firm must shut down. In the long run, assuming that the price is above the AC curve, the firm would still have to shut down since profits are being squeezed. If the price is below the minimum point of the AC curve, then the firm must shut-down before getting to the long run. The number of firms would start to decrease as profits are being lost, and it becomes an unattractive industry. If the demand increases, then profits would increase accordingly. In the short run, we find firms rushing into the industry to get such profits. As the number of firms increases, in the long run, we find that the quantity per firm produced decreases as well as the price, but average costs are increasing. Hence, profits are being squeezed, and in the long run, firms start to leave the market as it becomes unattractive (OSullivan et al., 2010).

4. Discuss why some long-run average cost curves are steeper on the downward side than others. Discuss fully.

The LRAC (Long Run Average Cost curve) demonstrates the economies of scale and diseconomies of scale of the firm, where the latter is the positive region of the curve. Therefore, as the economies of scale increase, i.e. the firm expands; its aim is to sustain the economies of scale without entering into the positive region of the curve. Therefore, if the long-run average cost curve is steeper, it is an indication of an inelastic status towards changes in the costs of production i.e. good news for the firm as it yields higher economies of scale or an ability to sustain such a position and status; thus, the steeper the curve, the more inelastic to the alterations of costs in the production process (OSullivan et al., 2010). 5. If you purchased a new model of a digital camera right after it is released, you will likely pay more than if you purchase it six months after release. Explain why this is an example of price discrimination on the part of the firm.

This price discrimination because the firm knows that there are segments of consumers who are up to date with the technology development and products, and thus they have an inelastic demand curve i.e. they do not mind paying the extra cost in the purchase price just so that they are one of the first consumers who get their hands on this new gadget. The firm knows that there are market segments, which would rather wait to purchase at a lower price, and thus, they have a higher elasticity value. Therefore, the firm would slowly lower its price after fully exposing the inelastic region of the demand for the product, and slowly turn into the elastic market segment to gain more bang for the buck (OSullivan et al., 2010).

6. Explain the rationale and the implications of the new guidelines used by the Department of Justice and the Federal Trade Commission for evaluating proposed mergers.

The rationale and implication of the new guidelines is to increase consumer welfare through a more efficient protocol on mergers and acquisitions, as it is mentioned in the Federal Trade Commission report (FTC, 2010). Basically, the new guideline looks for an efficient way to measure concentration of a market with a revision and less emphasis on the HHI (HerfindahlHirschman Index). In addition the use of more than one methodology to evaluate such process is in the market will aid to view the results from various angles, therefore allowing for a better costbenefit analysis and understanding the impact on the economic environment as well as consumer welfare.

References OSullivan, Arthur. Sheffrin, Steven. Perez, Stephen. 2010. Survey of Economics: Principles, Applications, and Tools. 4th ed. Prentice Hall.

FTC. 2010. Federal Trade Commission Seeks Views On Proposed Update of the Horizontal Merger Guidelines: Revisions undertaken jointly by the Federal Trade Commission (FTC) and the Department of Justice. . Federal Trade Commission. Retrieved on July 24, 2011 from http://www.ftc.gov/opa/2010/04/hmg.shtm