SOCS0030: Introduction to Economics I
Problem Set 2 2020-21
Instructions:
• This problem set has 4 pages with 4 questions.
• Please complete the 2 core questions AND pick 1 of the two optional questions and answer that. So you will have to submit answers to 3 questions in total.
There are absolutely NO benefits to solving both optional questions. Only the FIRST solution appearing on your exam sheet will count towards your final mark. NOT the one with the highest scores BUT the first!
However, DO attempt to answer all parts of each question you complete! No points will be subtracted for wrong answers but partial credit will be awarded for partial answers.
• The total number of point is 100 but your score on this problem set will be scaled to count as 50% of your final mark. (The other 50% of your final mark will come from Problem Set 1.)
• Make sure you read the questions carefully and do not miss any assumptions or hints which are there to help you.
• Submit your answers in one, single file via Turnitin by 9AM on 13 Jan, 2021.
1. CORE QUESTION, PLEASE COMPLETE!
The Effect of Payroll Taxes on Firms
To reduce high youth unemployment rates, the Swedish government halved the social security contribution (payroll tax, that is, a proportional taxon wage) paid by employers for workers aged 26 and below. The next government repealed the policy, thereby increasing labor costs of firms employing young workers in 2015. In this exercise, you will analyze the effects of this repeal.
Consider competitive firms in Sweden, whose only input for production is youth labor (e.g. call centers, fast food restaurants etc.). Assume their production functions exhibit decreasing marginal product of labor throughout. Let Jättebra be such a company, producing cool video games.
(a) (4 points) With youth labor measured on the horizontal axis and output measured on the vertical, graph Jättebra’s production frontier, isoprofit lines and optimal production plan in 2014, before the repeal.
(b) (4 points) Where do we see the firm’s profit in optimum in your graph? Does the “zero- profit condition” imply that the firm’s profit is 0 in optimum? Explain.
(c) (5 points) In the model you sketched in part (a), how would you illustrate the change the repeal caused? Ie. what changes in your graph from part (a) and how does that affect the firm’soptimum?
(d) (5 points) Plot Jättebra’s labor demand curve. How does it relate to your graph in part (a) and how does the repeal change it, if at all? Pinpoint the old and new optimum in this plot.
(e) (6 points) Plot Jättebra’s output supply curve. How does it relate to your graph in part (a) and how does the repeal change it, if at all? Pinpoint the old and new optimum in this plot.
(f) (6 points) Assume when researchers look at data on the number of firms in Sweden, they see a decrease as result of the repeal. Is this consistent with firms having production functions that exhibit decreasing marginal product of labor throughout?
2. CORE QUESTION, PLEASE COMPLETE!
Number of Coffee Shops in London
In this exercise, you will analyze how different changes in the economic environment affect the number of firms in the competitive industry of London coffee shops. Assume that all firms in the industry have access to the same technology, which uses multiple inputs (labour, capital and intermediate goods such as baristas, espresso machines and coffee) and exhibits first increasing, then decreasing returns to scale. There are fixed costs in this industry, for instance, the rental price of the shop, for which business owners sign contracts for at least a year in advance.
(a) (5 points) On two side-by-side graphs (one for an individual coffee shop and one for the whole industry), illustrate one coffee shop’s marginal, average variable and average cost curves, assuming the industry is in long-run equilibrium.
(b) (6 points) Due to the real estate boom, the rental price of the shop increases. Can you definitively say what happens to the number of coffee shops in the industry? If yes, does it increase, decrease or stay the same?
(c) (6 points) Evening Standard (one of the newspapers distributed for free in the tube) publishes a lead article about new research that finds coffee is actually good for you. Whether you can trust this new piece of research is questionable, nonetheless demand for coffee in London increases. Can you definitively say now what happens to the number of coffee shops in the industry? If yes, does it increase, decrease or stay the same?
(d) (7 points) Now consider the scheduled increase in the National Living Wage and suppose first that this causes the average cost (AC) curve to shift up without changing the output level at which the curve reaches its lowest point. In this case, can you predict whether the number of firms increases or decreases?
(e) (6 points) In part (d), which way would the lowest point of the curve have to shift in order for us not to be sure whether the number of coffee shops increases or decreases?
3. (40 points) OPTIONAL QUESTION - ONLY PICK AND COMPLETE ONE OF THE TWO!
Either of these options will ask you to write a short essay of 600 words. The essay must be written in full sentences and must be well-structured: each paragraph should deal with one major issue or idea and that these ideas should be developed in a logical sequence. Please include a short introduction, which lays out your main message (ie. the question you will answer or the claim you will argue for throughout the essay). Wrap up your work with a short conclusion.
Note: This an essay. There is not a single good answer. Make sure you state any assumptions you need for your analysis and that your arguments are consistent with those assumptions.
OPTION 1: Amazon enters the pharmacy market
Read the article, “Amazon launches online pharmacy in challenge to traditional retailers” by H. Dempsey, D. Lee and A. Gray, written in the Financial Times on 17 Nov. 2020 (link: https://www.ft.com/content/f45c4956-108f-4b69-b115-c73cfc55f0e3).
Using a (graphical) model we learnt in class, illustrate how Amazon’s entry in the pharmacy market will impact the whole sector, as well as individual firms. How do you think consumers will be affected?
OPTION 2: Price of Covid-19 Tests in the UK
Read the article, “Private firms criticized over £295 coronavirus testing kits” by S. Murphy and R.
Neate, written in The Guardian on 18 March, 2020 (link:
https://www.theguardian.com/world/2020/mar/18/private-firms-criticised-over-295- coronavirus-testing-kits).
Using a (graphical) model we learnt in class, explain how and why the testing kit price increased from £149 to £249. What problems did this give rise to?
In some countries, like Hungary, the government introduced a price capon Covid- 19 tests. Using a (graphical) model learnt in the module, illustrate and explain the effects of a hypothetical price cap on testing kits in the UK? Who would such a cap benefit? Would anyone be adversely affected? Would the price cap solve any of the problems that you have identified earlier?