ECON 103 Lecture Notes - Lecture 7: Arbitrage, Price Ceiling

101 views3 pages

skycod857

28 Jul 2016

School

George Mason University

Department

Economics

Course

ECON 103

Professor

Donald Boudreaux

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Law of one price (not really a law. Ex 1: safeway and giant are selling the same type of milk at very similar prices. Violation (not an example): you walk onto campus and see a person selling apples for at the south end. You keep walking and see someone selling apples for at the north end. So you start buying apples on the north end () and resell them on the south end at a higher price to make money. But then other people start reselling apples from north end as well and so the prices on the north end begin to rise and the supply on the south end begins to rise. There are people living on both sides of the mountain. People on the west side of the rocks have a good harvest this year and got lots of wheat.

Related Questions

CLASS NOTES ARE LOCATED WHERE IT SAYS CLASS NOTES!

During the early 1700s, a sailing ship is wrecked on an uninhabited island in the Caribbean Sea. The passengers and crew survive but lose all their possessions. There is no source of fresh water on the island, but coconut palm trees are fairly abundant, and the survivors are able to drink milk harvested from coconuts. There are no mammals living on the island, but many birds roost there, and these become a source of meat. There are a number of mango trees that provide fruit. A long, tough form of sawgrass grows in a number of different places on the island. This grass can be woven into knee-length sleeveless shirts, which are the basic type of clothing for people of both genders. The people on this island have developed a simple system of direct market exchange. Currently, two mangos trade for five coconuts, six coconuts trade for a pound of meat, and three pounds of meat trade for four shirts.

1. Use a formula that was stated in class, and in my notes, to calculate the total number of distinct relative prices in the islandâs economy. Note that when this formula is used to count relative prices, any given pair of goods is considered to have only one relative price. For example, if we count the price of a pound of meat in mangos as one relative price, then we donât count the price of mangos in pounds of meat as a second relative price.

(Class Notes: In a barter economy with markets, each good should have a market price, per unit, in terms of each of the other goods: baskets of fish per bushel of apples, bags of coconuts per bushel of apples, etc. A price of this type â units of one good per unit of the other good â is called a relative price (alternatively, a barter price). If there are different goods traded in an economy, then there turn out to be relative prices for a merchant to keep track of, in each market he visits. Each of the n goods has unit prices: one for each of the other goods. We divide by two to avoid counting reciprocal duplicates: if it costs 2 bags of coconuts to buy a bushel of apples, then it costs 1/2 bushel of apples to buy a bag of coconuts, and so on. )

2. Use the price information you are given to calculate all the distinct relative prices. Remember that the prices we are interested in are unit prices. A unit price is the price of a single unit of one good in units of another good. For each pair of goods, use the order that produces the highest unit price. In the case of coconuts and shirts, for example, if the price of a shirt in coconuts is higher than the price of a coconut in shirts, then report the first price but not the second one. Note: In calculating unit prices, donât worry about issues of divisibility. Assume that any good can be divided in any way, so that fractions or decimals can be components of unit prices.

3. For each relative price you just calculated, calculate the relative price if the order of the two items is switched. (In the scenario above, for example, you would now calculate the price of a coconut in shirts.) What very simple formula can you use to do this? Explain briefly.

4. Now suppose the people on this island start using mangos as money. The relative prices on the island do not change, and the absolute prices are consistent with them. a. Use a formula stated in class, and in my notes, to calculate the total number of absolute prices in the islandâs economy. b. Report these absolute prices.

Class Notes: ( In a monetary economy, in contrast, each good has a single absolute price (alternatively, a money price), which is its unit price in terms of money: dollars per bushel of apples, etc. If we assume that one of the n goods is used as money, then a merchant only needs to keep track of absolute prices. As long as there are more than two different goods ( ), it turns out that , and the difference between these two numbers gets very big as n gets large. Even if there are only 10 different goods, then there are 45 relative prices and only 9 absolute prices. And if there are 100 different goods, which is a more realistic number, then there are 99 absolute prices but almost 5000 relative prices.)

5. Comment briefly on the potential advantages and disadvantages of using mangos as money, using our list of the desirable properties of money as a guide.

6. Suppose you are a merchant on this island, where mangos are used as money in the market (see Item 4 above). A competing merchant who dislikes using money in transactions is willing to trade coconuts for shirts (or vice-versa) directly, at a rate of five coconuts per shirt. Explain, carefully and completely, how you could use this merchantâs willingness to trade these two goods, at this rate, in order to make a profit of one unit of money for yourself by (1) using money to buy units of a good in the market, (2) trading those units of the good to this merchant, in exchange for units of another good, and (3) selling those units in the market for money. Identify the items traded and the quantities, and verify the amount of the profit. Finally, explain what you would need to do in order to make a larger profit (double, for example).

Salvatore Chapter 1:

Discussion Questions: 9. How is the concept of a normal return on investment related to the distinction between business and economic profit?

Problems:

5. Determine which of the two investment projects a manager should choose if the discount rate of the firm is 10%. The first project promises a profit of $100,000 in each of the next 4 years, while the second project promises a profit of $75,000 in each of the next 6 years.

6. Determine which of the two investment projects of Problem 5 the manager should choose if the discount rate of the firm is 20%.

15. Integration Problem Samantha Roberts has a job as a pharmacist earning $30,000 per year, and she is deciding whether to take another job as the manager of another pharmacy for $40,000 per year or to purchase a pharmacy that generates a revenue of $200,000per year. To purchase the pharmacy, Samantha would have to use her $20,000 savings and borrow another $80,000 at an interest rate of 10% per year. The pharmacy that Samantha is contemplating purchasing has additional expenses of $80,000 for supplies, $40,000 for hired help, $10,000 for rent, and $5,000 for utilities. Assume that income and business taxes are zero and that the repayment of the principle of the loan does not start before 3 years. (a) What would be the business and economic profit if Samantha purchased the pharmacy? Should Samantha purchase the pharmacy? (b) Suppose that Samantha expects that another pharmacy will open nearby at the end of 3 years and that this will drive the economic profit of the pharmacy to zero. What would the revenue of the pharmacy be in 3 years? (c) What theory of profit would account for profits being earned by the pharmacy during the first 3 years of operation? (d) Suppose that Samantha expects to sell the pharmacy at the end of 3 years for $50,000 more than the price she paid for it and that she requires a 15% return on her investment. Should she still purchase the pharmacy?

Spreadsheet Problem (see attached Excel doc)

Using the data below, (Excel doc) where column A represents student numbers, column B the finishing time for a 1 mile race for 10 students, and column C the age of the students, (a) Use the data analysis tools to plot a line graph of all the finishing times. (b) Calculate a mean, median, mode, sample variance, sample standard deviation, and coefficient of variation to statistically describe the data. (c) Use Excel to fine the covariance between the two variables. What does the covariance indicate about the relationship between finishing time and age?

Note:

P15(d): Change ââ¦ for $50,000 more than â¦â to ââ¦ for $50,000 less than â¦â Compare the present value of economic profit in each of the next three years and the loss of $50,000 in the third year using 15% as the discount rate.

The spreadsheet problem (b): Calculate a mean, â¦. to statistically describe the data of both variables, Time and Age.

Individual problems:

3-1 You won a free ticket to see a Bruce Springsteen concert (assume the ticket has no resale value). U2 has a concert the same knight, and this represents your next-best alternative activity. Tickets to the U2 concert cost $80, and on any particular day, you would be willing to pay up to $100 to see this band. Assume that there are no additional costs of seeing either show. Based on the information presented, what is the opportunity cost of seeing Bruce Springsteen?

3-3 Because of the housing bubble, many houses are now selling for much less than their selling price just 2 to 3 years ago. There is evidence that homeowners with virtually identical houses tend to ask for more is they paid more for the house. What fallacy are they making?

Salvatore Chapter 3:

Discussion Questions:

9. How would you react to a sales managerâs announcement that he or she has in place a marketing program to maximize sales?

Problems:

1(a). Given the following total-revenue function: TR= 9Q - Q^2

Derive the total-, average-, and marginal- revenue schedules from Q=0 to Q=6 by 1âs.

7. Given the total-cost schedule: Q 0 1 2 3 4

TC 1 12 14 15 20

Derive the average- and marginal-cost schedules.

9. With the total-revenue curve of Problem 1 and the total-cost curve of problem 7, derive the total-profit function and show how the firm determines the profit-maximizing level of output.

Note:

DQ9: Does maximum sales (revenue) equal maximum profit (see figure 3-4)?

Revised P1(a): Derive the total-revenue, average-revenue, and marginal-revenue schedules from Q = 0 to Q = 4 by 1s.

Average revenue (AR) = total revenue (TR)/Q

Marginal revenue (MR) = change in total revenue/change in Q

For example:

Q	TR	AR	MR
2	14	7 (=14/2)
3	18	6 (=18/3)	4 (=(18-14)/(3-2)

Revised P9: With the total-revenue schedule of Problem 1 and the total-cost schedule of Problem 7, show the profit-maximizing level of output (profit=TR-TC).

Froeb et al. Chapter 4:

Individual problems:

4-5 Your insurance firm processes claims through its newer, larger high-tech facility and its older, smaller low-tech facility. Each month, the high-tech facility handles 10,000 claims, incurs $100,000 in fixed costs and $100,000 in variable costs. Each month, the low-tech facility handles 2,000 claims, incurs $16,000 in fixed costs and $24,000 in variable costs. If you anticipate a decrease in the number of claims, where will you lay off workers?

4-6 A copier company wants to expand production. It currently has 20 workers who share eight copiers. Two months ago, the firm added two new copiers, and output increased by 100,000 pages per day. One month ago, they added five workers, and productivity also increased by 50,000 pages per day. Copiers cost about twice as much as workers. Would you recommend they hire another employee or buy another copier?

This discussion involves a business ethics case that companies and boards of directors regularly face in conduction business.:

1. Identify the most important and ethical issues arising from the situation.

2. Identify the viable options for addressing these issues and the ethical implication of the identified options.

3. Reach a definite resolution of the ethical issues by choosing what you think is the best option.

4. Develop a strategy for implementing your resolution. Please cite your references.

Background

Paul Oliver, Sr., immigrated to the United States from Greece. After working for several wineries, he started Oliver Winery, Inc., which eventually found a market niche in non-varietal jug wines. Through mass-marketing techniques, the company established a substantial presence in this segment of the market. Ten years ago, Paul, Jr., joined the firm after receiving a degree in enology (the study of winemaking). He convinced his father of the desirability of entering a different segment of the wine market: premium varietals. To do this, the company needed a large infusion of capital to purchase appropriate vineyards. Reluctantly, Paul, Sr., agreed to take the company public. The initial public offering succeeded, and 40 percent of the company's stock went into outsiders' hands. Also, for the first time, outsiders served on the board of directors. Although Paul, Jr., wanted to use a new name for the premium varietal to appeal to a more upscale market, his father insisted on using the name, Oliver.

Board Meeting

The board of directors met, along with Janet Stabler, the director of marketing of Oliver Winery, Inc. The following directors were in attendance:

Paul Oliver, Sr., chairman of the board and founder of the company

Paul Oliver, Jr., CEO, has an advanced degree in enology

Cyrus Abbott, CFO, has an MBA

Arlene Dale, the comptroller, has a CPA with a master's degree in accounting

Raj Ray, COO, has a master's degree in industrial engineering

LaTasha Lane, vice president legal, has a J.D. degree

Elisabeth Constable, the union representative to the board, has a GED degree

Rev. John W. Calvin, the outside director, has a Doctor of Divinity degree

Carlos Menendez, the outside director, has an MFA degree

Oliver, Sr.:

The next item on the agenda is a proposal to develop a new line of wines. Janet Stabler will briefly present the proposal.

Stabler:

Thank you. The proposal is to enter the fortified wine market. It's the only type of wine in which unit sales are increasing. We'll make the wines cheaply and package them in pint bottles with screw-on caps. Our chief competitors are Canandaigua with Richard's Wild Irish Rose, Gallo with Thunderbird and Night Train Express, and Mogen David with MD 20/20. We'll market the wine with little or no media advertising by strategically sampling the product to targeted consumers. That's it in a nutshell.

Oliver, Sr.:

Any questions before we vote?

Menendez:

Who'll buy this wine?

Calvin:

From what I know about the consumers of your competitors, it appears to me that it's bought by homeless winos.

Stabler:

Not entirely. For example, pensioners on a fixed income would find the price of the wine appealing. Thunderbird has been recently introduced into England and has become very popular with the yuppie crowd.

Calvin:

Then why put it in pint bottles?

Stabler:

For the convenience of consumers.

Menendez:

Why would pensioners want a small bottle?

Calvin:

Homeless people want it in pints so they can fit it in their hip pockets. They obviously don't have a wine cellar to lay away their favorite bottles of Mad Dog.

Stabler:

The pint-size also keeps the price as low as possible.

Calvin:

Translation: The homeless don't have to panhandle as long before they can make a purchase. Also, why would you increase the alcoholic content to 18 percent and make it so sweet if it weren't for the wino market?

Stabler:

Many people like sweet dessert wines and 18 percent are not that much more than other types of wines that have 12 percent alcohol.

Menendez:

Is it legal?

Lane:

Sure. We sell to the retailers. It may be against the law to sell to intoxicated persons, but that's the retailers' business. We cannot control what they do.

Calvin:

Isn't this product intended for a perpetually intoxicated audience that many people consider to be ill? Wouldn't we be taking advantage of their illness by selling highly sugared alcohol that suppresses their appetite? I've spoken to drinkers who claim to live on a gallon of this type of product a day.

Oliver, Jr.:

What will this do to our image? We're still trying to get our premium wines accepted.

Stabler:

Of course, we won't use Oliver's name on these wines. We will use another name.

Menendez:

Is it okay to do that?

Stabler:

Why not? Canandaigua, Gallo, and Mogen David all do the same thing. None of them put their corporate name on this low-end product.

Abbott:

We're getting away from the crux of the matter. Profit margins would be at least 10 percent higher on this line than our others. Moreover, unit sales might increase over time. Our other lines are stagnant or decreasing. The public shareholders are grousing.

Dale:

Not to mention that our stock options have become almost worthless. I'm only a few years from retirement. We need to increase the profitability of the company.

Ray:

Operationally, this proposal is a great fit. We can use the grapes we reject from the premium line. It will also insulate us from bad grape years because any grape will do for this wine. We can fill a lot of our unused capacity.

Constable:

And hire back some of the workers who were laid off!

Stabler:

It's a marketing dream. Just give out some samples to "bell cows."

Menendez:

What are bell cows?

Stabler:

Opinion leaders who will induce other consumers to switch to our brand.

Calvin:

Do you mean wino gurus?

Oliver, Sr.:

Look, if we don't do it, others will. In fact, they already have.

Abbott:

And they'll get richer, and we'll get poorer.

Lane:

Gallo pulled out of several of these skid-row markets as did Canandaigua. Little good it did. The alcoholics just switched to malt liquor, vodka, or anything they could get their hands on.

Dale:

I think our concern is misplaced. These people are the dregs of society. They contribute nothing.

Calvin:

They're human beings who need help. We're profiting off their misfortune and misery.

Oliver, Sr.:

We can take that up when we decide on what charities to support. Is anyone opposed to the proposal?

Calvin:

Is this a done deal? I believe we should contribute half of our profits from this product to support homeless shelters and other programs that benefit indigent and homeless people. If not, I must resign from this board.

Sources

Carrie Dolan, Gallo Conducts Test to Placate Critics of Its Cheap Wine, The Wall Street Journal, June 16, 1989, p. B3.

Frank J. Prial, Experiments by a Wine Maker Fails to Thwart Street Drunks, The New York Times, February 11, 1990, p. A29.

Alix M. Freedman, "Winos, and Thunderbird Are a Subject Gallo Doesn't Like to Discuss," Wall Street Journal, February 25, 1988, p. 1.

mauvecoyote443

ECON 103 Lecture Notes - Lecture 7: Arbitrage, Price Ceiling

Document Summary

Get access

Related Documents

ECON 103 Lecture Notes - Lecture 4: Ceteris Paribus, Demand Curve, Price Drop

ECON 103 Lecture Notes - Lecture 5: Ramen, Styrofoam, Demand Curve

ECON 101 Lecture Notes - Lecture 14: Ceteris Paribus, Barter, Grapefruit Juice

Related Questions