Economics: The Wealth of Nations by Adam Smith, use of Knowledge in the society by Hayek. Relationship between the theses of the two Authors.

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Please note that you are encouraged to work with your classmates. However, I take a very dim view of assignments which are identical: you are referred to the section on Student Misconduct in the University of Calgary Calendar for the possible consequences of not handing in your own work. You should assume that the person grading this assignment has no previous knowledge of economics. Hence your answers need to be intelligible, coherent, and comprehensive. All graphs should be graphed to scale (use graph paper), readily decipherable, and clearly labelled. You might find it helpful to read through the assignment, then go and read your class notes and the parts of the text which seem relevant and only then try and do the questions. Attempting this assignment without consulting your notes and the text is hazardous to your health and your grade. Please read the preceding sentence again! An understanding of the theory informs how to set the model up, i.e., what mathematics are required. A little thought in how to set the model up can save a great deal of time flailing away doing unproductive mathematics. Part 1: Exploratory Questions 1. Write a two page essay which explains the basic ideas found in A. Smith’s Wealth of Nations, Volume 1, Book 1, Chapters 1-3 and in F. Hayek’s “The Use of Knowledge in Society.” What is the relationship between the theses of these two authors? How is their discussion related to the role prices play in a market economy? F15 Econ 301(02) Problem Set 3 Page 2 2. Read Chapter 1 of T. Schelling’s Economic Reasoning and the Ethics of Policy. Explain his argument why an airport that provides service to a low income town should not have the same quality of landing lights as an airport in a town with a higher income. Schelling shared the Nobel Prize in Economics for 2005. Part 2: Problems 1. The production function for oranges on Orange Island is y = L 1/2 if K ≥ 1. However if K < 1, then y = 0 regardless of the amount of L utilized, where y is the output of oranges, L is labour input and K is land input. The demand for oranges is D(p) = 100 − p. The input price of labour is 4; for land 100. (a) If a firm is cost minimizing, how much land does it use? (b) Find the average avoidable cost functions for a firm which produces y. [HINT: Assume K is fixed in the short run.] (c) Find a competitive firm’s supply function. If there are n firms in the industry, What is industry supply? [HINT: The short-run marginal cost function is MCSR(y) = 8y.] (d) Suppose that there are two firms in the industry and that they are price takers. What are the equilibrium price and quantity? Firm supply and profits? Using two diagrams graph this competitive equilibrium. In one diagram illustrate the market equilibrium. In the second show the equilibrium position of a representative firm. On this second diagram make sure you indicate the profit maximizing output of a firm and the profit earned. (e) Is the equilibrium you found in part (d) a short-run or long-run equilibrium? Why? If the industry is not in long-run equilibrium, explain the adjustment process that will occur. (f) The efficient scale of production is 5. What is the efficient average cost? (g) What are the long-run equilibrium price, quantity, and number of firms? 2. After the industry has reached the long-run equilibrium in the preceding problem, the government imposes a version of “a we need revenue and everyone knows that we can impose taxes on carbon because it is bad” tax. F15 Econ 301(02) Problem Set 3 Page 3 Specifically, it charges the firm a per unit tax of $10 based on its CO2 emissions. (a) Find the new short-run equilibrium price, quantity and firm supply. Graph the before and after tax short-run market and firm equilibrium (supra 3d). [HINT: How does the tax affect the marginal cost of a firm?] What percentage of the tax is passed on to consumers in the short-run? What is the change in total surplus, where total surplus = consumers surplus + producers surplus + government revenue? (b) Find the new long-run competitive equilibrium. What is the long-run competitive equilibrium number of firms? Describe the adjustment process that must occur. On your two diagrams from part a), indicate the long-run market and firm equilibrium. What percentage of the tax is eventually passed on to consumers? 3. There are two types of gold mines in the world. The short-run cost function for the low cost producers is c l (q) = q 2 . The marginal cost of a low cost producer is MCl SR = 2q. There is a perfectly elastic supply of high cost producers at price equals 4. The demand curve for gold is p = 30 − Q. (a) What is the supply curve of a low cost producer? (b) What it the market supply of low cost gold producers? (c) What is the market supply curve? (d) What is the equilibrium price, market equilibrium quantity, aggregate production of the high cost firms, production by the low cost producer, and quasi-rents of the low cost firm? (e) Let the fixed and sunk cost of the low cost firm equal f. For what value of f does the low cost producer make economic profits? Explain. (f) How much would you pay for the low cost producer’s gold mine if the interest rate was 5%? If you paid your maximum, what would be your economic profits?