Introductory Microeconomics Assignment

Read attachment 2. Assume that the market for cooking oil is perfectly competitive.

a) Use the demand/supply model to explain why the price of cooking oil has increased so much. Carefully list all the contributing factors and explain whether they have caused demand or supply to be affected.

b) The article states that the Malaysian government has responded to the crisis by subsidizing cooking oil, and that this has resulted in smuggling. Consider first a world where smuggling is not possible. Using the demand/supply model, explain the effects of the subsidies.

c) Show how the demand and supply in the market for cooking oil in Malaysia and Singapore are likely to be affected as smugglers ‘move the oil from more subsidized markets, like Malaysia's, to less subsidized markets, like Singapore's’.

Attachment 2

‘Rising prices for cooking oil are forcing residents of Asia’s largest slum, in Mumbai, India, to ration every drop. Bakeries in the United States are fretting over higher shortening costs. And here in Malaysia, brand-new factories built to convert vegetable oil into diesel sit idle, their owners unable to afford the raw material. This is the other oil shock. From India to Indiana, shortages and soaring prices for palm oil, soybean oil and many other types of vegetable oils are the latest, most striking example of a developing global problem: costly food. The food price index of the Food and Agriculture Organization of the United Nations, based on export prices for 60 internationally traded foodstuffs, climbed 37 percent last year. That was on top of a 14 percent increase in 2006, and the trend has accelerated this winter…. Soaring fuel prices have altered the equation for growing food and transporting it across the

globe. Huge demand for biofuels has created tension between using land to produce fuel and using it for food. A growing middle class in the developing world is demanding more protein, from pork and hamburgers to chicken and ice cream. And all this is happening even as global climate change may be starting to make it harder to grow food in some of the places best equipped to do so, like Australia. In the last few years, world demand for crops and meat has been rising sharply. It remains an open question how and when the supply will catch up…. Governments in many poor countries have tried to respond by stepping up food subsidies, imposing or tightening price controls, restricting exports and cutting food import duties. These temporary measures are already breaking down. Across Southeast Asia, for example, families have been hoarding palm oil. Smugglers have been bidding up prices as they move the oil from more subsidized markets, like Malaysia’s, to less subsidized markets, like

Singapore’s….’ (‘A new, global oil quandary: Costly fuel means costly calories’, The New York Times, 19 January 2008)

Q2. Read attachment 5. It explains how governments of many developing countries have been subsidising the prices of fuel-oil, diesel and petrol paid by the consumers. Consider the market for oil in these countries.

a) Consider first the case of a small country that has no oil reserves. It has to import all the oil it needs. Its government administers a per litre subsidy program by purchasing oil and reselling it at a cheaper price. Show the impact of the subsidy on consumer surplus in the market for oil.

b) Now consider the case of Indonesia and assume that before the subsidies were implemented, Indonesia was a net exporter of oil. The article mentions that the subsidies have turned Indonesia, a big oil producer, into an energy importer. Using the model of demand/supply with international trade, explain how the introduction of subsidies could have turned Indonesia into an importer of oil.

c) Using the model of demand/supply with international trade, explain how the elimination of the subsidies affects the well-being of the oil producers in Indonesia.

Attachment 5

‘Cutting energy subsidies is difficult. Their drawbacks are huge: they distort the economy, fuel corruption, bust budgets and, perversely, benefit the rich, as big users of energy, far more than the poor. They suck money from health care and education. Yet ending them can turn poverty to destitution—and rage. Rulers in Egypt, Indonesia, Nigeria and many other places know that to their cost. Nevertheless, a surprising number of countries have made inroads. A study by the IMF last year of 28 reform attempts found that 12 were fully successful and another 11 partially so…. In Indonesia, though the current president has cut subsidies three times in his eight-year tenure, prompted each time by pressure on the budget and current account, they still outstrip spending on health, education and housing combined. They long ago turned the country, a big oil producer, into an energy importer. As the leading presidential candidates, Prabowo Subianto, a former general, and Joko Widodo (Jokowi), the governor of Jakarta, debate how to get the country’s stuttering economy moving, the ballooning subsidy bill—this year a likely $24.5 billion—is again on the agenda. Jokowi’s team says it is “considering” phasing out subsidies over four years or so. By local standards, that counts as high political courage.’‘Price squeeze’, The Economist, 14 June 2014)

Q3.Read attachments 6 and 7. Assume that the rental housing market is perfectly competitive.

a) Use the demand/supply model to show how the imposition of a maximum rental price (below the equilibrium price that would otherwise exist) is likely to affect the price and quantity traded in the New York rental housing market.

b) What do you think are some of the long-run consequences of the rent ceiling? Who will benefit and who will lose from this policy?

c) What do you think is the impact of the rent control on house prices in New York? That is, using the demand/supply model, compare the equilibrium price in the house market before and after the implementation of the rent control.

Attachment 6

‘New York City has had rent control laws since 1947, on grounds that they were necessary to protect people from rising rents. New York State expanded the regime in 1969, creating a rent stabilization program to cover apartments built after 1947 and before 1974 – allowable rent increases are set by the City's Rent Guidelines Board. The restrictions were loosened somewhat in 1971 and again in 1997 because of the realization that the system was benefiting wealthy renters…. This system is destructive to the city's housing stock, because landlords who own rent-controlled apartments have less incentive to pay for repairs and upkeep. It also warps the housing market, and forces many new arrivals to occupy the least desirable

apartments. New York has a city-wide vacancy rate of just 3% – and when good rentstabilized apartments come on the market, you have to either know someone or pay someone (a broker, for example) to get it. The result is that many renters who pay below-market rents are reluctant to move -- because it's too difficult to get as good a deal elsewhere in the city. Thus, economists Ed Glaeser and Erzo Luttmer estimate that 21% of the city's renters live in apartments that are bigger or smaller than they would otherwise occupy. The controlled rents certainly don't increase the number of affordable apartments….’ (‘Rent control is the real New York scandal’, The Wall Street Journal, 13 September 2008)

Attachment 7

‘This might be acceptable if all the rent-controlled and rent-stabilized units were inhabited by the poor people the programs were designed to help and if most poor people lived in rentregulated units. But according to data from N.Y.U.’s Furman Center for Real Estate and Urban Policy, a majority of people in rent-regulated Manhattan apartments make far above the poverty level.’

(‘The perverse effects of rent regulation’, The New York Times, 28 July 2013)

Q4.Read attachment 3.

a) The article states that both amongst the rich and the poor, there is an increase in the

number of mothers who choose to stay at home to raise their own kids. What is the

opportunity cost of staying at home for the ‘highly educated bankers’ wives’? What about for those from poorer backgrounds?

b) Consider the situation of Jennifer, one of the ‘highly educated bankers’ wives’ mentioned in the article. Jennifer is currently working as a consultant and has to decide whether to quit her job to become a stay-at-home mother. Assume that if she quits her job, she will become a stay-at-home mother for the next 5 years. Her current salary is $70,000 per year. Assume that this is not expected to change for the next 5 years. If Jennifer does not become a stay-at-home mother, she would have to send her child to child care, and child care costs $15,000 per year. If she becomes a stay-at-home mother, she expects to spend more on toys to entertain her child at home – roughly, $5,000 per year. Jennifer also derives a sense of satisfaction from taking care of her child at home instead of working. Assuming we can quantify this satisfaction in monetary terms, what is the minimum level of satisfaction that Jennifer will need to derive, in monetary terms, before she decides to quit her current job and become a stay-at-home mother?

c) Read attachment 4, which is about the decision of the Quebec government to subsidize day care so that the cost to families is reduced to $7 per day. (In comparison, parents living in Melbourne pay around $100 per day for example.) How is the introduction of such a program likely to affect the choices of mothers?

d) Consider the decision-making process of the government of Quebec. While deciding on the policy, they would have done a cost/benefit analysis. What could they have considered as the costs of the policy? Benefits? In class, we said that benefits should be measured keeping the decision-maker’s objective in mind. Suppose the Quebec government is quite shortsighted and its objectives are shaped by maximizing the number of votes it gets in the upcoming elections. What would it regard as the benefits of the program? Now assume that the Quebec government cares about the long-run – what the implications of its policies will be for generations to come. Explain how the decision of the government would be different under these two different goals.

Attachment 3

‘In 1967 the share of mothers who did not work outside the home stood at 49%; by the turn of the millennium it had dropped to just 23%. Many thought this number would continue to fall as women sought to “have it all”. Instead, the proportion of stay-at-home mothers has been rising steadily for the past 15 years, according to new data crunched by the Pew Research Centre.… Taken as a whole, the group includes mothers at both ends of the social scale. Some are highly educated bankers’ wives who choose not to work because they don’t need the money and would rather spend their time hot-housing their toddlers so that they may one day get into Harvard. Others are poorer but calculate that, after paying for child care, the money they make sweeping floors or serving burgers does not justify the time away from their little ones.’

(‘The return of the stay-at-home mother’, The Economist, 19 April 2014)

Attachment 4

‘There is one place in North America where parents of young children don't have to worry about child care. In Quebec, full-time day care costs just $7 a day — Canadian dollars, at that — thanks to a government program aimed at one of the thorniest problems that workers in their 20's, 30's and 40's face…. Almost a decade after the family policy started, however, there was still a big mystery about it. Nobody had done the work to find out how it had affected children. The province was spending $1.4 billion a year on a grand social experiment, yet no one had bothered to look at the results. So three economists took up the challenge a few years ago, realizing that the program offered an excellent way to examine a much-debated topic. The three — Michael Baker and Kevin Milligan, who are Canadian, and Jonathan Gruber, an American — collected data, looked at various measures of well-being since the program started and compared Quebec with the rest of Canada over the same

period. When they finished last year, the answer seemed clear. “Across almost everything we looked at,” said Mr. Gruber, an M.I.T., professor, “the policy led to much worse outcomes for kids.” Young children in Quebec are more anxious and aggressive than they were a decade ago, even though children elsewhere in Canada did not show big changes. Quebec children also learn to use a toilet, climb stairs and count to three at later ages, on average, than they once did. The effects weren't so great for parents, either. More of them reported being depressed, and they were less satisfied with their marriages — which also didn't happen in other provinces…. The big lesson from Quebec is that parents really do need more support, but they need the kind of support that allows them to choose what is best for their family…. Yes, this would cost money, and not a little bit. Some taxes would have to be increased, and

other spending would have to be cut…. Fortunately, research shows that these investments can produce a nice return. They create a better-educated, healthier work force to compete with other countries over the next century.’ (‘The price of day care can be high’, The New York Times, 14 June 2006)

Q5 Read attachment 1. Assume that the market for golf is perfectly competitive.

a) Does the article suggest that golf is a normal or an inferior good?

b) According to the article, what has happened to the equilibrium price of golf over time? What has caused this change? Has there been a shift in the demand curve? Why or why not? Has there been a shift in the supply curve? Why or why not? Explain using the demand/supply model.

Attachment 1

‘Dan Washburn, a journalist who lived in China for a decade, uses golf as a barometer of change. Under Mao Zedong the sport was banned, like so many things that were decadent and fun. When the country began to open up under Deng Xiaoping, a few golf courses were allowed, to entertain foreign investors. As China grew richer, more and more locals wanted to try the sport. Suddenly more golf courses were being built in China than anywhere else, despite the fact that their construction was technically illegal…. Many new courses appeared to make no economic sense—the owners couldn’t plausibly recoup their costs by charging green fees. Mr Washburn explains that golf was often a marketing tool to sell luxury villas nearby….’

(‘Birdies, bribes and bulldozers’, The Economist, 14 June 2014)