## Economics Study Set 19

Business

## Quiz 21 :

Income Inequality, Poverty, and Discrimination

(a) Remember that the price elasticity of demand is given by: Since we are given that the elasticity of demand for hip replacement surgeries is 0.2, we have: We see then that if health insurance begins to cover hip replacement surgeries, and everyone who wants a hip replacement surgery has insurance, then this will decrease the price of a surgery by 50%. In other words, the % change in price is 50%. We then have: Multiplying both sides by 50%, we get that the percentage change in quantity will be 10% . Suppose insurance covered 90% of the price instead. We then substitute 90% for the change in price, and get the following: Multiplying both sides by 90%, we get that the percentage change in quantity will be 18% . (b) If the price of hip surgery jumps from $50,000 to $100,000, and the insurance company is still covering 90% of the price, then each insured patient pay $10,000 for a hip surgery. We see that a hip surgery costs $100,000 and the insurance will pay for $90,000 (or 90%) of the cost, leaving the remaining $10,000 to be paid by the patient. Compared with having to pay $50,000, there will definitely be more demand after the insurance company insures hip replacement surgeries, as the price to a consumer is much lower when there is insurance ($10,000 with insurance compared with $50,000 without insurance). Thus, quantity demanded will increase. To find out by how much quantity demanded will increase; we refer back to the price elasticity of demand of.2. We are now trying to find the percentage change in quantity demanded when the price is $50,000 and drops to $10,000, or an 80% decrease in the price paid. Thus, we have: Multiplying both sides by 80%, we get that the % change in quantity will be 16% .

Pure competition: very large number of firms; standardized products; no control over price: price takers; no obstacles to entry; no nonprice competition. Pure monopoly: one firm; unique product: with no close substitutes; much control over price: price maker; entry is blocked; mostly public relations advertising. Monopolistic competition: many firms; differentiated products; some control over price in a narrow range; relatively easy entry; much nonprice competition: advertising, trademarks, brand names. Oligopoly: few firms; standardized or differentiated products; control over price circumscribed by mutual interdependence: much collusion; many obstacles to entry; much nonprice competition, particularly product differentiation. (a) Hometown supermarket: oligopoly. Supermarkets are few in number in any one area; their size makes new entry very difficult; there is much nonprice competition. However, there is much price competition as they compete for market share, and there seems to be no collusion. In this regard, the supermarket acts more like a monopolistic competitor. Note that this answer may vary by area. Some areas could be characterized by monopolistic competition while isolated small towns may have a monopoly situation. (b) Steel industry: oligopoly within the domestic production market. Firms are few in number; their products are standardized to some extent; their size makes new entry very difficult; there is much nonprice competition; there is little, if any, price competition; while there may be no collusion, there does seem to be much price leadership. (c) Kansas wheat farm: pure competition. There are a great number of similar farms; the product is standardized; there is no control over price; there is no nonprice competition. However, entry is difficult because of the cost of acquiring land from a present proprietor. Of course, government programs to assist agriculture complicate the purity of this example. (d) Commercial bank: monopolistic competition. There are many similar banks; the services are differentiated as much as the bank can make them appear to be; there is control over price (mostly interest charged or offered) within a narrow range; entry is relatively easy (maybe too easy!); there is much advertising. Once again, not every bank may fit this model-smaller towns may have an oligopoly or monopoly situation. (e) Automobile industry: oligopoly. There are the Big Three automakers, so they are few in number; their products are differentiated; their size makes new entry very difficult; there is much nonprice competition; there is little true price competition; while there does not appear to be any collusion, there has been much price leadership. However, imports have made the industry more competitive in the past two decades, which has substantially reduced the market power of the U.S. automakers.

(a) The company is choosing between spending $5000 on giving the employee a raise and spending $5000 on the employee's insurance policy. We see that if the company chooses to pay the employee a higher income, then the entire amount of $5000 will be part of the company's taxable income, and they must pay 35% of that in taxes. However, if the company chooses to spend the $5000 on the employee's insurance policy, then the entire amount is tax deductible, meaning it will not be counted as taxable income. Thus, the company would have to pay $1750 in taxes if it chose to pay the employee with a raise and $0 in taxes if it chose to pay the employee with health benefits. (b) After paying a 20% tax for additional $5000, the employee will keep $4000. We see that a 20% tax on $5000 will take away $1000, leaving her with $4000. Thus, she can spend a maximum of $4000 on health insurance if the company chose to pay her through a higher salary, and she chose to purchase health insurance with that raise. (c) If the company just spent $5000 on a health insurance policy for the employee, then the company can spend $1000 more than if the employee just got her own policy. The company will not be taxed for the $5000 they spend on the employee, therefore the company can spend the entire $5000. However, the employee can only spend $4000 on a health insurance policy if the company chose to give her a $5000 raise, since the tax will take away $1000 of the $5000. (d) The employee, if she was going to purchase health insurance with the money earned from the raise, would prefer to have the money given to her in having the employer purchase health insurance for her. In this way, she will have more money to spend on health insurance. There will be no reason why the firm will deny the employee her preference, simply because it also benefits the firm to give the money in the form of a health insurance policy. The company is not taxed for giving $5000 in health insurance policy but is taxed if it gives $5000 more in salary to an employee, and thus the firm will prefer also to give the $5000 in a health insurance policy. (e) If the full amount of health insurance can be deducted, then there is no longer a difference in whether the employee gets the $5000 in form of health insurance or higher salary. In fact, the employee may prefer to have an increase in salary, just because she can spend the $5000 in whatever way she wants to. If she wants to spend the entire $5000 in health insurance, then she could. This will be the same as the firm spending $5000 on health insurance for the employee. However, getting a higher salary now also gives her the option of spending part of the $5000 elsewhere, should she decide not to use the entire amount on health insurance. Her tax liability will decrease by $5000 is she spent the entire $5000 in health insurance, since any health care spending is now tax deductible.