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theory of comparative advantage

1. The theory of comparative advantage is generally used to demonstrate the benefits of international trade. Could the argument also be used to show that it might be worthwhile for firms to contract out specific activities even when they are equally or more cost effective in money terms than external contractors in providing the same activities or functions?

2. Some people, believing that the consumption of alcohol is both 'individually and socially undesirable', claim that governments should put taxes on liquor so that people will consume less alcohol and spend more money on other goods. Indicate how an understanding of demand and of price elasticity of demand is useful in analyzing this argument.

3. Why do economists believe short-run marginal cost curves have positive slopes?
Why does this belief lead to the notion that short-run supply curves have positive slopes?

4. (a) If the government imposes a lump-sun tax of $10,000 per year - that is, a tax that is fixed for one year - how will this tax affect the shape of the firm's short-run average total cost and marginal cost curves? Assess the view that a profit maximizing monopolist should respond to this tax imposition by increasing price.

(b) Evaluate the following statement:
"A monopolist produced 1 million units last year. If a $10 per unit tax is imposed, the profits of the monopolist will decrease by $10 million."

5. Critically evaluate each of the following statements as advice on how to maximize profits or minimize losses:

(a) "The reason why we charge a lower price at higher output levels is because we are able to spread our fixed costs over a larger production run."

(b) "Regardless of the economic environment, every firm will maximize profits by operating at the minimum point of its average total cost curve."

(c) "Monopolists always try to maximize the difference between price and average costs."

6. Airlines practice price discrimination by charging leisure travelers and business travellers different prices.
(a) What conditions are required for successful third-degree price discrimination? Why do airlines adopt this pricing policy?

(b) In airline pricing what group of customers tends to pay the higher price - business travelers or leisure travelers? Why? Explain.

(c) Why do airlines impose restrictions like advance purchase requirements, weekend stay requirements and time-of day restrictions in the provision of discount fares? Explain.

(d) Why are some heavily discounted airfares only available for sale on the Internet?

(e) What factors, other than price discrimination, might be responsible for the charging of different airfares to a given destination?

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Solution Summary

The theory of comparative advantage is examined.