Directions: Please do each question below. The question weights are as indicated. Use graphs where you find them useful, but be sure to explain them. In general, be sure to explain yourself well enough that the grader understands you and knows that you know what you are doing. Finally, please type your answers double spaced, with adequate margins. Please draw your graphs neatly and legibly. Illegible answers will be considered incorrect. Good luck! 1a. (30%). In 1970, the economic historian, Evsey Domar, said that it would be impossible to have at one and the same time “free” land, “free” labour, and a land-owning aristocracy. If “free” land means land that is in excess supply—and therefore has a zero price—and “free” labour means labour that is free of bondage, explain why this combination would be impossible. 1b. (5%). Show that there is a labour theory of value when land is “free” as above. That is, show that the total value of output equals the value contributed by labour. (Hint: A unit of labour can be said to contribute the value of its marginal product to output value.) 1c. (10%). If land is “free,” what three organizations of an agrarian economy are possible? Show that these three are the only possibilities. If bondage arises in conditions where land is “free,” what basic change in economic conditions could
bring about its peaceful demise? Would the result necessarily be to make labour better off? Explain briefly.
2. (15%). A worker-managed firm is a firm managed by elected representatives of its employees. Such firms are believed to maximize profits per worker rather than total profits, as described in the text, pp. 196-200.
Consider such a firm in the short run, when labour is the only variable input. If the firm faces a product price, P, which it cannot alter by changing its output, will it have an upward-sloping product supply curve or will its short-run supply curve be downward-sloping? Will an increase in demand cause P to rise by more, less, or the same as the demand increase? You may assume diminishing returns to labour and constant returns to scale in production.
(Hint: Don’t panic! This is straightforward. Suppose this firm produces an output, Q, with labour, L, and capital, K. In the short run, K is fixed, as are capital costs, F. If MPL is labour’s marginal physical product, the profit-per-worker maximum is where P(MPL) = (PQ – F)/L as at A in Fig. 6.1, p. 197 of the text. Now re-arrange this equality so that F/P is alone on one side of the equation. It can be shown that constant returns to scale implies Q = (MPL)L + (MPK)K, while diminishing returns to labour then implies that an increase in L raises the marginal physical product of capital, MPK.)
3a (30%). Suppose that a firm introduces a profitable innovation that reduces production costs. As a result, rival firms suffer wealth losses, and some will go out of business, although historically, the old production methods usually survive for a time before disappearing completely.
Show that society receives a net gain from this innovation in the sense that its benefits to society are greater than its costs, even if we don’t count the innovator’s profits and even if the innovator is able to exercise some market power after innovating. (Hint: Think in terms of consumer and producer surplus.)
3b (10%). Given that the net gain to society of the innovation is positive, why might a government still want to suppress the innovation? (Hint: Does a government consider all consumer and producer surplus to be equal? How might this relate to the nature of the political system?)
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