1. A local gangster is in court, accused of directing his enforcers to break the legs of anyone who defaults on a debt owed to him. He admits to the fact, but explains: “We provide a valuable service to borrowers who do not have good enough credit standing to obtain loans from banks. In the interests of full disclosure, we always inform our borrowers that we will break their legs if they default. We have found that borrowers would very likely fail to exercise due diligence in their use of the borrowed funds if we allowed them to walk away from their loans whenever they say they are unable to pay. Indeed, it would be impossible to carry on our business if we allowed something like a declaration of bankruptcy to cancel the debts owed us.”
a. Is this type of service a “valuable service to borrowers”?
b. Would it be efficient to permit contracts in which borrowers agreed in advance that their legs would be broken if they failed to repay?
c. Does it follow that this form of contract enforcement should be legalized?

2. The market demand curve for heroin is said to be highly inelastic: addicts simply have to have their fix, it seems. Heroin supply in the U.S. is also said to be monopolized by the Mafia, which we assume to be interested in maximizing profits. Are these statements consistent?

3. A monopolist has a cost function given by c(y) = 2y. What are the optimal levels of output and price, and the level of profit, if:
a. the demand curve is given by D(p) = 100 – 2p
b. the demand curve is given by D(p) = 10p-3
c. the demand curve is given by D(p) = 100/p [Think carefully about this one]
d. Now return to case a., so D(p) = 100 – 2p. But now c(y) = 48 + (1/48)y. Find the optimal levels of output and price, and the level of profit.
e. In case d., there is a concern that the monopolist is charging too much, and so the government puts a price ceiling of 10. Find the new optimal level of output, and the level of profit, for the monopolist.

4. Use the web or other source to find an example of a real cartel. Write a short paragraph (200 words maximum) about it, including (if possible) when it was established, how successful it was, how long it lasted, and what goods or services were involved.

5. Senegal, a small country, buys propane (for cooking) on the world market, partly because there is no domestic production of propane. To encourage households to cook with propane instead of wood (which is scarce and polluting), the country is considering subsidizing imports of propane. Use a demand and supply analysis to show the effect of such a subsidy on the price paid by consumers, and the quantity demanded and supplied.

6. Consider a perfectly competitive constant-cost industry in long-run equilibrium, which produces toothbrushes. The government introduces a tax of ¥3 per toothbrush; the proceeds are to be used for “dental education.” Explain, with the aid of appropriate diagrams (for both a typical firm, and the industry) why, in the short-run, the price paid by consumers for toothbrushes will rise by less than ¥3, but in the long-run the prices will rise by ¥3.

7. Suppose that the supply curve is vertical – as it would be for land, for instance. What is the deadweight loss of a tax in this market?

8. Market segmentation (third-degree price discrimination) is more common in the sale of services (e.g. by income for medical services, by age for movie tickets or transportation) than for sale of manufactured goods. Why?

1. A local gangster is in court, accused of directing his enforcers...