Question from Past Microeconomics Qualifying ExamEdit
Fall 2000 - Section II, Question three, George Mason University
- Analyze the following economic puzzles:
- a. "The distinction between the long run and the short run is a fiction with no counterpart in the real world." Evaluate this critisism, explaining why one might make such a statement, but show how this fictional distinction might be defended.
- b. In macroeconomic analysis, the possibility of economic equilibrium with a degree of unemployment is ordinarily assumed. But in microeconomic analysis, we generally postulate that prices must be such to clear markets. Is it possible to give a microeconomic explanation for unemployment, without calling upon wage rigidities due to government or union action to keep wage rates from falling?
- c. The concept of marginal utility is subject to the objection that it implies a numerical measurement of total utility.
- (i) Can we overcome this difficulty?
- (ii) Is it important that we do so?
- (iii) Translate into terms which do not involve the cardinal measurement of utility: the law of diminishing marginal utility, and the Pareto optimality condition that the ratio of the marginal utilities of two goods must equal for all individuals in a free-exchange economy.
- a. The concept of "long run" and "short run" can seem a fiction because, (1) there is no line that divides where "short run" ends and "long run" begins and (2) even if there was a line, that line would change based on the scenario in question. While it's true that the difference is difficult to pin down, its useful as a intellectual tool (as well as a rhetorical shorthand) to understand what will happen quickly and what will happen as people adapt to changes. What is "tall" and what is "short" has similar problems (a short building can be taller than a tall person) but no one is suggesting the populace abandon this counterpart and express all heights in measured units.
- b. A simple micro example of why there exists unemployment is the efficiency wage, a tool business people use to correct for asymmetric information. By offering more money than the equilibrium, employers produce a better pool of applicants and create an incentive for employees to work hard (fear of losing the job and not finding another; fear of losing the job and finding another but at lower pay).
- c. See Below.
- (i)Of course. By restricting language to rankings and not absolute numbers, marginal utility can be expressed without needed to pin down an actual number.
- (ii)It can be for purposes of explanation to newcomers of the discipline and for more advanced work where actual marginal utility is difficult to measure. However, the concept is much easier to grasp with cardinal utility and allows us to perform mathematical operations that open up new avenues of understanding (such as producing and consuming where marginal cost equals marginal benefit).
- (iii)An alternative definition of diminishing marginal utility is: For every additional unit of a good consumed, the good becomes less and less satisfying. Conversely, for the Pareto optimality condition, it would be the same to say the ratio of the prices of two goods must equal for all individuals in a free-exchange economy.