MIcroeconomics

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Smith owns orange orchards in California. Every year he harvests and sells his products in a market. In California, there are 40,000 orange farmers, and therefore Smith accounts for a tiny proportion of the total market size. This means he does not have any power to determine the market price of orange. Oranges produced in California are assumed to be fairly identical although there is a slight variation in taste, size, and quality, etc.

This year (2015), Smith produced oranges significantly more compared to last year (2014). According to agricultural scientists and economists, it may be due to the fact that a number of kettle and livestock, owned by his neighbor, Jim, who crossed over the fence of orange orchards, increasing the amount of manure significantly in his orchards. It has been known that manure could serve as a valuable fertilizer since it provides many nutrients for crop and fruit production. However, too much manure can lead to nitrate leaching, accelerated level of eutrophication of lake and phosphors run-off, hurting the quality of local lakes, near which, approximately 100,000 million urban residents resides.

While his orange production increased this year, Smith found that CA residents’ preference for oranges dramatically decreased as well. He hired a famous economist, Diana to find out how market equilibrium price and quantity of orange would change, which would be very informative for his production plan in the future. The next day, Diana informed Smith of her economic analysis in detail via his work email.

Then, Smith made a phone call to ask Diana if increasing the market price of orange would boost his sales revenue this year. She responded by saying, “Hmmm, that is a good question, but it is hard to say with 100% certainty because it depends on the consumer’s responses to a change in the price of an orange”.

At the end of year, he found his farm operation less profitable than expected. Hence, he put his farm up for sale and began to advertise the sale of his orchard online . A lot of potential buyers visited his orchards, and asked him a lot of questions regarding its quality, such as quality of soil, profitability, the type of fertilizer he uses, etc. Since those characteristics are not known to buyers, he tends not to reveal the full and correct information about his property, and potential buyers would end up buying that property at a higher price than the market price.

1.  Discuss the type of market structure of a farm Smith is operating
2.  Discuss a negative and a positive externalities illustrated in the second    paragraph of this article, and what types of economic problems will arise from them, and how can they be resolved using economic tools or policies?
3.  Based on the information, in the third paragraph, discuss the the change in market equilibrium price and quantity of orange, using the concept of supply & demand
4.  Diana advised Smith by saying, “it is hard to say with 100% certainty because it depends on consumer’s responses to a change in the price of an orange”. Discuss what that means, using the relationship between the change in total revenue and the change in the price. Please refer to pp. 163-164.
5.  In the last paragraph, discuss how one of the following two economic concepts (adverse selection vs moral hazard) is relevant (refer to chapter 8)

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