1. A hotel owner, having heard that new hotels plan to open in his area, says, \
ID: 1199205 • Letter: 1
Question
1. A hotel owner, having heard that new hotels plan to open in his area, says, "we have
too many hotels in this town already. Statistics show that vacancy rates average 20
percent on any given night." Assuming this is correct, evaluate his negative assessment
of the situation in terms of business-stealing and product-variety externalities.
2. Explain the theory that education acts as a signaling device' How does this contrast
to the theory of education as an investment in human capital?
3. Explain the difference betwee n inferior goods and normat goods' As a developing
economy experiences increases in income (measured by GDP), what do you predict
will happen to the demand for inferior goods?
Explanation / Answer
1. The product-variety externality arises because a new firm would offer a product different from those of the existing firms. Due to product-variety externality consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers.
The business-stealing externality arises because firms post a price above marginal cost and therefore, are always eager to sell additional units. Due to business-stealing externality other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms.
So, here the hotel-owner is feared of losing customers due to these externalities and hence makes this assessment. But the entry of new hotels will raise the efficiency of the locality.
2. The theory of signaling says that those who have desirable productivity characteristics are more likely to finish educational programs.
The human capital theory says that productivity characteristics are enhanced by the learning that takes place in formal educational programs.
3. Inferior goods are those goods whose demand decreases when consumer income rises and vice versa.
Normal goods are those goods for which consumers' demand increases when their income increases.
In a developing economy, as experiences increases in income (measured by GDP), demand for inferior goods will decrease.
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