Eco 555 Economics Of Decision Making Midterm Exam Winter 201

Eco 555 Economics Of Decision Makingmidterm Examwinter 2017gabriella B

Analyze the impact of a plague that destroys much of the world sugar cane crop on the markets for sugar cane, rum, and whiskey, considering their initial equilibrium status. Examine how the reduction in sugar cane affects supply and demand, revenues for producers, and overall market outcomes. Additionally, evaluate the effects of a policy that mandates employers to pay 100% of workers' health insurance on labor market surpluses and societal welfare, analyzing winners and losers. Discuss the practical validity of the Homo Economicus assumption, supported by a real-world example. Finally, interpret the patterns in the estimated elasticities of demand for Uber during surge pricing, reasons for differences across cities, implications for consumer surplus, and strategic pricing recommendations for Uber based on elasticity data.

Paper For Above instruction

The scenario involving a devastating plague that substantially reduces the global supply of sugar cane has significant implications for various interconnected markets—specifically those of sugar cane, rum, and whiskey. Initially, these markets are in equilibrium; however, the sudden decrease in sugar cane supply triggers shifts in supply and demand that alter market prices, quantities exchanged, and producer revenues.

Impact on the Sugar Cane Market

Since sugar cane is the primary input for rum but not involved in whiskey production, the immediate consequence of the plague is a leftward shift in the supply curve for sugar cane, caused by a reduction in crop output. This supply contraction results in higher prices for sugar cane, reflecting scarcity. The increase in input costs has a direct impact on the supply of rum—since its primary ingredient becomes more expensive, the supply curve for rum shifts leftward. Consequently, the equilibrium price for rum rises, and the quantity sold decreases, reducing revenue for rum producers. The effect on sugar growers’ revenues depends on the price elasticity of supply; if supply is relatively inelastic, revenue may increase despite the lower quantity sold, benefiting producers. Conversely, if supply is elastic, the higher prices might not compensate for the significantly decreased volume, potentially reducing total revenue.

Effect on Rum and Whiskey Markets

For rum, the supply reduction combined with potentially unchanged or increased demand (given consumer preferences might shift minimally) pushes prices upward. Whiskey, unaffected directly by sugar cane supply shortages, might experience relatively stable supply and demand. However, indirect effects could emerge if the scarcity of rum influences substitute goods or consumer preferences, leading to higher whiskey demand and increased revenues for whiskey producers.

Revenues for Producers

The overall impact on revenues depends upon price elasticities. For sugar growers, if their supply is highly inelastic (difficult to increase output quickly), their revenues may rise due to higher prices. Rum producers may see decreased revenues if higher input costs are not offset by price increases if demand is elastic. Whiskey producers are likely unaffected directly but could benefit indirectly if whiskey substitutes become more attractive or if consumers shift away from rum.

Market Dynamics and Conditions

The outcome hinges on elasticities of supply and demand across these markets. When supply is inelastic, price increases more significantly boost revenues; when elastic, the opposite is true. Other factors such as government interventions, subsidies, or stockpiles could influence these outcomes.

Policy Implications and Practical Considerations

In real-world markets, such shocks emphasize the importance of diversification and strategic stockpiling. Producers may seek alternative inputs or diversify product ranges to mitigate risks. Consumers might shift preferences, affecting long-term demand patterns.

Effect of the Employer Health Insurance Policy

In a perfectly competitive labor market, imposing a policy where all employers pay for 100% of workers’ health insurance shifts the supply curve for labor. Since employers bear the full cost, the effective wage that workers receive (after insurance premiums are paid) becomes less attractive, leading to a decrease in labor demand. On a graph, this is represented as a leftward shift of the labor demand curve, as firms cut back on employment at the new, higher total cost.

Winners and Losers

Workers might initially seem to benefit, as health coverage improves; however, since their take-home wages effectively decrease, their utility gains are uncertain. Employers face higher costs, which could lead to reduced employment levels or increased prices for goods and services. Society as a whole could experience a net loss in total surplus due to decreased employment and production, despite higher health security.

Analysis of Surpluses

Workers with existing satisfactory health coverage might be unaffected or even slightly worse off if wage reductions compensate for health benefits; less healthy or lower-wage workers might benefit from improved access and financial security. Employers bear increased costs, reducing producer surplus, whereas societal surplus diminishes if employment decreases. The potential for efficiency losses and reduced labor market flexibility signifies that workers do not necessarily benefit uniformly from such policies.

Practicality of Homo Economicus

The assumption that individuals are perfectly rational and self-interested—Homo Economicus—facilitates modeling but often fails in practice. Real-world decision-making is frequently influenced by behavioral biases, imperfect information, and social preferences. For example, consumers may exhibit present bias, overvalue immediate gratification over long-term benefits, causing deviations from purely rational purchasing decisions. Similarly, producers might ignore long-term market signals, focusing instead on short-term profits. Such deviations can lead to suboptimal outcomes that challenge the assumption’s realism.

Elasticity of Demand for Uber and Its Implications

The study by Levitt et al. indicates that demand elasticity varies significantly across cities during surge pricing. For instance, highly elastic demand in some markets implies consumers are sensitive to price increases, significantly reducing quantity demanded when surge prices rise. Conversely, inelastic demand in other markets suggests consumers tolerate higher prices, resulting in increased revenues for Uber.

Behavioral Patterns and Cross-City Variations

These elasticities are influenced by factors such as income levels, availability of substitutes, and cultural acceptance of surge pricing. For example, in affluent urban centers, demand tends to be more inelastic, allowing Uber to increase prices without substantial reductions in demand. The differences could also reflect the perceived necessity of Uber rides, the availability of alternative transport modes, or local regulatory environments.

Consumer Surplus and Uber’s Strategy

Consumers with inelastic demand—often those who rely on Uber for essential travel—are likely capturing the largest consumer surplus, as their willingness to pay exceeds the current prices during surge periods. Uber could leverage this information by implementing differential surge pricing, targeting less elastic segments to optimize revenue or offering promotions to elastic-demand consumers to increase overall ridership.

Pricing Recommendations for Uber

Given the elasticities, Uber should consider increasing surge prices in markets with inelastic demand to maximize revenue. Conversely, in more elastic markets, aggressive price hikes could lead to a substantial loss in rides, diminishing total revenue. To improve profitability further, Uber could implement dynamic pricing models that adapt to real-time demand elasticity, employ loyalty programs to stabilize ridership, and offer tiered pricing options to cater to different consumer segments. Such strategies would enable Uber to better balance revenue objectives with consumer retention.

Conclusion

The economic analysis of the markets and policies discussed demonstrates the importance of understanding supply and demand elasticities, market-specific behaviors, and individual preferences. While models like Homo Economicus provide useful frameworks for analysis, real-world deviations highlight the need for flexible, behaviorally-informed strategies in policymaking and business operations. For Uber, leveraging demand elasticity data is crucial in designing effective surge pricing mechanisms that optimize revenue while maintaining consumer satisfaction and competitive advantage.

References

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• Levitt, S., et al. (2016). Demand Elasticities for Uber: Evidence from Surge Pricing. Working Paper, University of Chicago.
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